Back to GetFilings.com

Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

For the Quarterly Period Ended September 28, 2003

OR

For the transition period from              to             

Commission File Number: 0-11674

LSI LOGIC CORPORATION

1621 Barber Lane
Milpitas, California 95035
(Address of principal executive offices)
(Zip code)

(408) 433-8000
(Registrant’s telephone number, including area code)

     Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YES [X]  NO [  ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act) YES [X]  NO [  ]

As of November 7, 2003, there were 379,055,880 shares of the registrant’s Common Stock, $.01 par value, outstanding.

Table of Contents

LSI LOGIC CORPORATION
Form 10-Q
For the Quarter Ended September 30, 2003
INDEX

2

Table of Contents

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

LSI LOGIC CORPORATION
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

See notes to unaudited consolidated financial statements.

3

Table of Contents

LSI LOGIC CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

(*)

Amortization of non-cash deferred stock compensation recorded in connection with acquisitions, if not shown separately, would have been included in cost of revenues, research and development and selling, general and administrative expenses as shown below:

See notes to unaudited consolidated financial statements.

4

Table of Contents

LSI LOGIC CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

See notes to unaudited consolidated financial statements.

5

Table of Contents

LSI LOGIC CORPORATION
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 — BASIS OF PRESENTATION

     In the opinion of LSI Logic Corporation (the “Company” or “LSI”), the accompanying unaudited consolidated financial statements contain all adjustments (consisting only of normal recurring adjustments, additional excess inventory and other related charges, in-process research and development and restructuring and other items, net as discussed in Note 3 to the Unaudited Consolidated Financial Statements, hereafter referred to as the Notes), necessary to present fairly the financial information included herein. While the Company believes that the disclosures are adequate to make the information not misleading, it is suggested that these financial statements be read in conjunction with the audited consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.

     For financial reporting purposes, the Company reports on a 13 or 14-week quarter with a year ending December 31. The current quarter ended September 28, 2003. For presentation purposes, the consolidated financial statements refer to the quarter’s calendar month end for convenience. The results of operations for the quarter ended September 30, 2003, 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.

Recent Accounting Pronouncements

     In January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.” FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective immediately for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 were to be applied for the first interim or annual period beginning after June 15, 2003. In October 2003, the FASB released a FASB Staff Position (FSP) deferring the effective date for applying the provisions of FIN 46. A public entity need not apply the provisions of FIN 46 to an interest held in a variable interest entity or potential variable interest entity until the end of the first interim or annual period ending December 15, 2003 (as of December 31, 2003, for an entity with a calendar year-end or quarter-end of December 31). On March 28, 2003, the Company entered into new operating leases to refinance the old leases. See Note 12 of the Notes. The Company refinanced these leases in a manner that best met the Company’s capital financing strategy, and cost of capital objectives and the new leases are not subject to the consolidation provisions of FIN 46. The Company believes that the adoption of this standard will not have a material impact on its consolidated balance sheet or statement of operations.

     In November 2002, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” EITF Issue No. 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF Issue No. 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of this standard did not have a material impact on the Company’s consolidated balance sheet or statement of operations.

     In May 2003, the EITF reached a consensus on Issue No. 03-05, “Applicability of AICPA Statement of Position 97-2 to Non-Software Deliverables in an Arrangement Containing More-Than-Incidental Software.” EITF Issue No. 03-05 provides guidance on whether non-software deliverables included in arrangements that contain more-than-incidental software are included within the scope of SOP 97-2. This issue does not address the allocation of the overall fee to the software and the non-software elements of the arrangement. This Issue does not address the determination of whether the software is more than incidental but assumes that an arrangement includes software that is more than incidental to the products or services as a whole.

6

Table of Contents

The provisions of EITF Issue No. 00-21 will apply to new revenue arrangements entered into after the beginning of an entity reporting period beginning after August 13, 2003. The adoption of this standard is not expected to have a material impact on the Company’s consolidated balance sheet or statement of operations.

