UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

|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

Commission file number 1-10079

CYPRESS SEMICONDUCTOR CORPORATION
(Exact name of registrant as specified in its charter)

3901 North First Street, San Jose, California 95134-1599
(Address of principal executive offices and zip code)

(408) 943-2600
(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 |_|

The total number of shares of the registrant’s common stock outstanding as of October 27, 2002 was 123,789,538.

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INDEX

PART I – FINANCIAL INFORMATION

PART II – OTHER INFORMATION

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PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CYPRESS SEMICONDUCTOR CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
(Unaudited)

ASSETS

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

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CYPRESS SEMICONDUCTOR CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

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CYPRESS SEMICONDUCTOR CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

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CYPRESS SEMICONDUCTOR CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
For the Quarter Ended September 29, 2002
(Unaudited)

Note 1 - Summary of Significant Accounting Policies

Fiscal Year

Cypress Semiconductor Corporation (“Cypress”) reports on a fiscal basis and ends its quarters on the Sunday closest to the end of the applicable calendar quarter. The three-month periods ended September 29, 2002 (“Q3 2002”), June 30, 2002 (“Q2 2002”), March 31, 2002 (“Q1 2002”), September 30, 2001 (“Q3 2001”), July 1, 2001 (“Q2 2001”) and April 1, 2001 (“Q1 2001”) all included thirteen weeks. The results of operations for the three and nine months ended September 29, 2002 are not necessarily indicative of the results to be expected for the full year.

Basis of Presentation

In the opinion of the management of Cypress, the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting solely of normal recurring adjustments) necessary to present fairly the financial information included therein. Certain prior year amounts have been reclassified to conform to current year presentation. Cypress believes that the disclosures are adequate to make the information not misleading. However, this financial data should be read in conjunction with the audited consolidated financial statements and related notes thereto included in Cypress’s Annual Report on Form 10-K for the fiscal year ended December 30, 2001.

The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

Goodwill and Purchased Intangibles

In July 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) Nos. 141 and 142, “Business Combinations” and “Goodwill and Other Intangible Assets,” respectively. SFAS No. 141 replaced Accounting Principles Board (“APB”) Opinion No. 16 and eliminated pooling-of-interests accounting prospectively for all business combinations initiated after June 30, 2001. It also provided guidance on purchase accounting related to the recognition of intangible assets and accounting for negative goodwill. SFAS No. 142 changed the accounting for goodwill from an amortization method to an impairment-only fair-value-approach. Under SFAS No. 142, Cypress discontinued amortizing the remaining balances of goodwill as of the beginning of the 2002 fiscal year. Goodwill is now required to be tested annually and whenever events or circumstances occur indicating that goodwill might be impaired. All identifiable intangibles will continue to be amortized over their remaining useful lives and assessed for impairment under SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”.

In connection with the adoption of SFAS No. 142, effective the beginning of fiscal 2002, Cypress stopped amortizing goodwill and performed a transitional goodwill impairment assessment and determined that there was no impairment of goodwill. Cypress will complete its required annual assessment in the fourth quarter of 2002.

In addition, upon adoption of SFAS No. 142, workforce-in-place no longer meets the definition of an identifiable asset. As a result, the net balance of $11.5 million, including associated deferred tax liabilities, previously classified as purchased intangible assets has been reclassified to goodwill in 2002.

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A reconciliation of previously reported net loss and net loss per share to the amounts adjusted for the exclusion of goodwill and workforce-in-place amortization, net of the related income tax effect, for the three and nine months ended September 30, 2001 is as follows:

Recent Accounting Pronouncements

In May 2002, the FASB issued SFAS No. 145, “Rescission of FAS Nos. 4, 44, and 64, Amendment of FAS No. 13, and Technical Corrections.” Among other things, SFAS No. 145 rescinds various pronouncements regarding early extinguishment of debt and allows extraordinary accounting treatment for early extinguishment only when the provisions of APB Opinion No. 30, “Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions” are met. Cypress adopted SFAS No. 145 in Q2 2002 and has, accordingly, reclassified an extraordinary gain from Q1 2002 to Other income and expense, net related to the repurchase of Convertible Subordinated Notes (“3.75% Notes”). (See further discussion in Note 6.)

In July 2002, the FASB issued SFAS No. 146, “Accounting for Exit or Disposal Activities.” SFAS No. 146 addresses the recognition, measurement and reporting of costs associated with exit and disposal activities, including restructuring activities that are currently accounted for pursuant to the guidance set forth in Emerging Issues Task Force (“EITF”) Issue 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 includes costs related to terminating a contract that is not a capital lease, costs to consolidate facilities or relocate employees, and certain termination benefits provided to employees who are involuntarily terminated. SFAS No. 146 is effective for exit or disposal activities initiated after December 31, 2002. SFAS No. 146 is applied prospectively upon adoption and, as a result would not have a material impact on Cypress’s current financial position or results of operations.

Note 2 - Acquisitions

Acquisition of Sahasra Networks, Inc.

On February 28, 2002, Cypress acquired 100% of the outstanding capital stock of Sahasra Networks, Inc. (“Sahasra”), a company working on a software-based method of making large-entry, next generation network search engines, for $3.2 million in cash and Cypress common stock. Sahasra is part of the Non-memory business segment and the Wide Area Network/Storage Area Network (“WAN/SAN”) market segment. The acquisition resulted in identifiable intangible assets of $2.7 million and a charge for in-process research and development of $0.5 million.

