LSI LOGIC CORP - 10-K Annual Report

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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(Mark One)

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001

OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO .

COMMISSION FILE NO. 0-11674
LSI LOGIC CORPORATION
(Exact name of registrant as specified in its charter)

1551 MCCARTHY BOULEVARD
MILPITAS, CALIFORNIA 95035
(Address of principal executive offices) (Zip Code)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (408) 433-8000

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
NONE
(Title of class)

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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in the definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendments to this Form 10-K. [ ]

The aggregate market value of the voting stock held by non-affiliates of
the Registrant, based upon the closing price of the Common Stock on March 8,
2002 as reported on the New York Stock Exchange, was approximately $18.58.
Shares of Common Stock held by each executive officer and director and by each
person who owns 5% or more of the outstanding Common Stock have been excluded in
that such persons may be deemed to be affiliates. This determination of
affiliate status is not necessarily a conclusive determination for other
purposes.

As of March 8, 2002, the Registrant had 369,190,586 shares of Common Stock
outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Parts of the following document are incorporated by reference into Parts
III, of this Form 10-K Report: Proxy Statement for Registrant's 2002 Annual
Meeting of Stockholders.
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FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K 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. Actual results could differ materially from
those projected in the forward-looking statements as a result of a number of
risks and uncertainties, including the risk factors set forth below and
elsewhere in this Report. See "Risk Factors" in Part I, Item 1 and "Management's
Discussion and Analysis of Financial Condition and Results of Operations" in
Part II, Item 7 below. Statements made herein are as of the date of the filing
of this Form 10-K with the Securities and Exchange Commission and should not be
relied upon as of any subsequent date. We expressly disclaim any obligation to
update information presented herein, except as may otherwise be required by law.

PART I

ITEM 1. BUSINESS

GENERAL

LSI Logic Corporation (together with its subsidiaries collectively referred
to as LSI Logic or the Company and referred to as we, us and our) is a leader in
the design, development, manufacture, and marketing of complex, high-performance
integrated circuits and storage systems. We are focused on the four markets of
consumer products, communications, storage components, and storage area network
systems. Our integrated circuits are used in a wide range of communication
devices, including devices used for wireless, broadband, data networking, and
set-top box applications. We also provide other types of integrated circuit
products and board-level products for use in consumer applications,
high-performance storage controllers, and systems for storage area networks.

We operate in two segments -- the Semiconductor segment and the Storage
Area Network (SAN) Systems segment -- in which we offer products and services
for a variety of electronic systems applications. Our products are marketed
primarily to original equipment manufacturers (OEMs) who sell products targeted
for applications in four major markets, which are:

- Consumer Products;

- Communications;

- Storage Components; and

- Storage Area Network Systems.

In the Semiconductor segment, we use advanced process technology and
comprehensive design methodologies to design, develop, manufacture and market
highly complex integrated circuits. These system-on-a-chip solutions include
both application specific integrated circuits, commonly referred to as ASICs and
standard products, as well as Redundant Array of Independent Disks (RAID) host
bus adapters and related products; and services. ASICs are designed for specific
applications defined by the customer, whereas standard products are for market
applications that we define. See also "Management's Discussion and Analysis of
Financial Condition and Results of Operations" in Item 7 of Part II herein.

We have developed methods of designing integrated circuits based on a
library of building blocks of industry-standard electronic functions,
interfaces, and protocols. Among these is our CoreWare design methodology. Our
advanced submicron manufacturing process technologies allow our customers to
combine one or more CoreWare library elements with memory and their own
proprietary logic to integrate a highly complex, system-level solution on a
single chip. (Our G10, G11, G12 and Gflx submicron process technologies are more
fully described in the section on Manufacturing below.) We have developed and
use complementary metal oxide semiconductor (CMOS) process technologies to
manufacture our integrated circuits.

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In the SAN Systems segment, our enterprise storage systems are designed,
manufactured, and sold by our wholly owned subsidiary -- LSI Logic Storage
Systems, Inc. Our high-performance, highly scalable open storage area network
systems and storage solutions are available through leading original equipment
manufacturers, or OEMs, and a worldwide network of resellers. Products and
solutions distributed through these channels may exclude LSI Logic Storage
Systems' brand identification. When included, LSI Logic Storage Systems brand
identity may appear alone or in tandem with third-party brand identification.

LSI Logic Corporation was incorporated in California on November 6, 1980,
and was reincorporated in Delaware on June 11, 1987. Our principal offices are
located at 1551 McCarthy Boulevard, Milpitas, California 95035, and our
telephone number at that location is (408) 433-8000. Our home page on the
Internet is at www.lsilogic.com.

BUSINESS STRATEGY

SEMICONDUCTOR BUSINESS STRATEGY

Our objective is to continue to be an industry leader in the design and
manufacture of highly integrated, complex integrated circuits and other
electronic components and system-level products that provide our customers with
silicon-based system-level solutions. To achieve this objective, our business
strategy includes the following key elements:

- Target Growth Markets and Selected Customers. We concentrate our sales
and marketing efforts on leading OEM customers in targeted growth
markets, led by the communications, consumer, storage components, and
storage area network systems applications. Our engineering expertise is
focused on developing technologies that will meet the needs of
leading-edge customers in order to succeed in these market areas.

- Emphasize CoreWare Methodology and System-on-a-Chip Capability. Our
CoreWare design methodology enables the integration of one or more
pre-designed circuit elements with customer-specified elements and memory
to create system capabilities on a single chip. This results in higher
product functionality, higher performance, greater differentiation, and
faster time to market. We also have used this design methodology to
develop proprietary standard products.

- Promote Highly Integrated Design and Manufacturing Technology. We use
proprietary and leading third-party electronic design automation, or EDA,
software design tools. Our design tool environment is highly integrated
with our manufacturing process requirements so that it will accurately
simulate product performance. This reduces design time and project cost.
We continually evaluate and, as appropriate, develop expertise with
third-party EDA tools from leading and emerging suppliers of such
products.

- Provide Flexibility in Design Engineering. We engage with customers of
our semiconductor products under various arrangements whereby the extent
of the engineering support we provide will be determined in accordance
with the customer's requirements. For example, a customer may primarily
use its own engineers for substantial development of its product design
and retain our support for silicon-specific engineering work. We also
enter into engineering design projects, including those on a "turn-key"
basis.

- Maintain High-Quality and Cost-Effective Manufacturing. We operate our
own manufacturing facilities in order to control our deployment of
advanced wafer fabrication technology, our manufacturing costs, and our
response to customer delivery requirements. We also use independent wafer
foundry services when appropriate and may seek to fill unused capacity in
our own foundries by offering such services to third parties. We perform
substantially all of our packaging, assembly, and final test operations
through subcontractors in Asia. Our production operations in Gresham,
Oregon, and Tsukuba, Japan, and our assembly and test subcontractors in
Asia are ISO-9002 certified, an important international measure for
quality.

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- Leverage Alliances with Key Partners. We are continually seeking to
establish relationships with key partners in a diverse range of
semiconductor and storage-system technologies to promote new products,
services, operating standards, and manufacturing capabilities and to
avail ourselves of cost efficiencies that may be obtained through
collaborative development.

- Develop and Drive Industry Standards to Achieve Market Advantage. We
have been a leader in developing and promoting important industry
standard architectures, functions, protocols, and interfaces. We believe
that this strategy will enable us to quickly launch new standard-based
products, allowing our customers to achieve time-to-market and other
competitive advantages.

- Operate Worldwide. We market our products and engage with our customers
on a worldwide basis through direct sales, marketing, and field technical
staff and through independent sales representatives and distributors. Our
network of design centers located in major markets allows us to provide
customers with highly experienced engineers, to interact with customer
engineering management and system architects, to develop designs for new
products, and to provide continuing after-sale customer support.

SAN SYSTEMS BUSINESS STRATEGY

- Highly Leveraged Core Competencies. In the SAN systems market, we
leverage expertise used to develop our semiconductors, storage
input/output components, storage management software, and storage systems
in the development of scalable storage solutions. We use the full scope
of our technical expertise to design and develop interoperable,
easy-to-manage, leading price/performance products.

- Modular Design Philosophy. Our flexible approach to storage system
design allows elements of a system to be configured and/or customized
together or separately to meet customer requirements. Benefits to our
customers include investment protection, reduced support costs, and a
common management interface and features. This allows customers to start
with pilot projects and later scale to full implementation.

- Flexible Business Models. Our strategy is to provide flexible,
customizable solutions with room for value-added components, software,
and services provided by the channel. Our modular product set allows OEMs
and resellers to devise a solution to best meet their needs and to
satisfy customers.

PRODUCTS AND SERVICES

SEMICONDUCTOR PRODUCTS

In our semiconductor components business, we design, manufacture and supply
ASICs, standard products, host adapter boards and host adapter boards software
to customers competing in global consumer, communications and storage markets.

ASICs are semiconductors that are designed for a unique, customer-specified
applications. Standard products, which incorporate our intellectual property
building blocks, are sold directly to customers for incorporation into
system-level products. Both our ASICs and standard products are predominantly
designed and manufactured using our proprietary process technologies.

Consumer Products. For the consumer market, we offer a broad array of
products, including both application specific standard products and custom
solutions.

Consumer standard products. We design, develop, manufacture and sell
semiconductor devices, software and reference designs for digital video and
audio applications. We enable new digital video and audio applications. We are
focused on providing solutions into rapidly growing applications such as DVD
players, digital set-top boxes, cable modems, broadcast encoders, video editing
systems, as well as emerging applications such as DVD recorders, home servers,
residential gateways and personal video recorders.

