XNYS:ELX Emulex Corp Quarterly Report 10-Q Filing - 4/1/2012

Effective Date 4/1/2012

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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 April 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  ¨   Smaller reporting company  ¨
  (Do not check if a 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 April 19, 2012, the registrant had 86,793,473 shares of common stock outstanding.

 

 

 


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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 intellectual property claims, with or without merit, that could result in costly litigation, cause product shipment delays, require us to indemnify customers, or require us to enter into royalty or licensing agreements, which may or may not be available. Furthermore, we have in the past obtained, and may be required in the future to obtain, licenses of technology owned by other parties. We cannot be certain that the necessary licenses will be available or that they can be obtained on commercially reasonable terms. If we were to fail to obtain such royalty or licensing agreements in a timely manner and on reasonable terms, our business, results of operations and financial condition could be materially adversely affected . Ongoing lawsuits, such as the action brought by Broadcom Corporation (Broadcom) described elsewhere in this Form 10-Q, 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 adequacy of any sunset period 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 which does not put us at a competitive disadvantage. In addition, the fact that the economy generally, and the technology and storage market 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 these uncertainties, we are unable to predict our future results with any accuracy. 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 products 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 effects 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-party suppliers and subcontractors for components and assembly; our ability to attract and retain key technical personnel; our

 

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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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EMULEX CORPORATION AND SUBSIDIARIES

INDEX

 

 

     PAGE  

Part I. FINANCIAL INFORMATION

  

Item 1. Financial Statements (unaudited)

  

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

     1   

Condensed Consolidated Statements of Operations for the Three and Nine months ended April  1, 2012 and March 27, 2011

     2   

Condensed Consolidated Statements of Cash Flows for the Nine months ended April 1, 2012 and March  27, 2011

     3   

Notes to Condensed Consolidated Financial Statements

     4   

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

     15   

Item 3. Quantitative and Qualitative Disclosures about Market Risk

     31   

Item 4. Controls and Procedures

     32   

Part II. OTHER INFORMATION

     32   

Item 1. Legal Proceedings

     32   

Item 1A. Risk Factors

     33   

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

     47   

Item 4. Mine Safety Disclosures

     48   

Item 6. Exhibits

     49   

Signatures

     50   

 

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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)

 

     April 1,
2012
    July 3,
2011
 
ASSETS   

Current assets:

    

Cash and cash equivalents

   $ 142,938      $ 131,160   

Investments

     58,563        37,025   

Accounts receivable, net of allowance for doubtful accounts of $1,888 and $1,743 at April 1, 2012 and July 3, 2011, respectively

     77,954        74,147   

Inventories

     30,267        20,508   

Prepaid income taxes

     7,870        12,709   

Prepaid expenses and other current assets

     9,657        9,684   

Deferred income taxes

     12,220        16,919   
  

 

 

   

 

 

 

Total current assets

     339,469        302,152   

Property and equipment, net

     60,875        64,095   

Investments

     —          15,165   

Goodwill

     177,290        177,290   

Intangible assets, net

     111,753        135,602   

Other assets

     8,824        8,535   
  

 

 

   

 

 

 

Total assets

   $ 698,211      $ 702,839   
  

 

 

   

 

 

 
LIABILITIES AND STOCKHOLDERS’ EQUITY   

Current liabilities:

    

Accounts payable

   $ 28,512      $ 29,043   

Accrued and other current liabilities

     39,515        42,199   
  

 

 

   

 

 

 

Total current liabilities

     68,027        71,242   

Other liabilities

     2,979        3,344   

Deferred income taxes

     687        11,362   

Accrued taxes

     28,385        28,200   
  

 

 

   

 

 

 

Total liabilities

     100,078        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; 104,291,805 and 102,655,094 issued at April 1, 2012 and July 3, 2011, respectively

     10,429        10,266   

Additional paid-in capital

     1,256,684        1,243,045   

Accumulated deficit

     (439,546     (456,060

Accumulated comprehensive loss

     (1,054     (238

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

     (228,380     (208,322
  

 

 

   

 

 

 

Total stockholders’ equity

     598,133        588,691   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 698,211      $ 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     Nine Months Ended  
     April 1,
2012
    March 27,
2011
    April 1,
2012
    March 27,
2011
 

Net revenues

   $ 125,746      $ 112,082      $ 372,814      $329,177   

Cost of sales:

        

Cost of goods sold

     45,828        42,060        138,179      123,304   

Amortization of core and developed technology intangible assets

     5,159        8,534        18,882      24,554   
  

 

 

   

 

 

   

 

 

   

 

 

Cost of sales

     50,987        50,594        157,061      147,858   
  

 

 

   

 

 

   

 

 

   

 

 

Gross profit

     74,759        61,488        215,753      181,319   
  

 

 

   

 

 

   

 

 

   

 

 

Operating expenses:

        

Engineering and development

     40,361        42,660        121,307      122,592   

Selling and marketing

     15,897        15,347        45,774      42,282   

General and administrative

     8,820        12,106        29,808      43,388   

Amortization of other intangible assets

     1,603        1,762        4,967      7,571   

In-process research and development impairment

     —          6,000        —        6,000   
  

 

 

   

 

 

   

 

 

   

 

 

Total operating expenses

     66,681        77,875        201,856      221,833   
  

 

 

   

 

 

   

 

 

   

 

 

Operating income (loss)

     8,078        (16,387     13,897      (40,514)   
  

 

 

   

 

 

   

 

 

   

 

 

Non-operating (expense) income, net:

        

Interest income

     19        19        74      61   

Interest expense

     (10     13        (14   (372)   

Impairment of strategic investment

     —          (9,184     —        (9,184)   

Other (expense) income, net

     (277     (101     265      (299)   
  

 

 

   

 

 

   

 

 

   

 

 

Total non-operating (expense) income, net

     (268     (9,253     325      (9,794)   
  

 

 

   

 

 

   

 

 

   

 

 

Income (loss) before income taxes

     7,810        (25,640     14,222      (50,308)   

Income tax (benefit) provision

     (869     (7,324     (2,292        17,608   
  

 

 

   

 

 

   

 

 

   

 

 

Net income (loss)

   $ 8,679      $ (18,316   $ 16,514      $(67,916)   
  

 

 

   

 

 

   

 

 

   

 

 

Net income (loss) per share:

        

Basic

   $ 0.10      $ (0.21   $ 0.19      $(0.80)   
  

 

 

   

 

 

   

 

 

   

 

 

Diluted

   $ 0.10      $ (0.21   $ 0.19      $(0.80)   
  

 

 

   

 

 

   

 

 

   

 

 

Number of shares used in per share computations:

        

Basic

     86,495        87,278        86,421      85,416   
  

 

 

   

 

 

   

 

 

   

 

 

Diluted

     88,518        87,278        88,369      85,416   
  

 

 

   

 

 

   

 

 

   

 

 

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)

 

     Nine Months Ended  
     April 1,
2012
    March 27,
2011
 

Cash flows from operating activities:

    

Net income (loss)

   $ 16,514      $ (67,916

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

    

Depreciation and amortization of property and equipment

     13,630        15,874   

Share-based compensation expense

     18,436        31,391   

Amortization of intangible assets

     23,849        32,125   

Impairment of strategic investment

     —          9,184   

In-process research and development impairment

     —          6,000   

Provision for losses on accounts receivable

     145        80   

Accrued interest income, net

     252        25   

Loss on disposal of property and equipment

     124        206   

Deferred income taxes

     (5,976     (1,028

Excess tax benefit from share-based compensation

     (448     (893

Foreign currency adjustments

     (236     608   

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

    

Accounts receivable, net

     (3,952     (5,792

Inventories

     (9,759     (3,871

Prepaid expenses and other assets

     (362     11,482   

Accounts payable, accrued liabilities, and other liabilities

     (3,599     (8,948

Accrued taxes

     185        (1,075

Income taxes payable and prepaid income taxes

     71        10,137   
  

 

 

   

 

 

 

Net cash provided by operating activities

     48,874        27,589   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Net proceeds from sale of property and equipment

