XNYS:ELX Emulex Corp Quarterly Report 10-Q Filing - 1/1/2012

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Form 10-Q
Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

 

x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended January 1, 2012

OR

 

¨ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission File No. 001-31353

 

 

EMULEX CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   51-0300558

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S Employer

Identification No.)

3333 Susan Street Costa Mesa,

California

  92626
(Address of principal executive offices)   (Zip Code)

(714) 662-5600

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer      x      Accelerated filer   ¨
Non-accelerated filer        ¨   (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of January 23, 2012, the registrant had 86,394,869 shares of common stock outstanding.

 

 

 


Table of Contents

CAUTIONARY STATEMENT RELATED TO FORWARD LOOKING STATEMENTS

Certain statements contained in this Form 10-Q may constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. We may also make forward-looking statements in other reports filed with the Securities and Exchange Commission, in materials delivered to stockholders and in press releases. In addition, our representatives may from time to time make oral forward-looking statements. Forward-looking statements provide current expectations of future events based on certain assumptions and include any statement that does not directly relate to any historical or current fact. Words such as “anticipates,” “in the opinion,” “believes,” “intends,” “expects,” “may,” “will,” “should,” “could,” “plans,” “forecasts,” “estimates,” “predicts,” “projects,” “potential,” “continue,” and similar expressions may be intended to identify forward-looking statements.

Actual future results could differ materially from those described in the forward-looking statements as a result of a variety of factors, including those discussed in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part I, Item 2, “Legal Proceedings” in Part II, Item 1, and “Risk Factors” in Part II, Item 1A of this Form 10-Q included elsewhere herein. We expressly disclaim any obligation or undertaking to release publicly any updates or changes to these forward-looking statements that may be made to reflect any future events or circumstances. We wish to caution readers that a number of important factors could cause actual results to differ materially from those in the forward-looking statements. These factors include the effects of ongoing lawsuits, such as the action brought by Broadcom Corporation (Broadcom) described elsewhere in this Form 10-Q, which present inherent risks, any of which could have a material adverse effect on our business, financial condition, or results of operations. Such potential risks include continuing expenses of litigation, risk of loss of patent rights and/or monetary damages, risk of injunction against the sale of products incorporating the technology in question, counterclaims, attorneys’ fees, incremental costs associated with product or component redesigns, and diversion of management’s attention from other business matters. With respect to the Broadcom litigation, such potential risks also include the availability of an adequate sunset period of time to make design changes, the ability to implement any design changes, the availability of customer resources to complete any re-qualification or re-testing that may be needed, the ability to maintain favorable working relationships with Emulex suppliers of SerDes modules, and the ability to obtain a settlement that does not put us at a competitive disadvantage. In addition, the fact that the economy generally, and the technology and storage segments specifically, have been in a state of uncertainty makes it difficult to determine if past experience is a good guide to the future and makes it impossible to determine if markets will grow or shrink in the short term. The current economic downturn and the resulting disruptions in world credit and equity markets that are creating economic uncertainty for our customers and the storage networking market as a whole has and could continue to adversely affect our revenues and results of operations. Furthermore, the effect of any actual or potential unsolicited offers to acquire us may have an adverse effect on our operations. As a result of this uncertainty, we are unable to predict with any accuracy what future results might be. Other factors affecting these forward-looking statements include but are not limited to the following: faster than anticipated decline in the storage networking market, slower than expected growth of the storage networking market or the failure of our Original Equipment Manufacturer (OEM) customers to successfully incorporate our products into their systems; our dependence on a limited number of customers and the effects of the loss of, decrease in or delays of orders by, any such customers, or the failure of such customers to make timely payments; the emergence of new or stronger competitors as a result of consolidation movements in the market; the timing and market acceptance of our or our OEM customers’ new or enhanced products; costs associated with entry into new areas of the storage technology market; the variability in the level of our backlog and the variable and seasonal procurement patterns of our customers; any inadequacy of our intellectual property protection and the costs of actual or potential third-party claims of infringement and any related indemnity obligations or adverse judgments; impairment charges, including but not limited to goodwill and intangible assets; changes in tax rates or legislation; the effect of acquisitions; the effects of terrorist activities; natural disasters, such as the earthquake and resulting tsunami off the coast of Japan in March 2011 and the significant flooding in various parts of Thailand in October 2011, and any resulting disruption in our supply chain or customer purchasing patterns or any other resulting economic or political instability; the highly competitive nature of the markets for our products as well as pricing pressures that may result from such competitive conditions; the effects of changes in our business model to separately charge for software; the effect of rapid migration of customers towards newer, lower cost product platforms; possible transitions from board or box level to application specific integrated circuit (ASIC) solutions for selected applications; a shift in unit product mix from higher-end to lower-end or mezzanine card products; a faster than anticipated decrease in the average unit selling prices or an increase in the manufactured cost of our products; delays in product development; our reliance on third-