     In April 2003, the FASB issued Statement No. 149 (“SFAS No. 149”), “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments by requiring that contracts with comparable characteristics be accounted for similarly. In particular, this statement clarifies the circumstances under which a contract with an initial net investment meets the characteristics of a derivative, clarifies when a derivative contains a financing component, amends the definition of an underlying to conform it to the language used in FIN 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” and amends certain other existing pronouncements. The provisions of SFAS No. 149, which were not already applied under an Implementation Issue, are effective for contracts entered into or modified after June 30, 2003. The adoption of this standard did not have a material impact on the Company’s consolidated balance sheet or statement of operations.

     In May 2003, the FASB issued Statement No. 150 (“SFAS No. 150”), “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS No. 150 establishes standards for classification and measurement of certain financial instruments with characteristics of both liabilities and equity. It requires financial instruments within its scope be classified as a liability (or an asset in some circumstances). Many of those financial instruments were previously classified as equity. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003. For financial instruments created before and still existing as of the issuance of this statement, a cumulative effect of change in accounting principle shall be reported upon implementation in the first interim period beginning after June 15, 2003. The adoption of this standard did not have a material impact on the Company’s consolidated balance sheet or statement of operations.

     In August 2003, the EITF reached a consensus on Issue No. 03-11, “Reporting Realized Gains and Losses on Derivative Instruments That are Subject to FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, and Not “Held for Trading Purposes” as Defined in EITF Issue No. 02-03, “Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities.” This issue addresses whether realized gains and losses should be shown gross or net in the income statement for contracts that are not held for trading purposes, but are derivatives subject to FASB Statement No. 133 (whether or not the derivative is designated as a hedging instrument). The provisions of EITF Issue No. 03-11 will be applied to derivative instruments entered into during reporting periods beginning after August 13, 2003. The adoption of this standard is not expected to have a material impact on the Company’s consolidated balance sheet or statements of operations.

NOTE 2 — STOCK-BASED COMPENSATION

     The Company adopted the disclosure requirements of Statement of Financial Accounting Standards No. 148 (“SFAS No. 148”) as of December 31, 2002. These disclosure requirements include more prominent presentation, in a tabular format, of the pro forma effect of using the fair value method of accounting for stock-based employee compensation in interim and annual financial statements. The following table provides pro forma disclosures as if the Company had recorded compensation costs based on the estimated grant date fair value, as defined by SFAS No. 123, for awards granted under its stock option and stock purchase plans. The estimated weighted-average grant date fair value, as defined by SFAS No. 123, was calculated using the Black-Scholes model. The Black-Scholes model was developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Company’s stock option awards. These models also require highly subjective assumptions, including future stock price volatility and expected time until exercise, which greatly affect the calculated grant date fair value.

*     This amount excludes amortization of non-cash deferred stock compensation on restricted stock awards.

7

Table of Contents

     For the three and nine months ended September 30, 2003, common stock equivalents of approximately 110.4 million and 90.2 million shares, respectively, were excluded from the computation of pro forma diluted loss per share as a result of their antidilutive effect. For the three and nine months ended September 30, 2002, common stock equivalents of approximately 59.6 million and 76.1 million shares, respectively, were excluded from the computation of pro forma diluted loss per share as a result of their antidilutive effect.

NOTE 3 — RESTRUCTURING AND OTHER ITEMS

     The Company recorded charges of $25 million and $185 million for restructuring of operations and other items for the three and nine months ended September 30, 2003, respectively. The Company recorded charges of $13 million and $72 million for restructuring of operations and other items for the three and nine months ended September 30, 2002, respectively. For a complete discussion of the 2002 restructuring actions, please refer to the Company’s Annual Report on Form 10-K.