     140        89   

Purchases of property and equipment

     (10,816     (16,049

Purchases of intangible assets

     —          (4,000

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

     —          (53,068

Loan to privately-held company

     —          (1,000

Cash received from escrow for prior business acquisition

     —          1,000   

Purchases of investments

     (23,692     (45,876

Maturities of investments

     17,067        83,879   
  

 

 

   

 

 

 

Net cash used in investing activities

     (17,301     (35,025
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Repurchase of common stock

     (20,058     (40,082

Minimum tax withholdings paid on behalf of employees for restricted stock

     (4,701     (5,241

Repayment of debt to the Founders of ServerEngines Corporation

     —          (26,897

Proceeds from issuance of common stock under stock plans

     4,790        4,559   

Excess tax benefit from share-based compensation expense

     448        893   
  

 

 

   

 

 

 

Net cash used in financing activities

     (19,521     (66,768
  

 

 

   

 

 

 

Effect of exchange rates on cash and cash equivalents

     (274     238   
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     11,778        (73,966

Cash and cash equivalents at beginning of period

     131,160        248,813   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 142,938      $ 174,847   
  

 

 

   

 

 

 

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 nine months ended April 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 $4.2 million, of which $1.1 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 $0.2 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

 

     Nine Months Ended  
     April 1,
2012
     March 27,
2011
 
     (in thousands)  

Cash paid during the period for:

     

Interest

   $ 4       $ 16   

Income taxes

   $ 3,432       $ 7,856   

Non-cash activities:

     

Purchases of property and equipment not paid, net

   $ 142       $ 1,335   

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 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.

 

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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 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. There was no impact to the Company’s financial statement disclosures upon adoption of this guidance in the interim period ended April 1, 2012.

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 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 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.

 

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2. Business Combinations

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 second half of the common stock in escrow was released on February 25, 2012.

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 of stock based compensation related to these 2.5 million shares in both the three months ended April 1, 2012 and March 27, 2011. The Company recognized approximately $4.1 million and $15.2 million of stock based compensation related to these 2.5 million shares during the nine months ended April 1, 2012 and March 27, 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 (unadjusted) in active markets for identical assets or liabilities;
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.

 

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

 

     Level 1      Level 2      Level 3      Total  
     (in thousands)  

April 1, 2012

           

Cash and cash equivalents

   $ 142,938       $ —         $ —         $ 142,938   

U.S. government securities

     50,286         —           —           50,286   

U.S. government sponsored entity securities

     2,900         —           —           2,900   

Corporate bonds

     714         —           —           714   

Marketable certificates of deposit

     —           4,670        —           4,670   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 196,838       $ 4,670      $ —         $ 201,508   
  

 

 

    

 

 

    

 

 

    

 

 

 

July 3, 2011

           

Cash and cash equivalents

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

U.S. government securities

     42,928         —           —           42,928   

U.S. government sponsored entity securities

     4,678         —           —           4,678   

Corporate bonds

     1,588         —           —           1,588   

Marketable certificates of deposit

     —           2,989         —           2,989   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 180,354       $ 2,989       $ —         $ 183,343   
  

 

 

    

 

 

    

 

 

    

 

 

 

The Company’s Level 2 securities were primarily valued based on information obtained from a third-party pricing service. To estimate fair value, the pricing service utilizes a pricing model for which all significant inputs are observable, either directly or indirectly from market data. These inputs include reported trades and broker/dealer quotes of the same or similar securities, issuer credit spreads, benchmark securities and other observable inputs.

There were no transfers between Level 1, Level 2, or Level 3 securities in the nine months ended April 1, 2012.

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)  

April 1, 2012

          

U.S. government securities

   $ 50,278       $ 8       $ —        $ 50,286   

U.S. government sponsored entity securities

     2,901         —           (1     2,900   

Corporate bonds

     714         —           —          714   

Marketable certificates of deposit

     4,670         —           —          4,670   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 58,563       $ 8       $ (1   $ 58,570   
  

 

 

    

 

 

    

 

 

   

 

 

 

July 3, 2011

          

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   

Marketable certificates of deposit

     2,989         —           —          2,989   
  

 

 

    

 

 

    

 

 

   

 

 

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

 

 

    

 

 

    

 

 

   

 

 

 

Investments at April 1, 2012 and July 3, 2011 were classified as follows:

 

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

Short-term investments (maturities within one year)

   $ 58,563       $ 37,025   

Long-term investments (maturities longer than one year)

     —           15,165   
  

 

 

    

 

 

 
   $ 58,563       $ 52,190   
  

 

 

    

 

 

 

 

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5. Inventories

Inventories are summarized as follows:

 

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

Raw materials

   $ 9,248       $ 6,352   

Finished goods

     21,019         14,156   
  

 

 

    

 

 

 
   $ 30,267       $ 20,508   
  

 

 

    

 

 

 

As of April 1, 2012 and July 3, 2011, finished goods inventory includes approximately $2.9 million and $0.4 million, respectively, related to inventory owned by customers for which revenue has been deferred due to rights of return, the amounts for which cannot be reasonably estimated.

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 nine months ended April 1, 2012.

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

 

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

Intangible assets subject to amortization:

               

Core technology and patents

   $ 77,345       $ (64,832   $ 12,513       $ 77,345       $ (61,052   $ 16,293   

Developed technology

     198,100         (100,986     97,114         198,100         (82,116     115,984   

Customer relationships

     5,100         (4,704     396         5,100         (3,831     1,269   

Tradename

     6,339         (4,908     1,431         6,339         (4,781     1,558   

Backlog

     —           —          —           1,660         (1,660     —     

Other

     707         (408     299         707         (209     498   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 
   $ 287,591       $ (175,838   $ 111,753       $ 289,251       $ (153,649   $ 135,602   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

The intangible assets subject to amortization are being amortized on a straight-line basis over expected useful lives ranging from approximately two to ten years. Aggregate amortization expense for intangible assets for the three months ended April 1, 2012 and March 27, 2011, was approximately $6.8 million and $10.3 million, respectively. Aggregated amortization expense for intangible assets for the nine months ended April 1, 2012 and March 27, 2011, was approximately $23.8 million and $32.1 million, respectively.

Amortization expense of approximately $5.2 million and $8.5 million related to core and developed technology is included in cost of sales for the three months ended April 1, 2012 and March 27, 2011, respectively. Amortization expense of approximately $18.9 million and $24.6 million related to core and developed technology is included in cost of sales for the nine months ended April 1, 2012 and March 27, 2011, respectively.

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

 

2012 (remaining 3 months)

   $ 6,750   

2013

     26,137   

2014

     25,832   

2015

     21,832   

2016

     20,901   

Thereafter

     10,301   
  

 

 

 
   $ 111,753   
  

 

 

 

 

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7. Accrued and Other Current Liabilities

Components of accrued and other current liabilities are as follows:

 

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

Payroll and related costs

   $ 17,029       $ 21,327   

Warranty liability

     2,359         2,166   

Accrued rebates

     9,600         10,546   

Other

     10,527         8,160   
  

 

 

    

 

 

 
   $ 39,515       $ 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 future costs of fulfilling its warranty obligations. Changes to the warranty liability during nine months ended April 1, 2012 were:

 

     (in thousands)  

Balance at beginning of period

   $ 2,166   

Accrual for warranties issued

     2,082   

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

     (740

Settlements made (in cash or in kind)

     (1,149
  

 

 

 

Balance at end of period

   $ 2,359   
  

 

 

 

8. Commitments and Contingencies

Litigation

Broadcom Patent Infringement 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.

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.

 

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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 (U.S. Patent 7,058,150) [the ‘150 patent] had been infringed by Emulex, and the jury rendered an advisory verdict on October 12, 2011 to the Court that it is not invalid, and awarded approximately $0.4 million 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. On December 16, 2011, the Court issued an additional JMOL that one of the patents (U.S. Patent 7,471,691) [the ‘691 patent] had been infringed by Emulex. The ‘150 patent, particularly Claim 8 considered at the trial, pertains to the use of multiple lanes of phase interpolators, and products that utilize clock and data recovery (CDR) circuits in SerDes modules on an application specific integrated circuit (ASIC). The ‘691 patent, particularly Claim 7 considered at the trial, pertains to fibre channel arbitrated loop switch crossbars and scoreboards, and products that utilize specialized ASICs used in storage arrays and pass-through modules.