The agreement with Sahasra includes provisions for additional contingent cash payments to employees and third parties of up to $2.3 million through December 2005 based on the amount of revenues generated by certain products in future periods. Additional provisions are included for the contingent issuance of up to 0.3 million shares of Cypress common stock through December 2004 based on the achievement of certain product development milestones. Cash payments or the issuance of shares contingent upon the payees remaining employed by Cypress will be accounted for as compensation for services and expensed in the appropriate periods. Cash payments to third parties based solely on product revenues will be recorded as an increase in the purchase price, if paid.

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Pro forma results of operations have not been presented because the historical results of operations of Sahasra are not material to Cypress’s consolidated results of operations.

Purchased Intangibles

The following tables present details of Cypress’s total purchased intangible assets:

Amortization charges associated with these acquired intangibles and other acquisition-related costs for the three months and nine months ended September 29, 2002 were $10.6 million and $32.1 million, respectively, and are included in acquisition costs in the condensed consolidated statements of operations. The estimated annual amortization expense of purchased intangible assets is as follows:

Contingent milestone/revenue-based compensation charges related to acquisitions for the three and nine months ended September 29, 2002 are $1.1 million and $12.7 million, respectively, and are included in research and development in the condensed consolidated statements of operations. The aggregate amount of contingent compensation that could be paid under all acquisition agreements assuming all milestones are met is $124.3 million as of September 29, 2002. However, Cypress expects that the ultimate amounts paid out will be substantially less than this figure.

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Note 3 - Restructuring Costs and Credits

On July 16, 2001, Cypress announced a restructuring plan that involved resizing its manufacturing facilities, reducing its workforce and combining facilities. The restructuring was precipitated by the worldwide economic slowdown, particularly in the business areas in which Cypress operates. The intended effect of the plan was to size the manufacturing operations and facilities to meet future demand and reduce expenses in all operations areas. During the third quarter of 2001, Cypress recorded restructuring charges of $132.1 million related to property, plant and equipment, leased facilities and personnel.

In connection with the July 16, 2001 announcement, in the third quarter of 2001, Cypress removed from service and held for sale equipment with a net book value of $122.1 million, resulting in a charge of $113.4 million. Cypress has actively marketed the equipment, but have had limited success to date in selling this equipment. Through September 29, 2002, the Company has sold equipment with a net book value (after write-off) of $29.7 million and placed back into service equipment having a net book value of $24.7 million. The proceeds from the sales of the assets approximated their carrying values. In the second and third quarters of 2002, Cypress placed back into service certain of these assets previously recorded as held for sale. The assets were needed to meet increased production requirements resulting from a substantial increase in unit demand versus our initial assumptions at the time of the Q3 2001 restructuring. When the assets were put back into service, they were written up to their prior cost basis (an adjustment of $13.2 million and $9.5 million in Q2 2002 and Q3 2002, respectively) reduced for depreciation expense that would have been recorded during the period the asset was removed from service (an adjustment of $2.9 million and $2.6 million in Q2 2002 and Q3 2002, respectively), as required by SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.” The net effect of the asset adjustment was a credit of $10.3 million and $7.0 million in Q2 2002 and Q3 2002, respectively. In the first quarter of 2002, Cypress sold and then leased back certain other pieces of equipment classified as held for sale. The proceeds from the sales of the assets approximated their net carrying values. If additional assets are placed back into service, Cypress will have to reverse previously recorded impairment charges in future periods. Cypress continues to actively market the remaining assets held for sale.

A restructuring charge of $1.6 million was recorded in Q1 2002 for additional cost reductions identified as part of the personnel portion of the Q3 2001 restructuring plan. The charge related to severance and related employee benefit costs for the termination of approximately 250 employees, the majority of whom were located in the Philippines facility. As of the end of Q3 2002, 103 of these employees had left Cypress.

In the third quarter of 2002, Cypress recorded net restructuring costs of $2.4 million, which comprised a charge of $9.4 million offset by a $7.0 million reversal for previously written-down equipment put back into service. The charge of $9.4 million consisted of $3.3 million for work force reductions for 71 employees, and included severance, benefit costs and stock compensation, $3.4 million for capital equipment removed from service and held for sale and $2.8 million for the exiting of facility leases. At the end of Q3 2002, 46 of the employees had left Cypress. Cypress closed two design centers resulting in workforce, equipment and facility lease charges and adjusted certain Q3 2001 estimates for lease accruals based upon current depressed market conditions. The charge of $9.4 million was offset by $7.0 million of previously written-down equipment put back into service to support an increase in demand for certain products that was not foreseen at the time of the initial restructuring of the equipment in Q3 2001, as discussed above.

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The following table summarizes the activity associated with the restructuring liabilities and asset write-downs since the inception of the restructuring plan in the third quarter of 2001:

Note 4 - Balance Sheet Components

Cash and Investments

Inventories, Net

Other Current Assets

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Other Assets

Other Current Liabilities

Note 5 - Commitments and Contingencies

Legal Matters

In January 2002, Cypress was contacted by Syndia Corp., which alleged that Cypress infringed two patents on which Jerome Lemelson was named as the inventor (see the Lemelson Partnership discussion below). These two patents are related to three of the non-stayed patents in the Lemelson Partnership litigation in Arizona. Cypress has reviewed and investigated the allegations by Syndia. Cypress believes that it has meritorious defenses to these allegations, and will vigorously defend itself in this matter. However, because of the nature and inherent uncertainties of litigation, should Syndia sue Cypress and should the outcome of the action be unfavorable, Cypress’s business, financial condition, results of operations and cash flows could be materially and adversely affected.

