##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549



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FORM 10-Q



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(Mark One)



|[X] | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
|--- | ---------------------------------------------------------------------------------------

For the Quarterly Period Ended September 29, 2002

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



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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)



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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 [   ]

As of November 8, 2002, there were 371,853,500 shares of the registrants
Common Stock, $.01 par value, outstanding.





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TABLE OF CONTENTS



|              |                                                                                               |                                                      |  |  |  |  |  | 
|------------- | --------------------------------------------------------------------------------------------- | ---------------------------------------------------- |  |  |  |  |  | 
|PART I       
|              | Item 1. Financial Statements                                                                 
|              |                                                                                               | CONSOLIDATED BALANCE SHEETS                         
|              |                                                                                               | CONSOLIDATED STATEMENTS OF OPERATIONS               
|              |                                                                                               | CONSOLIDATED STATEMENTS OF CASH FLOWS               
|              |                                                                                               | NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
|              | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|              | Item 3. Quantitative and Qualitative Disclosures about Market Risk                           
|              | Item 4. Controls and Procedures                                                              
|PART II      
|              | Item 1. Legal Proceedings                                                                    
|              | Item 6. Exhibits and Reports on Form 8-K                                                     
|SIGNATURES   
|EXHIBIT INDEX
|EXHIBIT 99.1 
|EXHIBIT 99.2 
|EXHIBIT 99.3 
|EXHIBIT 99.4 



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##### Table of Contents



LSI LOGIC CORPORATION
Form 10-Q
For the Quarter Ended September 30, 2002
INDEX

|                           |                                                                                       |                                                                                                             |  |    |   |      |  | 
|-------------------------- | ------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------- |  | -- | - | ---- |  | 
|                           |                                                                                       |                                                                                                             |  |    |   | Page
|                           |                                                                                       |                                                                                                             |  |    |   | No. 
|                           |                                                                                       |                                                                                                             |  |    |   |     
|                           |                                                                                       | PART I. FINANCIAL INFORMATION                                                                               |  |    |   |     
|                          
|                          
|                          
|                          
|Item 1                     | Financial Statements                                                                  |                                                                                                             |  |    |  
|                          
|                          
|                          
|                          
|                           |                                                                                       | Consolidated Balance Sheets  September 30, 2002 (unaudited) and December 31, 2001                          |  |    | 3 |     
|                          
|                          
|                          
|                          
|                           |                                                                                       | Consolidated Statements of Operations  Three and Nine Months Ended September 30, 2002 and 2001 (unaudited) |  |    | 4 |     
|                          
|                          
|                          
|                          
|                           |                                                                                       | Consolidated Statements of Cash Flows  Nine Months Ended September 30, 2002 and 2001 (unaudited)           |  |    | 5 |     
|                          
|                          
|                          
|                          
|                           |                                                                                       | Notes to Consolidated Financial Statements                                                                  |  |    | 6 |     
|                          
|                          
|                          
|                          
|Item 2                     | Management's Discussion and Analysis of Financial Condition and Results of Operations |                                                                                                             |  | 18 |  
|                          
|                          
|                          
|                          
|Item 3                     | Quantitative and Qualitative Disclosures About Market Risk                            |                                                                                                             |  | 32 |  
|                          
|                          
|                          
|                          
|Item 4                     | Controls and Procedures                                                               |                                                                                                             |  | 32 |  
|                          
|                          
|                          
|                          
|PART II. OTHER INFORMATION |                                                                                       |                                                                                                             |  |   
|                          
|                          
|                          
|                          
|Item 1                     | Legal Proceedings                                                                     |                                                                                                             |  | 33 |  
|                          
|                          
|                          
|                          
|Item 6                     | Exhibits and Reports on Form 8-K                                                      |                                                                                                             |  | 33 |  
|                          
|                          
|                          
|                          
|                           | Signatures                                                                            |                                                                                                             |  | 34 |  

2



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##### Table of Contents






PART I




Item 1. Financial Statements




LSI LOGIC CORPORATION
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

|                                                                                                  |                                                          |      |               |           |              |   |           |           | 
|------------------------------------------------------------------------------------------------- | -------------------------------------------------------- | ---- | ------------- | --------- | ------------ | - | --------- | --------- | 
|                                                                                                  |                                                          |      | September 30, |           | December 31,
|(In thousands, except per-share amounts)                                                          |                                                          | 2002 |               | 2001     
|                                                                                                  |                                                          |      |               |          
|Assets                                                                                            |                                                          |      |               |           |              |   |           |          
|Cash and cash equivalents                                                                         |                                                          | $    | 471,390       |           |              | $ | 757,138   |          
|Short-term investments                                                                            |                                                          |      | 472,104       |           |              |   | 256,169   |          
|Accounts receivable, less allowances of $6,615 and $20,151                                        |                                                          |      | 301,105       |           |              |   | 191,731   |          
|Inventories                                                                                       |                                                          |      | 223,712       |           |              |   | 256,629   |          
|Deferred tax assets                                                                               |                                                          |      | 161,422       |           |              |   | 160,371   |          
|Prepaid expenses and other current assets                                                         |                                                          |      | 171,988       |           |              |   | 193,710   |          
|                                                                                                  |                                                          |      |               |           |              |   |           |          
|                                                                                                  | Total current assets                                     |      |               | 1,801,721 |              |   |           | 1,815,748 | 
|Property and equipment, net                                                                       |                                                          |      | 782,036       |           |              |   | 944,374   |          
|Goodwill and other intangibles (Note 2)                                                           |                                                          |      | 1,266,805     |           |              |   | 1,297,542 |          
|Deferred tax assets                                                                               |                                                          |      | 110,077       |           |              |   | 107,957   |          
|Non-current assets and deposits                                                                   |                                                          |      | 287,022       |           |              |   | 249,485   |          
|Investment in available-for-sale securities                                                       |                                                          |      | 43,212        |           |              |   | 78,433    |          
|Other assets                                                                                      |                                                          |      | 108,210       |           |              |   | 132,233   |          
|                                                                                                  |                                                          |      |               |           |              |   |           |          
|                                                                                                  | Total assets                                             |      | $             | 4,399,083 |              |   | $         | 4,625,772 | 
|                                                                                                  |                                                          |      |               |           |              |   |           |          
|Liabilities and Stockholders Equity                                                              |                                                          |      |               |           |              |   |           |          
|Accounts payable                                                                                  |                                                          | $    | 116,147       |           |              | $ | 136,739   |          
|Accrued salaries, wages and benefits                                                              |                                                          |      | 94,219        |           |              |   | 72,260    |          
|Other accrued liabilities                                                                         |                                                          |      | 250,458       |           |              |   | 227,467   |          
|Income tax payable                                                                                |                                                          |      | 65,349        |           |              |   | 73,187    |          
|Current portion of long-term obligations                                                          |                                                          |      | 344           |           |              |   | 332       |          
|                                                                                                  |                                                          |      |               |           |              |   |           |          
|                                                                                                  | Total current liabilities                                |      |               | 526,517   |              |   |           | 509,985   | 
|Deferred tax liabilities                                                                          |                                                          |      | 173,995       |           |              |   | 173,759   |          
|Long-term debt and capital lease obligations                                                      |                                                          |      | 1,287,133     |           |              |   | 1,335,806 |          
|Other non-current liabilities                                                                     |                                                          |      | 108,439       |           |              |   | 120,470   |          
|                                                                                                  |                                                          |      |               |           |              |   |           |          
|                                                                                                  | Total long-term obligations and deferred tax liabilities |      |               | 1,569,567 |              |   |           | 1,630,035 | 
|                                                                                                  |                                                          |      |               |           |              |   |           |          
|Commitments and contingencies (Note 14)                                                           |                                                          |      |               |           |              |   |           |          
|Minority interest in subsidiary                                                                   |                                                          |      | 7,381         |           |              |   | 5,867     |          
|                                                                                                  |                                                          |      |               |           |              |   |           |          
|Stockholders equity:                                                                             |                                                          |      |               |           |              |   |           |          
|Preferred shares; $.01 par value; 2,000 shares authorized                                         |                                                          |      |              |           |              |   |          |          
|Common stock; $.01 par value; 1,300,000 shares
authorized; 371,841 and 368,446 shares outstanding |                                                          |      | 3,718         |           |              |   | 3,684     |          
|Additional paid-in capital                                                                        |                                                          |      | 2,935,371     |           |              |   | 2,905,638 |          
|Deferred stock compensation                                                                       |                                                          |      | (62,290       | )         |              |   | (124,091  | )        
|Accumulated deficit                                                                               |                                                          |      | (581,473      | )         |              |   | (319,803  | )        
|Accumulated other comprehensive income                                                            |                                                          |      | 292           |           |              |   | 14,457    |          
|                                                                                                  |                                                          |      |               |           |              |   |           |          
|                                                                                                  | Total stockholders equity                               |      |               | 2,295,618 |              |   |           | 2,479,885 | 
|                                                                                                  |                                                          |      |               |           |              |   |           |          
|                                                                                                  | Total liabilities and stockholders equity               |      | $             | 4,399,083 |              |   | $         | 4,625,772 | 
|                                                                                                  |                                                          |      |               |           |              |   |           |          

See notes to unaudited consolidated financial statements.

3



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##### Table of Contents






LSI LOGIC CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

|                                            |  |                                                                 |                          |      |                    |         |                   |      |         |         |           |   |         |           |           |   |         |           | 
|------------------------------------------- |  | --------------------------------------------------------------- | ------------------------ | ---- | ------------------ | ------- | ----------------- | ---- | ------- | ------- | --------- | - | ------- | --------- | --------- | - | ------- | --------- | 
|                                            |  |                                                                 |                          |      | Three Months Ended |         | Nine Months Ended
|                                            |  |                                                                 |                          |      | September 30,      |         | September 30,    
|                                            |  |                                                                 |                          |      |                    |         |                  
|(In thousands, except per share amounts)    |  | 2002                                                            |                          | 2001 |                    | 2002    |                   | 2001
|                                            |  |                                                                 |                          |      |                    |         |                   |     
|Revenues                                    |  | $                                                               | 486,964                  |      |                    | $       | 396,675           |      |         | $       | 1,337,241 |   |         | $         | 1,379,093 |  
|                                            |  |                                                                 |                          |      |                    |         |                   |      |         |         |           |   |         |           |           |  
|Costs and expenses:                         |  |                                                                 |                          |      |                    |         |                   |      |         |         |           |   |         |           |           |  
|                                            |  | Cost of revenues                                                |                          |      | 288,433            |         |                   |      | 286,640 |         |           |   | 823,974 |           |           |   | 882,544 |          
|                                            |  | Additional excess inventory charges                             |                          |      |                   |         |                   |      | 50,038  |         |           |   | 45,526  |           |           |   | 158,064 |          
|                                            |  | Research and development                                        |                          |      | 114,423            |         |                   |      | 135,634 |         |           |   | 341,599 |           |           |   | 381,813 |          
|                                            |  | Selling, general and administrative                             |                          |      | 59,054             |         |                   |      | 80,128  |         |           |   | 174,600 |           |           |   | 236,579 |          
|                                            |  | Acquired in-process research and development                    |                          |      | 1,922              |         |                   |      | 19,100  |         |           |   | 1,922   |           |           |   | 96,600  |          
|                                            |  | Restructuring of operations and other non-
recurring items, net |                          |      | 12,985             |         |                   |      | 132,531 |         |           |   | 71,640  |           |           |   | 192,370 |          
|                                            |  | Amortization of non-cash deferred stock
compensation(*)         |                          |      | 14,204             |         |                   |      | 26,805  |         |           |   | 64,974  |           |           |   | 75,912  |          
|                                            |  | Amortization of intangibles                                     |                          |      | 19,673             |         |                   |      | 57,725  |         |           |   | 57,977  |           |           |   | 128,283 |          
|                                            |  |                                                                 |                          |      |                    |         |                   |      |         |         |           |   |         |           |           |  
|                                            |  |                                                                 | Total costs and expenses |      |                    | 510,694 |                   |      |         | 788,601 |           |   |         | 1,582,212 |           |   |         | 2,152,165 | 
|                                            |  |                                                                 |                          |      |                    |         |                   |      |         |         |           |   |         |           |           |  
|Loss from operations                        |  |                                                                 | (23,730                  | )    |                    |         | (391,926          | )    |         |         | (244,971  | ) |         |           | (773,072  | )
|Interest expense                            |  |                                                                 | (10,079                  | )    |                    |         | (10,037           | )    |         |         | (41,399   | ) |         |           | (29,841   | )
|Interest income and other, net              |  |                                                                 | 14,121                   |      |                    |         | 3,881             |      |         |         | 20,388    |   |         |           | 21,904    |  
|                                            |  |                                                                 |                          |      |                    |         |                   |      |         |         |           |   |         |           |           |  
|Loss before income taxes                    |  |                                                                 | (19,688                  | )    |                    |         | (398,082          | )    |         |         | (265,982  | ) |         |           | (781,009  | )
|Provision/ (benefit) for income taxes       |  |                                                                 | 7,938                    |      |                    |         |                  |      |         |         | (4,312    | ) |         |           | (39,198   | )
|                                            |  |                                                                 |                          |      |                    |         |                   |      |         |         |           |   |         |           |           |  
|Net loss                                    |  | $                                                               | (27,626                  | )    |                    | $       | (398,082          | )    |         | $       | (261,670  | ) |         | $         | (741,811  | )
|                                            |  |                                                                 |                          |      |                    |         |                   |      |         |         |           |   |         |           |           |  
|Loss per share:                             |  |                                                                 |                          |      |                    |         |                   |      |         |         |           |   |         |           |           |  
|                                            |  | Basic                                                           |                          | $    | (0.07              | )       |                   | $    | (1.09   | )       |           | $ | (0.71   | )         |           | $ | (2.16   | )        
|                                            |  |                                                                 |                          |      |                    |         |                   |      |         |         |           |   |         |           |           |  
|                                            |  | Dilutive                                                        |                          | $    | (0.07              | )       |                   | $    | (1.09   | )       |           | $ | (0.71   | )         |           | $ | (2.16   | )        
|                                            |  |                                                                 |                          |      |                    |         |                   |      |         |         |           |   |         |           |           |  
|Shares used in computing per share amounts: |  |                                                                 |                          |      |                    |         |                   |      |         |         |           |   |         |           |           |  
|                                            |  | Basic                                                           |                          |      | 370,948            |         |                   |      | 364,441 |         |           |   | 369,707 |           |           |   | 343,441 |          
|                                            |  |                                                                 |                          |      |                    |         |                   |      |         |         |           |   |         |           |           |  
|                                            |  | Dilutive                                                        |                          |      | 370,948            |         |                   |      | 364,441 |         |           |   | 369,707 |           |           |   | 343,441 |          
|                                            |  |                                                                 |                          |      |                    |         |                   |      |         |         |           |   |         |           |           |  



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| |  | (*) Amortization of non-cash deferred stock compensation, if not shown
separately, would have been included in cost of revenues, research
and development and selling, general and administrative expenses as
shown below:
| |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                    |  |                                  |        |                                 |  |      |        |      |  |   |        |  |  |   |        | 
|----------------------------------- |  | -------------------------------- | ------ | ------------------------------- |  | ---- | ------ | ---- |  | - | ------ |  |  | - | ------ | 
|                                    |  | Three months ended September 30, |        | Nine months ended September 30,
|                                    |  |                                  |        |                                
|                                    |  | 2002                             |        | 2001                            |  | 2002 |        | 2001
|                                    |  |                                  |        |                                 |  |      |        |     
|Cost of revenues                    |  | $                                | 310    |                                 |  | $    | 621    |      |  | $ | 1,304  |  |  | $ | 1,469  | 
|Research and development            |  |                                  | 10,286 |                                 |  |      | 19,454 |      |  |   | 49,185 |  |  |   | 56,161 | 
|Selling, general and administrative |  |                                  | 3,608  |                                 |  |      | 6,730  |      |  |   | 14,485 |  |  |   | 18,282 | 

See notes to unaudited consolidated financial statements.