On March 16, 2012, the Court issued a decision concerning injunctive relief for the ‘150 and the ‘691 patents. The decision provided, in part, for a sunset period of 18 months relating to the ‘150 patent, starting on October 12, 2011. The decision further provided for a sunset period of 18 months relating to the ‘691 patent, starting on December 16, 2011. The affected products for the ‘150 patent include the BE2, BE3, XE201, and SOC 442 ASICs, products containing them, and products not colorably different from them. The affected products for the ‘691 patent include the SOC 320, SOC 422, and SOC 442 ASICs, products containing them, and products not colorably different from them. The sunset period allows the Company to sell the affected products to existing customers for specific customer devices, subject to limitations relating to when the products had been qualified and when certain firm orders had been placed. The decision further provided for the Company to pay a royalty of nine percent on all sales of such products made during the sunset period, and also provided that foreign sales (outside the U.S.) are beyond the scope of the suit. On April 3, 2012, the Court issued a Permanent Injunction which, with respect to both the ‘150 and ‘691 patents, further describe the prohibited activities, contain sunset provision terms including royalty rates and computations, limit the territory to allow sales of products that are manufactured outside the U.S. to customers located outside the U.S., permit design around efforts including modifications and design, development, and testing to eliminate infringement, and permit service and technical support for certain products. The Permanent Injunction refers to an Appendix to that Order, but no appendix was included when the Permanent Injunction was issued on April 3, 2012. The Appendix is to identify the permitted sunset sales, which would include the existing Emulex customers, the particular customer platform and the Emulex product or devices. On April 4, 2012, the Company filed a notice of appeal. On April 23, 2012, the Court stated that the Appendix is to be in final form by June 4, 2012.

On April 12, 2012, the Court scheduled the start of the re-trial relating to the ‘194 family of patents that the previous jury could not reach a unanimous verdict on for April 2, 2013. The previous trial involved the following patents in the ‘194 family: U.S. Patent 6,424,194, Claim 1; U.S. Patent 7,486,124, Claim 5; and U.S. Patent 7,724,057, Claim 42, all of which pertain to circuitry used to deserialize signals. The Court has not issued any rulings with respect to these remaining three patents.

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, filed a formal appeal of the previous infringement verdicts, damages and judgments on April 4, 2012. 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. The Company also accrued approximately $0.5 million of royalty liability during its quarter ended April 1, 2012 as a result of the decision of the Court on March 16, 2012. The Company is currently unable to determine whether any further loss will occur or to estimate the range of any such further loss.

Other Litigation

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. On April 4, 2012, the Court granted the parties order on joint stipulation to dismiss this lawsuit without prejudice.

 

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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 District of New York as Case No. 01 CIV. 10053 (SAS), Master File No. 21 MC92 (SAS) against Vixel and two of its officers and directors (one of which is James M. McCluney, the Company’s current Chief Executive Officer) and certain underwriters who participated in the Vixel initial public offering in late 1999. The amended complaint alleged violations under Section 10(b) of the Exchange Act and Section 11 of the Securities Act and sought unspecified damages on behalf of persons who purchased Vixel stock during the period October 1, 1999 through December 6, 2000. On April 2, 2009, the parties signed a Stipulation and Agreement of Settlement (the 2009 Settlement) to the District Court for preliminary approval. The District Court granted the plaintiffs’ motion for preliminary approval and preliminarily certified the settlement classes on June 10, 2009. The settlement “fairness” hearing was held on September 10, 2009. On October 6, 2009, the District Court entered an opinion granting final approval to the settlement and directing that the Clerk of the District Court close these actions. The 2009 Settlement provides for Emulex to pay zero and for insurers to pay the entire settlement amount of $586 million for all defendants. Notices of appeal of the opinion granting final approval were originally filed by six groups of appellants. On January 10, 2012, the last remaining appellant dismissed his appeal, permitting the 2009 Settlement to close and conclude this litigation.

In addition to the ongoing litigation discussed above, the Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of the open matters will not have a material adverse effect on the Company’s consolidated financial position, results of operations or liquidity.

Other Commitments and Contingencies

The Company has recorded approximately $34.0 million of liabilities associated with uncertain tax positions as of April 1, 2012 for which a reasonably reliable estimate of the period of payment cannot be made.

The Company has entered into various agreements for professional services, non-recurring engineering, and purchases of inventory. As of April 1, 2012, the Company’s obligations associated with such agreements were approximately $64.7 million.

In addition, the Company provides limited indemnification in selected circumstances within its various customer contracts whereby the Company indemnifies the parties to whom it sells its products with respect to the Company’s product infringement of certain intellectual property, and in some limited cases against bodily injury or damage to real or tangible personal property caused by a defective Company product. It is not possible to predict the maximum potential amount of future payments under these or similar agreements, due to the conditional nature of the Company’s obligations and the unique facts and circumstances involved in each particular agreement. As of April 1, 2012, the Company has not incurred any significant costs related to indemnification of its customers.

9. Treasury Stock

In early August 2008, the Company’s Board of Directors authorized a plan to repurchase up to $100.0 million of its outstanding common stock. In April 2009, upon receipt of an unsolicited acquisition proposal and related tender offer of Broadcom Corporation to acquire the Company, the Company’s Board of Directors elected to temporarily suspend any activity under the share repurchase plan. In light of Broadcom allowing its tender offer to expire on July 14, 2009, Emulex’s Board of Directors elected to reactivate the $100.0 million share repurchase plan effective July 15, 2009. As of April 1, 2012, the Company has repurchased approximately 9.0 million shares of its common stock for an aggregate purchase price of approximately $78.4 million at an average purchase price of $8.67 per share under this plan. Approximately 2.9 million shares for an aggregate purchase price of approximately $20.1 million at an average purchase price of $6.83 per share were purchased during the nine months ended April 1, 2012. Approximately $21.6 million is available under this program after these repurchases. The Company may repurchase additional shares from time-to-time in open market purchases or privately negotiated transactions. It is expected that any future share repurchases will be financed by available cash balances and cash from operations. The Company’s Board of Directors has not set an expiration date for the plan.

 

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10. Stock-Based Compensation

The assumptions utilized to compute the fair value of stock option grants under the 2005 Equity Incentive Plan (Equity Incentive Plan) and the 1997 Stock Award Plan for Non-Employee Directors (Director Plan) for the three and nine months ended April 1, 2012 and March 27, 2011 were:

 

     Three Months Ended    Nine Months Ended
     April 1,
2012 (1)
   March 27,
2011 (1)
   April 1,
2012
  March 27,
2011

Expected volatility

   N/A    N/A    45% – 47%   39% — 45%

Weighted average expected volatility

   N/A    N/A    46%   43%

Expected dividends

   N/A    N/A     

Expected term (in years)

   N/A    N/A    3.57 – 5.57   3.34 — 5.34

Weighted average expected term (in years)

   N/A    N/A    4.41   4.16

Risk-free rate

   N/A    N/A    0.67% – 1.22%   0.69% — 1.80%

 

(1) No options were granted during both the three months ended April 1, 2012 and March 27, 2011.