 

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party suppliers and subcontractors for components and assembly; our ability to attract and retain key technical personnel; our ability to benefit from our research and development activities; our dependence on international sales and internationally produced products; changes in accounting standards; and the potential effects of global warming and any resulting regulatory changes on our business. These and other factors could cause actual results to differ materially from those in the forward-looking statements and are discussed elsewhere in this Form 10-Q, in our other filings with the Securities and Exchange Commission or in materials incorporated therein by reference.

 

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Table of Contents

EMULEX CORPORATION AND SUBSIDIARIES

INDEX

 

     PAGE  

Part I. FINANCIAL INFORMATION

  

Item 1. Financial Statements (unaudited)

  

Condensed Consolidated Balance Sheets as of January 1, 2012 and July 3, 2011

     5   

Condensed Consolidated Statements of Operations for the Three and Six months ended January  1, 2012 and December 26, 2010

     6   

Condensed Consolidated Statements of Cash Flows for the Six months ended January  1, 2012 and December 26, 2010

     7   

Notes to Condensed Consolidated Financial Statements

     8   

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     20   

Item 3. Quantitative and Qualitative Disclosures about Market Risk

     36   

Item 4. Controls and Procedures

     36   

Part II. OTHER INFORMATION

  

Item 1. Legal Proceedings

     37   

Item 1A. Risk Factors

     37   

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

     53   

Item 6. Exhibits

     54   

Signatures

     55   

 

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

EMULEX CORPORATION AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(unaudited, in thousands, except share data)

 

     January 1,
2012
    July 3,
2011
 
ASSETS     

Current assets:

    

Cash and cash equivalents

   $ 132,340      $ 131,160   

Investments

     59,354        37,025   

Accounts receivable, net of allowance for doubtful accounts of $1,804 and $1,743 at January 1, 2012 and July 3, 2011, respectively

     88,881        74,147   

Inventories

     22,670        20,508   

Prepaid income taxes

     13,528        12,709   

Prepaid expenses and other current assets

     10,770        9,684   

Deferred income taxes

     11,468        16,919   
  

 

 

   

 

 

 

Total current assets

     339,011        302,152   

Property and equipment, net

     61,357        64,095   

Investments

     —          15,165   

Goodwill

     177,290        177,290   

Intangible assets, net

     118,515        135,602   

Other assets

     7,873        8,535   
  

 

 

   

 

 

 

Total assets

   $ 704,046      $ 702,839   
  

 

 

   

 

 

 
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Current liabilities:

    

Accounts payable

   $ 39,009      $ 29,043   

Accrued liabilities

     42,421        42,199   
  

 

 

   

 

 

 

Total current liabilities

     81,430        71,242   

Other liabilities

     3,054        3,344   

Deferred income taxes

     7,593        11,362   

Accrued taxes

     28,200        28,200   
  

 

 

   

 

 

 

Total liabilities

     120,277        114,148   
  

 

 

   

 

 

 

Commitments and contingencies (Note 8)

    

Stockholders’ equity:

    

Preferred stock, $0.01 par value; 1,000,000 shares authorized (150,000 shares designated as Series A Junior Participating Preferred Stock); none issued and outstanding

     —          —     

Common stock, $0.10 par value; 240,000,000 shares authorized; 103,882,668 and 102,655,094 issued at January 1, 2012 and July 3, 2011, respectively

     10,388        10,266   

Additional paid-in capital

     1,251,432        1,243,045   

Accumulated deficit

     (448,225     (456,060

Accumulated comprehensive loss

     (1,446     (238

Treasury stock, at cost; 17,592,322 and 14,656,242 shares at January 1, 2012 and July 3, 2011, respectively

     (228,380     (208,322
  

 

 

   

 

 

 

Total stockholders’ equity

     583,769        588,691   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 704,046      $ 702,839   
  