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##### Table of Contents






LSI LOGIC CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

|                                                             |                                                                                                                 |                                   |          |            |                   |   |          |            |          |   | 
|------------------------------------------------------------ | --------------------------------------------------------------------------------------------------------------- | --------------------------------- | -------- | ---------- | ----------------- | - | -------- | ---------- | -------- | - | 
|                                                             |                                                                                                                 |                                   |          |            | Nine Months Ended
|                                                             |                                                                                                                 |                                   |          |            | September 30,    
|                                                             |                                                                                                                 |                                   |          |            |                  
|(In thousands)                                               |                                                                                                                 | 2002                              |          | 2001      
|                                                             |                                                                                                                 |                                   |          |           
|Operating activities:                                        |                                                                                                                 |                                   |          |            |                   |   |          |           
|Net loss                                                     |                                                                                                                 | $                                 | (261,670 | )          |                   | $ | (741,811 | )         
|Adjustments:                                                 |                                                                                                                 |                                   |          |            |                   |   |          |           
|                                                             | Depreciation and amortization                                                                                   |                                   |          | 259,754    |                   |   |          | 395,830    |         
|                                                             | Amortization of non-cash deferred stock compensation                                                            |                                   |          | 64,974     |                   |   |          | 75,912     |         
|                                                             | Acquired in-process research and development                                                                    |                                   |          | 1,922      |                   |   |          | 96,600     |         
|                                                             | Non-cash restructuring and non-recurring items, net                                                             |                                   |          | 56,473     |                   |   |          | 166,353    |         
|                                                             | Gain on repurchase of Convertible Subordinated Notes                                                            |                                   |          | (11,574    | )                 |   |          |           |         
|                                                             | Loss on write down of equity securities                                                                         |                                   |          | 9,905      |                   |   |          | 11,440     |         
|                                                             | Changes in working capital components, net of assets acquired and liabilities
assumed in business combinations: |                                   |          |            |                   |   |          |            |         
|                                                             |                                                                                                                 | Accounts receivable, net          |          |            | (106,573          | ) |          |            | 316,549  |  
|                                                             |                                                                                                                 | Inventories, net                  |          |            | 46,099            |   |          |            | (5,029   | )
|                                                             |                                                                                                                 | Prepaid expenses and other assets |          |            | 10,452            |   |          |            | (63,703  | )
|                                                             |                                                                                                                 | Accounts payable                  |          |            | (20,860           | ) |          |            | (130,376 | )
|                                                             |                                                                                                                 | Accrued and other liabilities     |          |            | (5,184            | ) |          |            | (26,224  | )
|                                                             |                                                                                                                 |                                   |          |            |                   |   |          |           
|                                                             | Net cash provided by operating activities                                                                       |                                   |          | 43,718     |                   |   |          | 95,541     |         
|                                                             |                                                                                                                 |                                   |          |            |                   |   |          |           
|Investing activities:                                        |                                                                                                                 |                                   |          |            |                   |   |          |           
|                                                             | Purchase of debt and equity securities available-for-sale                                                       |                                   |          | (1,283,235 | )                 |   |          | (1,097,075 | )       
|                                                             | Maturities and sales of debt and equity securities available-for-sale                                           |                                   |          | 1,061,153  |                   |   |          | 1,587,649  |         
|                                                             | Purchases of property and equipment, net of retirements                                                         |                                   |          | (23,230    | )                 |   |          | (151,397   | )       
|                                                             | Increase in non-current assets and deposits                                                                     |                                   |          | (10,658    | )                 |   |          | (323,290   | )       
|                                                             | Acquisition of companies, net of cash acquired                                                                  |                                   |          | (50,472    | )                 |   |          | (177,677   | )       
|                                                             |                                                                                                                 |                                   |          |            |                   |   |          |           
|                                                             | Net cash used in investing activities                                                                           |                                   |          | (306,442   | )                 |   |          | (161,790   | )       
|                                                             |                                                                                                                 |                                   |          |            |                   |   |          |           
|Financing activities:                                        |                                                                                                                 |                                   |          |            |                   |   |          |           
|                                                             | Proceeds from borrowings                                                                                        |                                   |          |           |                   |   |          | 200,000    |         
|                                                             | Repayment of debt obligations                                                                                   |                                   |          | (247       | )                 |   |          | (1,068     | )       
|                                                             | Debt issuance costs                                                                                             |                                   |          |           |                   |   |          | (1,000     | )       
|                                                             | Repurchase of Convertible Subordinated Notes                                                                    |                                   |          | (50,626    | )                 |   |          |           |         
|                                                             | Issuance of common stock, net                                                                                   |                                   |          | 26,249     |                   |   |          | 55,058     |         
|                                                             |                                                                                                                 |                                   |          |            |                   |   |          |           
|                                                             | Net cash (used in)/provided by financing activities                                                             |                                   |          | (24,624    | )                 |   |          | 252,990    |         
|                                                             |                                                                                                                 |                                   |          |            |                   |   |          |           
|Effect of exchange rate changes on cash and cash equivalents |                                                                                                                 |                                   | 1,600    |            |                   |   | 583      |           
|                                                             |                                                                                                                 |                                   |          |            |                   |   |          |           
|(Decrease)/increase in cash and cash equivalents             |                                                                                                                 |                                   | (285,748 | )          |                   |   | 187,324  |           
|                                                             |                                                                                                                 |                                   |          |            |                   |   |          |           
|Cash and cash equivalents at beginning of period             |                                                                                                                 |                                   | 757,138  |            |                   |   | 235,895  |           
|                                                             |                                                                                                                 |                                   |          |            |                   |   |          |           
|Cash and cash equivalents at end of period                   |                                                                                                                 | $                                 | 471,390  |            |                   | $ | 423,219  |           
|                                                             |                                                                                                                 |                                   |          |            |                   |   |          |           

See notes to unaudited consolidated financial statements.

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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, additional excess
inventory and other related charges, in-process research and development and
restructuring and other non-recurring items, net as discussed in Notes 3 and 11
to the 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, 2001.

For financial reporting purposes, the Company reports on a 13 or 14-week
quarter with a year ending December 31. For presentation purposes, the
consolidated financial statements refer to the quarters calendar month end for
convenience. The current quarter ended on September 29, 2002. The results of operations for the quarter ended September 30, 2002
are not necessarily indicative of the results to be expected for the full year.

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.

NOTE 2  GOODWILL AND INTANGIBLE ASSETS

The Company adopted Statement of Financial Accounting Standards (SFAS)
No. 142, Goodwill and Other Intangible Assets on January 1, 2002. As a
result, goodwill is no longer amortized, but is instead tested for impairment
annually or sooner if circumstances indicate that it may no longer be
recoverable. The annual impairment test will be performed in the fourth quarter
of 2002. In addition, intangible assets acquired prior to July 1, 2001 that do
not meet the criteria for recognition under SFAS No. 141 Business
Combinations have been reclassified to goodwill.

Upon adoption, the Company completed the transitional goodwill impairment
assessment required by SFAS No. 142 and concluded that goodwill was not
impaired as of January 1, 2002. For the purpose of measuring the impairment,
goodwill was assigned to reporting units as defined by SFAS No. 142. The
reporting units identified by the Company are Semiconductor and Storage
Systems.

6



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##### Table of Contents



Goodwill and intangible assets by reportable segment are comprised of the
following (in thousands):

|                               |                  |                 |                    |                    |         |                    |          |                   |   |                 |           |              |         |         |          |   |   |          |          |  
|------------------------------ | ---------------- | --------------- | ------------------ | ------------------ | ------- | ------------------ | -------- | ----------------- | - | --------------- | --------- | ------------ | ------- | ------- | -------- | - | - | -------- | -------- | -
|                               |                  |                 |                    |                    |         | September 30, 2002 |          | December 31, 2001
|                               |                  |                 |                    |                    |         |                    |          |                  
|                               |                  |                 |                    |                    |         | Gross              |          | Accumulated       |   | Gross           |           | Accumulated 
|                               |                  |                 |                    |                    |         | Carrying Amount    |          | Amortization      |   | Carrying Amount |           | Amortization
|                               |                  |                 |                    |                    |         |                    |          |                   |   |                 |           |             
|Unamortized intangible assets: |                  |                 |                    |                    |         |                    |          |                   |   |                 |           |              |         |         |          |  
|                               |                  | Semiconductor   |                    | $                  | 892,043 |                    |          | $                 |  |                 |           | $            | 899,180 |         |          | $ |  |         
|                               |                  | Storage Systems |                    |                    | 73,341  |                    |          |                   |  |                 |           |              | 53,000  |         |          |   |  |         
|                               |                  |                 |                    |                    |         |                    |          |                   |   |                 |           |              |         |         |          |  
|                               |                  |                 |                    | Total goodwill (a) |         |                    | 965,384  |                   |   |                 |          |              |         |         | 952,180  |   |   |          |         |  
|Amortized intangible assets:   |                  |                 |                    |                    |         |                    |          |                   |   |                 |           |              |         |         |          |  
|                               | Semiconductor:   |                 |                    |                    |         |                    |          |                   |   |                 |           |              |         |         |          |   |  
|                               |                  |                 | Current technology |                    |         | 374,513            |          |                   |   | (146,985        | )         |              |         | 374,513 |          |   |   | (100,538 | )       
|                               |                  |                 | Trademarks         |                    |         | 37,347             |          |                   |   | (12,141         | )         |              |         | 37,347  |          |   |   | (7,797   | )       
|                               |                  |                 |                    |                    |         |                    |          |                   |   |                 |           |              |         |         |          |  
|                               |                  |                 |                    | Subtotal           |         |                    | 411,860  |                   |   |                 | (159,126  | )            |         |         | 411,860  |   |   |          | (108,335 | )
|                               | Storage Systems: |                 |                    |                    |         |                    |          |                   |   |                 |           |              |         |         |          |   |  
|                               |                  |                 | Current technology |                    |         | 63,029             |          |                   |   | (26,823         | )         |              |         | 56,490  |          |   |   | (20,817  | )       
|                               |                  |                 | Trademarks         |                    |         | 3,750              |          |                   |   | (1,830          | )         |              |         | 3,500   |          |   |   | (1,498   | )       
|                               |                  |                 | Customer base      |                    |         | 5,010              |          |                   |   | (1,475          | )         |              |         | 5,010   |          |   |   | (848     | )       
|                               |                  |                 | Supply agreement   |                    |         | 7,247              |          |                   |   | (221            | )         |              |         |        |          |   |   |         |         
|                               |                  |                 |                    |                    |         |                    |          |                   |   |                 |           |              |         |         |          |  
|                               |                  |                 |                    | Subtotal           |         |                    | 79,036   |                   |   |                 | (30,349   | )            |         |         | 65,000   |   |   |          | (23,163  | )
|                               |                  |                 |                    |                    |         |                    |          |                   |   |                 |           |              |         |         |          |  
|Total                          |                  | $               | 1,456,280          |                    |         | $                  | (189,475 | )                 |   | $               | 1,429,040 |              |         | $       | (131,498 | )
|                               |                  |                 |                    |                    |         |                    |          |                   |   |                 |           |              |         |         |          |  



---

|(a) |  | Goodwill is net of accumulated amortization immediately prior to the
adoption of SFAS No. 142.
|--- |  | ----------------------------------------------------------------------------------------------

Amortization expense (in thousands):

|                   |  |                                  |        |                                 |  |      |        |      |  |   |        |  |  |   |         | 
|------------------ |  | -------------------------------- | ------ | ------------------------------- |  | ---- | ------ | ---- |  | - | ------ |  |  | - | ------- | 
|                   |  | Three Months Ended September 30, |        | Nine Months Ended September 30,
|                   |  |                                  |        |                                
|                   |  | 2002                             |        | 2001                            |  | 2002 |        | 2001
|                   |  |                                  |        |                                 |  |      |        |     
|Goodwill           |  | $                                |       |                                 |  | $    | 41,397 |      |  | $ |       |  |  | $ | 88,992  | 
|Current technology |  |                                  | 17,681 |                                 |  |      | 14,658 |      |  |   | 52,453 |  |  |   | 35,640  | 
|Trademarks         |  |                                  | 1,562  |                                 |  |      | 1,461  |      |  |   | 4,676  |  |  |   | 3,024   | 
|Customer base      |  |                                  | 209    |                                 |  |      | 209    |      |  |   | 627    |  |  |   | 627     | 
|Supply agreement   |  |                                  | 221    |                                 |  |      |       |      |  |   | 221    |  |  |   |        | 
|                   |  |                                  |        |                                 |  |      |        |      |  |   |        |  |  |   |         | 
|Total              |  | $                                | 19,673 |                                 |  | $    | 57,725 |      |  | $ | 57,977 |  |  | $ | 128,283 | 
|                   |  |                                  |        |                                 |  |      |        |      |  |   |        |  |  |   |         | 

The amounts allocated to current technology, trademarks, customer base and
supply agreement are being amortized over their estimated weighted average
useful lives of six years.

The estimated future amortization expense of intangible assets as of
September 30, 2002 is as follows (in millions):

|                              |  |         |     | 
|----------------------------- |  | ------- | --- | 
|                              |  | Amount:
|                              |  |        
|Fiscal year:                  |  |         |     | 
|2002 (remaining three months) |  | $       | 20  | 
|2003                          |  |         | 83  | 
|2004                          |  |         | 82  | 
|2005                          |  |         | 72  | 
|2006                          |  |         | 40  | 
|2007 and later                |  |         | 4   | 
|                              |  |         |     | 
|                              |  | $       | 301 | 
|                              |  |         |     | 

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Pro forma net loss and pro forma net loss per share excluding amortization
expense for goodwill are as follows:

|                                    |  |                                  |         |                                 |  |      |          |      |  |   |          |   |  |   |          |  
|----------------------------------- |  | -------------------------------- | ------- | ------------------------------- |  | ---- | -------- | ---- |  | - | -------- | - |  | - | -------- | -
|                                    |  | Three Months Ended September 30, |         | Nine Months Ended September 30,
|                                    |  |                                  |         |                                
|(in thousands)                      |  | 2002                             |         | 2001                            |  | 2002 |          | 2001
|                                    |  |                                  |         |                                 |  |      |          |     
|Net loss, as reported               |  | $                                | (27,626 | )                               |  | $    | (398,082 | )    |  | $ | (261,670 | ) |  | $ | (741,811 | )
|Add back goodwill amortization      |  |                                  |        |                                 |  |      | 41,397   |      |  |   |         |   |  |   | 88,992   |  
|                                    |  |                                  |         |                                 |  |      |          |      |  |   |          |   |  |   |          |  
|Pro forma net loss                  |  |                                  | (27,626 | )                               |  |      | (356,685 | )    |  |   | (261,670 | ) |  |   | (652,819 | )
|                                    |  |                                  |         |                                 |  |      |          |      |  |   |          |   |  |   |          |  
|Basic loss per share, as reported   |  |                                  | (0.07   | )                               |  |      | (1.09    | )    |  |   | (0.71    | ) |  |   | (2.16    | )
|Add back goodwill amortization      |  |                                  |        |                                 |  |      | 0.11     |      |  |   |         |   |  |   | 0.26     |  
|                                    |  |                                  |         |                                 |  |      |          |      |  |   |          |   |  |   |          |  
|Basic pro forma loss per share      |  |                                  | (0.07   | )                               |  |      | (0.98    | )    |  |   | (0.71    | ) |  |   | (1.90    | )
|                                    |  |                                  |         |                                 |  |      |          |      |  |   |          |   |  |   |          |  
|Diluted loss per share, as reported |  |                                  | (0.07   | )                               |  |      | (1.09    | )    |  |   | (0.71    | ) |  |   | (2.16    | )
|Add back goodwill amortization      |  |                                  |        |                                 |  |      | 0.11     |      |  |   |         |   |  |   | 0.26     |  
|                                    |  |                                  |         |                                 |  |      |          |      |  |   |          |   |  |   |          |  
|Diluted pro forma loss per share    |  | $                                | (0.07   | )                               |  | $    | (0.98    | )    |  | $ | (0.71    | ) |  | $ | (1.90    | )
|                                    |  |                                  |         |                                 |  |      |          |      |  |   |          |   |  |   |          |  

NOTE 3  RESTRUCTURING AND OTHER NON-RECURRING ITEMS

The Company recorded a charge of approximately $13 million and $72 million
in restructuring and other non-recurring items for the three and nine months
ended September 30, 2002, respectively. The $13 million charge in the current
quarter reflects the decrease in the fair market value of assets held for sale.
The details of the restructuring and non-recurring items are discussed further
below. The Company recorded restructuring and non-recurring charges of
approximately $133 million and $192 million for the three and nine months ended
September 30, 2001. For a discussion of the 2001 restructuring actions, please
refer to the Companys Annual Report on Form 10-K.

Restructuring:

In the first quarter of 2002, the Company announced a set of actions to
reduce costs and streamline operations. These actions included a worldwide
reduction in workforce, downsizing the Companys manufacturing operations in
Tsukuba, Japan and the decision to exit the CDMA handset standard product line.
During the three months ended March 31, 2002, the Company recorded a
restructuring charge for severance for approximately 1,400 employees worldwide,
fixed asset write-downs due to impairment in the U.S. and Japan that will be
disposed of by sale, and exit costs primarily associated with cancelled
contracts and operating leases. In the second quarter of 2002, the Company
completed the sale of the CDMA handset product line to a third party,
recognizing a net gain of approximately $6 million.