The assumptions utilized to compute the fair value of the compensatory element related to the shares to be purchased under the Emulex Corporation Employee Stock Purchase Plan (Purchase Plan) for the three and nine months ended April 1, 2012 and March 27, 2011 were:

 

     Three Months Ended     Nine Months Ended  
     April 1,
2012
    March 27,
2011
    April 1,
2012
    March 27,
2011
 

Expected volatility

     45     37     45     37

Expected dividends

     —          —          —          —     

Expected term (in years)

     0.49        0.49        0.49        0.49   

Risk-free rate

     0.06     0.18     0.06     0.18

A summary of stock-based compensation expense, by functional line item in the condensed consolidated statements of operations is as follows:

 

     Three Months
Ended
April 1,
2012
     Three Months
Ended
March  27,
2011
     Nine Months
Ended

April  1,
2012
     Nine Months
Ended
March 27,
2011
 
     (in thousands)  

Cost of revenues

   $ 223       $ 424       $ 990       $ 1,319   

Engineering

     2,547         3,223         7,831         12,740   

Sales and marketing

     938         1,333         2,874         3,584   

General and administrative

     2,149         2,455         6,741         13,748   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 5,857       $ 7,435       $ 18,436       $ 31,391   
  

 

 

    

 

 

    

 

 

    

 

 

 

A summary of stock option activity for the nine months ended April 1, 2012 is as follows:

 

     Options     Weighted
Average
Exercise Price
     Weighted
Average
Remaining
Contractual
Term
     Aggregate
Intrinsic
Value
 
                  (in years)      (in millions)  

Options outstanding at July 3, 2011

     7,099,171      $ 16.30         2.82       $ 1.5   

Options granted

     189,000      $ 7.68         

Options exercised

     (235,005   $ 8.15         

Options expired

     (2,518,480   $ 21.74         

Options forfeited

     (23,790   $ 8.18         
  

 

 

         

Options outstanding at April 1, 2012

     4,510,896      $ 13.38         3.09       $ 3.5   
  

 

 

         

 

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Table of Contents

A summary of unvested stock awards activity for nine months ended April 1, 2012 is as follows:

 

     Number of
Awards
    Weighted
Average Grant
Date Fair
Value
 

Awards outstanding and unvested at July 3, 2011

     3,615,080      $ 10.17   

Awards granted

     1,584,046      $ 7.58   

Awards vested

     (1,570,786   $ 9.79   

Awards forfeited

     (188,968   $ 9.98   
  

 

 

   

Awards outstanding and unvested at April 1, 2012

     3,439,372      $ 9.16   
  

 

 

   

As of April 1, 2012, there was approximately $18.3 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the plans. Such cost is expected to be recognized over a weighted-average period of approximately 1.2 years.

At Emulex’s Annual Shareholders Meeting on November 29, 2011, the shareholders approved an increase in the number of shares authorized under the Purchase Plan by 1.5 million shares. As of April 1, 2012, including the shares newly authorized, the Company anticipates that the number of shares authorized under the Equity Incentive Plan, the Director Plan, the Purchase Plan, and nine other stock-based plans, which are closed for future grants but have options outstanding, are sufficient to cover future stock option exercises, restricted stock awards, and shares that will be purchased under the Purchase Plan during the next six month option period from November 1, 2011 to April 30, 2012.

11. Income Taxes

The Company provides for income taxes in interim periods based on the estimated effective income tax rate for the complete fiscal year. The income tax provision is computed on the pretax income of the consolidated entities located within each taxing jurisdiction based on current tax law. Deferred tax assets and liabilities are determined based on the future tax consequences associated with temporary differences between income and expenses reported for financial accounting and tax reporting purposes. A valuation allowance for deferred tax assets is recorded to the extent that the Company cannot determine that the ultimate realization of the net deferred tax assets is more likely than not.

Realization of deferred tax assets is principally dependent upon the achievement of future taxable income, the estimation of which requires significant management judgment. Assumptions regarding future profitability may change due to many factors, including future market conditions and the Company’s ability to successfully execute its business plans and/or tax planning strategies. These changes, if any, may require material adjustments to these deferred tax asset balances. Due to uncertainties surrounding the realization of the Company’s cumulative federal and state capital loss carryforwards, Massachusetts research credit carryforwards, California research credit carryforwards and other California deferred tax assets, the Company previously recorded a full valuation allowance against the portion of its deferred tax assets relating to such items. On a quarterly basis, the Company reassesses the need for these valuation allowances based on operating results and its assessment of the likelihood of future taxable income and developments in the relevant tax jurisdictions. The Company continues to maintain a valuation allowance against these deferred tax assets as of April 1, 2012 since the Company believes it is more likely than not that such deferred tax assets will not be realized.

As of April 1, 2012, the liability for income taxes associated with uncertain tax positions was $34.0 million for which a reasonably reliable estimate for the period of payment cannot be made. If the potential benefit from such uncertain tax positions were fully recognized in the Company’s tax provision, approximately $31.4 million of such liability would reduce the Company’s effective tax rate. Absent any resolution of the on-going audit by the Internal Revenue Service (IRS) discussed below, the Company does not expect that the liability for its unrecognized tax positions will change significantly within the next 12 months.

The Company’s federal income tax returns for fiscal years 2008 to 2011 and California income tax returns for fiscal years 2007 to 2011 are subject to audit as the statute of limitations has not yet expired. The Company’s federal income tax return for fiscal years 2008 and 2009 are currently under examination by the IRS. Additionally, the IRS is examining an amended return filed for fiscal year 2007. The Company is also currently under audit by various state and international taxing authorities. While the Company strives to resolve open matters with each tax authority at the examination level, it may decide to challenge any assessments that may be made, and may exercise its right to appeal. The Company has accrued for what it believes are adequate amounts of tax and related interest, if any, that may result from these examinations. Such accruals are reviewed quarterly and adjusted as events occur that affect potential liabilities for additional taxes, such as lapsing of applicable statutes of limitations, proposed assessments by tax authorities, negotiations between tax authorities, identification

 

13


Table of Contents

of new issues, and issuance of new legislation, regulations or case law. If the ultimate resolution of these audits are substantially different from Management’s estimate of any potential associated liabilities, the resulting audit adjustments could have a material adverse effect on the Company’s tax provision, net income and cash flows.

12. Net Income (Loss) Per Share

The following table sets forth the computation of basic and diluted net income (loss) per share:

 

     Three Months Ended     Nine Months Ended  
     April 1,
2012
    March 27,
2011
    April 1,
2012
    March 27,
2011
 
     (in thousands, except per
share data)
    (in thousands, except per
share data)
 

Numerator — Net income (loss)

   $ 8,679      $ (18,316   $ 16,514      $ (67,916

Less: Undistributed earnings allocated to participating securities

     (8     —          (16     —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Undistributed earnings allocated to common shareholders for basic net income (loss) per share

   $ 8,671      $ (18,316   $ 16,498      $ (67,916
  

 

 

   

 

 

   

 

 

   

 

 

 

Undistributed earnings allocated to common shareholders for diluted net income (loss) per share

   $ 8,671      $ (18,316   $ 16,498      $ (67,916
  

 

 

   

 

 

   

 

 

   

 

 

 

Denominator:

        

Denominator for basic net income (loss) per share — weighted average shares outstanding

     86,495        87,278        86,421        85,416   

Dilutive options outstanding, unvested stock units and ESPP

     2,023        —          1,948        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Denominator for diluted net income (loss) per share — adjusted weighted average shares outstanding

     88,518        87,278        88,369        85,416   
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic net income (loss) per share

   $ 0.10      $ (0.21   $ 0.19      $ (0.80
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted net income (loss) per share

   $ 0.10      $ (0.21   $ 0.19      $ (0.80
  

 

 

   

 

 

   

 

 

   

 

 

 

Antidilutive options and unvested stock excluded from the computations

     4,421        7,786        5,616        8,949   
  

 

 

   

 

 

   

 

 

   

 

 

 

Average market price of common stock

   $ 9.84      $ 11.31      $ 8.26      $ 10.66   
  

 

 

   

 

 

   

 

 

   

 

 

 

The antidilutive stock options and unvested stock were excluded from the computation of diluted net income (loss) per share due to the assumed proceeds from the award’s exercise or vesting being greater than the average market price of the common shares or due to the Company incurring a net loss for the periods presented.