In July 2001, Cypress filed a complaint in the United States International Trade Commission (ITC) against Integrated Circuit Systems, Inc. (ICS) and Pericom Semiconductor Corporation (Pericom) for infringement of one of its U.S. patents. The ITC subsequently instituted an investigation based upon Cypress’s complaint. In December 2001, Cypress settled this dispute with Pericom. In November 2001, ICS filed a complaint in the ITC against Cypress for infringement of two U.S. patents, one of which is also asserted against Cypress in an earlier-filed action in California (see below), the other of which (U.S. Patent No. 5,703,537) ICS voluntarily withdrew from the ITC proceedings following its motion that ICS’ own product data sheets invalidated ICS’ asserted claim. In March 2001, Cypress filed a complaint in the United States District Court for the District of Delaware against ICS for infringement of three of its U.S. patents. In April 2001, ICS filed a complaint in the United States District Court for the Northern District of California against Cypress. Cypress has resolved its disputes with ICS. Pursuant to a settlement agreement between the parties, the Delaware and California suits were dismissed with prejudice in August of 2002, and the administrative law judge in the ITC suit issued an order terminating the investigations in August 2002. The settlement agreement with ICS did not have a material effect on Cypress’s business, financial position, results of operations or cash flows.

On November 16, 2000, Momentum, Inc. filed a complaint in the Santa Clara County Superior Court against Cypress for breach of warranty and deceit, in which it seeks consequential, indirect and punitive damages and costs. In February 2001, the Momentum complaint was dismissed, but they were given 30 days to refile. Momentum filed its Amended Complaint on April 16, 2001. Cypress has resolved its disputes with Momentum as of September 2002, and a stipulation to dismiss the suit with prejudice was filed in October 2002 per a settlement agreement between the parties. The settlement agreement with Momentum will not have a material effect on Cypress’s business, financial position, results of operations, or cash flows.

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In January 1998, an attorney representing the estate of Mr. Jerome Lemelson contacted Cypress and charged that Cypress infringed certain patents owned by Mr. Lemelson and/or a partnership controlled by Mr. Lemelson’s estate. On February 26, 1999, the Lemelson Partnership sued Cypress and 87 other companies in the United States District Court for the District of Arizona for infringement of 16 patents. In May 2000, the Court stayed litigation on 14 of the 16 patents in view of concurrent litigation in Nevada on the same 14 patents, brought against the Lemelson Partnership by manufacturers of machine vision and bar coding equipment. The Nevada litigation is currently scheduled to go to trial on November 18, 2002. In October 2001, the Lemelson Partnership amended its complaint to add allegations that two more patents were infringed. Thus, there are currently four patents that are not stayed in this litigation. Of the four patents that are not stayed, three are related to each other, and these three are also related to the two patents that Syndia has asserted have been infringed by Cypress (see above). Cypress has reviewed and investigated the allegations in both the original and amended complaints. Cypress believes that it has meritorious defenses to these allegations, and will vigorously defend itself in this matter. However, because of the nature and inherent uncertainties of litigation, should the outcome of this action be unfavorable, Cypress’s business, financial condition, results of operations and cash flows could be materially and adversely affected.

In February 2002, Cypress was contacted by an attorney representing Mr. Peng Tan, alleging that Cypress infringed a patent owned by Mr. Tan. Cypress has reviewed and investigated the allegations. Cypress believes it has meritorious defenses to these allegations, and will vigorously defend itself in this matter. However, because of the nature and inherent uncertainties of litigation, should Mr. Tan sue Cypress and should the outcome of the action be unfavorable, Cypress’s business, financial condition, results of operations and cash flows could be materially and adversely affected.

Cypress is currently a party to various legal proceedings, claims, disputes and litigation arising in the ordinary course of business, including those noted above. Cypress currently believes that the ultimate outcome of these proceedings, individually and in the aggregate, will not have a material adverse affect on Cypress’s financial position, results of operation or cash flows. However, because of the nature and inherent uncertainties of litigation, should the outcome of these actions be unfavorable, Cypress’s business, financial condition, results of operations and cash flows could be materially and adversely affected.

Note 6 - Debt and Equity Transactions

At September 29, 2002, Cypress had outstanding a series of equity options (on Cypress Common Stock) with an initial cost of $26.0 million, which is classified in stockholders’ equity. The contracts require physical settlement and expire in December 2002. Upon expiration of the options, if Cypress’s stock price is above the threshold price of $20 per share, Cypress will receive a settlement value totaling $28.9 million. If Cypress’s stock price is below the threshold price of $20 per share, Cypress will receive 1.4 million shares of its Common Stock. During Q3 2002, the contracts resulted in no net cash flows and for the nine months ended September 29, 2002, the contracts resulted in net cash inflows of $1.6 million.

During Q3 2002, the final put contract was closed for which Cypress received premiums of $0.2 million in Q2, 2002. Cypress took delivery of 0.3 million shares of its common stock for an aggregate price of $4.9 million. The transactions were recorded in stockholders’ equity in the condensed consolidated balance sheet.

Cypress has recorded provisions for deferred stock compensation related to acquisitions, issuance of options to third parties, and the issuance of stock options below fair value. Included in cost of revenue, selling, general and administrative expense and research and development expense in the condensed consolidated statements of operations, is deferred stock compensation expense of approximately $7.8 million and $28.1 million for three months and nine months ended September 29, 2002, respectively, and $10.4 million and $21.1 million for three months and nine months ended September 30, 2001, respectively.

