##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q _____________________ (Mark One)þ
    
    Quarterly Report Pursuant to
Section 13 or 15(d) of the
Securities Exchange Act of 1934
 For the quarterly period ended March 27, 2005 OR o
    
    Transition Report Pursuant to Section 13 or 15(d) of theSecurities Exchange Act of 1934
 Commission File No. 001-31353 EMULEX CORPORATION (Exact name of registrant as specified in its charter)
 Delaware
    
    51-0300558(State or other jurisdiction
    
    (I.R.S Employerof incorporation or organization)
    
    Identification No.)3333 Susan StreetCosta Mesa, California
    
    92626(Address of principal executive offices)
    
    (Zip Code)
 (714) 662-5600
(Registrants telephone number, including area code)   Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past
90 days.  Yes þ      No o Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of
the Exchange Act).  Yes þ      No o As of April 29, 2005 the registrant had 83,106,596 shares of common stock outstanding.




---



EMULEX CORPORATION AND SUBSIDIARIES INDEX PAGEPart
I.   FINANCIAL INFORMATIONItem 1.
    
    Financial Statements (Unaudited)Condensed Consolidated Balance Sheets
March 27, 2005 and June 27, 2004
    
    
    2Condensed Consolidated Statements of Income
Three and nine months ended March 27, 2005 and March 28,
2004
    
    
    3Condensed Consolidated Statements of Cash Flows
Nine months ended March 27, 2005 and March 28, 2004
    
    
    4Notes
to Condensed Consolidated Financial Statements
    
    
    5Item 2.
    
    Managements Discussion and Analysis of
Financial Condition and Results of Operations
    
    
    13Item 3.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    36Item 4.
    
    Controls and Procedures
    
    
    36Part
II.   OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    37Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    38Item 6.
    
    Exhibits
    
    
    39Signatures
    
    
    41EXHIBIT 31.AEXHIBIT 31.BEXHIBIT 32
  1




---



##### Table of Contents



PART I. FINANCIAL INFORMATION 
 Item 1. Financial Statements EMULEX CORPORATION AND SUBSIDIARIES 
  
 March 27,
    
    
    June 27,2005
    
    2004AssetsCurrent assets:Cash and cash equivalents
    
    $
    154,886
    
    
    $
    192,137Restricted cash
    
    
    
    
    
    
    23Investments
    
    
    343,235
    
    
    
    220,114Accounts and other receivables, net
    
    
    54,167
    
    
    
    61,720Litigation settlements receivable
    
    
    
    
    
    
    5,101Inventories, net
    
    
    26,842
    
    
    
    31,835Prepaid expenses
    
    
    4,645
    
    
    
    3,572Deferred income taxes
    
    
    21,449
    
    
    
    26,824Total current assets
    
    
    605,224
    
    
    
    541,326Property and equipment, net
    
    
    63,598
    
    
    
    64,570Investments
    
    
    115,727
    
    
    
    243,125Intangibles, net
    
    
    102,609
    
    
    
    122,667Other assets
    
    
    837
    
    
    
    1,293$
    887,995
    
    
    $
    972,981Liabilities and Stockholders EquityCurrent liabilities:Accounts payable
    
    $
    26,985
    
    
    $
    21,747Accrued liabilities
    
    
    24,617
    
    
    
    22,839Income taxes payable
    
    
    21,753
    
    
    
    9,910Total current liabilities
    
    
    73,355
    
    
    
    54,496Convertible subordinated notes
    
    
    359,771
    
    
    
    524,845Deferred income taxes and other
    
    
    6,651
    
    
    
    486Total liabilities
    
    
    439,777
    
    
    
    579,827Commitments and contingencies (notes 7 and 8)Stockholders equity:Preferred stock, $0.01 par value; 1,000,000 shares authorized
(150,000 shares designated as Series A Junior Participating
Preferred Stock); none issued and outstanding
    
    
    
    
    
    
    Common stock, $0.10 par value; 240,000,000 shares authorized;
82,911,045 and 82,413,845 shares issued and outstanding at
March 27, 2005, and June 27, 2004, respectively
    
    
    8,291
    
    
    
    8,241Additional paid-in capital
    
    
    941,201
    
    
    
    936,123Deferred compensation
    
    
    (4,106
    )
    
    
    (7,754
    )Accumulated deficit
    
    
    (497,168
    )
    
    
    (543,456
    )Total stockholders equity
    
    
    448,218
    
    
    
    393,154$
    887,995
    
    
    $
    972,981
 See accompanying notes to the condensed consolidated financial statements. 2




---



##### Table of Contents



EMULEX CORPORATION AND SUBSIDIARIES 
  
 Three Months Ended
    
    Nine Months EndedMarch 27,
    
    
    March 28,
    
    
    March 27,
    
    
    March 28,2005
    
    2004
    
    2005
    
    2004Net revenues
    
    $
    102,580
    
    
    $
    99,038
    
    
    $
    267,476
    
    
    $
    277,984Cost of sales
    
    
    37,446
    
    
    
    36,374
    
    
    
    100,238
    
    
    
    99,507Gross profit
    
    
    65,134
    
    
    
    62,664
    
    
    
    167,238
    
    
    
    178,477Operating expenses:Engineering and development
    
    
    21,042
    
    
    
    19,046
    
    
    
    60,985
    
    
    
    53,701Selling and marketing
    
    
    8,004
    
    
    
    8,366
    
    
    
    23,015
    
    
    
    19,818General and administrative
    
    
    4,223
    
    
    
    6,014
    
    
    
    7,381
    
    
    
    15,259Amortization of intangibles
    
    
    6,547
    
    
    
    6,795
    
    
    
    19,642
    
    
    
    12,546Impairment of goodwill
    
    
    
    
    
    
    
    
    
    
    1,793
    
    
    
    In-process research and development
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,400Total operating expenses
    
    
    39,816
    
    
    
    40,221
    
    
    
    112,816
    
    
    
    112,724Operating income
    
    
    25,318
    
    
    
    22,443
    
    
    
    54,422
    
    
    
    65,753Nonoperating income:Interest income
    
    
    3,341
    
    
    
    2,224
    
    
    
    9,242
    
    
    
    6,700Interest expense
    
    
    (1,016
    )
    
    
    (1,525
    )
    
    
    (3,419
    )
    
    
    (3,285
    )Gain (loss) on repurchase of
convertible subordinated notes
    
    
    (279
    )
    
    
    (231
    )
    
    
    12,811
    
    
    
    2,670Other income (expense), net
    
    
    (24
    )
    
    
    (23
    )
    
    
    48
    
    
    
    141Total nonoperating income
    
    
    2,022
    
    
    
    445
    
    
    
    18,682
    
    
    
    6,226Income before income taxes
    
    
    27,340
    
    
    
    22,888
    
    
    
    73,104
    
    
    
    71,979Income tax provision
    
    
    9,552
    
    
    
    8,560
    
    
    
    26,816
    
    
    
    31,448Net income
    
    $
    17,788
    
    
    $
    14,328
    
    
    $
    46,288
    
    
    $
    40,531Net income per share:Basic
    
    $
    0.21
    
    
    $
    0.18
    
    
    $
    0.56
    
    
    $
    0.49Diluted
    
    $
    0.20
    
    
    $
    0.16
    
    
    $
    0.52
    
    
    $
    0.46Number of shares used in per share
computations:Basic
    
    
    82,963
    
    
    
    81,872
    
    
    
    82,710
    
    
    
    82,928Diluted
    
    
    93,415
    
    
    
    96,571
    
    
    
    93,467
    
    
    
    91,481
 See accompanying notes to the condensed consolidated financial statements. 3




---



##### Table of Contents



EMULEX CORPORATION AND SUBSIDIARIES 
  
 Nine Months EndedMarch 27,
    
    
    March 28,2005
    
    2004Cash flows from operating activities:Net income
    
    $
    46,288
    
    
    $
    40,531Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation and amortization of property and equipment
    
    
    10,723
    
    
    
    9,254Amortization of discount on 0.25% convertible subordinated notes
    
    
    2,262
    
    
    
    1,052Gain on repurchase of convertible subordinated notes
    
    
    (12,811
    )
    
    
    (2,670
    )Insurance recovery on shareholder litigation settlements
    
    
    (4,649
    )
    
    
    Stock-based compensation
    
    
    3,305
    
    
    
    5,265Amortization of other intangibles
    
    
    19,642
    
    
    
    12,546Impairment of goodwill
    
    
    1,793
    
    
    
    In-process research and development
    
    
    
    
    
    
    11,400Deferred income taxes
    
    
    9,753
    
    
    
    7,932Tax benefit from exercise of stock options
    
    
    1,619
    
    
    
    5,597Other
    
    
    22
    
    
    
    172Changes in assets and liabilities:Accounts and other receivables
    
    
    7,553
    
    
    
    (12,026
    )Inventories
    
    
    4,993
    
    
    
    (18,285
    )Prepaid expenses and other assets
    
    
    (974
    )
    
    
    2,466Accounts payable and accrued liabilities
    
    
    7,806
    
    
    
    7,405Payment of litigation settlements, net of reimbursement
    
    
    9,052
    
    
    
    (31,506
    )Income taxes payable
    
    
    11,843
    
    
    
    11,086Net cash provided by operating activities
    
    
    118,220
    
    
    
    50,219Cash flows from investing activities:Net proceeds from sale of property and equipment
    
    
    42
    
    
    
    53Additions to property and equipment
    
    
    (9,815
    )
    
    
    (42,743
    )Decrease in restricted cash related to the construction escrow account
    
    
    23
    
    
    
    9,096Payments for Vixel Corporation, net of cash acquired
    
    
    
    
    
    
    (294,096
    )Payments for the technology assets of Trebia Networks, Inc.
    
    
    
    
    
    
    (2,094
    )Purchases of investments
    
    
    (560,490
    )
    
    
    (280,149
    )Maturities of investments
    
    
    564,767
    
    
    
    317,479Net cash used in investing activities
    
    
    (5,473
    )
    
    
    (292,454
    )Cash flows from financing activities:Repayment of short term indebtedness, notes payable and capital leases
    
    
    
    
    
    
    (175,290
    )Proceeds from short term indebtedness
    
    
    
    
    
    
    174,000Proceeds from issuance of common stock under stock option and
employee stock purchase plans
    
    
    4,268
    
    
    
    10,348Repurchase of common stock
    
    
    
    
    
    
    (40,500
    )Net proceeds from issuance of 0.25% convertible subordinated notes
    
    
    
    
    
    
    505,179Repurchase of convertible subordinated notes
    
    
    (154,266
    )
    
    
    (185,609
    )Net cash provided by (used in) financing activities
    
    
    (149,998
    )
    
    
    288,128Net increase (decrease) in cash and cash equivalents
    
    
    (37,251
    )
    
    
    45,893Cash and cash equivalents at beginning of period
    
    
    192,137
    
    
    
    136,971Cash and cash equivalents at end of period
    
    $
    154,886
    
    
    $
    182,864Supplemental disclosures:Noncash investing and financing activities:Fair value of assets acquired
    
    $
    
    
    
    $
    20,936Fair value of liabilities assumed
    
    
    
    
    
    
    13,449Stock options assumed for acquired business
    
    
    
    
    
    
    47,538Cash paid during the period for:Interest
    
    $
    761
    
    
    $
    2,226Income taxes
    
    
    3,836
    
    
    
    6,888
 See accompanying notes to the condensed consolidated financial statements. 4




---



##### Table of Contents



EMULEX CORPORATION AND SUBSIDIARIES 
   1.
    Summary of Significant Accounting Policies and Basis of PresentationIn the opinion of the Company, the accompanying unaudited condensed consolidated financial
statements contain all adjustments (which are normal recurring accruals) necessary to present
fairly its financial position as of March 27, 2005, and June 27, 2004, and its condensed
consolidated statements of income for the three and nine months ended March 27, 2005, and March
28, 2004 and its condensed consolidated statements of cash flows for the nine months then
ended. Interim results for the nine months ended March 27, 2005, are not necessarily
indicative of the results that may be expected for the year ending July 3, 2005. The interim
financial statements should be read in conjunction with the Companys Annual Report on Form
10-K for the fiscal year ended June 27, 2004.New Accounting StandardsEmerging Issues Task Force Issue 04-08, The Effect of Contingently Convertible Debt on Diluted
Earnings per Share, (EITF 04-08) became effective for fiscal periods ending after December
15, 2004. EITF 04-08 requires the inclusion of shares related to certain contingently
convertible debt instruments for computing diluted earnings per share using the if-converted
method, even when a market price contingency has not been met. The effect of EITF 04-08 has
increased our weighted average shares outstanding by approximately 8.4 million (related to the
Companys outstanding 0.25 percent contingent convertible subordinated notes of $364.5 million
issued in December 2003 and January 2004) in calculating the Companys diluted earnings per
share calculation for the quarter ended March 27, 2005. Prior periods earnings per share
amounts presented for comparative purposes have been restated to conform to this method.In November 2004, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standard (SFAS) No. 151 Inventory Costs, an amendment of ARB No. 43,
Chapter 4. The amendments made by SFAS No. 151 clarify that abnormal amounts of idle facility
expense, freight, handling costs, and wasted materials (spoilage) should be recognized as
current-period charges and require the allocation of fixed production overheads to inventory
based on the normal capacity of the production facilities. The guidance is effective for
inventory costs incurred during fiscal years beginning after June 15, 2005. The Company does
not believe SFAS No. 151 will have a significant impact on the Companys consolidated results
of operations or financial position.In December 2004, the FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets, an amendment
of APB Opinion No. 29, Accounting for Nonmonetary Transactions. SFAS No. 153 states that
exchanges of nonmonetary assets should be measured based on the fair value of the assets
exchanged. Further, SFAS No. 153 eliminates the narrow exception for nonmonetary exchanges of
similar productive assets and replaces it with a broader exception for exchanges of nonmonetary
assets that do not have commercial substance. SFAS No. 153 is effective for nonmonetary asset
exchanges occurring in fiscal periods beginning after June 15, 2005. The provisions of SFAS
No. 153 shall be applied prospectively. The Company does not believe the adoption of SFAS No.
153 will have a significant impact on the Companys consolidated results of operations or
financial position.In November 2003, the EITF reached an interim consensus on EITF 03-01, The Meaning of
Other-Than-Temporary Impairment and its Application to Certain Investments, to require
additional disclosure requirements for securities classified as available-for-sale or
held-to-maturity for fiscal years ending after December 15, 2003. In March 2004, the EITF
reached a final consensus on this Issue, to provide additional guidance, which companies must
follow in determining whether investment securities have an impairment, which should be
considered other-than-temporary. The effective date of this consensus has been delayed pending
further FASB action. EITF 03-01 is not expected to have a significant impact on the carrying
value of the Companys investments.In December 2004, the FASB issued two FASB Staff Positions (FSPs) that provide accounting
guidance on how companies should account for the effects of the American Jobs Creations Act of
2004 (the Act) that was signed into law on October 22, 2004. The Act could affect how
companies report their deferred income tax balances. The FSPs are FSP 109-1(FSP 109-1); the
second is FSP 109-2 (FSP 109-2). In FSP 109-1, the FASB concludes that the tax relief
(special tax deduction for domestic manufacturing) from the Act should be 5




---



##### Table of Contents



EMULEX CORPORATION AND SUBSIDIARIES   accounted for as a special deduction instead of a tax rate reduction. FSP 109-2 gives a
company additional time to evaluate the effects of the Act on any plan for Income Taxes.
However, companies must provide certain disclosures if they choose to utilize the additional
time granted by the FASB. The Company is evaluating the impact, if any, these FSPs may have on
its results of operations, financial condition or cash flows.In December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment. SFAS No.
123R requires that the compensation cost relating to share-based payment transactions be
recognized in financial statements. That cost will be measured based on the fair value of the
equity or liability instruments issued. SFAS No. 123R covers a wide range of share-based
compensation arrangements including share options, restricted share plans, performance-based
awards, share appreciation rights, and employee share purchase plans. SFAS No. 123R replaces
SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes Accounting Principles
Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. SFAS No. 123R is
effective as of the first annual reporting period that begins after June 15, 2005; however,
early adoption is permitted. The Company is currently evaluating its alternatives, which will likely
include early adoption during the three months ending July 3, 2005. The adoption of SFAS No. 123R will have a significant impact on the
Companys results of operations, as demonstrated by the SFAS No. 123 pro-forma disclosures
below.Stock-Based CompensationThe Company currently accounts for its stock-based awards to employees using the intrinsic
value method under APB 25 and related interpretations. Stock-based awards to non-employees, if
any, are recorded using the fair value method. Had the Company determined compensation cost
based on the fair value at the grant date for all its stock options under SFAS No. 123, the
Companys net income would have been the pro forma amounts indicated below (in thousands,
except per share data): Three Months Ended
    
    Nine Months EndedMarch 27,
    
    
    March 28,
    
    
    March 27,
    
    
    March 28,2005
    
    2004
    
    2005
    
    2004Net income as reported
    
    $
    17,788
    
    
    $
    14,328
    
    
    $
    46,288
    
    
    $
    40,531Add: total employee
stock-based compensation
expense included in net
income as reported, net of
related tax effects
    
    
    622
    
    
    
    1,596
    
    
    
    2,301
    
    
    
    3,924Deduct: Total employee
stock-based compensation
expense determined
under fair value method for
all awards, net of related
tax effects
    
    
    (5,419
    )
    
    
    (2,925
    )
    
    
    (18,898
    )
    
    
    (22,507
    )Pro forma net income
    
    $
    12,991
    
    
    $
    12,999
    
    
    $
    26,691
    
    
    $
    21,948Pro forma net income per shareBasic  as reported
    
    $
    0.21
    
    
    $
    0.18
    
    
    $
    0.56
    
    
    $
    0.49Basic  pro forma
    
    $
    0.16
    
    
    $
    0.16
    
    
    $
    0.36
    
    
    $
    0.26Diluted  as reported
    
    $
    0.20
    
    
    $
    0.16
    
    
    $
    0.52
    
    
    $
    0.46Diluted  pro forma
    
    $
    0.15
    
    
    $
    0.14
    
    
    $
    0.34
    
    
    $
    0.26
 6




---



##### Table of Contents



EMULEX CORPORATION AND SUBSIDIARIES   The fair value of each option granted during the three and nine months ended March 27, 2005,
and March 28, 2004, was estimated on the date of grant using the Black-Scholes option-pricing
model with the following assumptions: Three Months Ended
    