On January 1, 2002, the Company adopted SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. SFAS No. 144 addresses financial
accounting and reporting for the impairment of long-lived assets and for
long-lived assets to be disposed. The adoption did not have a significant
effect on the Companys financial position and results of operations.

Assets held for sale of $77 million and $89 million were included as a
component of prepaid expenses and other current assets as of September 30, 2002
and December 31, 2001, respectively. In September 2002, the Company recorded
$13 million of additional fixed asset write-downs to reflect the decrease in
the fair market value of the assets during the period. The fair value of
assets determined to be impaired was the result of independent appraisals and
the use of management estimates. 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 book value
for the assets. The Company will 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.

8



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##### Table of Contents



The following table sets forth the Companys restructuring reserves as of
September 30, 2002:

|                                                |  |              |        |               |  |             |        |             |  |         |         |             |  |               |         |   |  |   |        |            |  |   |         |   |  |   |        | 
|----------------------------------------------- |  | ------------ | ------ | ------------- |  | ----------- | ------ | ----------- |  | ------- | ------- | ----------- |  | ------------- | ------- | - |  | - | ------ | ---------- |  | - | ------- | - |  | - | ------ | 
|                                                |  | Balance at   |        | Restructuring |  |             |        |             |  |         |         |             |  | Restructuring |         |   |  |   |        | Balance at
|                                                |  | December 31, |        | Expense       |  | Utilized Q1 |        | Utilized Q2 |  | Expense |         | Utilized Q3 |  | September 30,
|(In thousands)                                  |  | 2001         |        | Q1 2002       |  | 2002        |        | 2002        |  | Q3 2002 |         | 2002        |  | 2002         
|                                                |  |              |        |               |  |             |        |             |  |         |         |             |  |              
|Write-down of excess assets(a)                  |  | $            | 3,762  |               |  | $           | 25,933 |             |  | $       | (27,623 | )           |  | $             | (765    | ) |  | $ | 12,985 |            |  | $ | (13,271 | ) |  | $ | 1,021  | 
|Lease terminations and maintenance
contracts(c) |  |              | 10,695 |               |  |             | 12,871 |             |  |         | (1,623  | )           |  |               | (1,066  | ) |  |   |       |            |  |   | (1,669  | ) |  |   | 19,208 | 
|Facility closure and other exit costs(c)        |  |              | 14,153 |               |  |             | 415    |             |  |         | (3,142  | )           |  |               | (2,723  | ) |  |   |       |            |  |   | (2,349  | ) |  |   | 6,354  | 
|Payments to employees for severance(b)          |  |              | 724    |               |  |             | 27,490 |             |  |         | (10,352 | )           |  |               | (9,932  | ) |  |   |       |            |  |   | (1,806  | ) |  |   | 6,124  | 
|                                                |  |              |        |               |  |             |        |             |  |         |         |             |  |               |         |   |  |   |        |            |  |   |         |   |  |   |        | 
|Total                                           |  | $            | 29,334 |               |  | $           | 66,709 |             |  | $       | (42,740 | )           |  | $             | (14,486 | ) |  | $ | 12,985 |            |  | $ | (19,095 | ) |  | $ | 32,707 | 
|                                                |  |              |        |               |  |             |        |             |  |         |         |             |  |               |         |   |  |   |        |            |  |   |         |   |  |   |        | 



---

|(a) |  | Amounts utilized in 2002 reflect a non-cash write-down of fixed assets in
the U.S. and Japan due to impairment of $38.3 million and cash payments
for machinery and equipment decommissioning costs of $3.3 million. The
fixed asset write-downs were accounted for as a reduction of the assets
and did not result in a liability. The $1.0 million balance as of
September 30, 2002 relates to machinery and equipment decommissioning
costs in the U.S.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|   
|   
|   
|(b) |  | Amounts utilized represent cash severance payments to approximately 80
and 1,230 employees during the three and nine months ended September 30,
2002, respectively. The $6.1 million balance as of September 30, 2002 will
be paid by early 2003.                                                                                                                                                                                                         
|   
|   
|   
|   
|(c) |  | Amounts utilized represent cash payments.                                                                                                                                                                                                                                                                                                                                                                                                                 

Other non-recurring items:

The Company recorded a net gain of approximately $2 million in other
non-recurring items during the first quarter of 2002, which consisted of a
nonrefundable deposit paid to the Company in the first quarter of 2002 related
to the termination of the agreement to sell the Colorado Springs fabrication
facility during 2001, offset in part by operating expenses for the CDMA handset
product line held for sale.

NOTE 4  LICENSE AGREEMENT

In the second quarter of 1999, the Company and Silterra Malaysia Sdn. Bhd.
(formerly known as Wafer Technology (Malaysia) Sdn. Bhd.) (Silterra) entered
into a technology transfer agreement under which the Company granted licenses
to Silterra with respect to certain of the Companys wafer fabrication
technologies and provides associated manufacturing training and related
services. In exchange, the Company received cash consideration of $75 million
and equity consideration over three years for which transfers and obligations
of the Company are scheduled to occur. The equity consideration was valued at
zero at September 30, 2002. The Company transferred technology to Silterra
valued at $2 million for the three months ended September 30, 2001, and $6
million and $14 million for the nine months ended September 30, 2002 and 2001,
respectively. The amounts were recorded as offsets to the Companys R&D
expenses. The obligations under the technology transfer agreement are
substantially complete as of September 30, 2002.

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NOTE 5  CASH AND INVESTMENTS

|                                            |                                 |      |               |         |              |   |         |         | 
|------------------------------------------- | ------------------------------- | ---- | ------------- | ------- | ------------ | - | ------- | ------- | 
|                                            |                                 |      | September 30, |         | December 31,
|(In thousands)                              |                                 | 2002 |               | 2001   
|                                            |                                 |      |               |        
|Cash and cash equivalents                   |                                 |      |               |         |              |   |         |        
|Overnight deposits                          |                                 | $    | 143,235       |         |              | $ | 295,439 |        
|Commercial paper                            |                                 |      | 13,517        |         |              |   | 151,793 |        
|U.S. government and agency securities       |                                 |      | 14,608        |         |              |   |        |        
|Corporate and municipal debt securities     |                                 |      | 34,743        |         |              |   | 9,957   |        
|                                            |                                 |      |               |         |              |   |         |        
|                                            | Total held-to-maturity          |      |               | 206,103 |              |   |         | 457,189 | 
|Cash                                        |                                 |      | 265,287       |         |              |   | 299,949 |        
|                                            |                                 |      |               |         |              |   |         |        
|                                            | Total cash and cash equivalents |      | $             | 471,390 |              |   | $       | 757,138 | 
|                                            |                                 |      |               |         |              |   |         |        
|Available-for-sale                          |                                 |      |               |         |              |   |         |        
|Corporate and municipal debt securities     |                                 | $    | 218,609       |         |              | $ | 191,405 |        
|Commercial paper                            |                                 |      | 7,500         |         |              |   | 19,851  |        
|Auction rate preferred stock                |                                 |      | 14,579        |         |              |   | 29,887  |        
|U.S. government and agency securities       |                                 |      | 131,519       |         |              |   | 15,026  |        
|Asset and mortgage backed securities        |                                 |      | 99,897        |         |              |   |        |        
|                                            |                                 |      |               |         |              |   |         |        
|                                            | Total short-term investments    |      | $             | 472,104 |              |   | $       | 256,169 | 
|                                            |                                 |      |               |         |              |   |         |        
|Investment in available-for-sale securities |                                 | $    | 43,212        |         |              | $ | 78,433  |        
|                                            |                                 |      |               |         |              |   |         |        
|                                            | Total other long-term assets    |      | $             | 43,212  |              |   | $       | 78,433  | 
|                                            |                                 |      |               |         |              |   |         |        
|                                            | Total available-for-sale        |      | $             | 515,316 |              |   | $       | 334,602 | 
|                                            |                                 |      |               |         |              |   |         |        

Unrealized holding gains and losses for held-to-maturity and
available-for-sale debt securities were not significant and accordingly the
amortized cost approximated fair market value at September 30, 2002 and
December 31, 2001. Realized gains and losses for held-to-maturity and
available-for-sale debt securities were not significant for the three and nine
months ended September 30, 2002 and 2001.

An unrealized gain of $0.9 million, net of the related tax effect of $0.3
million, and $22 million, net of the related tax effect of $12 million, related
to marketable equity securities was included in accumulated other comprehensive
income as of September 30, 2002 and December 31, 2001, respectively. The
company realized a net pre-tax loss of $9.9 million associated with the decline
in value of available-for-sale equity securities during the three and nine
months ended September 30, 2002. The decline in value was considered by
management to be other than temporary. During the nine months ended September
30, 2001, the Company sold equity securities for approximately $8 million in
the open market, realizing a pre-tax gain of approximately $5 million. The
Company realized a pre-tax loss of approximately $4 million associated with two
equity investments in certain technology companies during the three months
ended September 30, 2001. During the nine months ended September 30, 2001, the
Company realized a pre-tax loss of approximately $7 million associated with the
decline in value of a marketable equity security that was considered to be
other than temporary.

NOTE 6  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. 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 does not hold derivative financial
instruments for speculative or trading purposes.

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Forward contracts are used to hedge certain cash flows denominated in
non-functional currencies. Changes in the fair value of forward contracts due
to changes in time value are excluded from the assessment of effectiveness and
are recognized in other income and expense. As of September 30, 2002 and
December 31, 2001, there was one contract outstanding at each date. The
contracts were each set to expire within one month and were designated as
foreign currency fair-value hedges in accordance with SFAS No. 133. For the
three and nine months ended September 30, 2002 and 2001, the change in time
value of the forward contracts was not significant. The Company did not record
any gains or losses due to hedge ineffectiveness for the three and nine months
ended September 30, 2002 and 2001.

The Company also enters into purchased currency option contracts that are
designated as foreign currency cash-flow hedges of third-party yen revenue
exposures. Changes in the fair value of currency option contracts due to
changes in time value are excluded from the assessment of effectiveness and are
recognized in other income and expense. As of September 30, 2002, the Company
held purchased currency option contracts that were designated as foreign
currency cash-flow hedges of third-party yen revenue exposures. The contracts
expire over a three-month period. There were no option contracts outstanding as
of December 31, 2001. For the three and nine months ended September 30, 2002
and 2001, the change in option time value was not significant. There were no
unrealized gains or losses included in accumulated other comprehensive income
as of September 30, 2002 or December 31, 2001. The Company did not record any
gains or losses due to hedge ineffectiveness for the three and nine months
ended September 30, 2002 and 2001.

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 other income and expense were not
significant.

Interest rate risk

The Company entered into interest rate swap transactions in the second
quarter of 2002. See Note 12 for further discussion of the interest rate swap
transactions.

NOTE 7  BALANCE SHEET DETAIL

|                           |                        |      |               |         |              |   |         |         | 
|-------------------------- | ---------------------- | ---- | ------------- | ------- | ------------ | - | ------- | ------- | 
|                           |                        |      | September 30, |         | December 31,
|(In thousands)             |                        | 2002 |               | 2001   
|                           |                        |      |               |        
|Inventories:               |                        |      |               |         |              |   |         |        
|                           | Raw materials          |      | $             | 16,741  |              |   | $       | 31,797  | 
|                           | Work-in-process        |      |               | 78,288  |              |   |         | 88,354  | 
|                           | Finished goods         |      |               | 128,683 |              |   |         | 136,478 | 
|                           |                        |      |               |         |              |   |         |        
|                           |                        | $    | 223,712       |         |              | $ | 256,629 |        
|                           |                        |      |               |         |              |   |         |        
|Other accrued liabilities: |                        |      |               |         |              |   |         |        
|                           | Accrued expenses       |      | $             | 166,710 |              |   | $       | 158,673 | 
|                           | Sales tax payable      |      |               | 20,132  |              |   |         | 7,044   | 
|                           | Interest payable       |      |               | 13,227  |              |   |         | 14,890  | 
|                           | Restructuring reserves |      |               | 32,707  |              |   |         | 29,334  | 
|                           | Deferred tax liability |      |               | 17,682  |              |   |         | 17,526  | 
|                           |                        |      |               |         |              |   |         |        
|                           |                        | $    | 250,458       |         |              | $ | 227,467 |        
|                           |                        |      |               |         |              |   |         |        

11



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NOTE 8  RECONCILIATION OF BASIC AND DILUTED LOSS PER SHARE

A reconciliation of the numerators and denominators of the basic and
diluted loss per share computations are as follows:

|                                          |                                           |       |                                  |         |      |        |         |         |  |         |           |        |   |   |          |          |   |  |         |         |           |   |       |       |  
|----------------------------------------- | ----------------------------------------- | ----- | -------------------------------- | ------- | ---- | ------ | ------- | ------- |  | ------- | --------- | ------ | - | - | -------- | -------- | - |  | ------- | ------- | --------- | - | ----- | ----- | -
|                                          |                                           |       | Three Months Ended September 30,
|                                          |                                           |       |                                 
|                                          |                                           |       | 2002                             |         | 2001
|                                          |                                           |       |                                  |         |     
|                                          |                                           |       |                                  |         |      |        |         |         |  |         | Per-Share |        |   |   |          |          |   |  |         |         | Per-Share
|(In thousands except per share amounts)   |                                           | Loss* |                                  | Shares+ |      | Amount |         | Loss*   |  | Shares+ |           | Amount
|                                          |                                           |       |                                  |         |      |        |         |         |  |         |           |       
|Basic EPS:                                |                                           |       |                                  |         |      |        |         |         |  |         |           |        |   |   |          |          |   |  |         |         |           |   |       |      
|Net loss available to common stockholders |                                           | $     | (27,626                          | )       |      |        | 370,948 |         |  | $       | (0.07     | )      |   | $ | (398,082 | )        |   |  | 364,441 |         |           | $ | (1.09 | )    
|                                          |                                           |       |                                  |         |      |        |         |         |  |         |           |        |   |   |          |          |   |  |         |         |           |   |       |      
|                                          | Effect of dilutive securities:            |       |                                  |        |      |        |         |        |  |         |           |       |   |   |          |         |   |  |         |        |           |   |       |      |  
|Diluted EPS:                              |                                           |       |                                  |         |      |        |         |         |  |         |           |        |   |   |          |          |   |  |         |         |           |   |       |      
|                                          | Net loss available to common stockholders |       | $                                | (27,626 | )    |        |         | 370,948 |  |         | $         | (0.07  | ) |   | $        | (398,082 | ) |  |         | 364,441 |           |   | $     | (1.09 | )
|                                          |                                           |       |                                  |         |      |        |         |         |  |         |           |        |   |   |          |          |   |  |         |         |           |   |       |      

|                                          |                                           |       |                                 |          |      |        |         |         |  |         |           |        |   |   |          |          |   |  |         |         |           |   |       |       |  
|----------------------------------------- | ----------------------------------------- | ----- | ------------------------------- | -------- | ---- | ------ | ------- | ------- |  | ------- | --------- | ------ | - | - | -------- | -------- | - |  | ------- | ------- | --------- | - | ----- | ----- | -
|                                          |                                           |       | Nine Months Ended September 30,
|                                          |                                           |       |                                
|                                          |                                           |       | 2002                            |          | 2001
|                                          |                                           |       |                                 |          |     
|                                          |                                           |       |                                 |          |      |        |         |         |  |         | Per-Share |        |   |   |          |          |   |  |         |         | Per-Share
|(In thousands except per share amounts)   |                                           | Loss* |                                 | Shares+  |      | Amount |         | Loss*   |  | Shares+ |           | Amount
|                                          |                                           |       |                                 |          |      |        |         |         |  |         |           |       
|Basic EPS:                                |                                           |       |                                 |          |      |        |         |         |  |         |           |        |   |   |          |          |   |  |         |         |           |   |       |      
|Net loss available to common stockholders |                                           | $     | (261,670                        | )        |      |        | 369,707 |         |  | $       | (0.71     | )      |   | $ | (741,811 | )        |   |  | 343,441 |         |           | $ | (2.16 | )    
|                                          |                                           |       |                                 |          |      |        |         |         |  |         |           |        |   |   |          |          |   |  |         |         |           |   |       |      
|                                          | Effect of dilutive securities:            |       |                                 |         |      |        |         |        |  |         |           |       |   |   |          |         |   |  |         |        |           |   |       |      |  
|Diluted EPS:                              |                                           |       |                                 |          |      |        |         |         |  |         |           |        |   |   |          |          |   |  |         |         |           |   |       |      
|                                          | Net loss available to common stockholders |       | $                               | (261,670 | )    |        |         | 369,707 |  |         | $         | (0.71  | ) |   | $        | (741,811 | ) |  |         | 343,441 |           |   | $     | (2.16 | )
|                                          |                                           |       |                                 |          |      |        |         |         |  |         |           |        |   |   |          |          |   |  |         |         |           |   |       |      



---

|* |  | Numerator  
|- |  | -----------
| 
| 
| 
| 
|+ |  | Denominator

Options to purchase approximately 57,393,575 shares and 72,436,345 shares
were outstanding at September 30, 2002 and 2001, respectively, and were
excluded from the computation of diluted shares because of their antidilutive
effect on loss per share for the three and nine months then ended. The exercise
price of these options ranged from $0.01 to $72.25 at September 30, 2002 and
2001.