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Convertible Subordinated Notes

During 2001, Cypress’s Board of Directors authorized the repurchase from time to time of up to $143.8 million of 3.75% Notes. In Q3 2002, Cypress did not repurchase any 3.75% Notes. For the nine months ended September 29, 2002, Cypress retired a total of $48.8 million principal, for $42.1 million, resulting in a pre-tax net gain of $5.9 million. The gain was net of the write-off of bond issuance costs of $0.8 million (pre-tax). The gains are included in other income and (expense), net in the condensed consolidated statements of operations. Since inception of the repurchase program in November 2001, Cypress has repurchased and retired $101.6 million in principal of the 3.75% Notes for $86.7 million. As discussed in Note 1, the Q1 2002 pre-tax net gain of $4.7 million was previously recorded as an extraordinary gain of $2.8 million, which was net of tax of $1.9 million and is now recorded as other income and expense, net in the condensed consolidated statement of operations.

Note 7 - Comprehensive Income (Loss)

The components of comprehensive income (loss), net of tax, are as follows:

Note 8 - Investments in Development Stage Companies

Cypress has invested in several privately and publicly held companies, all of which can be considered in the startup or development stages. In addition, from time to time, Cypress has loaned funds to these and other startup or development stage companies. These investments and loans are inherently risky as the market for the technologies or products under development by these companies are typically in the early stages and may never materialize. At September 29, 2002, Cypress had cumulatively invested $43.5 million, directly or indirectly, in development stage companies including a loan of $8.5 million to one development stage company, all of which could be lost if the companies are not successful. Cypress regularly reviews these investments for any impairment. Cypress wrote down investments and loans in five development stage companies totaling $13.8 million in Q3 2002 and $15.6 million for the first nine months of 2002, based upon other-than-temporary declines in value of the investments. As of September 29, 2002, Cypress has cumulatively written off $24.8 million of the original investment and loan balances.

Note 9 - Foreign Currency Derivatives

Cypress purchases capital equipment denominated in foreign currencies and has foreign subsidiaries that operate and sell Cypress’s products in various global markets. As a result, Cypress is exposed to risks associated with changes in foreign currency exchange rates. At any point in time, Cypress might use various hedge instruments, primarily forward contracts, to manage the exposures associated with forecasted purchases of equipment and net asset or liability positions. Cypress does not enter into derivative financial instruments for speculative or trading purposes.

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Cypress estimates the fair value of its forward contracts based on changes in forward rates from published sources. Cypress accounts for its hedges of committed purchases of equipment as cash flow hedges, such that changes in fair value for the effective portion of hedge contracts, if material, are recorded in other comprehensive income in stockholders’ equity. Amounts deferred in other comprehensive income will be recorded in the statement of operations in the period in which the underlying transactions impact earnings. At September 29, 2002, the effective portion of unrealized gains on cash flow hedges recorded in other comprehensive income was $0.7 million net of tax. The remaining unrealized gains on such contracts, which are recorded in other income and expense, net in the condensed consolidated statements of operations, totaled $0.4 million year-to-date. The prior year comparable amounts were not material. As of September 29, 2002, such forward contracts for Euro exposures had an aggregate notional value of $13.1 million.

Cypress records its hedges of foreign currency denominated assets and liabilities at fair value with the related gains or losses recorded in other income. The gains and losses on these contracts are substantially offset by transaction losses and gains on the underlying balances being hedged. As of September 29, 2002, Cypress held forward contracts with an aggregate notional value of $3.2 million to hedge the risks associated with yen foreign currency denominated assets and liabilities. Aggregate net foreign exchange gains (losses) on these hedging transactions and foreign currency remeasurement gains (losses) were $0.2 million and $0.4 million, respectively, for Q3 2002 and the nine months ended September 29, 2002 compared to $0.2 million and $4.1 million for the comparable 2001 periods, respectively. The amounts are included in other income and (expense), net in the condensed consolidated statements of operations.

Note 10 - Income Taxes

Cypress’s effective rates of income tax expense or (benefit) for Q3 2002 and Q3 2001 were 0.2% and (3.4%), respectively. For the nine months ended September 29, 2002 and September 30, 2001, Cypress’s effective rates of income tax expense or (benefit) were 0.7% and (3.5%), respectively. A tax provision of $0.1 million was recorded during Q3 2002 compared to a tax benefit of $12.8 million during Q3 2001. The Q3 2002 tax provision was attributable to income earned in certain countries that is not offset by current year net operating losses in other countries. The future tax benefit of certain losses is not currently recognized due to management’s assessment of the likelihood of realization of these benefits. On an ongoing basis, Cypress’s effective tax rate may vary from the U.S. statutory rate primarily due to utilization of future benefits, the earnings of foreign subsidiaries taxed at different rates, tax credits, and other business factors.

Note 11 - 2001 Employee Stock Purchase Assistance Plan

Included in other current assets, Cypress has outstanding loans, consisting of outstanding principal and accrued interest, of $105.8 million to employees and former employees under the shareholder-approved 2001 Employee Stock Purchase Assistance Plan. The loans were made by Cypress to employees for the purpose of purchasing Cypress common stock. Each loan is evidenced by a full recourse promissory note executed by the employee in favor of Cypress and is secured by a pledge of the shares of Cypress’s common stock purchased with the proceeds of the loan. The benefits to Cypress from this program include increased employee retention. In accordance with the plan, the CEO and the Board of Directors do not participate in this program. To date, there have been immaterial write-offs. As of September 29, 2002, Cypress has a loss reserve against these accounts of $15.9 million which includes an increase to the reserve of $14.7 million recorded in Q3 2002. In increasing this reserve, management considered various factors, including an independent fair value analysis of these employee and former employee loans and the underlying collateral. At September 29, 2002, the difference between the carrying value of the loan and the underlying common stock collateral was $54.8 million.