    Nine Months EndedMarch 27,
    
    
    March 28,
    
    
    March 27,
    
    
    March 28,2005
    
    2004
    
    2005
    
    2004Risk-free interest rate
    
    
    4.0%
    
    
    
    2.1%
    
    
    
    2.0% - 4.0%
    
    
    
    1.0% - 2.5%Stock volatility
    
    
    50.0%
    
    
    
    106.1%
    
    
    
    50.0% - 84.0%
    
    
    
    41.0% - 117.7%Dividend yield
    
    
    0.0%
    
    
    
    0.0%
    
    
    
    0.0%
    
    
    
    0.0%Average expected lives (years)
    
    
    2.9
    
    
    
    3.4
    
    
    
    0.5 - 2.9
    
    
    
    0.5 - 3.4Weighted-average fair value
per option granted
    
    
    $6.08
    
    
    
    $17.98
    
    
    
    $3.49 - $6.08
    
    
    
    $4.92 - $17.98
  The Black-Scholes model, and other currently accepted option valuation models, were developed
to estimate the fair value of freely-tradable, fully-transferable options without vesting
restrictions, which significantly differ from the Companys stock option plans. These models
also require highly subjective assumptions, including future stock price volatility and
expected time until exercise, which greatly affect the calculated fair value on the grant date.2.
    Business CombinationOn November 13, 2003, the Company completed the cash
tender offer to acquire all outstanding shares of Vixel Corporation. On November 17, 2003, the Company completed its acquisition of
Vixel. The Company acquired Vixel to expand its Fibre Channel product line and paid $298.4
million in cash for all outstanding common stock, preferred stock and warrants of Vixel
Corporation. The Company also incurred acquisition-related expenses of $6.7 million in cash.
In addition, the Company issued 2.2 million stock options with a fair value of approximately
$47.5 million and kept the original vesting periods for the options in exchange for the
outstanding Vixel options for a total acquisition value of $352.7 million. The Company
calculated the fair value of the 2.2 million stock options issued at the date of acquisition
using the Black-Scholes option-pricing model.The acquisition has been included in the condensed consolidated balance sheets of the Company
and the operating results of Vixel have been included in the condensed consolidated statements
of operations of the Company since the date that the Company gained effective control of Vixel,
November 13, 2003. Operations of Vixel, since the acquisition, have been included within the
Companys one operating segment, networking products.In connection with the preparation of Vixel Corporations tax return in the first quarter of
fiscal 2005, the Company revised estimates and discovered errors related to the deferred tax
assets of Vixel Corporation (acquired in November 2003). As a result, the Company recorded a
$1.8 million impairment of goodwill in the three months ended September 26, 2004. Had these
items been recorded in fiscal 2004, the Companys net loss would have been $1.8 million higher,
or $534.1 million, instead of $532.3 million. The Company does not believe that this $1.8
million impairment of goodwill is material to fiscal 2004 or will be material to fiscal 2005
operations or financial results. Excluding this adjustment, net income for the nine months
ended March 27, 2005, would have been $48.1 million.3.
    InventoriesInventories, net, are summarized as follows: March 27,
    
    
    June 27,2005
    
    2004(in thousands)Raw materials
    
    $
    13,857
    
    
    $
    19,181Finished goods
    
    
    12,985
    
    
    
    12,654$
    26,842
    
    
    $
    31,835
 7




---



##### Table of Contents



EMULEX CORPORATION AND SUBSIDIARIES   4.
    IntangiblesIntangibles, net, are as follows: March 27,
    
    
    June 27,2005
    
    2004(in thousands)Intangible assets subject to amortization:Core technology and patents
    
    $
    98,884
    
    
    $
    99,094Accumulated amortization, core technology and patents
    
    
    (35,613
    )
    
    
    (24,774
    )Developed technology
    
    
    9,365
    
    
    
    9,400Accumulated amortization, developed technology
    
    
    (3,234
    )
    
    
    (1,472
    )Customer relationships
    
    
    38,058
    
    
    
    38,200Accumulated amortization, customer relationships
    
    
    (10,516
    )
    
    
    (4,786
    )Tradename
    
    
    4,981
    
    
    
    5,000Accumulated amortization, tradename
    
    
    (983
    )
    
    
    (448
    )Covenants not-to-compete
    
    
    3,089
    
    
    
    3,100Accumulated amortization, covenants not-to-compete
    
    
    (1,422
    )
    
    
    (647
    )Intangible assets subject to amortization
    
    $
    102,609
    
    
    $
    122,667
  The recorded value of the specifically-identified intangible assets associated with the
acquisition of Vixel were reduced during the three months ended March 27, 2005, by $0.4 million
related to tax benefits associated with stock option exercises.The intangible assets subject to amortization are being amortized on a straight-line basis over
lives ranging from two to seven years. Aggregated amortization expense for these intangibles
for the three and nine months ended March 27, 2005, was $6.5 million and $19.6 million,
respectively. For the following five full fiscal years aggregated amortization expense is
expected to be (in thousands): 2005
    
    $
    26,1622006
    
    $
    26,0192007
    
    $
    25,3412008
    
    $
    21,2152009
    
    $
    11,550
  5.
    Other AssetsComponents of other assets are as follows: March 27,
    
    
    June 27,2005
    
    2004(in thousands)Deferred debt issuance costs-
convertible subordinated notes, net
    
    $
    282
    
    
    $
    833Long-term prepaid assets
    
    
    451
    
    
    
    236Refundable deposits
    
    
    104
    
    
    
    224$
    837
    
    
    $
    1,293
  6.
    Accrued LiabilitiesComponents of accrued liabilities are as follows: March 27
    
    
    June 27,2005
    
    2004(in thousands)Payroll and related costs
    
    $
    8,324
    
    
    $
    8,936Warranty reserves
    
    
    4,767
    
    
    
    4,046Deferred revenue
    
    
    1,492
    
    
    
    1,561Accrued advertising and promotions
    
    
    1,473
    
    
    
    1,139Accrued property, sales, franchise and related taxes
    
    
    2,225
    
    
    
    1,938Other
    
    
    6,336
    
    
    
    5,219Intangible assets subject to amortization
    
    $
    24,617
    
    
    $
    22,839
 8




---



##### Table of Contents



EMULEX CORPORATION AND SUBSIDIARIES   Deferred revenue includes an accrual for estimated returns and allowances of $1.5 million at
March 27, 2005 and June 27, 2004.The Company provides a warranty of between one and five years on its products. The Company
records a provision for estimated warranty-related costs based on historical product returns
and the Companys expected future cost of fulfilling its warranty obligations.Changes to the warranty reserve for the three and nine months ended March 27, 2005, and March
28, 2004, were: Three Months Ended
    
    Nine Months EndedMarch 27,
    
    
    March 28,
    
    
    March 27,
    
    
    March 28,2005
    
    2004
    
    2005
    
    2004Balance at beginning of period
    
    $
    4,152
    
    
    $
    4,204
    
    
    $
    4,046
    
    
    $
    2,349Additions to costs and expenses
    
    
    1,213
    
    
    
    796
    
    
    
    2,450
    
    
    
    2,279Amounts charged against reserve
    
    
    (598
    )
    
    
    (501
    )
    
    
    (1,729
    )
    
    
    (1,582
    )Beginning balance of Vixel
Corporation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,453Balance at end of period
    
    $
    4,767
    
    
    $
    4,499
    
    
    $
    4,767
    
    
    $
    4,499
  7.
    Convertible Subordinated NotesIn fiscal 2002, the Company completed a $345.0 million private placement of 1.75 percent
convertible subordinated notes due February 1, 2007. Interest is payable in cash on February
1 and August 1 of each year beginning August 1, 2002.During the nine months ended March 28, 2004, the Company bought back approximately $191.6
million in face value of its 1.75 percent convertible subordinated notes for approximately
$185.6 million, resulting in a net pre-tax gain of approximately $2.7 million. On January 27,
2005, the Company announced the redemption of all of its remaining 1.75 percent convertible
notes effective February 22, 2005. In February 2005, the Company repurchased approximately
$17.0 million of its 1.75 percent convertible notes at a premium to face value, spending
approximately $17.1 million. The resulting net pre-tax loss of $0.3 million from the
repurchase of these 1.75 percent convertible notes was recorded in the three months ended
March 27, 2005. The repurchased notes were cancelled leaving no 1.75 convertible notes
outstanding at March 27, 2005.In fiscal 2004, the Company completed a $517.5 million private placement of 0.25 percent
contingent convertible subordinated notes due December 15, 2023. Interest is payable in cash
on June 15 and December 15 of each year beginning June 15, 2004. Under the terms of the
offering, the notes will be convertible into shares of Emulex common stock at a price of
$43.20 per share at the option of the holder upon the occurrence of any of the following:  
    prior to December 15, 2021, on any date during any fiscal quarter (and only
during such fiscal quarter) after the fiscal quarter ending December 31, 2003, if
the closing sale price of the Companys common stock was more than 120% of the
then current conversion price for at least 20 trading days in the period of the 30
consecutive trading days ending on the last day of the previous fiscal quarter;
    on or after December 15, 2021, at all times on or after any date on which the
closing sale price of the Companys common stock is more than 120% of the then
current conversion price of the notes;
    if the Company elects to redeem the notes on or after December 20, 2008;
    upon the occurrence of specified corporate transactions or significant
distributions to holders of the Companys common stock; or
    subject to specified exceptions, for the ten business day period after any five
consecutive trading day period in which the average trading prices for the notes
for such five trading day period was less than 98% of the average conversion value
of the notes during that period. 9




---



##### Table of Contents



EMULEX CORPORATION AND SUBSIDIARIES   The notes will mature in twenty years and will not be callable for the first five years.
Holders of the notes may require the Company to purchase the notes for cash by giving written
notice within the 20 business days prior to each of December 15, 2006, December 15, 2008,
December 15, 2013 or December 15, 2018 or upon a change in control. The Company incurred
total associated bankers fees of approximately $11.6 million, which were recorded as a
reduction to the proceeds from the issuance of the notes and will be accreted over the
effective life of the notes, as well as $0.7 million of other associated debt issuance costs,
which have been included in other assets and will also be amortized over the effective life of
the notes. The effective life of the Companys 0.25 percent contingent convertible
subordinated notes due 2023 is three years, which is the period up to the first date that the
holders can require us to repurchase the notes.On August 25, 2004, the Company repurchased approximately $153.0 million of its 0.25 percent
convertible subordinated notes at a discount to face value, spending approximately $137.2
million. The resulting net pre-tax gain of $13.1 million from the repurchase of these 0.25
percent convertible subordinated notes was recorded in the nine months ended March 27, 2005.
The repurchased notes were cancelled, leaving 0.25 percent convertible subordinated notes
outstanding with a face value of approximately $364.5 million that, if converted, would result
in the issuance of approximately 8.4 million shares. At March 27, 2005, approximately $47
million aggregate par value of the Companys 0.25 percent contingent convertible notes
remained authorized for repurchase at a discount to par value.8.
    Commitments and ContingenciesLitigationOn May 23, 2003, Vixel filed a patent infringement action against Brocade Communications
Systems, Inc. in the United States District Court for the Northern District of California,
Civil Action No. C-030-02446. The complaint states that Brocade is infringing U.S. Patent No.
6,185,203, entitled Fibre Channel Switching Fabric, U.S. Patent No. 6,118,776, entitled
Methods and Apparatus for Fibre Channel Interconnection of Private Loop Devices, and U.S.
Patent No. 6,470,007, entitled Interconnect System for Fibre Channel Arbitrated Loop
Including Private Loop Devices, through the unauthorized manufacture, use, sale and offering
for sale of various storage area network switching products, including but not limited to,
Brocades Silkworm switch products. Brocade denied infringement and challenged the validity
of the patents referenced. Brocade also challenged the enforceability of those patents. In
the suit against Brocade, Vixel was seeking unspecified past damages, potential future
royalties, or, alternatively, injunctive relief.On September 24, 2004, Emulex Corporation and Brocade Communications Systems, Inc. entered
into a settlement including a litigation standstill agreement whereby Emulex and Brocade
agreed to dismiss without prejudice their claims and counterclaims against each other in the
pending patent infringement case in the United States District Court for the Northern District
of California entitled Vixel Corporation. v. Brocade Communications Systems, Inc., Civil
Action No. C-030-02446. The settlement included the formation of a strategic relationship
under which the parties are to work together to pursue mutual objectives. Under the
litigation standstill agreement both parties preserved their respective rights, no
restrictions of any kind were imposed on either partys ability to sell products, no licenses
were granted by either party, no money was exchanged, and they agreed to a three year
standstill during which neither party may initiate litigation against the other party with
respect to certain of their respective patents.On November 15, 2001, prior to the Companys acquisition of Vixel Corporation, a securities
class action was filed in the United States District Court in the Southern District of New
York as Case No. 01 CIV. 10053(SAS), Master File No. 21 MC92 (SAS) against Vixel and two of
its officers and directors and certain underwriters who participated in the Vixel initial
public offering in late 1999. The amended complaint alleges violations under Section 10(b) of
the Exchange Act and Section 11 of the Securities Act and seeks unspecified damages on behalf
of persons who purchased Vixel stock during the period October 1, 1999 through December 6,
2000. In October 2002, the parties agreed to toll the statute of limitations with respect to
Vixels officers and directors until September 30, 2003, and on the basis of this agreement,
Vixels officers and directors were dismissed from the lawsuit without prejudice. During June
2003, Vixel and the other issuer defendants in the action reached a tentative settlement with
the plaintiffs that would, among other things, result in the dismissal with prejudice of all
claims against the defendants and their officers and directors. In 10




---



##### Table of Contents



EMULEX CORPORATION AND SUBSIDIARIES   connection with the possible settlement, those officers and directors who had entered tolling
agreements with the plaintiffs agreed to extend those agreements so that they would not expire
prior to any settlement being finalized. Although Vixel approved this settlement proposal in
principle, it remains subject to a number of procedural conditions, as well as formal approval
by the court.On October 9, 2003, before the Companys acquisition of Vixel, a purported class action
lawsuit was filed in King County Superior Court of the State of Washington against Vixel and
each of Vixels directors and certain unnamed individuals (the Vixel Parties), entitled
Russell Fink v. Vixel Corporation, et al., Case No. 03-2-37226-9SEA. The complaint made
general allegations that, among other things, Vixels directors breached their fiduciary
duties to Vixel stockholders in connection with the approval of the merger with Emulex and
sought to enjoin the tender offer and have the merger agreement declared unlawful, among other
forms of relief. On November 7, 2003, the Vixel Parties entered into a memorandum of
understanding for a $0.7 million settlement with the plaintiff in the class action suit
pursuant to which the parties have agreed to settle the action, subject to court approval. The
$0.7 million was recorded as general and administrative expense during the three months ended
December 28, 2003. Formal settlement documents were signed on May 5, 2004 and the plaintiff
has completed discovery as agreed to by the parties. In August 2004, final court approval was
obtained for the settlement of the Fink v. Vixel litigation, and the Company paid the $0.7
million settlement. During the three months ended December 26, 2004, the Company received a
$0.3 million reimbursement from its insurer relating to the Fink v. Vixel litigation.Beginning on or about February 20, 2001, the Company and certain of its officers and directors
were named as defendants in a number of securities class action lawsuits filed in the United
States District Court, Central District of California, Case No. SACV-01-219 GLT (ANx). The
plaintiffs in the actions represent purchasers of the Companys common stock during various
periods ranging from January 18, 2001, through February 9, 2001. The complaints alleged that
the Company and certain of its officers and directors made misrepresentations and omissions in
violation of sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended. The
complaints generally seek compensatory damages, costs and attorneys fees in an unspecified
amount. In addition, the Company has received inquiries about events giving rise to the
lawsuits from the SEC and the Nasdaq Stock Market. On April 22, 2003, the Company entered into
two Memoranda of Understanding agreeing to terms of settlement for both the class action and
derivative litigation. The settlement was approved and $39.5 million held in escrow was paid
by the Company into the settlement fund during the nine months ended March 28, 2004. Gateway
Partners filed a challenge to the allocation of settlement funds among the plaintiffs and
adequacy of the settlement notice, and the district court ruled against such challenge on
November 23, 2004. On December 13, 2004, Gateway Partners filed an appeal and a motion to
stop distribution from the settlement fund; both of which were filed with the United States
Court of Appeals for the Ninth Circuit (Index No. 04-57123). On January 12, 2005, attorneys
for Gateway Partners sent a letter to the appeals court stating that a stipulation would be
filed confirming that no proceeds of the settlement fund would be distributed until the appeal
is resolved, and that Gateway Partners would not have to post a bond.Related to the Companys insurance coverage on the class action and derivative lawsuits
settled in 2003, during the three months ended March 28, 2004, the Company reached an
agreement with one of its insurers, under which the Company received $10.0 million less $2.0
million previously paid by the insurer for the defense of the securities class action
lawsuits, resulting in a net payment to the Company of $8.0 million. In July 2004, the
Company obtained an arbitration award against two of its insurers, and subsequently collected
a total of $9.5 million plus $0.3 million in interest. As the amounts received exceeded the
$5.1 million receivable reflected on the Companys books, the Company recorded a reduction in
general and administrative expenses during the nine months ended March 27, 2005 of $4.4
million, as well as interest income of $0.3 million.Additionally, the Company is involved in various claims and legal actions arising in the
ordinary course of business. In the opinion of management, the ultimate disposition of these
matters will not have a material adverse effect on the Companys consolidated financial
position, results of operations or liquidity. 11




---



##### Table of Contents



EMULEX CORPORATION AND SUBSIDIARIES   Other Commitments and ContingenciesThe Company has entered into purchase agreements for certain key inventory components, and as
of March 27, 2005, the Companys remaining purchase obligation for these key components
accounted for $8.9 million of the Companys total inventory purchase obligation of $21.7
million.9.
    Earnings per ShareBasic net income per share is computed by dividing net income by the weighted average number
of common shares outstanding during the period. Diluted net income per share is computed by
dividing adjusted net income by the weighted average number of common shares outstanding
during the period increased to include, if dilutive, the number of additional common shares
that would be outstanding if the potential common shares from stock option plans and
convertible subordinated notes had been issued. The dilutive effect of outstanding stock
options is reflected in diluted net income per share by application of the treasury stock
method. The dilutive effect of convertible subordinated notes is reflected in diluted net
income per share by application of the if-converted method. The following table sets forth
the computation of basic and diluted net income per share: Three Months Ended
    