Common equivalent shares associated with the 2001, 2000 and 1999
Convertible Notes of 47,599,494 and 47,680,400 were excluded from the
calculation of diluted shares because of their antidilutive effect on loss per
share for the three and nine months ended September 30, 2002, respectively. For
the three and nine months ended September 30, 2001, common equivalent shares of
29,117,261 associated with the 2000 and 1999 Convertible Notes were excluded
from the calculation of diluted shares because of their antidilutive effect on
loss per share.

NOTE 9  COMPREHENSIVE LOSS

Comprehensive loss is defined as a change in equity of a company during a
period from transactions and other events and circumstances, excluding
transactions resulting from investments by owners and distributions to owners.
Comprehensive loss, net of taxes for the current reporting period and
comparable period in the prior year is as follows:

|                                                                                                     |  |                                  |         |                                 |  |      |          |      |  |   |          |   |  |   |          |  
|---------------------------------------------------------------------------------------------------- |  | -------------------------------- | ------- | ------------------------------- |  | ---- | -------- | ---- |  | - | -------- | - |  | - | -------- | -
|                                                                                                     |  | Three Months Ended September 30, |         | Nine Months Ended September 30,
|                                                                                                     |  |                                  |         |                                
|(In thousands)                                                                                       |  | 2002                             |         | 2001                            |  | 2002 |          | 2001
|                                                                                                     |  |                                  |         |                                 |  |      |          |     
|Net loss                                                                                             |  | $                                | (27,626 | )                               |  | $    | (398,082 | )    |  | $ | (261,670 | ) |  | $ | (741,811 | )
|Change in unrealized gain on derivative instruments
designated as and qualifying as cash-flow hedges |  |                                  |        |                                 |  |      | (4,093   | )    |  |   |         |   |  |   | 833      |  
|Change in unrealized gain on available for sale
securities,
net of tax                               |  |                                  | (5,520  | )                               |  |      | (16,758  | )    |  |   | (21,787  | ) |  |   | (23,599  | )
|Change in foreign currency translation adjustments                                                   |  |                                  | (6,572  | )                               |  |      | 15,035   |      |  |   | 7,627    |   |  |   | (8,496   | )
|                                                                                                     |  |                                  |         |                                 |  |      |          |      |  |   |          |   |  |   |          |  
|Comprehensive loss                                                                                   |  | $                                | (39,718 | )                               |  | $    | (403,898 | )    |  | $ | (275,830 | ) |  | $ | (773,073 | )
|                                                                                                     |  |                                  |         |                                 |  |      |          |      |  |   |          |   |  |   |          |  

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NOTE 10  SEGMENT REPORTING

The Company operates in two reportable segments: the Semiconductor segment
and the Storage Systems segment (formerly referred to as the SAN Systems
segment). 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 both application specific integrated
circuits, commonly referred to as ASICs, application specific standard products
in silicon, or ASSPs, as well as Redundant Array of Independent Disks (RAID)
host bus adapters and related products and services. In the Storage Systems
segment, the Company designs, manufactures, markets and supports
high-performance, highly scalable open storage area network systems, storage
solutions and a complete line of RAID systems, subsystems and related software.

The following is a summary of operations by segment for the three and nine
months ended September 30, 2002 and 2001:

|                               |                 |       |   |                                  |         |                                 |   |          |          |   |   |           |           |   |   |           |           |  
|------------------------------ | --------------- | ----- | - | -------------------------------- | ------- | ------------------------------- | - | -------- | -------- | - | - | --------- | --------- | - | - | --------- | --------- | -
|                               |                 |       |   | Three months ended September 30, |         | Nine months ended September 30,
|                               |                 |       |   |                                  |         |                                
|(In thousands)                 |                 | 2002  |   | 2001                             |         | 2002                            |   | 2001    
|                               |                 |       |   |                                  |         |                                 |   |         
|Revenues:                      |                 |       |   |                                  |         |                                 |   |          |          |   |   |           |           |   |   |          
|                               | Semiconductor   |       | $ | 400,245                          |         |                                 | $ | 351,369  |          |   | $ | 1,107,596 |           |   | $ | 1,220,228 |          
|                               | Storage Systems |       |   | 86,719                           |         |                                 |   | 45,306   |          |   |   | 229,645   |           |   |   | 158,865   |          
|                               |                 |       |   |                                  |         |                                 |   |          |          |   |   |           |           |   |   |          
|                               |                 | Total |   | $                                | 486,964 |                                 |   | $        | 396,675  |   |   | $         | 1,337,241 |   |   | $         | 1,379,093 |  
|                               |                 |       |   |                                  |         |                                 |   |          |          |   |   |           |           |   |   |          
|(Loss)/income from operations: |                 |       |   |                                  |         |                                 |   |          |          |   |   |           |           |   |   |          
|                               | Semiconductor   |       | $ | (29,271                          | )       |                                 | $ | (375,566 | )        |   | $ | (257,863  | )         |   | $ | (726,706  | )        
|                               | Storage Systems |       |   | 5,541                            |         |                                 |   | (16,360  | )        |   |   | 12,892    |           |   |   | (46,366   | )        
|                               |                 |       |   |                                  |         |                                 |   |          |          |   |   |           |           |   |   |          
|                               |                 | Total |   | $                                | (23,730 | )                               |   | $        | (391,926 | ) |   | $         | (244,971  | ) |   | $         | (773,072  | )
|                               |                 |       |   |                                  |         |                                 |   |          |          |   |   |           |           |   |   |          

Intersegment revenues for the periods presented above were not
significant. Restructuring of operations and other non-recurring items
primarily impacted the Semiconductor segment.

One customer represented 21% of the Companys total consolidated revenues
for each of the three months ended September 30, 2002 and 2001, respectively.
In the Semiconductor segment, one customer represented 26% and 23% of total
Semiconductor revenues for the three months ended September 30, 2002 and 2001,
respectively. In the Storage Systems segment, there were three customers with
revenues representing 39%, 21% and 16% of total Storage Systems revenues for
the three months ended September 30, 2002. For the three months ended September
30, 2001, there were three customers with revenues representing 24%, 20% and
10% of total Storage Systems revenues.

One customer represented 17% and 18% of the Companys total consolidated
revenues for the nine months ended September 30, 2002 and 2001, respectively.
In the Semiconductor segment, one customer represented 21% of total
Semiconductor revenues for each of the nine months ended September 30, 2002 and
2001, respectively. In the Storage Systems segment, there were three customers
with revenues representing 35%, 19% and 17% of total Storage Systems revenues
for the nine months ended September 30, 2002, respectively. For the nine months
ended September 30, 2001, there were four customers with revenues representing
21%, 17%, 16% and 11% of total Storage Systems revenues.

The following is a summary of total assets by segment as of September 30,
2002 and December 31, 2001:

|               |                 |       |   |               |           |              |   |           |           | 
|-------------- | --------------- | ----- | - | ------------- | --------- | ------------ | - | --------- | --------- | 
|               |                 |       |   | September 30, |           | December 31,
|(In thousands) |                 | 2002  |   | 2001         
|               |                 |       |   |              
|Total assets:  |                 |       |   |               |           |              |   |          
|               | Semiconductor   |       | $ | 4,120,835     |           |              | $ | 4,301,326 |          
|               | Storage Systems |       |   | 278,248       |           |              |   | 324,446   |          
|               |                 |       |   |               |           |              |   |          
|               |                 | Total |   | $             | 4,399,083 |              |   | $         | 4,625,772 | 
|               |                 |       |   |               |           |              |   |          

Revenues from domestic operations were $233 million, representing 48% of
consolidated revenues for the third quarter of 2002 compared to $168 million,
representing 42% of consolidated revenues for the same period of 2001.

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Revenues from domestic operations were $674 million, representing 50% of
consolidated revenues, for the first nine months of 2002 compared to $676
million, representing 49% of consolidated revenues, for the same period of
2001.

NOTE 11  ACQUISITIONS

Acquisition of Mylex Business Unit.On August 29, 2002, the Company
finalized the Asset Purchase Agreement with International Business Machines
Corporation (IBM). Under the agreement, the Company acquired certain
tangible and intangible assets associated with IBMs Mylex business unit. The
acquisition will enhance product offerings in the expanding entry-level storage
systems space within the Storage Systems segment and the PCI-RAID offering in
the Semiconductor segment. The acquisition was accounted for as a purchase.

The Company paid approximately $50.5 million in cash, which included
direct acquisition costs of $0.5 million for legal and accounting fees. The
total purchase price was allocated to the estimated fair value of assets
acquired based on independent appraisals and management estimates as follows:

|                                                  |  |   |        | 
|------------------------------------------------- |  | - | ------ | 
|(In thousands)                                    |  |   |        | 
|Fair value of net assets acquired                 |  | $ | 14,173 | 
|In-process research and development               |  |   | 1,922  | 
|Current technology                                |  |   | 6,539  | 
|Trademarks                                        |  |   | 250    | 
|Supply agreement                                  |  |   | 7,247  | 
|Excess of purchase price over net assets acquired |  |   | 20,341 | 
|                                                  |  |   |        | 
|Total purchase price                              |  | $ | 50,472 | 
|                                                  |  |   |        | 

In-process research and development.In connection with the purchase of
the Mylex business unit, the Company recorded a $1.9 million charge to
in-process research and development during the third quarter of 2002. The
amount was determined by identifying research projects for which technological
feasibility had not been established and for which no alternative future uses
existed. As of the acquisition date, there were several projects that met the
above criteria. The projects were for development of storage systems hardware,
firmware and subsystem components technology.

The value of the projects identified to be in progress were determined by
estimating the future cash flows from the projects once commercially feasible,
discounting the net cash flows back to their present value and then applying a
percentage of completion to the calculated value. The percentage of completion
for the projects were determined based on research and development expenses
incurred as of August 29, 2002, as a percentage of total research and
development expenses to bring the projects to technological feasibility. The
discount rate used was 25% for the projects. Development of storage systems
hardware technology was started in 2000. Development of firmware and subsystems
components technology was started in 2002. As of August 29, 2002, the Company
estimated that the projects were from 10% to 50% complete.

Development of the technology remains a substantial risk to the Company
due to a number of factors, including the remaining effort to achieve
technological feasibility, rapidly changing customer markets and competitive
threats from other companies. Additionally, the value of other intangible
assets acquired may become impaired.

Useful life of intangible assets.The amounts allocated to current
technology, trademarks and the supply agreement are being amortized over their
estimated useful lives of 2 to 4.3 years using the straight-line method.

Pro forma statement of earnings information has not been presented because
the effect of this acquisition was not material

Acquisition of C-Cube.On May 11, 2001, the Company completed the
acquisition of C-Cube Microsystems Inc. (C-Cube). The Company issued
approximately 40.2 million shares of its common stock, 10.6 million options and
0.8 million warrants in exchange for the outstanding ordinary shares, options
and warrants of C-Cube. The fair value of common shares issued was $18.73 per
share. The total purchase price for the acquisition of C-Cube was $893.7
million. For a discussion of the acquisition of C-Cube, please refer to our
Annual Report on Form 10-K.

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The following pro forma summary is provided for illustrative purposes only
and is not necessarily indicative of the consolidated results of operations for
future periods or that actually would have been realized had the Company and
C-Cube been a consolidated entity during the periods presented. The summary
combines the results of operations as if C-Cube had been acquired as of January
1, 2001.

The summary includes the impact of certain adjustments such as
amortization of intangibles and non-cash deferred stock compensation.
Additionally, the in-process research and development charge of $77.5 million
has been excluded from the periods presented as it arose from the acquisition
of C-Cube. The restructuring and other non-recurring charges were included in
the pro forma calculation, as the charges did not relate to the acquisition of
C-Cube.

|                                  |  |                                 |           |      |  |   |           |  
|--------------------------------- |  | ------------------------------- | --------- | ---- |  | - | --------- | -
|                                  |  | Nine Months ended September 30,
|(Unaudited, amounts in thousands, |  |                                
|except per share amounts)         |  | 2002                            |           | 2001
|                                  |  |                                 |           |     
|Revenues                          |  | $                               | 1,337,241 |      |  | $ | 1,445,829 |  
|Net loss                          |  | $                               | (261,670  | )    |  | $ | (712,344  | )
|Basic EPS                         |  | $                               | (0.71     | )    |  | $ | (1.96     | )
|Diluted EPS                       |  | $                               | (0.71     | )    |  | $ | (1.96     | )

NOTE 12  DEBT

|                                                                                                               |  |               |           |              |  |   |           |  
|-------------------------------------------------------------------------------------------------------------- |  | ------------- | --------- | ------------ |  | - | --------- | -
|                                                                                                               |  | September 30, |           | December 31,
|(In thousands)                                                                                                 |  | 2002          |           | 2001        
|                                                                                                               |  |               |           |             
|2001 Convertible Subordinated Notes                                                                            |  | $             | 490,000   |              |  | $ | 490,000   |  
|2000 Convertible Subordinated Notes                                                                            |  |               | 412,600   |              |  |   | 500,000   |  
|1999 Convertible Subordinated Notes                                                                            |  |               | 344,935   |              |  |   | 344,935   |  
|Change in fair value of interest rate risk on Convertible
Subordinated Notes (in accordance with SFAS No. 133) |  |               | 38,986    |              |  |   |          |  
|Capital lease obligations                                                                                      |  |               | 956       |              |  |   | 1,203     |  
|                                                                                                               |  |               |           |              |  |   |           |  
|                                                                                                               |  |               | 1,287,477 |              |  |   | 1,336,138 |  
|Current portion of long-term debt, capital lease obligations and
short-term borrowings                         |  |               | (344      | )            |  |   | (332      | )
|                                                                                                               |  |               |           |              |  |   |           |  
|Long-term debt and capital lease obligations                                                                   |  | $             | 1,287,133 |              |  | $ | 1,335,806 |  
|                                                                                                               |  |               |           |              |  |   |           |  

In September 2002, the Company repurchased $87.4 million of the 2000
Convertible Subordinated Notes, recognizing a pre-tax gain of $11.6 million.
The Company has adopted the provisions of Statement of Financial Accounting
Standards No. 145, Rescission of FASB Statements No. 4, 44, and 64, Amendment
of FASB Statement No. 13, and Technical Corrections related to extinguishment
of debt. As a result, the gain on the repurchase of debt is included in
interest income and other, net, on the income statement. In October 2002, an
additional $47.6 million of Convertible Subordinated Notes were
repurchased,
resulting in a pre-tax gain of $2.7 million to be recognized in the fourth
quarter of 2002.

In June 2002, the Company entered into interest rate swap transactions
(the swaps) with various investment banks. The swaps effectively convert
fixed interest payments on the notional amount of $1.085 billion Convertible
Subordinated Notes to LIBOR-based floating rates. The swaps were entered into
in order to hedge the fixed rate interest expense on the Companys 4% and 4.25%
Convertible Subordinated Notes (the Notes). Under the terms of the swaps, the
Company must provide collateral to match any mark-to-market exposure on the
swaps. The collateral of approximately $10.9 million was included in
non-current assets as of September 30, 2002. The swaps qualify to be accounted
for as a fair value hedge under the provisions of SFAS No. 133, with changes in
the fair value of the interest rate risk on the Notes being offset by changes in the fair
value of the swaps through income. The net mark-to-market impact of the
changes in fair value of the interest rate risk on the Notes and the swaps on earnings was
not significant for the three and nine months ended September 30, 2002. The
change in fair value of the interest rate risk was $39.0 million at September
30, 2002 and is included in long-term debt and offsets the change in fair value
of the swaps, which was $38.0 million at September 30, 2002 and is included in
other long-term assets.