Consumer custom solutions. We also design, manufacture and sell systems on
a chip (SoC) for consumer applications. We focus on consumer market segments
employing our intellectual property portfolio,

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design methodology and turnkey product offerings (including manufacturing,
assembly and test) to provide a complete solution. Our main focus is in the
video game console market. We plan to expand into digital cameras and
camcorders, portable digital audio and video, personal digital assistant
multimedia products and other emerging multimedia applications where an
effective standard solution is not available.

In May 2001, LSI Logic acquired C-Cube Microsystems, Inc., a leader in
digital media processing for $893.7 million. The acquisition of C-Cube enhanced
the Company's presence in the worldwide cable modem, cable set-top box, DVD and
other major consumer markets in the semiconductor segment. In addition, the
acquisition enabled LSI Logic to have a strong market presence in the growing
China semiconductor market.

Storage Components

Our ASIC and standard product solutions to customers in worldwide storage
component markets make possible data storage and transmission between a host
computer and peripheral devices such as magnetic and optical disk drives,
scanners, printers, and disk and tape-based storage systems. We offer industry
leading standard products including product families in Fibre Channel, SCSI,
SCSI expanders, integrated circuits for motherboard or adapter applications,
host adapter boards, and software. Our storage components also include a product
family of PCI-RAID host adapters featuring IDE, SCSI and Fibre Channel
interfaces, along with software and utilities for storage configuration and
management. We also offer ASIC solutions to customers, who develop Fibre Channel
SAN switches and host adapters, storage systems, and hard disk drive and tape
peripherals. Our Fibre Channel offerings include the GigaBlaze high performance
2Gb/s FC transceiver and the Merlin family of high-performance Fibre Channel
protocol controllers.

We provide tools, libraries, semiconductor processes and packaging products
that enable our OEM customers to reliably develop high-performance designs for
advanced computer systems. We provide a suite of MIPS cores and ARM processors,
in addition to industry-standard bus interface cores such as USB, IEEE 1394, and
PCI.

Communications and ASIC Technology

Reflecting that ASIC technology is the primary method of engagement for LSI
Logic in serving global communications markets, the Company in early 2002
announced the consolidation of its Communications business and its ASIC
technology and product development activities.

Communications products. We offer a blend of high-performance,
high-integration and low-power silicon solutions that are pivotal in development
of Internet infrastructure. We develop ASICs using ARM-based processor, digital
signal processor (DSP), high-speed transceiver and mixed-signal cores. LSI Logic
targets the following global communications markets: high speed metropolitan and
wide area networks (WAN), optical networking, wireless communications
infrastructure, wireless local area networks, home networking, residential
broadband gateways, and digital subscriber lines (DSL).

We develop and market a portfolio of standard, high-speed communications
interfaces for our own standard products and as building block cores in
customer-specific ASIC designs. LSI Logic focuses on serving customers in the
Local Area Network (LAN) enterprise market, the emerging Metro sector and the
Wide Area Network (WAN) telecommunications market.

ASIC Technology

Our CoreWare design methodology offers a comprehensive design approach for
creating a system on a chip efficiently, predictably, and rapidly. Our CoreWare
libraries include industry standard, intellectual property building blocks. Our
emphasis on cell-based product lines reflects the market preference for use of
this methodology to develop advanced integrated circuits. Customers obtain
greater flexibility in the design of system-level products using our cell-based
technology. Our CoreWare cells are connected together electronically to form an
entire system on a single chip. These system-on-a-chip solutions can be used in
ASICs or standard products focused on the communications, consumer and storage
markets.

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Our ASIC customers utilize our engineering design capabilities in a variety
of ways. Typically, the ASIC design process involves participation by both LSI
Logic and customer engineers.

We engage our customers early in their new system product development
process and accept large design assignments where we share development costs
with the customer. We provide advice on the product design strategies to
optimize product performance and suitability for the targeted application. In
addition, our capabilities include support in the areas of architecture and
system-level design simulation, verification, and synthesis used in the
development of complex integrated circuits.

Our software design tool environment supports and automatically performs
key elements of the design process from circuit concept to physical layout of
the circuit design. The design tool environment features a combination of
internally developed proprietary software and third-party tools that are highly
integrated with our manufacturing process requirements. The design environment
includes expanded interface capabilities with a range of third-party tools from
leading EDA vendors and features hardware/software co-verification capability.

After completion of the ASIC engineering design effort, we produce and test
prototype circuits for shipment to the customer. We then begin volume production
of integrated circuits that have been developed through one or more of the
arrangements described above in accordance with the customer's quantity and
delivery requirements.

SAN SYSTEMS PRODUCTS

In the SAN Systems segment, we offer a broad line of network storage that
spans customer enterprises from workgroup to data center. Our product lines
range from intelligent controller and drive modules to complete storage systems.
These offerings allow our products to be integrated on a component basis or
aggregated into a complete storage solution, increasing OEM flexibility in
creating differentiated products. Modular products also allow our indirect
channel partners to customize solutions, bundling our products with value-added
components, software, and services.

- SAN Storage. Our MetaStor brand storage systems, distributed by
StorageTek and LSI Logic sales representatives are based on highly
available and scalable hardware and software components integrated into
fully tested storage area networks for the enterprise market.

- MetaStor E-Series. The MetaStor E-Series storage systems for storage
area networks combine fibre channel performance with our proprietary
Multi-Pathing Architecture to deliver high performance for a wide variety
of applications. Highly available and fully redundant dual-active
controllers, efficiently managed with SANtricity Storage Manager
software, differentiate our storage from that of our competitors.

The MetaStor E-Series storage family supports all high-use operating
systems, including Windows NT, Solaris(TM), HP-UX, AIX, SGI, IRIX, NetWare and
Linux platforms. Our products allow customers to dynamically increase storage
capacity from 36 gigabytes (billions of information bytes) to as much as 39
terabytes (trillions of information bytes) per system. Customers can expand
storage to their computer applications, maintain redundant records and change
configurations even when their systems are operating. The result is a
growth-oriented, highly available, easy to manage system.

- SANtricity Storage Manager Software. This storage management software
enables users to consolidate storage through the SANshare
storage-partitioning feature. In addition, this software provides a
single management interface and remote access capabilities, allowing
centralized management of all MetaStor storage. An enhanced graphical
user interface makes the software quite easy to use. Other features
provide for automatic device discovery and one-button configuration.

- Network-Attached Storage. The MetaStor N-Series is a family of
network-attached storage solutions that enables users to share files
among a variety of hosts, regardless of operating systems, lowering the
cost of ownership by consolidating storage and management functions in a
single, open storage

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environment. Features include multi-protocol support, a high-performance
file system, hot recovery point-in-time copies, flexible backup
solutions, and enterprise-level storage management.

- Storage Virtualization. The ContinuStor Director is an intelligent
storage management system that provides storage virtualization,
heterogeneous storage, and host support and local and remote mirroring
capabilities. Storage Virtualization is an emerging method of managing
storage without regard to its physical characteristics, enabling the
interoperability of storage devices from different manufacturers in a
more efficient manner. This generally results in a significant reduction
of storage management complexity, improvements in capacity utilization
and more cost-effective business continuance and disaster recovery
implementations with respect to data storage.

- Storage Controller Modules. Designed from the chip-level up, our storage
controller modules support both Ultra2 SCSI and Fibre Channel interfaces.
Using LSI Logic ASICs, the controllers deliver superior performance for
both high-transaction volumes and large data block workloads. Combined
with our drive modules, each controller module manages scalable capacity
up to 39 terabytes. Modules can either be rack-mounted or installed
desk-side configurations. Other features include HotScale technology for
dynamic system expansion and reconfiguration, redundant dual-active
controllers and automatic fail-over for maximum data availability.

- Storage Drive Modules. Our storage drive modules increase storage
capacity and performance as needs change. Drive modules use our chip
capabilities to monitor power, temperature, and fans, and to relay
information back to the controller. Advanced technology from industry
disk drive vendors is integrated into the modules to maximize capacity
and minimize floor space requirements.

As a major open computing vendor, we deliver storage systems that operate
within the Windows NT, UNIX, Solaris, NetWare, and Linux operating-system
environments. These products are targeted at key data storage applications,
including:

- Internet servers;

- Electronic commerce;

- Data warehousing;

- On-line transaction processing;

- Video delivery, editing and production; and

- Migration of mission critical applications off mainframe computers.

In 2001, LSI Logic Storage Systems, Inc. enhanced its entire product line
when it introduced the E4600, the E4600HPCx and SANtricity Storage Manager 8.0
software. These new products extend the range of applicability to better serve
market segments that demand the highest levels of connectivity, performance and
storage capacity.

We offer a toll-free 24 hours-a-day, 7 days-a-week technical support
hotline for customers worldwide using the MetaStor line of network- and
server-attached enterprise storage systems. We also offer a number of flexible
services and support programs that allow customers to choose the level of
telephone and onsite support appropriate to their needs.

MARKETING AND DISTRIBUTION

SEMICONDUCTOR MARKETING AND DISTRIBUTION

The highly competitive semiconductor industry is characterized by rapidly
changing technology, short product cycles, and emerging standards. Our marketing
strategy requires that we accurately forecast trends in the evolution of product
and technology development. We must then act upon this knowledge in a timely
manner to develop competitively priced products offering superior performance.
As part of this strategy, we are active in the formulation and adoption of
critical industry standards that influence the design specifications

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of our products. Offering products with superior price and performance
characteristics is essential to satisfy the rapidly changing needs of our
customers in the dynamic communications, consumer and storage markets.

Our semiconductor products and design services are primarily sold through
our network of direct sales and marketing, field engineering offices and sales
representatives located in North America, Europe, Japan, China and elsewhere in
Asia. Our sites are interconnected by means of advanced computer networking
systems that allow for the continuous, uninterrupted exchange of information
that is vital for the proper execution of our sales and marketing activities.
International sales are subject to risks common to export activities, including
governmental regulations, tariff increases and other trade barriers and currency
fluctuations.