    Nine Months EndedMarch 27
    
    
    March 28,
    
    
    March 27
    
    
    March 28,2005
    
    2004
    
    2005
    
    2004Numerator:Net income
    
    $
    17,788
    
    
    $
    14,328
    
    
    $
    46,288
    
    
    $
    40,531Adjustment for interest expense of convertible
subordinated notes, net of tax
    
    
    661
    
    
    
    772
    
    
    
    2,160
    
    
    
    1,598Numerator for diluted net income per share
    
    $
    18,449
    
    
    $
    15,100
    
    
    $
    48,448
    
    
    $
    42,129Denominator:Denominator for basic net income per share -
weighted average shares outstanding
    
    
    82,963
    
    
    
    81,872
    
    
    
    82,710
    
    
    
    82,928Effect of dilutive securities:Dilutive options outstanding
    
    
    1,817
    
    
    
    2,340
    
    
    
    1,213
    
    
    
    2,132Dilutive common shares from assumed
conversion of subordinated notes
    
    
    8,635
    
    
    
    12,359
    
    
    
    9,544
    
    
    
    6,421Denominator for diluted net income per share -
adjusted weighted average shares outstanding
    
    
    93,415
    
    
    
    96,571
    
    
    
    93,467
    
    
    
    91,481Basic net income per share
    
    $
    0.21
    
    
    $
    0.18
    
    
    $
    0.56
    
    
    $
    0.49Diluted net income per share
    
    $
    0.20
    
    
    $
    0.16
    
    
    $
    0.52
    
    
    $
    0.46Antidilutive options excluded from computation
    
    
    8,259
    
    
    
    3,954
    
    
    
    9,516
    
    
    
    3,937Average market price of common stock
    
    $
    17.03
    
    
    $
    25.53
    
    
    $
    13.64
    
    
    $
    25.62
  The antidilutive options were excluded from the computation of diluted net income per share
because the options exercise price was greater than the average market price of the common shares during the periods presented. The effect of the Companys 1.75 percent convertible
subordinated notes and 0.25 percent contingent convertible subordinated notes are included in
the calculations above, using the if-converted method. The three and nine months ended March
27, 2005 have been calculated in accordance with EITF 04-08. Additionally, prior periods have
been restated in accordance with EITF 04-08 for our 0.25 percent contingent convertible
subordinated notes.10.
    Subsequent EventsOn April 28, 2005, the Company bought back approximately $47.0 million face value of its 0.25
percent convertible subordinated notes at a discount to face value, spending approximately
$43.6 million. The resulting net pre-tax gain of $2.8 million from the repurchase of these
0.25 percent convertible subordinated notes will be recorded during the three months ending
July 3, 2005. The repurchased notes were cancelled. Currently,
no more convertible subordinated notes remain authorized for
repurchase by our Board of Directors, however, our Board may
authorize future additional purchases from time to time based on
future market conditions. 12




---



##### Table of Contents



Item 2.   Managements Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements Certain statements contained in this Form 10-Q may constitute forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995. We may also make
forward-looking statements in other reports filed with the Securities and Exchange Commission, in
materials delivered to stockholders and in press releases. In addition, our representatives may
from time to time make oral forward-looking statements. Forward-looking statements provide current
expectations of future events based on certain assumptions and include any statement that does not
directly relate to any historical or current fact. Words such as anticipates, in the opinion,
believes, intends, expects, may, will, should, could, plans, forecasts,
estimates, predicts, projects, potential, continue and similar expressions may be
intended to identify forward-looking statements. Actual future results could differ materially from those described in the forward-looking
statements as a result of a variety of factors, including those discussed in Managements
Discussion and Analysis of Financial Condition and Results of Operations set forth below, and, in
particular, the subsection entitled Risk Factors. These factors include risks related to the
fact that the economy generally, and the technology and storage segments specifically, have been in
a state of uncertainty making it difficult to determine if past experience is a good guide to the
future and making it impossible to determine if markets will grow or shrink in the short term. In
the past, our results have been significantly impacted by a widespread slowdown in information
technology investment that has also pressured the storage networking market that is the mainstay of
our business. A downturn in information technology spending could adversely affect our revenues
and results of operations. As a result of this uncertainty, we are unable to predict with any
accuracy what future results might be. Other factors affecting these forward-looking statements
include, but are not limited to, the following: slower than expected growth of the storage
networking market or the failure of our Original Equipment Manufacturer, or OEM, customers to
successfully incorporate our products into their systems; our dependence on a limited number of
customers and the effects of the loss of, or decrease or delays in orders by, any such customers,
or the failure of such customers to make payments; the emergence of new or stronger competitors as
a result of consolidation movements in the market; the timing and market acceptance of our or our
OEM customers new or enhanced products; the variability in the level of our backlog and the
variable booking patterns of our customers; the effects of terrorist activities, natural disasters
and resulting political or economic instability; the highly competitive nature of the markets for
our products, as well as pricing pressures that may result from such competitive conditions; our
ability and the ability of our OEM customers to keep pace with the rapid technological changes in
our industry and gain market acceptance for new products and technologies; the effect of rapid
migration of customers towards newer, lower cost product platforms; possible transitions from board
or box level to application specific integrated circuit, or ASIC, solutions for selected
applications; a shift in unit product mix from high-end to lower-end products; a decrease in the
average unit selling prices or an increase in the manufactured cost of our products; delays in
product development; our reliance on third-party suppliers and subcontractors for components and
assembly; any inadequacy of our intellectual property protection or the potential for third-party
claims of infringement; inadequacy of our system of internal controls; our ability to attract,
retain and motivate key technical personnel; our dependence on foreign sales and foreign-produced
products; the effect of acquisitions; impairment charges; and changes in tax rates or changes in
accounting standards, including changes in the accounting treatment of employee stock options. Readers should carefully review these cautionary statements since they identify certain important
factors that could cause actual results to differ materially from those in the forward-looking
statements and from historical trends and are in addition to other factors discussed elsewhere in
this Form 10-Q, in our filings with the Securities and Exchange Commission or in materials
incorporated therein by reference. We caution the reader, however, that these lists of risk
factors may not be exhaustive. We expressly disclaim any obligation or undertaking to release
publicly any updates or changes to these forward-looking statements that may be made to reflect any
future events or circumstances. 13




---



##### Table of Contents



Executive Overview Emulex is a leading suppler of a broad range of advanced storage networking infrastructure
solutions. Our products and technologies leverage an adaptable common architecture that extends
from deep within the storage array to the server edge of storage networks. Our award-winning
storage networking solution offerings include host bus adapters, or HBAs, embedded storage
switches, storage Input/Output, or I/O, controllers and storage area network, or SAN, storage
switch products. HBAs are the data communication products that enable servers to connect to
storage networks by offloading communication-processing tasks as information is delivered and sent
to the storage network. Embedded storage switches and I/0 controllers are deployed inside storage
arrays, tape libraries and other storage appliances, delivering improved performance and
reliability and storage connectivity. The worlds largest storage and server OEMs rely on our
highly flexible common architecture to establish a robust foundation for cost-effectively
integrating a wide array of storage protocols, standards and speeds. We rely almost exclusively on OEMs and sales through distribution channels for our revenue. Our
OEM customers include the worlds leading server and storage providers, including Bull, Dell, EMC,
Engenio, Fujitsu Ltd., Fujitsu Siemens, Hewlett-Packard, Hitachi Data Systems, IBM, NEC, Network
Appliance, Quantum Corp., StorageTek, Sun Microsystems, Unisys and Xyratex. Our distribution
partners include ACAL, Avnet, Bell Microproducts, Info-X, Netmarks, Tech Data and Tokyo Electron.
In addition, we include industry leaders Brocade, Cisco, Computer Associates, Intel, McDATA,
Microsoft, Novell, Oracle, Red Hat and VERITAS among our strategic partners. The market for
storage networking infrastructure solutions is concentrated among large OEMs and, as such, a
significant portion of our revenues is generated from sales to a limited number of customers. We believe that continued investment in next generation storage networking infrastructure solutions
is required in order to achieve future revenue growth and profitability. Although we reduced our
headcount by 27 in August 2004 in an effort to realign our resources, we continue to, and currently
plan to invest in research and development, sales and marketing, and capital equipment to deliver
leading-edge products to our customers, including additional four gigabit per second connectivity
solutions, increased Linux offerings, and products focused on the small to medium business and
blade server markets. As of March 27, 2005, we had a total of 509 employees. Our corporate headquarters are located at 3333 Susan Street, Costa Mesa, California 92626. Our
periodic and current reports filed with or furnished to the Securities and Exchange Commission
pursuant to the requirements of the Securities and Exchange Act of 1934 are available free of
charge through our website (www.emulex.com) as soon as reasonably practicable after such reports
are electronically filed with, or furnished to, the Securities and Exchange Commission. References
contained herein to Emulex, the Company, the Registrant, we, our and us refer to Emulex
Corporation and its subsidiaries. Business Combination On November 13, 2003, we completed the cash tender offer by Aviary Acquisition Corporation, our
wholly owned subsidiary, to acquire all outstanding shares of Vixel Corporation. On November 17,
2003, we completed our acquisition of Vixel. We acquired Vixel, a leading supplier of embedded
switch ASICs and subsystems for the storage networking market, to expand our Fibre Channel product
line and paid $298.4 million in cash for all outstanding common stock, preferred stock and warrants
of Vixel Corporation. We also incurred acquisition-related expenses of $6.7 million in cash. In
addition, we issued 2.2 million stock options with a fair value of approximately $47.5 million and
kept the original vesting periods for the options in exchange for the outstanding Vixel options for
a total acquisition value of $352.7 million. We calculated the fair value of the 2.2 million stock
options issued at the date of acquisition using the Black-Scholes option-pricing model. The
operations of Vixel, since its acquisition, are included within the Companys one operating
segment, networking products. Additional information is contained below under Impairment of
Goodwill. 14




---



##### Table of Contents



Results of Operations The following discussion and analysis should be read in conjunction with the Condensed Consolidated
Financial Statements included elsewhere herein. Percentage of Net RevenuesThree months ended
    
    
    Nine Months endedMarch 27, 2005
    
    
    March 28, 2004
    
    
    March 27, 2005
    
    
    March 28, 2004Net revenues
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Cost of sales
    
    
    36.5
    
    
    
    36.7
    
    
    
    37.5
    
    
    
    35.8Gross profit
    
    
    63.5
    
    
    
    63.3
    
    
    
    62.5
    
    
    
    64.2Operating expenses:Engineering and development
    
    
    20.5
    
    
    
    19.2
    
    
    
    22.8
    
    
    
    19.3Selling and marketing
    
    
    7.8
    
    
    
    8.4
    
    
    
    8.6
    
    
    
    7.1General and administrative
    
    
    4.1
    
    
    
    6.1
    
    
    
    2.8
    
    
    
    5.5Amortization of intangibles
    
    
    6.4
    
    
    
    6.9
    
    
    
    7.3
    
    
    
    4.5Impairment of goodwill
    
    
    
    
    
    
    
    
    
    
    0.7
    
    
    
    In-process research and development
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4.1Total operating expenses
    
    
    38.8
    
    
    
    40.6
    
    
    
    42.2
    
    
    
    40.5Operating income
    
    
    24.7
    
    
    
    22.7
    
    
    
    20.3
    
    
    
    23.7Nonoperating income:Interest income
    
    
    3.3
    
    
    
    2.2
    
    
    
    3.5
    
    
    
    2.4Interest expense
    
    
    (1.0
    )
    
    
    (1.5
    )
    
    
    (1.3
    )
    
    
    (1.2
    )Gain (loss) on repurchase of convertible
subordinated notes
    
    
    (0.3
    )
    
    
    (0.3
    )
    
    
    4.8
    
    
    
    1.0Other income (expense), net
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total nonoperating income
    
    
    2.0
    
    
    
    0.4
    
    
    
    7.0
    
    
    
    2.2Income before income taxes
    
    
    26.7
    
    
    
    23.1
    
    
    
    27.3
    
    
    
    25.9Income tax provision
    
    
    9.4
    
    
    
    8.6
    
    
    
    10.0
    
    
    
    11.3Net income
    
    
    17.3
    %
    
    
    14.5
    %
    
    
    17.3
    %
    
    
    14.6
    %
 Three months ended March 27, 2005 compared to three months ended March 28, 2004 Net Revenues.Net revenues for the third quarter of fiscal 2005 ended March 27, 2005, increased by
$3.5 million, or four percent, to $102.6 million, compared to $99.0 million for the same quarter of
fiscal 2004 ended March 28, 2004. The following chart details our net revenues by product line for the three months ended March 27,
2005 and March 28, 2004: Net Revenues by Product Line Three Months
    
    
    
    
    
    
    Three MonthsEnded
    
    
    Percentage
    
    
    Ended
    
    
    PercentageMarch 27,
    
    
    of Net
    
    
    March 28,
    
    
    of Net
    
    
    Increase/
    
    
    Percentage(in thousands)
    
    2005
    
    
    Revenues
    
    
    2004
    
    
    Revenues
    
    
    (Decrease)
    
    
    ChangeFibre Channel
    
    $
    102,545
    
    
    
    100
    %
    
    $
    99,016
    
    
    
    100
    %
    
    $
    3,529
    
    
    
    4
    %IP networking
    
    
    29
    
    
    
    
    
    
    
    16
    
    
    
    
    
    
    
    13
    
    
    
    81
    %Other
    
    
    6
    
    
    
    
    
    
    
    6
    
    
    
    
    
    
    
    
    
    
    
    Total net revenues
    
    $
    102,580
    
    
    
    100
    %
    
    $
    99,038
    
    
    
    100
    %
    
    $
    3,542
    
    
    
    4
    %
 15




---



##### Table of Contents



Net revenues from our Fibre Channel products have continued to represent substantially all of our
net revenues. We believe that our net revenues from our Fibre Channel products are being generated
primarily as a result of our product certifications and qualifications with OEM customers, which
generate both direct OEM sales and indirect sales through distribution. Our IP networking products
consist of both our iSCSI products, as well as legacy VI and cLAN products. We expect that our VI,
cLAN and traditional networking products, which have all entered end-of-life status, will
contribute negligible revenues to succeeding quarters. We do not expect material revenue from
iSCSI products for the foreseeable future. In addition to direct sales, some of our larger OEM customers purchased or marketed products
indirectly through distributors, resellers or other third parties. If these indirect purchases are
purchases of customer-specific models, we are able to track these sales. However, if these
indirect purchases are purchases of our standard models, we are not able to distinguish them by OEM
customer. Customers whose direct net revenues, or total direct and indirect net revenues
(including customer-specific models purchased or marketed indirectly through distributors,
resellers and other third parties), exceeded 10 percent of our net revenues were as follows: Net Revenues by Major Customers Direct Revenues
    
    
    Total Direct and Indirect Revenues (2)Three Months
    
    
    Three Months
    
    
    Three Months
    
    
    Three MonthsEnded
    
    
    Ended
    
    
    Ended
    
    
    EndedMarch 27, 2005
    
    
    March 28, 2004
    
    
    March 27, 2005
    
    
    March 28, 2004Net revenue percentage (1) :EMC
    
    
    
    
    
    
    
    
    
    
    22
    %
    
    
    26
    %Hewlett-Packard
    
    
    10
    %
    
    
    15
    %
    
    
    11
    %
    
    
    17
    %IBM
    
    
    31
    %
    
    
    21
    %
    
    
    32
    %
    
    
    21
    %Info-X
    
    
    20
    %
    
    
    13
    %
    
    
    
    
    
    
    
   (1)
    
    Amounts less than 10 percent are not presented.(2)
    
    Customer-specific models sold indirectly are included with the OEMs revenues in these columns rather than as
revenue for the distributors, resellers or other third parties. Direct sales to our top five customers accounted for 71 percent of total net revenues for the three
months ended March 27, 2005, compared to 65 percent for the three months ended March 28, 2004, and
we expect to be similarly concentrated in the future. Our net revenues from our customers can be
significantly impacted by changes to our customers business and their business models. Our
EMC-specific models are sold both directly to EMC and indirectly through distributors such as
Info-X. As a result, for the three months ended March 27, 2005, and March 28, 2004, direct
revenues attributable to EMC were less than 10 percent of our total net revenues, but direct and
indirect revenues attributable to EMC were greater than 10 percent of our total net revenues. The following chart details our net revenues by sales channel for the three months ended March 27,
2005, and March 28, 2004: Net Revenues by Sales Channel Three Months
    
    
    
    
    
    
    Three MonthsEnded
    
    
    Percentage
    
    
    Ended
    
    
    PercentageMarch 27,
    
    
    of Net
    
    
    March 28,
    
    
    of Net
    
    
    Increase/
    
    
    Percentage(in thousands)
    
    2005
    
    
    Revenues
    
    
    2004
    
    
    Revenues
    
    
    (Decrease)
    
    
    ChangeOEM
    
    $
    65,222
    
    
    
    64
    %
    
    $
    61,502
    
    
    
    62
    %
    
    $
    3,720
    
    
    
    6
    %Distribution
    
    
    37,355
    
    
    
    36
    %
    
    
    37,499
    
    
    
    38
    %
    
    
    (144
    )
    
    
    Other
    
    
    3
    
    
    
    
    
    
    
    37
    
    
    
    
    
    
    
    (34
    )
    
    
    (92
    %)Total net revenues
    
    $
    102,580
    
    
    
    100
    %
    
    $
    99,038
    
    
    
    100
    %
    
    $
    3,542
    
    
    
    4
    %
 The increase in our net OEM revenues for the three months ended March 27, 2005 compared to the
three months ended March 28, 2004 was primarily due to an increase in our IBM business, partially
offset by decreases at two of our other major OEMs. 16




---



##### Table of Contents



The following chart details our net domestic and international revenues based on billed-to location
for the three months ended March 27, 2005, and March 28, 2004: Net Domestic and International Revenues Three Months
    
    
    
    
    