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

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EMULEX CORPORATION AND SUBSIDIARIES

Condensed Consolidated Statements of Operations

(unaudited, in thousands, except per share data)

 

     Three Months Ended     Six Months Ended  
     January 1,
2012
    December 26,
2010
    January 1,
2012
    December 26,
2010
 

Net revenues

   $ 128,671      $ 113,998      $ 247,068      $ 217,095   

Cost of sales:

        

Cost of goods sold

     48,099        41,443        92,351        81,244   

Amortization of core and developed technology intangible assets

     5,149        9,621        13,723        16,020   
  

 

 

   

 

 

   

 

 

   

 

 

 

Cost of sales

     53,248        51,064        106,074        97,264   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     75,423        62,934        140,994        119,831   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

        

Engineering and development

     37,671        41,668        80,946        79,932   

Selling and marketing

     15,260        14,226        29,877        26,935   

General and administrative

     9,123        13,663        20,988        31,282   

Amortization of other intangible assets

     1,602        3,465        3,364        5,809   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     63,656        73,022        135,175        143,958   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income (loss)

     11,767        (10,088     5,819        (24,127
  

 

 

   

 

 

   

 

 

   

 

 

 

Non-operating income (expense), net:

        

Interest income

     32        21        55        42   

Interest expense

     (2     (10     (4     (385

Other (expense) income, net

     141        (45     542        (198
  

 

 

   

 

 

   

 

 

   

 

 

 

Total non-operating income (expense), net

     171        (34     593        (541
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     11,938        (10,122     6,412        (24,668

Income tax provision (benefit)

     (3,056     30,854        (1,423     24,932   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ 14,994      $ (40,976   $ 7,835      $ (49,600
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) per share:

        

Basic

   $ 0.17      $ (0.47   $ 0.09      $ (0.59
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ 0.17      $ (0.47   $ 0.09      $ (0.59
  

 

 

   

 

 

   

 

 

   

 

 

 

Number of shares used in per share computations:

        

Basic

     85,906        86,565        86,384        84,485   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

     87,816        86,565        88,323        84,485   
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

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EMULEX CORPORATION AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(unaudited, in thousands)

 

     Six Months Ended  
     January 1,
2012
    December 26,
2010
 

Cash flows from operating activities:

    

Net income (loss)

   $ 7,835      $ (49,600

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

    

Depreciation and amortization of property and equipment

     9,177        10,625   

Share-based compensation expense

     12,579        23,956   

Amortization of intangible assets

     17,087        21,829   

Provision for losses on accounts receivable

     61        10   

Accrued interest income, net

     213        23   

Loss on disposal of property and equipment

     190        194   

Deferred income taxes

     1,681        (6,224

Excess tax benefit from share-based compensation

     (70     (485

Foreign currency adjustments

     (1,348     324   

Changes in assets and liabilities, net of effects from acquisitions:

    

Accounts receivable, net

     (14,795     (10,888

Inventories

     (2,162     (2,110

Prepaid expenses and other assets

     (591     3,621   

Accounts payable, accrued liabilities, and other liabilities

     9,176        (3,089

Accrued taxes

     —          1,190   

Income taxes payable and prepaid income taxes

     (902     27,636   
  

 

 

   

 

 

 

Net cash provided by operating activities

     38,131        17,012   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Net proceeds from sale of property and equipment

     38        99   

Purchases of property and equipment

     (6,086     (8,999

Purchases of intangible assets

     —          (4,000

Payments for the purchase of ServerEngines Corporation, net of cash acquired

     —          (53,068

Investment in and loans to privately-held companies

     —          (1,000

Cash received from escrow for prior business acquisition

     —          1,000   

Purchases of investments

     (18,030     (36,528

Maturities of investments

     10,653        72,691   
  

 

 

   

 

 

 

Net cash used in investing activities

     (13,425     (29,805
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Repurchase of common stock

     (20,058     (40,082

Tax withholding payments reimbursed by common stock

     (3,152     (4,231

Repayment of debt to the Founders of ServerEngines Corporation

     —          (26,897

Proceeds from issuance of common stock under stock plans

     168        3,384   

Excess tax benefit from share-based compensation expense

     70        485   
  

 

 

   

 

 

 

Net cash used in financing activities

     (22,972     (67,341
  

 

 

   

 

 