Note 12 - Segment Reporting

Cypress operates under two reportable business segments, Memory Products and Non-memory Products. The Memory Products business segment includes static random access memories (“SRAMs”) and is characterized by high unit sales volume and is generally subject to greater pricing pressures than Cypress’s Non-memory Products. The Non-memory Products business segment includes data communication devices, programmable logic products, specialty memories, clocks and interface products.

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Cypress’s divisions are also aligned to enhance focus on certain market segments. The WAN and SAN market segments help provide product definition in the networking arena. Similarly, the Wireless Terminals and Wireless Infrastructure market segments help focus our efforts in the wireless market. The Computation and consumer market segment includes products used in computers, peripherals, consumer and other applications. Cypress’s current Memory and Non-memory business segments continue to operate as they have in the past. The market focus provides systems knowledge, cross-product-line product portfolio definition, early engagement with strategic accounts and added management of research and development spending.

Cypress evaluates the performance of its segments based on profit or loss from operations before income taxes, excluding acquisition costs and non-recurring gains and losses.

Market Segment Information

The tables below set forth information about the market segments formed during fiscal 2000. Cypress does not allocate interest income and expense, other income and expense, income taxes, restructuring costs and credits, acquisition costs and non-recurring items to market segments. In addition, Cypress does not allocate assets to market segments. Market segments do not have significant non-cash items other than depreciation and amortization in reported profit or loss. Cypress periodically reviews its customer and product portfolio and makes corresponding changes to its segment data alignment as appropriate. The tables below reflect the effect of that review, and prior quarter and prior year segmentation has been reclassified to reflect our current presentation.

Market Segment Net Revenues

Market Segment Loss Before Provision for Income Taxes

Business Segment Information

Cypress’s reportable business segments are business units that offer different products. Products that fall under the two business segments differ in nature, are manufactured utilizing different technologies and have a different end-purpose. As such, they are managed separately. Memory Products are manufactured using more advanced technology. A significant portion of the wafers produced for Memory Products are manufactured at Cypress’s technologically advanced, eight-inch wafer production facility located in Minnesota (Fab 4). Memory Products are used by a variety of end-users generally for the storage and retrieval of information. In contrast to Memory Products, Non-memory Products are manufactured utilizing less technologically advanced processes. A majority of wafers for Non-memory Products are manufactured at Cypress’s six-inch wafer production facility located in Texas (Fab 2), while some wafers are procured from foundries. Products in the Non-memory segment perform functions such as timing management, data transfer and routing in computer, communications and storage systems. Non-memory Products range from high volume Universal Serial Bus (“USB”) interfaces for personal computers to high value products such as our OC-48 SERDES device for optical communications systems.

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The tables below set forth information about the reportable business segments for the three and nine months ended September 29, 2002 and September 30, 2001, respectively. Cypress does not allocate interest income and expense, other income and expense, income taxes, restructuring costs and credits, acquisition costs and non-recurring items to business segments. Cypress does not allocate assets to business segments. In addition, business segments do not have significant non-cash items other than depreciation and amortization in reported profit or loss.

Business Segment Net Revenues

Business Segment Loss before Provision for Income Taxes

Note 13 - Net Income (Loss) Per Share

Basic net income (loss) per common share is computed using the weighted-average common shares outstanding for the period. Diluted net income (loss) per common share is computed as though all potential dilutive common shares were outstanding during the period. Dilutive securities include stock options and shares issuable upon the conversion of convertible debt.

For the three and nine months ended September 29, 2002, common stock issuable upon the assumed conversion of convertible subordinated notes of 9.1 million and 9.2 million shares, respectively, were excluded from the calculation of diluted net loss per share, along with total outstanding options of 37.3 million with a weighted-average exercise price of $15.18, as the effect would be anti-dilutive.

For the three and nine months ended September 30, 2001, common stock issuable upon the assumed conversion of convertible subordinated notes of 10.7 million shares were excluded from the calculation of diluted net loss per share, along with total outstanding options of 29.3 million with a weighted-average exercise price of $14.41, as the effect would be anti-dilutive.

Note 14 - Subsequent Events

On October 17, 2002, Cypress announced a restructuring plan that includes the resizing of Cypress manufacturing facilities and the reduction of operating expenses, including research and development and selling, marketing and administration. The restructuring plan will result in a reduction of workforce, the exiting of certain leased facilities and the write-off of additional fixed assets to be held-for-sale. The restructuring is precipitated by the continued economic slowdown, particularly in the business areas in which Cypress operates. Although the plan and restructuring charges have not been finalized, Cypress expects to reduce its workforce by 275 to 325 employees.