     Restructuring and impairment of long-lived assets:

     On January 1, 2003, the Company adopted SFAS No. 146, “Accounting for Exit or Disposal Activities.” SFAS No. 146 has been applied to restructuring activities initiated after December 31, 2002 and changes the timing of when restructuring charges are recorded to the date when the liabilities are incurred. The adoption of SFAS No. 146 did not affect restructuring reserves recorded prior to December 31, 2002.

     First quarter of 2003:

     In February 2003, the Company downsized operations and recorded $36 million in charges for restructuring of operations and other items. Of this charge, $21 million was associated with the Semiconductor segment and $15 million was attributable to the Storage Systems segment. The charges consisted of severance and termination benefits for approximately 210 employees primarily involved in manufacturing operations, research and development and marketing and sales; costs associated with exiting certain operating leases primarily for real estate; and a write-down of certain acquired intangibles and other long-lived assets. During the nine months ended September 30, 2003, payments related to the February 2003 restructuring actions consisted of approximately $4 million for severance and termination benefits and $0.5 million for lease and contract terminations.

     Second quarter of 2003:

     In April 2003, the Company announced a restructuring of its operations that included a reduction in workforce and the consolidation of certain non-manufacturing facilities. A charge of $33 million was recorded in the Semiconductor segment consisting of severance and termination benefits for approximately 325 employees involved in manufacturing operations, research and development, marketing, sales and administration; costs associated with exiting certain operating leases primarily for real estate; other exit costs; and a write-down of fixed assets due to impairment. During the nine months ended September 30, 2003, payments related to the April 2003 restructuring actions consisted of approximately $8 million for severance and termination benefits and $2 million for lease and contract terminations.

     In June 2003, the Company announced the decision to sell the Tsukuba, Japan manufacturing facility. During the second quarter, a charge of $73 million was recorded in the Semiconductor segment to write down fixed assets to their fair market value, and reclassify the fair value from property, plant and equipment to other current assets to reflect the intention to dispose of the facility within the next twelve months. In addition, approximately $2 million in restructuring charges were recorded in the second quarter for severance and other exit costs. See further discussion in the third quarter below.

     In June 2003, the Company also recorded $19 million of additional fixed asset write-downs to reflect the decrease in fair market value of the assets during the period. This write-down included a reduction in the value of the Colorado Springs fabrication facility of $16 million to reflect continued and accelerated efforts to sell the facility.

8

Table of Contents

     Third quarter of 2003:

     Agreement to sell Japan fabrication facility:

     In September 2003, the Company entered into a definitive agreement to sell the Tsukuba, Japan facility to Rohm Company Ltd. (“Rohm”), a Japanese company, for 2.65 billion yen ($23.7 million as of September 30, 2003). The transaction is scheduled to close in the fourth quarter of 2003. As part of the definitive agreement, the Company agreed to purchase a minimum amount of production wafers from Rohm for a period of 15 months following the close of the transaction. As a result, a charge of approximately $4 million was recorded in cost of revenues during the third quarter of 2003. This charge is a result of the application of our policy to accrue for non-cancelable inventory purchase commitments in excess of 12 months of judged demand. Included in the $4 million charge to cost of revenues is a reclassification of $3 million from restructuring expense originally recorded in the second quarter of 2003 to better reflect the terms of the definitive agreement. Also in the quarter, $2 million was recorded for additional severance benefits to be paid and for contract termination and other exit costs associated with the definitive agreement. During the nine months ended September 30, 2003, there were no payments related to the amounts accrued for severance and other exit costs for the Japan restructuring actions.

     Other third quarter 2003 restructuring actions:

     In the third quarter of 2003, the Company continued to consolidate non-manufacturing facilities and recorded $2 million for costs associated with exiting certain operating leases for real estate as the facilities ceased being used.