 

Effect of exchange rates on cash and cash equivalents

     (554     111   
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     1,180        (80,023

Cash and cash equivalents at beginning of period

     131,160        248,813   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 132,340      $ 168,790   
  

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

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EMULEX CORPORATION AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements (unaudited)

1. Basis of Presentation

In the opinion of the management of Emulex Corporation (Emulex or the Company), the accompanying unaudited condensed consolidated financial statements contain adjustments which are normal recurring accruals necessary to present fairly the Company’s consolidated financial position, results of operations, and cash flows. Interim results for the three months and six months ended January 1, 2012, are not necessarily indicative of the results that may be expected for the fiscal year ending July 1, 2012. The accompanying condensed consolidated interim financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the fiscal year ended July 3, 2011. The preparation of the condensed consolidated financial statements requires the use of estimates, and actual results could differ materially from management’s estimates.

The Company has a 52 or 53 week fiscal year that ends on the Sunday nearest to June 30. Accordingly, every fifth or sixth fiscal year will be a 53-week fiscal year. Fiscal year 2012 is a 52-week fiscal year. The last 53 week fiscal year was fiscal 2011.

Certain reclassifications have been made to prior year amounts to conform to current year’s presentation.

Consolidation of Facilities

During fiscal 2011, the Company commenced the consolidation of certain leased facilities in Colorado and Washington. The consolidation of facilities was completed during the first quarter of fiscal 2012. Total charges related to the facility consolidation and related workforce reductions were approximately $4.1 million, of which $1.0 million was recorded in fiscal 2012 and $3.1 million was recorded in fiscal 2011. The charges consisted primarily of salaries and benefits based on continuous employment of affected employees through the facility closure dates. In fiscal 2012, the charges were comprised of salaries and benefits expense of approximately $0.4 million, acceleration of rent expense of approximately $0.5 million, and other costs of approximately $0.1 million. In fiscal 2011, the charges were comprised of salaries and benefits expense of approximately $2.6 million, acceleration of fixed assets depreciation expense of approximately $0.3 million, and other costs of approximately $0.2 million.

Supplemental Cash Flow Information

 

     Six Months Ended  
     January 1,
2012
     December 26,
2010
 
     (in thousands)  

Cash paid during the period for:

     

Interest

   $ 3       $ 13   

Income taxes

   $ 1,724       $ 2,444   

Non-cash activities:

     

Purchases of property and equipment not paid, net

   $ 936       $ 3,778   

Settlement of other assets in conjunction with business acquisition

   $ —         $ 24,466 (1) 

 

 

(1) Related to the ServerEngines acquisition. See Note 2.

Recently Adopted Accounting Standards

In December 2010, the FASB issued ASU 2010-29, “Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations.” ASU 2010-29 affects any public entity that enters into business combinations that are material on an individual or aggregate basis. The comparative financial statements should present and disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. The amendments also expand the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The amendments are effective

 

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prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010, or the Company’s 2012 fiscal year. There was no financial statement impact of the Company’s adoption of this guidance on July 4, 2011.

In January 2010, the FASB issued ASU 2010-06, “Improving Disclosures about Fair Value Measurements” amending ASC 820, “Fair Value Measurements and Disclosures” requiring additional disclosure and clarifying existing disclosure requirements about fair value measurements. ASU 2010-06 requires entities to provide fair value disclosures by each class of assets and liabilities, which may be a subset of assets and liabilities within a line item in the statement of financial position. The additional requirements also include disclosure regarding the amounts and reasons for significant transfers in and out of Level 1 and 2 of the fair value hierarchy and separate presentation of purchases, sales, issuances and settlements of items within Level 3 of the fair value hierarchy. The guidance clarifies existing disclosure requirements regarding the inputs and valuation techniques used to measure fair value for measurements that fall in either Level 2 or Level 3 of the hierarchy. ASU 2010-06 was effective for interim and annual reporting periods beginning after December 15, 2009, or the third quarter of the Company’s 2010 fiscal year, except for the disclosures about purchases, sales, issuances and settlements of items within Level 3, which is effective for fiscal years beginning after December 15, 2010, or the Company’s 2012 fiscal year, and for interim periods within those fiscal years. There was no impact to the Company’s financial statements disclosures upon adoption of this guidance.