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On October 14, 2002, the board of directors authorized a new discretionary stock repurchase program to acquire shares of Cypress common stock in the open market at any time. The maximum number of shares that may be repurchased under this program is 5.0 million. The stock repurchase program, while at the discretion of management, is contingent on numerous factors, including cash balances and cash flows. This discretionary stock repurchase program is in addition to the prior board authorized program in 2001 authorizing the repurchase from time to time of up to $143.8 million of the 3.75% Notes. As of September 29, 2002, Cypress has repurchased and retired a total of $101.6 million in principal of the 3.75% Notes. See further discussion related to the 3.75% Notes in Note 6.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

CYPRESS SEMICONDUCTOR CORPORATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

For the Three and Nine Months Periods Ended September 29, 2002

This report contains forward-looking statements, within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, about the prospects for Cypress as well as the semiconductor industry more generally, including without limitation, statements about our book-to-bill ratio, contingent compensation obligations arising from the acquisitions, pressure on average selling prices, expected benefits from the implementation of Cypress’s restructuring plans, the impact of the current economic downturn on our cash balances and cash flow from operations, rate of growth of selling, general and administrative expenses, profitability goals, revenue goals, growth rate goals, market share goals, market size and growth projections, new product introductions, capital expenditure plans, planned manufacturing capacity, and efficiency and cost goals. Actual results could differ materially from those described in the forward-looking statements as a result of the various factors listed above and including, but not limited to, the factors identified in “Risk Factors” below.

Results of Operations

Overview

Weakness in the semiconductor and related industries continues to adversely affect our financial position, results of operations and cash flows. Revenue improved in the fiscal quarter ended September 29, 2002 (“Q3 2002”) versus the fiscal quarter ended September 30, 2001 (“Q3 2001”), but revenue for the first nine months of fiscal 2002 was lower than revenue for the first nine months of fiscal 2001. The third quarter of 2002 marked the fourth consecutive quarter of revenue growth. Including the effects of the Q3 2001 restructuring and related charges, net loss for both Q3 2002 and the first nine months of 2002 improved from the comparable 2001 periods. Revenues for Q3 2002 were $205.0 million, up 13.7% from the $180.3 million recorded in Q3 2001. Revenues for the first nine months of 2002 were $600.3 million, a decline of 4.4% from the $628.1 million recorded in the first nine months of 2001. As of the end of Q3 2002, quarterly bookings were $184 million with a book-to-bill ratio of 0.90. For the same period one year ago, quarterly bookings were $183 million with a book-to-bill ratio of 1.02.

On a same device basis, average sales prices (“ASPs”) continued to decline in Q3 2002 and for the first nine months of 2002. Compared to prior year’s periods, prices have declined in all market segments. This has been somewhat mitigated by changes in product mix as well as significantly higher volumes versus the prior year. Unit volumes increased 36.9% to 141 million units in Q3 2002 from 103 million units in Q3 2001. Nine-month volumes increased 37.4% to 411 million units for the nine months of 2002 from 299 million units in 2001.

In Q3 2002, Cypress recorded impairment charges of $13.8 million related to its investments in and loans to development stage companies. The total impairment charges for such investments and loans for the first nine months of 2002 was $15.6 million. In addition, in Q3 2002, Cypress recorded a charge of $14.7 million to increase the reserve for the outstanding loans to employees under the shareholder-approved 2001 Employee Stock Purchase Assistance Plan.

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Revenues

Wide area networks (“WAN”) and storage area networks (“SAN”) revenue increased 17.9% from $57.5 million in Q3 2001 to $67.8 million in Q3 2002. The increase is attributable to increased unit volumes. WAN/SAN revenue for the first nine months of 2002 declined by 28.9% or $79.5 million from the comparable 2001 nine-month period. Unit volumes in the networking market (Transmission, Metro and Access) decreased in the first nine months of 2002 versus the comparable 2001 period due to postponed infrastructure investment and excess inventory both at original equipment manufacturers and in the after markets. The segment has shown modest recovery of unit volumes since the third quarter of 2001 increasing for the fourth consecutive quarter. Wireless Terminals and Wireless Infrastructure (“WIT/WIN”) revenues in Q3 2002 and the first nine months of 2002 increased by 22.8% and 9.2%, respectively, from the comparable 2001 periods. Improvement in revenue was driven by an increase in the cellular handset business and the continued shift toward higher-density memories in cell phones. Volume improvement in Q3 2002 and the first nine months of 2002 versus the comparable 2001 periods were somewhat offset by price erosion from the comparable 2001 periods.

Revenue within the Computation and consumer market segment increased from the 2001 comparable periods by $0.5 million and $34.6 million, respectively, for Q3 2002 and the first nine months of 2002. Third quarter 2002 revenue was relatively flat compared to Q3 2001 as higher volumes were offset by lower ASPs. Comparing the first nine months of 2002 to the comparable period in 2001, sales volumes were substantially higher, but were somewhat offset by lower prices. Unit sales growth is primarily due to the development and market acceptance of our family of plug-and-play USB devices. Additional unit demand for the USB and programmable clock products has offset lower sales of clocks into the PC market.

Cost of Revenues/Gross Margin

Gross margins for Q3 2002 and the first nine months of 2002 represented 45.8% and 43.3% of sales, respectively, versus (15.4)% and 30.4%, respectively, for the comparable periods in 2001. Both Q3 2001 and the first nine months of 2001 included a $93.1 million charge for excess inventory. Volumes remained strong in Q3 2002 and the first nine months of 2002 due to increases in sales volumes in both WIT/WIN and Computation and consumer.

During Q3 2002 and the first nine months of 2002, our gross margin increased as a result of the sale of the Q3 2001 previously reserved inventory in an amount representing the reserves previously recognized. The incremental gross profit benefit of $6.3 million and $12.9 million recognized in Q3 2002 and the first nine months of 2002 is equivalent to the original cost basis of the inventory sold.