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NOTE 13  STOCK OPTION EXCHANGE PROGRAM

On August 20, 2002, the Company filed an offer to exchange stock options
outstanding under the 1991 Equity Incentive Plan and the 1999 Nonstatutory
Stock Option Plan for new options. Under the exchange offer, eligible
employees had the opportunity to exchange eligible stock options for the
promise to grant new options in the future under the 1999 Nonstatutory Stock
Option Plan. The exchange offer expired September 18, 2002 and the Company
accepted an aggregate of 16,546,370 options for exchange. The Company will
grant a new option that will cover two shares of LSI Logic common stock for
every three shares covered by an option an employee elected to exchange. The
exercise price per share of the new options will be equal to the fair market
value of the Companys common stock on the new grant date, which is expected to
be March 20, 2003. The exchange program is not expected to result in the
recording of any compensation expense.

NOTE 14 COMMITMENTS AND CONTINGENCIES

The Company uses operating leases to finance certain equipment used in its
wafer fabrication facilities. As of September 30, 2002 the Company had two
operating leases, commonly referred to as synthetic leases. A synthetic lease
represents a form of off-balance sheet financing under which an unrelated third
party funds up to 100% of the costs of acquisition and installation of the
property.

In March 2000, the Company entered into a master lease and security
agreement with ABN AMRO Bank and two other banks acting as the Lessor and
several other banks acting as Participants for up to $250 million for certain
wafer fabrication equipment. Each lease supplement pursuant to the transaction
will have a lease term of three years with two consecutive one-year renewal
options. The Company may, at the end of any lease term, return, or purchase at
a stated amount, all the equipment. As of September 30, 2002, the Company had
fully drawn against the agreement.

In April 2001, the Company entered into a master lease and security
agreement with a group of banks for up to $230 million for certain wafer
fabrication equipment. The Lessor under this lease is an unrelated trust
administered and managed by Wells Fargo Bank Northwest. Each lease supplement
pursuant to the transaction will have a lease term of five years with two
consecutive one-year renewal options. The Company may, at the end of any lease
term, return, or purchase at a stated amount, all the equipment. The agreement
was amended in the fourth quarter of 2001 to reduce the total availability to
$161 million. As of September 30, 2002, the Company had fully drawn under this
agreement.

In the third quarter of 2001, the Company amended the master lease and
security agreements entered into in March 2000 and April 2001 as described
above. As of September 30, 2002, there was $276 million outstanding under these
two leases. Pursuant to the amendments, the Company now participates in each of
these leases as a debt holder, replacing some of the existing banks. As of
September 30, 2002, the Companys debt contribution was $223 million, of which
$53 million was classified as prepaid and other current assets and the balance
was classified as non-current assets and deposits. In addition, cash collateral
of $53 million was recorded as non-current assets. The lessors have access to
the cash collateral only in the event of a default by the Company. The Company
is required to maintain a minimum balance in cash, cash equivalents and
short-term investments of $350 million. The Company was in compliance with this
requirement as of September 30, 2002.

No officer, director or employee of the Company has any financial interest
with regards to these leasing arrangements or with the trust used in the April
2001 lease. The minimum lease payments under the two lease agreements,
excluding option periods, are $3.1 million for the year 2003, and $1.0 million
each in 2004 and 2005. These payments reflect the amendments and as such,
exclude any payments on the Companys debt participation.

NOTE 15  LEGAL MATTERS

Reference is made to the Companys most recent Form 10-K with respect to
Item 3, Legal Proceedings for a discussion of certain pending legal proceedings
and the matter pertaining to the Companys Canadian subsidiary (LSI Canada).
During July 2002, the Company (including LSI Canada) entered into a negotiated
settlement (Settlement) with those parties who represent a substantial
majority of the dissenting shares and who were the complainants in the related
claim seeking relief for oppression. As a result and in accordance with the
provisions of the Settlement, the Court was asked by the parties to the
Settlement to find and so order that
payment by LSI Canada of the proposed all-inclusive settlement proceeds would
fully satisfy the obligation of LSI Canada to pay fair

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value and any related
claims for interest and costs for all of the dissenting shares, that the
parties to the Settlement may bind all other dissenting shares to such result
and to order certain other actions be taken that would cause a full and final
resolution of including all claims that are or may be associated with the
matter, including a complete dismissal, with prejudice, of the related claim
for relief from oppression. The Court did issue an Order and Judgment
consistent with the parties requests, which became effective on August 30,
2002. As of September 30, 2002, the period during which any appeals could have
been made expired. The matter has been fully and finally resolved and there
has been no material adverse effect on the Company.

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Item 2. Managements Discussion and Analysis of Financial Condition and Results
of Operations

GENERAL

We believe that our future operating results will continue to be subject
to quarterly variations based upon a wide variety of factors detailed in Risk
Factors in Part I of our Annual Report on Form 10-K for the year ended December
31, 2001.

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.
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. Risks and uncertainties that may affect
our results may include, among others:



| |  |  | Cyclical nature of the Semiconductor industry and the markets addressed by our products;                                                                 
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Availability and extent of utilization of manufacturing capacity;                                                                                        
|
| |  |  | Use of foundries to outsource production of a substantial portion of our wafer requirements;                                                             
|
| |  |  | Disruptions in general economic activity due to worsening global
business conditions or caused by the effects of terrorist activities and
armed conflict;
|
| |  |  | Dependence on a limited number of customers for a substantial
portion of our revenues;                                                                   
|
| |  |  | Price erosion;                                                                                                                                           
|
| |  |  | Competitive factors;                                                                                                                                     
|
| |  |  | Timing and success of new product introductions;                                                                                                         
|
| |  |  | Changes in product mix;                                                                                                                                  
|
| |  |  | Fluctuations in manufacturing yields;                                                                                                                    
|
| |  |  | Product obsolescence;                                                                                                                                    
|
| |  |  | Business and product market cycles;                                                                                                                      
|
| |  |  | Economic and technological risks associated with our acquisitions, investments and alliance activities; and                                              
|
| |  |  | The ability to develop and implement new technologies.                                                                                                   

Our operating results could also be impacted by sudden fluctuations in
customer requirements, foreign currency exchange rate fluctuations and other
economic conditions affecting customer demand and the cost of operations in one
or more of the global markets in which we do business. We operate in a
technologically advanced, rapidly changing and highly competitive environment.
While we cannot predict what effect these various factors may have on our
financial results, the aggregate effect of these and other factors could result
in significant volatility in our future performance. To the extent our
performance may not meet expectations published by external sources, public
reaction could result in a sudden and significantly adverse impact on the
market price of our securities, particularly on a short-term basis.

We have international subsidiaries and distributors that operate and sell
our products globally. Further, we purchase a substantial portion of our raw
materials and manufacturing equipment from foreign suppliers and incur labor
and other operating costs in foreign currencies, particularly in our Japanese
manufacturing facilities. As a result, we are exposed to the risk of changes in
foreign currency exchange rates or declining economic conditions in these
countries. We utilize forward exchange contracts and purchased currency option
contracts to manage our exposure associated with net asset and liability
positions and cash flows denominated in non-functional

18



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currencies. (See Note 6 of the Notes to the Consolidated Financial
Statements, hereafter referred to as the Notes.) There is no assurance that
these hedging transactions will eliminate exposure to currency rate
fluctuations that could affect our operating results.

Our corporate headquarters and some of our manufacturing facilities are
located near major earthquake faults. As a result, in the event of a major
earthquake, we could suffer damages that could significantly and adversely
affect our operating results and financial condition.

We operate in an industry sector where the value of securities is highly
volatile and may be influenced by economic and other factors beyond our
control.

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.

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 for the year ended December 31, 2001.

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 the 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, 2001.

ACQUISITIONS AND OTHER

On August 29, 2002, we finalized the Asset Purchase Agreement with
International Business Machines Corporation (IBM). Under the agreement, we
acquired certain tangible and intangible assets associated with IBMs Mylex
business unit for approximately $50.0 million in cash and incurred $0.5 million
in direct acquisition costs. The acquisition is expected to enhance product
offerings in the expanding entry-level storage systems space within the Storage
Systems segment and the PCI-RAID offering in the Semiconductor segment. The
acquisition was accounted for as a purchase. (See Note 11 of the Notes.)

Stock option exchange

On August 20, 2002, we filed an offer to exchange stock options
outstanding under the 1991 Equity Incentive Plan and the 1999 Nonstatutory
Stock Option Plan for new options. Under the exchange offer, eligible
employees had the opportunity to exchange eligible stock options for the
promise to grant new options in the future under the 1999 Nonstatutory Stock
Option Plan. The exchange offer expired September 18, 2002, and we accepted an
aggregate of 16,546,370 options for exchange. We will grant a new option that
will cover two shares of our companys common stock for every three shares
covered by an option an employee elected to exchange. The exercise price per
share of the new options will be equal to the fair market value of our
companys common stock on the new grant date, which is expected to be March 20,
2003. The exchange program is not expected to result in the recording of any
compensation expense.

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RESULTS OF OPERATIONS

Our results of operations for the three and nine months ended September
30, 2002 are as follows:

Revenues:

|                        |  |                    |       |                   |  |                |       |                |  |                |       |  |  |   |         |  |  |   |         | 
|----------------------- |  | ------------------ | ----- | ----------------- |  | -------------- | ----- | -------------- |  | -------------- | ----- |  |  | - | ------- |  |  | - | ------- | 
|                        |  | Three months ended |       | Nine months ended
|                        |  |                    |       |                  
|(in millions)           |  | Sept. 30, 2002     |       | June 30, 2002     |  | Sept. 30, 2001 |       | Sept. 30, 2002 |  | Sept. 30, 2001
|                        |  |                    |       |                   |  |                |       |                |  |               
|Semiconductor segment   |  | $                  | 400.3 |                   |  | $              | 354.8 |                |  | $              | 351.4 |  |  | $ | 1,107.6 |  |  | $ | 1,220.2 | 
|Storage Systems segment |  |                    | 86.7  |                   |  |                | 83.0  |                |  |                | 45.3  |  |  |   | 229.6   |  |  |   | 158.9   | 
|                        |  |                    |       |                   |  |                |       |                |  |                |       |  |  |   |         |  |  |   |         | 
|Consolidated            |  | $                  | 487.0 |                   |  | $              | 437.8 |                |  | $              | 396.7 |  |  | $ | 1,337.2 |  |  | $ | 1,379.1 | 
|                        |  |                    |       |                   |  |                |       |                |  |                |       |  |  |   |         |  |  |   |         | 

Third quarter of 2002 compared to the second quarter of 2002

Total consolidated revenues for the third quarter of 2002 increased $49.2
million or 11% from the second quarter of 2002. Revenues for the Semiconductor
segment increased $45.5 million or 13% in the third quarter of 2002 as
compared to the prior quarter. The increase for the Semiconductor segment was
primarily attributable to growth in the demand for ASICs. Revenues increased
significantly in both the consumer and communication product groups. The demand
for semiconductors used in consumer product applications such as DVD players
and video game consoles increased primarily as a result of seasonality,
however, this growth was partly offset by weakness in demand for semiconductors
used in consumer applications such as digital set-top boxes and cable modems.
In the communications group, revenues increased primarily due to increased
demand for semiconductors used in office automation and networking equipment.
Revenues for the storage components group increased only slightly
quarter-to-quarter mainly because of continued weakness in the server market.

Revenues for the Storage Systems segment (formerly referred to as the SAN
Systems segment) increased $3.7 million or 4% from the second quarter of 2002.
The increase is due to approximately one month of revenues from the
Mylex business unit that was acquired and included in our consolidated
financial statements from August 29, 2002. (See Note 11 of the Notes.) Mylex
contributed $7.0 million in total revenues in the current quarter, $5.9 million
of which related to the Storage Systems segment and $1.1 million to the storage
components group under the Semiconductor segment.

Looking forward, the visibility for customers, and in turn, for LSI, is
much less than what we would like to see. Overall, the semiconductor industry
recovery continues at a gradual and uneven pace. In the fourth quarter of 2002,
we expect modest revenue growth in the communication products, storage
components and storage systems groups while revenues for the consumer products
group are expected to be weaker due to seasonality. We expect total
consolidated revenues to be in the range of $475 million to $500 million.

Third quarter and nine months ended September 30, 2002 compared to the
same periods of 2001

Total consolidated revenues for the third quarter of 2002 increased $90.3
million or 23% compared to the third quarter of 2001. Revenues for the
Semiconductor segment increased $48.9 million or 14% for the third quarter of
2002 as compared to the same period of the previous year. The increase in
revenues in the current quarter as compared to the same quarter in 2001 was
mainly due to increased demand for semiconductors used in consumer products,
communications and storage components product applications. This was partially
offset by a decline in revenues from semiconductors used in consumer
applications such as digital set-top boxes and cable modems. The RAID business
of AMI, which was acquired in August 2001, also contributed to higher revenues
due to a full quarter of revenue contribution in the current quarter.

Total consolidated revenues for the nine months ended September 30, 2002
decreased $41.9 million or 3% from the same period of 2001, while Semiconductor
revenues decreased $112.6 million or 9% over the same period. This decrease was
primarily attributable to an overall decline in sales of our products due to
continuing weak economic conditions. This decline was offset in part by
revenues from C-Cube, which became a part of the Semiconductor segment after it
was acquired in May 2001 and revenues from RAID products, which also became a
part of the Semiconductor segment with the acquisition of the RAID business of
AMI in August 2001.

Revenues for the Storage Systems segment increased $41.4 million or 91%
for the third quarter of 2002 from the same period of 2001. Revenues for this
segment increased $70.7 million or 44% for the nine months ended September 30,
2002 from the same period

20



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of 2001. The increases for the three and nine months ended September 30,
2002 as compared to the same periods of 2001 are due to overall increased
demand for products in the Storage Systems segment and sales to a new master
distributor. Revenues in the current quarter also increased due to additional
revenues of $5.9 million from the Mylex acquisition, which was completed in
August 2002 and became primarily a part of the Storage Systems segment.

There were no significant intersegment revenues during the periods
presented.

Significant Customers

The following table summarizes the number of our significant customers who
accounted for 10% or more of our revenues, along with the percentage of
revenues they individually represent on a consolidated basis and by segment:

|                         |                                     |  |                                  |              |                                 |  |      |              |      |  |  |              |   |  |  |                   |  
|------------------------ | ----------------------------------- |  | -------------------------------- | ------------ | ------------------------------- |  | ---- | ------------ | ---- |  |  | ------------ | - |  |  | ----------------- | -
|                         |                                     |  | Three months ended September 30, |              | Nine months ended September 30,
|                         |                                     |  |                                  |              |                                
|                         |                                     |  | 2002                             |              | 2001                            |  | 2002 |              | 2001
|                         |                                     |  |                                  |              |                                 |  |      |              |     
|Semiconductor segment:   |                                     |  |                                  |              |                                 |  |      |              |      |  |  |              |   |  |  |                  
|                         | Number of significant customers     |  |                                  | 1            |                                 |  |      | 1            |      |  |  | 1            |   |  |  | 1                 |  
|                         | Percentage of segment revenues      |  |                                  | 26           | %                               |  |      | 23           | %    |  |  | 21           | % |  |  | 21                | %
|Storage Systems segment: |                                     |  |                                  |              |                                 |  |      |              |      |  |  |              |   |  |  |                  
|                         | Number of significant customers     |  |                                  | 3            |                                 |  |      | 3            |      |  |  | 3            |   |  |  | 4                 |  
|                         | Percentage of segment revenues      |  |                                  | 39%, 21%, 16 | %                               |  |      | 24%, 20%, 10 | %    |  |  | 35%, 19%, 17 | % |  |  | 21%, 17%, 16%, 11 | %
|Consolidated:            |                                     |  |                                  |              |                                 |  |      |              |      |  |  |              |   |  |  |                  
|                         | Number of significant customers     |  |                                  | 1            |                                 |  |      | 1            |      |  |  | 1            |   |  |  | 1                 |  
|                         | Percentage of consolidated revenues |  |                                  | 21           | %                               |  |      | 21           | %    |  |  | 17           | % |  |  | 18                | %