In September 2011, the FASB issued ASU 2011-08, “Intangibles — Goodwill and Other (Topic 350): Testing Goodwill for Impairment.” Under ASU 2011-08, an entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. However, if an entity concludes otherwise, then it is required to perform the first step of the two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit. If the carrying amount of a reporting unit exceeds its fair value, then the entity is required to perform the second step of the goodwill impairment test to measure the amount of the impairment loss, if any. An entity also has the option to bypass the qualitative assessment for any reporting unit in any period and proceed directly to performing the first step of the two-step goodwill impairment test. An entity may resume performing the qualitative assessment in any subsequent period. The Company elected to early adopt this guidance during the first fiscal quarter ended October 2, 2011. There was no financial statement impact as a result of the Company’s early adoption of this guidance in the interim period ended October 2, 2011. The Company will continue to perform its annual impairment test during the fourth fiscal quarter.

Recently Issued Accounting Standards

In May 2011, the FASB issued ASU 2011-04, “Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS.” The amendments result in a consistent definition of fair value and common requirements for measurement of and disclosure about fair value between U.S. GAAP and IFRS. The amendments clarify the application of existing fair value measurement and disclosure requirements, including: a) application of the highest and best use and valuation premise concepts, b) measurement of the fair value of an instrument classified in a reporting entity’s shareholders’ equity, and c) quantitative disclosure about the unobservable inputs used in a fair value measurement that is categorized within Level 3 of the fair value hierarchy. The amendments also change a particular principle or requirement for fair value measurement and disclosure, including: a) measurement of the fair value of financial instruments that are managed within a portfolio, b) application of premiums and discounts in a fair value measurement, and c) additional disclosure about fair value measurements. The amendments are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011, or the Company’s third quarter of fiscal year 2012. Early application by public entities is not permitted. The Company is currently assessing the impact of the disclosure but does not expect any financial impact of adopting this guidance.

In June 2011, the FASB issued ASU 2011-05, “Comprehensive Income (Topic 220): Presentation of Comprehensive Income.” ASU 2011-05 eliminates the option to report other comprehensive income and its components in the statement of changes in equity. Instead, an entity can elect to present items of net income and

 

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other comprehensive income in one continuous statement (referred to as the statement of comprehensive income) or in two separate, but consecutive, statements. Each component of net income and each component of other comprehensive income, together with totals for comprehensive income and its two parts (i.e., net income and other comprehensive income), would need to be displayed under either alternative. The statement(s) would need to be presented with equal prominence as the other primary financial statements. The amendments are to be applied retrospectively. In December 2011, the FASB issued ASU 2011-12, “Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05.” ASU 2011-12 defers only those changes in ASU 2011-05 that related to the presentation of reclassification adjustments. The amendments in ASU 2011-12 supersede only those paragraphs that pertain to how and where reclassification adjustments are presented. All other requirements in ASU 2011-05 are not affected by ASU 2011-12, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. For public entities, these amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. The Company is currently assessing the impact of the disclosure guidance effective in fiscal 2013 but does not expect any financial impact of adopting this guidance.

2. Business Combinations

ServerEngines Corporation

On August 25, 2010, the Company acquired 100% of the outstanding common stock of ServerEngines Corporation (ServerEngines), a privately-held, fabless semiconductor company located in Sunnyvale, California. The Company accounted for the acquisition using the purchase method of accounting in accordance with ASC 805, “Business Combinations.” The aggregate purchase price was approximately $135.7 million, including $54.8 million in cash, $67.4 million in common stock, $11.5 million in contingent consideration and $2.0 million in options assumed. Included in the common stock issued and contingent consideration was approximately 2.2 million shares of Emulex common stock held in escrow for up to 18 months from the acquisition date subject to certain standard representations and warranties defined in the merger agreement. The first half of the common stock in escrow was released on August 25, 2011, the first anniversary of the acquisition date.

The contingent consideration was related to 4.0 million shares that are issuable upon achievement of two post-closing milestones. Approximately 2.5 million shares are tied to the employment of certain recipients, and were therefore accounted for as stock-based compensation over the service period. The Company recognized approximately $1.4 million and $3.3 million of stock based compensation related to these 2.5 million shares during the three months ended January 1, 2012 and December 26, 2011, respectively. The Company recognized approximately $2.7 million and $13.8 million of stock based compensation related to these 2.5 million shares during the six months ended January 1, 2012 and December 26, 2011, respectively. The first post-closing milestone was met during the quarter ended December 26, 2010 in fiscal 2011.