13. Comprehensive Income (Loss)

Components of comprehensive income (loss) are as follows:

 

     Three Months Ended     Nine Months Ended  
     April 1,
2012
     March 27,
2011
    April 1,
2012
    March 27,
2011
 
     (in thousands)     (in thousands)  

Net income (loss)

   $ 8,679       $ (18,316   $ 16,514      $ (67,916

Other comprehensive income (loss):

         

Foreign currency translation adjustments, net of income taxes

     392         196        (816     327   
  

 

 

    

 

 

   

 

 

   

 

 

 
   $ 9,071       $ (18,120   $ 15,698      $ (67,589
  

 

 

    

 

 

   

 

 

   

 

 

 

 

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Table of Contents

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

Executive Overview

Emulex designs and markets high speed enterprise-class products that are used to connect servers and storage arrays. The world’s leading server and storage Original Equipment Manufacturers (OEMs) depend on our broad range of products to help build high performance, highly reliable, and scalable Fibre Channel Storage Area Networks (SAN) and Ethernet Converged Networking solutions.

Our Company operates within a single business segment that has two primary market-focused product lines. Beginning the first quarter of fiscal 2012, these primary product lines are Network Connectivity Products (NCP) and Storage Connectivity Products (SCP). We believe this new product line reporting is more consistent with how third party analysts view our addressable markets, and will provide a more transparent view of our business.

Customers in the NCP market use our industry standard Fibre Channel and Ethernet solutions to provide server Input/Output (I/O) and target storage array connectivity to create networks for mission critical enterprise and cloud data centers. These products enable servers to reliably and efficiently connect to Local Area Networks (LANs), SANs, and Network Attached Storage (NAS) by offloading data communication processing tasks from the server as information is delivered and sent to the network. Our products use industry standard protocols including Fibre Channel Protocol (FCP), Internet Protocol (IP), Transmission Control Protocol (TCP)/IP, Internet Small Computer System Interface (iSCSI), NAS, and Fibre Channel over Ethernet (FCoE).

Our Ethernet products include Universal Local Area Network on Motherboard application specific integrated circuits (ULOMs), OneConnect Universal Converged Network Adapters (UCNAs), and custom form factor solutions for OEM blade servers that enable high performance, scalable networks and convergence. Our Fibre Channel based products include Fibre Channel application specific integrated circuits (ASICs), LightPulse® Host Bus Adaptors (HBAs), and custom form factor solutions for OEM blade servers.

SCP includes our InSpeed®, FibreSpy®, switch-on-a-chip (SOC) or backend connectivity, bridge, and router products. SCP are deployed inside storage arrays, tape libraries, and other storage appliances, and connect storage controllers to storage capacity, delivering improved performance, reliability, and connectivity. Our products use industry standard protocols including Fibre Channel, Serial Attached Small Computer Interface (SAS), and Serial Advanced Technology Attachment (SATA).

Our Advanced Technology and Other Products (ATP) category primarily consists of Integrated Baseboard Management Controllers (iBMC), OneCommand® Vision products, certain legacy products and other products and services.

We rely almost exclusively on OEMs and sales through distribution channels for our revenue. Our significant OEM customers include the world’s leading server and storage providers, including Cisco Systems, Inc. (Cisco), Dell Inc. (Dell), EMC Corporation (EMC), Fujitsu Ltd. (Fujitsu), Groupe Bull (Bull), Hewlett-Packard Company (Hewlett-Packard), Hitachi Data Systems (HDS), Hitachi Limited (Hitachi), Huawei Technologies Company Ltd. (Huawei), Intel Corporation (Intel), International Business Machines Corporation (IBM), NEC Corporation (NEC), Network Appliance, Inc. (NetApp), Oracle Corporation (Oracle), Quantum Corporation (Quantum), Unisys Corporation (Unisys), and Xyratex Ltd. (Xyratex). Our significant distributors include ASI Computer Technologies, Inc. (ASI), Avnet, Inc. (Avnet), Digital China Technology Limited, Info X Distribution, LLC (Info X), Ingram Micro Inc. (Ingram Micro), Macnica Networks Corporation (Macnica), Netmarks Inc. (Netmarks), SYNNEX Corporation (SYNNEX), Tech Data Corporation (Tech Data), and Tokyo Electron Device Ltd. (TED). The market for networking infrastructure solutions is concentrated among large OEMs, and as such, a significant portion of our revenues are generated from sales to a limited number of customers.

As of April 1, 2012, we had a total of 997 employees.

Our corporate headquarters are located at 3333 Susan Street, Costa Mesa, California 92626. Our periodic and current reports filed with, or furnished to, the Securities and Exchange Commission pursuant to the requirements of the Securities and Exchange Act of 1934 are available free of charge through our website (www.emulex.com) as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the Securities and Exchange Commission. References contained herein to “Emulex,” the “Company,” the “Registrant,” “we,” “our,” and “us” refer to Emulex Corporation and its subsidiaries.

 

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Table of Contents

Consolidation of Facilities

During fiscal 2011, we 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 $4.2 million, of which $1.1 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 $0.2 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.

Business Combination

On August 25, 2010, we acquired 100% of the outstanding common shares of ServerEngines Corporation (ServerEngines), a privately-held, fabless semiconductor company located in Sunnyvale, California. The combination of Emulex and ServerEngines’ technology creates a unique offering to deliver I/O connectivity for converged networking solutions, including adapters, mezzanine cards and LAN on Motherboard (LOM) solutions. In addition, the acquisition adds the ServerEngines’ PilotTM family of Servers Management Controllers, which reside on the motherboard, enabling remote IP based “lights out” management capabilities.

Product Redesign Activities

Broadcom Corporation (Broadcom) filed a consolidated patent infringement suit against us during fiscal 2010. 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 (U.S. Patent 7,058,150) [the ‘150 patent] had been infringed by us, and the jury rendered an advisory verdict on October 12, 2011 to the Court that the ‘150 patent is not invalid, and awarded approximately $0.4 million in damages related 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 on the remaining four patents for which no unanimous verdict was reached. Subsequent to the trial, the Court issued orders consistent with the advisory verdicts of invalidity, and issued an order that one additional patent (U.S. Patent 7,471,691) [the ‘691 patent] had been infringed by us. On March 16, 2012, the Court issued a decision concerning injunctive relief for the ‘150 and the ‘691 patents. The decision provided, in part, for a sunset period of 18 months relating to the ‘150 patent, starting on October 12, 2011. The decision further provided for a sunset period of 18 months relating to the ‘691 patent, starting on December 16, 2011. The affected products for the ‘150 patent include the BE2, BE3, XE201, and SOC 442 ASICs, products containing them, and products not colorably different from them. The affected products for the ‘691 patent include the SOC 320, SOC 422, and SOC 442 ASICs, products containing them, and products not colorably different from them. The sunset period allows Emulex to sell the affected products to existing customers for specific customer devices, subject to limitations relating to when the products had been qualified by the customers and when certain firm orders had been placed. The decision further provided for Emulex to pay a royalty of nine % on all sales of such products made during the sunset period. The decision also provided that foreign sales (outside the U.S.) are beyond the scope of the suit. On April 3, 2012, the Court issued a Permanent Injunction which, with respect to both the ‘150 and ‘691 patents, further describe the prohibited activities, contain sunset provision terms including royalty rates and computations, limit the territory to allow sales of products that are manufactured outside the U.S. to customers located outside the U.S., permit design around efforts including modifications and design, development, and testing to eliminate infringement, and permit service and technical support for certain products. On April 4, 2012, we filed a notice of appeal. In connection with the October 12, 2011 verdict, we accrued approximately $0.4 million in damages during our first quarter ended October 2, 2011. In connection with the March 16, 2012 injunction decision of the Court, we accrued approximately $0.5 million in royalty liability in our third quarter ended April 1, 2012 for the sales of affected products from the beginning of the sunset periods through the end of the quarter.

As a result of the suit, we expect to incur incremental mitigation and appeal related expenses during the next 12 to 15 months in the range of $15 million – $25 million. Engineering and development costs will include expenses for activities to redesign, design around, modify, design, develop, test and requalify certain of our affected products during the sunset period, and to implement our end of life processes in the U.S. for certain other affected products. Sales and marketing costs are likely to include expenses for customer support, pre-production samples, education and training, and other miscellaneous costs. General and administrative costs will include expenses for our appeal of the previous verdicts and judgments. See Note 8 in the notes to the condensed consolidated financial statements under the caption “Litigation” in Part I, Item 1 of this Form 10-Q.