Revenues by geography

In the current quarter, revenues were up in North America, Japan and Asia
while they declined in Europe as compared to the third quarter of 2001. The
following table summarizes our revenues by geography:

|          |               |   |                                  |         |                                 |   |         |         |      |   |           |         |  |   |           |         | 
|--------- | ------------- | - | -------------------------------- | ------- | ------------------------------- | - | ------- | ------- | ---- | - | --------- | ------- |  | - | --------- | ------- | 
|          |               |   | Three months ended September 30, |         | Nine months ended September 30,
|          |               |   |                                  |         |                                
|          |               |   | 2002                             |         | 2001                            |   | 2002    |         | 2001
|          |               |   |                                  |         |                                 |   |         |         |     
|Revenues: |               |   |                                  |         |                                 |   |         |         |      |   |           |         |  |   |           |        
|          | North America |   | $                                | 233,160 |                                 |   | $       | 168,400 |      |   | $         | 673,805 |  |   | $         | 675,835 | 
|          | Japan         |   |                                  | 119,174 |                                 |   |         | 91,630  |      |   |           | 270,691 |  |   |           | 287,743 | 
|          | Europe        |   |                                  | 36,802  |                                 |   |         | 50,071  |      |   |           | 121,645 |  |   |           | 224,514 | 
|          | Asia          |   |                                  | 97,828  |                                 |   |         | 86,574  |      |   |           | 271,100 |  |   |           | 191,001 | 
|          |               |   |                                  |         |                                 |   |         |         |      |   |           |         |  |   |           |        
|Total     |               | $ | 486,964                          |         |                                 | $ | 396,675 |         |      | $ | 1,337,241 |         |  | $ | 1,379,093 |        
|          |               |   |                                  |         |                                 |   |         |         |      |   |           |         |  |   |           |        

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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 ended |    | Nine months ended
|                        |  |                                |       |                    |    |                  
|(in millions)           |  | Sept. 30, 2002                 |       | June 30, 2002      |    | Sept. 30, 2001    |       | Sept. 30, 2002 |    | Sept. 30, 2001
|                        |  |                                |       |                    |    |                   |       |                |    |               
|Semiconductor segment   |  | $                              | 167.0 |                    |    | $                 | 133.4 |                |    | $              | 45.7 |  |    | $ | 383.8 |  |    | $ | 292.1 | 
|                        |  | Percentage of segment revenues |       |                    | 42 | %                 |       |                | 38 | %              |      |  | 13 | % |       |  | 35 | % |       |  | 24 | %
|Storage Systems segment |  | $                              | 31.5  |                    |    | $                 | 30.0  |                |    | $              | 14.3 |  |    | $ | 83.9  |  |    | $ | 46.4  | 
|                        |  | Percentage of segment revenues |       |                    | 36 | %                 |       |                | 36 | %              |      |  | 32 | % |       |  | 37 | % |       |  | 29 | %
|                        |  |                                |       |                    |    |                   |       |                |    |                |      |  |    |   |       |  |    |   |       | 
|Consolidated            |  | $                              | 198.5 |                    |    | $                 | 163.4 |                |    | $              | 60.0 |  |    | $ | 467.7 |  |    | $ | 338.5 | 
|                        |  |                                |       |                    |    |                   |       |                |    |                |      |  |    |   |       |  |    |   |       | 
|                        |  | Percentage of revenues         |       |                    | 41 | %                 |       |                | 37 | %              |      |  | 15 | % |       |  | 35 | % |       |  | 25 | %

We have advanced wafer manufacturing operations in Oregon, which is our
primary manufacturing site, and in Japan. We also acquire wafers from foundries
in other locations. This allows us to maintain our ability to provide products
to customers with minimal disruption in the manufacturing process due to
economic and geographic risks associated with each location.

Third quarter of 2002 compared to the second quarter of 2002

The consolidated gross profit margin percentage increased to 41% in the
third quarter of 2002 from 37% in the second quarter of 2002. The gross profit
margin percentage for the Semiconductor segment increased to 42% in the third
quarter of 2002 from 38% in the second quarter of 2002, while the gross profit
margin percentage for the Storage Systems segment was flat at 36%.

The increase in consolidated gross profit margins for the third quarter of
2002 compared to the second quarter of 2002 is a result of the following
factors:

     Higher revenues and lower manufacturing variances and period costs
due to better capacity utilization;

     A favorable shift in product mix in the Semiconductor segment in the
third quarter of 2002, where revenues from higher margin products grew more
than revenues for lower margin products; and

     Additional excess inventory and related charges of $4.8 million
recorded in the second quarter of 2002 also contributed to the lower margin in
that quarter. These charges impacted the Semiconductor segment and were
primarily associated with underutilization charges related to a partial idling
of our fabrication facilities due to decreased demand. No such charges were
recorded in the current quarter. This reflects the improved capacity
utilization in our manufacturing facilities since May 2002. Overall factory
capacity was reduced as part of the restructuring actions taken in 2001 and
early 2002, which has contributed in part to the improvement in capacity
utilization in the third quarter of 2002 along with increased demand.

We expect gross margin to be about 40% in the fourth quarter of 2002.

Third quarter and nine months ended September 30, 2002 compared to the
same periods of 2001

The consolidated gross profit margin percentage increased to 41% in the
third quarter of 2002 from 15% in the same period of 2001. The gross profit
margin percentage for the Semiconductor segment increased to 42% from 13% over
the same period, while the margin percentage for the Storage Systems segment
increased to 36% in the current quarter from 32% in the same period of 2001.

The consolidated gross profit margin percentage increased to 35% in the
first nine months of 2002 from 25% in the same period of 2001. The gross profit
margin percentage for the Semiconductor segment increased to 35% from 24%,
while the margin percentage for the Storage Systems segment increased to 37%
from 29% over the same period.

The following factors were primarily responsible for these changes in
gross profit margins over the above noted periods:

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| |  |  | Lower manufacturing variances and period costs for the Semiconductor
segment in the current period;                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Lower compensation related expenses due to a decrease in average
headcount in 2002 as compared to the same period of 2001; and                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|
| |  |  | Lower additional excess inventory and related charges of $0 and $45.5
million for the three and nine months ended September 30, 2002,
respectively, as compared to $50.0 million and $158.1 million for the
same periods in 2001. The charges in 2002 and for the three months ended
September 30, 2001 impacted the Semiconductor segment and were primarily
associated with underutilization charges associated with a partial idling
of our fabrication facilities due to decreased demand. The charges of
$158.1 million for the nine months ended September 30, 2001, including a
charge of $6.0 million for the Storage Systems segment, were primarily
due to:



| |  |  | - A sudden and significant decrease in forecasted revenue and calculated in
accordance with our policy, which is primarily based on inventory levels in
excess of 12-month demand for each specific product and use of management
judgment; and
| |  |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | - Impairment charges recorded in costs of sales associated with the
closure of the Colorado Springs facility in 2001.                                                                                                                          

Higher revenues in the current quarter as compared to the third quarter in
2001 also contributed to better margins in the current quarter. However, for
the nine months ended September 30, 2002, the above favorable factors were
partially offset by a decrease in Semiconductor revenues in the current period
as compared to 2001.

Our operating environment, combined with the resources required to operate
in the Semiconductor industry, requires that we manage a variety of factors.
These factors include, among other things:



| |  |  | 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.

Changes in the relative strength of the yen may have a greater impact on
our gross profit margin than other foreign exchange fluctuations. This is
because we have significant yen-denominated revenues from sales in
Japan, which are
partially offset by yen-denominated expenses at our wafer fabrication
operations in Japan. The yen remained relatively stable compared to the U.S.
dollar, that is, the average yen exchange rate for the third quarter of 2002
remained unchanged from the same period of 2001. Moreover, we hedged a portion
of our remaining yen exposure. (See Note 6 of the Notes.) Future changes in the
relative strength of the yen or mix of foreign currency denominated revenues
and costs could have a significant effect on our gross profit margin or
operating results.

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Research and development:

|                        |                                |                |                    |               |                   |                |       |                |   |                |       |    |   |   |       |    |   |   |       |    |  
|----------------------- | ------------------------------ | -------------- | ------------------ | ------------- | ----------------- | -------------- | ----- | -------------- | - | -------------- | ----- | -- | - | - | ----- | -- | - | - | ----- | -- | -
|                        |                                |                | Three months ended |               | Nine months ended
|                        |                                |                |                    |               |                  
|(in millions)           |                                | Sept. 30, 2002 |                    | June 30, 2002 |                   | Sept. 30, 2001 |       | Sept. 30, 2002 |   | Sept. 30, 2001
|                        |                                |                |                    |               |                   |                |       |                |   |               
|Semiconductor segment   |                                | $              | 105.4              |               |                   | $              | 105.5 |                |   | $              | 128.7 |    |   | $ | 317.3 |    |   | $ | 359.2 |   
|                        | Percentage of segment
revenues |                |                    | 26            | %                 |                |       | 30             | % |                |       | 37 | % |   |       | 29 | % |   |       | 29 | %
|Storage Systems segment |                                | $              | 9.0                |               |                   | $              | 7.3   |                |   | $              | 6.9   |    |   | $ | 24.3  |    |   | $ | 22.6  |   
|                        | Percentage of segment
revenues |                |                    | 10            | %                 |                |       | 9              | % |                |       | 15 | % |   |       | 11 | % |   |       | 14 | %
|                        |                                |                |                    |               |                   |                |       |                |   |                |       |    |   |   |       |    |   |   |       |   
|Consolidated            |                                | $              | 114.4              |               |                   | $              | 112.8 |                |   | $              | 135.6 |    |   | $ | 341.6 |    |   | $ | 381.8 |   
|                        |                                |                |                    |               |                   |                |       |                |   |                |       |    |   |   |       |    |   |   |       |   
|                        | Percentage of revenues         |                |                    | 23            | %                 |                |       | 26             | % |                |       | 34 | % |   |       | 26 | % |   |       | 28 | %

Third quarter of 2002 compared to the second quarter of 2002

Research and development (R&D) expenses increased $1.6 million or 1%
during the third quarter of 2002 from the second quarter of 2002. The increase
is mainly attributed to continuing R&D costs of the Mylex business unit, which
was acquired from IBM and is included in our consolidated financial statements
from August 29, 2002 (See Note 11 of the Notes) and R&D expenditures related to
continued development of advanced sub-micron products and process technologies.
One of the technologies under development in the current quarter was
RapidChip. The RapidChip platform product combines the high-density,
high-performance and proven intellectual property benefits of cell-based ASICs
with the advantages of Field Programmable Gate Arrays (FPGAs), such as
customization and faster time to market. RapidChip is in the
medium-to-lower-end of cell based ASICs and the high end of programmable
devices like FPGAs. We believe that this will be one of the most active
products in the high-density chip market segment for many years.

As a percentage of revenues, consolidated R&D expenses decreased to 23% in
the third quarter of 2002 from 26% in the second quarter of 2002. For the
Semiconductor segment, R&D as a percentage of segment revenues decreased to 26%
in the third quarter of 2002 from 30% in the second quarter of 2002 while for
the Storage Systems segment, R&D expenses increased to 10% in the current
quarter from 9% in the prior quarter. The change in R&D expenses as a
percentage of revenues is primarily a result of higher revenues offset by
slightly higher R&D expenses in the current quarter as compared to the second
quarter of 2002.

In association with the technology transfer agreement entered into with
Silterra in Malaysia during 1999, we did not record any benefit in the third
quarter of 2002 as compared to a $2.0 million benefit recorded in the second
quarter of 2002. We expect to record a benefit of $2.0 million in the fourth
quarter of 2002. The obligations under the technology transfer agreement are
substantially complete as of September 30, 2002. (See Note 4 of the Notes.)

Third quarter and nine months ended September 30, 2002 compared to the
same periods of 2001

R&D expenses, on a consolidated basis, decreased $21.2 million or 16%
during the third quarter of 2002 as compared to the third quarter of 2001. R&D
expenses for the Semiconductor segment decreased $23.3 million or 18%, while
for the Storage Systems segment, R&D expenses increased by $2.1 million or 30%
over the same period. R&D expenses for the Semiconductor segment have decreased
over the two comparable periods discussed above primarily as a result of the
restructuring actions of 2001 and 2002. (See Note 3 of the Notes.) The
decrease was offset in part by the following:



| |  |  | A lower benefit associated with the technology transfer agreement
entered into with Silterra in Malaysia during 1999. (See Note 4 of the
Notes.) No benefit was recorded in the third quarter of 2002 as compared
to $2 million benefit recorded in the same period of 2001;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Continued R&D expenses for the former AMI RAID business, which is a
part of the Semiconductor segment and is included in our consolidated
financial statements from August 31, 2001; and                                                                                    
|
| |  |  | Expenditures related to continued development of advanced
sub-micron products and process technologies, which includes the
development of RapidChip.                                                                                                                        

While R&D expenses for the Storage Systems segment also decreased over the
two comparable periods discussed above due to the restructuring actions of 2001
and 2002, this decrease was offset by additional R&D expenses incurred in the
current quarter for the

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former Mylex business unit of IBM, which is now primarily a part of the
Storage Systems segment and is included in our consolidated financial
statements from August 29, 2002.

As a percentage of revenues, consolidated R&D expenses decreased to 23% in
the third quarter of 2002 from 34% in the same quarter of 2001. For the
Semiconductor segment, R&D expenses as a percentage of revenue decreased to 26%
in the third quarter of 2002 from 37% in the same period of 2001 as a result of
higher revenues combined with lower R&D expenses as discussed above. R&D
expenses as a percentage of revenues for the Storage Systems segment decreased
to 10% in the third quarter of 2002 from 15% in the same quarter of 2001 as a
result of an increase in revenues offset partly by an increase in R&D expenses
in the current period.

Consolidated R&D expenses decreased $40.2 million or 11% during the first
nine months of 2002 as compared to the same period of 2001. During the same
period, R&D expenses for the Semiconductor segment decreased $41.9 million or
12%. The decrease in this segment was primarily attributable to the cost
cutting measures implemented as part of the restructuring actions in 2001 and
2002. (See Note 3 of the Notes.) The decrease was offset in part by the
following:



| |  |  | A benefit of $6 million was recorded during the nine months ended
September 30, 2002, as compared to $14 million recorded during the nine
months ended September 30, 2001. This benefit is associated with a
technology transfer agreement entered into with Silterra in Malaysia
during 1999 (See Note 4 of the Notes);
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Continued R&D expenses for the former C-Cube and AMI RAID businesses,
which are a part of the Semiconductor segment and included in our
consolidated financial statements from May 11, 2001 and August 31, 2001,
respectively; and                                                                                      
|
| |  |  | Expenditures related to continued development of advanced
sub-micron products and process technologies, which includes the
development of RapidChip.                                                                                                                                                                    

R&D expenses for the Storage Systems segment increased $1.7 million or 8%
in the first nine months of 2002 from the same period of 2001. This increase is
mainly due to continuing R&D expenses for the former Mylex business unit of
IBM, which was acquired in the current quarter and is included in our
consolidated financial statements from August 29, 2001.

As a percentage of revenues, consolidated R&D expenses decreased to 26% in
the first nine months of 2002 from 28% in the same period of 2001. R&D expenses
as a percentage of revenues for the Semiconductor segment stayed flat at 29%
over the two periods. This is a result of R&D spending reductions offset in
part by lower revenues in the current period as compared to the prior period.
The spending reductions were a result of the various cost cutting measures as
discussed above. R&D expenses as a percentage of revenues for the Storage
Systems segment decreased to 11% in the current nine-month period from 14% in the first
nine months of 2001 as a result of an increase in revenues offset in part by an
increase in R&D expenses in the current period.

Selling, general and administrative:

|                        |                               |                |                    |               |                   |                |      |                |   |                |      |    |   |   |       |    |   |   |       |    |  
|----------------------- | ----------------------------- | -------------- | ------------------ | ------------- | ----------------- | -------------- | ---- | -------------- | - | -------------- | ---- | -- | - | - | ----- | -- | - | - | ----- | -- | -
|                        |                               |                | Three months ended |               | Nine months ended
|                        |                               |                |                    |               |                  
|(in millions)           |                               | Sept. 30, 2002 |                    | June 30, 2002 |                   | Sept. 30, 2001 |      | Sept. 30, 2002 |   | Sept. 30, 2001
|                        |                               |                |                    |               |                   |                |      |                |   |               
|Semiconductor segment   |                               | $              | 46.8               |               |                   | $              | 45.6 |                |   | $              | 62.6 |    |   | $ | 139.1 |    |   | $ | 185.5 |   
|                        | Percentage of
segment revenue |                |                    | 12            | %                 |                |      | 13             | % |                |      | 18 | % |   |       | 13 | % |   |       | 15 | %
|Storage Systems segment |                               | $              | 12.3               |               |                   | $              | 11.8 |                |   | $              | 17.5 |    |   | $ | 35.5  |    |   | $ | 51.1  |   
|                        | Percentage of
segment revenue |                |                    | 14            | %                 |                |      | 14             | % |                |      | 39 | % |   |       | 15 | % |   |       | 32 | %
|                        |                               |                |                    |               |                   |                |      |                |   |                |      |    |   |   |       |    |   |   |       |   
|Consolidated            |                               | $              | 59.1               |               |                   | $              | 57.4 |                |   | $              | 80.1 |    |   | $ | 174.6 |    |   | $ | 236.6 |   
|                        |                               |                |                    |               |                   |                |      |                |   |                |      |    |   |   |       |    |   |   |       |   
|                        | Percentage of revenue         |                |                    | 12            | %                 |                |      | 13             | % |                |      | 20 | % |   |       | 13 | % |   |       | 17 | %

Third quarter of 2002 compared to the second quarter of 2002

Selling, general and administrative (SG&A) expenses increased $1.7
million or 3% during the third quarter of 2002 from the second quarter of 2002.
The increase is mainly due to increases in compensation related costs.