The Company has allocated the purchase price to the assets acquired and liabilities assumed at estimated fair values. The excess of the purchase price over the aggregate fair values was recorded as goodwill. This acquisition has been included in the consolidated balance sheet of the Company and the operating results have been included in the consolidated statement of income since the date of acquisition.

3. Fair Value of Financial Instruments

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The fair value hierarchy is based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value. A description of the three levels of inputs is as follows:

Level 1 — Quoted prices in active markets for identical assets or liabilities;

 

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  Level 2 — Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and

 

  Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

Financial instruments measured at fair value on a recurring basis as of January 1, 2012 and July 3, 2011 are as follows:

 

     Level 1      Level 2      Level 3      Total  
     (in thousands)  

January 1, 2012

           

Cash and cash equivalents

   $ 132,340       $ —         $ —         $ 132,340   

Term deposits

     4,920         —           —           4,920   

U.S. government securities

     50,351         —           —           50,351   

U.S. government sponsored entity securities

     3,398         —           —           3,398   

Corporate bonds

     714         —           —           714   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 191,723       $ —         $ —         $ 191,723   
  

 

 

    

 

 

    

 

 

    

 

 

 

July 3, 2011

           

Cash and cash equivalents

   $ 131,160       $ —         $ —         $ 131,160   

Term deposits

     2,989         —           —           2,989   

U.S. government securities

     42,928         —           —           42,928   

U.S. government sponsored entity securities

     4,678         —           —           4,678   

Corporate bonds

     1,588         —           —           1,588   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 183,343       $ —         $ —         $ 183,343   
  

 

 

    

 

 

    

 

 

    

 

 

 

4. Investments

The Company’s portfolio of held-to-maturity investments consists of the following:

 

     Cost      Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair Value  
     (in thousands)  

January 1, 2012

          

Term deposits

   $ 4,920       $ —         $ —        $ 4,920   

U.S. government securities

     50,321         30         —          50,351   

U.S. government sponsored entity securities

     3,399         —           (1     3,398   

Corporate bonds

     714         —           —          714   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 59,354       $ 30       $ (1   $ 59,383   
  

 

 

    

 

 

    

 

 

   

 

 

 

July 3, 2011

          

Term deposits

   $ 2,989       $ —         $ —        $ 2,989   

U.S. government securities

     42,934         —           (6     42,928   

U.S. government sponsored entity securities

     4,680         —           (2     4,678   

Corporate bonds

     1,587         1         —          1,588   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 52,190       $ 1       $ (8   $ 52,183   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

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Investments at January 1, 2012 and July 3, 2011 were classified as shown below:

 

     January 1,
2012
     July 3,
2011
 
     (in thousands)  

Short-term investments (maturities within one year)

   $ 59,354       $ 37,025   

Long-term investments (maturities longer than one year)

     —           15,165   
  

 

 

    

 

 

 
   $ 59,354       $ 52,190   
  

 

 

    

 

 

 

5. Inventories

Inventories are summarized as follows:

 

     January 1,
2012
     July 3,
2011
 
     (in thousands)  

Raw materials

   $ 6,850       $ 6,352   

Finished goods

     15,820         14,156   
  

 

 

    

 

 

 
   $ 22,670       $ 20,508   
  

 

 

    

 

 

 

6. Goodwill and Intangible Assets, net

Goodwill relates to the purchase of Sierra Logic, Inc. in fiscal 2007, the purchase of a privately-held storage networking company in fiscal 2010 and the purchase of ServerEngines Corporation in fiscal 2011. There was no activity in goodwill during the six months ended January 1, 2012.

Intangible assets, net, are as follows (in thousands):

 

     January 1, 2012      July 3, 2011  
     Gross      Accumulated
Amortization
    Net      Gross      Accumulated
Amortization
    Net  

Intangible assets subject to amortization:

               

Core technology and patents

   $ 77,345       $ (63,572   $ 13,773       $ 77,345       $ (61,052   $ 16,293   

Developed technology

     198,100         (95,838     102,262         198,100         (82,116     115,984   

Customer relationships

     5,100         (4,467     633         5,100         (3,831     1,269   

Tradename

     6,339         (4,865     1,474         6,339         (4,781     1,558   

Backlog

     —           —          —           1,660         (1,660     —     

Other

     707         (334     373         707         (209     498   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 
   $ 287,591       $ (169,076   $ 118,515       $ 289,251       $ (153,649   $ 135,602   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

The intangible assets subject to amortization are being amortized on a straight-line basis over original lives ranging from approximately two to ten years. Aggregate amortization expense for intangible assets for the three months ended January 1, 2012 and December 26, 2010, was approximately $6.8 million and $13.1 million, respectively. Aggregated amortization expense for intangible assets for the six months ended January 1, 2012 and December 26, 2010, was approximately $17.1 million and $21.8 million, respectively.