We rely primarily on direct sales and marketing, but we also work with
independent distributors in North America, Europe, Japan and elsewhere in Asia.
Some of our distributors possess engineering capabilities and design and
purchase both ASICs and standard products from us for resale to their customers.
Other distributors focus solely on the sale of standard products. Our agreements
with distributors generally grant limited rights to return standard product
inventory and obtain credits for price reductions applicable to standard
products held in inventory. We maintain appropriate reserves to account for
these factors. However, owing to the relatively small quantities of products
held in inventory by our distributors, we believe that these arrangements do not
result in material financial exposure for our company.

SAN SYSTEMS MARKETING AND DISTRIBUTION

SAN systems products are sold worldwide both on a direct basis to OEMs and
through indirect channels to end-users. The MetaStor brand of scalable SAN
systems is exclusively marketed through a worldwide network of value-added
resellers, system integrators and distributors. We closely manage these
relationships to meet the diverse needs of end-users. Our marketing efforts are
driven by an industry-wide trend toward the implementation of storage area
networks to maximize performance, availability and efficiency.

Our direct sales force provides customized SAN systems solutions generally
to large, well-known manufacturers of computer equipment. Our product
development strategy focuses on implementing the latest storage technologies to
improve the performance of our hardware and software storage solutions. As a
pioneer in the development of redundant array of independent disks (RAID)
technology, and as a member of the Fibre Channel Industry Association and
Storage Networking Industry Association, we are continually driving industry
standards for fibre channel and SAN solutions.

In January 2002, the Company and Storage Technology Corporation
(StorageTek) announced an alliance under which StorageTek will become the
worldwide master distributor of co-branded open storage products. Further, the
companies will market a full line of scalable, high performance, high
availability disk storage systems that will be engineered and manufactured by
LSI Logic Storage Systems and sold, installed and supported by StorageTek.

CUSTOMERS

We seek to leverage our expertise in the fields of communications,
consumer, storage components and SAN systems by marketing our products and
services to market leaders. Our strategic-account focus is on larger, well-known
companies that produce high-volume products incorporating our semiconductors and
storage system products. We recognize that this strategy may result in increased
dependence on a limited number of customers for a substantial portion of our
revenues. It is possible that we will not achieve significant sales volumes from
one or more of the customers we have selected. While this could result in lower
revenues and higher unit costs owing to an under-utilization of our resources,
we believe this strategy provides us with the greatest opportunity to drive
further growth in sales and unit volumes.

We operate in a rigorous competitive environment and our continued success
requires that we consistently develop and manufacture products that meet the
needs of our customers. There is no assurance that we will achieve significant
sales revenues from one or more of our strategic customers. This could result in
lower revenues for our company.

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In 2001, Sony accounted for approximately 18% of our consolidated revenues.
No other customer accounted for greater than 10% of consolidated revenues.

MANUFACTURING

SEMICONDUCTOR MANUFACTURING

Our semiconductor manufacturing operations convert a design into packaged
silicon chips and support customer requirements for volume production.
Manufacturing begins with fabrication of custom-diffused silicon wafers. Layers
of metal interconnects are deposited onto the wafer and patterned using
customized photo masks. Wafers are then tested and cut into die. Die that pass
initial tests are then sent to the assembly process where the fabricated
circuits are assembled into plastic package or laminate substrate ball grid
array. The finished devices undergo additional testing and quality assurance
before shipment. Dedicated computer systems are used in this comprehensive
testing sequence. The test programs use the basic functional test criteria from
the design simulation. The customer specifies the functional test criteria for
ASIC circuits.

We own and operate manufacturing operations in the United States, Japan,
and Hong Kong. In January 2002, we announced a restructuring of the Japan
manufacturing facility. In addition, we utilize external wafer foundries located
in Taiwan and Malaysia. We use high-performance CMOS process technologies in the
volume manufacture of our products. The production operations are fully
computer-integrated to increase efficiency and reduce costs.

Semiconductor process technologies are identified in terms of the size of
channel length within the transistors, measured in millionths of a meter called
"microns." The measurement of the channel length is expressed in two ways:
effective electrical channel length and drawn gate length. The effective
electrical channel length is smaller than the drawn gate length. In this Report
on Form 10-K, we use the electrical effective channel length to identify our
process technologies.

Our advanced submicron manufacturing processes are capable of producing
products with an effective electrical channel length within each transistor as
small as 0.13-micron in our G12 technology. Our 0.18-micron (G11 process
technology) allows up to 24 million usable gates on a single chip. Our G10
process technology is capable of producing 0.25-micron effective channel length
products. We have a joint development technology for Gflx, a new flexible
process technology capable of combining all of the system functions to create
totally new classes of products on a single chip. The Gflx technology is more
than twice as dense as the previous generation G12 process technology, allowing
designers to incorporate added functions onto a single chip. The 0.10-micron
effective channel length Gflx process technology offers 78 million usable logic
gates. These advanced process technologies allow for greater circuit density and
increased functionality on a single chip.

A majority of our wafers are fabricated in our factories in Gresham, Oregon
and Tsukuba, Japan. The rest of the wafers are manufactured at our external
wafer foundries in Taiwan and Malaysia. The factories in Gresham and Tsukuba are
ISO-9002 certified -- an important internationally recognized standard for
quality. In July 1999, the older of the two Tsukuba factories, which produced
0.38-micron products, was closed after eleven years of service. This action was
taken as part of a comprehensive restructuring and cost reduction plan commenced
in 1998. In January 2002, the Company announced a restructuring of the Japan
manufacturing facility. In October 2001, the manufacturing facility in Colorado
Springs, Colorado, which produced 0.65-micron, 0.54-micron and 0.25-micron
wafers, was closed after ten years of service. This action was taken as part of
a comprehensive restructuring and cost reduction plan that commenced in April
2001.

Our newest manufacturing facility is located in Gresham, Oregon on 325
acres outside of Portland. This facility is equipped for advanced manufacturing
operations and is designed to accommodate our expansion requirements well into
the foreseeable future. The plant is equipped to produce eight-inch wafers
hosting products manufactured to the G10, G11, G12, and Gflx processes.

On April 4, 2001, we announced a co-development and foundry supply
agreement with Taiwan Semiconductor Manufacturing Company Ltd. (TSMC). This
agreement is part of our strategy to "outsource," that is to procure a larger
portion of our wafer requirements from external sources. As a result of our

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joint development efforts with TSMC we anticipate purchasing, consistent with
our "outsourcing" strategy, such portion of our wafer volume requirements based
on the 0.13-micron process technology that we do not manufacture ourselves. In
addition, we anticipate being able to defer the need to expand our manufacturing
capacity for the 0.13-micron technology beyond the time when products designed
for that technology would begin volume production. We also anticipate
collaborating with TSMC on further advancement in wafer fabrication technology.

Our fixed costs for manufacturing are high and are expected to remain high
because we must continually make significant capital expenditures and add new
advanced capacity in order to remain competitive. If demand for our products
does not absorb the additional capacity, the increase in fixed costs and
operating expenses related to increases in production capacity may result in a
material adverse impact on our operating results and financial condition.
(Additional risk factors are set forth in the Risk Factors section below.)

We offer a wide range of packaging solutions for system-on-a-chip designs.
We have also developed a high-performance, high-density interconnect packaging
technology, known as flip chip, which essentially replaces the wires that
connect the edge of the die to a package with solder bumps spread over the
entire external surface of the die. This technology enables us to reach
exceptional performance and lead-count levels in packages required for process
technologies of 0.18 micron and below. We also offer a mini-ball grid array
package that features a smaller package size without sacrificing electrical and
thermal performance. We also offer a wide array of plastic wire-bond packaging
options.

Final assembly (i.e., assembly in a plastic or laminate substrate package)
and test operations are conducted by our Hong Kong affiliate through independent
subcontractors in the Philippines, Malaysia, South Korea, Taiwan, and Hong Kong.
We also utilize subcontractors in Thailand for the assembly and test of our host
adapter boards.

Both manufacturing and sales of our semiconductor products may be impacted
by political and economic conditions abroad. Protectionist trade legislation in
either the United States or foreign countries, such as a change in the current
tariff structures, export compliance laws or other trade policies, could
adversely affect our ability to manufacture or sell products in or into foreign
markets. We cannot guarantee that current arrangements with our component
suppliers or assembly, testing and packaging subcontractors will continue, and
we do not maintain an extensive inventory of assembled components. The failure
to secure assembly and test capacity could affect our sales and result in a
material adverse impact on our operating results and financial condition.

Development of advanced manufacturing technologies in the semiconductor
industry frequently requires that critical selections be made as to those
vendors from which essential equipment (including future enhancements) and
after-sales services and support will be purchased. Some of our equipment
selections require that we procure certain specific types of materials or
components specifically designed to our specifications. Therefore, when we
implement specific technology choices, we may become dependent upon certain
sole-source vendors. Accordingly, our capability to switch to other technologies
and vendors may be substantially restricted and a switch may involve significant
expense and could delay our technology advancements and decrease manufacturing
capabilities.

The semiconductor equipment and materials industries also include a number
of vendors that are relatively small and have limited resources. Several of
these vendors supply us with equipment and/or services. We do not have long-term
supply or service agreements with vendors of certain critical items, and
shortages could occur in various essential materials due to interruption of
supply or increased demand in the industry. Given the limited number of
suppliers of certain of the materials and components used in our products, if we
experience difficulty in obtaining essential materials in the future we cannot
be assured that alternative suppliers will be available to meet our needs. Such
disruptions could materially affect our operations, which could have a material
adverse impact on our operating results and financial condition.