     In September 2003, the Company decided to discontinue development programs and to refocus sales and marketing efforts for certain product lines in the Semiconductor segment. As a result of an analysis of future net cash flows related to the affected product lines, it was determined that certain acquired intangible assets were impaired. An impairment charge of $21 million related to the write-down of the acquired intangible assets to fair market value was recorded in the third quarter of 2003. These intangible assets were originally acquired in connection with the acquisition of C-Cube Microsystems in the second quarter of 2001. In addition, $2 million in restructuring charges were recorded in the third quarter of 2003. These charges related to severance and termination benefits for approximately 97 employees primarily involved in research and development and for certain contract termination costs. The severance benefits were paid during the third quarter of 2003.

     The fair value of equipment, facilities and intangible assets determined to be impaired was the result of 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 carrying value of the assets held for sale. The Company reassesses the realizability of the carrying value of these assets at the end of each quarter until the assets are sold or otherwise disposed of and additional adjustments may be necessary. Assets held for sale of $59 million and $74 million were included as a component of prepaid expenses and other current assets as of September 30, 2003 and December 31, 2002, respectively. Assets classified as held for sale are not depreciated.

     The following table sets forth the Company’s restructuring reserves as of September 30, 2003, which are included in other accrued liabilities on the balance sheet:

9

Table of Contents

(a)		The amounts utilized in 2003 reflect $145.1 million of non-cash write-downs of amortizable intangible and other long-lived assets in the U.S and Japan due to impairment, and $1.7 million in cash payments to decommission and sell assets. The write-downs of the intangible and other long-lived assets were accounted for as a reduction of the assets and did not result in a liability. The $4.3 million balance as of September 30, 2003, relates to machinery and equipment decommissioning costs in the U.S and estimates of selling costs for assets held for sale and is expected to be utilized during 2003.
(b)		Amounts utilized represent cash payments. The balance remaining for primarily real estate lease terminations and maintenance contracts will be paid during the remaining terms of these contracts, which extend through 2011.
(c)		Amounts utilized represent cash payments. The balance remaining for facility closure and other exit costs will be paid during 2003.
(d)		Amounts utilized represent cash severance payments to approximately 604 employees during the nine months ended September 30, 2003. The balance remaining for severance is expected to be paid by the end of the first quarter of 2004.

     Other items:

     A gain of approximately $2 million was recorded in restructuring and other items, net during the second quarter of 2003 associated with additional sales of intellectual property associated with the CDMA handset product line.

NOTE 4 —INVESTMENTS

     An unrealized gain on available-for-sale securities of $7 million, net of the related tax effect of $4 million, and $3 million, net of the related tax effect of $1 million, was included in accumulated other comprehensive income as of September 30, 2003 and December 31, 2002, respectively. Net realized gains on sales of available-for-sale debt securities were $0.1 million and $9 million for the three and nine months ended September 30, 2003, respectively. Net realized gains on available-for-sale debt securities were $5 million and $6 million for the three and nine months ended September 30, 2002, respectively.

     During the three months ended September 30, 2003, the Company realized a pre-tax loss of $0.4 million associated with certain investments in equity securities because management believed the decline in value was other than temporary. All of this pre-tax loss is related to losses from non-marketable equity securities accounted for under the cost method. During the nine months ended September 30, 2003, the Company realized a pre-tax loss of $10.5 million associated with certain investments in equity securities because management believed the decline in value was other than temporary. Of this pre-tax loss, approximately, $2.7 million related to marketable equity securities accounted for as available-for-sale and approximately $7.8 million related to losses from non-marketable equity securities accounted for under the cost method.

     During the three months ended September 30, 2002, the Company realized a pre-tax loss of $9.9 million associated with certain investments in equity securities because management believed the decline in value was other than temporary. Of this pre-tax loss, approximately, $5.5 million related to marketable equity securities accounted for as available-for-sale securities and approximately, $4.4 million related to losses from non-marketable equity securities accounted for under the cost method. During the nine months ended September 30, 2002, the Company realized a pre-tax loss of $12.0 million associated with certain investments in equity securities because management believed the decline in value was other than temporary. Of this pre-tax loss, approximately, $5.5 million related to marketable equity securities accounted for as available-for-sale securities and approximately $6.5 million related to losses from non-marketable equity securities accounted for under the cost method.