As a percentage of revenues, consolidated SG&A expenses decreased to 12%
in the third quarter of 2002 from 13% in the second quarter of 2002. For the
Semiconductor segment, SG&A expenses, as a percentage of revenues, decreased to
12% from 13%, and for

25



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the Storage Systems segment, it remained flat at 14% over the two
consecutive quarters. This decline is mainly a result of higher revenues during
the current quarter.

Third quarter and nine months ended September 30, 2002 compared to the
same periods of 2001

Consolidated SG&A expenses decreased $21.0 million or 26% during the third
quarter of 2002 as compared to the third quarter of 2001. SG&A expenses for the
Semiconductor segment decreased $15.8 million or 25%, while for the Storage
Systems segment, SG&A expenses decreased $5.2 million or 30% over the same
period.

Consolidated SG&A expenses decreased $62.0 million or 26% during the first
nine months of 2002 as compared to the same period of 2001. SG&A expenses for
the Semiconductor segment decreased $46.4 million or 25% while SG&A expenses
for the Storage Systems segment decreased $15.6 million or 31% over the same
period. The decrease on a consolidated basis and by segment for the three and
nine months ended September 30, 2002 as compared to 2001 was primarily attributable to the
various cost cutting measures implemented in 2001 and 2002 (See Note 3 of the
Notes). This decrease was offset in part by continued SG&A expenses for the
former C-Cube and AMI RAID businesses, which are a part of the Semiconductor
segment and included in our consolidated financial statements from May 11, 2001
and August 31, 2001, respectively. Continuing expenses incurred in the current
quarter for the former Mylex business unit also offset the decrease in SG&A
expenses. The Mylex business unit is primarily a part of the Storage Systems
segment and is included in our consolidated financial statements from August
29, 2002 (See Note 11 of the Notes).

As a percentage of revenues, SG&A expenses decreased to 12% in the third
quarter of 2002 from 20% in the third quarter of 2001 on a consolidated basis
while for the Semiconductor segment, it decreased to 12% from 18% over the same
period. The decrease is a result of savings from SG&A cost cutting measures
discussed above, combined with higher revenues in the current quarter.

Consolidated SG&A expenses decreased to 13% in the first nine months of
2002 from 17% in the same period of 2001 while for the Semiconductor segment,
it decreased to 13% from 15% over the same period. The decrease is a result of
savings from SG&A cost cutting measures discussed above, offset in part by
lower revenues in the current nine-month period as compared to the prior year.

For the Storage Systems segment, SG&A expenses as a percentage of revenues
decreased to 14% in the third quarter of 2002 from 39% in the same period of
2001, and to 15% in the first nine months of 2002 from 32% in the same period
of 2001. The decrease for both periods presented is a result of savings in
SG&A expenses from the cost cutting measures discussed above, accompanied by
higher revenues in the current year as compared to the same periods of the
prior year.

Restructuring of operations and other non-recurring items:We recorded a
charge of approximately $13 million and $72 million in restructuring and other
non-recurring items for the three and nine months ended September 30, 2002,
respectively. The $13 million charge in the current quarter reflects the
decrease in the fair market value of assets held for sale. More details of the
restructuring and non-recurring items are discussed below. We recorded
restructuring and non-recurring charges of approximately $133 million and $192
million for the three and nine months ended September 30, 2001. For a
discussion of the 2001 restructuring actions, please refer to our Annual Report
on Form 10-K for the year ended December 31, 2001.

Restructuring:

In the first quarter of 2002, we announced a set of actions to reduce
costs and streamline operations. These actions included a worldwide reduction
in workforce, downsizing our manufacturing operations in Tsukuba, Japan and the
decision to exit the CDMA handset standard product line. During the three
months ended March 31, 2002, we recorded a restructuring charge for severance
for approximately 1,400 employees worldwide, fixed asset write-downs due to
impairment in the U.S. and Japan that will be disposed of by sale, and exit
costs primarily associated with cancelled contracts and operating leases. In
the second quarter of 2002, we completed the sale of the CDMA handset product
line to a third party, recognizing a net gain of approximately $6 million.

On January 1, 2002, we adopted Statement of Financial Accounting Standard
(SFAS) No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets. SFAS No. 144 addresses financial accounting and reporting for the
impairment of long-lived assets and for long-lived assets to be disposed. The
adoption did not have a significant effect on our financial position and
results of operations.

26



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##### Table of Contents



Assets held for sale of $77 million and $89 million were included as a
component of prepaid expenses and other current assets as of September 30, 2002
and December 31, 2001, respectively. In September 2002, we recorded $13 million
of additional fixed asset write-downs to reflect the decrease in the fair
market value of the assets during the period. The fair value of assets
determined to be impaired was the result of independent appraisals and the use
of management estimates. 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 book value for the assets. We
will reassess the realizability of the carrying value of these assets at the
end of each quarter until the assets are sold or otherwise disposed of and
additional adjustments may be necessary.

The following table sets forth our restructuring reserves as of September
30, 2002:

|                                                |  |              |        |               |  |             |        |             |  |         |         |             |  |               |         |   |  |   |        |            |  |   |         |   |  |   |        | 
|----------------------------------------------- |  | ------------ | ------ | ------------- |  | ----------- | ------ | ----------- |  | ------- | ------- | ----------- |  | ------------- | ------- | - |  | - | ------ | ---------- |  | - | ------- | - |  | - | ------ | 
|                                                |  | Balance at   |        | Restructuring |  |             |        |             |  |         |         |             |  | Restructuring |         |   |  |   |        | Balance at
|                                                |  | December 31, |        | Expense       |  | Utilized Q1 |        | Utilized Q1 |  | Expense |         | Utilized Q3 |  | September 30,
|(In thousands)                                  |  | 2001         |        | Q1 2002       |  | 2002        |        | 2002        |  | Q3 2002 |         | 2002        |  | 2002         
|                                                |  |              |        |               |  |             |        |             |  |         |         |             |  |              
|Write-down of excess assets(a)                  |  | $            | 3,762  |               |  | $           | 25,933 |             |  | $       | (27,623 | )           |  | $             | (765    | ) |  | $ | 12,985 |            |  | $ | (13,271 | ) |  | $ | 1,021  | 
|Lease terminations and maintenance
contracts(c) |  |              | 10,695 |               |  |             | 12,871 |             |  |         | (1,623  | )           |  |               | (1,066  | ) |  |   |       |            |  |   | (1,669  | ) |  |   | 19,208 | 
|Facility closure and other exit costs(c)        |  |              | 14,153 |               |  |             | 415    |             |  |         | (3,142  | )           |  |               | (2,723  | ) |  |   |       |            |  |   | (2,349  | ) |  |   | 6,354  | 
|Payments to employees for severance(b)          |  |              | 724    |               |  |             | 27,490 |             |  |         | (10,352 | )           |  |               | (9,932  | ) |  |   |       |            |  |   | (1,806  | ) |  |   | 6,124  | 
|                                                |  |              |        |               |  |             |        |             |  |         |         |             |  |               |         |   |  |   |        |            |  |   |         |   |  |   |        | 
|Total                                           |  | $            | 29,334 |               |  | $           | 66,709 |             |  | $       | (42,740 | )           |  | $             | (14,486 | ) |  | $ | 12,985 |            |  | $ | (19,095 | ) |  | $ | 32,707 | 
|                                                |  |              |        |               |  |             |        |             |  |         |         |             |  |               |         |   |  |   |        |            |  |   |         |   |  |   |        | 



---

|(a) |  | Amounts utilized in 2002 reflect a non-cash write-down of fixed assets in
the U.S. and Japan due to impairment of $38.3 million and cash payments
for machinery and equipment decommissioning costs of $3.3 million. The
fixed asset write-downs were accounted for as a reduction of the assets
and did not result in a liability. The $1.0 million balance as of
September 30, 2002 relates to machinery and equipment decommissioning
costs in the U.S.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|   
|   
|   
|(b) |  | Amounts utilized represent cash severance payments to approximately 80
and 1,230 employees during the three and nine months ended September 30,
2002, respectively. The $6.1 million balance as of September 30, 2002 will
be paid by early 2003.                                                                                                                                                                                                         
|   
|   
|   
|   
|(c) |  | Amounts utilized represent cash payments.                                                                                                                                                                                                                                                                                                                                                                                                                 

Other non-recurring items:

We recorded a net gain of approximately $2 million in other non-recurring
items during the first quarter of 2002, which consisted of a nonrefundable
deposit paid to us in the first quarter of 2002 related to the termination of
the agreement to sell the Colorado Springs fabrication facility during 2001,
offset in part by operating expenses for the CDMA handset product line held for
sale.

Acquired in-process research and development:An amount of $1.9 million
was recorded for in-process research and development (IPR&D) in the current
quarter in connection with the acquisition of the Mylex business unit from IBM.
No amounts were recorded for IPR&D in the first two quarters of 2002. In the
second and third quarters of 2001, in connection with the acquisitions of
C-Cube and the RAID business of AMI, we recorded charges of $77.5 million and
$19.1 million associated with IPR&D, respectively. The amount of IPR&D was
determined by identifying research projects for which technological feasibility
had not been established and no alternative future uses existed as of the
acquisition date. For further discussion of the C-Cube and AMI acquisitions,
please refer to our Annual Report on Form 10-K.

Mylex IPR&D.As of the acquisition date, the projects in process were for
development of storage systems hardware, firmware and subsystem components
technology.

The value of the projects identified to be in progress were determined by
estimating the future cash flows from the projects once commercially feasible,
discounting the net cash flows back to their present value and then applying a
percentage of completion to the calculated value. The percentage of completion
for the projects were determined based on research and development expenses
incurred as of August 29, 2002, as a percentage of total research and
development expenses to bring the projects to technological feasibility. The
discount rate used was 25% for the projects. Development of storage systems
hardware technology was started in 2000. Development of firmware and subsystems
components technology was started in 2002. As of August 29, 2002, we estimated
that the projects were from 10% to 50% complete.

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Development of the technology remains a substantial risk due to a number
of factors, including the remaining effort to achieve technological
feasibility, rapidly changing customer markets and competitive threats from
other companies. Additionally, the value of other intangible assets acquired
may become impaired.

Amortization of intangibles:We adopted SFAS No. 142, Goodwill and Other
Intangible Assets on January 1, 2002. As a result, goodwill is no longer
amortized, but is instead tested for impairment annually or sooner if
circumstances indicate that it may no longer be recoverable. In addition,
intangible assets acquired prior to July 1, 2001 that do not meet the criteria
for recognition under SFAS No. 141 Business Combinations have been
reclassified to goodwill. (See Note 2 of the Notes.)

Amortization of intangible assets was $19.7 million and $19.1 million for
the second and third quarters of 2002, respectively. The increase over the
prior quarter is due to the additional amortization of intangible assets
recorded in the current quarter in connection with acquisition of the Mylex
business unit.

Amortization of goodwill and other intangibles was $57.7 million for the
three months ended September 30, 2001. Amortization of intangible assets was
$58.0 million for the first nine months of 2002 as compared to $128.3 million
for the same period of 2001. The decrease is primarily attributable to the
adoption of SFAS Nos. 141 and 142 as discussed above, offset by the additional
intangible assets and related amortization recorded in connection with the
acquisitions of the Mylex business unit in the current quarter and the RAID
business of AMI in the third quarter of 2001. We had approximately $301.4
million of intangible assets, net of accumulated amortization that will
continue to amortize as of September 30, 2002.

Amortization of non-cash deferred stock compensation:Amortization of
non-cash deferred stock compensation of $14.2 million and $65.0 million for the
three and nine months ended September 30, 2002, respectively, is a result of
non-cash deferred stock compensation recorded in connection with the
acquisitions of C-Cube and the RAID business during the second and third
quarters of 2001, respectively, Syntax in the fourth quarter of 2000 and
DataPath in the third quarter of 2000. The expense due to amortization of
non-cash deferred stock compensation was $26.8 million and $75.9 million for
the three and nine months ended September 30, 2001, respectively. No deferred
stock compensation was recorded in connection with the acquisition of the Mylex
business unit in the current quarter.

Interest expense:Interest expense decreased by $5.4 million to $10.1
million in the third quarter of 2002 from $15.5 million in the second quarter
of 2002. The decrease is due to a reduction in the effective interest rate
payable on the Convertible Subordinated Notes as a result of the interest rate
swap transactions (the swaps) entered into in the second quarter of 2002 as
explained below.

Interest expense remained relatively flat at $10 million in the third
quarter of 2002 and 2001. Interest expense increased $11.6 million to $41.4
million in the first nine months of 2002 from $29.8 million in the same period
of 2001. The increases in the current periods of 2002 as compared to the same
periods of 2001 are primarily attributable to higher debt outstanding as of
September 30, 2002 due to the issuance of the 4% Convertible Subordinated Notes
for $490 million in October 2001, offset by the reduction in the effective
interest rate payable as a result of the swaps on the Convertible Subordinated
Notes entered into in the second quarter of 2002 as explained below.

We entered into interest rate swap transactions with various investment
banks in June 2002. The swaps effectively convert fixed interest payments on
$1.085 billion Convertible Subordinated Notes to LIBOR-based floating rates.
The swaps are intended to better match interest rate risk between our
investment portfolio (See Note 5 of the Notes), which generates interest income
at floating rates, and our debt, which bears a fixed interest payment. See our
Annual Report on Form 10-K for a discussion of the Convertible Subordinated
Notes. The swaps qualify for hedge accounting treatment under SFAS No. 133.
(See Note 12 of the Notes.)

In September 2002, we repurchased $87.4 million of the $500 million 4%
Convertible Subordinated Notes issued in 2000, recognizing a pre-tax gain of
$11.6 million. We have adopted the provisions of Statement of Financial
Accounting Standards No. 145, Rescission of FASB Statements No. 4, 44, and 64,
Amendment of FASB Statement No. 13, and Technical Corrections related to
extinguishment of debt. As a result, the gain on the repurchase of debt is
included in interest income and other, net, on the income statement. In
October 2002, an additional $47.6 million of Convertible Subordinated Notes
were repurchased, resulting in a pre-tax gain of $2.7 million to be recognized
in the fourth quarter of 2002.

Interest income and other, net:Interest income and other, net, was $14.1
million in the third quarter of 2002 as compared to $2.6 million in the second
quarter of 2002. Interest income increased to $11.7 million in the current
quarter from $6.4 million in the second quarter of 2002. The increase in
interest income is mainly due to improved returns on our short-term
investments. Other income of $2.4 million in the current quarter included a
gain of $11.6 million on the repurchase of a portion on the 2000 Convertible

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Subordinated Notes (See Note 12 of the Notes) and a gain on miscellaneous asset
sales offset in part by a write down of certain equity investments for $9.9
million due to impairment considered to be other than temporary. (See Note 5 of
the Notes.)

In the third quarter of 2002, interest income and other, net, increased
$10.2 million to $14.1 million from $3.9 million in the third quarter of 2001.
Interest income increased to $11.7 million in the current quarter from $9.2
million in the third quarter of 2001. The increase in interest income is
mainly due to improved returns on higher cash and short-term investment
balances, partially offset by lower interest rates in the current quarter.
Other income, net, also increased in the current quarter primarily due to the
$11.6 million gain recorded on the repurchase of a portion of the 2000
Convertible Subordinated Notes.

In the first nine months of 2002, interest income and other, net,
decreased $1.5 million to $20.4 million from $21.9 million in the same period
of 2001. Interest income decreased to $23.6 million year to date in 2002 from
$37.0 million in the same period of 2001. The decrease in interest income is
attributable to lower interest rates during the current year as compared to the
prior year. In the third quarter and first nine months of 2001, other expense
of $5.3 million and $15.1 million included expenses due to a write down of
equity investments due to impairment considered to be other than temporary, the
write-off of debt issuance costs associated with a master lease and security
agreement and the time value of purchased option contracts, offset by a gain on
sale of securities in the first quarter of 2001. (See Notes 5 and 6 of the
Notes.)