The primary raw materials used in the manufacturing of semiconductors
include raw wafers and certain chemicals used in the processing of
semiconductors. The raw wafers are obtained primarily from suppliers in Japan
and their U.S. subsidiaries, whereas other material inputs are obtained on a
local basis. Our operations

9

also depend upon a continuing adequate supply of electricity, natural gas and
water. These energy sources have historically been available on a continuous
basis and in adequate quantities for our needs. However, given the recent power
shortage in California, it is possible that other areas of the country,
including Oregon, may experience similar shortages. An interruption in the
supply of raw materials or energy inputs for any reason would have an adverse
effect on our manufacturing operations.

Our manufacturing facilities incorporate sophisticated computer integrated
manufacturing systems, which depend upon a mix of our proprietary software and
systems and software purchased from third parties. Failure of these systems
would cause a disruption in the manufacturing process and could result in a
delay in completion and shipment of products.

SAN SYSTEMS MANUFACTURING

The manufacturing of SAN systems products involves the assembly and testing
of components, including our semiconductors, which are then integrated into
final products.

SAN systems product and manufacturing designs are highly modularized for
flexibility. Our manufacturing operations include Configure to Order and
Assemble to Order capabilities. These processes have been implemented in an
effort to reduce requisite lead times for the delivery of product.

- US Manufacturing. Our US manufacturing facility in Wichita, Kansas,
assembles and tests high performance array controllers, rack-mount
modules and complete storage systems.

ISO-9001 certification at our Kansas manufacturing facility has been
maintained since April 1992. This facility is currently certified ISO 9001:2000
compliant as of October 2001. Product quality is achieved through employee
training, automated testing, and sample auditing. Supply line management extends
quality through the component and subassembly supplier base with continuous
reporting and supplier/product qualification programs.

- European Manufacturing. The Company maintains a manufacturing facility
in Cork, Ireland through an agreement with Flextronics International Ltd.
This facility is capable of assembly and testing of high performance
array controllers, rack-mount modules and complete storage systems.

The Irish site was established to provide flexibility in satisfying
European demand and to serve as a backup site in the event natural or human-made
disasters affect the manufacturing capacity of the Wichita, Kansas facility. The
Irish site is certified as ISO 9001:2000 compliant as of December 2001.

Our SAN systems manufacturing operations are based primarily on an
integrated Enterprise Resource Planning (ERP) manufacturing application system
purchased from a third party. This ERP system is augmented with several of our
proprietary software tools that support the production process through automated
product configuration and automated electronic testing. Failure of these systems
would cause a disruption in the manufacturing process and could result in delays
of product shipments and/or customer billings.

Our manufacturing facility in Wichita, Kansas depends upon a continuous
supply of electricity from a single utility provider. Any natural or manmade
disruptions could materially affect our operating results and financial
condition.

BACKLOG

SEMICONDUCTOR BACKLOG

In the Semiconductor segment, we generally do not have long-term volume
purchase contracts with our customers. Instead, customers place purchase orders
that are subject to acceptance by us. The timing of the design activities for
which we receive payment and the placement of orders included in our backlog at
any particular time is generally within the control of the customer. For
example, there could be a significant time lag between the commencement of
design work and the delivery of a purchase order for the units of a developed
product. Also, customers may from time to time revise delivery quantities or
delivery schedules to

10

reflect their changing needs. For these reasons, our backlog as of any
particular date is not a meaningful indicator of future sales.

SAN SYSTEMS BACKLOG

In the SAN Systems segment, our large customers who are original equipment
manufacturers place orders that are subject to acceptance by us in accordance
with their requirements and our delivery lead time capabilities. In our reseller
channel, we typically receive requests for product to be delivered within two
weeks or less. Accordingly, our backlog as of any particular date is not a
meaningful indicator of future sales.

COMPETITION

SEMICONDUCTOR COMPETITORS

The semiconductor industry is intensely competitive and characterized by
constant technological change, rapid product obsolescence, evolving industry
standards and price erosion. Many of our competitors are larger, diversified
companies with substantially greater financial resources. Some of these also are
customers who have internal semiconductor design and manufacturing capacity. We
also compete with smaller and emerging companies whose strategy is to sell
products into specialized markets or to provide a portion of the products and
services that we offer.

Our major competitors include large domestic companies such as IBM
Corporation, Agere Systems, Inc., Texas Instruments, Inc., and Agilent
Technologies, Inc. Other competitors in strategic markets include Adaptec, Inc.,
QLogic Corporation, PMC-Sierra, Inc., Broadcom Corporation, and Conexant
Systems, Inc.

We also face competition from certain large foreign corporations, including
Philips Electronics, N.V., ST Microelectronics, S.A., and Toshiba Corporation.

The principal competitive factors in the industry include:

- design capabilities;

- differentiating product features;

- product performance characteristics;

- time to market;

- price;

- manufacturing processes; and

- utilization of emerging industry standards.

We believe that we presently compete favorably with respect to these
factors. It is possible, however, that other custom design solutions will be
developed by our competitors that could have a material adverse impact on our
competitive position. Our competitors may also decide from time to time to
aggressively lower prices of products that compete with us in order to sell
related products or achieve strategic goals. Strategic pricing by competitors
can place strong pricing pressure on our products in certain transactions,
resulting in lower selling prices and lower gross profit margins for those
transactions.

The markets into which we sell our semiconductor products are subject to
severe price competition. We expect to continue to experience declines in the
selling prices of our semiconductor products over the life cycle of each
product. In order to offset or partially offset declines in the selling prices
of our products, we must continue to reduce the costs of products through
product design changes, manufacturing process changes, and yield improvements.
We do not believe that we can continually achieve cost reductions that fully
offset the price declines of our products, and therefore gross profit margin
percentages will generally decline for existing products over their life cycles.

11

We are increasingly emphasizing our CoreWare design methodology and
system-on-a-chip capability. Competitive factors that are important to the
success of this strategy include:

- selection, quantity and quality of our CoreWare library elements;

- our ability to offer our customers systems level expertise; and

- quality of software to support system-level integration.

Although there are other companies that offer similar types of products and
related services, we believe that we currently compete favorably with those
companies. However, competition in this area is increasing, and there is no
assurance that our CoreWare methodology approach and product offerings will
continue to receive market acceptance. Customers in our targeted markets
frequently require system-level solutions. Our ability to deliver complete
solutions may also require that we succeed in obtaining licenses to necessary
software and integrating this software with our semiconductors.

SAN SYSTEMS COMPETITORS

The SAN systems market is characterized by many of the same pressures found
in the semiconductor industry. We believe that important competitive factors in
the storage-systems market include the following:

- product performance and price;

- support for new industry and customer standards;

- scalability;

- interoperability with other network devices;

- features and functionality;

- availability;

- reliability, technical service, and support;

- quality of system integration;

- existence and accessibility of differentiating features; and

- quality and availability of supporting software.

Our failure to compete successfully with respect to any of these or other
factors could have a material adverse effect on our results of operations and
financial condition. Our SAN systems products compete primarily with products
from independent storage providers such as EMC Corporation, Hitachi Data Systems
Corporation and MTI Technology Corporation. In addition, many of our current and
potential customers in this market have internal storage divisions that produce
products that compete directly or indirectly with our storage-system products.
There is no assurance that these customers, which include Hewlett-Packard
Company, IBM Corporation, Sun Microsystems, Inc., Silicon Graphics and NCR, will
continue to purchase our storage systems products.

PATENTS, TRADEMARKS AND LICENSES

The Company has filed a number of patent applications and currently holds
numerous patents, expiring from 2002 to 2021, relating to certain of our
products and technologies in both the Semiconductor and the SAN Systems
segments. In both segments, we also maintain trademarks for certain of our
products and services and claim copyright protection for certain proprietary
software and documentation. Patents, trademarks, and other forms of protection
for our intellectual property are important, but we believe our future success
principally depends upon the technical competence and creative skills of our
personnel.

In the Semiconductor segment, we also protect our trade secret and other
proprietary information through agreements with our customers, suppliers,
employees, and consultants and through other security measures. We have entered
into certain cross-license agreements that generally provide for the
non-exclusive

12

licensing of rights to design, manufacture, and sell products and, in some
cases, for cross-licensing of future improvements developed by either party.

We continue to expand our portfolio of patents and trademarks. We offer a
staged incentive to engineers to identify, document and submit invention
disclosures. We have developed an internal review procedure to maintain a high
level of disclosure quality and to establish priorities and plans for filings
both in the United States and abroad. The review process is based solely on
engineering and management judgment, with no assurance that a specific filing
will issue, or if issued, will deliver any lasting value to us. There is no
assurance that the rights granted under any patents will provide competitive
advantages to us or will be adequate to safeguard and maintain our proprietary
rights. Moreover, the laws of certain countries in which our products are or may
be manufactured or sold may not protect our products and intellectual property
rights to the same extent as the U.S. legal system.

As is typical in the high technology industry, from time to time we have
received communications from other parties asserting that certain of our
products, processes, technologies or information infringe upon their patent
rights, copyrights, trademark rights or other intellectual property rights. We
regularly evaluate such assertions. In light of industry practice, we believe
with respect to existing or future claims that any licenses or other rights that
may be necessary can generally be obtained on commercially reasonable terms.
Nevertheless, there is no assurance that licenses will be obtained on acceptable
terms or that a claim will not result in litigation or other administrative
proceedings.

In the SAN Systems segment, we own a portfolio of patents and patent
applications concerning a variety of storage technologies. We also maintain
trademarks for certain of our products and services and claim copyright
protection for certain proprietary software and documentation. Similar to the
Semiconductor segment, we protect our trade secrets and other proprietary
information through agreements and other security measures, and have implemented
internal procedures to identify patentable inventions and pursue protection in
selected jurisdictions.