     For marketable equity securities, the impairment losses were measured using the closing market price of the marketable securities on the date management determined that the investments were impaired. For non-marketable equity securities, the impairment losses were measured using the “down” financing pricing.

     In order to determine if an impairment has occurred, the Company reviews the financial performance of each investee, industry performance and outlooks for each investee, the trading prices of marketable securities and the “down” financing pricing for non-marketable equity securities.

     The carrying value of the above noted impaired marketable and non-marketable equity investments, as of September 30, 2003 was $3.7 million and $6.2 million, respectively.

NOTE 5 — DERIVATIVE FINANCIAL INSTRUMENTS

Foreign currency risk

     The Company 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 interest income and other, net. During the second quarter of 2003, the Company terminated all outstanding purchased currency options hedging previously forecasted yen revenues because the underlying revenue agreements were modified to be denominated in U.S. dollars. At the time the options were terminated, there were no unrealized gains

10

Table of Contents

or losses in accumulated other comprehensive income. The change in option time value was approximately $1 million for the nine months ended September 30, 2003. For the nine months ended September 30, 2002, the change in option time value was not significant. During the nine months ended September 30, 2003 and 2002, amounts reclassified to revenue were not significant. The Company did not record any gains or losses due to hedge ineffectiveness for the nine months ended September 30, 2003 and 2002. There were no option contracts outstanding as of December 31, 2002. There were no unrealized gains or losses included in accumulated other comprehensive income as of September 30, 2003 or December 31, 2002.

     The Company enters into forward contracts that are designated as foreign currency cash-flow hedges of forecasted payments in euros. Changes in the fair value of the forward contracts due to changes in time value are excluded from the assessment of effectiveness and are recognized in interest income and other, net. As of September 30, 2003, the Company held forward contracts designated as foreign currency cash flow hedges of forecasted euro payment transactions that were set to expire over a three month period. There were no such hedges outstanding as of December 31, 2002. For the three and nine months ended September 30, 2003, the change in time value of these forward contracts was not significant. The unrealized gains included in accumulated other comprehensive income as of September 30, 2003, which will be reclassified to interest income and other, net over the next three months, were not significant. The amounts reclassified to the income statement for the three and nine months ended September 30, 2003 were not significant. The Company did not record any gains or losses due to hedge ineffectiveness for the nine months ended September 30, 2003.

     Forward exchange contracts and options are also used to hedge certain foreign currency-denominated assets or liabilities. These derivatives do not qualify for SFAS No. 133 hedge accounting treatment. Accordingly, changes in the fair value of these hedges are recorded immediately in earnings to offset the changes in fair value of the assets or liabilities being hedged. The related gains and losses included in interest income and other, net were not significant.

     In October 2003, the Company entered into a forward contract to protect the U.S. dollar value of a portion of the net investment in the Company’s wholly owned Japanese subsidiary denominated in yen. The derivative has been designated as and qualifies as a net investment hedge and will be recorded as an asset or liability in the statement of financial position. Effective changes in the value of the derivative will be recorded to the accumulated other comprehensive income until the substantial liquidation of the subsidiary. The time value of the forward contract is excluded from the assessment of hedge effectiveness.

Interest rate risk

     With the objective of protecting cash flows and earnings of the Company from the impact of fluctuations in interest rates, while minimizing the cost of capital, the Company may enter into or terminate interest rate swaps, such as the below mentioned transactions.