Amortization expense of approximately $5.1 million and $9.6 million related to core and developed technology is included in cost of sales in the accompanying condensed consolidated statements of operations for the three months ended January 1, 2012 and December 26, 2010, respectively. Amortization expense of approximately $13.7 million and $16.0 million related to core and developed technology is included in cost of sales in the accompanying condensed consolidated statements of operations for the six months ended January 1, 2012 and December 26, 2010, respectively.

 

12


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The following table presents the estimated future aggregated amortization expense of intangible assets as of January 1, 2012 (in thousands):

 

2012 (remaining 6 months)

   $ 13,502   

2013

     26,140   

2014

     25,835   

2015

     21,835   

2016

     20,902   

Thereafter

     10,301   
  

 

 

 
   $ 118,515   
  

 

 

 

7. Accrued Liabilities

Components of accrued liabilities are as follows:

 

     January 1,
2012
     July 3,
2011
 
     (in thousands)  

Payroll and related costs

   $ 19,796       $ 21,327   

Warranty liability

     2,683         2,166   

Accrued rebates

     11,678         10,546   

Other

     8,264         8,160   
  

 

 

    

 

 

 
   $ 42,421       $ 42,199   
  

 

 

    

 

 

 

The Company provides a warranty of between one to five years on its products. The Company records a provision for estimated warranty related costs at the time of sale based on historical product return rates and the Company’s estimates of expected future costs of fulfilling its warranty obligations. Changes to the warranty liability during six months ended January 1, 2012 were:

 

     (in thousands)  

Balance at beginning of period

   $ 2,166   

Accrual for warranties issued

     1,315   

Changes to pre-existing warranties (including changes in estimates)

     171   

Settlements made (in cash or in kind)

     (969
  

 

 

 

Balance at end of period

   $ 2,683   
  

 

 

 

8. Commitments and Contingencies

Litigation

On September 14, 2009, Broadcom Corporation (Broadcom) filed a patent infringement lawsuit against the Company in the United States District Court in the Central District of California. The original complaint alleged infringement by the Company of ten Broadcom patents covering certain data and storage networking technologies. On January 11, 2010, the Court set a trial date of September 20, 2011. On February 23, 2010, Broadcom filed a first amended complaint adding allegations of infringement for one additional Broadcom patent. The first amended complaint sought unspecified damages and injunctive relief. On March 25, 2010, the Company filed its answer and affirmative defenses to the first amended complaint alleging that it believed that the Broadcom patents at issue were invalid or not infringed, or both. In addition, the Company asserted counterclaims for declaratory judgment of invalidity and non-infringement against each of the Broadcom patents at issue, and sought award of attorneys’ fees, costs, and expenses.

On May 26, 2010, Broadcom filed a separate patent infringement lawsuit against the Company in the United States District Court in the Central District of California. The 2010 lawsuit alleged infringement of a Broadcom patent covering certain data and storage networking technologies by certain Emulex products. Broadcom sought a judgment for damages, injunctive relief, and an award of attorneys’ fees and costs.

 

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On June 30, 2010, the Court consolidated the 2009 and 2010 patent cases into a single case. On October 14, 2010, the Court issued an order on the parties’ joint stipulation dismissing three patents from the case. On November 1, 2010, the Court issued an order allowing Broadcom to make infringement assertions against additional Emulex products. In a Court ruling dated December 17, 2010, the Court provided interpretations of certain terms contained in the claims of the patents being asserted by Broadcom. In February and May 2011, the Court issued separate orders on the parties’ joint stipulations collectively dismissing two patents from the case (leaving seven patents in the case). The Court heard the parties’ respective motions for summary judgment and subsequently issued a ruling on August 3, 2011 barring Broadcom’s claim for infringement on one patent, leaving six patents in the case. On August 25, 2011, the Company met with a mediator and representatives of Broadcom concerning potential settlement of the case. On September 2, 2011, the parties submitted a joint summary of the mediation proceedings, in which they stated that the mediation proceedings continued for a full day, that the parties were unable to reach a settlement agreement, and that although both parties remained available for further discussions, the parties did not believe that further settlement discussions prior to the September 20, 2011 trial would be likely to lead to agreement.