Please see Item 3, Legal Proceedings for information regarding pending
patent litigation against LSI; please also refer to the additional risk factors
set forth in the Risk Factors section; and Note 12 of the Notes to Consolidated
Financial Statements for additional information.

RESEARCH AND DEVELOPMENT

Our industry is characterized by rapid changes in products, design tools,
and process technologies. We must continue to improve our existing products,
design-tool environment and process technologies and to develop new ones in a
cost-effective manner to meet changing customer requirements and emerging
industry standards. If we are not able to successfully introduce new products,
design tools and process technologies or to achieve volume production of
products at acceptable yields using new manufacturing processes, there could be
a material adverse impact on our operating results and financial condition.

We operate research and development facilities in California, Colorado,
Oregon and Kansas. The following table shows our expenditures on research and
development activities for each of the last three fiscal years (in thousands).

Research and development expenses primarily consist of salaries and related
costs of employees engaged in ongoing research, design and development
activities and subcontracting costs.

13

WORKING CAPITAL

Information regarding our working capital practices is incorporated herein
by reference from Item 7 of Part II hereof under the heading "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Financial Condition and Liquidity".

FINANCIAL INFORMATION ABOUT GEOGRAPHIC AREAS

This information is included in Note 11 ("Segment Reporting") of Notes to
Financial Statements and Supplementary Data, which information is incorporated
herein by reference to Item 8 of Part II hereof.

ENVIRONMENTAL REGULATION

Federal, state and local regulations, in addition to those of other
nations, impose various environmental controls on the use and discharge of
certain chemicals and gases used in semiconductor processing. Our facilities
have been designed to comply with these regulations, and we believe that our
activities conform to current environmental regulations. However, increasing
public attention has been focused on the environmental impact of electronics and
semiconductor manufacturing operations. While to date we have not experienced
any material adverse impact on our business from environmental regulations, we
cannot assure you that such regulations will not be amended so as to impose
expensive obligations on us in the future. In addition, violations of
environmental regulations or impermissible discharges of hazardous substances
could result in the necessity for the following actions:

- additional capital improvements to comply with such regulations or to
restrict discharges;

- liability to our employees and/or third parties; and/or

- business interruptions as a consequence of permit suspensions or
revocations or as a consequence of the granting of injunctions requested
by governmental agencies or private parties.

EMPLOYEES

As of December 31, 2001, we had 6,737 full-time employees.

In January 2002, the Company announced a series of restructuring actions to
tailor the Company to its current lower level of revenues. These actions
included reducing the worldwide workforce by approximately 1,400 positions or 20
percent of the Company's workforce.

Our future success depends upon the continued service of our key technical
and management personnel and on our ability to continue to attract and retain
qualified employees, particularly those highly skilled design, process, and test
engineers involved in the manufacture of existing products and the development
of new products and processes. We currently have favorable employee relations,
but the competition for such personnel is intense, and the loss of key employees
or the inability to hire such employees when needed could have a material
adverse input on our business and financial condition.

SEASONALITY

The Company's business is largely focused on the communications and
consumer products markets. As a result, the Company's results may follow a
seasonal pattern, with stronger growth in the second half of the year,
reflecting the buying patterns of the Company's customers.

14

RISK FACTORS

Keep these risk factors in mind when you read "forward-looking" statements
elsewhere in this Form 10-K and in the documents incorporated herein by
reference. These are statements that relate to our expectations for future
events and time periods. Generally, the words, "anticipate," "expect," "intend'
and similar expressions identify forward-looking statements. Forward-looking
statements involve risks and uncertainties, and actual results could differ
materially from those anticipated in the forward-looking statements.

We operate in a cyclical industry and a general economic downturn may
reduce our revenues. The semiconductor industry is cyclical in nature and is
characterized by wide fluctuations in product supply and demand. In 2001, the
economic growth in the United States slowed significantly, which in turn, led to
a severe downturn in the semiconductor industry. During a period of industry
overcapacity, profitability can drop sharply as factory utilization declines and
high fixed costs of operating wafer fabrication facilities are spread over a
lower net revenue base. The Company's overall business bottomed in 2001 and the
Company is on track to restore profitability in the near future. However, any
additional terrorist activities may adversely affect the U.S. economy. In turn,
we may face interruption of production and services due to increased security
measures in light of recent terrorist activities, which may affect the recovery
of the Company in 2002 and adversely impact its operating results and financial
condition.

Our product and process development activities occur in a highly
competitive environment characterized by rapid technological change. The
Semiconductor and SAN Systems segments in which we conduct business are
characterized by rapid technological change, short product cycles and evolving
industry standards. We believe our future success depends, in part, on our
ability to improve on existing technologies and to develop and implement new
ones in order to continue to reduce semiconductor chip size and improve product
performance and manufacturing yields. We must also be able to adopt and
implement emerging industry standards and to adapt products and processes to
technological changes. If we are not able to implement new process technologies
successfully or to achieve volume production of new products at acceptable
yields, our operating results and financial condition will be adversely
impacted.

In addition, we must continue to develop and introduce new products that
compete effectively on the basis of price and performance and that satisfy
customer requirements. We continue to emphasize engineering development and
acquisition of CoreWare building blocks and integration of our CoreWare
libraries into our design capabilities. Our cores and standard products are
intended to be based upon industry standard functions, interfaces and protocols
so that they are useful in a wide variety of systems applications. Development
of new products and cores often requires long-term forecasting of market trends,
development and implementation of new or changing technologies and a substantial
capital commitment. We cannot assure you that the cores or standard products
that we select for investment of our financial and engineering resources will be
developed or acquired in a timely manner or will enjoy market acceptance.

We operate highly complex and costly manufacturing facilities. The
manufacture and introduction of our products is a complicated process. We
confront challenges in the manufacturing process that require us to:

- maintain a competitive manufacturing cost structure;

- implement the latest process technologies required to manufacture new
products;

- exercise stringent quality control measures to ensure high yields;

- effectively manage the subcontractors engaged in the test and assembly of
products; and

- update equipment and facilities as required for leading edge production
capabilities.

We do not control the timing or size of orders for our products. We
generally do not have long-term volume production contracts with our customers.
There is a risk that we will be unable to meet sudden increases in demand beyond
our current manufacturing capacity, which may result in additional capital
expenditures and production costs. On the other hand, order volumes below
anticipated levels may result in the under-utilization of our manufacturing
facilities, resulting in higher per unit costs, which could adversely affect our
operating results and financial condition.

15

Our manufacturing facilities are subject to disruption. Our newest wafer
fabrication site located in Gresham, Oregon is a highly complex,
state-of-the-art facility. Anticipated production rates depend upon the reliable
operation and effective integration of a variety of hardware and software
components. There is no assurance that all of these components will be fully
functional or successfully integrated on time or that the facility will achieve
the forecasted yield targets. The capital expenditures required to bring the
facility to full operating capacity may be greater than we anticipate and result
in lower margins.

Operations at any of our primary manufacturing facilities, or at any of our
test and assembly subcontractors, may be disrupted for reasons beyond our
control, including work stoppages, fire, earthquake, floods or other natural
disasters. Recently, California experienced a power shortage. Any future
shortages could subject us to electrical "blackouts" or other unscheduled
interruption of electrical power.

We outsource a substantial portion of wafers manufactured. The Company has
developed outsourcing arrangements for the manufacture of some of its products
based on a process technology that the Company does not possess. There is no
assurance that the third party manufacturer will be able to produce and deliver
wafers that meet the Company's specifications or that it will be able to provide
successfully the process technology it has committed. If the third party is not
able to deliver products and process technology on a timely and reliable basis,
the Company's results of operations could be adversely affected.

We have significant capital requirements to maintain and grow our
business. In order to remain competitive, we must continue to make significant
investments in new facilities and capital equipment. During 2002, we anticipate
that we will spend less than $200 million on capital assets and that we will be
required to spend potentially larger amounts thereafter. In addition, the high
level of capital expenditures required to remain competitive results in
relatively high fixed costs. If demand for our products does not absorb
additional capacity, the fixed costs and operating expenses related to increases
in our production capacity could have a material adverse impact on our operating
results and financial condition.

We finance our capital expenditure needs from operating cash flows, bank
financing and capital market financing. As of December 31, 2001, we had
convertible notes outstanding of approximately $1.3 billion. As of December 31,
2001, we have two operating leases financed by several commercial banks. We may
need to seek additional equity or debt financing from time to time, including
issuance of warrants and cannot be certain that additional financing will be
available on favorable terms. Moreover, any future equity or convertible debt
financing will decrease the percentage of equity ownership of existing
stockholders and may result in dilution, depending on the price at which the
equity is sold or the debt is converted.

We are exposed to fluctuations in foreign currency exchange rates. We have
international subsidiaries and distributors that operate and sell our products
globally. Further, we purchase a substantial portion of our raw materials and
manufacturing equipment from foreign suppliers, and incur labor and other
operating costs in foreign currencies, particularly in our Japanese
manufacturing facilities. As a result, we are exposed to the risk of changes in
foreign currency exchange rates or declining economic conditions in these
countries.

We do business in Europe and face risks associated with the Euro. A new
European currency was implemented in January 1999 to replace the separate
currencies of eleven western European countries, and beginning in January 2002,
was the only effective currency in these countries. This has required changes in
our operations as we modified systems and commercial arrangements to deal with
the new currency.