     In the second quarter of 2003, the Company terminated interest rate swaps (the “Swaps”) with a notional amount of $740 million. The unrecognized gain of $44 million from the termination of these Swaps was included as a component of the Convertible Notes and is being amortized as an adjustment to interest expense over the remaining term of the hedged Convertible Notes (see Note 7). The Swaps had effectively converted fixed interest payments on a portion of the Company’s 4% and 4.25% Convertible Subordinated Notes (“Convertible Notes”) to LIBOR-based floating rates. Under the terms of the Swaps, the Company provided collateral to match any mark-to-market exposure on the Swaps. The Swaps qualified for hedge accounting as fair value hedges, with changes in the fair value of the interest rate risk on the Convertible Notes being offset by changes in the fair values of the Swaps recorded as a component of interest expense. The difference between the changes in the fair values of the derivative and the hedged risk resulted in a benefit to interest expense of $1 million for the nine months ended September 30, 2003. For the nine months ended September 30, 2002, a charge to interest expense for the difference between the changes in the fair values of the derivative and the hedged risk was not significant. Collateral of approximately $7 million included in other long-term assets as of December 31, 2002, was returned to the Company upon termination of the Swaps.

     In the second quarter of 2003, the Company entered into an interest rate swap transaction to effectively convert the LIBOR-based floating rate interest payments on the equipment operating leases discussed in Note 12, with an initial notional amount of $395 million, to a fixed interest rate (the “Lease Swap”). The Lease Swap qualifies to be accounted for as a cash flow hedge of the forecasted interest payments attributable to the benchmark interest rate on the equipment operating leases through September 2006. The unrealized gains or losses included in accumulated other comprehensive income will be reclassified to cost of revenues on a quarterly basis as lease payments are made. A loss of approximately $2 million, net of tax of $1 million included in accumulated other comprehensive income as of September 30, 2003, is expected to be reclassified to cost of revenues within the next 12 months. The loss due to ineffectiveness recorded in interest income and other, net during the three and nine months ended September 30, 2003 was not significant. Under the terms of the Lease Swap, the Company must provide collateral to match any mark-to-market exposure on the swap. As of September 30, 2003, collateral of approximately $8 million was included in other long-term assets.

11

Table of Contents

NOTE 6 — BALANCE SHEET DETAIL

     The Company monitors the recoverability of goodwill recorded in connection with acquisitions annually, or sooner if events or changes in circumstances indicate that the carrying amount may not be recoverable. An impairment, if any, would be determined in accordance with SFAS No. 142, which uses a fair value model for determining the carrying value of goodwill. See the Company’s Annual Report on Form 10-K for further discussion.

12

Table of Contents

NOTE 7 — DEBT

*

The interest rate payable on a portion of the Convertible Subordinated Notes was converted to floating rates through interest rate swaps. Interest rate swaps with a notional amount of $740 million were terminated in the second quarter of 2003 (see Note 5). The weighted average interest rate payable on the Convertible Subordinated Notes, after adjusting for the impact of the interest rate swaps was 4.02% and 2.16% for the three months ended September 30, 2003 and 2002, respectively, and 4.55% and 3.38% for the nine months ended September 30, 2003 and 2002, respectively.

     On September 18, 2003, the Company redeemed the balance of the 1999 Convertible Subordinated Notes (the “1999 Convertible Notes”) that were outstanding on that date. Cash of $173 million was paid to redeem the remaining 1999 Convertible Notes at a total redemption price of $1,008.86 per $1,000 principal amount of the notes consisting of $1,008.50 principal amount plus accrued interest of $0.36. A net pre-tax loss of $1 million was recognized, in interest income and other, net, on the redemption of the 1999 Convertible Notes. The pre-tax loss is net of the write-off of debt issuance costs and the remaining deferred gain on the terminated Swap (see Note 5).

     On May 12, 2003, the Company issued $350 million of 4% Convertible Subordinated Notes (the “2003 Convertible Notes”) due in 2010. The 2003 Convertible Notes are subordinated to all existing and future senior debt, are convertible at the holder’s option at any time prior to the maturity date of such notes, into shares of the Company’s common stock at a conversion price of $13.42 per share. The Company cannot elect to redeem the 2003 Convertible Notes prior to maturity. However, each holder of the 2003 Convertible Notes has the right to cause the Company to repurchase all of such holder’s convertible notes at 100% of their principal amount plus accrued interest upon the occurrence of any fundamental change, which includes a transaction or event such as an exchange offer, liquidation, tender offer, consolidation, merger or combination. Interest is payable semiannually. The Company paid approximately $10.9 million in debt issuance costs that are being amortized using the interest method.