    
    Three MonthsEnded
    
    
    Percentage
    
    
    Ended
    
    
    PercentageMarch 27,
    
    
    of Net
    
    
    March 28,
    
    
    of Net
    
    
    Increase/
    
    
    Percentage(in thousands)
    
    2005
    
    
    Revenues
    
    
    2004
    
    
    Revenues
    
    
    (Decrease)
    
    
    ChangeUnited States
    
    $
    57,848
    
    
    
    57
    %
    
    $
    51,006
    
    
    
    51
    %
    
    $
    6,842
    
    
    
    13
    %Europe and rest of
world
    
    
    28,952
    
    
    
    28
    %
    
    
    38,406
    
    
    
    39
    %
    
    
    (9,454
    )
    
    
    (25
    %)Pacific Rim Countries
    
    
    15,780
    
    
    
    15
    %
    
    
    9,626
    
    
    
    10
    %
    
    
    6,154
    
    
    
    64
    %Total net revenues
    
    $
    102,580
    
    
    
    100
    %
    
    $
    99,038
    
    
    
    100
    %
    
    $
    3,542
    
    
    
    4
    %
 Because we sell to OEMs and distributors who ultimately resell our products to their customers, the
geographic mix of our net revenues may not be reflective of the geographic mix of end-user demand
or installations. Gross Profit.Cost of sales included the cost of production of finished products as well as
support costs and other expenses related to inventory management, manufacturing quality and order
fulfillment. In the three months ended March 27, 2005, gross profit increased $2.5 million, or
four percent, to $65.1 million, from $62.7 million in the three months ended March 28, 2004. The
increase in gross profit in the three months ended March 27, 2005, compared to the three months
ended March 28, 2004, was primarily due to higher revenues. For the three months ended March 28,
2004, cost of sales included $0.6 million of retention bonuses for terminated employees related to
the Vixel acquisition. For the three months ended March 27, 2005 and March 28, 2004, cost of sales
included $36 thousand and $0.6 million of amortized deferred stock-based compensation expenses,
respectively. Gross margins remained relatively unchanged at approximately 63 percent for both the
three months ended March 27, 2005 and March 28, 2004. Engineering and Development.Engineering and development expenses consisted primarily of salaries
and related expenses for personnel engaged in the design, development and technical support of our
products. These expenses included third-party fees paid to consultants, prototype development
expenses and computer services costs related to supporting computer tools used in the engineering
and design process. Engineering and development expenses were $21.0 million and $19.0 million in
the three months ended March 27, 2005 and March 28, 2004, representing 21 percent and 19 percent of
net revenues in each period, respectively. Engineering and development expenses increased by $2.0
million, or ten percent, in the three months ended March 27, 2005, compared to the three months
ended March 28, 2004. The increase in engineering and development expenses was due to our
continued investment in our storage networking infrastructure product development. Engineering and
development expenses included $0.3 million and $0.7 million of amortized deferred stock-based
compensation expenses for the three months ended March 27, 2005 and March 28, 2004, respectively.
Due to the technical nature of our products, engineering support is a critical part of our strategy
during both the development of our products and the support of our customers from product design
through deployment into the market. We intend to continue to make significant investments in the
technical support and enhancement of our current products, as well as the continued development of
new products. Engineering expenses can fluctuate significantly from quarter to quarter depending
on several factors, including, but not limited to, non-recurring engineering charges associated
with new product introduction schedules, hiring patterns and depreciation of capital equipment. Selling and Marketing.Selling and marketing expenses consisted primarily of salaries, commissions
and related expenses for personnel engaged in the marketing and sales of our products, as well as
trade shows, product literature, promotional support costs and other advertising-related costs.
Selling and marketing expenses were $8.0 million and $8.4 million in the three months ended March
27, 2005 and March 28, 2004, representing approximately eight percent of net revenues for both
periods. Selling and marketing expenses decreased by $0.4 million, or four percent, in the three
months ended March 27, 2005, compared to the three months ended March 28, 2004 primarily due to
decreased advertising and other promotion costs. For the three months ended March 27, 2005,
selling and marketing expenses included $0.2 million of amortized deferred stock-based compensation
expenses. For the three months ended March 28, 2004 selling and marketing expenses included $0.6
million of amortized deferred stock-based compensation expenses, primarily related to the
acquisition of Vixel. General and Administrative.Ongoing general and administrative expenses consisted primarily of
salaries and related expenses for executives, financial accounting support, human resources,
administrative services, professional fees and other associated corporate expenses. General and
administrative expenses were $4.2 million, or four percent of 17




---



##### Table of Contents



net revenues, in the three months ended March 27, 2005, compared to $6.0 million, or six percent of
net revenues, for the three months ended March 28, 2004, resulting in a decrease of $1.8 million,
or 30 percent. The decrease was primarily a result of the elimination of duplicative expenses
associated with the acquisition of Vixel, as the majority of the general and administrative costs
of Vixel Corporation were redundant with the general and administrative costs of Emulex Corporation
prior to the acquisition. For the three months ended March 27, 2005 and March 28, 2004, general
and administrative expenses included $0.4 million and $1.0 million of amortized deferred
stock-based compensation expenses, respectively. Amortization of Intangibles.Amortization of intangibles included the amortization of intangible
assets with estimable lives related to the acquisitions of Vixel in November 2003 and Giganet in
March 2001, as well as the purchase of the technology assets of Trebia Networks in October 2003.
Amortization of intangibles was $6.5 million and $6.8 million in the three months ended March 27,
2005 and March 28, 2004, representing six percent and seven percent of net revenues in each period,
respectively. Amortization of intangibles decreased by $0.3 million, or four percent, in the three
months ended March 27, 2005 compared to the three months ended March 28, 2004. This decrease was
primarily attributable to intangible assets that were fully amortized in the fiscal year ended June
27, 2004. Nonoperating Income.Nonoperating income consisted primarily of interest income, interest expense
and other non-operating income and expense items such as the gains or losses on the repurchase of
convertible subordinated notes. Our nonoperating income increased by $1.6 million to $2.0 million
in the three months ended March 27, 2005, compared to nonoperating income of $0.4 million in the
three months ended March 28, 2004. In the three months ended March 27, 2005, interest income was
$3.3 million, or $1.1 million higher than in the three months ended March 28, 2004, primarily due
to higher overall balances of cash and investments, as well as some improvement in interest rates.
Interest expense was $1.0 million, or $0.5 million lower, in the three months ended March 27, 2005,
compared to the three months ended March 28, 2004, primarily due to lower outstanding balances of
the convertible subordinated notes during the three months ended March 27, 2005 as compared to the
three months ended March 28, 2004. Other nonoperating income also includes a loss of $0.3 million
for the three months ended March 27, 2005, related to the redemption of $17.0 million face value of
our 1.75 percent convertible subordinated notes. For the three months ended March 28, 2004, other
nonoperating income includes a loss of $0.2 million related to the repurchase of approximately
$12.3 million face value of our 1.75 percent convertible subordinated notes. Income Taxes. In the three months ended March 27, 2005 we recorded a tax provision in the amount
of $9.6 million, or approximately 35 percent of our income before income taxes. Our tax provision
for the three months ended March 27, 2005, included a benefit of
approximately $0.5 million primarily related
to research and development tax credits. We expect our tax rate to return to approximately 37
percent in upcoming quarters. In the three months ended March 28, 2004, we recorded a tax
provision in the amount of $8.6 million, or approximately 37 percent of our income before income
taxes. Nine months ended March 27, 2005, compared to Nine months ended March 28, 2004 Net Revenues.Net revenues for the nine months ended March 27, 2005 decreased by $10.5 million, or
four percent, to $267.5 million, compared to $278.0 million for the corresponding period of the
prior year ended March 28, 2004. The following chart details our net revenues by product line for the nine months ended March 27,
2005 and March 28, 2004. Net Revenues by Product Line Nine Months
    
    
    Percentage
    
    
    Nine Months
    
    
    PercentageEnded
    
    
    of Net
    
    
    Ended
    
    
    of Net
    
    
    Increase/
    
    
    Percentage(in thousands)
    
    March 27, 2005
    
    
    Revenues
    
    
    March 28, 2004
    
    
    Revenues
    
    
    (Decrease)
    
    
    ChangeFibre Channel
    
    $
    267,429
    
    
    
    100
    %
    
    $
    277,451
    
    
    
    100
    %
    
    $
    (10,022
    )
    
    
    (4
    %)IP networking
    
    
    34
    
    
    
    
    
    
    
    519
    
    
    
    
    
    
    
    (485
    )
    
    
    (93
    %)Other
    
    
    13
    
    
    
    
    
    
    
    14
    
    
    
    
    
    
    
    (1
    )
    
    
    (7
    %)Total net revenues
    
    $
    267,476
    
    
    
    100
    %
    
    $
    277,984
    
    
    
    100
    %
    
    $
    (10,508
    )
    
    
    (4
    %)
 18




---



##### Table of Contents



We believe the lower net revenue from Fibre Channel products for the nine months ended March 27,
2005, compared to the corresponding period of the prior year, is primarily due to reduced demand
from one of our major OEM customers, Hewlett-Packard, and preparation for the shift to EMCs Select
Program as discussed below. In addition to direct sales, some of our larger OEM customers purchased or marketed products
indirectly through distributors, resellers or other third parties. Customers whose direct net
revenues, or total direct and indirect net revenues (including customer-specific models purchased
or marketed indirectly through distributors, resellers and other third parties), exceeded 10
percent of our net revenues were as follows: Net Revenues by Major Customers Direct Revenues
    
    
    Total Direct and Indirect Revenues (2)Nine Months
    
    
    Nine Months
    
    
    Nine Months
    
    
    Nine MonthsEnded
    
    
    Ended
    
    
    Ended
    
    
    EndedMarch 27, 2005
    
    
    March 28, 2004
    
    
    March 27, 2005
    
    
    March 28, 2004Net revenue percentage (1):EMC
    
    
    
    
    
    
    
    
    
    
    19
    %
    
    
    25
    %Hewlett-Packard
    
    
    13
    %
    
    
    19
    %
    
    
    15
    %
    
    
    21
    %IBM
    
    
    30
    %
    
    
    23
    %
    
    
    30
    %
    
    
    23
    %Info-X
    
    
    15
    %
    
    
    11
    %
    
    
    
    
    
    
    
   (1)
    
    Amounts less than 10 percent are not presented.(2)
    
    Customer-specific models sold indirectly are included with the OEMs revenues in these columns rather
than as revenue for the distributors, resellers or other third parties. Direct sales to our top five customers accounted for 68 percent of total net revenues for the nine
months ended March 27, 2005, compared to 69 percent for the nine months ended March 28, 2004, and
we expect to be similarly concentrated in the future. Our net revenues from our customers can be
significantly impacted by changes to our customers business and their business models. Under the
vendor fulfillment role planned by EMC for EMCs Select Program, a portion of the sales of our
EMC-specific models are to be directly purchased by EMC from Emulex instead of being sold from
inventory owned by EMCs distribution partners. Our implementation of the EMC Select program is
dependent on EMC. During the nine months ended March 27, 2005,
as fewer EMC-specific models were sold to EMCs distribution
partners, the level of inventory held by EMCs distribution
partners was decreased in preparation for EMCs Select Program,
 thereby reducing our revenue. The following chart details our net revenues by sales channel for the nine months ended March 27,
2005, and March 28, 2004: Net Revenues by Sales Channel Nine Months
    
    
    Percentage
    
    
    Nine Months
    
    
    PercentageEnded
    
    
    of Net
    
    
    Ended
    
    
    of Net
    
    
    Increase/
    
    
    Percentage(in thousands)
    
    March 27, 2005
    
    
    Revenues
    
    
    March 28, 2004
    
    
    Revenues
    
    
    (Decrease)
    
    
    ChangeOEM
    
    $
    176,219
    
    
    
    66
    %
    
    $
    175,819
    
    
    
    63
    %
    
    $
    400
    
    
    
    Distribution
    
    
    90,816
    
    
    
    34
    %
    
    
    102,031
    
    
    
    37
    %
    
    
    (11,215
    )
    
    
    (11
    )%Other
    
    
    441
    
    
    
    
    
    
    
    134
    
    
    
    
    
    
    
    307
    
    
    
    229
    %Total net revenues
    
    $
    267,476
    
    
    
    100
    %
    
    $
    277,984
    
    
    
    100
    %
    
    $
    (10,508
    )
    
    
    (4
    )%
 The following chart details our net domestic and international revenues based on billed-to location
for the nine months ended March 27, 2005 and March 28, 2004: Net Domestic and International Revenues Nine Months
    
    
    Percentage
    
    
    Nine Months
    
    
    PercentageEnded
    
    
    of Net
    
    
    Ended
    
    
    of Net
    
    
    Increase/
    
    
    Percentage(in thousands)
    
    March 27, 2005
    
    
    Revenues
    
    
    March 28, 2004
    
    
    Revenues
    
    
    (Decrease)
    
    
    ChangeUnited States
    
    $
    146,218
    
    
    
    55
    %
    
    $
    155,568
    
    
    
    56
    %
    
    $
    (9,350
    )
    
    
    (6
    )%Europe and rest of
world
    
    
    81,797
    
    
    
    30
    %
    
    
    94,635
    
    
    
    34
    %
    
    
    (12,838
    )
    
    
    (14
    )%Pacific Rim Countries
    
    
    39,461
    
    
    
    15
    %
    
    
    27,781
    
    
    
    10
    %
    
    
    11,680
    
    
    
    42
    %Total net revenues
    
    $
    267,476
    
    
    
    100
    %
    
    $
    277,984
    
    
    
    100
    %
    
    $
    (10,508
    )
    
    
    4
    %
 19




---



##### Table of Contents



Because we sell to OEMs and distributors who ultimately resell our products to their customers, the
geographic mix of our net revenues may not be reflective of the geographic mix of end-user demand
or installations. Gross Profit.In the nine months ended March 27, 2005, gross profit decreased $11.2 million, or
six percent, to $167.2 million, from $178.5 million in the nine months ended March 28, 2004. Gross
margin decreased to 63 percent in the nine months ended March 27, 2005, compared to 64 percent in
the nine months ended March 28, 2004. Starting in late September 2001, some of our major customers
made announcements that general economic conditions, exacerbated by the increase in economic
uncertainty in the aftermath of the terrorist events of September 11, 2001, were having a negative
impact on their financial results. The announcements made, and forecasts received, indicated
deteriorating demand for our one gigabit per second, or Gbps, products as these customers were
expected to migrate to two Gbps products for future purchases. As a result, we recorded an
estimated excess and obsolete inventory charge totaling $13.6 million during the first quarter of
fiscal 2002. After initially recording this one Gbps reserve during the first quarter of fiscal
2002, we have subsequently reduced this reserve by a total of $8.9 million through March 27, 2005,
as previously reserved inventory has been sold. Overall, we have been able to recover a
significant portion of this reserved inventory that was not expected based on our forecasts and the
forecasts received from our customers at the time that this excess and obsolete charge was
recorded. In addition to the sale of this previously-reserved product, we have also scrapped $4.2
million of this reserved inventory and negotiated and paid cancellation charges of $0.2 million
through December 28, 2003, related to this excess and obsolete inventory charge since it was
initially recorded. In the nine months ended March 28, 2004, the reduction related to our one Gbps
reserve, as previously reserved inventory was sold, was $1.9 million. There was no reduction in
the nine months ended March 27, 2005. Excluding the reduction of the excess and obsolete inventory
reserve of $1.9 million in the nine months ended March 28, 2004, gross profit would have been
$176.6 million and gross margin would have been 64 percent. The remaining decrease in gross profit
and gross margin in the nine months ended March 27, 2005, compared to the nine months ended March
28, 2004, was primarily due to lower production volumes of HBAs as we temporarily curtailed
production to reduce inventory, spreading our fixed manufacturing costs across fewer units,
especially during the three months ended September 26, 2004, and product mix, including the
increased mix of Fibre Channel switch products which carry lower gross margins than HBAs. Also,
cost of sales included $0.1 million and $0.9 million of amortized deferred stock-based compensation
expense for the nine months ended March 27, 2005, and March 28, 2004, respectively. Engineering and Development.Engineering and development expenses were $61.0 million and $53.7
million in the nine months ended March 27, 2005, and March 28, 2004, representing 23 percent and 19
percent of net revenues in each period, respectively. Engineering and development expenses
increased by $7.3 million, or 14 percent, in the nine months ended March 27, 2005 compared to the
nine months ended March 28, 2004. This increase was primarily due to the inclusion of the
engineering and development expenses associated with our acquisition of Vixel for the entire nine
months ended March 27, 2005 versus only a part of the corresponding period of the prior year.
Since we completed our integration of Vixels day-to-day operations during the three months ended
March 28, 2004, we no longer separately track former-Vixel operations. However, the expenses
associated with the former-Vixel operations are estimated to account for approximately $3.5 million
of the overall $7.3 million increase. The remaining increase was due to our continued investment
in our storage networking infrastructure product development. Engineering and development expenses
included $1.2 million and $1.7 million of amortized deferred stock-based compensation expenses for
the nine months ended March 27, 2005, and March 28, 2004, respectively. Selling and Marketing.Selling and marketing expenses were $23.0 million and $19.8 million in the
nine months ended March 27, 2005, and March 28, 2004, representing nine and seven percent of net
revenues, respectively. Selling and marketing expenses increased by $3.2 million, or 16 percent,
in the nine months ended March 27, 2005, compared to the nine months ended March 28, 2004. This
increase was partially due to the inclusion of the selling and marketing expenses associated with
our acquisition of Vixel in November 2003. As discussed previously, we no longer track
former-Vixel operations separately. However, the expenses associated with the former-Vixel
operations are estimated to account for approximately $1.1 million of the overall $3.2 million
increase in selling and marketing expenses. Additionally, selling and marketing expenses related
to personnel and advertising and other promotions for the nine months ended March 27, 2005
increased by approximately $1.0 million and $0.5 million, respectively, compared to the same period
of the prior year. For the nine months ended March 27, 2005, selling and marketing expenses
included $0.7 million of amortized deferred stock-based compensation expenses. For the nine months
ended March 28, 2004 selling and marketing expenses included $2.0 million of amortized deferred
stock-based compensation expenses. As a portion of selling and marketing expenses, such as selling
and marketing employees base compensation and amortized deferred stock-based compensation expense,
is not driven directly by increases or decreases in net revenues, the expenses fluctuate as a
percent of net revenues. 20




---



##### Table of Contents



General and Administrative.General and administrative expenses were $7.4 million in the nine
months ended March 27, 2005. General and administrative expenses for the nine months ended March
27, 2005, included a $4.6 million reduction related to reimbursement received from our insurance
carriers during the period, in excess of our receivable. This reimbursement is primarily related
to the shareholder litigation settled and recorded as general and administrative expense in our
fiscal year ended June 29, 2003. General and administrative expenses for the nine months ended
March 27, 2005, excluding this $4.6 million insurance reimbursement would have been $12.0 million,
or four percent of net revenues, compared to $15.3 million, or five percent of net revenues, for
the nine months ended March 28, 2004. This would represent a decrease of $3.2 million in the nine
months ended March 27, 2005, excluding the insurance recovery, compared to the nine months ended
March 28, 2004. Similar to other operating expenses, we no longer track former-Vixel operations
separately. However, the expenses associated with the former-Vixel operations are estimated to
account for approximately $2.4 million of the decrease in general and administrative expenses, as
the majority of the general and administrative costs of Vixel Corporation were redundant with the
general and administrative costs of Emulex Corporation prior to the acquisition. For the nine
months ended March 27, 2005, general and administrative expenses included $1.3 million of amortized
deferred stock-based compensation expenses. For the nine months ended March 27, 2004 general and
administrative expenses included $1.4 million of amortized deferred stock-based compensation
expenses. Amortization of Intangibles.Amortization of intangibles included the amortization of intangible
assets with estimable lives related to the acquisitions of Vixel in November 2003 and Giganet in
March 2001, as well as the purchase of the technology assets of Trebia Networks in October 2003.
For the nine months ended March 27, 2005, amortization of intangibles was $19.6 million, or seven
percent of net revenues. Amortization of intangibles for the nine months ended March 28, 2004 was
$12.5 million, or five percent of net revenues. The $7.1 million increase in amortization of
intangibles for the nine months ended March 27, 2005 in comparison to the same relative period of
the prior year was due to the addition of amortization related to the Vixel acquisition and the
purchase of the technology assets of Trebia Networks, which due to the timing of the acquisition
and purchase, was not included for the full nine month period ended March 28, 2004. Impairment of Goodwill.On June 30, 2004, we announced that tepid demand experienced in the fourth
fiscal quarter of 2004 from two of our customers resulted in lower than expected revenue, earnings
and cash flows in the fourth fiscal quarter of 2004 and was expected to result in lower sequential
revenue, earnings and cash flows in the first fiscal quarter of 2005. These events and
circumstances resulted in a subsequent drop in our stock price, which indicated a potential
impairment might have occurred. As a result, we conducted a SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, analysis, as well as a SFAS No. 142, Goodwill and
Other Intangible Assets, analysis, including a second step goodwill impairment test. The results
of the SFAS No. 144 analysis indicated that our long-lived assets were not impaired. However, the
SFAS No. 142 analysis indicated that goodwill was impaired. This determination was made at the
reporting unit level and consisted of two steps. First, the fair value of our only reporting unit
was determined, based on a market approach, and compared to its carrying amount. Next, as the
carrying amount exceeded the fair value, the second step of SFAS No. 142 was performed. The
implied fair value of goodwill was determined by allocating the fair value in a manner similar to a
purchase price allocation, in accordance with SFAS No. 141, Business Combinations. As a result
of this SFAS No. 142 analysis, on September 9, 2004, we concluded that a $583.5 million charge for
goodwill impairment should be recorded as of June 27, 2004. After recording this impairment
charge, there was no goodwill remaining on our balance sheet as of June 27, 2004. In connection
with the preparation of Vixel Corporations tax return in the first quarter of fiscal 2005, we
revised estimates and discovered errors related to the deferred tax assets of Vixel Corporation
(acquired in November 2003). These events resulted in a revision to Vixels purchase price
allocation to decrease net deferred tax assets and increase goodwill, which was impaired. This
resulted in a $1.8 million impairment of goodwill charge for the three months ended September 26,
2004. Had these items been recorded in fiscal 2004, our net loss would have been $1.8 million
higher, or $534.1 million, instead of $532.3 million. We do not believe that this $1.8 million
impairment of goodwill is material to fiscal 2004 or will be material to fiscal 2005 operations or
financial results. Excluding this adjustment, net income for the nine months ended March 27, 2005,
would have been $48.1 million. In-Process Research and Development.The in-process research and development expense of $11.4
million, or four percent of net revenues, recorded in the nine months ended March 28, 2004, was
related to our acquisition of Vixel Corporation in November 2003. There was no in-process research
and development expense for the nine months ended March 27, 2005. Nonoperating Income.Nonoperating income consisted primarily of interest income, interest expense
and other non-operating income and expense items such as the gains on the repurchase of convertible
subordinated notes. Our nonoperating income increased by $12.5 million to $18.7 million in the
nine months ended March 27, 2005, from $6.2 million in the nine months ended March 28, 2004. The
$12.5 million increase in nonoperating income was 21




---



##### Table of Contents



primarily due to a net gain of $12.8 million related to the repurchase of convertible subordinated
notes in the nine months ended March 27, 2005, compared to a net gain of $2.7 million related to
the repurchase of convertible subordinated notes in the nine months ended March 28, 2004.
Additionally, interest income increased $2.5 million to $9.2 million in the nine months ended March
27, 2005, compared to $6.7 million in the nine months ended March 28, 2004, due to the receipt of
$0.3 million of interest related to the insurance reimbursement discussed below in Liquidity and
Capital Resources, higher overall balances of cash and investments, and some improvement in
interest rates. Interest expense, which is primarily due to our outstanding convertible
subordinated notes, increased by $0.1 million to $3.4 million in the nine months ended March 27,
2005, compared to $3.3 million in the nine months ended March 28, 2004. Income Taxes. In the nine months ended March 27, 2005, we recorded a tax provision in the amount
of $26.8 million, or approximately 37 percent of our income before income taxes. In the nine
months ended March 28, 2004, we recorded a tax provision in the amount of $31.4 million, or
approximately 44 percent of our income before income taxes, primarily due to the in-process
research and development expense of $11.4 million associated with the Vixel acquisition being
non-deductible for tax purposes. Critical Accounting Policies The preparation of the financial statements requires estimation and judgment that affect the
reported amounts of net revenues, expenses, assets and liabilities in accordance with accounting
principles generally accepted in the United States. We base our estimates on historical experience
and on various other assumptions that we believe to be reasonable under the circumstances and which
form the basis for making judgments about the carrying values of assets and liabilities. Critical
accounting policies are defined as those that are reflective of significant judgments and
uncertainties, and could potentially result in materially different results under different
assumptions and conditions. If these estimates differ significantly from actual results, the
impact to the financial statements may be material. We believe the following are critical accounting policies and require us to make significant
judgments and estimates in the preparation of our consolidated financial statements: revenue
recognition; warranty; allowance for doubtful accounts; goodwill; other intangibles and long-lived
assets; inventories; income taxes and stock-based compensation. Revenue Recognition. We recognize revenue at the time of shipment when title and risk of loss have
passed, evidence of an arrangement has been obtained, pricing is fixed or determinable at the date
of sale and collectibility has been reasonably assured. We make certain sales through two-tier
distribution channels and have various distribution agreements with selected distributors and
Master Value Added Resellers, or collectively the Distributors. These distribution agreements may
be terminated upon written notice by either party. Additionally, these Distributors are generally
given privileges to return a portion of inventory and to participate in price protection and
cooperative marketing programs. Therefore, we recognize revenue on our standard products sold to
our Distributors based on data received from the Distributors and managements estimates to
approximate the point that these products have been resold by the Distributors. As OEM-specific
models sold to our Distributors are governed under the related OEM agreements rather than under
these distribution agreements, we recognize revenue at the time of shipment to the Distributors
when title and risk of loss have passed, evidence of an arrangement has been obtained and
collectibility has been reasonably assured. Additionally, we maintain accruals and allowances for
price protection and cooperative marketing programs. Warranty. We provide a warranty of between one and five years on our products. We record a
provision for estimated warranty-related costs based on historical product return rates and
managements estimates of expected future costs to fulfill warranty obligations. Allowance for Doubtful Accounts. We maintain an allowance for doubtful accounts based upon
historical write-offs as a percentage of net revenues. Although we have not experienced
significant losses on accounts receivable historically, our accounts receivable are concentrated
with a small number of customers. Consequently, any write-off associated with one of these
customers could have a significant impact on our allowance for doubtful accounts and results of
operations. Goodwill, Other Intangibles and Long-Lived Assets. Other intangibles resulting from the
acquisitions of Vixel and Giganet and the purchase of the technology assets of Trebia Networks are
carried at cost less accumulated amortization. For assets with determinable useful lives,
amortization is computed using the straight-line method over the estimated economic lives of the
respective intangible assets, ranging from two to seven years. In accordance with SFAS No. 142,
goodwill and other intangibles that have indeterminate lives will be tested for impairment based on
discounted cash flows and market capitalization at least annually, but also on an interim basis if
an event or circumstance indicates
that it is more likely than not that an impairment loss has been incurred. Our annual impairment
test occurs during our fourth fiscal quarter each year. 22




---



##### Table of Contents



Additionally, SFAS No. 144, under which the recoverability of long-lived assets is assessed by
determining whether the carrying value of an asset can be recovered through projected undiscounted
future operating cash flows over its remaining life whenever events or changes in circumstances
indicate that we may not be able to recover the assets carrying value, such as in the fiscal
fourth quarter of 2004 when tepid demand from two of our customers and a subsequent drop in our
stock price resulted in an indication of impairment to our goodwill and other intangible assets.
The amount of impairment, if any, is measured based on fair value, which is determined using
projected discounted future operating cash flows. Assets to be disposed of are reported at the
lower of the carrying amount or fair value less costs to sell. At the end of June 2004, events and circumstances, including tepid fiscal fourth quarter of 2004
demand from two of our customers coupled with a subsequent drop in our stock price, indicated that
a potential impairment of goodwill existed. As a result, we conducted a SFAS No. 144, Accounting
for the Impairment or Disposal of Long-Lived Assets, analysis, as well as a SFAS No. 142,
Goodwill and Other Intangible Assets analysis, including a second step goodwill impairment test.
The result of SFAS No. 144 analysis indicated that none of our long-lived assets had been impaired.
Any future impairment loss could materially and adversely affect our financial position and
results of operations. However, the SFAS No. 142 analysis indicated that all of our goodwill,
which was in excess of $580 million, was impaired. Inventories.Inventories are stated at the lower of cost on a first-in, first-out basis or
market. We use a standard cost system for purposes of determining cost. The standards are
adjusted periodically to ensure they represent actual cost. We regularly compare forecasted
demand and the composition of the forecast against inventory on hand and open purchase commitments
in an effort to ensure the carrying value of inventory does not exceed net realizable value.
Accordingly, we may have to record reductions to the carrying value of excess and obsolete
inventory if forecasted demand decreases, as we have previously recorded, including an excess and
obsolete inventory charge of $13.6 million during the three months ended September 30, 2001. Income Taxes. We account for income taxes using the asset and liability method, which recognizes
deferred tax assets and liabilities for the future tax consequences attributable to temporary
differences between the financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax
rates expected to apply to taxable income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change
in tax rates is recognized in income in the period that includes the enactment date. We regularly
review historical and anticipated future pre-tax results of operations to determine whether we will
be able to realize the benefit of our deferred tax assets. A valuation allowance is required to
reduce the potential deferred tax asset when it is more likely than not that all or some portion of
the potential deferred tax asset will not be realized due to the lack of sufficient taxable income. Stock-Based Compensation. We account for our stock-based awards to employees using the intrinsic
value method. Stock-based awards to non-employees, if any, are recorded using the fair value
method. See note 1 of the Condensed Consolidated Financial Statements for more information. In
December 2004, the FASB issued SFAS No. 123 (revised 2004), Share-Based Payment, or SFAS No.
123R. SFAS No. 123R requires that the compensation cost related to share-based payment
transactions, measured based on the fair value of the equity or liability instruments issued, be
recognized in the financial statements. Determining the fair value of options using the
Black-Scholes model, or other currently accepted option valuation models, requires highly
subjective assumptions, including future stock price volatility and expected time until exercise,
which greatly affect the calculated fair value on the grant date. SFAS No. 123R is required for
our first interim period of fiscal 2006, which would be the three months ending October 2, 2005;
however, early adoption is permitted. The Company is currently evaluating its alternatives, which
will likely include early adoption during the three months ending
July 3, 2005. The adoption of SFAS No. 123R will have a significant
impact on our results of operations. Liquidity and Capital Resources As of March 27, 2005, we had $531.9 million in working capital and $613.8 million in cash and cash
equivalents, current investments and long-term investments. At June 27, 2004, we had $486.8
million in working capital and $655.4 million in cash and cash equivalents, restricted cash,
current investments and long-term investments. Our cash and cash equivalents decreased by $37.3
million to $154.9 million as of March 27, 2005, from $192.1 million as of June 27, 2004. The
decrease in cash and cash equivalents was due to our financing activities, which used $150.0
million, and our investing activities, which used $5.5 million. The cash and cash equivalents used
by financing and investing activities were partially offset by our operating activities, which provided $118.2
million of cash and cash equivalents. 23




---



##### Table of Contents



In the nine months ended March 27, 2005, operating activities provided $118.2 million of cash and
cash equivalents compared to providing $50.2 million in the nine months ended March 28, 2004.
During the nine months ended March 27, 2005, the Company received reimbursement from some of our
insurance carriers related to shareholder litigation settlements of approximately $9.8 million and
paid settlements of $0.7 million. During the nine months ended March 28, 2004, the Company paid
litigation settlements of $31.5 million net. Additionally, cash provided by operating activities
for the nine months ended March 27, 2005 was driven by net income of $46.3 million adjusted for
non-cash reconciling items, the most significant of which were amortization of other intangibles,
depreciation and amortization of property and equipment, deferred income taxes, and a gain on the
repurchase of our 0.25 percent contingent convertible subordinated notes. Additionally, decreases
in inventories and accounts and other receivables, and increases in accounts payable, accrued
liabilities and income taxes payable, increased our net cash provided by operating activities. In the nine months ended March 27, 2005, investing activities used $5.5 million of cash and cash
equivalents, primarily due to the additions to property and equipment and investment maturities in
excess of purchases of new investments. During the nine months ended March 27, 2005, we spent $9.8
million on additions to property and equipment compared to spending $42.7 million during the same
period of the prior year. The additions to property and equipment in the prior year were primarily
related to the building of our new corporate headquarters. For the nine months ended March 28,
2004, investing activities used $292.5 million of cash and cash equivalents, primarily due to the
purchase of Vixel Corporation and the technology assets of Trebia Networks. Financing activities used $150.0 million of cash and cash equivalents in the nine months ended
March 27, 2005, primarily due to repurchases of our convertible subordinated notes. During the
nine months ended March 27, 2005, we repurchased $153.0 million in face value of our 0.25 percent
convertible subordinated notes at a net discount, for $137.2 million, and $17.0 million in face
value of our 1.75 percent convertible subordinated notes for $17.1 million. For the nine months
ended March 28, 2004, financing activities provided $288.1 million of cash and cash equivalents due
primarily to net proceeds of $505.2 million from the issuance of our 0.25 percent contingent
convertible debt, partially offset by the repurchases of common stock and some of our 1.75 percent
convertible subordinated notes, for $40.5 million and $185.6 million, respectively. As of March 27, 2005, we no longer had outstanding any amounts in face value of our 1.75 percent
convertible subordinated notes due 2007. During the three months ended March 27, 2005, we
announced and completed the redemption of all of our 1.75 percent convertible notes for the
aggregate redemption price of $17.1 million, resulting in a pre-tax loss of $0.3 million. As of March 27, 2005, we had approximately $364.5 million in face value of our 0.25 percent
contingent convertible subordinated notes due 2023 outstanding. Interest is payable in cash on
June 15 and December 15 of each year. Under the terms of the offering, the notes will be
convertible, at the option of the holder and subject to the satisfaction of certain conditions,
into shares of our common stock at a price of $43.20 per share.Holders of the notes may require
us to purchase the notes for cash by giving written notice within the 20 business days prior to
each of December 15, 2006, December 15, 2008, December 15, 2013, and December 15, 2018. See note 7
to the condensed consolidated financial statements contained herein for more information. On April 28, 2005, we bought back approximately $47.0 million face value of our convertible
subordinated notes at a discount to face value at an aggregate redemption price of $43.6 million.
The repurchased notes were cancelled. Currently, no more convertible subordinated notes remain
authorized for repurchase by our Board of Directors, however, our Board may authorize future
additional purchases from time to time based on future market conditions. We have entered into purchase agreements for inventory, and as of March 27, 2005, our remaining
inventory purchase obligation for these items was $21.7 million, including $8.9 million related to
key inventory components. On October 9, 2003, before our acquisition of Vixel, a purported class action lawsuit was filed in
King County Superior Court of the State of Washington against Vixel and each of Vixels directors
and certain unnamed individuals (the Vixel Parties), entitled Russell Fink v. Vixel Corporation,
et al., Case No. 03-2-37226-9SEA. The complaint made general allegations that, among other things,
Vixels directors breached their fiduciary duties to Vixel stockholders in connection with the
approval of the merger with Emulex and sought to enjoin the tender offer and have the merger
agreement declared unlawful, among other forms of relief. On November 7, 2003, the Vixel Parties
entered into a memorandum of understanding for a $0.7 million settlement with the plaintiff in the
class action suit 24




---



##### Table of Contents



pursuant to which the parties have agreed to settle the action, subject to court approval. The
$0.7 million was recorded as general and administrative expense for the nine months ended March 28,
2004. Formal settlement documents were signed on May 5, 2004 and the plaintiff has completed
discovery as agreed to by the parties. In August 2004, final court approval was obtained for the
settlement of the Fink v. Vixel litigation, and we paid the $0.7 million settlement. During the
nine months ended March 27, 2005, we received a $0.3 million reimbursement from our insurer
relating to the Fink v. Vixel litigation. In July 2004, we obtained an arbitration award against two of our insurers related to class action
and derivative lawsuits settled in 2003, and subsequently collected a total of $9.5 million plus
$0.3 million in interest during the three months ended September 26, 2004. As the amounts
received exceeded the $5.1 million receivable reflected on our books, we recorded a reduction in
general and administrative expenses during the three months ended September 26, 2004, of $4.4
million, as well as interest income of $0.3 million. As part of our commitment to storage networking infrastructure product development, we expect to
continue our investments in property and equipment, most notably for additional engineering
equipment, and continued enhancement of our global IT infrastructure. Furthermore, we plan to
devote additional resources to our engineering, sales and marketing efforts as part of our
on-going diversification and growth strategy. We believe that our existing cash and cash equivalents balances, facilities and equipment leases,
investments and anticipated cash flows from operating activities will be sufficient to support our
working capital needs and capital expenditure requirements for at least the next 12 months. As described above, the following summarizes our contractual obligations at March 27, 2005, and
the effect such obligations are expected to have on our liquidity and cash flow in future periods: Payments Due by Period(in thousands)Less than
    
    
    1-3
    
    
    4-5
    
    
    After 5Total
    
    
    1 Year (2)
    
    
    Years (3)
    
    
    Years (4)
    
    
    YearsConvertible subordinated
notes and interest (1)
    
    $
    366,323
    
    
    $
    456
    
    
    $
    365,867
    
    
    $
    
    
    
    $
    Leases
    
    
    5,313
    
    
    
    371
    
    
    
    2,133
    
    
    
    1,428
    
    
    
    1,381Inventory purchase commitments
    
    
    21,697
    
    
    
    21,697
    
    
    
    
    
    
    
    
    
    
    
    Other commitments
    
    
    500
    
    
    
    500
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    393,833
    
    
    $
    23,024
    
    
    $
    368,000
    
    
    $
    1,428
    
    
    $
    1,381
   (1)
    
    The principal payment related to the remaining outstanding 0.25 percent contingent convertible
subordinated notes of $364.5 million is shown as a payment in the period from July 4, 2005 through
July 1, 2007, or 1-3 years above, as holders of these 20-year notes may require us to purchase the
notes for cash by giving us written notice as early as 20 business days prior to each of December
15, 2006, December 15, 2008, December 15, 2013, and December 15, 2018.(2)
    
    Fiscal year ending July 3, 2005.(3)
    
    Fiscal years ending July 2, 2006, and July 1, 2007.(4)
    
    Fiscal years ending June 29, 2008, and June 28, 2009. Risk Factors A downturn in information technology spending in general or spending on computer and storage
systems in particular could adversely affect our revenues and results of operations. The demand for our Fibre Channel products, which comprise substantially all of our net revenues,
has been driven by the demand for high-performance storage networking products and solutions that
support enterprise computing applications, including on-line transaction processing, data mining,
data warehousing, multimedia and Internet applications. Any significant downturn in demand for
such products, solutions and applications, could adversely affect our business, results of
operations and financial condition. The adverse effects of any sustained downturn in information
technology spending on our operating results may be exacerbated by expenses associated with our
research and development investments, strategic investments and merger and acquisition activity, as
well as customer service and support, which are expected to continue despite any such downturn. 25




---



##### Table of Contents



Our business depends upon the continued growth of the Fibre Channel storage networking market, and
our business will be adversely affected if such growth does not occur or occurs more slowly than we
anticipate. The size of our potential market is largely dependent upon the acceptance of our Fibre Channel
storage networking technologies, as well as the overall demand for storage. We believe that our
investment in the Fibre Channel storage networking market provides opportunity for revenue growth
and profitability for the future. However, the market for Fibre Channel storage networking
products may not gain broader acceptance and customers may choose alternative technologies and/or
products supplied by other companies. Recently, interest has re-emerged for iSCSI storage
networking solutions, which may satisfy some I/0 connectivity requirements through standard
Ethernet adapters and software at little to no incremental cost to end users. Such iSCSI solutions
are likely to compete with Fibre Channel solutions, particularly in the low end of the market. In
addition, other technologies such as Serial Attached SCSI or SAS, may compete with our Fibre
Channel embedded switched solutions in the future. Furthermore, since our products are sold as
parts of integrated systems, demand for our products is driven by the demand for these integrated
systems, including other companies complementary products. A lack of demand for the integrated
systems or a lack of complementary products required for these integrated systems could have a
material adverse effect on our business, results of operations and financial condition. If the
Fibre Channel storage networking market does not grow, or grows more slowly than we anticipate,
attracts more competitors than we expect, as discussed below, or if our products do not achieve
continued market acceptance, our business, results of operations and financial condition could be
materially adversely affected. Because a significant portion of our revenues are generated from sales to a limited number of
customers, none of which are the subject of exclusive or long-term contracts, the loss of one or
more of these customers, or our customers failure to make timely payments to us, could adversely
affect our business. We rely almost exclusively on original equipment manufacturers, or OEMs, and sales through
distribution channels for our revenue. For the three months ended March 27, 2005, we derived
approximately 64 percent of our net revenues from OEMs and 36 percent from sales through
distribution. Furthermore, because some of our sales through distribution channels consist of OEM
products, OEM customers effectively generated more than 85 percent of our revenue for the three and
nine months ended March 27, 2005. We may be unable to retain our current OEM and distributor
customers or to recruit additional or replacement customers. Although we have attempted to expand our base of customers, including customers for embedded
switching products, we believe our revenues in the future will continue to be similarly derived
from a limited number of customers. As a result, to the extent that sales to any of our
significant customers do not increase in accordance with our expectations or are reduced or
delayed, our business, results of operations and financial condition could be materially adversely
affected. As is common in the technology industry, our agreements with OEMs and distributors are typically
non-exclusive, have no volume commitments, and often may be terminated by either party without
cause. It is increasingly commonplace for our OEM and distributor customers to utilize or carry
competing product lines. If we were to lose business from one or more significant OEM or
distributor customers to a competitor, our business, results of operations and financial condition
could be materially adversely affected. In addition, our OEMs may elect to change their business
practices in ways that affect the timing of our revenues, which may materially adversely affect our
business, results of operations and financial condition. Our markets are highly competitive and our business and results of operations may be adversely
affected by entry of new competitors into the markets, aggressive pricing and the introduction or
expansion of competitive products and technologies. The markets for our products are highly competitive and are characterized by rapid technological
advances, price erosion, frequent new product introductions and evolving industry standards. We
expect that our markets will continue to attract new competition. Our current and potential
competition consists of major domestic and international companies, some of which have
substantially greater financial, technical, marketing and distribution resources than we have.
Additional companies, including but not limited to our suppliers, strategic partners, OEM customers
and emerging companies, may enter the markets for our storage networking products and new or
stronger competitors may emerge as a result of consolidation movements in the marketplace.
Additionally, our existing competitors continue to introduce products with improved
price/performance characteristics, and we have to do the 26




---



##### Table of Contents



same to remain competitive. Furthermore, competitors may introduce new products to the market
before we do, and thus obtain a first to market advantage over us. Increased competition could
result in increased price competition, reduced revenues, lower profit margins or loss of market
share, any of which could have a material adverse effect on our business, results of operations and
financial condition. Alternative legacy technologies such as SCSI and port bypass circuits compete with our Fibre
Channel I/O and embedded switch products, respectively, for customers. Our success depends in part
on our own ability and on the ability of our OEM customers to develop storage networking solutions
that are competitive with these alternative legacy technologies. Additionally, in the future other
technologies that we are not currently developing may evolve to address the storage networking
applications currently served by our Fibre Channel product line today, reducing our market
opportunity. Our operating results are difficult to forecast and could be adversely affected by many factors,
and our stock price may decline if our results fail to meet expectations. Our revenues and results of operations have varied on a quarterly basis in the past and may vary
significantly in the future. Accordingly, we believe that period-to-period comparisons of our
results of operations are not necessarily meaningful, and you should not rely on such comparisons
as indications of our future performance. We may be unable to maintain our current levels of
growth or profitability in the future. Our revenues and results of operations are difficult to
forecast and could be adversely affected by many factors, including, among others:  
    changes in the size, mix, timing and terms of OEM and other customer orders;
    changes in the sales and deployment cycles for our products and/or desired inventory
levels for our products;
    acquisitions or strategic investments by our customers, competitors or us;
    the timing and market acceptance of new or enhanced product introductions by us, our OEM
customers and our competitors;
    market share losses or difficulty in gaining incremental market share growth;
    fluctuations in product development, procurement, resource utilization and other operating expenses;
    component shortages experienced by us;
    reduced demand from our customers, if there is a shortage of, or difficulties in
acquiring, components or other products, such as Fibre Channel disk drives, used in
conjunction with our products in the deployment of systems;
    the inability of our electronics manufacturing service, or EMS, providers to produce and
distribute our products in a timely fashion;
    difficulties with updates, changes or additions to our information technology systems;
    breaches of our network security, including viruses;
    changes in general social and economic conditions, including but not limited to natural
disasters, terrorism, public health and slower than expected market growth, with resulting
changes in customer technology budgeting and spending;
    changes in technology, industry standards or consumer preferences;
    seasonality; and/or
    changes in our accounting or other policies resulting from the adoption of new laws,
regulations or pronouncements. 27




---



##### Table of Contents



As a result of these and other unexpected factors or developments, we expect that in the future
operating results will be from time to time below the expectations of investors or market analysts,
which could have a material adverse effect on our stock price. Our relatively small backlog of unfilled orders, possible customer delays or deferrals and our
tendency to generate a large percentage of our quarterly sales near the end of the quarter
contribute to possible fluctuations in our operating results that could have an adverse impact on
our results of operations and stock price. Historically, we have generally shipped products quickly after we receive orders, meaning that we
do not always have a significant backlog of unfilled orders. As a result, our revenues in a given
quarter may depend substantially on orders booked during that quarter. Alternatively, orders
already in backlog may be deferred or cancelled. Also, we have typically generated a large
percentage of our quarterly revenues in the last month of the quarter. Because our expense levels
are largely based on our expectations of future sales, in the event we experience unexpected
decreases in sales, our expenses may be disproportionately large relative to our revenues and we
may be unable to adjust spending in a timely manner to compensate for any unexpected revenue
shortfall. A material shortfall in sales in relation to our quarterly expectations or any delay,
deferral or cancellation of customer orders would likely have an immediate and adverse impact on
our results of operations and may adversely affect our stock price. Our industry is subject to rapid technological change, and we must keep pace with the changes to
successfully compete. The markets for our products are characterized by rapidly changing technology, evolving industry
standards and the frequent introduction of new products and enhancements. Our future success
depends in large part on our ability to enhance our existing products and to introduce new products
on a timely basis to meet changes in customer preferences and evolving industry standards.
Currently, new and proposed technologies such as four, eight and ten gigabit per second, or Gbps,
Fibre Channel solutions; Infiniband; PCI-X 2.0; PCI Express; PCI Express Advanced Switching; iSCSI;
Serial ATA, or SATA; Serial Attached SCSI, or SAS; and Remote Direct Memory Access, or RDMA; are in
development by many companies and their ultimate acceptance and deployment in the market is
uncertain. We are developing some, but not all of these technologies, and we cannot be sure that
the technologies we chose to develop will achieve market acceptance, or that technologies that we
chose not to develop will be available to purchase or license from third parties or will be
immaterial to our business. Furthermore, if our products are not available in time for the
qualification cycle at an OEM it may be up to three years, if ever, before another qualification
cycle is available to us. In addition, new products and enhancements developed by us may not be
backwards compatible to existing equipment already installed in the market. If we are unable, for
technological or other reasons, to develop new products, enhance or sell existing products, or
consume existing products in a timely and cost-effective manner in response to technological and
market changes, our business, results of operations and financial condition may be materially
adversely affected. We have experienced losses in our history and may experience losses in our future that may
adversely affect our stock price and financial condition. We have experienced losses in our history, including a loss of $532.3 million in fiscal 2004. Any
losses, including losses caused by impairment of long-lived assets or goodwill, may adversely
affect the perception of our business by analysts and investors, which could adversely affect our
stock price. To the extent that we are unable to generate positive operating profits or positive
cash flow from operations, our financial condition may be materially adversely affected. The migration of our customers toward newer product platforms may have a significant adverse
effect. As our customers migrate from one platform to the enhanced price/performance of the next platform,
we may experience reduced revenue, gross profit or gross margin levels associated with lower
average selling prices or higher relative product costs associated with improved performance.
While we regularly compare forecasted demand for our products against inventory on hand and open
purchase commitments, to the extent that customers migrate more quickly than anticipated, the
corresponding reduction in demand for older product platforms may result in obsolete inventory and
related charges which could have a material adverse effect on our financial condition and results
of operations. 28




---



##### Table of Contents



Any failure of our OEM customers to keep up with rapid technological change and successfully market
and sell systems that incorporate new technologies could adversely affect our business. Our revenues depend significantly upon the ability and willingness of our OEM customers to commit
significant resources to develop, promote and deliver products that incorporate our technology. In
addition, if our customers products are not commercially successful, it may have a material
adverse effect on our business, results of operations and financial condition. Rapid changes in the evolution of technology, including the unexpected extent or timing of the
transition from HBA solutions or embedded switch box solutions to lower-priced ASIC solutions,
could adversely affect our business. Historically, the electronics industry has developed higher performance ASICs that create chip
level solutions that replace selected board level or box level solutions at a significantly lower
average selling price. We have previously experienced this trend and expect it to continue in the
future. If this transition is more abrupt or is more widespread than anticipated, there can be no
assurance that we will be able to modify our business model in a timely manner, if at all, in order
to mitigate the effects of this transition on our business, results of operations and financial
position. If customers elect to utilize lower-end HBAs in higher-end environments or applications, our
business could be negatively affected. We supply three families of HBAs that target separate high-end, mid-range and small and
medium-sized business, or SMB, markets. Historically, the majority of our Fibre Channel revenue
has come from our high-end server and storage solutions. In the future, increased revenues are
expected to come from SMB and midrange server and storage solutions, which have lower average
selling prices. If customers elect to utilize lower-end HBAs in higher-end environments or
applications, our business could be negatively affected. A decrease in the average unit selling prices and/or an increase in the manufactured cost of our
products could adversely affect our revenue, gross margins and financial performance. In the past, we have experienced downward pressure on the average unit selling prices of our
products. Furthermore, we may provide pricing discounts to customers based upon volume purchase
criteria, and achievement of such discounts may reduce our average unit selling prices. To the
extent that growth in unit demand fails to offset decreases in average unit selling prices, our
revenues and financial performance could be materially adversely affected. Although historically
we have achieved offsetting cost reductions, to the extent that average unit selling prices of our
products decrease without a corresponding decrease in the costs of such products, our gross margins
and financial performance could be materially adversely affected. Furthermore, if the manufactured
cost of our products were to increase due to inflation or other factors, our gross margins and
financial performance could be materially adversely affected. Delays in product development could adversely affect our business. We have experienced delays in product development in the past and may experience similar delays in
the future. Prior delays have resulted from numerous factors, such as:  
    difficulties in hiring and retaining necessary employees and independent contractors;
    difficulties in reallocating engineering resources and other resource limitations;
    unanticipated engineering or manufacturing complexity, including from third-party
suppliers of intellectual property including foundries of our ASICs;
    undetected errors or failures in software and hardware;
    changing OEM product specifications;
    delays in the acceptance or shipment of products by OEM customers; and/or
    changing market or competitive product requirements. 29




---



##### Table of Contents



Given the short product life cycles in the markets for our products and the relatively long product
development cycles, any delay or unanticipated difficulty associated with new product introductions
or product enhancements could have a material adverse effect on our business, results of operations
and financial condition. Our products are complex and may contain undetected hardware or software defects or bugs that could
increase our costs, reduce our net revenues or damage our reputation. Our products are complex and may contain undetected hardware or software defects or bugs when first
introduced or as newer versions are released. We are also exposed to risks associated with latent
defects in existing products. From time to time, we have found errors in existing, new or enhanced
products. If any of our products contains defects or bugs, or has reliability, quality or
compatibility problems, our reputation may be damaged and customers may be reluctant to buy our
products, which could materially and adversely affect our ability to retain existing customers and
attract new customers. In addition, these defects or bugs could interrupt or delay sales or
shipment of our products to our customers. Furthermore, if any of these problems are not found
until after we have commenced commercial shipment of a product, we may be required to incur
additional development costs and product recall, repair or replacement costs. These problems may
divert our technical and other resources from other development efforts and could result in
significant warranty and repair costs. Our joint development activities may result in products that are not commercially successful or
that are not available in a timely fashion. We have engaged in joint development projects with third parties in the past and we expect to
continue doing so in the future. Joint development can magnify several risks for us, including the
loss of control over development of aspects of the jointly developed products and over the timing
of product availability. Accordingly, we face increased risk that joint development activities
will result in products that are not commercially successful or that are not available in a timely
fashion. During April 2003 we announced a joint development activity with Intel Corporation relating to
storage processors that integrate SATA, SAS and Fibre Channel interfaces within a single
architecture. Under the agreement, we will develop the protocol controller hardware, firmware and
drivers. Intel will integrate its Intel® Xscale microarchitecture as the core technology for
the new processors and will manufacture the processors on its 90-nanometer process technology.
This activity has risks resulting from unproven new-generation manufacturing technology, from the
licensing of technology to Intel and from increased development costs. A change in our business relationships with our third-party suppliers or our electronics
manufacturing service providers could adversely affect our business. We rely on third-party suppliers for components and the manufacture of our products, and we have
experienced delays or difficulty in securing components and finished goods in the past. Delays or
difficulty in securing components or finished goods may be caused by numerous factors including,
but not limited to:  
    discontinued production by a supplier;
    required long-term purchase commitments;
    undetected errors, failures or production quality issues;
    timeliness of product delivery;
    sole sourcing;
    financial stability and viability of our suppliers and EMS providers;
    changes in business strategies of our suppliers and EMS providers;
    increases in manufacturing costs due to lower volumes or more complex manufacturing process than anticipated; 30




---



##### Table of Contents




    disruption in shipping channels;
    natural disasters;
    inability or unwillingness of our suppliers or EMS providers to continue their business with us;
    environmental, tax or legislative changes in the location where our products are produced;
    difficulties associated with foreign operations; and/or
    market shortages. There is a risk that we will not be able to retain our current suppliers or change to alternative
suppliers. An interruption in supply, the cost of shifting to a new supplier or EMS providers,
disputes with suppliers or EMS providers, or the cost associated with a long-term purchase
commitment could have a material adverse effect on our business, results of operations and
financial condition. If our intellectual property protections are inadequate, it could adversely affect our business. We believe that our continued success depends primarily on continuing innovation, marketing and
technical expertise, as well as the quality of product support and customer relations. At the same
time, our success is partially dependent on the proprietary technology contained in our products.
We currently rely on a combination of patents, copyrights, trademarks, trade secret laws and
contractual provisions to establish and protect our intellectual property rights in our products.
For a more complete description of our intellectual property, you should read Business 
Intellectual Property contained within our 2004 Annual Report on Form 10-K. We cannot be certain that the steps we take to protect our intellectual property will adequately
protect our proprietary rights, that others will not independently develop or otherwise acquire
equivalent or superior technology, or that we can maintain such technology as trade secrets. In
addition, the laws of some of the countries in which our products are or may be developed,
manufactured or sold may not protect our products and intellectual property rights to the same
extent as the laws of the United States or at all. Furthermore, we enter into various development
projects and arrangements with other companies. In some cases, these arrangements allow for the
sharing or use of our intellectual property. Our failure to protect our intellectual property
rights could have a material adverse effect on our business, results of operations and financial
condition. For more information on legal proceedings related to Emulex, see Part II, Item 1, Legal
Proceedings. Ongoing lawsuits present inherent risks, any of which could have a material adverse effect on our
business, financial condition or results of operations. Such potential risks include the
continuing expenses of litigation, the risk of loss of patent rights, the risk of injunction
against the sale of products incorporating the technology in question, counterclaims and attorneys
fee liability. Third-party claims of intellectual property infringement could adversely affect our business. We believe that our products and technology do not infringe on the intellectual property rights of
others or upon intellectual property rights that may be granted in the future pursuant to pending
applications. We occasionally receive communications from third parties alleging patent
infringement, and there is always the chance that third parties may assert infringement claims
against us. Any such claims, with or without merit, could result in costly litigation, cause
product shipment delays or require us to enter into royalty or licensing agreements, which may or
may not be available. Furthermore, we have in the past obtained, and may be required in the future
to obtain, licenses of technology owned by other parties. We cannot be certain that the necessary
licenses will be available or that they can be obtained on commercially reasonable terms. If we
were to fail to obtain such royalty or licensing agreements in a timely manner and on reasonable
terms, our business, results of operations and financial condition would be materially adversely
affected. 31




---



##### Table of Contents



The inability or increased cost of attracting, motivating or retaining key managerial and technical
personnel could adversely affect our business. Our success depends to a significant degree upon the performance and continued service of key
managers, as well as engineers involved in the development of our storage networking technologies
and technical support of our storage networking products and customers. Competition for such
highly skilled employees in the communities in which we operate, as well as our industry, is
intense, and we cannot be certain that we will be successful in recruiting, training and retaining
such personnel. In addition, employees may leave our company and subsequently compete against us.
Also, many of these key managerial and technical personnel receive stock options as part of our
employee retention initiatives. New regulations, volatility in the stock market and other factors
could diminish the value of our stock options, putting us at a competitive disadvantage and forcing
us to use more cash compensation. If we are unable to attract new managerial and technical
employees, or are unable to retain and motivate our current key managerial and technical employees,
or are forced to use more cash compensation to retain and motivate key personnel, our business,
results of operations and financial condition could be materially adversely affected. Our international business activities subject us to risks that could adversely affect our business. For the three months ended March 27, 2005, sales in the United States accounted for 57 percent of
our total net revenues, sales in the Pacific Rim countries accounted for 15 percent of our total
net revenues, and sales in Europe and the rest of the world accounted for 28 percent of our total
net revenues. We expect that our sales will be similarly distributed for the foreseeable future.
All of our sales are currently denominated in U.S. dollars. As a result, if the value of the U.S.
dollar increases relative to foreign currencies, our products could become less competitive in
international markets. Additionally, a significant portion of our products is produced at our EMS
providers production facilities in Spain, Mexico and Malaysia. As a result, we are subject to the
risks inherent in international operations. Our international business activities could be
affected, limited or disrupted by a variety of factors, including:  
    the imposition of or changes in governmental controls, taxes, tariffs, trade
restrictions and regulatory requirements;
    the costs and risks of localizing products for foreign countries;
    longer accounts receivable payment cycles;
    changes in the value of local currencies relative to our functional currency;
    import and export restrictions;
    loss of tax benefits, or increases in tax expenses, due to international production;
    general economic and social conditions within foreign countries;
    taxation in multiple jurisdictions; and/or
    political instability, war or terrorism. All of these factors could harm future sales of our products to international customers or future
production outside of the United States of our products, and have a material adverse effect on our
business, results of operations and financial condition. Potential acquisitions or strategic investments may be more costly or less profitable than
anticipated and may adversely affect the price of our company stock. We may pursue acquisitions or strategic investments that could provide new technologies, products
or service offerings. Future acquisitions or strategic investments may negatively impact our
results of operations as a result of operating losses incurred by the acquired entity, the use of
significant amounts of cash, potentially dilutive issuances of equity or equity-linked securities,
incurrence of debt, amortization of intangible assets with determinable lives or impairment of
intangible assets. Furthermore, we may incur significant expenses pursuing acquisitions or
strategic investments that ultimately may not be completed. Moreover, to the extent that any
proposed acquisition or strategic investment is not favorably received by stockholders, analysts
and others in the investment community, the price of our common stock could be adversely affected.
In addition, acquisitions or strategic investments involve numerous risks, including: 32




---



##### Table of Contents




    difficulties in the assimilation of the operations, technologies, products and personnel
of the acquired company;
    purchased technology that is not adopted by customers in the way or the time frame we anticipated;
    the diversion of managements attention from other business concerns;
    risks of entering markets in which we have no or limited prior experience;
    minority interest in a company, resulting from a strategic investment, that could have
an impact on our results;
    risks related to the effect that the acquired companys internal control processes might
have on our financial reporting and managements report on our internal controls over
financial reporting; and/or
    the potential loss of key employees of the acquired company. In the event that an acquisition or strategic investment does occur and we are unable to obtain
anticipated profits or successfully integrate operations, technologies, products or personnel that
we acquire, our business, results of operations and financial condition could be materially
adversely affected. Our stock price is volatile, which has and may result in lawsuits against us and our officers and
directors. The stock market in general and the stock prices in technology-based companies in particular have
experienced extreme volatility that often has been unrelated to the operating performance of any
specific public company. The market price of our common stock has fluctuated in the past and is
likely to fluctuate in the future as well. For example, during the calendar year 2004 the market
price of our common stock ranged from a low of $9.26 per share to a high of $31.30 per share.
Factors that could have a significant impact on the market price of our common stock include, but
are not limited to, the following:  
    quarterly variations in customer demand and operating results;
    announcements of new products by us or our competitors;
    the gain or loss of significant customers or design wins;
    changes in analysts earnings estimates;
    changes in analyst recommendations, price targets or other parameters that may not be
related to earnings estimates;
    rumors or dissemination of false information;
    pricing pressures;
    short selling of our common stock;
    dilution resulting from conversion of outstanding convertible subordinated notes into shares of our common stock;
    general conditions in the computer, storage or communications markets; and/or
    events affecting other companies that investors deem to be comparable to us. In the past, companies, including us, that have experienced volatility in the market price of their
stock have been the objects of securities class action litigation. If we were to be the subject of
similar litigation in the future or experience unfavorable outcomes in any of our pending
litigation, as discussed in Part II, Item 1, Legal
Proceedings, contained elsewhere herein, it could have a material adverse effect on our results of
operations and financial condition. 33




---



##### Table of Contents



Terrorist activities and resulting military and other actions could adversely affect our business. The terrorist attacks in New York and Washington, D.C. in September 2001 disrupted commerce
throughout the United States and Europe. The continued threat of terrorism within the United
States and Europe and the military action and heightened security measures in response to such
threat may cause significant disruption to commerce throughout the world. To the extent that such
disruptions result in delays or cancellations of customer orders, delays in collecting cash, a
general decrease in corporate spending on information technology or our inability to effectively
market, manufacture or ship our products, our business, financial condition, and results of
operations could be materially and adversely affected. We are unable to predict whether the threat
of terrorism or the responses thereto will result in any long-term commercial disruptions or if
such activities or responses will have any long-term material adverse effect on our business,
results of operations or financial condition. Our corporate offices and principal product development facilities are located in a region that is
subject to earthquakes and other natural disasters. Our California and Washington facilities, including our corporate offices and principal product
development facilities, are located near major earthquake faults. Any disruption in our business
activities, personal injury or damage to the facilities in excess of our currently insured amounts
as a result of earthquakes or other such natural disasters, could have a material adverse effect on
our business, results of operations and financial condition. Our shareholder rights plan, certificate of incorporation and Delaware law could adversely affect
the performance of our stock. Our shareholder rights plan and provisions of our certificate of incorporation and of the Delaware
General Corporation Law could make it more difficult for a third party to acquire us, even if doing
so would be beneficial to our shareholders. The shareholder rights plan and these provisions of
our certificate of incorporation and Delaware law are intended to encourage potential acquirers to
negotiate with us and allow our board of directors the opportunity to consider alternative
proposals in the interest of maximizing shareholder value. However, such provisions may also
discourage acquisition proposals or delay or prevent a change in control, which could harm our
stock price. For more information, please read note 12 to the Consolidated Financial Statements
contained in our 2004 Annual Report on Form 10-K, our certificate of incorporation and Delaware law
for more information on the anti-takeover effects of provisions of our shareholder rights plan. Our system of internal controls may be inadequate. We maintain a system of internal controls in order to ensure we are able to collect, process,
summarize and disclose the information required by the Securities and Exchange Commission within
the time periods specified. Any system of controls, however well designed and operated, can
provide only reasonable, and not absolute, assurance that the objectives of the system are met. In
addition, the design of any control system is based in part upon certain assumptions about the
likelihood of future events. Because of these and other inherent limitations of control systems,
there can be no assurance that any design will succeed in achieving its stated goals under all
potential future conditions, regardless of how remote. Additionally, public companies in the
United States are required to review their internal controls under the Sarbanes-Oxley Act of 2002.
If the internal controls put in place by us are not adequate or in conformity with the requirements
of the Sarbanes-Oxley Act of 2002, and the rules and regulations of the Securities and Exchange
Commission, we may be required to restate our financial statements, receive an adverse audit
opinion, and/or take other actions which will divert significant financial and managerial
resources, as well as be subject to fines and/or other government enforcement actions.
Furthermore, the price of our common stock could be adversely affected. Changes in laws, regulations and financial accounting standards may affect our reported results of
operations. New laws, regulations and accounting standards, as well as changes to and varying interpretations
of currently accepted accounting practices in the technology industry might adversely affect our
reported financial results, which could have an adverse effect on our stock price. Furthermore,
new guidance related to the expensing of stock options in SFAS No. 123R will materially adversely
affect our reported financial results when adopted, and may affect our stock price. SFAS No. 123R
is effective for annual periods beginning after June 15, 2005; however, early adoption is
permitted. We are currently evaluating our alternatives, which will
likely include early adoption during the three months ending
July 3, 2005. 34




---



##### Table of Contents



The final determination of our income tax liability may be materially different from our income tax
provisions and accruals. We are subject to income taxes in both the United States and international jurisdictions.
Significant judgment is required in determining our worldwide provision for income taxes. In the
ordinary course of our business, there are many transactions where the ultimate tax determination
is uncertain. Additionally, our calculations of income taxes are based on our interpretations of
applicable tax laws in the jurisdictions in which we file. Although we believe our tax estimates
are reasonable, there is no assurance that the final determination of our income tax liability will
not be materially different than what is reflected in our income tax provisions and accruals.
Should additional taxes be assessed as a result of new legislation, an audit or litigation, if our
effective tax rate should change as a result of changes in federal, international or state and
local tax laws, or if we were to change the locations where we operate, there could be a material
effect on our income tax provision and net income in the period or periods in which that
determination is made, and potentially to future periods as well. We may need additional capital in the future and such additional financing may not be available on
favorable terms. While we believe we have adequate working capital to meet our expected cash requirements for the
immediate future, we may need to raise additional funds through public or private debt or equity
financings in order to:  
    take advantage of unanticipated opportunities, including more rapid international
expansion or acquisitions of complementary businesses or technologies;
    develop new products or services;
    repay outstanding indebtedness; and/or
    respond to unanticipated competitive pressures. Any additional financing we may need may not be available on terms favorable to us, or at all. If
adequate funds are not available or are not available on acceptable terms, we may not be able to
take advantage of business opportunities, develop new products or services or otherwise respond to
unanticipated competitive pressures. In any such case, our business, results of operations and
financial condition could be materially adversely affected. In fiscal 2004, we completed a $517.5 million private placement of 0.25 percent contingent
convertible subordinated notes due 2023. During the three months ended September 26, 2004, we
repurchased and cancelled $153.0 million in face value of these 0.25 percent notes, leaving
approximately $364.5 million still outstanding as of March 27, 2005. The holders of our 0.25
percent notes may require us to purchase the notes for cash as early as December 2006. If we have
insufficient liquidity and capital resources to repay the principal amounts of our outstanding
convertible notes and the notes offered hereby when due, we may be forced to raise additional funds
through public or private debt or equity financings, which may not be available on favorable terms,
if at all. If such financings were not available on favorable terms, our business, results of
operations and financial condition could be materially adversely affected. On April 28, 2005, we bought back approximately $47.0 million face value of our convertible
subordinated notes at a discount to face value at an aggregate redemption price of $43.6 million.
The repurchased notes were cancelled. Currently, no more convertible subordinated notes remain
authorized for repurchase by our Board of Directors, however, our Board may authorize future
additional purchases from time to time based on future market conditions. Conversion of our outstanding notes would dilute the ownership interest of existing stockholders. The conversion of our notes into shares of our common stock would dilute the ownership interests of
existing stockholders. Any sales in the public market of the common stock issuable upon conversion
of the notes could adversely affect prevailing market prices of our common stock. In addition, the
existence of the notes may encourage short selling by market participants due to this dilution or
to facilitate trading strategies involving notes and common stock. See the Risk Factor Changes in
laws, regulations and financial accounting standards may affect our reported results of operations
above. 35




---



##### Table of Contents



Item 3.   Quantitative and Qualitative Disclosures about Market Risk Interest Rate Sensitivity At March 27, 2005, our investment portfolio of $459.0 million consisted primarily of fixed income
securities, excluding those classified as cash and cash equivalents. We have the positive intent
and ability to hold these securities to maturity. Currently, the carrying amount of these
securities approximates fair market value. However, the fair market value of these securities is
subject to interest rate risk and would decline in value if market interest rates increased. If
market interest rates were to increase immediately and uniformly by 10 percent from the levels
existing as of March 27, 2005, the decline in the fair value of the portfolio would not be material
to our financial position, results of operations and cash flows. However, if interest rates
decreased and securities within our portfolio matured and were re-invested in securities with lower
interest rates, interest income would decrease in the future. As of March 27, 2005, we had $364.5 million face value 0.25 percent contingent convertible
subordinated notes issued and outstanding. The fair value, based on quoted market prices, of our
0.25 percent contigent convertible subordinated notes at March 27, 2005, was $339.0 million. The
fair value of these notes may increase or decrease due to various factors, including fluctuations
in the market price of our common stock, fluctuations in market interest rates and fluctuations in
general economic conditions. Foreign Currency We have executed and will continue to execute transactions in foreign currencies. As a result, we
may be exposed to financial market risk resulting from fluctuations in foreign currency rates,
particularly the British Pound and the Euro. Given the relatively small number of foreign
currency transactions, we do not believe that our potential exposure to fluctuations in foreign
currency rates is significant. 
 Item 4.   Controls and Procedures We maintain disclosure controls and procedures designed to ensure that we are able to collect the
information we are required to disclose in the reports we file with the Securities and Exchange
Commission, or SEC, and to process, summarize and disclose this information within the time periods
specified in the rules of the SEC. Based on their evaluation of our disclosure controls and
procedures, our management, with the participation of the Chief Executive and Chief Financial
Officers, has concluded that, as of the end of the period covered by this Quarterly Report on Form
10-Q, these disclosure controls and procedures were effective to ensure that we are able to record,
process, summarize and report the information we are required to disclose in the reports we file
with the SEC within the required time periods. There were no changes in our internal controls over financial reporting that occurred during the
period covered by this Quarterly Report on Form 10-Q that have materially affected, or are
reasonably likely to materially affect, our internal control over financial reporting. 36




---



##### Table of Contents



PART II:   OTHER INFORMATION 
 Item 1.   Legal Proceedings Litigation On May 23, 2003, Vixel filed a patent infringement action against Brocade Communications Systems,
Inc. in the United States District Court for the Northern District of California, Civil Action No.
C-030-02446. The complaint states that Brocade is infringing U.S. Patent No. 6,185,203, entitled
Fibre Channel Switching Fabric, U.S. Patent No. 6,118,776, entitled Methods and Apparatus for
Fibre Channel Interconnection of Private Loop Devices, and U.S. Patent No. 6,470,007, entitled
Interconnect System for Fibre Channel Arbitrated Loop Including Private Loop Devices, through
the unauthorized manufacture, use, sale and offering for sale of various storage area network
switching products, including but not limited to, Brocades Silkworm switch products. Brocade
denied infringement and challenged the validity of the patents referenced. Brocade also
challenged the enforceability of those patents. In the suit against Brocade, Vixel was seeking
unspecified past damages, potential future royalties, or, alternatively, injunctive relief. On September 24, 2004, Emulex Corporation and Brocade Communications Systems, Inc. entered into a
settlement including a litigation standstill agreement whereby Emulex and Brocade agreed to
dismiss without prejudice their claims and counterclaims against each other in the pending patent
infringement case in the United States District Court for the Northern District of California
entitled Vixel Corporation. v. Brocade Communications Systems, Inc., Civil Action No. C-030-02446.
The settlement included the formation of a strategic relationship under which the parties are to
work together to pursue mutual objectives. Under the litigation standstill agreement both parties
preserved their respective rights, no restrictions of any kind were imposed on either partys
ability to sell products, no licenses were granted by either party, no money was exchanged, and
they agreed to a three year standstill during which neither party may initiate litigation against
the other party with respect to certain of their respective patents. On November 15, 2001, prior to the Companys acquisition of Vixel Corporation, a securities class
action was filed in the United States District Court in the Southern District of New York as Case
No. 01 CIV. 10053(SAS), Master File No. 21 MC92 (SAS) against Vixel and two of its officers and
directors and certain underwriters who participated in the Vixel initial public offering in late
1999. The amended complaint alleges violations under Section 10(b) of the Exchange Act and
Section 11 of the Securities Act and seeks unspecified damages on behalf of persons who purchased
Vixel stock during the period October 1, 1999 through December 6, 2000. In October 2002, the
parties agreed to toll the statute of limitations with respect to Vixels officers and directors
until September 30, 2003, and on the basis of this agreement, Vixels officers and directors were
dismissed from the lawsuit without prejudice. During June 2003, Vixel and the other issuer
defendants in the action reached a tentative settlement with the plaintiffs that would, among
other things, result in the dismissal with prejudice of all claims against the defendants and
their officers and directors. In connection with the possible settlement, those officers and
directors who had entered tolling agreements with the plaintiffs agreed to extend those agreements
so that they would not expire prior to any settlement being finalized. Although Vixel approved
this settlement proposal in principle, it remains subject to a number of procedural conditions, as
well as formal approval by the court. On October 9, 2003, before the Companys acquisition of Vixel, a purported class action lawsuit
was filed in King County Superior Court of the State of Washington against Vixel and each of
Vixels directors and certain unnamed individuals (the Vixel Parties), entitled Russell Fink v.
Vixel Corporation, et al., Case No. 03-2-37226-9SEA. The complaint made general allegations that,
among other things, Vixels directors breached their fiduciary duties to Vixel stockholders in
connection with the approval of the merger with Emulex and sought to enjoin the tender offer and
have the merger agreement declared unlawful, among other forms of relief. On November 7, 2003, the
Vixel Parties entered into a memorandum of understanding for a $0.7 million settlement with the
plaintiff in the class action suit pursuant to which the parties have agreed to settle the action,
subject to court approval. The $0.7 million was recorded as general and administrative expense
during the three months ended December 28, 2003. Formal settlement documents were signed on May
5, 2004 and the plaintiff has completed discovery as agreed to by the parties. In August 2004,
final court approval was obtained for the settlement of the Fink v. Vixel litigation, and the
Company paid the $0.7 million settlement. During the three months ended December 26, 2004, the
Company received a $0.3 million reimbursement from its insurer relating to the Fink v. Vixel
litigation. Beginning on or about February 20, 2001, the Company and certain of its officers and directors
were named as defendants in a number of securities class action lawsuits filed in the United
States District Court, Central District of California, Case No. SACV-01-219 GLT (ANx). The
plaintiffs in the actions represent purchasers of the 37




---



##### Table of Contents



Companys common stock during various periods ranging from January 18, 2001, through February 9,
2001. The complaints alleged that the Company and certain of its officers and directors made
misrepresentations and omissions in violation of sections 10(b) and 20(a) of the Securities
Exchange Act of 1934, as amended. The complaints generally seek compensatory damages, costs and
attorneys fees in an unspecified amount. In addition, the Company has received inquiries about
events giving rise to the lawsuits from the SEC and the Nasdaq Stock Market. On April 22, 2003,
the Company entered into two Memoranda of Understanding agreeing to terms of settlement for both
the class action and derivative litigation. The settlement was approved and $39.5 million held in
escrow was paid by the Company into the settlement fund during the nine months ended March 28,
2004. Gateway Partners filed a challenge to the allocation of settlement funds, among the
plaintiffs and adequacy of the settlement notice, and the district court ruled against such
challenge on November 23, 2004. On December 13, 2004, Gateway Partners filed an appeal and a
motion to stop distribution from the settlement fund; both of which were filed with the United
States Court of Appeals for the Ninth Circuit (Index No. 04-57123). On January 12, 2005,
attorneys for Gateway Partners sent a letter to the appeals court stating that a stipulation would
be filed confirming that no proceeds of the settlement fund would be distributed until the appeal
is resolved, and that Gateway Partners would not have to post a bond. Related to the Companys insurance coverage and derivative lawsuits settled in 2003, during the
three months ended March 28, 2004, the Company reached an agreement with one of its insurers,
under which the Company received $10.0 million less $2.0 million previously paid by the insurer
for the defense of the securities class action lawsuits, resulting in a net payment to the Company
of $8.0 million. In July 2004, the Company obtained an arbitration award against two of its
insurers, and subsequently collected a total of $9.5 million plus $0.3 million in interest. As
the amounts received exceeded the $5.1 million receivable reflected on the Companys books, the
Company recorded a reduction in general and administrative expenses during the three months ended
September 26, 2004, of $4.4 million, as well as interest income of $0.3 million. Ongoing lawsuits present inherent risks, any of which could have a material adverse effect on the
Companys business, financial condition or results of operations. Such potential risks include
the continuing expenses of litigation, counterclaims and attorneys fee liability. Additionally, the Company is involved in various claims and legal actions arising in the ordinary
course of business. In the opinion of management, the ultimate disposition of these matters will
not have a material adverse effect on the Companys consolidated financial position, results of
operations or liquidity. 
 Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds We did not repurchase any equity securities during the nine months ended March 27, 2005. In
September 2001, our Board of Directors authorized the repurchase of up to four million shares of
our common stock. The repurchase plan authorized us to make purchases in the open market or
through privately negotiated transactions with the timing and terms of any purchase to be
determined by management based on market conditions. As of March 27, 2005, a total of 2.5 million
shares had been repurchased and 1.5 million shares remain available for repurchase. 38




---



##### Table of Contents



Item 6.   Exhibits Exhibit 3.1
    
    Certificate of Incorporation, as amended (incorporated by reference to Exhibit
3.1 to the Companys 1997 Annual Report on Form 10-K).Exhibit 3.2
    
    Certificate of Amendment of Certificate of Incorporation of the Company
(incorporated by reference to Exhibit 3.4 to the Companys Quarterly Report on Form
10-Q for the quarterly period ended December 31, 2000).Exhibit 3.3
    
    Bylaws of the Company, as amended (incorporated by reference to Exhibit 3.3 to
the Companys quarterly report on form 10-Q for the quarterly period ended September
29, 2002).Exhibit 3.4
    
    Amendment to Bylaws of the Company adopted by the Board of Directors on March 2,
2001 (incorporated by reference to Exhibit 3.4 to the Companys 2002 Annual Report on
Form 10-K).Exhibit 3.5
    
    Certificate of Designations of Series A Junior Participating Preferred Stock
(incorporated by reference to Exhibit 4 to the Companys Current Report on Form 8-K
filed February 2, 1989).Exhibit 4.1
    
    Rights Agreement dated January 19, 1989, as amended (incorporated by reference
to Exhibit 4 to the Companys Current Report on Form 8-K filed February 2, 1989).Exhibit 4.2
    
    Certificate regarding extension of Final Expiration Date of Rights Agreement
dated January 18, 1999 (incorporated by reference to Exhibit 4.2 of Amendment No. 2 to
the Registration Statement on Form S-3, filed on May 17, 1999).Exhibit 4.3
    
    Form of 1.75% Convertible Subordinated Note due February 1, 2007 (incorporated
by reference to Exhibit 4.8 to the Registration Statement on Form S-3, amended on June 28, 2002).Exhibit 4.4
    
    Indenture between the Company, as Issuer, and State Street Bank and Trust
Company of California, N.A., as Trustee, dated January 29, 2002, related to the
Companys 1.75% Convertible Subordinated Notes due February 1, 2007 (incorporated by
reference to Exhibit 4.9 to the Registration Statement on Form S-3, amended on June 28, 2002).Exhibit 4.5
    
    Registration Rights Agreement between the Company and Credit Suisse First Boston
Corporation dated January 29, 2002, related to the Companys 1.75% Convertible
Subordinated Notes due February 1, 2007 (incorporated by reference to Exhibit 4.10 to
the Registration Statement on Form S-3, amended on June 28, 2002).Exhibit 4.6
    
    Form of 0.25% Convertible Subordinated Note due 2023 (incorporated by reference
to Exhibit 4.6 to the Companys Quarterly Report on Form 10-Q for the quarterly period
ended December 28, 2003).Exhibit 4.7
    
    Indenture between the Company, as Issuer, and State Street Bank and Trust
Company of California, N.A., as Trustee, dated December 12, 2003, related to the
Companys 0.25% Convertible Subordinated Notes due 2023 (incorporated by reference to
Exhibit 4.7 to the Companys Quarterly Report on Form 10-Q for the quarterly period
ended December 28, 2003).Exhibit 4.8
    
    Registration Rights Agreement between the Company and Credit Suisse First Boston
Corporation dated December 12, 2003, related to the Companys 0.25% Convertible
Subordinated Notes due 2023 (incorporated by reference to Exhibit 4.8 to the Companys
Quarterly Report on Form 10-Q for the quarterly period ended December 28, 2003).Exhibit 10.1
    
    Emulex Corporation 1997 Stock Option Plan for Non-Employee Directors, as
amended (incorporated by reference to Appendix C to the Companys Definitive Proxy
Statement for its Annual Meeting of Stockholders held on November 18, 2004).
 39




---



##### Table of Contents



Exhibit 10.2
    
    Emulex Corporation Employee Stock Purchase Plan, as amended (incorporated by
reference to Appendix D to the Companys Definitive Proxy Statement for its Annual
Meeting of Stockholders held on November 18, 2004).Exhibit 10.3
    
    Vixel Corporation Amended and Restated 1995 Stock Option Plan (incorporated by
reference to Exhibit 10.2 of Amendment No. 1 to the Registration Statement on Form S-1
of Vixel Corporation (File No. 333-81347), filed on August 16, 1999).Exhibit 10.4
    
    Vixel Corporation 1999 Equity Incentive Plan (as amended) (incorporated by
reference to Exhibit 10.23 of Amendment No. 1 to the Registration Statement on Form S-1
of Vixel Corporation (File No. 333-81347), filed on August 16, 1999).Exhibit 10.5
    
    Vixel Corporation 2000 Non-Officer Equity Incentive Plan (incorporate reference
to Exhibit 99.1 of the Registration Statement on Form S-8/S-3 of Vixel Corporation
(File No. 333-39000), filed on June 9, 2000).Exhibit 10.6
    
    Emulex Corporation 2004 Employee Stock Incentive Plan (incorporated by
reference to Appendix B to the Companys Definitive Proxy Statement for its Annual
Meeting of Stockholders held on November 18, 2004).Exhibit 10.7
    
    Key Employee Retention Agreement with Paul F. Folino (incorporated by reference
to Exhibit 10.7 to the Companys Quarterly Report on Form 10-Q for the quarterly period
ended December 26, 2004 filed on February 4, 2005).Exhibit 10.8
    
    Form of Key Employee Retention Agreement to which the following executive
officers of the Company are a party: James M. McCluney, Kirk D. Roller, William F.
Gill, Sadie A. Herrera, Marshall D. Lee, Karen Mulvany, Michael J. Rockenbach and
Michael E. Smith (incorporated by reference to Exhibit 10.8 to the Companys Quarterly
Report on Form 10-Q for the quarterly period ended December 26, 2004 filed on February 4, 2005).Exhibit 31A
    
    Certification of the Principal Executive Officer Pursuant to 17 CFR
240.13a-14(a), as Adopted Pursuant to § 302 of the Sarbanes-Oxley Act of 2002.Exhibit 31B
    
    Certification of the Principal Financial Officer Pursuant to 17 CFR
240.13a-14(a), as Adopted Pursuant to § 302 of the Sarbanes-Oxley Act of 2002.Exhibit 32
    
    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to § 906 of
the Sarbanes-Oxley Act of 2002.
 40




---



##### Table of Contents



SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized. Date: May 6, 2005 EMULEX CORPORATIONBy:
    
    /s/  Paul F. FolinoPaul F. Folino
Chairman of the Board and Chief Executive OfficerBy:
    
    /s/  Michael J. RockenbachMichael J. Rockenbach
Executive Vice President and
Chief Financial Officer
(Principal Financial and Chief Accounting Officer)
 41




---



##### Table of Contents



EXHIBIT INDEX Exhibit 3.1
    
    Certificate of Incorporation, as amended (incorporated by reference to Exhibit
3.1 to the Companys 1997 Annual Report on Form 10-K).Exhibit 3.2
    
    Certificate of Amendment of Certificate of Incorporation of the Company
(incorporated by reference to Exhibit 3.4 to the Companys Quarterly Report on Form
10-Q for the quarterly period ended December 31, 2000).Exhibit 3.3
    
    Bylaws of the Company, as amended (incorporated by reference to Exhibit 3.3 to
the Companys quarterly report on form 10-Q for the quarterly period ended September
29, 2002).Exhibit 3.4
    
    Amendment to Bylaws of the Company adopted by the Board of Directors on March 2,
2001 (incorporated by reference to Exhibit 3.4 to the Companys 2002 Annual Report on
Form 10-K).Exhibit 3.5
    
    Certificate of Designations of Series A Junior Participating Preferred Stock
(incorporated by reference to Exhibit 4 to the Companys Current Report on Form 8-K
filed February 2, 1989).Exhibit 4.1
    
    Rights Agreement dated January 19, 1989, as amended (incorporated by reference
to Exhibit 4 to the Companys Current Report on Form 8-K filed February 2, 1989).Exhibit 4.2
    
    Certificate regarding extension of Final Expiration Date of Rights Agreement
dated January 18, 1999 (incorporated by reference to Exhibit 4.2 of Amendment No. 2 to
the Registration Statement on Form S-3, filed on May 17, 1999).Exhibit 4.3
    
    Form of 1.75% Convertible Subordinated Note due February 1, 2007 (incorporated
by reference to Exhibit 4.8 to the Registration Statement on Form S-3, amended on June 28, 2002).Exhibit 4.4
    
    Indenture between the Company, as Issuer, and State Street Bank and Trust
Company of California, N.A., as Trustee, dated January 29, 2002, related to the
Companys 1.75% Convertible Subordinated Notes due February 1, 2007 (incorporated by
reference to Exhibit 4.9 to the Registration Statement on Form S-3, amended on June 28, 2002).Exhibit 4.5
    
    Registration Rights Agreement between the Company and Credit Suisse First Boston
Corporation dated January 29, 2002, related to the Companys 1.75% Convertible
Subordinated Notes due February 1, 2007 (incorporated by reference to Exhibit 4.10 to
the Registration Statement on Form S-3, amended on June 28, 2002).Exhibit 4.6
    
    Form of 0.25% Convertible Subordinated Note due 2023 (incorporated by reference
to Exhibit 4.6 to the Companys Quarterly Report on Form 10-Q for the quarterly period
ended December 28, 2003).Exhibit 4.7
    
    Indenture between the Company, as Issuer, and State Street Bank and Trust
Company of California, N.A., as Trustee, dated December 12, 2003, related to the
Companys 0.25% Convertible Subordinated Notes due 2023 (incorporated by reference to
Exhibit 4.7 to the Companys Quarterly Report on Form 10-Q for the quarterly period
ended December 28, 2003).Exhibit 4.8
    
    Registration Rights Agreement between the Company and Credit Suisse First Boston
Corporation dated December 12, 2003, related to the Companys 0.25% Convertible
Subordinated Notes due 2023 (incorporated by reference to Exhibit 4.8 to the Companys
Quarterly Report on Form 10-Q for the quarterly period ended December 28, 2003).Exhibit 10.1
    
    Emulex Corporation 1997 Stock Option Plan for Non-Employee Directors, as
amended (incorporated by reference to Appendix C to the Companys Definitive Proxy
Statement for its Annual Meeting of Stockholders held on November 18, 2004).




---



##### Table of Contents



Exhibit 10.2
    
    Emulex Corporation Employee Stock Purchase Plan, as amended (incorporated by
reference to Appendix D to the Companys Definitive Proxy Statement for its Annual
Meeting of Stockholders held on November 18, 2004).Exhibit 10.3
    
    Vixel Corporation Amended and Restated 1995 Stock Option Plan (incorporated by
reference to Exhibit 10.2 of Amendment No. 1 to the Registration Statement on Form S-1
of Vixel Corporation (File No. 333-81347), filed on August 16, 1999).Exhibit 10.4
    
    Vixel Corporation 1999 Equity Incentive Plan (as amended) (incorporated by
reference to Exhibit 10.23 of Amendment No. 1 to the Registration Statement on Form S-1
of Vixel Corporation (File No. 333-81347), filed on August 16, 1999).Exhibit 10.5
    
    Vixel Corporation 2000 Non-Officer Equity Incentive Plan (incorporate reference
to Exhibit 99.1 of the Registration Statement on Form S-8/S-3 of Vixel Corporation
(File No. 333-39000), filed on June 9, 2000).Exhibit 10.6
    
    Emulex Corporation 2004 Employee Stock Incentive Plan (incorporated by
reference to Appendix B to the Companys Definitive Proxy Statement for its Annual
Meeting of Stockholders held on November 18, 2004).Exhibit 10.7
    
    Key Employee Retention Agreement with Paul F. Folino (incorporated by reference
to Exhibit 10.7 to the Companys Quarterly Report on Form 10-Q for the quarterly period
ended December 26, 2004 filed on February 4, 2005).Exhibit 10.8
    
    Form of Key Employee Retention Agreement to which the following executive
officers of the Company are a party: James M. McCluney, Kirk D. Roller, William F.
Gill, Sadie A. Herrera, Marshall D. Lee, Karen Mulvany, Michael J. Rockenbach and
Michael E. Smith (incorporated by reference to Exhibit 10.8 to the Companys Quarterly
Report on Form 10-Q for the quarterly period ended December 26, 2004 filed on February 4, 2005).Exhibit 31A
    
    Certification of the Principal Executive Officer Pursuant to 17 CFR
240.13a-14(a), as Adopted Pursuant to § 302 of the Sarbanes-Oxley Act of 2002.Exhibit 31B
    
    Certification of the Principal Financial Officer Pursuant to 17 CFR
240.13a-14(a), as Adopted Pursuant to § 302 of the Sarbanes-Oxley Act of 2002.Exhibit 32
    
    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to § 906 of
the Sarbanes-Oxley Act of 2002.