We procure parts and raw materials from limited domestic and foreign
sources. We use a wide range of parts and raw materials in the production of
our semiconductors, host adapter boards, and storage systems, including silicon
wafers, processing chemicals, and electronic and mechanical components. We do
not generally have guaranteed supply arrangements with our suppliers and do not
maintain an extensive inventory of parts and materials for manufacturing. We
purchase some of these parts and materials from a limited number of vendors and
some from a single supplier. On occasion, we have experienced difficulty in
securing an adequate volume and quality of parts and materials. There is no
assurance that, if we have difficulty in obtaining parts or materials in the
future, alternative suppliers will be available, or that these suppliers will
provide parts and materials in a timely manner or on favorable terms. As a
result, we may be adversely affected by delays in new and current product
shipments. If we cannot obtain adequate materials for

16

manufacture of our products, there could be a material adverse impact on our
operating results and financial condition.

We operate in highly competitive markets. We compete in markets that are
intensely competitive and that exhibit both rapid technological change and
continual price erosion. Our competitors include many large domestic and foreign
companies that have substantially greater financial, technical and management
resources than we do. Several major diversified electronics companies offer ASIC
products and/or other standard products that are competitive with our product
lines. Other competitors are specialized, rapidly growing companies that sell
products into the same markets that we target. Some of our large customers may
develop internal design and production capabilities to manufacture their own
products, thereby displacing our products. There is no assurance that the price
and performance of our products will be superior relative to the products of our
competitors. As a result, we may experience a loss of competitive position that
could result in lower prices, fewer customer orders, reduced revenues, reduced
gross profit margins and loss of market share. To remain competitive, we
continually evaluate our worldwide operations, looking for additional cost
savings and technological improvements.

Our future competitive performance depends on a number of factors,
including our ability to:

- properly identify target markets;

- accurately identify emerging technological trends and demand for product
features and performance characteristics;

- develop and maintain competitive products;

- enhance our products by adding innovative features that differentiate our
products from those of our competitors;

- bring products to market on a timely basis at competitive prices;

- respond effectively to new technological changes or new product
announcements by others;

- adapt products and processes to technological changes; and

- adopt and/or set emerging industry standards.

We may not meet our design, development and introduction schedules for new
products or enhancements to our existing and future products. In addition, our
products may not achieve market acceptance or sell at favorable prices.

We are dependent on a limited number of customers. We are increasingly
dependent on a limited number of customers for a substantial portion of revenues
as a result of our strategy to focus our marketing and selling efforts on
select, large-volume customers. One customer represented 18% of our total
consolidated revenues for the year ended December 31, 2001. In the Semiconductor
segment, one customer represented 21% of total Semiconductor revenues for the
year ended December 31, 2001. In the SAN Systems segment, there were two
customers with revenues representing 21% each, and one customer with revenues
representing 13% of total SAN Systems revenues for the year ended December 31,
2001.

Our operating results and financial condition could be affected if:

- we do not win new product designs from major customers;

- major customers reduce or cancel their existing business with us;

- major customers make significant changes in scheduled deliveries; or

- there are declines in the prices of products that we sell to these
customers.

We utilize indirect channels of distribution over which we exercise limited
control. We derive a material percentage of product revenues from independent
reseller and distributor channels. Our financial results could be adversely
affected if our relationship with these resellers or distributors were to
deteriorate or if the financial condition of these resellers or distributors
were to decline. Given the current economic environment, the risk of

17

distributors going out of business is significantly increased. In addition, as
our business grows, we may have an increased reliance on indirect channels of
distribution. There can be no assurance that we will be successful in
maintaining or expanding these indirect channels of distribution. This could
result in the loss of certain sales opportunities. Furthermore, the partial
reliance on indirect channels of distribution may reduce our visibility with
respect to future business, thereby making it more difficult to accurately
forecast orders.

Our Company operations are affected by cyclical fluctuations. The
Semiconductor and SAN Systems segments in which we compete are subject to
cyclical fluctuations in demand. In 2001, we experienced declines in sales or
the prices of our products as a result of the following:

- rapid technological change, product obsolescence, and price erosion in
our products;

- maturing product cycles in our products or products sold by our
customers;

- increases in worldwide manufacturing capacity for semiconductors,
resulting in declining prices; reduced product demand;

- excess inventory within the supply chain; and

- decline of the United States and worldwide economy, causing declines in
our product markets or the markets of our suppliers and customers.

The semiconductor industry has in the past experienced periods of rapid
expansion of production capacity. Even when the demand for our products remains
constant, the availability of additional excess production capacity in the
industry creates competitive pressure that can degrade pricing levels, which can
reduce revenues. Furthermore, customers who benefit from shorter lead times may
defer some purchases to future periods, which could affect our demand and
revenues for the short term. As a result, we may experience downturns or
fluctuations in demand in the future and experience adverse effects on our
operating results and financial condition.

We engage in acquisitions and alliances giving rise to economic and
technological risks. We intend to continue to make investments in companies,
products and technologies, either through acquisitions or investment alliances.
Acquisitions and investment activities often involve risks, including the need
to:

- acquire timely access to needed capital for investments related to
acquisitions and alliances;

- conduct acquisitions that are timely relative to existing business
opportunities;

- successfully prevail over competing bidders for target acquisitions at an
acceptable price;

- invest in companies and technologies that contribute to the growth of our
business;

- retain the key employees of the acquired operation;

- incorporate acquired operations into our business and maintain uniform
standards, controls, and procedures; and

- develop the capabilities necessary to exploit newly acquired
technologies.

Mergers and acquisitions of high-technology companies bear inherent risks.
No assurance can be given that our previous or future acquisitions will be
successful and will not materially adversely affect our business, operating
results or financial condition. We must manage any growth effectively. Failure
to manage growth effectively and to integrate acquisitions could adversely
affect our operating results and financial condition.

There is uncertainty associated with our research and development
investments. Our research and development activities are intended to maintain
and enhance our competitive position by utilizing the latest advances in the
design and manufacture of semiconductors and storage systems including
networking, communications and storage technologies. Technical innovations are
inherently complex and require long development cycles and the commitment of
extensive engineering resources. We must incur substantial research and
development costs to confirm the technical feasibility and commercial viability
of a product that in the end may not be successful. If we are not able to
successfully and timely complete our research and

18

development programs, we may face competitive disadvantages. There is no
assurance that we will recover the development costs associated with such
programs or that we will be able to secure the financial resources necessary to
fund future research and development efforts.

The price of our securities may be subject to wide fluctuations. Our stock
has experienced substantial price volatility, particularly as a result of
quarterly variations in results, the published expectation of analysts, and as a
result of announcements by our competitors and us. In addition, the stock market
has experienced price and volume fluctuations that have affected the market
price of many technology companies, in particular, and that have often been
unrelated to the operating performance of such companies. In addition, the price
of our securities may also be affected by general global, economic and market
conditions, and the cost of operations in one or more of our product markets.
While we cannot predict the individual effect that these factors may have on the
price or our securities, these factors, either individually or in the aggregate,
could result in significant variations in price during any given period of time.
These fluctuations in our stock price also impact the price of our outstanding
convertible securities and the likelihood of the convertible securities being
converted into cash or equity. If we are required to redeem any of the
convertible securities for cash it may affect our liquidity position.

Our global operations expose the Company to numerous international business
risks. We have substantial business activities in Asia and Europe. Both
manufacturing and sales of our products may be adversely impacted by changes in
political and economic conditions abroad. A change in the current tax laws,
tariff structures, export laws, regulatory requirements or trade policies in
either the United States or foreign countries could adversely impact our ability
to manufacture or sell our products in foreign markets. Moreover, a significant
decrease in sales by our customers to end users in either Asia or Europe could
result in a decline in orders.

We subcontract test and assembly functions to independent companies located
in Asia. A reduction in the number or capacity of qualified subcontractors or a
substantial increase in pricing could cause longer lead times, delays in the
delivery of products to customers, or increased costs.

The high technology industry in which we operate is prone to intellectual
property litigation. Our success is dependent in part on our technology and
other proprietary rights, and we believe that there is value in the protection
afforded by our patents, patent applications and trademarks. However, the
industry is characterized by rapidly changing technology and our future success
depends primarily on the technical competence and creative skills of our
personnel, rather than on patent and trademark protection.

As is typical in the high technology industry, from time to time we have
received communications from other parties asserting that certain of our
products, processes, technologies or information infringe upon their patent
rights, copyrights, trademark rights or other intellectual property rights. We
regularly evaluate such assertions. In light of industry practice, we believe
with respect to existing or future claims that any licenses or other rights that
may be necessary can generally be obtained on commercially reasonable terms.
Nevertheless, there is no assurance that licenses will be obtained on acceptable
terms or that a claim will not result in litigation or other administrative
proceedings. Resolution of whether the Company's product or intellectual
property has infringed on valid rights held by others could have a material
adverse effect on the Company's financial position or results of operation and
may require material changed in production processes and products

See Item 3 "Legal Proceedings" contained in Part I of this Report.

We must attract and retain key employees in a highly competitive
environment. Our employees are vital to our success and our key management,
engineering and other employees are difficult to replace. We do not generally
have employment contracts with our key employees. We do, however, maintain key
person life insurance for one of our employees. The expansion of high technology
companies in Silicon Valley, Colorado, Oregon and elsewhere where we operate our
business has increased demand and competition for qualified personnel, and
despite the economic slowdown, competition for these personnel is intense. Our
continued growth and future operating results will depend upon our ability to
attract, hire and retain significant numbers of qualified employees.

19

See also the Critical Accounting Policies contained in Part II, Item 7 of
the Management's Discussion and Analysis of Financial Condition and Results of
Operations.

ITEM 2. PROPERTIES

The Company's Milpitas facilities are leased and contain the Company's
corporate executive headquarters (for both the Semiconductor segment and the SAN
Systems segment), administration and engineering offices. The Company maintains
leased facilities in Fremont California, housing engineering offices, logistics
and warehouses.