     Approximately $28 million of the proceeds from issuance of the 2003 Convertible Notes were used to purchase call spread options on LSI’s common stock (the “Call Spread Options”). The Call Spread Options, including fees and costs, have been accounted for as capital transactions in accordance with Emerging Issues Task Force No. 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.” The Call Spread Options cover approximately 26.1 million shares of Company common stock, which is the number of shares that are initially issuable upon conversion of the 2003 Convertible Notes in full.

13

Table of Contents

The Call Spread Options are designed to mitigate dilution from conversion of the 2003 Convertible Notes in the event that the market price per share of the Company’s common stock upon exercise of the Call Spread Options is greater than $13.42 and is less than or equal to $23.875. The Call Spread Options may be settled at the Company’s option in either net shares or in cash and expire in 2010. Settlement of the Call Spread Options in net shares on the expiration date would result in the Company receiving a number of shares, not to exceed 26.1 million shares, of our common stock with a value equal to the amount otherwise receivable on cash settlement. Should there be an early unwind of the Call Spread Options, the amount of cash or net shares potentially received by the Company will be dependent upon then existing overall market conditions, and on the Company’s stock price, the volatility of the Company’s stock and the amount of time remaining on the Call Spread Options.

     The proceeds from the 2003 Convertible Notes were used to repurchase $153 million of the 1999 Convertible Subordinated Notes and $135 million of the 2000 Convertible Subordinated Notes. A net pre-tax loss of $2 million was recognized, in interest income and other, net, on the repurchases of the 1999 and 2000 Convertible Notes. The pre-tax loss is net of the write-off of debt issuance costs and a portion of the deferred gain on the terminated Swaps (see Note 5).

NOTE 8 — COMMON STOCK

     Stock option plans. In May 2003, the stockholders approved an amendment to the Amended 1995 Director Option Plan to increase the number of shares of common stock reserved for issuance there under by one million. As of September 30, 2003, 1.1 million shares were available for future grants under the Amended 1995 Director Option Plan.

     In May 2003, the stockholders approved the adoption of the 2003 Equity Incentive Plan (“2003 Plan”) under which 11 million shares of common stock were reserved for issuance. Under the terms of the 2003 Plan, the Company may grant stock options or restricted stock awards to employees with an exercise price that is no less than the fair market value of the stock on the date of grant. No participant shall be granted options covering more than 2 million shares in any year. The term of each option is determined by the Board of Directors and is usually ten years. Options generally vest in annual increments of 25% per year commencing one year from the date of grant. Under the 2003 Plan, the Company may also grant restricted stock awards. No participant may be granted more than 0.5 million shares of restricted stock in any year. The vesting requirements for the restricted stock awards are determined by the Board of Directors. As of September 30, 2003, there were 11 million shares available for future grants under the 2003 Plan.

     Stock option exchange program. On August 20, 2002, the Company filed with the Securities Exchange Commission 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 under the 1999 Nonstatutory Stock Option Plan. Directors and executive officers of the Company were not eligible to participate in this program. The exchange offer expired September 18, 2002, and the Company accepted options to purchase an aggregate of 16,546,370 shares for exchange. On March 20, 2003, the Company granted a new option that covered two shares of LSI Logic common stock for every three shares covered by an option that an employee had elected to exchange. The exercise price per share of the new options was equal to the fair market value of the Company’s common stock on the grant date. The Company granted options to purchase 10,691,139 shares at an exercise price of $5.06 per share. The exchange program did not result in the recording of any compensation expense in the statement of operations.

14

Table of Contents

NOTE 9 — 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: