**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

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**FORM 10-Q**

**(Mark One)**

**x**                              Quarterlyreport pursuant to Section 13 or 15(d) of the Securities Exchange Actof 1934

**Forthe quarterly period ended September 30, 2005**

**or**

** ̈**                                 Transitionreport pursuant to Section 13 or 15(d) of the Securities Exchange Actof 1934

**Forthe transition period from                     to                    **

**Commissionfile number 0-15071**

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**ADAPTEC, INC.**

(Exact name of registrantas specified in its charter)

| **DELAWARE**                                    | **94-2748530**       |
|-------------------------------------------------|----------------------|
| (State or other  jurisdiction of                | (I.R.S. Employer     |
| incorporation or  organization)                 | Identification  No.) |
| **691 S. MILPITAS BLVD., MILPITAS, CALIFORNIA** | **95035**            |
| (Address of  principal executive offices)       | (Zip Code)           |

 

Registrant’s telephonenumber, including area code **(408) 945-8600**

**N/A**

(Former name, formeraddress and former fiscal year, if changed since last report)

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Indicateby check mark whether the registrant: (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.

Yes xNo  ̈

Indicateby check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act)

Yes xNo  ̈

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).

Yes  ̈No x

Thenumber of shares of Adaptec’s common stock outstanding as of November 2,2005 was 113,376,831.

 

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**TABLEOF CONTENTS**

|               | ** **             | ** **                                                                                  | **Page** |
|---------------|------------------------|---------------------------------------------------------------------------------------------|----------|
| Part I.  | Financial  Information |                                                                                        |
|          | Item 1.                | Financial  Statements:                                                                      |     |
|          |                   | Unaudited  Condensed Consolidated Statements of Operations                                  | 3        |
|          |                   | Unaudited  Condensed Consolidated Balance Sheets                                            | 4        |
|          |                   | Unaudited  Condensed Consolidated Statements of Cash Flows                                  | 5        |
|          |                   | Notes  to Unaudited Condensed Consolidated Financial Statements                             | 6        |
|          | Item  2.               | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 26       |
|          | Item  3.               | Quantitative  and Qualitative Disclosures About Market Risk                                 | 51       |
|          | Item  4.               | Controls  and Procedures                                                                    | 51       |
| Part II. | Other  Information     |                                                                                        |
|          | Item  4.               | Submission  of Matters to a Vote of Security Holders                                        | 52       |
|          | Item 6.                | Exhibits                                                                                    | 52       |
|          | Signature              | 53                                                                                          |
|               |                        |                                                                                             |          |  |

 

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**PART I. FINANCIAL INFORMATION**

**Item 1.**                        FinancialStatements

**ADAPTEC, INC.CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS(unaudited)**

| ** **                                                        | ** ** | **Three-Month Period Ended**                                | ** ** | **Six-Month Period Ended** | ** ** |
|-------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                        | ** ** | **September 30,  2005**                                          | ** ** | **September 30,  2004**         | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
| ** **                                                        | ** ** | **(in thousands, except per share amounts)** | ** ** |
| Net revenues                                                      |       |                                                                  | $          | 83,234                               |       |   |   | $ | 99,752 |   |   |   | $ | 155,749 |   |   |   | $ | 198,609 |   |   |
| Cost of revenues                                                  |       |                                                                  | 54,315     |                                 |       |   | 53,145 |   |   |   | 103,525 |   |   |   | 104,992 |   |   |
| Gross profit                                                      |       |                                                                  | 28,919     |                                 |       |   | 46,607 |   |   |   | 52,224 |   |   |   | 93,617 |   |   |
| Operating expenses:                                               |       |                                                                  |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Research and development                                          |       |                                                                  | 15,680     |                                 |       |   | 22,336 |   |   |   | 31,856 |   |   |   | 46,127 |   |   |
| Selling, marketing and  administrative                            |       |                                                                  | 16,273     |                                 |       |   | 20,153 |   |   |   | 33,555 |   |   |   | 37,248 |   |   |
| Amortization of  acquisition-related intangible assets            |       |                                                                  | 1,761      |                                 |       |   | 2,392 |   |   |   | 3,777 |   |   |   | 4,888 |   |   |
| Restructuring charges                                             |       |                                                                  | 478        |                                 |       |   | 1,928 |   |   |   | 518 |   |   |   | 2,747 |   |   |
| Goodwill impairment                                               |       |                                                                  | 90,602     |                                 |       |   | — |   |   |   | 90,602 |   |   |   | — |   |   |
| Total operating expenses                                          |       |                                                                  | 124,794    |                                 |       |   | 46,809 |   |   |   | 160,308 |   |   |   | 91,010 |   |   |
| Income (loss) from  continuing operations                         |       |                                                                  | (95,875    | )                                    |       |   | (202 | ) |   |   | (108,084 | ) |   |   | 2,607 |   |   |
| Interest and other  income                                        |       |                                                                  | 4,523      |                                 |       |   | 3,659 |   |   |   | 8,131 |   |   |   | 5,502 |   |   |
| Interest expense                                                  |       |                                                                  | (868       | )                                    |       |   | (1,145 | ) |   |   | (1,840 | ) |   |   | (2,267 | ) |   |
| Income (loss) from  continuing operations before income taxes     |       |                                                                  | (92,220    | )                                    |       |   | 2,312 |   |   |   | (101,793 | ) |   |   | 5,842 |   |   |
| Provision for (benefit  from) income taxes                        |       |                                                                  | 2,557      |                                 |       |   | (10,443 | ) |   |   | 3,445 |   |   |   | (9,345 | ) |   |
| Income (loss) from  continuing operations                         |       |                                                                  | (94,777    | )                                    |       |   | 12,755 |   |   |   | (105,238 | ) |   |   | 15,187 |   |   |
| Discontinued operations,  net of taxes (Note 4)              |       |                                                                  |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loss from discontinued  operations, net of taxes             |       |                                                                  | (4,053     | )                                    |       |   | (20,818 | ) |   |   | (29,565 | ) |   |   | (23,240 | ) |   |
| Loss from disposal of  discontinued operations, net of taxes |       |                                                                  | (6,976     | )                                    |       |   | — |   |   |   | (6,976 | ) |   |   | — |   |   |
| Loss from discontinued  operations                                |       |                                                                  | (11,029    | )                                    |       |   | (20,818 | ) |   |   | (36,541 | ) |   |   | (23,240 | ) |   |
| Net loss                                                          |       |                                                                  | $          | (105,806                             | )          |   |   | $ | (8,063 | ) |   |   | $ | (141,779 | ) |   |   | $ | (8,053 | ) |   |
| Net income (loss) per share:                                      |       |                                                                  |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                                             |       |                                                                  |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Continuing operations                                             |       |                                                                  | $          | (0.84                                | )          |   |   | $ | 0.12 |   |   |   | $ | (0.93 | ) |   |   | $ | 0.14 |   |   |
| Discontinued operations                                           |       |                                                                  | $          | (0.10                                | )          |   |   | $ | (0.19 | ) |   |   | $ | (0.32 | ) |   |   | $ | (0.21 | ) |   |
| Net loss                                                          |       |                                                                  | $          | (0.94                                | )          |   |   | $ | (0.07 | ) |   |   | $ | (1.26 | ) |   |   | $ | (0.07 | ) |   |
| Diluted                                                           |       |                                                                  |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Continuing operations                                             |       |                                                                  | $          | (0.84                                | )          |   |   | $ | 0.10 |   |   |   | $ | (0.93 | ) |   |   | $ | 0.12 |   |   |
| Discontinued operations                                           |       |                                                                  | $          | (0.10                                | )          |   |   | $ | (0.15 | ) |   |   | $ | (0.32 | ) |   |   | $ | (0.17 | ) |   |
| Net loss                                                          |       |                                                                  | $          | (0.94                                | )          |   |   | $ | (0.06 | ) |   |   | $ | (1.26 | ) |   |   | $ | (0.05 | ) |   |
| Shares used in computing net income (loss) per  share:            |       |                                                                  |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                                             |       |                                                                  | 112,965    |                                 |       |   | 110,312 |   |   |   | 112,705 |   |   |   | 110,076 |   |   |
| Diluted                                                           |       |                                                                  | 112,965    |                                 |       |   | 134,140 |   |   |   | 112,705 |   |   |   | 131,302 |   |   |

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

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**ADAPTEC, INC.CONDENSED CONSOLIDATED BALANCE SHEETS(unaudited)**

| ** **                                                   | ** ** | **September 30, 2005** | ** ** | **March 31, 2005** | ** ** |
|--------------------------------------------------------------|------------|----------------------------------|------------|------------------------------|------------|
| ** **                                                   | ** ** | **(in thousands)**          | ** ** |
| **Assets**                                                   |       |                             |       |                         |       |   |   |   |   |
| Current assets:                                              |       |                             |       |                         |       |   |   |   |   |
| Cash and cash equivalents                                    |       |                             | $          | 79,025                       |       |   |   | $ | 441,588 |   |   |
| Marketable securities                                        |       |                             | 409,951    |                         |       |   | 84,968 |   |   |
| Restricted cash and marketable securities                    |       |                             | 1,665      |                         |       |   | 1,766 |   |   |
| Accounts receivable, net                                     |       |                             | 74,121     |                         |       |   | 70,159 |   |   |
| Inventories                                                  |       |                             | 33,119     |                         |       |   | 60,204 |   |   |
| Prepaid expenses and other current assets                    |       |                             | 33,493     |                         |       |   | 26,081 |   |   |
| Current assets of discontinued operations                    |       |                             | 10,626     |                         |       |   | — |   |   |
| Total current assets                                         |       |                             | 642,000    |                         |       |   | 684,766 |   |   |
| Property and  equipment, net                                 |       |                             | 47,045     |                         |       |   | 56,180 |   |   |
| Restricted  marketable securities, less current portion      |       |                             | 3,870      |                         |       |   | 4,615 |   |   |
| Goodwill                                                     |       |                             | —     |                         |       |   | 91,486 |   |   |
| Other intangible  assets, net                                |       |                             | 25,064     |                         |       |   | 79,457 |   |   |
| Other long-term  assets                                      |       |                             | 10,293     |                         |       |   | 47,002 |   |   |
| Long-term  assets of discontinued operations                 |       |                             | 26,671     |                         |       |   | — |   |   |
| Total assets                                                 |       |                             | $          | 754,943                      |       |   |   | $ | 963,506 |   |   |
| **Liabilities  and Stockholders’ Equity**               |       |                             |       |                         |       |   |   |   |   |
| Current liabilities:                                         |       |                             |       |                         |       |   |   |   |   |
| Accounts payable                                             |       |                             | $          | 52,702                       |       |   |   | $ | 61,637 |   |   |
| Accrued liabilities                                          |       |                             | 86,374     |                         |       |   | 116,007 |   |   |
| Current liabilities of discontinued operations               |       |                             | 4,554      |                         |       |   | — |   |   |
| Total current liabilities                                    |       |                             | 143,630    |                         |       |   | 177,644 |   |   |
| 3⁄4% Convertible  Senior Subordinated Notes               |       |                             | 225,000    |                         |       |   | 225,000 |   |   |
| 3% Convertible  Subordinated Notes                           |       |                             | 11,992     |                         |       |   | 35,190 |   |   |
| Other long-term  liabilities                                 |       |                             | 3,692      |                         |       |   | 15,349 |   |   |
| Commitments and  contingencies (Note 12)                     |       |                             |       |                         |       |   |   |   |   |
| Stockholders’ equity:                                   |       |                             |       |                         |       |   |   |   |   |
| Common stock                                                 |       |                             | 113        |                         |       |   | 112 |   |   |
| Additional paid-in capital                                   |       |                             | 167,846    |                         |       |   | 165,707 |   |   |
| Deferred stock-based compensation                            |       |                             | (699       | )                            |       |   | (2,416 | ) |   |
| Accumulated other comprehensive income (loss), net  of taxes |       |                             | (1,066     | )                            |       |   | 706 |   |   |
| Retained earnings                                            |       |                             | 204,435    |                         |       |   | 346,214 |   |   |
| Total stockholders’ equity                              |       |                             | 370,629    |                         |       |   | 510,323 |   |   |
| Total liabilities and  stockholders’ equity             |       |                             | $          | 754,943                      |       |   |   | $ | 963,506 |   |   |

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

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**ADAPTEC, INC.CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(unaudited)**

| ** **                                                                                                         | ** ** | **Six-Month Period Ended** | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                                         | ** ** | **September 30, 2005**     | ** ** | **September 30, 2004** | ** ** |
| ** **                                                                                                         | ** ** | **(in thousands)**              | ** ** |
| **Cash Flows From Operating Activities:**                                                                          |       |                                 |       |   |   |   |   |   |   |
| Net income (loss) from  continuing operations                                                                      |       |                                 | $          | (105,238 | ) |   |   | $ | 15,187 |   |   |
| Adjustments to reconcile loss from continuing  operations to net cash provided by (used for) operating activities: |       |                                 |       |   |   |   |   |   |   |
| Non-cash restructuring  charges                                                                                    |       |                                 | —     |   |   |   | 109 |   |   |
| Impairment of goodwill                                                                                             |       |                                 | 90,602     |   |   |   | — |   |   |
| Stock-based compensation                                                                                           |       |                                 | 264        |   |   |   | 1,519 |   |   |
| Non-cash effect of tax  settlement                                                                                 |       |                                 | —     |   |   |   | (4,068 | ) |   |
| Loss on extinguishment  of debt                                                                                    |       |                                 | 102        |   |   |   | — |   |   |
| Depreciation and  amortization                                                                                     |       |                                 | 13,044     |   |   |   | 19,037 |   |   |
| Deferred income taxes                                                                                              |       |                                 | —     |   |   |   | 31 |   |   |
| Other non-cash items                                                                                               |       |                                 | (129       | ) |   |   | 104 |   |   |
| Changes in assets and  liabilities (net of acquired businesses)                                                    |       |                                 | (15,050    | ) |   |   | (18,442 | ) |   |
| **Net Cash Provided by (Used for)  Operating Activities of Continuing Operations**                                 |       |                                 | (16,405    | ) |   |   | 13,477 |   |   |
| **Net Cash Provided by (Used for)  Operating Activities of Discontinued Operations**                               |       |                                 | 5,080      |   |   |   | (13,466 | ) |   |
| **Net Cash Provided by (Used for)  Operating Activities**                                                          |       |                                 | $          | (11,325 | ) |   |   | $ | 11 |   |   |
| **Cash Flows From Investing Activities:**                                                                          |       |                                 |       |   |   |   |   |   |   |
| Purchases of certain net  assets in connection with acquisitions, net of cash acquired                        |       |                                 | —     |   |   |   | (65,380 | ) |   |
| Maturities of restricted  marketable securities                                                                    |       |                                 | 844        |   |   |   | 1,369 |   |   |
| Purchases of property  and equipment                                                                               |       |                                 | (5,416     | ) |   |   | (6,486 | ) |   |
| Proceeds from the sale  of property and equipment                                                                  |       |                                 | 2,684      |   |   |   | — |   |   |
| Purchases of marketable  securities                                                                                |       |                                 | (438,060   | ) |   |   | (211,741 | ) |   |
| Sales of marketable  securities                                                                                    |       |                                 | 107,141    |   |   |   | 296,524 |   |   |
| Maturities of marketable  securities                                                                               |       |                                 | 4,511      |   |   |   | 42,777 |   |   |
| **Net Cash Provided by (Used for)  Investing Activities of Continuing Operations**                            |       |                                 | (328,296   | ) |   |   | 57,063 |   |   |
| **Net Cash Provided by (Used for)  Investing Activities of Discontinued Operations**                               |       |                                 | (1,655     | ) |   |   | (59,341 | ) |   |
| **Net Cash Provided by (Used for)  Investing Activities**                                                          |       |                                 | (329,951   | ) |   |   | (2,278 | ) |   |
| **Cash Flows From Financing Activities:**                                                                          |       |                                 |       |   |   |   |   |   |   |
| Repurchases and  redemption of long-term debt                                                                      |       |                                 | (22,988    | ) |   |   | — |   |   |
| Proceeds from issuance  of common stock                                                                            |       |                                 | 2,554      |   |   |   | 3,771 |   |   |
| **Net Cash Provided by (Used for)  Financing Activities**                                                          |       |                                 | (20,434    | ) |   |   | 3,771 |   |   |
| **Effect of Foreign Currency  Translation on Cash and Cash Equivalents**                                           |       |                                 | (853       | ) |   |   | (306 | ) |   |
| **Net Increase (Decrease) in Cash  and Cash Equivalents**                                                          |       |                                 | (362,563   | ) |   |   | 1,198 |   |   |
| **Cash and Cash Equivalents at  Beginning of Period**                                                              |       |                                 | 441,588    |   |   |   | 102,463 |   |   |
| **Cash and Cash Equivalents at End of Period**                                                                     |       |                                 | $          | 79,025 |   |   |   | $ | 103,661 |   |   |

 

See accompanying Notes to Unaudited Condensed Consolidated Financial Statements.

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**ADAPTEC, INC.NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(unaudited)**

**1.   Basis of Presentation**

In the opinion of management, the accompanyingUnaudited Condensed Consolidated Interim Financial Statements (“financialstatements”) of Adaptec, Inc. and its wholly-owned subsidiaries(collectively, the “Company”) have been prepared on a consistent basis with theMarch 31, 2005 audited consolidated financial statements and include alladjustments, consisting of only normal recurring adjustments, necessary tofairly state the information set forth therein. The financial statements havebeen prepared in accordance with the regulations of the SEC, and, therefore,omit certain information and footnote disclosure necessary to present thestatements in accordance with accounting principles generally accepted in theUnited States of America. These financial statements should be read inconjunction with the audited consolidated financial statements and notesthereto included in the Company’s Annual Report on Form 10-K for theyear ended March 31, 2005, which was filed with the SEC on June 14,2005. The second quarters of fiscal 2006 and 2005 ended September 30, 2005and October 1, 2004, respectively. For presentation purposes, theaccompanying financial statements have been shown as ending on September 30.The results of operations for the second quarter and first half of fiscal 2006are not necessarily indicative of the results to be expected for the entirefiscal year.

Certain reclassifications have been made to priorperiod reported amounts to conform to the current period presentation,including reclassification of auction rate securities from cash and cashequivalents to marketable securities. Previously, such auction rate securitieswere classified as cash and cash equivalents. Accordingly, the Company hasrevised its presentation and made adjustments to the accompanying UnauditedCondensed Consolidated Statement of Cash Flows to reflect the gross purchasesand sales of these auction rate securities as investing activities. Thisadjustment resulted in a net increase in cash used for investing activities by$13.8 million in the first half of fiscal 2005. This reclassification hadno impact on previously reported results of operations, operating cash flows orworking capital of the Company.

In addition, as discussed in Note 4, on September 30,2005, the Company completed the sale of its IBM i/p Series RAID componentbusiness (“IBM i/p Series RAID Business”) to International BusinessMachines (“IBM”) and on September 29, 2005 the Company’s Board ofDirectors approved management’s recommendation to divest its systems business. TheIBM i/p Series RAID Business sale and the planned divestiture of thesystems business have been accounted for as discontinued operations. Accordingly,the Company has reclassified the underlying Unaudited Condensed ConsolidatedStatements of Operations and Cash Flows and related disclosures for all periodspresented to reflect the IBM i/p Series RAID Business and the systemsbusiness as discontinued operations. Unless otherwise indicated and other thanbalance sheet amounts as of March 31, 2005, the Notes to the UnauditedCondensed Consolidated Financial Statements relate to the discussion of theCompany’s continuing operations. In addition, in the second quarter of fiscal2006, the Company reorganized its reportable segments. At September 30,2005 the Company’s reportable segments were DPS and DSG, which are describedmore fully in Note 14.

The net income (loss) per share and shares used incomputing net income (loss) per share for diluted discontinued operations, netloss and related disclosures for the second quarter and first half of fiscal2005 have been corrected from the amounts disclosed in the Form 8-Kfiled with the Securities and Exchange Commission on November 3, 2005.

The glossary of acronyms and accounting rules andregulations referred to within this Quarterly Report on Form 10-Q islisted in alphabetical order in Note 17.

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**2.   RecentAccounting Pronouncements**

In June 2005, the FASB issued SFAS No. 154,which changes the requirements for the accounting for, and reporting of, achange in accounting principle. Previously, most voluntary changes inaccounting principles were required to be recognized by way of a cumulativeeffect adjustment within net income during the period of the change. SFAS No. 154requires retrospective application to prior periods’ financial statements,unless it is impracticable to determine either the period-specific effects orthe cumulative effect of the change. SFAS No. 154 is effective foraccounting changes made in fiscal years beginning after December 15, 2005;however, the Statement does not change the transition provisions of anyexisting accounting pronouncements. The Company’s results of operations andfinancial condition will only be impacted following the adoption of SFAS No. 154if it implements changes in accounting principles that are addressed by thestandard or corrects accounting errors in future periods.

In December 2004, the FASB issued SFAS No. 123(R).This statement replaces SFAS No. 123, amends SFAS No. 95 andsupersedes APB Opinion No. 25. SFAS No. 123(R) requirescompanies to apply a fair-value based measurement method in accounting forshare-based payment transactions with employees and to record compensationexpense for all stock awards granted and to awards modified, repurchased orcancelled after the required effective date. In addition, the Company isrequired to record compensation expense (as previous awards continue to vest) forthe unvested portion of previously granted awards that remain outstanding atthe date of adoption. In April 2005, the SEC approved that SFAS No. 123(R) willbe effective for annual periods, as opposed to interim periods as originallyissued by the FASB, beginning after June 15, 2005. The Company iscurrently evaluating the impact of adopting this statement; however, theCompany expects that it will have a significant impact on the Company’sconsolidated financial statements. The impact on the Company’s consolidatedfinancial statements will depend on the transition method, the option-pricingmodel used to compute fair value and the inputs to that model such asvolatility and expected life. The pro forma disclosures of the impact of SFAS No. 123provided in Note 3 may not be representative of the impact of adoptingthis statement.

In March 2005, the SEC issued SAB 107, whichoffers guidance on SFAS No. 123(R). SAB 107 was issued to assist preparersby simplifying some of the implementation challenges of SFAS No. 123(R) whileenhancing the information that investors receive. SAB 107 creates a frameworkthat is premised on two overarching themes: (a) considerable judgment willbe required by preparers to successfully implement FAS No. 123(R),specifically when valuing employee stock options; and (b) reasonableindividuals, acting in good faith, may conclude differently on the fair valueof employee stock options. Key topics covered by SAB 107 include valuationmodels, expected volatility and expected term. The Company will apply theprinciples of SAB 107 in conjunction with its adoption of SFAS No. 123(R).

In November 2004, the FASB issued SFAS No. 151,which clarifies the accounting for abnormal amounts of facility expense,freight, handling costs and wasted materials (spoilage) to require them to berecognized as current-period charges. This statement is effective for inventorycosts incurred during fiscal years beginning after June 15, 2005. Earlierapplication is permitted. The adoption of this standard is not expected to havea material impact on the Company’s financial statements.

At its March 2004meeting, the EITF reached a consensus on recognition and measurement guidancepreviously discussed under EITF 03-01. The consensus clarified themeaning of other-than-temporary impairment and its application to investmentsclassified as either available-for-sale or held-to-maturity under SFAS No. 115and investments accounted for under the cost method or the equity method. In September 2004,the FASB delayed the recognition and measurement guidance to be applied toother-than-temporary impairment evaluations. The FASB expects to issueadditional implementation guidance with respect to debt securities that areimpaired solely due to interest rates and/or sector spreads. If this additionalimplementation guidance is issued as currently written, the Company may have torecognize 

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unrealizedlosses on investments in the Statements of Operations. If there is a materialdecline in the fair value of investments, the Company’s financial statementscould be adversely affected.

**3.   Stock-Based Compensation**

The Company accounts for stock-based compensationusing the intrinsic-value-based method, which is in accordance with APB OpinionNo. 25 as interpreted by FIN 44 and complies with the disclosureprovisions of SFAS No. 148, an amendment of SFAS No. 123. The Companyaccounts for equity instruments issued to non-employees in accordance with theprovisions of SFAS No. 123 and EITF No. 96-18, which requiresthat such equity instruments be recorded at their fair value on the measurementdate, which is typically the date of grant.

Thefollowing table illustrates the effect on net loss and net loss per share as ifthe Company had applied the fair value recognition provisions of SFAS No. 123to employee and director stock option plans, including shares issued under theCompany’s ESPP, collectively called “options,” for all periods presented:

| ** **                                                                                                     | ** ** | **Three-Month Period Ended**                                | ** ** | **Six-Month Period Ended**     | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                                                     | ** ** | **  September 30,  2005**                              | ** ** | **  September 30,  2004** | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
| ** **                                                                                                     | ** ** | **(in thousands, except per share amounts)** | ** ** |
| Net loss, as  reported                                                                                         |       |                                                                  | $          | (105,806                                 | )          |   |   | $ | (8,063 | ) |   |   | $ | (141,779 | ) |   |   | $ | (8,053 | ) |   |
| Add: Deferred  stock-based compensation expense included in reported net loss                                  |       |                                                                  | 1,029      |                                     |       |   | 873 |   |   |   | 1,303 |   |   |   | 1,678 |   |   |
| Deduct: Total  stock-based compensation expense determined under the fair value-based  method, net of tax |       |                                                                  | (2,884     | )                                        |       |   | (2,589 | ) |   |   | (6,380 | ) |   |   | (6,086 | ) |   |
| Pro forma net loss                                                                                             |       |                                                                  | $          | (107,661                                 | )          |   |   | $ | (9,779 | ) |   |   | $ | (146,856 | ) |   |   | $ | (12,461 | ) |   |
| Basic net loss per share:                                                                                      |       |                                                                  |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| As reported                                                                                                    |       |                                                                  | $          | (0.94                                    | )          |   |   | $ | (0.07 | ) |   |   | $ | (1.26 | ) |   |   | $ | (0.07 | ) |   |
| Pro forma                                                                                                      |       |                                                                  | $          | (0.95                                    | )          |   |   | $ | (0.09 | ) |   |   | $ | (1.30 | ) |   |   | $ | (0.11 | ) |   |
| Diluted net loss  per share:                                                                                   |       |                                                                  |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |
| As reported                                                                                                    |       |                                                                  | $          | (0.94                                    | )          |   |   | $ | (0.06 | ) |   |   | $ | (1.26 | ) |   |   | $ | (0.05 | ) |   |
| Pro forma                                                                                                      |       |                                                                  | $          | (0.95                                    | )          |   |   | $ | (0.07 | ) |   |   | $ | (1.30 | ) |   |   | $ | (0.09 | ) |   |

 

SFAS No. 123 requires the use of option pricingmodels that were not developed for use in valuing employee stock options. TheBlack-Scholes option pricing model, used by the Company, was developed for usein estimating the fair value of short-lived exchange traded options that haveno vesting restrictions and are fully transferable. In addition, option pricingmodels require the input of highly subjective assumptions, including the option’sexpected life and the price volatility of the underlying stock.

8

----

Thefair value of options granted in the second quarter and first half of fiscal2006 and 2005, as reported were estimated at the date of grant using theBlack-Scholes valuation model with the following weighted average assumptions:

| ** **                    | ** ** | **Three-Month Period Ended** | ** ** | **Six-Month Period Ended** | ** ** |
|-------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **                    | ** ** | **September 30,  2005**           | ** ** | **September 30,  2004**         | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
| Employee Stock  Option Plans: |       |                                   |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Expected life (in  years)     |       |                                   | 2.5        |                                 |       |   | 3 |   |   |   | 2.5 |   |   |   | 3 |   |   |
| Risk-free  interest rates     |       |                                   | 4.2        | %                                    |       |   | 2.9 | % |   |   | 4.1 | % |   |   | 2.9 | % |   |
| Expected  volatility          |       |                                   | 39         | %                                    |       |   | 56 | % |   |   | 38 | % |   |   | 56 | % |   |
| Dividend yield                |       |                                   | —     |                                 |       |   | — |   |   |   | — |   |   |   | — |   |   |
| ESPP:                         |       |                                   |       |                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Expected life (in  years)     |       |                                   | 1.1        |                                 |       |   | 1.4 |   |   |   | 1.1 |   |   |   | 1.4 |   |   |
| Risk-free  interest rates     |       |                                   | 3.8        | %                                    |       |   | 2.1 | % |   |   | 3.8 | % |   |   | 2.1 | % |   |
| Expected  volatility          |       |                                   | 39         | %                                    |       |   | 50 | % |   |   | 39 | % |   |   | 50 | % |   |
| Dividend yield                |       |                                   | —     |                                 |       |   | — |   |   |   | — |   |   |   | — |   |   |

 

**4.   DiscontinuedOperations**

**IBM i/p Series RAIDBusiness:**

On September 30, 2005, the Company entered into aseries of arrangements with IBM pursuant to which the Company sold its IBM i/p Series RAIDBusiness to IBM for approximately $22.0 million plus $1.3 million for certainfixed assets. In addition, IBM purchased certain related inventory at theCompany’s net book value of $0.8 million. The consideration has been includedin “Prepaid expenses and other current assets” on the Unaudited CondensedConsolidated Balance Sheet. Under the terms of the agreements, the Companygranted IBM a nonexclusive license to certain intellectual property and sold toIBM substantially all of the assets dedicated to the engineering andmanufacturing of RAID controllers and connectivity products for the IBM i/p Series RAIDBusiness. Under the terms of the nonexclusive license, IBM will pay royaltiesto the Company for the sale of its board-level products over the next sixquarters, which will be recognized as contingent consideration in discontinuedoperations when earned.

Under the terms of the arrangement, IBM forgave alloutstanding liabilities that existed at June 30, 2005 which were due underthe Distribution Agreement that was entered into in December 2004. Expensesincurred in the transaction primarily included costs of approximately $0.5million for legal and accounting fees. In addition, the Company accrued $0.3million for lease obligations. These amounts have been included in “AccruedLiabilities” and “Other Long-Term Liabilities” on the Unaudited CondensedConsolidated Balance Sheets. A loss of $7.0 million was incurred on thedisposal of the IBM i/p Series RAID Business.

Netrevenues and the components of income (loss) related to these discontinuedoperations, which were previously included in the Company’s DPS segment, wereas follows:

| ** **                                                     | ** ** | **Three-Month Period Ended** | ** ** | **Six-Month Period Ended** | ** ** |
|----------------------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **                                                     | ** ** | **September 30,  2005**           | ** ** | **September 30,  2004**         | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
| ** **                                                     | ** ** | **(in thousands)**                | ** ** |
| Net revenues                                                   |       |                                   | $          | 15,357                               |       |   |   | $ | 5,186 |   |   |   | $ | 19,809 |   |   |   | $ | 5,186 |   |   |
| Income (loss) from discontinued operations before income taxes |       |                                   | 3,694      |                                 |       |   | (2,604 | ) |   |   | (14,663 | ) |   |   | (5,604 | ) |   |
| Provision for  (benefit from) income taxes                     |       |                                   | (833       | )                                    |       |   | 11,809 |   |   |   | (642 | ) |   |   | 10,811 |   |   |
| Income (loss) from  discontinued operations, net of taxes      |       |                                   | $          | 4,527                                |       |   |   | $ | (14,413 | ) |   |   | $ | (14,021 | ) |   |   | $ | (16,415 | ) |   |

 

9

----

 

Thecomponents of net assets related to the discontinued operations were asfollows:

| ** **                            | ** ** | **September 30, 2005** | ** ** |
|---------------------------------------|------------|----------------------------------|------------|
| ** **                            | ** ** | **(in thousands)**          | ** ** |
| Inventories                           |       |                             | $          | 838 |   |   |
| Prepaid expenses                      |       |                             | 11,139     |   |   |
| Property and  equipment, net          |       |                             | 3,326      |   |   |
| Other  intangibles, net               |       |                             | 10,958     |   |   |
| Other long-term  assets               |       |                             | 24,507     |   |   |
| Accrued  liabilities                  |       |                             | (10,051    | ) |   |
| Other long-term  liabilities          |       |                             | (10,625    | ) |   |
| Net assets of discontinued operations |       |                             | $          | 30,092 |   |   |

 

Accounts receivablerelated to the IBM i/p Series RAID Business were not included indiscontinued operations as the Company will be retaining these assets.

**Systems Business:**

On September 29, 2005, the Company’s Board ofDirectors approved management’s recommendation to divest its systems business,which includes substantially all of the operating assets and cash flows thatwere obtained through the Snap Appliance and Eurologic Systems acquisitions aswell as internally developed hardware and software. In connection with thisaction, the Company has classified the systems business as a discontinuedoperation in the financial statements. The Company has entered into anexclusive arrangement with an investment banker to sell this business andexpects to receive proceeds, less cost to sell, in excess of its carryingvalue.

Netrevenues and the components of loss related to the discontinued operations, wereas follows:

| ** **                                                          | ** ** | **Three-Month Period Ended** | ** ** | **Six-Month Period Ended** | ** ** |
|---------------------------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **                                                          | ** ** | **September 30,  2005**           | ** ** | **September 30,  2004**         | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
| ** **                                                          | ** ** | **(in thousands)**                | ** ** |
| Net revenues                                                        |       |                                   | $          | 16,466                               |       |   |   | $ | 16,762 |   |   |   | $ | 37,897 |   |   |   | $ | 33,407 |   |   |
| Loss from discontinued operations before provision for income taxes |       |                                   | (8,538     | )                                    |       |   | (8,222 | ) |   |   | (15,476 | ) |   |   | (8,735 | ) |   |
| Provision for  (benefit from) income taxes                          |       |                                   | 42         |                                 |       |   | (1,817 | ) |   |   | 68 |   |   |   | (1,910 | ) |   |
| Loss from  discontinued operations, net of taxes               |       |                                   | $          | (8,580                               | )          |   |   | $ | (6,405 | ) |   |   | $ | (15,544 | ) |   |   | $ | (6,825 | ) |   |

 

10

----

Thecomponents of net assets related to the discontinued operations were asfollows:

| ** **                                      | ** ** | **September 30, 2005** | ** ** |
|-------------------------------------------------|------------|----------------------------------|------------|
| ** **                                      | ** ** | **(in thousands)**          | ** ** |
| Inventories                                     |       |                             | $          | 10,542 |   |   |
| Prepaid expenses                                |       |                             | 84         |   |   |
| Current assets of discontinued operations       |       |                             | 10,626     |   |   |
| Property and  equipment, net                    |       |                             | 1,911      |   |   |
| Other  intangibles, net                         |       |                             | 24,730     |   |   |
| Other long-term  assets                         |       |                             | 30         |   |   |
| Total assets of discontinued operations         |       |                             | 37,297     |   |   |
| Accrued  liabilities                            |       |                             | (4,554     | ) |   |
| Current  liabilities of discontinued operations |       |                             | (4,554     | ) |   |
| Net assets of  discontinued operations          |       |                             | $          | 32,743 |   |   |

 

Accounts receivablerelated to the systems business were not included in discontinued operations asthe Company intends to retain these assets.

**5.   Balance Sheet Details**

**Inventories:**

| ** **      | ** ** | **September 30, 2005** | ** ** | **March 31, 2005** | ** ** |
|-----------------|------------|----------------------------------|------------|------------------------------|------------|
| ** **      | ** ** | **(in thousands)**          | ** ** |
| Raw materials   |       |                             | $          | 10,601                       |       |   |   | $ | 15,914 |   |   |
| Work-in-process |       |                             | 4,142      |                         |       |   | 7,435 |   |   |
| Finished goods  |       |                             | 18,376     |                         |       |   | 36,855 |   |   |
| Total           |       |                             | $          | 33,119                       |       |   |   | $ | 60,204 |   |   |

 

In the first half offiscal 2006, the Company recorded an excess inventory adjustment of $1.9million related to the transition of its products to comply with the EuropeanUnion Restriction on Use of Hazardous Substances Directive.

**AccruedLiabilities:**

| ** **                              | ** ** | **September 30, 2005** | ** ** | **March 31, 2005** | ** ** |
|-----------------------------------------|------------|----------------------------------|------------|------------------------------|------------|
| ** **                              | ** ** | **(in thousands)**          | ** ** |
| Tax related                             |       |                             | $          | 48,003                       |       |   |   | $ | 57,538 |   |   |
| Acquisition  related                    |       |                             | 3,650      |                         |       |   | 6,748 |   |   |
| Accrued  compensation and related taxes |       |                             | 16,697     |                         |       |   | 18,304 |   |   |
| IBM distribution  agreement             |       |                             | —     |                         |       |   | 11,575 |   |   |
| Other                                   |       |                             | 18,024     |                         |       |   | 21,842 |   |   |
| Total                                   |       |                             | $          | 86,374                       |       |   |   | $ | 116,007 |   |   |

 

11

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**6.   Goodwilland Other Intangible Assets**

**Goodwill:**

Goodwillallocated to the Company’s reportable segments and changes in the carryingamount of goodwill for the first half of fiscal 2006 was as follows:

| ** **                          | ** ** | **OEM**                 | ** ** | **Channel** | ** ** | **Total** | ** ** |
|-------------------------------------|------------|-------------------------|------------|-------------|------------|-----------|------------|
| ** **                          | ** ** | **(in thousands)** | ** ** |
| Balance at  March 31, 2005     |       | $                       | 48,783     |        | $          | 42,703    |       | $ | 91,486 |   |
| Goodwill  adjustments               |       | (166                    | )          | (718        | )          | (884      | )          |
| Balance at  June 30, 2005      |       | 48,617                  |       | 41,985      |       | 90,602    |       |
| Goodwill  impairment                |       | (48,617                 | )          | (41,985     | )          | (90,602   | )          |
| Balance at  September 30, 2005 |       | $                       | —     |        | $          | —    |       | $ | — |   |

 

In the first quarter offiscal 2006, adjustments were made to goodwill for changes to theacquisition-related restructuring reserves and other purchase price adjustmentsfor the IBM i/p Series RAID business and Snap Appliance. As a result ofthe segment reorganization, discussed in Note 14, an assessment of the recoverabilityof goodwill was performed. Impairment of goodwill is tested at the Company’soperating segment level by comparing each segment’s carrying amount, includinggoodwill, to the fair value of that segment. To determine fair value, theCompany’s review process uses the income, or discounted cash flows, approachand the market approach. In performing its analysis, the Company uses the bestinformation available under the circumstances, including reasonable andsupportable assumptions and projections. If the carrying amount of theoperating segment exceeds its implied fair value, goodwill is consideredimpaired and a second step is performed to measure the amount of impairmentloss, if any. As a result of this review, the Company wrote-off its entire balanceof goodwill in the second quarter of fiscal 2006. Factors that led to thisconclusion were industry technology changes such as parallel to serial technologyand migration of core functionality to server chipsets; required increasedinvestments that eventually led to the sale of the i/p Series RAID Business andthe proposed sale of the Systems Business; continued losses associated withsales of Systems to IBM; and general market conditions.

**Other IntangibleAssets:**

| ** **                                 | ** ** | **September 30, 2005** | ** ** | **March 31, 2005**  | ** ** |
|--------------------------------------------|------------|----------------------------------|------------|-------------------------------|------------|
| ** **                                 | ** ** | **Gross Carrying  Amount**  | ** ** | **Accumulated  Amortization** | ** ** | **Gross Carrying  Amount** | ** ** | **Accumulated  Amortization** | ** ** |
| ** **                                 | ** ** | **(in thousands)**               | ** ** |
| Acquisition-related  intangible assets:    |       |                             |       |                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Patents, core and existing technologies    |       |                             | $          | 39,578                        |       |   |   | $ | (26,295 | ) |   |   | $ | 74,009 |   |   |   | $ | (26,265 | ) |   |
| Supply agreement                           |       |                             | —     |                          |       |   | — |   |   |   | 7,600 |   |   |   | (1,140 | ) |   |
| Customer relationships                     |       |                             | 1,047      |                          |       |   | (643 | ) |   |   | 1,290 |   |   |   | (631 | ) |   |
| Trade names                                |       |                             | 674        |                          |       |   | (520 | ) |   |   | 10,930 |   |   |   | (1,523 | ) |   |
| Foundry agreement                          |       |                             | —     |                          |       |   | — |   |   |   | 600 |   |   |   | (90 | ) |   |
| Subtotal                                   |       |                             | 41,299     |                          |       |   | (27,458 | ) |   |   | 94,429 |   |   |   | (29,649 | ) |   |
| Intellectual  property assets and warrants |       |                             | 41,623     |                          |       |   | (30,400 | ) |   |   | 41,942 |   |   |   | (27,265 | ) |   |
| Total                                      |       |                             | $          | 82,922                        |       |   |   | $ | (57,858 | ) |   |   | $ | 136,371 |   |   |   | $ | (56,914 | ) |   |

 

Amortization of other intangible assets was $3.5million and $4.1 million in the second quarter of fiscal 2006 and 2005,respectively. Amortization of other intangible assets was $7.2 million and$8.3 million in the first half of fiscal 2006 and 2005, respectively.

12

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Theannual amortization expense of the other intangible assets that existed as of September 30,2005 is expected to be as follows:

| ** **                   | ** ** | **Estimated Amortization Expense**    | ** ** |
|------------------------------|------------|-------------------------------------------------|------------|
| ** **                   | ** ** | **Acquisition-related  Intangible Assets** | ** ** | **Intellectual  Property Assets** | ** ** |
| ** **                   | ** ** | **(in thousands)**                              | ** ** |
| Fiscal Years:                |       |                                            |       |   |   |   |   |   |   |
| 2006 (remaining  six months) |       |                                            | $          | 3,376 |   |   |   | $ | 3,216 |   |   |
| 2007                         |       |                                            | 5,726      |   |   |   | 6,316 |   |   |
| 2008                         |       |                                            | 2,534      |   |   |   | 1,691 |   |   |
| 2009                         |       |                                            | 2,205      |   |   |   | — |   |   |
| 2010 and  thereafter         |       |                                            | —     |   |   |   | — |   |   |
| Total                        |       |                                            | $          | 13,841 |   |   |   | $ | 11,223 |   |   |

 

**7.   Interestand Other Income**

Thecomponents of interest and other income for the second quarter and first halfof fiscal 2006 and 2005, were as follows:

| ** **                                   | ** ** | **Three-Month Period Ended** | ** ** | **Six-Month Period Ended** | ** ** |
|----------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **                                   | ** ** | **September 30,  2005**           | ** ** | **September 30,  2004**         | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
| ** **                                   | ** ** | **(in thousands)**                     | ** ** |
| Interest income                              |       |                                   | $          | 3,969                                |       |   |   | $ | 3,034 |   |   |   | $ | 7,543 |   |   |   | $ | 5,760 |   |   |
| Payment of  license fee with NSE             |       |                                   | —     |                                 |       |   | — |   |   |   | — |   |   |   | (1,250 | ) |   |
| Loss on  redemption of debt                  |       |                                   | (16        | )                                    |       |   | — |   |   |   | (102 | ) |   |   | — |   |   |
| Foreign currency  transaction gains (losses) |       |                                   | (63        | )                                    |       |   | 295 |   |   |   | (380 | ) |   |   | 339 |   |   |
| Other                                        |       |                                   | 633        |                                 |       |   | 330 |   |   |   | 1,070 |   |   |   | 653 |   |   |
| Total                                        |       |                                   | $          | 4,523                                |       |   |   | $ | 3,659 |   |   |   | $ | 8,131 |   |   |   | $ | 5,502 |   |   |

 

In the second quarter of fiscal 2006, the Companyrepurchased $3.4 million in aggregate principal amount of its 3% ConvertibleSubordinated Notes (“3% Notes”) on the open market for an aggregate price of$3.4 million, resulting in an immaterial loss. In the first half of fiscal2006, the Company repurchased $23.2 million in aggregate principal amount ofits 3% Notes on the open market for an aggregate price of $23.1 million,resulting in an immaterial  loss. Theloss on extinguishment of debt has been included in “Interest and other income”in the Company’s Unaudited Condensed Consolidated Statement of Operations.

In June 2004, the Company, Nevada SCSIEnterprises, Inc. and Thomas A. Gafford (jointly, “NSE”) entered into alicense and release agreement, pursuant to which the Company paid NSE$1.3 million as a one-time, fully paid-up license fee to settle NSE’sclaims that some of the Company’s products infringed certain patents. Thelicense and release agreement expressly excluded any sales of products made byEurologic prior to the Company’s April 2003 acquisition of Eurologic. In November 2004,the Company exercised its option to secure a license and release with respectto such Eurologic sales by payment to NSE of a royalty fee of$0.4 million. The Company has filed a claim against the Eurologicacquisition Holdback for the $0.4 million royalty it paid with respect toEurologic’s pre-acquisition sales. The Eurologic shareholders are disputing theCompany’s right to withhold the $0.4 million from the Holdback. See Note12 for further discussion of the Eurologic Holdback.

13

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**8.   Restructuring Charges**

In the first half of fiscal 2006, the Company recordedprovision adjustments of $0.5 million related to severance and benefits asactual costs were lower than anticipated and additional lease costs related tothe estimated loss of facilities that the Company subleased in Californiathrough April 2008 and the United Kingdom through December 2005, theend of the lease term. This restructuring charge pertained to the Company’srestructuring plans that it implemented in each quarter of fiscal 2005, and therestructuring plans that it implemented in fiscal 2004, fiscal 2003, fiscal2002 and fiscal 2001. The fiscal 2004 restructuring plan was completed in thefirst quarter of fiscal 2006. For a complete discussion of all restructuring actionsthat were implemented prior to fiscal 2006, please refer to the Notes toConsolidated Financial Statements included in the Company’s Annual Report on Form 10-Kfor the year ended March 31, 2005. All expenses, including adjustments,associated with the Company’s restructuring plans are included in “Restructuringcharges” in the Unaudited Condensed Consolidated Statements of Operations andare not allocated to segments, but are managed at the corporate level.

Theactivity in the accrued restructuring reserves related to all of the plans wasas follows for the first half of fiscal 2006:

| ** **                                  | ** ** | **Severance And  Benefits** | ** ** | **Other Charges** | ** ** | **Total** | ** ** |
|---------------------------------------------|------------|----------------------------------|------------|------------------------|------------|-----------|------------|
| ** **                                  | ** ** | **(in thousands)**          | ** ** |
| Reserve balance  at March 31, 2005     |       |                             | $          | 896                    |       |      |       | $ | 1,627 |   |   | $ | 2,523 |   |
| Provision  adjustments                      |       |                             | (198       | )                      |       |      | 716        |   |   | 518 |   |
| Cash paid                                   |       |                             | (611       | )                      |       |      | (595       | ) |   | (1,206 | ) |
| Reserve balance  at September 30, 2005 |       |                             | $          | 87                     |       |      |       | $ | 1,748 |   |   | $ | 1,835 |   |

 

The Company anticipatesthat the remaining restructuring reserve balance of $1.8 million will besubstantially paid out by the first quarter of fiscal 2009, primarilyattributable to longer term lease obligations. The remaining restructuringreserve balance is reflected both in “Accrued liabilities” and “Other long-termliabilities” in the Unaudited Condensed Consolidated Balance Sheet.

**9.   Net Income (Loss) Per Share**

Basic net income (loss) per share is computed bydividing net income (loss) by the weighted average number of common sharesoutstanding during the period. Diluted net income (loss) per share gives effectto all potentially dilutive common shares outstanding during the period, whichinclude certain stock options and warrants, calculated using the treasury stockmethod, and convertible notes which are potentially dilutive at certainearnings levels, and are computed using the if-converted method.

14

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Areconciliation of the numerator and denominator of the basic and diluted income(loss) per share computations for continuing operations, discontinuedoperations and net loss were as follows:

| ** **                                                                                         | ** ** | **Three-Month Period Ended**       | ** ** |
|----------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                                         | ** ** | **Continuing Operations**               | ** ** | **Discontinued Operations** | ** ** | **Net loss** | ** ** |
| ** **                                                                                         | ** ** | **September 30,  2005**                 | ** ** | **September 30,  2004** | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
| ** **                                                                                         | ** ** | **(in thousands, except per share amounts)** | ** ** |
| Numerators:                                                                                        |       |                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Income (loss)                                                                                      |       |                                         | $          | (94,777 | ) |   |   | $ | 12,755 |   |   |   | $ | (11,029 | ) |   |   | $ | (20,818 | ) |   |   | $ | (105,806 | ) |   |   | $ | (8,063 | ) |   |
| Adjustment for interest expense on 3¤4% Notes, net of taxes                              |       |                                         | —     |   |   |   | 454 |   |   |   | — |   |   |   | 454 |   |   |   | — |   |   |   | 454 |   |   |
| Adjustment for interest expense on 3% Notes, net of  taxes                                         |       |                                         | —     |   |   |   | 196 |   |   |   | — |   |   |   | 196 |   |   |   | — |   |   |   | 196 |   |   |
| Adjusted income (loss)                                                                             |       |                                         | $          | (94,777 | ) |   |   | $ | 13,405 |   |   |   | $ | (11,029 | ) |   |   | $ | (20,168 | ) |   |   | $ | (105,806 | ) |   |   | $ | (7,413 | ) |   |
| Denominators:                                                                                      |       |                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Weighted average shares outstanding—basic                                                     |       |                                         | 112,965    |   |   |   | 110,312 |   |   |   | 112,965 |   |   |   | 110,312 |   |   |   | 112,965 |   |   |   | 110,312 |   |   |
| Effect  of dilutive  securities:                                                                   |       |                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Employee stock options and other                                                                   |       |                                         | —     |   |   |   | 2,306 |   |   |   | — |   |   |   | 2,306 |   |   |   | — |   |   |   | 2,306 |   |   |
| 3¤4% Notes                                                                                    |       |                                         | —     |   |   |   | 19,224 |   |   |   | — |   |   |   | 19,224 |   |   |   | — |   |   |   | 19,224 |   |   |
| 3% Notes                                                                                           |       |                                         | —     |   |   |   | 2,298 |   |   |   | — |   |   |   | 2,298 |   |   |   | — |   |   |   | 2,298 |   |   |
| Weighted average shares and potentially dilutive  common shares outstanding—diluted |       |                                         | 112,965    |   |   |   | 134,140 |   |   |   | 112,965 |   |   |   | 134,140 |   |   |   | 112,965 |   |   |   | 134,140 |   |   |
| Income (loss) per  share:                                                                          |       |                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                                                                              |       |                                         | $          | (0.84 | ) |   |   | $ | 0.12 |   |   |   | $ | (0.10 | ) |   |   | $ | (0.19 | ) |   |   | $ | (0.94 | ) |   |   | $ | (0.07 | ) |   |
| Diluted                                                                                            |       |                                         | $          | (0.84 | ) |   |   | $ | 0.10 |   |   |   | $ | (0.10 | ) |   |   | $ | (0.15 | ) |   |   | $ | (0.94 | ) |   |   | $ | (0.06 | ) |   |

 

15

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| ** **                                                                                              | ** ** | **Six-Month Period Ended**         | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                                              | ** ** | **Continuing Operations**               | ** ** | **Discontinued Operations** | ** ** | **Net loss** | ** ** |
| ** **                                                                                              | ** ** | **September 30,  2005**                 | ** ** | **September 30,  2004** | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
| ** **                                                                                              | ** ** | **(in thousands, except per share amounts)** | ** ** |
| Numerators:                                                                                             |       |                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Income (loss)                                                                                           |       |                                         | $          | (105,238 | ) |   |   | $ | 15,187 |   |   |   | $ | (36,541 | ) |   |   | $ | (23,240 | ) |   |   | $ | (141,779 | ) |   |   | $ | (8,053 | ) |   |
| Adjustment for  interest expense on 3¤4% Convertible Senior Subordinated Notes,  net of taxes |       |                                         | —     |   |   |   | 917 |   |   |   | — |   |   |   | 917 |   |   |   | — |   |   |   | 917 |   |   |
| Adjustment for  interest expense on 3% Notes, net of taxes                                              |       |                                         | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Adjusted income  (loss)                                                                                 |       |                                         | $          | (105,238 | ) |   |   | $ | 16,104 |   |   |   | $ | (36,541 | ) |   |   | $ | (22,323 | ) |   |   | $ | (141,779 | ) |   |   | $ | (7,136 | ) |   |
| Denominators:                                                                                           |       |                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Weighted average  shares outstanding—basic                                                         |       |                                         | 112,705    |   |   |   | 110,076 |   |   |   | 112,705 |   |   |   | 110,076 |   |   |   | 112,705 |   |   |   | 110,076 |   |   |
| Effect of dilutive  securities:                                                                         |       |                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Employee stock  options and other                                                                       |       |                                         | —     |   |   |   | 2,002 |   |   |   | — |   |   |   | 2,002 |   |   |   | — |   |   |   | 2,002 |   |   |
| 3¤4% Convertible Senior Subordinated Notes                                                         |       |                                         | —     |   |   |   | 19,224 |   |   |   | — |   |   |   | 19,224 |   |   |   | — |   |   |   | 19,224 |   |   |
| 3% Notes                                                                                                |       |                                         | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Weighted average  shares and potentially dilutive common shares outstanding—diluted                |       |                                         | 112,705    |   |   |   | 131,302 |   |   |   | 112,705 |   |   |   | 131,302 |   |   |   | 112,705 |   |   |   | 131,302 |   |   |
| Income (loss) per share:                                                                                |       |                                         |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                                                                                   |       |                                         | $          | (0.93 | ) |   |   | $ | 0.14 |   |   |   | $ | (0.32 | ) |   |   | $ | (0.21 | ) |   |   | $ | (1.26 | ) |   |   | $ | (0.07 | ) |   |
| Diluted                                                                                                 |       |                                         | $          | (0.93 | ) |   |   | $ | 0.12 |   |   |   | $ | (0.32 | ) |   |   | $ | (0.17 | ) |   |   | $ | (1.26 | ) |   |   | $ | (0.05 | ) |   |

 

Dilutedloss per share from continuing operations, discontinued operations and net lossfor the second quarter and first half of fiscal 2006 was based only on theweighted-average number of shares outstanding during the period, as theinclusion of any common stock equivalents would have been anti-dilutive. Inaddition, certain potential common shares were excluded from the dilutedcomputation from continuing operations, discontinued operations and net lossfor the second quarter and first half of fiscal 2005 because their inclusionwould have been anti-dilutive. The items excluded for the second quarters andfirst half of fiscal 2006 and 2005 from continuing operations, discontinuedoperations and net loss were as follows:

| ** **                                       | ** ** | **Three-Month Period Ended** | ** ** | **Six-Month Period Ended** | ** ** |
|--------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **                                       | ** ** | **September 30,  2005**           | ** ** | **September 30,  2004**         | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
| ** **                                       | ** ** | **(in thousands)**                | ** ** |
| Outstanding  employee stock options              |       |                                   | 19,461     |                                 |       |   | — |   |   |   | 19,820 |   |   |   | — |   |   |
| Warrants(1)                                      |       |                                   | 19,874     |                                 |       |   | — |   |   |   | 19,874 |   |   |   | — |   |   |
| 3¤4%  Convertible Senior Subordinated Notes |       |                                   | 19,224     |                                 |       |   | — |   |   |   | 19,224 |   |   |   | — |   |   |
| 3% Notes                                         |       |                                   | 880        |                                 |       |   | — |   |   |   | 1,154 |   |   |   | 2,298 |   |   |

----

(1)          Inconnection with the issuance of its 3¤4%Notes, the Company entered into a derivative financial instrument to repurchaseup to 19,224,000 shares of its common stock, at the Company’s option, atspecified prices in the future to mitigate any potential dilution as a resultof the conversion of the 3¤4%

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Notes. For furtherdiscussion on this derivative financial instrument, please refer to Note 6of the Notes to Consolidated Financial Statements in the Company’s AnnualReport on Form 10-K for the year ended March 31, 2005.

**10.   Comprehensive Loss**

TheCompany’s comprehensive loss, which consisted of net loss and the changes innet unrealized gains (losses) on marketable securities, net of taxes, andforeign currency translation adjustments, net of taxes, were as follows:

| ** **                                                            | ** ** | **Three-Month Period Ended** | ** ** | **Six-Month Period Ended** | ** ** |
|-----------------------------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **                                                            | ** ** | **September 30,  2005**           | ** ** | **September 30,  2004**         | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
| ** **                                                            | ** ** | **(in thousands)**                | ** ** |
| Net loss                                                              |       |                                   | $          | (105,806                             | )          |   |   | $ | (8,063 | ) |   |   | $ | (141,779 | ) |   |   | $ | (8,053 | ) |   |
| Net unrealized  gains (losses) on marketable securities, net of taxes |       |                                   | (1,231     | )                                    |       |   | 60 |   |   |   | (810 | ) |   |   | (3,034 | ) |   |
| Foreign currency  translation adjustment, net of taxes                |       |                                   | (157       | )                                    |       |   | 101 |   |   |   | (962 | ) |   |   | (53 | ) |   |
| Comprehensive  loss                                                   |       |                                   | $          | (107,194                             | )          |   |   | $ | (7,902 | ) |   |   | $ | (143,551 | ) |   |   | $ | (11,140 | ) |   |

 

Thecomponents of accumulated other comprehensive income (loss), net of taxes, wereas follows:

| ** **                                                                                                    | ** ** | **September 30,  2005** | ** ** | **March 31,  2005** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|--------------------------|------------|
| ** **                                                                                                    | ** ** | **(in thousands)**      | ** ** |
| Unrealized losses  on marketable securities                                                                   |       |                         | $          | (1361                    | )          |   |   | $ | (546 | ) |   |
| Foreign currency  translation, net of tax of $197 at September 30, 2005 and $834 at  March 31, 2005 |       |                         | 295        |                     |       |   | 1,252 |   |   |
| Total                                                                                                         |       |                         | $          | (1,066                   | )          |   |   | $ | 706 |   |   |

 

**11.**   Income Taxes

Income tax provisions forinterim periods are based on the Company’s estimated annual income tax. Theestimated annual tax for fiscal 2006 primarily consists of foreign taxesrelated to the Company’s foreign subsidiaries and interest accrued on prioryears’ tax disputes. The Company currently has a full valuation allowance onits net deferred tax assets. The Company is in ongoing negotiations with theIRS with regard to its various tax disputes that may result in settlement ofcertain issues. The Company’s tax rate for the period in which a settlement isreached will be impacted if the settlement materially differs from the amountspreviously accrued. The tax rate for second quarter and the first half offiscal 2005 also differed from the combined United States Federal and statestatutory income tax rate of 40% due to a benefit of $9.9 million fromdiscrete events relating to the method and amount of settled controversies. Asa result of the settlement, $4.1 million previously recorded as a taxprovision has been reclassified as a reduction to additional paid-in capital,$1.8 million previously recorded as a tax provision has reversed, and a$4.0 million tax benefit associated with a refund claim has beenrecognized during the second quarter of fiscal 2005.

**12.   Commitments and Contingencies**

The Company has been, or is, subject to IRS audits forits fiscal years 1994 through 2003. The fiscal 1994 through fiscal 1996 cycle,which is docketed in the United States Tax Court, was resolved in December 2001.The outcome did not have a material adverse effect on the Company’s financialposition or results of operations, as sufficient tax provisions had been made.The final Tax Court stipulation will be 

17

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filed when the subsequentaudit cycles are completed. Tax credits that were generated but not used insubsequent years may be carried back to the fiscal 1994 to 1996 audit cycle.

On December 15, 2000, the Company received astatutory notice of deficiency from the IRS with respect to its Federal incometax return for fiscal 1997. The Company filed a Petition with the United StatesTax Court on March 14, 2001, contesting the asserted deficiencies.Settlement agreements have been filed with the United States Tax Court on allbut one issue. The Company believes that the final outcome of all issues willnot have a material adverse impact on its financial position or results ofoperations, as the Company believes that it has meritorious defenses againstthe asserted deficiencies and any proposed adjustments and that it has madesufficient tax provisions. However, the Company cannot predict with certaintyhow these matters will be resolved and whether it will be required to makeadditional payments.

In addition, the IRS is currently auditing the Company’sFederal income tax returns for fiscal 1998 through fiscal 2003. In the thirdquarter of fiscal 2005, the Company resolved all issues for fiscal 1998 throughfiscal 2001, other than the rollover impact of any potential resolution on theremaining fiscal 1997 issue and tax credits that were generated but not used insubsequent years that may be carried back. The Company believes that it hasprovided sufficient tax provisions for these years and the ultimate outcome ofthe IRS audits will not have a material adverse impact on its financialposition or results of operations in future periods. However, the Companycannot predict with certainty how these matters will be resolved and whether itwill be required to make additional tax payments.

The Company is a party to other litigation matters andclaims, including those related to intellectual property, which are normal inthe course of its operations, and while the results of such litigation mattersand claims cannot be predicted with certainty, the Company believes that thefinal outcome of such matters will not have a material adverse impact on itsfinancial position or results of operations. However, because of the nature andinherent uncertainties of litigation, should the outcome of these actions beunfavorable, the Company’s business, financial condition, results of operationsand cash flows could be materially and adversely affected.

In connection with theCompany’s acquisitions of Snap Appliance, Eurologic, Elipsan Limited (“Elipsan”),and Platys Communications, Inc. (“Platys”), a portion of the purchaseprice and other future payments totaling $6.7 million, $3.8 million, $2.0million and $15.0 million, respectively, were held back (the “Holdbacks”) forunknown liabilities that may have existed as of the acquisition dates. TheCompany has asserted claims against the Snap Appliance, Eurologic and PlatysHoldbacks totaling $3.0 million, $1.5 million and $0.7 million,respectively. The Elipsan Holdback of $2.0 million was paid in the secondquarter of fiscal 2006.

**13.   Guarantees**

*IntellectualProperty Indemnification Obligations*

The Company has enteredinto agreements with customers and suppliers that include intellectual propertyindemnification obligations. These indemnification obligations generallyrequire the Company to compensate the other party for certain damages and costsincurred as a result of third party intellectual property claims arising fromthese transactions. In each of these circumstances, payment by the Company isconditional on the other party making a claim pursuant to the proceduresspecified in the particular contract, which procedures typically allow theCompany to challenge the other party’s claims. Further, the Company’sobligations under these agreements may be limited in terms of time and/or amount,and in some instances, the Company may have recourse against third parties forcertain payments made by it under these agreements. It is not possible to makea reasonable estimate of the maximum potential amount of future payments underthese or similar agreements due to the conditional nature of the Company’sobligations and the unique facts and circumstances involved in each particularagreement. 

18

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Historically,the Company has not incurred significant costs to defend lawsuits or settleclaims related to such agreements and no amount has been accrued in theaccompanying financial statements with respect to these indemnificationguarantees.

*Product Warranty*

The Company provides an accrual for estimated futurewarranty costs based upon the historical relationship of warranty costs tosales. The estimated future warranty obligations related to product sales arerecorded in the period in which the related revenue is recognized. Theestimated future warranty obligations are affected by product failure rates,material usage and replacement costs incurred in correcting a product failure.If actual product failure rates, material usage or replacement costs differfrom the Company’s estimates, revisions to the estimated warranty obligationswould be required; however, the Company made no adjustments to pre-existingwarranty accruals in the first half of fiscal 2006 and 2005.

Areconciliation of the changes to the Company’s warranty accrual for the firsthalf of fiscal 2006 and 2005 was as follows:

| ** **                                                   | ** ** | **Six-Month Period Ended** | ** ** |
|--------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                   | ** ** | **September 30,  2005**         | ** ** | **September 30,  2004** | ** ** |
| ** **                                                   | ** ** | **(in thousands)**              | ** ** |
| Balance at  beginning of period                              |       |                                 | $          | 2,084 |   |   |   | $ | 1,598 |   |   |
| Warranties provided                                          |       |                                 | 2,745      |   |   |   | 2,574 |   |   |
| Actual costs incurred                                        |       |                                 | (2,880     | ) |   |   | (2,783 | ) |   |
| Warranties classified as liabilities held for sale  (Note 4) |       |                                 | (354       | ) |   |   | — |   |   |
| Balance at end of  period                                    |       |                                 | $          | 1,595 |   |   |   | $ | 1,389 |   |   |

 

**14.   Segment Reporting**

In the second quarter of fiscal 2006, the Companyreorganized its internal organization structure related to its OEM and Channelsegments. Where historically the Company’s former OEM and Channel segments eachoffered an integrated set of customer-focused products, the new organization ismanaged at the product level.

For the periodended September 30, 2005, the Company operated in two reportable segments:DPS and DSG. A description of the types of customers or products and servicesprovided by each reportable segment is as follows:

·       DPSprovides storage products and currently sells all of its storage technologiesin various form factors, such as board-level products, ASICs and stand-alonesoftware. The Company sells these products directly to OEMs, ODMs thatsupply OEMs, VARs and end users through its network of distribution andreseller customers.

·       DSGprovides high-performance I/O connectivity and digital media products forpersonal computing platforms, including notebook and desktop PCs. The Companysells these products to retailers, OEMs and distributors.

The unallocated corporate income and expenses, whichare in the “Other” category, include amortization of acquisition-relatedintangible assets, restructuring charges, goodwill impairment, other charges,interest and other income, interest expense, all administrative expenses andcertain research and development, selling and marketing expenses.

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Summarizedfinancial information on the Company’s reportable segments, under the neworganizational structure, is shown in the following table. The segmentfinancial data for the second quarter of fiscal 2005 and first half of fiscal2005 and fiscal 2006 has been restated to reflect this change. There were nointer-segment revenues for the periods shown below. The Company does notseparately track all tangible assets or depreciation by operating segments norare the segments evaluated under these criteria. Segment financial informationis summarized as follows for the second quarters and first half of fiscal 2006and 2005:

| ** **                                         | ** ** | **DPS**                 | ** ** | **DSG** | ** ** | **Other** | ** ** | **Total** | ** ** |
|----------------------------------------------------|------------|-------------------------|------------|---------|------------|-----------|------------|-----------|------------|
| ** **                                         | ** ** | **(in thousands)** | ** ** |
| Three-Month Period  Ended September 30, 2005: |       |                    |       |    |       |      |       |      |       |
| Net revenues                                       |       | $                       | 72,110     |    | $          | 11,124    |       | $         | —     |   | $ | 83,234 |   |
| Segment income (loss)                              |       | 17,712                  |       | (1,094  | )          | (108,838  | )          | (92,220   | )          |
| Three-Month Period  Ended September 30, 2004: |       |                    |       |    |       |      |       |      |       |
| Net revenues                                       |       | $                       | 90,398     |    | $          | 9,354     |       | $         | —     |   | $ | 99,752 |   |
| Segment income                                     |       | 24,586                  |       | 2,925   |       | (25,199   | )          | 2,312     |       |
| Six-Month Period  Ended September 30, 2005:   |       |                    |       |    |       |      |       |      |       |
| Net revenues                                       |       | $                       | 135,833    |    | $          | 19,916    |       | $         | —     |   | $ | 155,749 |   |
| Segment income (loss)                              |       | 28,235                  |       | (1,472  | )          | (128,556  | )          | (101,793  | )          |
| Six-Month Period  Ended September 30, 2004:   |       |                    |       |    |       |      |       |      |       |
| Net revenues                                       |       | $                       | 178,651    |    | $          | 19,958    |       | $         | —     |   | $ | 198,609 |   |
| Segment income                                     |       | 47,826                  |       | 5,960   |       | (47,944   | )          | 5,842     |       |

 

Thefollowing table presents the details of unallocated corporate income andexpenses for the second quarters and first half of fiscal 2006 and 2005:

| ** **                           | ** ** | **Three-Month Period Ended** | ** ** | **Six-Month Period Ended** | ** ** |
|--------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **                           | ** ** | **September 30, 2005**       | ** ** | **September 30, 2004**     | ** ** | **September 30, 2005** | ** ** | **September 30, 2004** | ** ** |
| ** **                           | ** ** | **(in thousands)**                | ** ** |
| Unallocated  corporate expenses, net |       |                                   | $          | (21,413                              | )          |   |   | $ | (25,785 | ) |   |   | $ | (43,727 | ) |   |   | $ | (48,432 | ) |   |
| Restructuring  charges               |       |                                   | (478       | )                                    |       |   | (1,928 | ) |   |   | (518 | ) |   |   | (2,747 | ) |   |
| Goodwill  impairment                 |       |                                   | (90,602    | )                                    |       |   | — |   |   |   | (90,602 | ) |   |   | — |   |   |
| Interest and  other income           |       |                                   | 4,523      |                                 |       |   | 3,659 |   |   |   | 8,131 |   |   |   | 5,502 |   |   |
| Interest expense                     |       |                                   | (868       | )                                    |       |   | (1,145 | ) |   |   | (1,840 | ) |   |   | (2,267 | ) |   |
| Total                                |       |                                   | $          | (108,838                             | )          |   |   | $ | (25,199 | ) |   |   | $ | (128,556 | ) |   |   | $ | (47,944 | ) |   |

 

**15.   SupplementalDisclosure of Cash Flows**

| ** **                                        | ** ** | **Six-Month Period Ended** | ** ** |
|---------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                        | ** ** | **September 30, 2005**     | ** ** | **September 30, 2004** | ** ** |
| ** **                                        | ** ** | **(in thousands)**              | ** ** |
| Non-cash  investing and financial activities:     |       |                                 |       |   |   |   |   |   |   |
| Deferred stock-based  compensation                |       |                                 | $          | — |   |   |   | $ | 7,060 |   |   |
| Adjustment for  deferred stock-based compensation |       |                                 | 414        |   |   |   | 58 |   |   |
| Unrealized loss on  available-for-sale securities |       |                                 | (810       | ) |   |   | (3,034 | ) |   |
|                                                   |            |                                      |            |  |  |  |  |  |  |  |  |

 

**16.   Business Acquisitions**

The acquisitions described below were previouslyaccounted for as purchase transactions and, accordingly, the results ofoperations and financial position of the acquired businesses were included inthe Company’s financial statements as of the respective effective dates of theacquisitions. However, as a result of the sale of the IBM i/p Series RAIDBusiness and the Company’s plan to divest its systems business, the 

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assets sold or expected tobe sold have been reclassified as Assets of Discontinued Operations on the UnauditedCondensed Consolidated Balance Sheet at September 30, 2005 and the relatedoperations have been reclassified to Loss from Discontinued Operations on the UnauditedCondensed Consolidated Statements of Operations, as discussed in Note 4.

**IBMi/p Series RAID:****  **OnJune 29, 2004, the Company completed the acquisition of the IBM i/p Series RAIDcomponent business line consisting of certain purchased RAID data protectionintellectual property, semiconductor designs and assets, and licensed from IBMrelated RAID intellectual property. The licensing agreement granted the Companythe right to use IBM’s RAID technology and embedded Power PC technology for theCompany’s internal and external RAID products to be sold to IBM and othercustomers. In conjunction with the acquisition, the Company also entered into athree-year exclusive product supply agreement under which the Company agreed tosupply RAID software, firmware and hardware to IBM for use in IBM’s iSeries andpSeries servers. The Company also entered into an agreement for IBM toprovide silicon wafer manufacturing processing services to the Company for theterm of the supply agreement at agreed upon rates.

The final purchase price was $49.3 million, whichconsisted of a cash payment to IBM of $47.5 million, warrants valued at$1.1 million, net of registration costs, and transaction costs of$0.7 million. This purchase price included a final adjustment of$0.2 million in the first quarter of fiscal 2006 to both goodwill andacquisitions costs. In connection with the acquisition, the Company issued awarrant to IBM to purchase 250,000 shares of the Company’s common stock at anexercise price of $8.13 per share. The warrant has a term of 5 years fromthe date of issuance and is immediately exercisable. The warrant was valuedusing the Black-Scholes valuation model using a volatility rate of 62%, arisk-free interest rate of 3.9% and an estimated life of 5 years. Thetransaction costs consisted primarily of legal, valuation and other fees. TheIBM i/p Series RAID business was included in the Company’s DPS segment.

**SnapAppliance:**   On July 23, 2004, the Companycompleted the acquisition of Snap Appliance, a provider of NAS products, toexpand its product offerings in the external storage market and to delivercost-effective, scalable and easy-to-use DAS, NAS, Fibre Channel and IP-basedSAN products from the workgroup to the data center. The final purchase pricewas $83.7 million, consisting of $76.7 million in cash and transactionfees and $7.0 million related to the fair value of assumed stock optionsto purchase 1.2 million shares of the Company’s common stock. Thispurchase price included a final adjustment of $0.7 million in the firsthalf of fiscal 2006 to both goodwill and acquisitions costs. The assumed stockoptions were valued using the Black-Scholes valuation model with the followingassumptions: volatility rate of 58%; a risk-free interest rate of 2.6%; and anestimated life of 2.25 years. In the first quarter of fiscal 2006,adjustments of $0.7 were made to both goodwill and the acquisition costs.

Of the total assumed stock options, stock options topurchase approximately 0.7 million shares of the Company’s common stock,with exercise prices ranging between $1.42 and $5.66 per share, were unvested(the “Snap Unvested Options”). The Snap Unvested Options have a ten-year termand vest primarily over four years from the date of grant. The intrinsic valueof the Snap Unvested Options of $3.6 million was accounted for as deferredstock-based compensation and is being recognized as compensation expense overthe related vesting periods.

In addition, a managementincentive program was established to pay former employees of Snap Appliancecash payments totaling $13.8 million, which is being paid, contingent upontheir employment with the Company, over a two-year period through the secondquarter of fiscal 2007. Payments under the management incentive program will beexpensed as employees meet their employment obligations or are recorded as partof the Snap Appliance acquisition-related restructuring for involuntaryterminations by the Company. Any amounts outstanding as of the completion ofthe sale of the systems business will be accelerated.

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***Acquisition-Related Restructuring:***

During the first quarter of fiscal 2006, the Companyfinalized its Snap Appliance integration plan to eliminate certain duplicativeresources, including severance and benefits in connection with the involuntarytermination of approximately 24 employees, exiting duplicative facilities anddisposing of duplicative assets. The acquisition-related restructuringliabilities were accounted for under EITF 95-3 and therefore wereincluded in the purchase price allocation. The Company recorded a totalliability of $6.7 million for these activities, of which the original estimateof $6.0 million was recorded in the second quarter of fiscal 2005 andadjustments were recorded in each subsequent quarter through the first quarterof fiscal 2006 totaling $0.7 million. Any further changes to the Company’sfinalized plan will be accounted for under SFAS No. 146 and will berecorded in “Restructuring charges” in the Unaudited Condensed ConsolidatedStatements of Operations. As of September 30, 2005, the Company hadutilized $4.1 million of these charges. The Company anticipates that theremaining restructuring reserve balance of $2.6 million will be paid outby the third quarter of fiscal 2012, primarily related to long-term facilityleases.

Theactivity in the accrued restructuring reserve related to the Snap Applianceacquisition-related restructuring plan was as follows for the first half offiscal 2006:

| ** **                                                  | ** ** | **Severance And**  | ** ** | ** **             | ** ** | ** ** | ** ** |
|-------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|------------|------------|
| ** **                                                  | ** ** | **Benefits**            | ** ** | **Other Charges** | ** ** | **Total**  | ** ** |
| ** **                                                  | ** ** | **(in thousands)** | ** ** |
| **Snap Appliance  Acquisition-Related Restructuring Plan:** |       |                    |       |                   |       |       |       |   |   |   |   |
| Reserve balance  at March 31, 2005                     |       |                    | 155        |                   |       |       | 2,901      |   |   | 3,056 |   |
| Adjustments                                                 |       |                    | (49        | )                      |       |       | —     |   |   | (49 | ) |
| Cash paid                                                   |       |                    | (60        | )                      |       |       | (379       | ) |   | (439 | ) |
| Reserve balance at  September 30, 2005                 |       |                    | $          | 46                     |       |       |       | $ | 2,522 |   |   | $ | 2,568 |   |
|                                                             |            |                         |            |                        |            |            |            |  |  |  |  |  |  |  |

 

**In-process Technology**

Aspart of the purchase agreements of the IBM i/p Series RAID business andSnap Appliance, certain amounts of the purchase prices were allocated to acquiredin-process technology which were determined through established valuationtechniques in the high-technology computer industry and written off in thefirst and second quarter of fiscal 2005, respectively, because technologicalfeasibility had not been established and no alternative future uses existed.The values were determined by estimating the net cash flows and discounting theestimated net cash flows to their present values. A summary of the amountswritten off were as follows:

| ** **                            | ** ** | **Acquired**                   | ** ** |
|---------------------------------------|------------|--------------------------------|------------|
| ** **                            | ** ** | **In-Process Technology** | ** ** |
| ** **                            | ** ** | **(in thousands)**        | ** ** |
| IBM i/p  Series RAID business(1) |       |                           | $          | 3,000 |   |   |
| Snap Appliance(2)                     |       |                           | 2,200      |   |   |

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(1)          The in-process projectswere related to designing semiconductors and related boards and enhancements toRAID and firmware code.

(2)          The identifiedin-process projects were related to operating system enhancements and systemfunctionality improvements.

The net cash flows from the identified projects werebased on estimates of revenues, cost of revenues, research and developmentexpenses, including costs to complete the projects, selling, marketing andadministrative expenses, royalty expenses and income taxes from the projects.The Company believes the assumptions used in the valuations were reasonable atthe time of the acquisitions. The estimated net 

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revenues and gross marginswere based on management’s projections of the projects and were in line withindustry averages. Estimated total net revenues from the projects of the IBMi/p Series RAID business and Snap Appliance were expected to grow throughfiscal 2009 and decline thereafter as other new products were expected tobecome available. Estimated operating expenses included research anddevelopment expenses and selling, marketing and administrative expenses basedupon historical and expected direct expense levels and general industrymetrics. Estimated research and development expenses included costs to bringthe projects to technological feasibility and costs associated with activitiesundertaken to correct errors or keep products updated with current information(also referred to as “maintenance” research and development) after a product isavailable for general release to customers. These activities range from 0% to5% of net revenues for the in-process technologies.

The effective tax rate used in the analysis of thein-process technologies reflects a combined historical industry specificaverage for the United States Federal and state statutory income tax rates. Thecost of capital reflects the estimated time to complete the projects and thelevel of risk involved. The following discount rates were used in computing thepresent value of net cash flows for the acquired companies: between 23% and 28%for the IBM i/p Series RAID business and approximately 24% for SnapAppliance.

The percentage of completion was determined usingcosts incurred by the IBM i/p Series RAID business and Snap Applianceprior to their respective acquisition dates compared to the estimated remainingresearch and development to be completed to bring the projects to technologicalfeasibility. The Company estimated, as of the respective acquisition dates forthe IBM i/p Series RAID business and Snap Appliance, that the projectswere approximately 50% complete and 25% complete, respectively. All projectsoutstanding as of the acquisition date for the IBM i/p Series RAIDbusiness ceased as of September 30, 2005 with the sale of the business.All projects outstanding as of the acquisition date for Snap Appliance werecompleted as of September 30, 2005.

Pro forma financial informationfor the second quarter and first half of fiscal 2005 has not been disclosed asthe acquisitions of the IBM i/p Series RAID business and Snap Appliancewere included as part of discontinued operations.

**17.   Glossary**

The following is alist of business related acronyms that are contained within this QuarterlyReport on Form 10-Q. They are listed in alphabetical order.

·       **ASIC:** Application Specific IntegratedCircuit

·       **ATA:** Advanced Technology Attachment

·       **DAS:** Direct-Attached Storage

·       **DPS:** Data Protection Solutions

·       **DSG:** Desktop Solutions Group

·       **ESPP:** Employee Stock Purchase Plan

·       **I/O:** Input/Output

·       **IP:** Internet Protocol

·       **IPsec:** Internet Protocol Security

·       **IRS:******InternalRevenue Service

·       **iSCSI:** Internet Protocol SCSI

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·       **NAS:** Network Attached Storage

·       **ODM:** Original Design Manufacturer

·       **OEM:** Original Equipment Manufacturer

·       **PC:** Personal Computer

·       **PCI:** Peripheral Component Interconnect

·       **RAID:** Redundant Array of Independent Disks

·       **ROC:** RAID on a Chip

·       **SAN:** Storage Area Networks

·       **SATA:** Serial Advanced Technology Attachment

·       **SCSI:** Small Computer System Interface

·       **SMI-S:** Storage Management InitiativeSpecification

·       **Ultra DMA:** Ultra Direct Memory Access

·       **USB:** Universal Serial Bus

·       **VARs:** Value Added Reseller

The following is alist of accounting rules and regulations and related regulatory bodiesreferred to within this Quarterly Report on Form 10-Q. They arelisted in alphabetical order.

·       **APB:** Accounting Principles Board

·       **APB Opinion No. 20:** Accounting Changes

·       **APB Opinion No. 25:**Accounting forStock Issued to Employees

·       **ARB:**Accounting Research Bulletin

·       **EITF:** Emerging Issues Task Force

·       **EITF No. 95-3:**Recognition ofLiabilities in Connection with Purchase Business Combinations

·       **EITF No. 96-18:**Accounting forEquity Instruments That Are Issued to Other Than Employees for Acquiring, or inConjunction with Selling, Goods or Services

·       **EITF No. 03-01:**The Meaning ofOther-Than-Temporary Impairment and Its Application to Certain Investments

·       **FASB:** Financial Accounting Standards Board

·       **FIN:** FASB Interpretation Number

·       **FIN 44:** Accounting for Certain TransactionsInvolving Stock Compensation

·       **SAB:**Staff Accounting Bulletin

·       **SAB 107:**Share Based Payment

·       **SEC:** Securities Exchange Commission

·       **SFAS:** Statement of Financial AccountingStandards

·       **SFAS No. 3:**Reporting AccountingChanges in Interim Financial Statements

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·       **SFAS No. 95:**Statement of Cash Flows

·       **SFAS No. 115:**Accounting for CertainInvestments in Debt and Equity Securities

·       **SFAS No. 123:**Accounting forStock-Based Compensation

·       **SFAS No. 123(R):**Share Based Payment

·       **SFAS No. 144:**Accounting for theImpairment or Disposal of Long-Lived Assets

·       **SFAS No. 146:**Accounting for CostsAssociated with Exit or Disposal Activities

·       **SFAS No. 148:**Accounting forStock-Based Compensation—Transition and Disclosure—an amendment of SFAS No. 123

·       **SFAS No. 151:**Inventory Costs—anamendment of ARB No. 43, Chapter 4

·       **SFAS No. 154:**Accounting Changes and Error Corrections, areplacement of APB Opinion No. 20 and SFAS No. 3

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**Item 2.**                        Management’sDiscussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q containsforward-looking statements that involve risks and uncertainties. The statementscontained in this document that are not purely historical are forward-lookingstatements within the meaning of Section 27A of the Securities Act of 1933and Section 21E of the Securities Exchange Act of 1934, including, withoutlimitation, statements regarding our expectations, beliefs, intentions orstrategies regarding our business, including, but not limited to, revenues fromour SCSI-based desktop products and our liquidity in future periods. We mayidentify these statements by the use of words such as “anticipate,” “believe,” “continue,”“could,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “potential,” “predict,”“project,” “should,” “will,” “would” and other similar expressions. Allforward-looking statements included in this document are based on informationavailable to us on the date hereof, and we assume no obligation to update anysuch forward-looking statements, except as may otherwise be required by law.

Our actual results could differ materially from thoseanticipated in these forward-looking statements as a result of certain factors,including those set forth in the “Risk Factors” section and elsewhere in thisdocument. In evaluating our business, current and prospective investors shouldconsider carefully these factors in addition to the other information set forthin this document.

While management believes that the discussion andanalysis in this report is adequate for a fair presentation of the informationpresented, we recommend that you read this discussion and analysis inconjunction with our Annual Report on Form 10-K for the year ended March 31,2005. Our critical accounting policies have not changed from our year ended March 31,2005. For a complete discussion of our critical accounting policies, pleaserefer to our Annual Report on Form 10-K for the year ended March 31,2005.

As discussed below, on September 30, 2005, wecompleted the sale to International Business Machnies, or IBM, of our IBM i/p Series RAIDcomponent business, or IBM i/p Series RAID Business, and on September 29,2005, the Company’s Board of Directorsapproved management’s recommendation to divest our systems business. Both ofthese businesses have been accounted for as discontinued operations. Accordingly, we have reclassified the underlyingUnaudited Condensed Consolidated Statements of Operations and Cash Flows andrelated disclosures for all periods presented to reflect the IBM i/p Series RAIDBusiness and systems business as discontinued operations. Unlessotherwise indicated, and other than balance sheet amounts as of March 31,2005, the following discussion pertains only to our continuing operations. In addition, in the second quarter offiscal 2006, we reorganized our reportable segments, which are described morefully in Note 14 to the Notes to the Unaudited Condensed Consolidated FinancialStatements.

For your convenience, wehave included, in Note 17 to the Notes to the Unaudited Condensed ConsolidatedFinancial Statements, a Glossary that contains a list of (1) key acronymscommonly used in our industry that are used in this Quarterly Report and (2) accountingrules and regulations that are also referred to herein. These key acronymsand accounting rules and regulations are listed in alphabetical order.

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**Results of Operations**

**Overview**

Our new managementteam is continuing to perform a thorough analysis of our operations, which itinitiated in the first quarter of fiscal 2006, and has begun making a detailedplan of our corporate strategy. This analysis of our operations includes areview of all aspects of our business, including our product portfolio, ourrelationships with strategic partners and our research and development focus. Duringthe second quarter of fiscal 2006, we implemented the following steps:

·       Wereorganized our internal organization structure related to our OEM and Channelsegments. Where historically our former OEM and Channel segments each offeredan integrated set of customer-focused products, the new organization is managedat the product level. At September 30, 2005, our reportable segments wereDPS and DSG. As a result of the segment reorganization, an assessment of therecoverability of goodwill was performed and we wrote-off the entire balance ofgoodwill of $90.6 million in the second quarter of fiscal 2006. All priorperiods have been restated to reflect our new segments.

·       OnSeptember 30, 2005, we sold our IBM i/p Series RAID Business to IBMfor approximately $22.0 million plus $1.3 million for certain fixed assets.In addition, IBM purchased certain related inventory at our net book value of$0.8 million. We also granted IBM a nonexclusive license to certainintellectual property and sold to IBM substantially all of the assets dedicatedto the engineering and manufacturing of RAID controllers and connectivityproducts for IBM’s i/p Series RAID Business. Under the terms of thenonexclusive license, IBM will pay us royalties for the sale of our board-levelproducts over the next six quarters, which will be recognized as contingentconsideration in discontinued operations when earned. A loss of$7.0 million was incurred on the disposal of the IBM i/p Series RAIDBusiness.

·       OnSeptember 29, 2005, our Board of Directors approved management’srecommendation to divest our systems business, which includes substantially allof the operating assets and cash flows that were obtained through the SnapAppliance and Eurologic Systems acquisitions as well as internally developedhardware and software. In connection with this action, we have classified thesystems business as a discontinued operation in the financial statements. Weexpect to receive proceeds, less cost to sell, in excess of its carrying value.

The actions that wehave taken and the actions that we are considering could adversely affect ourbusiness and financial results in the short-term, may not have the long-termbeneficial results that we intend and could result in the following:

·       Lossof customers;

·       Reducedrevenue base;

·       Impairmentof our assets;

·       Increasedoperating costs; and

·       Materialrestructuring charges.

Our future revenue growth remains largely dependent onthe success of our data protection solutions, new OEM design wins and ourproducts addressing new technologies (i.e., Serial Attached SCSI, SATA andiSCSI).

In the second quarter of fiscal 2006, our revenuesdecreased 17% as compared to the second quarter of fiscal 2005 primarilyreflecting a decline in sales volumes of our SCSI products, which was partiallyoffset by sales of our serial products primarily sold to OEMs. The declinein gross margin in the second 

27

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quarter of fiscal 2006compared to the second quarter of fiscal 2005 was primarily due to changes inour product and customer mix, which led to lower average selling prices, anexcess inventory adjustment of $1.6 million related to our dual tunerproducts in our DSG segment and fixed costs associated with our manufacturingfacilities that were distributed over lower revenue levels. Operating expensesdecreased in the second quarter of fiscal 2006 as compared to the secondquarter of fiscal 2005, primarily as a result of reduced headcount related tothe ServerEngines and Vitesse strategic alliances we entered into in the fourthquarter of fiscal 2005 and decreased infrastructure spending and reducedheadcount as a result of restructuring programs implemented in fiscal 2005.

Thefollowing table sets forth the items in the UnauditedCondensed Consolidated Statements of Operations as a percentage of netrevenues:

| ** **                                                        | ** ** | **Three-Month Period Ended(1)** | ** ** | **Six-Month Period Ended(2)** | ** ** |
|-------------------------------------------------------------------|------------|-------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                        | ** ** | **September 30,  2005**              | ** ** | **September 30,  2004**            | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
| Net revenues                                                      |       |                                      | 100        | %                                       |       |   | 100 | % |   |   | 100 | % |   |   | 100 | % |   |
| Cost of revenues                                                  |       |                                      | 65         |                                    |       |   | 53 |   |   |   | 66 |   |   |   | 53 |   |   |
| Gross margin                                                      |       |                                      | 35         |                                    |       |   | 47 |   |   |   | 34 |   |   |   | 47 |   |   |
| Operating expenses:                                               |       |                                      |       |                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Research and development                                          |       |                                      | 19         |                                    |       |   | 23 |   |   |   | 21 |   |   |   | 23 |   |   |
| Selling, marketing and administrative                             |       |                                      | 19         |                                    |       |   | 20 |   |   |   | 22 |   |   |   | 19 |   |   |
| Amortization of acquisition-related intangible  assets            |       |                                      | 2          |                                    |       |   | 2 |   |   |   | 2 |   |   |   | 3 |   |   |
| Restructuring charges                                             |       |                                      | 1          |                                    |       |   | 2 |   |   |   | 0 |   |   |   | 1 |   |   |
| Goodwill impairment                                               |       |                                      | 109        |                                    |       |   | — |   |   |   | 58 |   |   |   | — |   |   |
| Total operating expenses                                          |       |                                      | 150        |                                    |       |   | 47 |   |   |   | 103 |   |   |   | 46 |   |   |
| Income (loss)  from continuing operations                         |       |                                      | (115       | )                                       |       |   | 0 |   |   |   | (69 | ) |   |   | 1 |   |   |
| Interest and  other income                                        |       |                                      | 5          |                                    |       |   | 4 |   |   |   | 5 |   |   |   | 3 |   |   |
| Interest expense                                                  |       |                                      | (1         | )                                       |       |   | (1 | ) |   |   | (1 | ) |   |   | (1 | ) |   |
| Income (loss)  from continuing operations before income taxes     |       |                                      | (111       | )                                       |       |   | 3 |   |   |   | (65 | ) |   |   | 3 |   |   |
| Provision for  (benefit from) income taxes                        |       |                                      | 3          |                                    |       |   | (10 | ) |   |   | 2 |   |   |   | (5 | ) |   |
| Income (loss)  from continuing operations                         |       |                                      | (114       | )                                       |       |   | 13 |   |   |   | (67 | ) |   |   | 8 |   |   |
| Discontinued  operations, net of taxes (Note 4)              |       |                                      |       |                                    |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loss from  discontinued operations, net of taxes                  |       |                                      | (5         | )                                       |       |   | (21 | ) |   |   | (19 | ) |   |   | (12 | ) |   |
| Loss from  disposal of discontinued operations, net of taxes |       |                                      | (8         | )                                       |       |   | — |   |   |   | (5 | ) |   |   | — |   |   |
| Loss from  discontinued operations                                |       |                                      | (13        | )                                       |       |   | (21 | ) |   |   | (24 | ) |   |   | (12 | ) |   |
| Net loss                                                          |       |                                      | (127       | )%                                      |       |   | (8 | )% |   |   | (91 | )% |   |   | (4 | )% |   |

----

(1)          In the second quarter offiscal 2006, we recorded a goodwill impairment charge of $90.6 million(Note 6). In the second quarter of fiscal 2005, we implemented arestructuring plan. These transactions affect the comparability of this data.

(2)          Inthe first half of fiscal 2006, we recorded a goodwill impairment charge of$90.6 million. In the first half of fiscal 2005, we made a payment of $1.3million to Nevada SCSI Enterprises, Inc., or NSE, in the form of a licensefee (Note 7) and implemented restructuring plans in the first and secondquarters of fiscal 2005. These transactions affect the comparability of thisdata.

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**Net Revenues.**

| ** **                | ** ** | **Three-Month Period Ended**               | ** ** | **Six-Month Period Ended** | ** ** |
|---------------------------|------------|------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                | ** ** | **September 30,  2005**                         | ** ** | **September 30,  2004**         | ** ** | **Percentage  Change** | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** | **Percentage  Change** | ** ** |
| ** **                | ** ** | **(in millions, except percentages)** | ** ** |
| **Segment Net Revenues:** | ** ** |                                                 | ** ** | ** **                           |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| DPS                       |       |                                                 | $          | 72.1                                 | ** ** |   |   | $ | 90.4 | ** ** |   |   | (20 | )% |   |   | $ | 135.8 | ** ** |   |   | $ | 178.6 | ** ** |   |   | (24 | )% |   |
| DSG                       |       |                                                 | 11.1       | ** **                           |       |   | 9.4 | ** ** |   |   | 19 | % |   |   | 19.9 | ** ** |   |   | 20.0 | ** ** |   |   | 0 | % |   |
| **Total  Net Revenues**   |       |                                                 | 83.2       | ** **                           |       |   | 99.8 | ** ** |   |   | **(17** | **)**% |   |   | 155.7 | ** ** |   |   | 198.6 | ** ** |   |   | **(22** | **)**% |   |
|                           |            |                                                      |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Net revenues from our DPS segment decreased by$18.3 million and $42.8 million in the second quarter and first halfof fiscal 2006, respectively, as compared to the corresponding periods offiscal 2005, reflecting a decline in sales volumes of our SCSI products, whichwas partially offset by sales of our serial products primarily to OEMs. Thedecline in sales volumes of our SCSI products was primarily attributable to thetransition from our Ultra 160 products to Ultra 320 products in which we have alower market share, a shift to lower cost SATA solutions and motherboards thatcontain built-in SCSI I/O functionality, thus reducing our average sellingprice.

Netrevenues from our DSG segment increased by $1.7 million in the secondquarter compared to the second quarter of fiscal 2005 as a result of increasedsales of our digital media products and sales of storage products that wereintroduced in the fourth quarter of fiscal 2005, partially offset by thedecline in sales volumes of our SCSI-based desktop computer products. We expectrevenues from our SCSI-based desktop computer products to continue to declineas OEMs are incorporating connectivity technologies directly into theirproducts. Net revenues from our DSG segment remained relatively flat in thefirst half of fiscal 2006 compared to the first half of fiscal 2005.

| ** **                   | ** ** | **Three-Month Period Ended** | ** ** | **Six-Month Period Ended** | ** ** |
|------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|
| ** **                   | ** ** | **September 30,  2005**           | ** ** | **September 30,  2004**         | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
| **Geographical  Revenues:**  | ** ** |                                   | ** ** | ** **                           |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| North America                |       |                                   | 32         | %                                    |       |   | 37 | % |   |   | 34 | % |   |   | 38 | % |   |
| Europe                       |       |                                   | 31         | %                                    |       |   | 31 | % |   |   | 31 | % |   |   | 30 | % |   |
| Pacific Rim                  |       |                                   | 37         | %                                    |       |   | 32 | % |   |   | 35 | % |   |   | 32 | % |   |
| Total  Geographical Revenues |       |                                   | 100        | %                                    |       |   | 100 | % |   |   | 100 | % |   |   | 100 | % |   |

 

Our overall internationalrevenues increased as a percentage of our total gross revenues in thesecond quarter and first half of fiscal 2006 as compared to the correspondingperiods of fiscal 2005 primarily as a result of the decline in North Americasales in the channel. Included in European revenues for the second quarter andfirst half of fiscal 2006 was $5.7 million and $10.7 million, respectively, ofa last time buy customer order.

A small number of ourcustomers account for a substantial portion of our net revenues, and we expectthat a limited number of customers will continue to represent a substantialportion of our net revenues for the foreseeable future. IBM, Dell andHewlett-Packard accounted for 27%, 15% and 12% of our total net revenues,respectively, in the second quarter of fiscal 2006. IBM and Dell accounted for24% and 14% of our total net revenues, respectively, in the second quarter offiscal 2005. IBM, Dell and Hewlett-Packard accounted for 26%, 15% and 10% ofour total net revenues, respectively, in the first half of fiscal 2006. IBM,Dell and Synnex accounted for 21%, 14% and 11%, respectively, in the first halfof fiscal 2005.

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**Gross Margin.**

| ** **   | ** ** | **Three-Month Period Ended**               | ** ** | **Six-Month Period Ended** | ** ** |
|--------------|------------|------------------------------------------------------|------------|--------------------------------------|------------|
| ** **   | ** ** | **September 30,  2005**                         | ** ** | **September 30,  2004**         | ** ** | **Percentage  Change** | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** | **Percentage  Change** | ** ** |
| ** **   | ** ** | **(in millions, except percentages)** | ** ** |
| Gross Profit |       |                                                 | $          | 28.9                                 |       |   |   | $ | 46.6 | ** ** |   |   | (38 | )% |   |   | $ | 52.2 |   |   |   | $ | 93.6 | ** ** |   |   | (44 | )% |   |
| Gross Margin |       |                                                 | 35         | %                                    |       |   | 47 | % |   |   |   | ** ** |   |   | 34 | % |   |   | 47 | % |   |   | ** ** | ** ** |   |

 

The decline in grossmargin in the second quarter and first half of fiscal 2006 compared to thecorresponding periods of fiscal 2005 was primarily due to changes in ourproduct and customer mix, which led to lower average selling prices, an excessinventory adjustment of $1.6 million related to our dual tuner products in ourDSG segment, fixed costs associated with our manufacturing facilities that weredistributed over lower revenue levels and an excess inventory adjustment of$1.9 million recorded in the first half of fiscal 2006 related to thetransition of our products to comply with the European Union RoHS Directive.Our gross margins will be significantly impacted in the future by the mix ofOEM and channel revenue.

**Researchand Development Expense.**

| ** **                | ** ** | **Three-Month Period Ended**               | ** ** | **Six-Month Period Ended** | ** ** |
|---------------------------|------------|------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                | ** ** | **September 30,  2005**                         | ** ** | **September 30,  2004**         | ** ** | **Percentage  Change** | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** | **Percentage  Change** | ** ** |
| ** **                | ** ** | **(in millions, except percentages)** | ** ** |
| Research and  Development |       |                                                 | $          | 15.7                                 |       |   |   | $ | 22.3 |   |   |   | (30 | )% |   |   | $ | 31.9 |   |   |   | $ | 46.1 |   |   |   | (31 | )% |   |
|                           |            |                                                      |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The decrease in researchand development expense in the second quarter and first half of fiscal 2006 ascompared to the corresponding periods of fiscal 2005 was primarily a result ofreduced headcount achieved as a result of the ServerEngines and Vitessestrategic alliances we entered into in the fourth quarter of fiscal 2005,decreased infrastructure spending and reduced headcount as a result ofrestructuring programs implemented in fiscal 2005 and decreased deferredcompensation charges of $0.6 million and $1.4 million in the secondquarter and first half of fiscal 2006, respectively compared to thecorresponding periods of fiscal 2005. Deferred compensation charges representedthe vesting of assumed stock options in connection with our acquisition ofPlatys Communications, Inc., or Platys, in August 2001. Deferredcompensation charges associated with the Platys acquisition ceased in the firstquarter of fiscal 2006.

**Selling,Marketing and Administrative Expense.**

| ** **                             | ** ** | **Three-Month Period Ended**               | ** ** | **Six-Month Period Ended** | ** ** |
|----------------------------------------|------------|------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                             | ** ** | **September 30,  2005**                         | ** ** | **September 30,  2004**         | ** ** | **Percentage  Change** | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** | **Percentage  Change** | ** ** |
| ** **                             | ** ** | **(in millions, except percentages)** | ** ** |
| Selling,  Marketing and Administrative |       |                                                 | $          | 16.3                                 |       |   |   | $ | 20.2 |   |   |   | (19 | )% |   |   | $ | 33.6 |   |   |   | $ | 37.2 |   |   |   | (10 | )% |   |
|                                        |            |                                                      |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The decrease in selling,marketing and administrative expense in the second quarter and first half offiscal 2006 as compared to the corresponding periods of fiscal 2005 wasprimarily a result of decreased spending due to reductions of our workforce andinfrastructure spending as a result of the restructuring plans we implementedin fiscal 2005. This was partially offset by compensation of $1.2 millionrelated to retirement costs of our former Chief Executive Officer.

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**Amortization of Acquisition-Related IntangibleAssets.**

| ** **                                             | ** ** | **Three-Month Period Ended**               | ** ** | **Six-Month Period Ended** | ** ** |
|--------------------------------------------------------|------------|------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                             | ** ** | **September 30,  2005**                         | ** ** | **September 30,  2004**         | ** ** | **Percentage  Change** | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** | **Percentage  Change** | ** ** |
| ** **                                             | ** ** | **(in millions, except percentages)** | ** ** |
| Amortization of  Acquisition-Related Intangible Assets |       |                                                 | $          | 1.8                                  |       |   |   | $ | 2.4 |   |   |   | (26 | )% |   |   | $ | 3.8 |   |   |   | $ | 4.9 |   |   |   | (23 | )% |   |
|                                                        |            |                                                      |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Acquisition-related intangible assets include patents,core and existing technologies, covenants-not-to-compete, customer relationshipsand trade names. We amortize the acquisition-related intangible assets overperiods which reflect the pattern in which the economic benefits of the assetsare expected to be realized, which is primarily using the straight-line methodover their estimated useful lives, ranging from three months to five years.

The decrease inamortization of acquisition-related intangible assets in the second quarter andfirst half of fiscal 2006 compared to the corresponding periods of fiscal 2005was due to intangible assets that became fully amortized in August 2005associated with our Platys acquisition and certain intangible assets thatbecame fully amortized in fiscal 2005 associated with our acquisition ofEurologic Systems Group Limited in April 2003.

**Restructuring Charges.**

| ** **                   | ** ** | **Three-Month Period Ended**               | ** ** | **Six-Month Period Ended** | ** ** |
|------------------------------|------------|------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                   | ** ** | **September 30, **                         | ** ** | **September 30, **         | ** ** | **Percentage ** | ** ** | **September 30, ** | ** ** | **September 30, ** | ** ** | **Percentage** | ** ** |
| ** **                   | ** ** | **2005**                                             | ** ** | **2004**                             | ** ** | **Change** | ** ** | **2005** | ** ** | **2004** | ** ** | **Change** | ** ** |
| ** **                   | ** ** | **(in millions, except percentages)** | ** ** |
| Restructuring  Charges  |       |                                                 | $          | 0.5                                  |       |   |   | $ | 1.9 |   |   |   | (75 | )% |   |   | $ | 0.5 |   |   |   | $ | 2.7 |   |   |   | (81 | )% |   |
|                              |            |                                                      |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

In the first half offiscal 2006, we recorded provision adjustments of $0.5 million related toseverance and benefits as actual costs were lower than anticipated andadditional lease costs related to the estimated loss of facilities that wesubleased in California through April 2008 and the United Kingdom through December 2005,the end of the lease term. This restructuring charge pertained to our restructuringplans that we implemented in each quarter of fiscal 2005, and restructuringplans that we implemented in fiscal 2004, fiscal 2003, fiscal 2002 and fiscal2001. The fiscal 2004 restructuring plan was completed in the first quarter offiscal 2006. For a complete discussion of all restructuring actions that wereimplemented prior to fiscal 2006, please refer to the Notes to ConsolidatedFinancial Statements included in our Annual Report on Form 10-K forthe year ended March 31, 2005. All expenses, including adjustments,associated with our restructuring plans are included in “Restructuring charges”in the Unaudited Condensed Consolidated Statements of Operations and are notallocated to segments, but are managed at the corporate level.

**Goodwill Impairment.**

| ** **          | ** ** | **Three-Month Period Ended**               | ** ** | **Six-Month Period Ended** | ** ** |
|---------------------|------------|------------------------------------------------------|------------|--------------------------------------|------------|
| ** **          | ** ** | **September 30,  2005**                         | ** ** | **September 30,  2004**         | ** ** | **Percentage  Change** | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** | **Percentage  Change** | ** ** |
| ** **          | ** ** | **(in millions, except percentages)** | ** ** |
| Goodwill Impairment |       |                                                 | $          | 90.6                                 |       |   |   | $ | — |   |   |   | 100 | % |   |   | $ | 90.6 |   |   |   | $ | — |   |   |   | 100 | % |   |
|                     |            |                                                      |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Goodwill is not amortized,but instead is reviewed annually and whenever events or circumstances occurwhich indicate that goodwill might be impaired. As a result of the segmentreorganization discussed above and in Note 14 to the Notes to UnauditedCondensed Consolidated Financial Statements, an 

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assessmentof the recoverability of goodwill was performed. Impairment of goodwill istested at our operating segment level by comparing each segment’s carryingamount, including goodwill, to the fair value of that segment. To determinefair value, our review process uses the income, or discounted cash flows,approach and the market approach. In performing our analysis, we use the bestinformation available under the circumstances, including reasonable andsupportable assumptions and projections. If the carrying amount of theoperating segment exceeds its implied fair value, goodwill is consideredimpaired and a second step is performed to measure the amount of impairmentloss, if any. As a result of this review, we wrote-off our entire balance ofgoodwill in the second quarter of 2006. Factors that led to this conclusionwere industry technology changes such as parallel to serial technology andmigration of core functionality to server chipsets; required increasedinvestments that eventually led to the sale of the i/p Series RAID Business andthe proposed sale of the Systems Business; continued losses associated withsales of Systems to IBM; and general market conditions.

**Interest and Other Income.**

| ** **                           | ** ** | **Three-Month Period Ended**               | ** ** | **Six-Month Period Ended** | ** ** |
|--------------------------------------|------------|------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                           | ** ** | **September 30,  2005**                         | ** ** | **September 30,  2004**         | ** ** | **Percentage  Change** | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** | **Percentage  Change** | ** ** |
| ** **                           | ** ** | **(in millions, except percentages)** | ** ** |
| **Interest and Other Income:**       |       |                                                 |       |                                 |       |   |   |   |   |   |   | ** ** |   |   |   |   |   |   |   |   |   |   |   | ** ** |   |
| Interest income                      |       |                                                 | $          | 3.9                                  |       |   |   | $ | 3.0 |   |   |   | 31 | % |   |   | $ | 7.5 |   |   |   | $ | 5.8 |   |   |   | 31 | % |   |
| Payment of  license fee with NSE     |       |                                                 | —     |                                 |       |   | — |   |   |   | — |   |   |   | — |   |   |   | (1.3 | ) |   |   | 100 | % |   |
| Loss on  redemption of debt          |       |                                                 | 0.0        |                                 |       |   | — |   |   |   | (100 | )% |   |   | (0.1 | ) |   |   | — |   |   |   | (100 | )% |   |
| Other                                |       |                                                 | 0.6        |                                 |       |   | 0.7 |   |   |   | (9 | )% |   |   | 0.7 |   |   |   | 1.0 |   |   |   | (30 | )% |   |
| **Total  Interest and Other Income** |       |                                                 | 4.5        |                                 |       |   | 3.7 |   | ** ** | ** ** | **24** | % |   |   | 8.1 |   |   |   | 5.5 |   | ** ** | ** ** | **48** | % |   |
|                                      |            |                                                      |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Interest and other income is primarily attributable tointerest income earned on our cash, cash equivalents and marketable securities,fluctuations in foreign currency gains or losses, realized gains and losses onmarketable securities, sublease income received from third parties and lossfrom the repurchase of our 3% Notes.

The increase in interestand other income in the second quarter and first half of fiscal 2006 ascompared to the corresponding periods of fiscal 2005 was primarily due tohigher interest income earned on our cash, cash equivalents and marketablesecurities and a one-time fully paid-up license fee of $1.3 million toNSE, which was recorded in the first half of fiscal 2005, primarily forhistorical products that incorporated certain technology. This was partiallyoffset by foreign currency fluctuations primarily related to the Euro and aloss of $0.1 million on the repurchase of our 3% Notes for the first half offiscal 2006. For further discussion on the settlement with NSE and gain on thesale of the property, please refer to Note 7 to the Notes to UnauditedCondensed Consolidated Financial Statements.

**Interest Expense.**

| ** **       | ** ** | **Three-Month Period Ended**               | ** ** | **Six-Month Period Ended** | ** ** |
|------------------|------------|------------------------------------------------------|------------|--------------------------------------|------------|
| ** **       | ** ** | **September 30,  2005**                         | ** ** | **September 30,  2004**         | ** ** | **Percentage  Change** | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** | **Percentage  Change** | ** ** |
| ** **       | ** ** | **(in millions, except percentages)** | ** ** |
| Interest Expense |       |                                                 | $          | (0.9                                 | )          |   |   | $ | (1.1 | ) |   |   | (24 | )% |   |   | $ | (1.8 | ) |   |   | $ | (2.3 | ) |   |   | (19 | )% |   |
|                  |            |                                                      |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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Interest expense isprimarily associated with our 3⁄4% Convertible Senior Subordinated Notes, or 3⁄4%Notes and 3% Convertible Subordinated Notes, or 3% Notes, issued in December 2003and March 2002, respectively. The decrease in interest expense for thesecond quarter and first half of fiscal 2006 compared to the correspondingperiods of fiscal 2005 was primarily due to the reduction in the outstandingbalances of the 3% Notes, as we repurchased $3.4 million and $23.2 million inaggregate principal amount of our 3% Notes during the second quarter and firsthalf of fiscal 2006, respectively.

**Income Taxes.**

| ** **                                 | ** ** | **Three-Month Period Ended**               | ** ** | **Six-Month Period Ended** | ** ** |
|--------------------------------------------|------------|------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                 | ** ** | **September 30,  2005**                         | ** ** | **September 30,  2004**         | ** ** | **Percentage  Change** | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** | **Percentage  Change** | ** ** |
| ** **                                 | ** ** | **(in millions, except percentages)** | ** ** |
| Provision for  (Benefit from) Income Taxes |       |                                                 | $          | 2.6                                  |       |   |   | $ | (10.4 | ) |   |   | (124 | )% |   |   | $ | 3.4 |   |   |   | $ | (9.4 | ) |   |   | (137 | )% |   |
|                                            |            |                                                      |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Income tax provisions forinterim periods are based on our estimated annual effective income tax. Theestimated annual tax for fiscal 2006 primarily consists of foreign taxesrelated to our foreign subsidiaries and interest accrued on prior years’ taxdisputes. We currently has a full valuation allowance on its net deferred taxassets. The tax rate for the second quarter and first half of fiscal 2005differed from the combined United States Federal and state statutory income taxrate of 40% primarily due to certain acquisition-related intangible assets,excluding goodwill, that are not fully deductible for tax purposes and interestaccrued on prior years’ tax disputes. We are engaged in negotiations with theIRS with regard to various tax disputes that may result in the settlement ofcertain issues. Our tax rate for the period in which a settlement is reachedwill be impacted if the settlement materially differs from the amountspreviously accrued. The tax rate for second quarter and the first half offiscal 2005 also differs from the combined United States Federal and statestatutory income tax rate of 40% due to a benefit of $9.9 million fromdiscrete events relating to the method and amount of settled controversies. Asa result of the settlement, $4.1 million previously recorded as a taxprovision has been reclassified as a reduction to additional paid in capital,$1.8 million previously recorded as a tax provision has been reversed, anda $4.0 million tax benefit associated with a refund claim has beenrecognized during the second quarter of fiscal 2005.

**Discontinued Operations.**

| ** **               | ** ** | **Three-Month Period Ended**               | ** ** | **Six-Month Period Ended** | ** ** |
|--------------------------|------------|------------------------------------------------------|------------|--------------------------------------|------------|
| ** **               | ** ** | **September 30,  2005**                         | ** ** | **September 30,  2004**         | ** ** | **Percentage  Change** | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** | **Percentage  Change** | ** ** |
| ** **               | ** ** | **(in millions, except percentages)** | ** ** |
| Discontinued  Operations |       |                                                 | $          | (11.0                                | )          |   |   | $ | (20.8 | ) |   |   | (47 | )% |   |   | $ | (36.5 | ) |   |   | $ | (23.2 | ) |   |   | 57 | % |   |
|                          |            |                                                      |            |                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

** **

**IBMi/p Series RAID Business:****  **On September 30,2005, we sold our IBM i/p Series RAID Business to IBM for approximately$22.0 million plus $1.3 million for certain fixed assets. In addition, IBMpurchased certain related inventory at our net book value of $0.8 million. Wealso granted IBM a nonexclusive license to certain intellectual property andsold to IBM substantially all of the assets dedicated to the engineering andmanufacturing of RAID controllers and connectivity products for IBM’s i/p Series RAIDBusiness. Under the terms of the nonexclusive license, IBM will pay usroyalties for the sale of its board-level products over the next six quarters,which will be recognized as contingent consideration in discontinued operationswhen earned.

Under the terms of the arrangement, IBM forgave alloutstanding liabilities that existed at June 30, 2005 which were due underthe Distribution Agreement that was entered into in December 2004. Expensesincurred in the transaction primarily include costs of approximately $0.5million for legal and accounting 

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fees. In addition, weaccrued $0.3 million for lease obligations. A loss of $7.0 million was incurredon the disposal of the IBM i/p Series RAID Business, which was previouslyincluded in our DPS segment.

**SystemsBusiness:  **On September 29, 2005, our Board ofDirectors approved management’s recommendation to divest our systems business,which includes substantially all of the operating assets and cash flows thatwere obtained through the Snap Appliance and Eurologic Systems acquisitions aswell as internally developed hardware and software. In connection with thisaction, we have classified the systems business as a discontinued operation inthe financial statements . We have entered into an exclusive arrangement withan investment banker to sell this business and expect to receive proceeds, lesscost to sell, in excess of our carrying value.

**Liquidity and Capital Resources**

**Key Components of Cash Flows**

Cash used for operations was $11.3 million in thefirst half of fiscal 2006 as compared to cash provided by operations of$0.01 million in the first half of fiscal 2005. Cash used in the firsthalf of fiscal 2006 resulted primarily from our net loss from continuingoperations of $105.2 million. This was partially offset by the benefit ofnon-cash items included in operating results, which primarily consisted of animpairment of goodwill of $90.6 million and depreciation and amortization of$13.0 million. Additional factors included changes to working capitalassets and liabilities that decreased cash provided by operating activities by$15.1 million and cash provided by operating activities of discontinuedoperations of $5.1 million. Operating cash for the first half of fiscal2005 resulted primarily from our net income from continuing operations of $15.2million and depreciation and amortization of $19.0 million. This was partiallyoffset by the non-cash effect a taxsettlement of $4.1 million, changes to working capital assets and liabilitiesthat decreased cash provided by operating activities of continuing operationsby $18.4 million and cash used by operating activities of discontinuedoperations of $13.5 million.

Cash used for investing activities was$330.0 million in the first half of fiscal 2006, which was primarily dueto net sales and maturities of restricted marketable securities and marketablesecurities, net of purchases, of $325.6 million, proceeds from the sale of propertyand equipment of $2.7 million and purchases of property and equipment fromcontinuing operations of $5.4 million. Cash used for investing activitieswas $2.3 million in the first half of fiscal 2005, which was primarily dueto net sales and maturities of restricted marketable securities and marketablesecurities, net of purchases, of $128.9 million, offset by our use of$65.4 million of cash to acquire Snap Appliance and the IBM i/p Series RAIDbusiness and cash used in investing activities of discontinued operations of$59.3 million.

Cash used for financing activities of$20.4 million in the first half of fiscal 2006 was primarily driven by therepurchase of $23.2 million in aggregate principal amount of our 3% Notes for$23.0 million. Cash provided by financing activities was $3.8 millionin the first half of fiscal 2005, which related to net proceeds received fromour issuance of common stock in connection with stock option exercises.

**Liquidity.****  **At September 30,2005, we had $489.0 million in cash, cash equivalents and marketablesecurities, of which approximately $62.4 million was held by our Singaporesubsidiary. In the fourth quarter of fiscal 2005, we repatriated$360.6 million of undistributed earnings from Singapore to the UnitedStates and incurred a tax liability of $17.6 million. The repatriatedamounts will be used to fund a qualified Domestic Reinvestment Plan, asrequired by the American Jobs Creation Act of 2004. If we do not spend therepatriated funds in accordance with our reinvestment plan, we may incuradditional tax liabilities. We have not provided for U.S. deferred income taxesor foreign withholding taxes on the remaining undistributed earnings sincethese earnings totaling approximately $255.6 million are intended to bereinvested indefinitely. Although we do not have any current plans torepatriate the remaining undistributed earnings from our Singapore subsidiaryto our United States parent company, if we were to 

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do so, additional incometaxes at the combined United States Federal and state statutory rate ofapproximately 40% could be incurred from the repatriation.

At September 30, 2005, we had $237.0 millionof aggregate principal amount in convertible notes outstanding, consisting of$12.0 million in aggregate principal amount of our 3% Notes that are due in March 2007and $225.0 million in aggregate principal amount of our 3⁄4% Notes that are duein December 2023.

We are required to maintain restricted cash orinvestments to serve as collateral for the first ten scheduled interestpayments on our 3⁄4% Notes. As of September 30, 2005, we had$5.5 million of restricted cash and restricted marketable securities,consisting of United States government securities, of which $1.6 millionwas classified as short-term and $3.9 million was long-term.

The IRS is currently auditing our income tax returnsfor fiscal 1997 and final settlement agreements have been filed with the UnitedStates Tax Court on all but one issue. In addition, the IRS is auditing ourFederal income tax returns for fiscal 1998 through fiscal 2003. We haveresolved all issues for fiscal 1998 through fiscal 2001 other than the rolloverimpact of any potential resolution on the remaining fiscal 1997 issue and taxcredits that were generated but not used in subsequent years that may becarried back. The fiscal 2002 and 2003 audit is ongoing. We believe that wehave sufficient tax provisions for these years. We believe the final outcome ofthe IRS audits will not have a material adverse impact on our liquidity. However,we cannot predict with certainty how these matters will be resolved and whetherwe will be required to make additional payments.

As of September 30, 2005, we did not have anymaterial changes to our contractual obligations that were disclosed in theLiquidity section of our Form 10-K for the year ended March 31,2005.

We believe that liquidityprovided by our existing working capital, together with expected cash flowsfrom operations and available sources of equity and equipment financing, willbe sufficient to support our operations through at least the next twelvemonths. However, should prevailing economic conditions and/or financial,business and other factors beyond our control adversely affect our estimates ofour future cash requirements, we would be required to fund our cashrequirements by alternative financing. There can be no assurance thatadditional financing, if needed, would be available on terms acceptable to usor at all.

**Recent Accounting Pronouncements**

In June 2005, the FASB issued SFAS No. 154,which changes the requirements for the accounting for, and reporting of, achange in accounting principle. Previously, most voluntary changes inaccounting principles were required to be recognized by way of a cumulativeeffect adjustment within net income during the period of the change. SFAS No. 154requires retrospective application to prior periods’ financial statements,unless it is impracticable to determine either the period-specific effects orthe cumulative effect of the change. SFAS No. 154 is effective foraccounting changes made in fiscal years beginning after December 15, 2005;however, the Statement does not change the transition provisions of anyexisting accounting pronouncements. Our results of operations and financialcondition will only be impacted following the adoption of SFAS No. 154 ifit implements changes in accounting principles that are addressed by thestandard or corrects accounting errors in future periods.

In December 2004, the FASB issued SFAS No. 123(R).This statement replaces SFAS No. 123, amends SFAS No. 95 andsupersedes APB Opinion No. 25. SFAS No. 123(R) requirescompanies to apply a fair-value based measurement method in accounting forshare-based payment transactions with employees and to record compensationexpense for all stock awards granted and to awards modified, repurchased orcancelled after the required effective date. In addition, we are required torecord compensation expense (as previous awards continue to vest) for theunvested portion of previously granted 

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awards that remainoutstanding at the date of adoption. In April 2005, the SEC approved thatSFAS No. 123(R) will be effective for annual periods, as opposedto interim periods as originally issued by the FASB, beginning after June 15,2005. We are currently evaluating the impact of adopting this statement;however, we expect that it will have a significant impact on our consolidatedfinancial statements. The impact on our consolidated financial statements willdepend on the transition method, the option-pricing model used to compute fairvalue and the inputs to that model such as volatility and expected life. Thepro forma disclosures of the impact of SFAS No. 123 provided inNote 3 of the Notes to the Unaudited Condensed Consolidated FinancialStatements may not be representative of the impact of adopting this statement.

In March 2005, the SEC issued SAB 107, whichoffers guidance on SFAS No. 123(R). SAB 107 was issued to assist preparersby simplifying some of the implementation challenges of SFAS No. 123(R) whileenhancing the information that investors receive. SAB 107 creates a frameworkthat is premised on two overarching themes: (a) considerable judgment willbe required by preparers to successfully implement SFAS No. 123(R),specifically when valuing employee stock options; and (b) reasonableindividuals, acting in good faith, may conclude differently on the fair valueof employee stock options. Key topics covered by SAB 107 include valuationmodels, expected volatility and expected term. We will apply the principles ofSAB 107 in conjunction with our adoption of SFAS No. 123(R).

In November 2004, the FASB issued SFAS No. 151,which clarifies the accounting for abnormal amounts of facility expense,freight, handling costs and wasted materials (spoilage) to require them to berecognized as current-period charges. This statement is effective for inventorycosts incurred during fiscal years beginning after June 15, 2005. Earlierapplication is permitted. The adoption of this standard is not expected to havea material impact on our financial statements.

At its March 2004meeting, the EITF reached a consensus on recognition and measurement guidancepreviously discussed under EITF 03-01. The consensus clarified themeaning of other-than-temporary impairment and its application to investmentsclassified as either available-for-sale or held-to-maturity under SFAS No. 115and investments accounted for under the cost method or the equity method. In September 2004,the FASB delayed the recognition and measurement guidance to be applied toother-than-temporary impairment evaluations. The FASB expects to issueadditional implementation guidance with respect to debt securities that areimpaired solely due to interest rates and/or sector spreads. If this additionalimplementation guidance is issued as currently written, we may have to recognizeunrealized losses on investments in the Statements of Operations. If there is amaterial decline in the fair value of investments, our financial statementscould be adversely affected.

**RISK FACTORS**

Our business faces significant risks. The risksdescribed below may not be the only risks we face. Additional risks that we donot yet know of or that we currently think are immaterial may also impair ourbusiness operations. If any of the events or circumstances described in thefollowing risks actually occurs, our business, financial condition or resultsof operations could suffer, and the trading price of our common stock coulddecline.

Our new managementteam is continuing to perform a thorough analysis of our operations, which itinitiated in the first quarter of fiscal 2006, and has begun making a detailedplan of our corporate strategy. This analysis of our operations includes areview of all aspects of our business, including our product portfolio, ourrelationships with strategic partners and our research and development focus. Duringthe second quarter of fiscal 2006, we implemented the following steps:

·       Wereorganized our internal organization structure related to our OEM and Channelsegments. Where historically our former OEM and Channel segments each offeredan integrated set of customer-focused products, the new organization is managedat the product level. At September 30, 

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2005, our reportablesegments were DPS and DSG. As a result of the segment reorganization, anassessment of the recoverability of goodwill was performed and we wrote-off theentire balance of goodwill of $90.6 million in the second quarter of fiscal2006.

·       OnSeptember 30, 2005, we sold our IBM i/p Series RAID Business to IBMfor approximately $22.0 million plus $1.3 million for certain fixed assets. Inaddition, IBM purchased certain related inventory at our net book value of $0.8million. We also granted IBM a nonexclusive license to certain intellectualproperty and sold to IBM substantially all of the assets dedicated to the engineeringand manufacturing of RAID controllers and connectivity products for IBM’s i/p Series RAIDBusiness. Under the terms of the nonexclusive license, IBM will pay usroyalties for the sale of our board-level products over the next six quarters,which will be recognized as contingent consideration in discontinued operationswhen earned. A loss of $7.0 million was incurred on the disposal of theIBM i/p Series RAID Business.

·       OnSeptember 29, 2005, our Board of Directors approved management’srecommendation to divest our systems business, which includes substantially allof the operating assets and cash flows that were obtained through the SnapAppliance and Eurologic Systems acquisitions as well as internally developedhardware and software. In connection with this action, we has classified thesystems business as a discontinued operation in the financial statements. Weexpect to receive proceeds, less cost to sell, in excess of its carrying value.

The actions that wehave taken and the actions that we are considering could adversely affect ourbusiness and financial results in the short-term, may not have the long-termbeneficial results that we intend and could result in the following:

·       Lossof customers;

·       Reducedrevenue base;

·       Impairmentof our assets;

·       Increasedoperating costs; and

·       Materialrestructuring charges.

***If we are unable tosuccessfully complete the divestiture of our systems business it could resultin an adverse effect on our business and financial results.***   Completingthe systems divestiture could cause significant diversions of management timeand resources. In addition, if the anticipated proceeds, less cost to sell,prove to be less than anticipated, it could lead to an impairment of ourassets. Additionally, customers for our systems products could be reluctant tocontinue to buy from us. We may not be successful in selling the systemsbusiness on terms that are acceptable to us or might not be able to find abuyer for the business. We may not be successful in overcoming these risks orany other problems encountered in connection with this divesture which mayadversely affect our business, financial position and operating results.

***Our operatingresults have fluctuated in the past, and are likely to continue to fluctuate,and if our future results are below the expectations of investors or securitiesanalysts, the market price of our common stock would likely declinesignificantly.***   Our quarterly operatingresults have fluctuated in the past, and are likely to vary significantly inthe future, based on a number of factors related to our industry and themarkets for our products. Factors that are likely to cause our operatingresults to fluctuate include those discussed in this Risk Factors section. Inthe first half of fiscal 2006, our operating results were materially affectedby unusual charges, including a goodwill impairment charge of $90.6 million andan excess inventory adjustment of $1.9 million related to the transition of ourproducts to comply with the RoHS Directive.

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Our operating expenses are largely based onanticipated revenues, and a large portion of our expenses, including facilitycosts and salaries, are fixed in the short term. As a result, lower thananticipated revenues for any reason could cause significant variations in ouroperating results from quarter to quarter.

Due to the factors summarized above, and the otherrisks described in this section, we believe that you should not rely onperiod-to-period comparisons of our financial results as an indication of ourfuture performance. In the event that our operating results fall below theexpectations of market analysts or investors, the market price of our commonstock could decline substantially.

***Our operating results may be adversely affected byunfavorable economic and market conditions and the uncertain geopoliticalenvironment.***   Adverse economic conditions insome markets may impact our business, which could result in:

·       Reduceddemand for our products as a result of a decrease in capital spending by ourcustomers;

·       Increasedprice competition for our products;

·       Increasedrisk of excess and obsolete inventories;

·       Excessfacilities and manufacturing capacity; and

·       Higheroverhead costs as a percentage of revenues.

Demand for our products would likely be negativelyaffected if demand in the server and network storage markets declines. Forexample, demand in the server market declined slightly in fiscal 2002 andfiscal 2003, which contributed to a decline in our net revenues. It isdifficult to predict future server sales growth, if any. In addition, othertechnologies may replace the technologies used in our existing products and theacceptance of our products using new technologies in the market may not bewidespread, which could adversely affect our revenues.

***Because our salesare made by means of standard purchase orders rather than long-term contracts,if demand for our customers’ products declines or if our customers do notcontrol their inventories effectively, they may cancel or reschedule shipmentspreviously ordered from us or reduce their levels of purchases from us.***   Thevolume and timing of orders received during a quarter are difficult toforecast. Our customers generally order based on their forecasts and theyfrequently encounter uncertain and changing demand for their products. Ifdemand falls below such forecasts or if our customers do not control theirinventories effectively, they may cancel or reschedule shipments previouslyordered from us. Our customers have from time to time in the past canceled orrescheduled shipments previously ordered from us, and we cannot assure you thatthey will not do so in the future. In addition, because our sales are made bymeans of standard purchase orders rather than long-term contracts, we cannotassure you that these customers will continue to purchase quantities of our productsat current levels, or at all. Historically, we have set our operating budgetbased on forecasts of future revenues because we do not have significantbacklog. Because much of our operating budget is relatively fixed in theshort-term, if revenues do not meet our expectations, then our financialresults will be adversely affected.

***We depend on a fewkey customers and the loss of any of them could significantly reduce ourrevenues.******  ***Historically, a small number of ourcustomers has accounted for a significant portion of our revenues. During thefirst half of fiscal 2006, sales to the ten customers from which we receivedthe greatest revenues accounted for approximately 81% of our total grossrevenues. In addition, IBM, Dell and Hewlett-Packard represented 27%, 15% and12%, respectively, of our total net revenues in the first half of fiscal 2006.We believe that our major customers continually evaluate whether or not topurchase products from alternate or additional sources. Additionally, customers’economic and market conditions frequently change. Accordingly, we cannot assureyou that a major customer will not reduce, delay or eliminate its purchasesfrom us, which would likely cause our revenues to decline. In addition, we donot carry credit insurance on 

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our accounts receivablesand any difficulty in collecting outstanding amounts due from our customers,particularly customers that place larger orders or experience financialdifficulties, could adversely affect our revenues and our net income. Becauseour sales are made by means of standard purchase orders rather than long-termcontracts, we cannot assure you that these customers will continue to purchasequantities of our products at current levels, or at all.

***Our dependence on new products may cause our netrevenues to fluctuate or decline.******  ***Our futuresuccess significantly depends upon our completing and introducing enhanced andnew products at competitive prices and performance levels in a timely manner.The success of new product introductions depends on several factors, includingthe following:

·       Designingproducts to meet customer needs;

·       Productcosts;

·       Timelycompletion and introduction of new product designs;

·       Qualityof new products;

·       Differentiationof new products from those of our competitors; and

·       Marketacceptance of our products.

Our product life cycles in each of our segments may beas brief as 12 months. As a result, we believe that we will continue toincur significant expenditures for research and development in the future. Wemay fail to identify new product opportunities and may not develop and bringnew products to market in a timely manner. In addition, products ortechnologies developed by others may render our products or technologiesobsolete or noncompetitive, or our targeted customers may not select ourproducts for design or integration into their products. The failure of any ofour new product development efforts could have an adverse effect on our businessand financial results.

We have introduced RAID-enabled products based on thenext generation SATA technology and delivered our products based on SerialAttached SCSI technology to certain major OEMs for testing andintegration. We will not succeed in generating significant revenues from ournew SATA and Serial Attached SCSI technology products if the market does notadapt to these new technologies, which would, over time, adversely affect ournet revenues and operating results.

***Our reliance onindustry standards and technological changes in the marketplace may cause ournet revenues to fluctuate or decline.***   Thecomputer industry is characterized by various, evolving standards andprotocols. We design our products to conform to certain industry standards andprotocols such as the following:

*Technologies:*

·       ATA

·       Fibrechannel

·       FireWire/1394

·       IPsec

·       iSCSI

·       PCI

·       PCI-Express

·       PCI-X

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·       RAID

·       SerialAttached SCSI

·       SATA

·       SCSI

·       SMI-S

·       UltraDMA

·  USB

*Operating Systems:*

·       Linux

·       Macintosh

·       Netware

·       OS/2

·       UNIX

·       Windows

If user acceptance of these standards declines, or ifnew standards emerge, and if we do not anticipate these changes and develop newproducts, these changes could adversely affect our business and financialresults.

***If we lose the cooperation of other hardware andsoftware producers whose products are integral to ours, our ability to sustainor grow our revenues could be adversely affected.***   Wemust design our products to operate effectively with a variety of hardware andsoftware products supplied by other manufacturers, including the following:

·       Microprocessors;

·       Peripherals;and

·       Operatingsystem software.

We depend on significant cooperation from thesemanufacturers to achieve our design objectives and develop products thatoperate successfully with their products. These companies could, from time totime, elect to make it more difficult for us to design our products forsuccessful operability with their products. For example, if one or more ofthese companies were to determine that as a result of competition or otherfactors our technology or products would not be broadly accepted by the marketswe target, these companies may no longer work with us to plan for new productsand new generations of our products, which would make it more difficult tointroduce products on a timely basis or at all. Further, some of thesecompanies might decide not to continue to offer products that are compatiblewith our technology and our markets could contract. If any of these events wereto occur, our revenue could be adversely affected.

***We depend oncontract manufacturers and subcontractors, and if they fail to meet ourmanufacturing needs, it could delay shipments of our products and result in theloss of customers.***   We rely on contractmanufacturers for manufacturing of a portion of our systems products andsubcontractors for the assembly and packaging of the integrated circuitsincluded in our products and for the assembly. We have no long-term agreementswith our assembly and packaging subcontractors. We have, from time to time,used board subcontractors to better balance production runs and capacity. Forexample, we employ Quanta 

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Computer, Inc. andSanmina-SCI Corporation to manufacture certain products related to theacquisition of Snap Appliance. We also employ Amkor Technology and AdvancedSemiconductor Engineering for our final assembly and test operations related toour ASIC products. We cannot assure you these subcontractors will continue tobe able and willing to meet our requirements for these components or services.For example, in the third quarter of fiscal 2005, Quanta Computer, Inc.could not meet our manufacturing needs and as a result initial product deliverydates committed to customers were not met. Any significant disruption in suppliesfrom or degradation in the quality of components or services supplied by, thesesubcontractors could delay shipments and result in the loss of customers orrevenues, which could have an adverse effect on our financial results. Ourmanagement team is evaluating increasing the use of contract manufacturers. Ifthey decide to do so the risks identified above will increase.

***We are subject tovarious environmental laws and regulations that could impose substantial costsupon us and may adversely affect our business.***   TheEuropean Parliament has enacted the Restriction on Use of Hazardous SubstancesDirective, or RoHS Directive, which restricts the sale of new electrical andelectronic equipment containing certain hazardous substances, including leadthat is currently used in some of the products we manufacture. We are workingto modify our manufacturing processes to eliminate lead from our products inaccordance with the timelines established in the RoHS Directive. This mayrequire us to make additional capital expenditures. In addition, the costsassociated with compliance may negatively impact our operating results andcompetitive position. For example, in the first half of fiscal 2006, we had anexcess inventory adjustment of $1.9 million related to the transition of ourproducts to comply with the RoHS Directive. We are also working with oursuppliers to redesign or reformulate their components containing lead to reduceor eliminate lead in our products. If we are unable to comply with the RoHSDirective, we may suffer a loss of revenue, be unable to sell affected productsin certain markets or countries and be at a competitive disadvantage.

The European Parliament has also recently finalizedthe Waste Electrical and Electronic Equipment Directive, or WEEE Directive,which makes producers of electrical and electronic equipment financiallyresponsible for specified collection, recycling, treatment and disposal of pastand future covered products. We may incur financial responsibility for thecollection, recycling, treatment or disposal of products covered under the WEEEDirective. Because the EU member states have not fully implemented the WEEEDirective, the nature and extent of the costs to comply and fees or penaltiesassociated with non-compliance are unknown at this time. Costs to comply withthe WEEE Directive and similar future legislation, if applicable, may alsoinclude legal and regulatory costs and insurance costs. We may also be requiredto take reserves for costs associated with compliance with these regulations.

***We entered intostrategic alliances with Vitesse for the development of our Serial AttachedSCSI ROC product and with ServerEngines to advance our development of iSCSIproducts, and if these companies fail to develop and bring new products to marketin a timely manner it could result in an adverse effect on our business andfinancial results.***   In January 2005, weentered into a strategic alliance with Vitesse for it to develop and market thenext generation of our Serial Attached SCSI products. In March 2005, weentered into a strategic alliance with ServerEngines to develop and market thenext generation of our IP storage products, such as 10Gb iSCSI. Accordingly, weare at risk that Vitesse and ServerEngines may encounter challenges in fulfillingtheir responsibilities under these alliances, such as timely completing andintroducing new product designs, maintaining the quality of new products,minimizing product costs, differentiating new products from those of ourcompetitors and achieving market acceptance of our products. The failure ofthis new product development effort could have an adverse effect on ourbusiness and financial results.

***If we do notprovide adequate support during our customers’ design and development stage, orif we are unable to provide such support in a timely manner, we may loserevenues to our competitors.***   Certain of ourproducts are designed to meet our customers’ specifications and, to the extentwe are not able to meet these expectations in a timely manner or provideadequate support during our customers’ design and 

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development stage, ourcustomers may choose to buy similar products from another company. If this wereto occur we may lose revenues and market share to our competitors.

***If we are unable to compete effectively, our netrevenues could be adversely affected.******  ***The marketsfor all of our products are intensely competitive and are characterized by thefollowing:

·       Rapidtechnological advances;

·       Frequentnew product introductions;

·       Evolvingindustry standards; and

·       Priceerosion.

Consequently, we must continue to enhance our productson a timely basis to keep pace with market demands. If we do not do so, or ifour competition is more effective in developing products that meet the needs ofour existing and potential customers, we may lose market share and notparticipate in the future growth of our target markets. For example, intensecompetition in the transition from products employing Ultra 160 technology toproducts employing Ultra 320 technology has adversely affected revenues fromour SCSI products. Our future success will depend on the level of acceptance ofour external storage products and products based on the next generation SATAand Serial Attached SCSI technologies by new and existing customers. Inaddition, we expect that our future success will depend significantly on ourability to participate in the ongoing development of the network storage marketin which we face intense competition from other companies that are alsofocusing on networked storage products.

We cannot assureyou that we will have sufficient resources to accomplish all of the following:

·       Satisfyany growth in demand for our products;

·       Maketimely introductions of new products;

·       Competesuccessfully in the future against existing or potential competitors;

·       ProvideOEMs with design specifications in a timely manner; and

·       Preventprice competition from eroding margins.

***Costs associated with acquisitions or strategicalliances may adversely affect our results of operations, which could beexacerbated if we are unable to integrate the acquired companies, products ortechnologies.***   In fiscal 2005, we acquiredSnap Appliance and the i/p Series RAID business from IBM. In fiscal 2004,we acquired Elipsan, ICP vortex, a provider of a broad range of hardware andsoftware RAID data protection products, and Eurologic, a provider of externaland networked storage products. In addition, we enter into strategic alliancesfrom time to time with other companies. For example, we entered into strategicalliances with Vitesse and ServerEngines in January and March 2005,respectively. As part of our overall strategy, we may continue to acquire orinvest in complementary companies, products or technologies and enter intostrategic alliances with other companies. In order to be successful in theseactivities, we must:

·       Conductacquisitions that are timely, relative to existing business opportunities;

·       Successfullyprevail over competing bidders for target acquisitions at an acceptable price;

·       Investin companies and technologies that contribute to the growth of our business;

·       Incorporateacquired operations into our business and maintain uniform standards, controlsand procedures;

·       Retainthe key employees of the acquired operations; and

·       Developthe capabilities necessary to exploit newly acquired technologies.

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The benefits of acquisitions or strategic alliancesmay prove to be less than anticipated and may not outweigh the costs reportedin our financial statements. For example, during the first half of fiscal 2006,we sold the IBM i/p Series RAID Business for a loss of $7.0 million andplan to divest our systems business, which includes certain assets we obtainedthrough the Snap Appliance and Eurologic Systems acquisitions.

Completing any potential future acquisitions orstrategic alliances could cause significant diversions of management time andresources. If we acquire new businesses, products or technologies in thefuture, we may be required to assume warranty claims or other contingentliabilities, including liabilities unknown at the time of acquisition, andamortize significant amounts of other intangible assets and, over time,recognize significant charges for impairment of goodwill, other intangibleassets or other losses. If we consummate any potential future acquisitions inwhich the consideration consists of stock or other securities, our existingstockholders’ ownership may be significantly diluted. If we proceed with anypotential future acquisitions in which the consideration is cash, we may berequired to use a substantial portion of our available cash. In addition, wemay be required to invest significant resources in order to perform under astrategic alliance or to complete an acquisition, which could adversely affectour results of operations, at least in the short-term, even if we believe thestrategic alliance or acquisition will benefit us in the long-term. We may notbe successful in overcoming these risks or any other problems encountered inconnection with these or other business combinations, investments or strategicalliances. These transactions may adversely affect our business, financialposition and operating results.

***Product qualityproblems could lead to reduced revenues and gross margins.******  ***We producehighly complex products that incorporate leading-edge technologies, includingboth hardware and software. Software often contains “bugs” which can interferewith expected operations. We cannot assure you that our pre-shipment testingprograms will be adequate to detect all defects which might interfere withcustomer satisfaction, reduce sales opportunities, or affect our gross marginsif the costs of remedying the problems exceed reserves established for thatpurpose. An inability to cure a product defect could result in the failure of aproduct line, and withdrawal, at least temporarily, from a product or marketsegment, damage to our reputation, inventory costs, product reengineeringexpenses, and a material impact on revenues and gross margins.

***If there is ashortage of components used in our customers’ products, our sales may decline,which could adversely affect our results of operations and financial position.***   Ifour customers are unable to purchase certain components which are embedded intotheir products, their demand for our products may decline. For example,beginning in the fourth quarter of fiscal 2005, we experienced the impact ofother companies’ enterprise drive shortages, which reduced the demand for ourSCSI-related products from our OEM and Channel customers. This negativelyaffected our revenues in the fourth quarter of fiscal 2005. Similar shortagesof components used in our customers’ products could adversely affect our netrevenues and financial results in future periods.

***The manufacture and introduction of our products ishighly complex.******  ***We confront challenges in themanufacturing process that require us to:

·       Maintaina competitive manufacturing cost structure;

·       Implementthe latest process technologies required to manufacture new products;

·       Exercisestringent quality control measures to ensure high yields;

·       Effectivelymanage inventory levels;

·       Effectivelymanage the subcontractors engaged in the wafer fabrication, test and assemblyof products; and

·       Updateequipment and facilities as required for leading-edge production capabilities.

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We cannot assure you that problems with ourmanufacturing process may not occur in the future. If any such problems withour manufacturing process were to occur, we might not be able to meet thedemands of our customers, which could harm our reputation, result in the lossof customers and adversely affect our net revenues and financial results infuture periods.

***We currently purchase all of the finished productionsilicon wafers used in our products from wafer suppliers, and if they fail tomeet our manufacturing needs, it would delay our production and our productshipments to customers and negatively affect our operations.***   Independentfoundries manufacture to our specifications all of the finished silicon wafersused for our products. We currently purchase finished production silicon wafersused in our products from Taiwan Semiconductor Manufacturing Company, or TSMC,and IBM. The manufacture of semiconductor devices is sensitive to a widevariety of factors, including the following:

·       Theavailability of raw materials;

·       Theavailability of manufacturing capacity;

·       Transitionto smaller geometries of semiconductor devices;

·       Thelevel of contaminants in the manufacturing environment;

·       Impuritiesin the materials used; and

·       Theperformance of personnel and equipment.

We cannot assure you that manufacturing problems maynot occur in the future. A shortage of raw materials or production capacitycould lead our wafer suppliers to allocate available capacity to othercustomers. Any prolonged inability to obtain wafers with competitiveperformance and cost attributes, adequate yields or timely deliveries woulddelay our production and our product shipments, and could have an adverseeffect on our business and financial results. We expect that our wafersuppliers will continually seek to convert their processes for manufacturingwafers to more advanced process technologies. Such conversions entail inherenttechnological risks that can affect yields and delivery times. If for anyreason the wafer suppliers we use are unable or unwilling to satisfy our waferneeds, we will be required to identify and qualify additional suppliers. Additionalwafer suppliers may be unavailable, may take significant amounts of time toqualify or may be unable to satisfy our requirements on a timely basis.

***We depend on theefforts of our distributors, which if reduced, could result in a loss of salesof our products in favor of competitive offerings.***   Wederived approximately 39% of our gross revenues for the first half of fiscal2006 from independent distributor and reseller channels. Our financial resultscould be adversely affected if our relationships with these distributors orresellers were to deteriorate or if the financial condition of thesedistributors or resellers were to decline.

Our distributors generally offer a diverse array ofproducts from several different manufacturers. Accordingly, we are at risk thatthese distributors may give higher priority to selling products from othersuppliers. A reduction in sales efforts by our current distributors couldadversely affect our business and financial results. For example, some of ourdistributors have threatened to stop selling our products or make pricing ofour products non-competitive if we do not agree to absorb their costs to complywith the RoHS and WEEE Directives with respect to our products. Ourdistributors build inventories in anticipation of future sales, and if suchsales do not occur as rapidly as they anticipate, our distributors willdecrease the size of their product orders. If we decrease our price protectionor distributor-incentive programs, our distributors may also decrease theirorders from us. In addition, we have from time to time taken actions to reducelevels of products at distributors and may do so in the future. These actionsmay affect our net revenues and negatively affect our financial results.

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***We reorganized ourbusiness segments and have planned significant system enhancements andimprovements, and these changes could adversely impact our business if notadequately managed and controlled.***   Inthe second quarter of fiscal 2006, we reorganized our internal organizationstructure related to our OEM and Channel segments. Where historically ourformer OEM and Channel segments each offered an integrated set ofcustomer-focused products, the new organization is managed at the productlevel. The reorganization has placed demands on our management and ouroperational and financial infrastructure. In addition, management is in theprocess of enhancing our supply-chain systems and processes. These systemenhancements and improvements require expenditures and allocation of managementresources. If these improvements are not implemented successfully, our abilityto manage our new organization could be impaired. In addition, we may berequired to incur additional expenditures to address these issues, which couldharm our financial position.

***If we do not meetour restructuring objectives, we may have to implement additional plans inorder to reduce our operating costs and may, as a result, incur additional materialrestructuring charges.***   We have implemented severalrestructuring plans to reduce our operating costs in fiscal 2005, fiscal 2004and fiscal 2003, and recorded related restructuring charges of$5.9 million, $4.3 million and $14.3 million, respectively. Theplans included primarily the reduction of our workforce and the consolidationof our manufacturing operations in Singapore. The goals of these plans were tosupport future growth opportunities, focus on investments that grow revenuesand increase operating margins. If we do not meet our restructuring objectives,we may have to implement additional restructuring plans to reduce our operatingcosts, which could cause us to incur material restructuring charges. Further,these restructuring plans may not achieve the goals we had in implementing themdue to such factors as significant costs or restrictions on workforcereductions that may be imposed in some international locales and a potentialadverse effect on employee morale that could harm our efficiency and ourability to act quickly and effectively in the rapidly changing technologymarkets in which we sell our products.

***Some of ourproducts contain “open source” software, and any failure to comply with theterms of one or more of these open source licenses could negatively affect ourbusiness.***   Some of our products are distributedwith software licensed by its authors or other third parties under so-called “opensource” licenses, including, for example, the GNU General Public License, orGPL, GNU Lesser General Public License, or LGPL, the Mozilla Public License,the BSD License, and the Apache License. Some of those licenses may require asa condition of the license that we make available source code for modificationsor derivative works we create based upon, incorporating, or using the opensource software, that we provide notices with our products, and/or that welicense such modifications or derivative works under the terms of a particularopen source license or other license granting third parties certain rights offurther use. If an author or other third party that distributes such opensource software were to allege that we had not complied with the conditions ofone or more of those open source licenses, we could be required to incur legalexpenses in defending against such allegations, and if our defenses were notsuccessful we could be enjoined from distribution of the products thatcontained the open source software and required to either make the source codefor the open source software available, to grant third parties certain rightsof further use of our software, or to remove the open source software from ourproducts, which could disrupt our distribution and sale of some of ourproducts. In addition, if we combine our proprietary software with open sourcesoftware in a certain manner, we could under some of the open source licenses,be required to release the source code of our proprietary software. If anauthor or other third party that distributes open source software were toobtain a judgment against us based on allegations that we had not complied withthe terms of any such open source licenses, we could also be subject toliability for copyright infringement damages and breach of contract for ourpast distribution of such open source software.

***Our operationsdepend on key personnel, the loss of whom could affect the growth and successof our business.******  ***In order to be successful, wemust retain and motivate our executives, the general managers of our businesssegments, our principal engineers and other key employees, including those inmanagerial, 

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technical, marketing andinformation technology support positions. In particular, our product generationefforts depend on hiring and retaining qualified engineers. Competition forexperienced management, technical, marketing and support personnel remainsintense. For example, we transitioned certain research and development effortsto North Carolina, where we have experienced significant competition in ourefforts to attract and retain qualified software engineers. The loss of any ofthese key employees could have a significant impact on our operations. We also mustcontinue to motivate employees and keep them focused on our strategies andgoals, which may be particularly difficult due to morale challenges posed byworkforce reductions, the announcement of the diverstiture of the systemsbusiness and general uncertainty.

***Our internationaloperations involve risks, and may be subject to political or other non-economicbarriers to our being able to sell our products in certain countries, localeconomic conditions that reduce demand for our products among our target marketsand potential disruption in the supply of necessary components.***   Manyof our subcontractors are primarily located in Asia and we have sales officesand customers located throughout Europe, Japan and other countries. Ourinternational operations and sales are subject to political and economic risks,including political instability, currency controls, changes in import/exportregulations, tariffs and freight rates. In addition, because our primary wafersupplier, TSMC, is located in Taiwan, we may be subject to certain risksresulting from political instability in Taiwan, including conflicts betweenTaiwan and the People’s Republic of China. These and other international riskscould result in the creation of political or other non-economic barriers to ourbeing able to sell our products in certain countries, create local economicconditions that reduce demand for our products among our target market orexpose us to potential disruption in the supply of necessary components orotherwise adversely affect our ability to generate revenue and operateeffectively.