Provision for income taxes:During the three months ended September 30,
2002, we recorded an income tax expense of $7.9 million. The expense relates
to income taxes for certain foreign subsidiaries. For the nine months ended
September 30, 2002, we recorded an income tax benefit of $4.3 million. The
benefit is the result of changes in the U.S. tax laws, which were enacted in
the first quarter of 2002, reduced by income taxes for certain foreign
subsidiaries. The future benefit of certain operating losses is not currently
being recognized. For the three and nine months ended September 30, 2001, an
income tax benefit was recorded in the amount of $0 and $39.2 million,
respectively. This benefit differs from the U.S. statutory rate due to certain
operating losses not benefited, losses of our foreign subsidiaries, which are
benefited at lower rates, and items related to acquisitions, which are not
deductible for tax purposes.

Financial Condition, Capital Resources and Liquidity

Cash, cash equivalents and short-term investments decreased to $943.5
million at September 30, 2002 from $1.0 billion at December 31, 2001. The
decrease is mainly due to the cash paid for the acquisition of the Mylex
business unit from IBM (See Note 11 of the Notes) and the repurchase of the
2000 Convertible Subordinated Notes in the current quarter (See Note 12 of the
Notes), offset by net cash provided by operating activities.

Working capital.Working capital decreased by $30.6 million to $1.28
billion at September 30, 2002 from $1.31 billion as of December 31, 2001.
Working capital in the first nine months of the current year was impacted by
the following activities:



| |  |  | We completed the acquisition of the Mylex business unit from IBM in
the current quarter for $50.5 million in cash, including $0.5 million
incurred for direct acquisition costs;                                                                                                                                                                                                                                                
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | We repurchased $87.4 million of the $500 million 4% Convertible
Subordinated Notes issued in 2000, recognizing a pre-tax gain of $11.6
million. We paid $50.3 million cash for this repurchase in the current
quarter and the balance of $25.5 million was settled in the fourth
quarter of 2002;                                                                                                                               
|
| |  |  | Inventories declined by $32.9 million due to reduced purchases of raw
materials, increased production through-put and increased sales in the
current quarter as compared to the fourth quarter of 2001;                                                                                                                                                                                                                         
|
| |  |  | Prepaid expenses and other current assets declined by $21.7 million primarily
due to a decrease in assets held for sale due to a write-down resulting
from a decline in the fair market value of the assets, miscellaneous
asset sales and other non-cash transfers from non-current assets and
deposits to prepaid expenses and other current assets in association with the
synthetic lease (See Notes 3 and 12 of the Notes);
|
| |  |  | Higher accrued salaries, wages and benefits due to timing differences
in payment of salaries, offset by lower payroll costs as a result of the
various restructuring actions taken in 2001 and January 2002; and                                                                                                                                                                                                                

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| |  |  | Accrued and other liabilities increased by $23.0 million, primarily
due to an increase of $25.5 million payable for the repurchase of the
2000 Convertible Subordinated Notes (See Note 12 of the Notes) not paid
until the fourth quarter of 2002, and changes in restructuring-related
accruals.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The decrease in working capital was offset, in part, by the following:



| |  |  | Accounts receivable increased by $109.4 million from $191.7 million
at December 31, 2001 to $301.1 million at September 30, 2002. This
increase is attributable to increased revenues in the third quarter of
the current year as compared to the fourth quarter of 2001, and by
timing differences in collections in the current quarter;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Accounts payable were lower by $20.6 million at September 30, 2002
as compared to December 31, 2001 due to lower purchases in the current
quarter; and                                                                                                                                                                                    
|
| |  |  | Lower income taxes payable due to the net income tax benefit recorded
in the current year.                                                                                                                                                                                                                                                

Cash and cash equivalents generated from operating activities.During the
first nine months of 2002, we provided $43.7 million of net cash and cash
equivalents from operating activities compared to $95.5 million generated in
the same period in 2001. The decrease in cash and cash equivalents provided by
operating activities was the result of higher net income (before depreciation
and amortization; non-cash restructuring and non-recurring items, net;
amortization of non-cash deferred stock compensation, IPR&D and loss on write
down of equity securities) for the first nine months of 2002 when compared to
the same period in 2001, offset by changes in working capital over the two
periods. Cash decreased by $76.1 million in the current nine-month period as
compared to an increase of $91.2 million in the prior period due to changes in
working capital.

Cash and cash equivalents used in investing activities.Cash and cash
equivalents used in investing activities was $306.4 million in the first nine
months of 2002, compared to $161.8 million used in the same period in 2001. The
primary investing activities during the current year as compared to the same
period in 2001 were as follows:



| |  |  | Purchases of debt and equity securities available for sale, net of
maturities and sales in the current year as compared to net sales in
2001;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | Lower purchases of property and equipment, net of retirements;                                                                               
|
| |  |  | Lower additional investments in non-current assets and deposits
in the current year; and                                                     
|
| |  |  | Lower cash paid in the current year towards acquisition of
companies.                                                                        

Net capital additions were $23.2 million in the current year as compared
to $151.4 million for the same period in 2001. We expect total capital
expenditures to be about $50 million in 2002.

Cash and cash equivalents provided by financing activities. Cash and cash
equivalents used in financing activities during the nine months ended September
30, 2002 were $24.6 million compared to $253.0 million provided in 2001. The
decrease is primarily attributable to the lack of new borrowings in 2002 (as
compared to $200.0 million borrowed in 2001) and payment of $50.6 million
towards the repurchase of the 2000 Convertible Subordinated Notes in the
current year (See Note 12 of the Notes), accompanied by lower net cash proceeds
from our employee stock option and purchase plans in 2002 as compared to 2001.

In order to remain competitive, we must continue to make investments in
new facilities and capital equipment. 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 through 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 of our earnings per share, depending on the price at which the equity
is sold or the debt is converted.

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As of September 30, 2002, we have Convertible Subordinated Notes of $345
million due in 2004, $413 million due in 2005, and $490 million due in 2006.
All the 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 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. Each holder of the 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. 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 securities for cash it may affect our
liquidity position. However, we believe that our current cash position and
expected future operating cash flows will be adequate to meet these obligations
as they mature, in the event they dont convert to equity.

In September 2002, we repurchased $87.4 million of the $500 million 4%
Convertible Subordinated Notes issued in 2000, recognizing a pre-tax gain of
$11.6 million. The gain on the repurchase of debt is included in interest
income and other, net, on the income statement. In October 2002, an additional
$47.6 million of Convertible Subordinated Notes were repurchased, resulting in
a pre-tax gain of $2.7 million to be recognized in the fourth quarter of 2002.
From time to time, we may buy back additional Convertible Subordinated Notes.

As of September 30, 2002, we had operating leases financing certain wafer
fabrication equipment (See Note 14 of the Notes).

The following table summarizes our contractual obligations at September
30, 2002 and the effect these obligations are expected to have on our liquidity
and cash flow in future periods.

|                                |       |                  |                        |           |  |           |       |               |  |       |       |       |  |   |   |   |  |   |         |         | 
|------------------------------- | ----- | ---------------- | ---------------------- | --------- |  | --------- | ----- | ------------- |  | ----- | ----- | ----- |  | - | - | - |  | - | ------- | ------- | 
|                                |       |                  | Payments due by period
|                                |       |                  |                       
|(in millions)                   |       | Less than 1 year |                        | 1-3 years |  | 4-5 years |       | After 5 years |  | Total
|                                |       |                  |                        |           |  |           |       |               |  |      
|Contractual Obligations         |       |                  |                        |           |  |           |       |               |  |       |       |       |  |   |   |   |  |   |         |        
|Convertible Subordinated Notes* |       | $                |                       |           |  | $         | 757.6 |               |  | $     | 490.0 |       |  | $ |  |   |  | $ | 1,247.6 |        
|Operating lease obligations     |       |                  | 32.6                   |           |  |           | 52.5  |               |  |       | 27.3  |       |  |   |  |   |  |   | 112.4   |        
|Capital lease obligations       |       |                  | 0.3                    |           |  |           | 0.8   |               |  |       |      |       |  |   |  |   |  |   | 1.1     |        
|                                |       |                  |                        |           |  |           |       |               |  |       |       |       |  |   |   |   |  |   |         |        
|                                | Total |                  | $                      | 32.9      |  |           | $     | 810.9         |  |       | $     | 517.3 |  |   | $ |  |  |   | $       | 1,361.1 | 
|                                |       |                  |                        |           |  |           |       |               |  |       |       |       |  |   |   |   |  |   |         |        



---

|* |  | Excludes the change in fair
value of the interest rate risk on the Convertible Subordinated Notes of
$39.0 million at September 30, 2002. See Note 12 of the Notes.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------

Recent Accounting Pronouncements

In April 2002, the Financial Accounting Standards Board (FASB) issued
FASB Statement (SFAS) No. 145, Rescission of SFAS Nos. 4, 44, and 64,
Amendment of SFAS No. 13, and Technical Corrections. SFAS No. 145 rescinds
SFAS No. 4, Reporting Gains and Losses from Extinguishment of Debt, and an
amendment of that Statement, SFAS No. 64, Extinguishments of Debt Made to
Satisfy Sinking-Fund Requirements, as well as SFAS No. 44, Accounting for
Intangible Assets of Motor Carriers. This Statement also amends SFAS No. 13,
Accounting for Leases, to eliminate an inconsistency between the required
accounting for sale-leaseback transactions and the required accounting for
certain lease modifications that have economic effects that are similar to
sale-leaseback transactions. This Statement also amends other existing
authoritative pronouncements to make various technical corrections, clarify
meanings, or describe their applicability under changed conditions. We early
adopted SFAS No. 145 in the current quarter.

In June 2002, the FASB issued SFAS No. 146, Accounting for Exit or
Disposal Activities (SFAS No. 146). SFAS No. 146 addresses significant
issues regarding the recognition, measurement, and reporting of costs that are
associated with exit and disposal activities, including restructuring
activities that are currently accounted for under EITF No. 94-3, Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit
an Activity (including Certain Costs Incurred in a Restructuring). The scope
of SFAS No. 146 also includes costs related to terminating a contract that is
not a capital lease and termination benefits that employees who are
involuntarily terminated receive under the terms of a one-time benefit
arrangement that is not an ongoing benefit arrangement or an individual
deferred-compensation contract. We are required to adopt the provisions of
SFAS No. 146 effective for exit or disposal activities initiated after December
31, 2002. The provisions of EITF No. 94-3 shall continue to apply for an exit
activity initiated under an exit plan that met the criteria of EITF No. 94-3
prior to the adoption of SFAS No. 146. The effect on adoption of SFAS No. 146
will change on a prospective basis the timing of when restructuring charges are
recorded from a commitment date approach to when the liability is incurred. We
do not anticipate that the adoption of this statement will have a material
impact on our consolidated balance sheet or statement of operations.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

In the second quarter of 2002, we entered into interest rate swap
transactions (the swaps) with various investment banks. (See Note 12 of the
Notes.) The objective of entering into the swaps was to better match interest
rate risk between our investment portfolio (See Note 5 of the Notes), which
generates interest income at floating rates and our Convertible Subordinated
Notes, which bears interest at fixed rates. The swaps effectively convert the
fixed interest payments on $1.085 billion of the Convertible Subordinated Notes
to LIBOR-based floating rates. The swaps qualify for hedge accounting
treatment under SFAS No. 133. The mark-to-market accounting for the swaps in
accordance with SFAS No. 133 did not have a significant impact on our results
of operations for the three or nine months ended September 30, 2002.

There have been no other significant changes in the market risk
disclosures during the nine months ended September 30, 2002, as compared to the
discussion in Part II of our Annual Report on Form 10-K for the year ended
December 31, 2001.




Item 4. Controls and Procedures

We maintain a rigorous set of disclosure controls and procedures and
internal controls designed to ensure that information required to be disclosed
in our filings under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commissions rules and forms. Our principal executive
and financial officers have evaluated our disclosure controls and procedures
pursuant to Rule 13a  14 of the Securities Exchange Act within 90 days prior
to the filing of this Quarterly Report on Form 10-Q and have determined that
such disclosure controls and procedures are effective to timely alert them to
material information relating to our company required to be disclosed in our
filings with the Securities and Exchange Commission. Subsequent to our
evaluation, there were no significant changes in internal controls or other
factors that could significantly affect our internal controls, including any
corrective actions with regard to significant deficiencies and material
weaknesses.

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PART II




Item 1. Legal Proceedings

Reference is made to our most recent Form 10-K with respect to Item 3,
Legal Proceedings for a discussion of certain pending legal proceedings and the
matter pertaining to our Canadian subsidiary (LSI Canada). During July 2002,
we (including LSI Canada) entered into a negotiated settlement (Settlement)
with those parties who represent a substantial majority of the dissenting
shares and who were the complainants in the related claim seeking relief for
oppression. As a result and in accordance with the provisions of the
Settlement, the Court was asked by the parties to the Settlement to find and so
order that payment by LSI Canada of the proposed all-inclusive settlement
proceeds would fully satisfy the obligation of LSI Canada to pay fair value and
any related claims for interest and costs for all of the dissenting shares,
that the parties to the Settlement may bind all other dissenting shares to such
result and to order certain other actions be taken that would cause a full and
final resolution of including all claims that are or may be associated with the
matter, including a complete dismissal, with prejudice, of the related claim
for relief from oppression. The Court did issue an Order and Judgment
consistent with the parties requests, which became effective on August 30,
2002. As of September 30, 2002, the period during which any appeals could have
been made, expired. The matter has been fully and finally resolved and there
has been no material adverse effect on our company.




Item 6. Exhibits and Reports on Form 8-K

(a)  Exhibits

|     |  |                                                                                                                                                                                 
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|99.1 |  | 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.                              
|99.2 |  | 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.                              
|99.3 |  | Certification of Chief Executive Officer pursuant to pursuant to Section
302(a) of the Sarbanes-Oxley Act of 2002.                                                              
|99.4 |  | Certification of Chief Financial Officer pursuant to pursuant to Section
302(a) of the Sarbanes-Oxley Act of 2002.                                                              
|99.5 |  | LSI Logic Corporation Tender Offer Statement. (Incorporated by
reference to exhibits filed with the Registrants Schedule TO
filed on August 20, 2002)                          
|99.6 |  | LSI Logic Corporation Amendment Number 1 to Tender Offer
Statement. (Incorporated by reference to exhibits filed with the
Registrants Schedule TO filed on August 23, 2002)    
|99.7 |  | LSI Logic Corporation Amendment Number 2 to Tender Offer
Statement. (Incorporated by reference to exhibits filed with the
Registrants Schedule TO filed on September 27, 2002.)

(b)  Reports on Form 8-K

On July 25, 2002, pursuant to Items 5 and 7 to report information set
forth in the Registrants news release dated July 24, 2002.

On August 7, 2002, pursuant to Item 9 to report sworn statements of the
Registrants Principal Executive Officer, Wilfred J. Corrigan, and the
Principal Financial Officer, Bryon Look, of LSI Logic Corporation pursuant to
the Securities Exchange Commission Order No. 4-460.

On September 5, 2002, pursuant to Items 5 and 7 to report information set
forth in the Registrants news release dated September 4, 2002.

On November 5, 2002, pursuant to Items 5 and 7 to report information set
forth in the Registrants news release dated October 23, 2002.

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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: November 12, 2002 | By                                                           | /s/  Bryon Look
|                        |                                                             
|                        | Bryon LookExecutive Vice President &
Chief Financial Officer

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EXHIBIT INDEX

|        |  |                                                                                                                                                                                 
|------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  |                                                                                                                                                                                 
|Number  |  | Description                                                                                                                                                                     
|        |  |                                                                                                                                                                                 
|99.1    |  | 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.                              
|       
|       
|       
|       
|99.2    |  | 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.                              
|       
|       
|       
|       
|99.3    |  | Certification of Chief Executive Officer pursuant to pursuant to Section
302(a) of the Sarbanes-Oxley Act of 2002.                                                              
|       
|       
|       
|       
|99.4    |  | Certification of Chief Financial Officer pursuant to pursuant to Section
302(a) of the Sarbanes-Oxley Act of 2002.                                                              
|99.5    |  | LSI Logic Corporation Tender Offer Statement. (Incorporated by
reference to exhibits filed with the Registrants Schedule TO
filed on August 20, 2002)                          
|99.6    |  | LSI Logic Corporation Amendment Number 1 to Tender Offer
Statement. (Incorporated by reference to exhibits filed with the
Registrants Schedule TO filed on August 23, 2002)    
|99.7    |  | LSI Logic Corporation Amendment Number 2 to Tender Offer
Statement. (Incorporated by reference to exhibits filed with the
Registrants Schedule TO filed on September 27, 2002.)

35