The Company owns the land and buildings housing its manufacturing
facilities for the Semiconductor segment in Gresham, Oregon, Tsukuba, Japan,
Fort Collins, Colorado, and owns the manufacturing control, assembly and test
facilities in Tsuen Wan, Hong Kong.

In April 2001, the Company announced the closure of its Colorado Springs
fabrication facility in August 2001. In May 2001, the Company entered into a
definitive agreement to sell the facility to a third party. On August 1, 2001,
the Company announced the termination of the agreement to sell the facility. The
Company closed the facility in October 2001 and intends to dispose the assets
within the next 12 months.

In September 2001, the Company announced the consolidation of its U.S.
manufacturing operations at Gresham, Oregon, and the transfer of process
research and development from Santa Clara, California, to Gresham, Oregon. As a
result, the Company closed the Santa Clara manufacturing facility. The lease for
this facility will expire in 2003. The Company does not plan on subleasing this
facility at this time.

In the SAN Systems segment, the Company owns the manufacturing and
executive offices site in Wichita, Kansas.

In addition, we maintain leased sales and engineering offices, regional
office space for our field sales, marketing and design center offices for both
our Semiconductor segment and our SAN Systems segment at various locations in
North America, Europe, Japan and elsewhere in Asia. We also maintain design
centers at various distributor locations. We also maintain leased executive
offices, design centers and sales offices in Bracknell, UK and Tokyo, Japan.
Leased facilities described above are subject to operating leases that expire in
2002 through 2011. (See Note 12 of Notes to Consolidated Financial Statements.)

We have plans to acquire additional equipment for some of the above
facilities, but we believe that our existing facilities and equipment are well
maintained, in good operating condition, suitable for our operations and are
adequate to meet our current requirements.

ITEM 3. LEGAL PROCEEDINGS

In late 1995, a lawsuit was filed by certain former shareholders of our
Canadian subsidiary ("LSI Canada") in the Court of Queen's Bench of Alberta,
Judicial District of Calgary (the "Court") in which the question of LSI Canada's
value at September 7, 1995 is to be determined. At present, parties representing
approximately 580,000 shares are contesting the value of $4.00 (Canadian) that
was paid to the other former shareholders of LSI Canada at the time all shares
of LSI Canada not then owned by the Company were acquired by the Company.
Following a hearing held in March 2001, the Court dismissed the motion of the
former shareholders that challenged the proprietary of the fair value
proceedings initiated by LSI Canada and the jurisdiction of the Court to
adjudicate the matter. In addition, the Court ruled that the portions of the
application of the former shareholders to initiate a claim based upon
allegations that our actions and certain named (former) directors and a (former)
officer of LSI Canada were oppressive of the rights of minority shareholders of
LSI Canada were to be struck and the balance of the claims were stayed. The
Court also directed all of the litigants to recommence preparation for trial in
the fair value proceeding and advised the litigants of the Court's intention to
schedule a date for trial of that matter as soon as practicable. While we cannot
give any assurances regarding the resolution of these matters, we believe that
the final outcome will not have a material adverse effect on our consolidated
results of operations or financial condition. No assurance can be given,
however, that these matters will be resolved without our becoming obligated to
make payments

20

or to pay other costs to the opposing parties, with the potential for having an
adverse effect on our financial position or results of operations.

In February 1999, a lawsuit alleging patent infringement was filed in the
United States District Court for the District of Arizona by the Lemelson
Medical, Education & Research Foundation, Limited Partnership against 88
electronics industry companies, including us. The case number is
CIV990377PHXRGS. The patents involved in this lawsuit are alleged to relate to
semiconductor manufacturing and computer imaging, including the use of bar
coding for automatic identification of articles. In September 1999, we filed an
answer denying infringement, raising affirmative defenses and asserting a
counterclaim for declaratory judgment of non-infringement, invalidity and
unenforceability of Lemelson's patents. In December 2001, the court held a
hearing on Cypress Semiconductor's and plaintiff's cross-motions for summary
judgment with respect to the 4,390,586 patent. In February 2002, the court
denied Cypress Semiconductor's motion for summary judgment. The court also
granted the plaintiff's cross motion in part with respect to Cypress
Semiconductor and denied the cross-motion with respect to all other defendants.
These activities are ongoing, and as yet, no trial date has been set. While we
cannot make any assurance regarding the eventual resolution of this matter, we
do not believe it will have a material adverse effect on our consolidated
results of operations or financial condition.

U.S. Philips Corporation, a subsidiary of Royal Philips Electronics of
Netherlands, filed suits on October 17, 2001 in the U.S. District Court in New
York against eight companies, including us, for allegedly infringing and
inducing others to infringe Philips U.S. Patent Number 4,689,740. This patent is
directed to devices and methods used with the Inter-Integrated Circuit Bus.
While we cannot make any assurance regarding the eventual resolution of this
matter, we do not believe it will have a material adverse effect on our
consolidated results of operations or financial condition.

The Company is a party to other litigation matters and claims that are
normal in the course of its operations, and while the results of such litigation
and claims cannot be predicted with certainty, the Company believes that the
final outcome of such matters is not expected to have a material adverse effect
on the Company's consolidated results of operations and financial position.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

EXECUTIVE OFFICERS OF THE COMPANY

The executive officers of the Company, who are elected by and serve at the
discretion of the Board of Directors, are as follows:

Mr. Corrigan has been associated with the Company in his present position
for more than the past five years.

21

John D'Errico was named Executive Vice President, Storage Components in
August 2000. From August 1998 to August 2000, he was Vice President, Colorado
Operations. Mr. D'Errico joined us in 1984 and has held various senior
management and executive positions at our manufacturing facilities in the U.S.
and Japan. Mr. D'Errico served as Vice President and General Manager, Pan-Asia
from April 1997 to August 1998, and Vice President, JSI from July 1994 to April
1997.

Thomas Georgens was named Executive Vice President, SAN Systems, in
November 2000. In August 1998, upon the acquisition of Symbios, Inc., a storage
company, he was named Senior Vice President and General Manager, SAN Systems.
Mr. Georgens joined Symbios in 1996, where he served as Vice President and
General Manager of Storage Systems until its acquisition by LSI Logic.

Jon Gibson was named Vice President, Human Resources in November, 2001. He
joined LSI in September 1984, as Employee Relations Manager. Mr. Gibson was
named Director of Human Resources in October 1987. From March 1999 until
November 2001, Mr. Gibson served as Senior Director of Human Resources.

Bryon Look was named Executive Vice President and Chief Financial Officer
in November 2000. Mr. Look joined us in March 1997 as Vice President, Corporate
Development and Strategic Planning. Prior to joining LSI, during a 21-year
career at Hewlett-Packard Company, a computer company, he held a variety of
management positions in finance and research and development, with the most
recent position being Manager of Business Development for Hewlett-Packard's
Corporate Development department.

W. Richard Marz joined the Company in September 1995 as Senior Vice
President, North American Marketing and Sales, and was named Executive Vice
President, Geographic Markets in May 1996, a position he held until July, 2001.
In July 2001, he was named Executive Vice President, ASIC Technology. In January
2002, he was named Executive Vice President, Communications and ASIC Technology.

David G. Pursel was named Vice President, General Counsel and Secretary in
June 2000. He joined LSI Logic in February 1996 as Associate General Counsel,
Chief Intellectual Property Counsel, and Assistant Secretary.

Giuseppe Staffaroni was named Executive Vice President, Consumer Products
in January 2002. Prior to that he was named Executive Vice President Broadband
Communications Group, in November 2000, having served as Vice President and
General Manager of the Broadband Communications Group since November 1999. Mr.
Staffaroni joined LSI Logic in 1990 as Director of Engineering in the Company's
Milan, Italy design center. From January 1996 to October 1997, he was Director
of Marketing, and from November 1997 to October 1999, he was Vice President and
General Manager of the Communications Product Division. Prior to joining LSI
Logic, Mr. Staffaroni held management positions at Texas Instruments and AT&T
Microelectronics.

Frank A. Tornaghi was named Executive Vice President, Worldwide Sales in
July 2001. Since joining the Company in 1984, Mr. Tornaghi has held several
management positions in sales at LSI Logic and was named a vice president in
1993. Most recently, he served as Vice President, North America Sales, from May
1993 to July 2001.

Joseph M. Zelayeta was named Executive Vice President, Worldwide
Operations, in September 1997. Mr. Zelayeta joined the Company in 1981. From
August 1995 to September 1997, he served as Senior Vice President of Research
and Development, and General Manager of U.S. Operations.

There are no family relationships between any executive officers and
directors.

22

PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS

On January 25, 2000, we announced a two-for-one stock split, which was
declared by the Board of Directors as a 100% stock dividend payable to
stockholders of record on February 4, 2000, as one new share of common stock for
each share held on that date. The newly issued common stock shares were
distributed on February 16, 2000. In the following table, market prices of our
common stock have been restated to give retroactive recognition to the
two-for-one common stock split.

Our stock trades on the New York Stock Exchange under the symbol "LSI." The
high and low sales prices for the stock for each full quarterly period within
the two most recent fiscal years as reported on the Exchange are:

At March 8, 2002, there were approximately 4,408 owners of record of our
common stock.

We have never paid cash dividends on our common stock. It is presently our
policy to reinvest our earnings internally, and we do not anticipate paying any
cash dividends to stockholders in the foreseeable future.