After a nearly three week trial that ended October 6, 2011, the jury reached a partial verdict involving two out of the six patents. The Court determined that one of the patents (US Patent 7,058,150) had been infringed by Emulex (in particular, by the Emulex BE2, BE3, XE201, and SOC 442 products), and the jury rendered an advisory verdict to the Court that it is not invalid, and awarded approximately $0.4 million (actual amount in dollars $387,922) in damages with respect to that patent. The jury reached a unanimous verdict of non-infringement on another patent relating to Emulex Fibre Channel switch products. A mistrial was declared concerning the remaining four patents for which no unanimous verdict was reached. On December 15, 2011, the Court issued judgments as a matter of law (JMOL) that the two patents, on which the jury had rendered advisory verdicts, were not invalid. The Court also issued, on December 16, 2011, a JMOL that one of the patents (US Patent 7,471,691) had been infringed by Emulex (in particular by the Emulex InSpeed® SOC 320, SOC 422, SOC 442, and Sequoia [containing SOC 442] products). The US Patent 7,058,150, particularly Claim 8 considered at the trial, pertains to the use of multiple lanes of phase interpolators, and the products involve clock and data recovery (CDR) circuits in SerDes modules on an application specific integrated circuit (ASIC). The US Patent 7,471,691, particularly Claim 7 considered at the trial, pertains to fibre channel arbitrated loop switch crossbars and scoreboards, and the products involve specialized ASICs used in storage arrays and pass-through modules. On January 6, 2012, Broadcom filed with the Court a Motion for Issuance of Permanent Injunction and proposed Permanent Injunction. The proposed Permanent Injunction relates to the two patents and the products mentioned above, and devices not colorably different therefrom. The deadline for the Company to file its opposition to the Broadcom motion is January 30, 2012; and the hearing date scheduled for that motion is March 2, 2012.

While the Company has contractual commitments from its suppliers concerning the defense and indemnification of certain Broadcom claims relating to certain technology provided by such suppliers, it cannot be certain that such defense and indemnification obligations will be promptly honored by such suppliers. This lawsuit continues to present risks that could have a material adverse effect on the Company’s business, financial condition, or results of operations, including loss of patent rights, monetary damages, and injunction against the sale of accused products. The Company continues to present a vigorous post-trial defense against this lawsuit, including a potential appeal of the JMOL rulings which found that the ‘150 and ‘691 patents were infringed by the Company. The Company accrued the approximately $0.4 million of damages liability relating to the ‘150 patent during its quarter ended October 2, 2011 as a result of the jury’s determination rendered on October 12, 2011 that the Company is to pay such damages to Broadcom, but is unable to determine whether any further loss will occur or to estimate the range of such further loss. Therefore, no further loss has been accrued.

See “Third party claims of intellectual property infringement could adversely affect our business” and “We are dependent on sole source and limited source third party suppliers and EMS providers for our products” in Item 1A—Risk Factors of this Form 10-Q for a description of certain risks relating to the Company’s litigation with Broadcom.

On November 9, 2009, the Company filed a lawsuit against Broadcom alleging that Broadcom had acted in an anticompetitive manner in violation of federal antitrust laws, as well as made defamatory statements and engaged in acts of unfair competition. The complaint seeks actual and punitive damages, attorneys’ fees and costs, and injunctive relief against Broadcom. On January 4, 2010, the Company filed an amended complaint. The amended complaint alleges that Broadcom has acted in an anticompetitive manner in violation of federal antitrust laws and made defamatory statements. The amended complaint seeks actual and punitive damages, attorneys’ fees and costs, and injunctive relief. On June 7, 2010, the Court denied Broadcom’s motion to dismiss the Company’s first amended complaint and to strike the Company’s defamation claim.

 

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On November 15, 2001, prior to the Company’s acquisition of Vixel Corporation, a securities class action lawsuit was filed in the United States District Court in the Southern Distr

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