***We depend on thirdparties to transport our products.******  ***We rely onindependent freight forwarders to move our products between manufacturingplants and our customers. Any transport or delivery problems because of theirerrors, or because of unforeseen interruptions in their activities due tofactors such as strikes, political instability, terrorism, natural disastersand accidents, could adversely affect our business, financial condition andresults of operations and ultimately impact our relationship with ourcustomers.

***If the carryingvalue of our long-lived assets is not recoverable, an impairment loss must berecognized which would adversely affect our financial results.***   Certainevents or changes in circumstances would require us to assess therecoverability of the carrying amount of our long-lived assets. In the firsthalf of fiscal 2006, we recorded a goodwill impairment charge of $90.6 millionrelated to our DPS segment. In fiscal 2005, we recorded a goodwill impairmentcharge of $52.3 million related to our Channel segment. In fiscal 2004, werecorded an impairment charge of $5.0 million related to certainproperties classified as held-for sale and a charge of $1.0 millionrelating to the decline in value of a minority investment. In fiscal 2003, werecorded an impairment charge of $1.5 million relating to the decline invalue of minority investments. In fiscal 2002, we recorded impairment chargesof $77.6 million relating to technology acquired in a prior acquisitionand the decline in value of minority investments. We will continue to evaluatethe recoverability of the carrying amount of our long-lived assets, and we mayincur substantial impairment charges which could adversely affect our financialresults.

***If actual resultsor events differ materially from those contemplated by us in making estimatesand assumptions, our reported financial condition and results of operations forfuture periods could be materially affected.***   Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the amounts reported in the consolidatedfinancial statements and accompanying notes. For example, we have identifiedkey accounting estimates in our Critical Accounting Policies in our AnnualReport on Form 10-K for the year ended March 31, 2005, whichincludes revenue, inventory, goodwill and income taxes. In addition,Note 1 of the Notes to Consolidated Financial Statements in our AnnualReport on Form 10-K for the year ended March 31, 2005 describesthe significant accounting policies essential to 

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preparing our consolidatedfinancial statements. The preparation of these financial statements requiresestimates and assumptions that affect the reported amounts and disclosures.Although we believe that our judgments and estimates are appropriate andcorrect, actual future results may differ materially from our estimates.

***If we are unable toprotect and enforce our intellectual property rights, we may be unable tocompete effectively.******  ***Although we actively maintain anddefend our intellectual property rights, we may be unable to adequately protectour proprietary rights. In addition, the laws of certain territories in whichour products are or may be developed, manufactured or sold, including Asia andEurope, may not protect our products and intellectual property rights to thesame extent as the laws of the United States. Because we conduct a substantialportion of our operations in Singapore and other locations outside of theUnited States and sell to a worldwide customer base, we are more dependent onour ability to protect our intellectual property in international environmentsthan would be the case if a larger portion of our operations were domestic.

Despite our efforts, we may be unable to prevent thirdparties from infringing upon or misappropriating our intellectual property,which could harm our business and ability to compete effectively. We have fromtime to time discovered counterfeit copies of our products being manufactured orsold by others. Although we have programs to detect and deter thecounterfeiting of our products, significant availability of counterfeitproducts could reduce our revenues and damage our reputation and goodwill withcustomers.

***Third parties mayassert infringement claims against us, which may be expensive to defend andcould divert our resources.******  ***Fromtime to time, third parties assert exclusive patent, copyright and otherintellectual property rights to our key technologies, and we expect to continueto receive such claims in the future. For example, in fiscal 2005, we, NevadaSCSI Enterprises, Inc. and Thomas A. Gafford (jointly, “NSE”) entered intoa license and release agreement, pursuant to which we paid NSE$1.7 million as a one-time, fully paid-up license fee to settle NSE’sclaims that some of our products infringed certain patents. In addition, weentered into a patent cross-license agreement with IBM in May 2000. Underthis agreement, which was amended in March 2002, we received a releasefrom infringement claims prior to January 1, 2000 and received the rightto use certain of IBM’s patents through June 30, 2007. In consideration,we paid, in annual installments, an aggregate patent fee of $13.3 million throughJune 30, 2004. The risks of our receiving additional claims from thirdparties may be enhanced in periods such as the one that we are currentlyentering where we are beginning to offer product lines employing newtechnologies relative to our existing products.

We cannot assure you that third parties will notassert other infringement claims against us, directly or indirectly, in thefuture, that assertions by third parties will not result in costly litigationor that we would prevail in such litigation or be able to license any valid andinfringed intellectual property from third parties on commercially reasonableterms. These claims may be asserted in respect of intellectual property that weown or that we license from others. In addition to claims brought against us bythird parties, we may also bring litigation against others to protect ourrights. Intellectual property litigation, regardless of the outcome, couldresult in substantial costs to us and diversion of our resources, and couldadversely affect our business and financial results.

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***We may be subjectto a higher effective tax rate that could negatively affect our results ofoperations and financial position.***   Oureffective tax rate is benefited by a Singapore tax holiday relating to certainof our products. The tax holiday package, which is effective until fiscal 2010,provides that profits derived from certain products may be exempt from tax,subject to certain conditions. If we do not meet the conditions andrequirements of the tax holiday in Singapore, our effective tax rate may increase,which would adversely affect our financial results. We held approximately$62.4 million of cash, cash equivalents and marketable securities at oursubsidiary in Singapore at September 30, 2005. During the fourth quarterof fiscal 2005, we repatriated $360.6 million of cash from Singapore tothe United States in connection with the American Jobs Creation Act of 2004which provides a one-time deduction of 85% for certain dividends fromcontrolled foreign corporations. If the amount repatriated does not qualify forthe one-time deduction, we could incur additional income taxes at up to theUnited States Federal statutory rate of 35%, which would negatively affect ourresults of operations and financial condition. Further, if our subsidiary inSingapore incurs losses in excess of their liquidity we may need to loan oursubsidiary in Singapore money that could result in unfavorable taxconsequences.

***We may be requiredto pay additional federal income taxes which could negatively affect ourresults of operations and financial position.***   On December 15,2000, we received a statutory notice of deficiency from the IRS with respect toour Federal income tax return for fiscal 1997. We filed a Petition with theUnited States Tax Court on March 14, 2001, contesting the asserteddeficiencies and settlement agreements have been filed with the United StatesTax Court on all but one issue. In addition, the IRS is currently auditing ourFederal income tax returns for fiscal 1998 through fiscal 2003. We haveresolved all issues for fiscal 1998 through fiscal 2001 other than the rolloverimpact of any potential resolution on the remaining fiscal 1997 issue and taxcredits that were generated but not used in subsequent years that may becarried back. While we believe we have meritorious defenses against theasserted deficiencies and any proposed adjustments, and that sufficient taxeshave been provided, we cannot predict the final outcome of these matters, andthe final resolution could adversely affect our results of operations andfinancial position.

***We may be engagedin legal proceedings that could cause us to incur unforeseen expenses and couldoccupy a significant amount of our management’s time and attention.***   Fromtime to time we are subject to litigation or claims that could negativelyaffect our business operations and financial position. Such disputes couldcause us to incur unforeseen expenses, could occupy a significant amount of ourmanagement’s time and attention, and could negatively affect our businessoperations and financial position.

***We have in the pastfinanced a portion of our capital expenditure needs from capital marketfinancing, and if we need to seek additional financing, it may not be availableon favorable terms.***   In order to finance strategicacquisitions, capital asset acquisitions and other general corporate needs, wehave in the past relied, in part, on the capital markets. Historically, we havebeen able to access capital markets, but this does not necessarily guaranteethat we will be able to access these markets in the future or at terms that areacceptable to us. The availability of capital in these markets is affected byseveral factors, including geopolitical risk, the interest rate environment andthe condition of the economy as a whole. In addition, our own operatingperformance, capital structure and expected future performance impacts ourability to raise capital. We believe that our current cash, cash equivalents,short-term investments and future cash provided by operations will besufficient to fund our needs for at least the next twelve months. However, ifour operating performance falls below expectations, we may need additionalfunds, which may not be available on favorable terms, if at all.

***We are exposed tofluctuations in foreign currency exchange rates.******  ***Because asignificant portion of our business is conducted outside the United States, weface exposure to adverse movements in non-United States currency exchangerates. These exposures may change over time as business practices evolve andcould have an adverse impact on our financial results and cash flows.Historically, our exposures have related to non-dollar-denominated operatingexpenses in Europe and Asia. We began Euro-denominated sales to ourdistribution customers in the European Union in the fourth quarter of fiscal2003. 

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Additionally, we purchasea substantial portion of our raw materials and manufacturing equipment fromforeign suppliers, and incur labor and other operating costs in foreigncurrencies, particularly in our Singapore manufacturing facility. An increasein the value of the dollar could increase the real cost to our customers of ourproducts in markets outside the United States where we sell in dollars, and aweakened dollar could increase the cost of local operating expenses and procurementof raw materials to the extent we must purchase components in foreigncurrencies.

***We hold minorityinterests in privately held venture funds, and if these venture funds facefinancial difficulties in their operations, our investments could be impaired.***   Wecontinue to hold minority interests in privately held venture funds. At September 30,2005, the carrying value of such investments aggregated $3.4 million. Wehave also committed to provide additional funding of up to $0.4 million.These investments are inherently risky because these venture funds invest incompanies that may still be in the development stage or depend on third partiesfor financing to support their ongoing operations. In addition, the markets forthe technologies or products of these companies are typically in the earlystages and may never develop. If these companies do not have adequate cashfunding to support their operations, or if they encounter difficultiesdeveloping their technologies or products, the venture funds’ investments inthese companies may be impaired, which in turn, could result in impairment ofour investment in these venture funds.

***Our spin-off ofRoxio Inc., which is now known as Napster Inc., may have potentialsubsequent tax liabilities that could negatively affect our results ofoperations.***   Pursuant to our distribution of theRoxio, Inc. common stock, we received an opinion fromPricewaterhouseCoopers LLP, or PwC, regarding the tax-free nature of thetransaction to us and to our stockholders under Section 355 of theInternal Revenue Code. The validity of the PwC opinion relating to thequalification of the distribution as a tax-free transaction is subject tofactual representations and assumptions. We are not aware of any facts orcircumstances that would cause such representations and assumptions to beuntrue. In addition, the opinion of PwC is not binding on the IRS. If Napsteror we fail to conform to the requirements set forth in the IRS regulations, itcould cause the distribution to be taxable to us and to our stockholders, andour financial results could be adversely affected.

***We may havepotential business conflicts of interest with Roxio, which is now known asNapster, with respect to our past and ongoing relationships, and we may notresolve these conflicts on terms favorable to us.***   Conflictsof interest may arise between Napster and us in areas relating to our past andongoing relationship, including tax, indemnification and other matters arisingfrom the separation. These and other business conflicts could adversely affectthe growth of our business in the future.

***Changes insecurities laws and regulations have increased and may continue to increase ourcosts.******  ***Changes in the laws and regulationsaffecting public companies, including the provisions of the Sarbanes-OxleyAct of 2002 and rules promulgated by the Securities and ExchangeCommission, have increased and may continue to increase our expenses as we evaluatethe implications of these rules and devote resources to respond to theirrequirements. In particular, we incurred additional administrative expense toimplement Section 404 of the Sarbanes-Oxley Act, which requires managementto report on, and our Independent Registered Public Accounting Firm to attestto, our internal control over financial reporting.

In addition, The Nasdaq National Market, on which ourcommon stock is listed, has also adopted comprehensive rules andregulations relating to corporate governance. These laws, rules andregulations have increased and will continue to increase the scope, complexityand cost of our corporate governance, reporting and disclosure practices. Wealso expect these developments to make it more difficult and more expensive forus to obtain director and officer liability insurance in the future, and we maybe required to accept reduced coverage or incur substantially higher costs toobtain coverage. Further, our board members, Interim Chief Executive Officerand Chief Financial Officer could face an increased risk of 

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personal liability inconnection with the performance of their duties. As a result, we may havedifficultly attracting and retaining qualified board members and executiveofficers, which would adversely affect our business.

***Internal controldeficiencies or weaknesses that are not yet identified could emerge.******  ***Over time wemay identify and correct deficiencies or weaknesses in our internal controlover financial reporting and, where and when appropriate, report on theidentification and correction of these deficiencies or weaknesses. However, theinternal control procedures can provide only reasonable, and not absolute,assurance that deficiencies or weaknesses are identified. Deficiencies orweaknesses that are not yet identified could emerge, and the identification andcorrections of these deficiencies or weaknesses could have a material impact onour results of operations.

***Internal controlissues that appear minor now may later become material weaknesses.******  ***We arerequired to publicly report on deficiencies or weaknesses in our internalcontrol over financial reporting that meet a materiality standard as requiredby law. Management may, at a point in time, accurately categorize a deficiencyor weakness as immaterial or minor and therefore not be required to publiclyreport such deficiency or weakness. Such determination, however, does notpreclude a change in circumstances such that the deficiency or weakness could,at a later time, become a material weakness that could have a material impacton our results of operations.

***We may encounternatural disasters, which could cause disruption to our employees or interruptthe manufacturing process for our products.***   Ouroperations could be subject to natural disasters and other businessdisruptions, which could seriously harm our revenues and financial conditionand increase our costs and expenses. Our corporate headquarters are located inCalifornia, near major earthquake faults. Additionally, our primary wafersupplier, TSMC, is located in Taiwan, which has experienced significantearthquakes in the past. A severe earthquake could cause disruption to ouremployees or interrupt the manufacturing process, which could affect TSMC’sability to supply wafers to us, which would negatively affect our business andfinancial results. The ultimate impact on us and our general infrastructure ofbeing located near major earthquake faults is unknown, but our net revenues andfinancial condition and our costs and expenses could be significantly impactedin the event of a major earthquake.

***Manmade problemssuch as computer viruses or terrorism may disrupt our operations and harm ouroperating results.******  ***Despite our implementation of networksecurity measures, our servers are vulnerable to computer viruses, break-insand similar disruptions from unauthorized tampering with our computer systems.Any such event could have an adverse effect on our business, operating results,and financial condition. In addition, the effects of war or acts of terrorismcould have an adverse effect on our business, operating results, and financialcondition. In addition, as a company with headquarters and significantoperations located in the United States, we may be impacted by actions againstthe United States. We are predominantly uninsured for losses and interruptionscaused by terrorist acts and acts of war.

***We may experience significant fluctuations in ourstock price, which may, in turn, significantly affect the trading price of ourconvertible notes.***   Our stock has experiencedsubstantial price volatility, particularly as a result of quarterly variationsin our operating results, the published expectations of analysts and as aresult of announcements by our competitors and us. In addition, the stock markethas experienced price and volume fluctuations that have affected the marketprice of many technology companies, in particular, and that have often beenunrelated to the operating performance of such companies. In addition, theprice of our securities may also be affected by general global, economic andmarket conditions and the cost of operations in one or more of our productmarkets. While we cannot predict the individual effect that these factors mayhave on the price or our securities, these factors, either individually or inthe aggregate, could result in significant variations in the price of ourcommon stock during any given period of time. These fluctuations in our stockprice also impact the price of our outstanding convertible securities and thelikelihood of the convertible securities being converted into our common stock.

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**Item 3.**                        Quantitativeand Qualitative Disclosures About Market Risk

For financial market risksrelated to changes in interest rates, equity price and foreign currencyexchange rates, reference is made to Item 7A “Quantitative and QualitativeDisclosures About Market Risk” contained in Part II of our Annual Reporton Form 10-K for the year ended March 31, 2005. Our exposure tomarket risk has not changed materially since March 31, 2005.

**Item 4.**                        Controlsand Procedures

**Evaluationof Disclosure Controls and Procedures**

Under the supervision andwith the participation of our management, including our Interim Chief ExecutiveOfficer (CEO) and our Chief Financial Officer (CFO), we conducted an evaluationof our disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934 (Exchange Act),as of the end of the period covered by this Quarterly Report on Form 10-Q.Based upon that evaluation, our Interim CEO and our CFO have concluded that thedesign and operation of our disclosure controls and procedures were effectiveto ensure that information required to be disclosed by us in reports that wefile or submit under the Exchange Act is recorded, processed, summarized andreported within the time periods specified in Securities and ExchangeCommission rules and forms.

**Changesin Internal Control Over Financial Reporting**

There has been no changein our internal control over financial reporting that occurred during theperiod covered by this Quarterly Report on Form 10-Q that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

**InherentLimitations on Effectiveness of Controls**

Our management, including our Interim CEO and CFO,does not expect that our disclosure controls and procedures or our internalcontrol over financial reporting will prevent or detect all error and allfraud. A control system, no matter how well designed and operated, can provideonly reasonable, not absolute, assurance that the control system’s objectiveswill be met. The design of a control system must reflect the fact that thereare resource constraints, and the benefits of controls must be consideredrelative to their costs. Further, because of the inherent limitations in allcontrol systems, no evaluation of controls can provide absolute assurance thatmisstatements due to error or fraud will not occur or that all control issuesand instances of fraud, if any, within the company have been detected. Theseinherent limitations include the realities that judgments in decision-makingcan be faulty and that breakdowns can occur because of simple error or mistake.Controls can also be circumvented by the individual acts of some persons, bycollusion of two or more people, or by management override of the controls. Thedesign of any system of controls is based in part on certain assumptions aboutthe likelihood of future events, and there can be no assurance that any designwill succeed in achieving its stated goals under all potential futureconditions. Projections of any evaluation of controls effectiveness to futureperiods are subject to risks. Over time, controls may become inadequate becauseof changes in conditions or deterioration in the degree of compliance withpolicies or procedures.

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**PART II. OTHER INFORMATION**

**Item 4.**                        Submissionof Matters to a Vote of Security Holders

OurAnnual Meeting of Stockholders was held on August 25, 2005, in ourprincipal executive offices located in Milpitas, California. Of the total112,479,437 shares of our common stock outstanding as of the record date,102,129,139 shares (91%) were present or represented by proxy at the meeting.The table below presents the voting results of election of our Board ofDirectors.

| ** **               | ** ** | **Votes**  | ** ** | **Votes Withheld** | ** ** |
|--------------------------|------------|------------|------------|-------------------------|------------|
| Carl J. Conti            |       | 94,398,727 |       |                    | 7,730,412  |   |   |
| Lucie J.  Fjeldstad      |       | 90,588,983 |       |                    | 11,540,156 |   |   |
| Joseph S. Kennedy        |       | 85,578,328 |       |                    | 16,550,811 |   |   |
| Ilene H. Lang            |       | 96,936,876 |       |                    | 5,192,263  |   |   |
| Robert J. Loarie         |       | 90,306,502 |       |                    | 11,822,637 |   |   |
| D. Scott Mercer          |       | 94,449,781 |       |                    | 7,679,358  |   |   |
| Douglas E. Van Houweling |       | 95,514,623 |       |                    | 6,614,516  |   |   |

 

The stockholders approved our stock option exchangeprogram for employees (excluding Section 16 officers and directors)providing for the exchange of stock options previously granted under ourCompany’s stock plans having an exercise price of $7.00 or greater per sharefor a lesser number of stock to be granted following the expiration of a tenderoffer to be made to such employees. The proposal received 44,179,183affirmative votes, 24,260,734 negative votes, 3,703,698 abstentions and29,985,524 broker non-votes. We decided not to implement this stock optionexchange program but instead granted options to purchase approximately 6.3million shares of our common stock  toour employees.

In addition, our stockholdersratified and approved the appointment of PricewaterhouseCoopers LLP as ourindependent registered public accounting firm for the fiscal year ending March 31,2006. The proposal received 99,044,923 affirmative votes, 2,955,318 negativevotes, 128,898 abstentions and no broker non-votes.

**Item 6.**                        Exhibits

| Exhibit Number | ** ** | **Description**                                                                                                                                |
|---------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------|
| Exhibit 10.1   |       | Registrant’s 2005 Deferred Compensation Plan                                                                                              |
| Exhibit 31.1   |       | Certification of Interim Chief Executive Officer  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                              |
| Exhibit 31.2   |       | Certification of Chief Financial Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                      |
| Exhibit 32.1   |       | Certification of Interim Chief Executive Officer and  Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002. |

 

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**SIGNATURE**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned hereuntoduly authorized.
| **ADAPTEC, INC.** |
|-------------------|
| By:               | /s/  MARSHALL L. MOHR |   |
|              | Marshall L. Mohr*Vice President and Chief Financial Officer* |   |
|              | *(principal  financial and accounting officer)* | Date: November 7, 2005 |

 

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**EXHIBIT INDEX**

| Exhibit Number | ** ** | ** **                                                                                                                                     | ** ** | **Description** |
|---------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|
| Exhibit 10.1   |       | Registrant’s 2005  Deferred Compensation Plan                                                                                             |
| Exhibit 31.1   |       | Certification of Interim  Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002.                             |
| Exhibit 31.2   |       | Certification of Chief  Financial Officer pursuant to Section 302 of the Sarbanes-Oxley  Act of 2002.                                     |
| Exhibit 32.1   |       | Certification of Interim Chief Executive Officer and  Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley  Act of 2002. |

 

 

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