 

16


Table of Contents

Results of Operations

The following discussion and analysis should be read in conjunction with the condensed consolidated financial statements included elsewhere herein.

 

     Percentage of Net Revenues     Percentage of Net Revenues  
     Three Months Ended     Nine Months Ended  
     April 1,
2012
    March 27,
2011
    April 1,
2012
    March 27,
2011
 

Net revenues

     100     100     100     100

Cost of sales

        

Cost of goods sold

     37        37        37        37   

Amortization of core and developed technology intangible assets

     4        8        5        8   
  

 

 

   

 

 

   

 

 

   

 

 

 

Cost of sales

     41        45        42        45   
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

     59        55        58        55   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

        

Engineering and development

     32        38        33        37   

Selling and marketing

     13        14        12        13   

General and administrative

     7        11        8        13   

Amortization of other intangible assets

     1        2        1        3   

In process research and development impairment

     —          5        —          2   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     53        70        54        68   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income (loss)

     6        (15     4        (13
  

 

 

   

 

 

   

 

 

   

 

 

 

Non-operating income (expense), net:

        

Interest income

     —          —          —          —     

Interest expense

     —          —          —          —     

Impairment of strategic investment

     —          —          —          —     

Other expense, net

     —          (8     —          (3
  

 

 

   

 

 

   

 

 

   

 

 

 

Total non-operating income (expense), net

     —          (8     —          (3
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes

     6        (23     4        (16
  

 

 

   

 

 

   

 

 

   

 

 

 

Income tax (benefit) provision

     (1     (7     —          5   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

     7     (16 )%      4     (21 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

 

17


Table of Contents

Three months ended April 1, 2012, compared to three months ended March 27, 2011

Net Revenues. Net revenues for the third quarter of fiscal 2012 ended April 1, 2012, increased by approximately $13.7 million, or 12%, to approximately $125.7 million, compared to approximately $112.0 million for the same quarter of fiscal 2011 ended March 27, 2011.

Net Revenues by Product Line

Net revenues by product line were as follows:

 

Three Months Three Months Three Months Three Months Three Months Three Months
     Net Revenues by Product Line  
(in thousands)    Three Months
Ended
April  1,

2012
     Percentage
of Net
Revenues
    Three Months
Ended
March 27,
2011
     Percentage
of Net
Revenues
    Increase/
(Decrease)
    Percentage
Change
 

Network Connectivity Products

   $ 91,127         73   $ 83,893         75   $ 7,234        9

Storage Connectivity Products

     27,855         22     21,012         19     6,843        33

Advanced Technology & Other Products

     6,764         5     7,177         6     (413     (6 )% 
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total net revenues

   $ 125,746         100   $ 112,082         100   $ 13,664        12
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

NCP primarily consists of standup HBAs, mezzanine cards, I/O ASICs, ULOMs, and UCNAs. For the three months ended April 1, 2012, our Fibre Channel based products accounted for approximately 70% of total NCP revenues, however, our Ethernet based products revenue grew by more than 100% compared to the same period in the prior year. The increase in our NCP revenue for the three months ended April 1, 2012 compared to the three months ended March 27, 2011 was primarily due to an increase in units shipped of approximately 31%, partially offset by a decrease in average selling price of approximately 17%.

SCP primarily consists of our InSpeed®, FibreSpy®, SOC or backend connectivity, and bridge and router products. For the three months ended April 1, 2012, our bridging products revenue grew by approximately 87%. The increase in our SCP net revenue for the three months ended April 1, 2012 compared to the three months ended March 27, 2011 was primarily due to an increase in units shipped of approximately 87%, partially offset by a decrease in average selling price of approximately 29%.

ATP primarily consists of our iBMCs, which are products previously sold by ServerEngines prior to our acquisition on August 25, 2010, OneCommand® Vision software products, certain legacy products and other products and services. For the three months ended April 1, 2012, our iBMC based products accounted for the majority of total ATP revenues. The decrease in our ATP revenue for the three months ended April 1, 2012 was primarily due to a decrease in units shipped of approximately 21%, partially offset by an increase in average selling price of approximately 19%.

 

18


Table of Contents

Net Revenues by Major Customers

In addition to direct sales, some of our larger OEM customers purchase or market products indirectly through distributors, resellers or other third parties. If these indirect sales are purchases of customer-specific models, we are able to track these sales. However, if these indirect sales are purchases of our standard models, we are not able to distinguish them by OEM customer. Customers whose direct net revenues, or total direct and indirect net revenues (including customer-specific models purchased or marketed indirectly through distributors, resellers and other third parties), exceeded 10% of our net revenues were as follows:

 

     Net Revenues by Major Customers  
     Direct Revenues     Total Direct and Indirect Revenues (2)  
     Three Months
Ended
April 1,
2012
    Three Months
Ended
March 27,
2011
    Three Months
Ended
April 1,
2012
    Three Months
Ended
March 27,
2011
 

Net revenue percentage (1):

        

OEM:

        

EMC

     —          —          11     —     

Hewlett-Packard

     24     20     28     24

IBM

     27     22     31     30

 

(1) Amounts less than 10% are not presented.
(2) Customer-specific models purchased or marketed indirectly through distributors, resellers, and other third parties are included with the OEM’s revenues in these columns rather than as revenue for the distributors, resellers or other third parties.

Direct sales to our top five customers accounted for approximately 70% of total net revenues for the three months ended April 1, 2012, compared to approximately 62% for the three months ended March 27, 2011. Direct and indirect sales to our top five customers accounted for approximately 82% of total net revenues for the three months ended April 1, 2012, compared to approximately 79% for the three months ended March 27, 2011. Our net revenues from customers can be significantly impacted by changes to our customers’ business and their business models.

Net Revenues by Sales Channel

Net revenues by sales channel were as follows:

 

     Net Revenues by Sales Channel  
(in thousands)    Three Months
Ended
April 1,
2012
     Percentage
of Net
Revenues
    Three Months
Ended
March 27,
2011
     Percentage
of Net
Revenues
    Increase/
(Decrease)
    Percentage
Change
 

OEM

   $ 115,327         92   $ 97,085         87   $ 18,242        19

Distribution

     10,282         8     14,989         13     (4,707     (31 )% 

Other

     137         —          8         —          129        1,613
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total net revenues

   $ 125,746         100   $ 112,082         100   $ 13,664        12
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

The increase in OEM net revenues for the three months ended April 1, 2012 compared to the three months ended March 27, 2011 was primarily due to an increase of approximately 31% in SCP revenues combined with an increase of approximately 17% in NCP revenues generated through our OEMs. The decrease in distribution net revenues for the three months ended April 1, 2012 compared to the three months ended March 27, 2011 was primarily due to a decrease of approximately 31% in NCP net revenues generated through distribution partners. We believe that our net revenues are being generated primarily as a result of product certifications and qualifications with our OEM customers, which take products directly and indirectly through distribution and contract manufacturers. We view product certifications and qualifications as an important indicator of our future revenue opportunities and growth. However, product certifications and qualifications do not necessarily ensure continued market acceptance of our products by our OEM customers. It is also very difficult to determine the future impact, if any, of product certifications and qualifications on our revenues.

 

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Table of Contents

Net Revenues by Geographic Territory

Our net revenues by geographic territory based on billed-to location were as follows:

 

     Net Revenues by Geographic Territory  
(in thousands)    Three Months
Ended
April 1,
2012
     Percentage
of Net
Revenues
    Three Months
Ended
March 27,
2011
     Percentage
of Net
Revenues
    Increase/
(Decrease)
    Percentage
Change
 

Asia Pacific

   $ 67,461         54   $ 58,827         53   $ 8,634        15

United States

     40,100         32     33,858         30     6,242        18

Europe, Middle East, and Africa

     17,919         14     17,268         15     651        4

Rest of the world

     266         —          2,129         2     (1,863     (88 )% 
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total net revenues

   $ 125,746         100   $ 112,082         100   $ 13,664        12
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

We believe the increase in Asia Pacific net revenues and decrease in Europe, Middle East, and Africa (EMEA) and rest of the world net revenues as a percentage of total net revenues for the three months ended April 1, 2012 compared to the three months ended March 27, 2011 was primarily due to our OEM customers continuing to migrate towards using contract manufacturers that are predominately located in Asia Pacific. However, as we sell to OEMs and distributors who ultimately resell our products to their customers, the geographic mix of our net revenues based on billed-to location may not be reflective of the geographic mix of end-user demand or installations.