In January 2002, the Department of Commerce revoked a 1998 antidumping order that had been imposed on static random access memories fabricated in Taiwan and imported into the United States. The United States Customs Service was ordered to refund, with interest, all duties deposited under the 1998 antidumping order. Between 1998 and 2001, Cypress charged $10.3 million to cost of revenues for such duties, recognizing $0.1 million and $0.4 million of such charges for the three and nine months ended September 30, 2001, respectively. During Q3 2002 Cypress received no refunds. Cypress received $12.7 million of refunds during the first nine months of 2002. During the first nine months of 2002, Cypress recorded $10.7 million as offsets to cost of revenues and $2.0 million as interest income. This benefit to our gross margin in the first nine months of 2002 was substantially offset by certain other items, including a change in estimate for deferred income on sales to distributors.

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Research and Development

Research and development (“R&D”) expenditures declined by $6.5 million in Q3 2002 when compared to Q3 2001 primarily as a result of Q3 2001 including additional charges of $5.5 million related to a settlement of a patent infringement suit and $1.5 million related to a periodic physical count of property, plant and equipment. Research and development expenditures for the first nine months of 2002 increased from the comparable 2001 period as Cypress continued its effort to enhance its product portfolio and to migrate to more advanced process technologies.

During Q3 2002 and the first nine months of 2002, Cypress recorded $7.6 million and $36.1 million, respectively, in non-cash deferred stock compensation and cash compensation related to milestone/revenue-based compensation from acquisitions as compared to $8.4 million and $14.7 million, respectively, for the comparable 2001 periods. The increase in acquisition-related compensation charges is attributed to our acquisitions made in the second half of 2001.

Selling, General and Administrative

Selling, general and administrative (“SG&A”) expenses increased in Q3 2002 from Q3 2001, but decreased slightly for the first nine months of 2002 versus the first nine months of 2001. Labor costs, sales commissions and other expenses were lower for both Q3 2002 and the first nine months of 2002 compared to the comparable 2001 periods. However, those improvements were offset by a Q3 2002 charge of $14.7 million to increase the reserve against outstanding loans to employees under the shareholder-approved 2001 Employee Stock Purchase Assistance Program. Cypress increased this reserve as a result of the continued decline in the value of its stock price, which stock is collateral for the loans.

For the three and nine months periods ending September 29, 2002, Cypress recorded $0.9 million and $3.5 million, respectively, in non-cash deferred compensation and cash compensation related to milestone/revenue-based compensation from acquisitions compared to $3.1 million and $8.3 million, respectively, in the comparable 2001 periods. The aggregate amount of contingent compensation that could be paid under all acquisition agreements assuming all milestones are met is $124.3 million as of September 29, 2002. However, Cypress expects that the ultimate amounts paid out will be substantially less than this figure.

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Restructuring

On July 16, 2001, we announced a restructuring plan that involved resizing its manufacturing facilities, reducing its workforce and combining facilities. The restructuring was precipitated by the worldwide economic slowdown, particularly in the business areas in which we operates. The intended effect of the plan was to size the manufacturing operations and facilities to meet future demand and reduce expenses in all operations areas. During the third quarter of 2001, we recorded restructuring charges of $132.1 million related to property, plant and equipment, leased facilities and personnel.

In connection with the July 16, 2001 announcement, in the third quarter of 2001, we removed from service and held for sale equipment with a net book value of $122.1 million, resulting in a charge of $113.4 million. We have actively marketed the equipment, but have had limited success to date in selling this equipment. Through September 29, 2002, we have sold equipment with a net book value (after write-off) of $29.7 million and placed back into service equipment having a net book value of $24.7 million. The proceeds from the sales of the assets approximated their carrying value. In the second and third quarters of 2002, we placed back into service certain of these assets previously recorded as held for sale. The assets were needed to meet increased production requirements resulting from a substantial increase in unit demand versus our initial assumptions at the time of the Q3 2001 restructuring. When the assets were put back into service, they were written up to their prior cost basis (an adjustment of $13.2 million and $9.5 million in Q2 2002 and Q3 2002, respectively) reduced for depreciation expense that would have been recorded during the period the asset was removed from service (an adjustment of $2.9 million and $2.6 million in Q2 2002 and Q3 2002, respectively), as required by SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.” The net effect of the asset adjustment was a credit of $10.3 million and $7.0 million in Q2 2002 and Q3 2002, respectively. In the first quarter of 2002, we sold and then leased back certain other pieces of equipment classified as held for sale. The proceeds from the sales of the assets approximated their net carrying values. If additional assets are placed back into service, we will have to reverse previously recorded impairment charges in future periods. We continue to actively market the remaining assets held for sale.

A restructuring charge of $1.6 million was recorded in Q1 2002 for additional cost reductions identified as part of the personnel portion of the Q3 2001 restructuring plan. The charge related to severance and related employee benefit costs for the termination of approximately 250 employees, the majority of whom were located in the Philippines facility. As of the end of Q3 2002, 103 of these employees had left Cypress.