23

ITEM 6. SELECTED FINANCIAL DATA

FIVE YEAR CONSOLIDATED SUMMARY

The Company's fiscal years ended on December 31 in 2001, 2000, 1999, 1998
and 1997. During 2001, the Company recorded a $97 million in-process research
and development ("IPR&D") charge associated with the acquisitions of C-Cube and
AMI, which were effective on May 11, 2001 and August 31, 2001, respectively. In
addition, the Company recorded $220 million in restructuring of operations and
other non-recurring items, net and $105 million in amortization of non-cash
deferred stock compensation. (See Notes 2

24

and 4 of the Notes to the Consolidated Financial Statements.) During 2000, the
Company recorded a $77 million IPR&D charge associated with the acquisitions of
ParaVoice, DataPath, IntraServer and the purchases of divisions of NeoMagic and
Cacheware. In addition, the Company recorded $41 million in non-cash deferred
stock compensation as a result of the adoption of FASB interpretation ("FIN")
No. 44, "Accounting for Certain Transactions Involving Stock Compensation,"
which was effective July 1, 2000. (See Note 2 of the Notes to the Consolidated
Financial Statements.) During 1999, the Company expensed an unamortized
preproduction balance of $92 million, net of taxes, associated with the
manufacturing facility in Gresham, Oregon and has presented it as a cumulative
effect of a change in accounting principle in accordance with SOP No. 98-5,
"Reporting on the Costs of Start-up Activities." (See Note 1 of the Notes to the
Consolidated Financial Statements.) During 1998, the Company reported a charge
for restructuring of operations and other non-recurring items, net of $75
million and a $146 million IPR&D charge related to the acquisition of Symbios on
August 6, 1998.

25

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

We operate in an industry sector where stock values are highly volatile and
may be influenced by economic and other factors beyond our control. We believe
that our future operating results will continue to be subject to quarterly
variations based upon a wide variety of factors. See additional discussion
contained in "Risk Factors" set forth in Part I, Item 1 of this Annual Report on
Form 10-K for the year ended December 31, 2001, which is incorporated by
reference into this Part II, Item 7.

Statements in this discussion and analysis include forward-looking
information within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities and Exchange Act of 1934, as amended.
These statements involve known and unknown risks and uncertainties. Our actual
results in future periods may be significantly different from any future
performance suggested in this report. Risks and uncertainties that may affect
our results may include, among others:

FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS

- The current economic downturn;

- Cyclical nature of both the Semiconductor and SAN Systems industries and
the markets addressed by our products;

- Availability and extent of utilization of manufacturing capacity;

- Price erosion;

- Competitive factors;

- Timing of new product introductions;

- Changes in product mix;

- Fluctuations in manufacturing yields;

- Product obsolescence;

- Business and product market cycles;

- Economic and technological risks associated with our acquisition and
alliance activities; and

- The ability to develop and implement new technologies.

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

We have international subsidiaries and distributors that operate and sell
our products globally. Further, we purchase a substantial portion of our raw
materials and manufacturing equipment from foreign suppliers and incur labor and
other operating costs in foreign currencies, particularly in our Japanese
manufacturing facilities. As a result, we are exposed to the risk of changes in
foreign currency exchange rates or declining economic conditions in these
countries. We utilize forward exchange and purchased currency option contracts
to manage our exposure associated with net asset and liability positions and
cash flows denominated in non-functional currencies. (See Note 6 of the Notes to
the Consolidated Financial Statements, hereafter referred

26

to as the Notes.) There is no assurance that these hedging transactions will
eliminate exposure to currency rate fluctuations that could affect our operating
results.

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

Where more than one significant factor contributed to changes in results
from year to year, we have quantified material factors throughout the MD&A where
practicable.

While management believes that the discussion and analysis in this report
is adequate for a fair presentation of the information, we recommend that you
read this discussion and analysis in conjunction with the remainder of this
Annual Report on Form 10-K.

CRITICAL ACCOUNTING POLICIES

The discussion and analysis of our financial condition and results of
operations are based on the consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. Note 1 of the Notes describes the significant accounting policies
essential to the consolidated financial statements. The preparation of these
financial statements requires estimates and assumptions that affect the reported
amounts and disclosures.

We believe the following to be critical accounting policies. That is, they
are both important to the portrayal of the Company's financial condition and
results, and they require critical management judgments and estimates about
matters that are inherently uncertain. Although we believe that our judgments
and estimates are appropriate and correct, actual future results may differ from
our estimates.

Inventory reserves. We establish reserves for estimated excess or obsolete
inventory based upon assumptions about demand and market conditions generally
over the following 12 months. We operate in a volatile industry sector
characterized by rapid changes in technology and market conditions.

Valuation of long-lived and intangible assets and goodwill. We operate our
own wafer fabrication facilities and make significant capital expenditures to
ensure that we are technologically competitive. In addition, we have actively
pursued the acquisition of businesses which have resulted in significant
goodwill and intangible assets. We assess the impairment of long-lived assets,
identifiable intangibles and related goodwill whenever events or changes in
circumstances indicate that the carrying value may not be recoverable. Factors
which we consider could trigger an impairment review include the following: (i)
significant negative industry or economic trends; (ii) exiting an activity in
conjunction with a restructuring of operations; (iii) current, historical or
projected losses that demonstrate continuing losses associated with an asset; or
(iv) a significant decline in our market capitalization relative to net book
value. When we determine that there is an indicator that the carrying value of
long-lived assets, identifiable intangibles and related goodwill may not be
recoverable, we measure impairment based on estimates of future cash flow. These
estimates include assumptions about future conditions within the Company and the
industry.

Restructuring reserves. We have recorded reserves for restructuring costs
related to the restructuring of operations. The restructuring costs include
payments to employees for severance, lease and contract termination fees,
decommissioning costs for fabrication equipment, and other costs to close
facilities. The reserves are recorded at the time we announce a plan to exit
certain activities and are based on estimates of the costs and length of time to
exit those activities.

Income taxes. We have recorded a valuation allowance to reduce the
deferred tax assets to the amount that is more likely than not to be realized.
We have considered future taxable income and ongoing prudent and feasible tax
planning strategies in assessing the need for the valuation allowance.

27

OVERVIEW

Revenues decreased 35% to $1.78 billion in 2001 from $2.74 billion in 2000.
The decrease was primarily the result of decreased demand, most notably for
products used in broadband access, networking infrastructure, storage
infrastructure applications, and storage area network ("SAN") systems,
reflecting the economic downturn in the industry. The decline in revenues was
partially offset by the additional revenues from acquisitions of C-Cube
Microsystems, Inc. ("C-Cube") and the RAID division of American Megatrends, Inc.
("AMI") in 2001.

Gross profit margin decreased to 23% in 2001 from 43% in 2000 primarily as
a result of decreased revenue for higher margin products, higher manufacturing
variances and period costs as a percentage of revenues and additional excess
inventory and related charges of $210.6 million for 2001 as compared to $11.1
million in 2000. The decrease in gross profit margin was offset in part by
cost-saving measures undertaken during 2001 discussed further in Note 4 of the
Notes. Operating expenses increased 61% to $1.4 billion in 2001 from $880
million in 2000. The increase was primarily a result of the operating expenses
of C-Cube and AMI, a $219.6 million charge for restructuring and other
non-recurring items, net, and other acquisition-related charges of $96.6 million
for in-process research and development ("IPR&D"), $104.6 million for
amortization of non-cash deferred stock compensation and $188.3 million in
amortization of intangibles. (See Notes 2 and 4 of the Notes.) Research and
development ("R&D") costs increased by $124.2 million in 2001 due to additional
costs incurred in connection with acquisitions in 2001 and continued core
business spending, which was offset in part by cost-saving measures undertaken
during the year. Selling, general and administrative ("SG&A") costs remained
relatively flat from year to year. Incremental, post-acquisition SG&A expenses
of C-Cube and AMI were largely offset by cost-saving measures undertaken during
the year. For the years ended December 31, 2001 and 2000, gains on sale of
investments in equity securities were $5.3 million and $80.1 million,
respectively. For the year ended December 31, 2001, we recorded a net loss of
$992.0 million, or $2.84 loss per diluted share, compared to net income for the
same period in 2000 of $236.6 million, or $0.70 income per diluted share. A
further discussion on results of operations is covered below.

Cash and short-term investments decreased by 11% to $1.01 billion as of
December 31, 2001 from $1.13 billion as of December 31, 2000. The decrease is
primarily attributable to lower cash flows from our continuing operations. Some
of the major transactions that impacted cash and short-term investments during
the year were as follows:

- Payments for acquisitions made in 2001.

- In the third quarter of 2001, we amended the master lease and security
agreements entered into in April 2001 and March 2000. (See Note 12 of the
Notes.) Pursuant to the amendments, we participated as a debt holder in
the lease transactions replacing some of the existing banks. As of
December 31, 2001, our debt contribution of $242 million was recorded as
non-current assets on the balance sheet. We cash collateralized $54
million of the remaining debt and equity investments of the lessors. This
was also recorded as non-current assets and deposits.

- On October 30, 2001, we issued $490 million of 4% Convertible
Subordinated Notes due in 2006, increasing our long term liabilities to
$1.5 billion at December 31, 2001 from $936.1 million at December 31,
2000. (See Note 8 of the Notes.)

Our significant cash position provides us with the capital to make
strategic acquisitions and to continue investing in key technologies.

Stock split. On January 25, 2000, we announced a two-for-one common stock
split, which was declared by the Board of Directors as a 100% stock dividend
payable to stockholders of record on February 4, 2000 as one new share of common
stock for each share held on that date. The newly issued common stock shares
were distributed on February 16, 2000. In the following discussion and analysis,
stockholders' equity has been restated to give retroactive recognition to the
two-for-one common stock split announced on January 25, 2000 for all periods
presented by reclassifying the par value of the newly issued shares arising from
the split from additional paid-in capital to common stock. In addition, all
references in