Gross Profit. Gross profit consists of net revenues less cost of sales. Our gross profit was as follows (in thousands):

 

Gross Profit

Three Months Ended

April 1, 2012

 

Percentage of

Net Revenues

 

Three Months Ended

March 27, 2011

 

Percentage of

Net Revenues

 

Increase/

(Decrease)

 

Percentage

Points Change

$74,759

  59%   $61,488   55%   $13,271   4%

Cost of sales includes the cost of producing, supporting, and managing our supply of finished products. Cost of sales also included approximately $5.2 million and $8.5 million of amortization of technology intangible assets for the three months ended April 1, 2012 and March 27, 2011, respectively. Approximately $0.2 million and $0.4 million of share-based compensation expense was also included in cost of sales for the three months ended April 1, 2012 and March 27, 2011, respectively. Gross margin percentage was favorably impacted due to higher volume and product mix, partially offset by approximately $0.5 million in royalty expenses related to the Permanent Injunction granted by the Court to Broadcom on March 16, 2012 for the sale of affected products from the beginning of the sunset period through April 1, 2012. Although gross margin improved in the three months ended April 1, 2012, we expect the trend toward increased sales of lower margin products to continue in the future.

Engineering and Development. Engineering and development expenses consist primarily of salaries and related expenses for personnel engaged in the design, development, and support of our products. These expenses also include third-party fees paid to consultants, prototype development expenses, and computer service costs related to supporting computer tools used in the design process. Engineering and development expenses were as follows (in thousands):

 

Engineering and Development

Three Months Ended

April 1, 2012

 

Percentage of

Net Revenues

 

Three Months Ended

March 27, 2011

 

Percentage of

Net Revenues

 

Increase/

(Decrease)

 

Percentage

Points Change

$40,361

  32%   $42,660   38%   $(2,299)   (6)%

Engineering and development expenses for the three months ended April 1, 2012 compared to the three months ended March 27, 2011 decreased approximately $2.3 million, or 5%. Approximately $2.5 million and $3.2 million of share-based compensation expense were included in engineering and development costs for the three months ended April 1, 2012 and March 27, 2011, respectively, with approximately $0.5 million being related to the ServerEngines acquisition for both the three months ended April 1, 2012 and March 27, 2011. Engineering and development headcount increased to 641 at April 1, 2012, from 629 at March 27, 2011. The increase in headcount resulted in a net increase in salary expense of approximately $0.4 million. The reduction in engineering and development expenses during the three months ended April 1, 2012 was also due to a decrease in non-recurring engineering, prototypes, and related costs associated with new product development of approximately $1.4 million, and lower depreciation expense of approximately $0.6 million. Although engineering and development expenses decreased in the current three month period compared to the same period in the prior year, we plan on continuing to invest in engineering and development. In addition, as a result of the Permanent Injunction granted by the Court to Broadcom on March 16, 2012, we expect to incur incremental engineering and development expenses to redesign our impacted products over the next 12 to 15 months. See “Product Redesign Activities” elsewhere in Part I, Item 2 of this Form 10-Q.

 

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Selling and Marketing. Selling and marketing expenses consist primarily of salaries, commissions, and related expenses for personnel engaged in the marketing and sales of our products, as well as trade shows, product literature, promotional support costs, and other advertising related costs. Sales and marketing expenses were as follows (in thousands):

 

Selling and Marketing

Three Months Ended

April 1, 2012

 

Percentage of

Net Revenues

 

Three Months Ended

March 27, 2011

 

Percentage of

Net Revenues

 

Increase/

(Decrease)

 

Percentage

Points Change

$15,897

  13%   $15,347   14%   $550   (1)%

Selling and marketing expenses for the three months ended April 1, 2012 compared to the three months ended March 27, 2011 increased approximately $0.6 million, or 4%. Approximately $0.9 million and $1.3 million of share-based compensation expense were included in selling and marketing costs for the three months ended April 1, 2012 and March 27, 2011, respectively. Selling and marketing headcount increased to 150 at April 1, 2012 from 138 at March 27, 2011. The increase in headcount resulted in a net increase of approximately $0.6 million in salary and related expenses as compared to the same period in fiscal 2011. The remaining increase in selling and marketing expenses during the three months ended April 1, 2012 was primarily due to an increase in marketing and advertising costs of approximately $0.4 million. We will continue to closely manage and target advertising, market promotions, and brand awareness expenses for our new and existing products in an effort to provide overall revenue growth. As a result of the Permanent Injunction granted by the Court to Broadcom on March 16, 2012, we also expect to incur incremental sales and marketing expenses to requalify and recertify our impacted products with customers over the next 12 to 15 months. See “Product Redesign Activities” elsewhere in Part I, Item 2 of this Form 10-Q.

General and Administrative. Ongoing general and administrative expenses consist primarily of salaries and related expenses for executives, financial accounting support, human resources, administrative services, professional fees, and other corporate expenses. General and administrative expenses were as follows (in thousands):

 

General and Administrative

Three Months Ended

April 1, 2012

 

Percentage of

Net Revenues

 

Three Months Ended

March 27, 2011

 

Percentage of

Net Revenues

 

Increase/

(Decrease)

 

Percentage

Points Change

$8,820

  7%   $12,106   11%   $(3,286)   (4)%

General and administrative expenses for the three months ended April 1, 2012 compared to the three months ended March 27, 2011 decreased approximately $3.3 million, or 27%. Approximately $2.1 million and $2.5 million of share-based compensation expense were included in general and administrative costs for the three months ended April 1, 2012 and March 27, 2011, respectively, with approximately $0.8 million being related to the ServerEngines acquisition for both the three months ended April 1, 2012 and March 27, 2011. General and administrative headcount decreased slightly to 139 at April 1, 2012 from 141 at March 27, 2011. The slight decrease in headcount resulted in a net decrease of approximately $0.2 million in salary and related expenses as compared to the same period in fiscal 2011. The remaining change was primarily due to a decrease in litigation costs of approximately $2.3 million.

Amortization of Other Intangible Assets. Amortization of other intangible assets consists of amortization of intangible assets such as patents, customer relationships, tradenames with estimable lives, covenants not to compete, and backlog. Amortization expense was as follows (in thousands):

 

Amortization of Other Intangible Assets

Three Months Ended

April 1, 2012

 

Percentage of

Net Revenues

 

Three Months Ended

March 27, 2011

 

Percentage of

Net Revenues

 

Increase/

(Decrease)

 

Percentage

Points Change

$1,603   1%   $1,762   2%   $(159)   (1)%

Amortization of other intangible assets for the three months ended April 1, 2012 compared to the three months ended March 27, 2011 decreased by approximately $0.2 million, or 9%. The decrease was primarily due to certain intangible assets being fully amortized in the first quarter of fiscal 2012.

 

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In-Process Research and Development Impairment. In-process research and development impairment represents impairment of an in-process research and development intangible asset (IPR&D). Our impairment of in process research and development was as follows (in thousands):

 

In-Process Research and Development Impairment

Three Months Ended

April 1, 2012

  

Percentage of

Net Revenues

  

Three Months Ended

March 27, 2011

  

Percentage of

Net Revenues

  

Increase/

(Decrease)

  

Percentage

Points Change

—  

   —      $6,000    5%    $(6,000)    (5)%

We did not record any impairment charges for in-process research and development during the three months ended April 1, 2012. During the three months ended March 27, 2011, the business climate for the product associated with the IPR&D from the acquisition of a privately-held company in fiscal 2010 deteriorated significantly as the technology was no longer expected to be designed into customer products and was determined to be other than temporary and thus, the entire amount of the IPR&D of approximately $6.0 million was impaired during the three months ended March 27, 2011.