In the third quarter of 2002, we recorded net restructuring costs of $2.4 million, which comprised a charge of $9.4 million offset by a $7.0 million reversal for previously written-down equipment put back into service. The charge of $9.4 million consisted of $3.3 million for work force reductions for 71 employees, and included severance, benefit costs and stock compensation, $3.4 million for capital equipment removed from service and held for sale and $2.8 million for the exiting of facility leases. At the end of Q3 2002, 46 of the employees had left Cypress. We closed two design centers resulting in workforce, equipment and facility lease charges and adjusted certain Q3 2001 estimates for lease accruals based upon current depressed market conditions. The charge of $9.4 million was offset by $7.0 million of previously written-down equipment put back into service to support an increase in demand for certain products that was not foreseen at the time of the initial restructuring of the equipment in Q3 2001 as discussed above.

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The following table summarizes the activity associated with the restructuring liabilities and asset write-downs since the inception of the restructuring plan in the third quarter of 2001:

Acquisition-related Costs

Acquisition costs consist primarily of the amortization of acquired intangible assets and expensed in-process R&D charges. Amortization of intangible assets was $10.7 million and $31.6 million for the three and nine months ended September 29, 2002, respectively, compared to $19.7 million and $49.5 million for the three and nine months ended September 30, 2001, respectively. We expensed in-process research and development of $0.5 million in Q1 2002 related to the acquisition of Sahasra Networks, Inc. We expensed in-process research and development of $5.3 million and $18.1 million, respectively, during the three and nine months ended September 30, 2001 related to the acquisitions of ScanLogic, International Microcircuits Inc. and HiBand. For both the three and nine months ended September 30, 2001, we had an impairment loss of $65.9 million related to Silicon Light Machines long-lived assets and $0.7 million in miscellaneous acquisition related costs.

Interest Income, Interest Expense and Other Income and (Expense), Net

Interest income in Q3 2002 was $3.3 million, a decrease of $7.2 million or 68.2% from the prior year’s third quarter while interest income for the first nine months of 2002 was $15.7 million, a decrease of $25.0 million or 61.4% from the comparable period in 2001. The decrease was due both to lower short- and long-term investment balances and decreased yields. That reduction was partially offset by $2.0 million of interest income related to the duty refunds from the United States Customs Service during the nine months ended 2002. In addition, in the third quarter and the first nine months of 2002, we recorded interest income of $1.4 million and $4.0 million, respectively, from loans to employees and former employees under the shareholder-approved 2001 Employee Stock Purchase Assistance Plan. The interest income related to the shareholder-approved 2001 Employee Stock Purchase Assistance Plan was $0.7 million and $1.0 million for the three and nine months ended September 30, 2001, respectively.

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Interest expense declined by $0.8 million and $2.4 million, respectively, in the quarter and nine months ending September 29, 2002 versus the comparable prior year periods. Interest expense is primarily associated with the 4.0% Convertible Subordinated Notes (“4.0% Notes”), issued in January 2000, due in 2005, and the 3.75% Convertible Subordinated Notes (“3.75% Notes”), issued in June 2000, due in 2005. The decrease in interest expense in 2002 compared to 2001 is attributable to the repurchase of $101.6 million in principal of the 3.75% Notes that occurred between November 2001 and June 2002.

Other income and (expense), net was $(14.7) million and $(13.6) million for the third quarter and first nine months of 2002 versus $(9.4) million and $(9.5) million for the comparable 2001 periods. Included in the amounts are charges related to gains on the repurchase of the 3.75% Notes, investment impairments and write-offs and foreign exchange gains and losses. During the first half of 2002, we recognized $5.9 million in gains on the repurchase of the 3.75% Notes. We did not repurchase any notes during Q3 2002 or during the first nine months of 2001. As of September 29, 2002, the remaining principal balance of the 4.0% Note and 3.75% Note, was $283.0 million and $185.9 million, respectively. During Q3 2002 we recorded impairment charges of $13.8 million for investments in and loans to five development stage companies. For the first nine months of 2002, we recorded total impairment charges of $15.6 million for investments in and loans to development stage companies. There were no such impairment charges in the first nine months of 2001.

Income Taxes

Our effective rates of income tax expense or (benefit) for Q3 2002 and Q3 2001 were 0.2% and (3.4%), respectively. For the nine months ended September 29, 2002 and September 30, 2001, our effective rates of income tax expense or (benefit) were 0.7% and (3.5%), respectively. A tax provision of $0.1 million was recorded during Q3 2002 compared to tax benefit of $12.8 million during Q3 2001. The Q3 2002 tax provision was attributable to income earned in certain countries that is not offset by current year net operating losses in other countries. The future tax benefit of certain losses is not currently recognized due to management’s assessment of the likelihood of realization of these benefits. On an ongoing basis, our effective tax rate may vary from the U.S. statutory rate primarily due to utilization of future benefits, the earnings of foreign subsidiaries taxed at different rates, tax credits, and other business factors.

Pro Forma Earnings (Loss)

In addition to our financial statements prepared in accordance with generally accepted accounting principles (“GAAP”), we provide our stockholders with pro forma financial information. We believe that our presentation of pro forma results is a useful addition to information provided to our stockholders. Our presentation of pro forma information excludes non-cash expenses resulting from acquisition or issuance of stock options, cash charges for payments based on the achievement of certain performance milestones under acquisition agreements, as well as unusual or infrequent expenses or credits that are not directly attributable to our ongoing operations and are expected to be incurred over a limited period of time. Because of these exclusions, our pro forma presentation is not in accordance with GAAP. Additionally, our presentation of pro forma information may not be consistent with that of other companies. Pro forma information is not a substitute for financial information prepared in accordance with GAAP. We believe that we have been consistent in our identification of unusual or infrequent items, including both favorable and unfavorable items. The following table reconciles our GAAP net loss with our pro forma net loss.

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