Non-operating Expense, net. Non-operating expense, net, consists primarily of interest income, interest expense, and other non-operating income and expense items. Our non-operating expense, net, was as follows (in thousands):

 

Non-operating Expense, net

Three Months Ended

April 1, 2012

  

Percentage of

Net Revenues

  

Three Months Ended

March 27, 2011

  

Percentage of

Net Revenues

  

Increase/

(Decrease)

  

Percentage

Points Change

$(268)

   —%    $(9,253)    (8)%    $(8,985)    (8%)

Our non-operating expense, net, for the three months ended April 1, 2012 compared to the three months ended March 27, 2011 decreased approximately $9.0 million, or 97%. The decrease in non-operating expense was primarily due to a non-recurring impairment charge of approximately $9.2 million related to our equity investment in a privately-held company during the three months ended March 27, 2011. During the three months ended March 27, 2011, the business climate of the privately-held company deteriorated significantly as the technology was no longer expected to be designed into customer products and was determined to be other than temporary and thus, the fair value of the privately-held company was deemed to be zero. As a result, the entire investment of approximately $9.2 million in the privately-held company was impaired.

Income Taxes. Income taxes were as follows (in thousands):

 

Income Taxes

Three Months Ended

April 1, 2012

  

Percentage of

Net Revenues

  

Three Months Ended

March 27, 2011

  

Percentage of

Net Revenues

  

Increase/

(Decrease)

  

Percentage

Points Change

$(869)

   (1)%    $(7,324)    (7)%    $6,455    6%

Income taxes for the three months ended April 1, 2012 compared to the three months ended March 27, 2011 increased approximately $6.5 million. Our effective tax benefit rate was approximately 11% and 29% for the three months ended April 1, 2012 and March 27, 2011, respectively. The decrease in our effective tax benefit rate for the three months ended April 1, 2012 compared to the three months ended March 27, 2011 was primarily due to higher projected worldwide income and an increase in the mix of earnings from U.S. versus international locations, which were partially offset by a reduction in non-deductible stock-based compensation expense related to the ServerEngines acquisition. In addition, our effective tax benefit rate for the three months ended March 27, 2011 was favorably impacted by the release of certain ASC 740 liabilities as a result of the expiration of the statute of limitations that was partially offset by a non-deductible impairment charge in such prior year.

We expect the annual effective tax benefit rate for fiscal 2012 to be approximately 16%. Our expected annual effective tax rate is lower than the U.S. federal statutory rate primarily due to the mix of earnings in international versus U.S. tax jurisdictions that are generally subject to lower statutory income tax rates. Changes in the mix of U.S. versus international earnings and changing tax laws could affect our actual tax expense for the full fiscal year 2012. As estimates and judgments are used to project such earnings, the impact to our tax provision could vary if the current planning or assumptions change. In addition, we do not forecast discrete events, such as a settlement of tax audits with governmental authorities or changes in tax laws, due to their inherent uncertainty. Such discrete events could materially impact our tax expense. As the tax rate is driven by various factors, it is not possible to estimate our future tax rate with a high degree of certainty.

 

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Nine months ended April 1, 2012, compared to nine months ended March 27, 2011

Net Revenues. Net revenues for the nine months ended April 1, 2012, increased by approximately $43.6 million, or 13%, to approximately $372.8 million compared to approximately $329.2 million for the nine months ended March 27, 2011.

Net Revenues by Product Line

Net revenues by product line were as follows:

 

     Net Revenues by Product Line  
(in thousands)    Nine Months
Ended
April 1,
2012
     Percentage
of Net
Revenues
    Nine Months
Ended
March 27,
2011
     Percentage
of Net
Revenues
    Increase/
(Decrease)
     Percentage
Change
 

Network Connectivity Products

   $ 274,336         74   $ 252,359         77   $ 21,977         9

Storage Connectivity Products

     79,320         21     59,308         18     20,012         34

Advanced Technology & Other Products

     19,158         5     17,510         5     1,648         9
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total net revenues

   $ 372,814         100   $ 329,177         100   $ 43,637         13
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Fibre Channel based products accounted for approximately 75% of our total NCP revenues in the nine months ended April 1, 2012. However, our Ethernet based products revenue within NCP also grew by nearly 100% compared to the same period in the prior year. The increase in our NCP revenue for the nine months ended April 1, 2012 compared to the nine months ended March 27, 2011 was primarily due to an increase in units shipped of approximately 25%, partially offset by a decrease in average selling price of approximately 13%.

Within SCP, Bridging products revenue grew by more than 40% for the nine months ended April 1, 2012. The increase in our SCP net revenue for the nine months ended April 1, 2012 compared to the nine months ended March 27, 2011 was primarily due to an increase in units shipped of approximately 49%, partially offset by a decrease in average selling price of approximately 10%.

For the nine months ended April 1, 2012, our iBMC based ATP revenues accounted for the majority of total ATP revenues. The increase in our ATP revenue for the nine months ended April 1, 2012 was primarily due to an increase in units shipped of approximately 48%, which includes units shipped for a full nine months in the current period, partially offset by an decrease in average selling price of approximately 26%.

Net Revenues by Major Customers

Customers whose direct net revenues, or total direct and indirect net revenues (including customer-specific models purchased or marketed indirectly through distributors, resellers and other third parties), exceeded 10% of our net revenues were as follows:

 

     Net Revenues by Major Customers  
     Direct Revenues     Total Direct and Indirect Revenues (2)  
      Nine Months
Ended April 1,
2012
    Nine Months
Ended March 27,
2011
    Nine Months
Ended April 1,
2012
    Nine Months
Ended March 27,
2011
 

Net revenue percentage (1):

        

OEM:

        

EMC

     —          —          —          10

Hewlett-Packard

     24     18     26     21

IBM

     31     24     35     33

 

(1) Amounts less than 10% are not presented.
(2) Customer-specific models purchased or marketed indirectly through distributors, resellers, and other third parties are included with the OEM’s revenues in these columns rather than as revenue for the distributors, resellers or other third parties.

 

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Direct sales to our top five customers accounted for approximately 71% of total net revenues for the nine months ended April 1, 2012, compared to approximately 62% for the nine months ended March 27, 2011. Direct and indirect sales to our top five customers accounted for approximately 81% of total net revenues for the nine months ended April 1, 2012, compared to approximately 79% for the nine months ended March 27, 2011. Our net revenues from customers can be significantly impacted by changes to our customers’ business and their business models.

Net Revenues by Sales Channel

Net revenues by sales channel were as follows:

 

     Net Revenues by Sales Channel  
(in thousands)    Nine Months
Ended
April 1,
2012
     Percentage
of Net
Revenues
    Nine Months
Ended
March 27,
2011
     Percentage
of Net
Revenues
    Increase/
(Decrease)
    Percentage
Change
 

OEM

   $ 337,288         90   $ 283,945         86   $ 53,343        19

Distribution

     35,331         10     45,204         14     (9,873     (21 )% 

Other

     195         —          28         —          167        597
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total net revenues

   $ 372,814         100   $ 329,177         100   $ 43,637        13
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

The increase in OEM net revenues for the nine months ended April 1, 2012 compared to the nine months ended March 27, 2011 was primarily due to an increase of approximately 35% in SCP revenues combined with an increase of approximately 14% in NCP revenues generated through our OEMs. The decrease in distribution net revenues for the nine months ended April 1, 2012 compared to the nine months ended March 27, 2011 was primarily due to a decrease of approximately 20% in NCP net revenues generated through distribution partners.

Net Revenues by Geographic Territory

Our net revenues by geographic territory based on billed-to location were as follows:

 

     Net Revenues by Geographic Territory  
(in thousands)    Nine Months
Ended
April 1,
2012
     Percentage
of Net
Revenues
    Nine Months
Ended
March 27,
2011
     Percentage
of Net
Revenues
    Increase/
(Decrease)
    Percentage
Change
 

Asia Pacific

   $ 214,515         58   $ 160,306         49   $ 54,209        34

United States

     104,142         28     99,181         30     4,961        5

Europe, Middle East, and Africa

     53,267         14     63,985         19     (10,718     (17 )% 

Rest of the world

     890         —          5,705         2     (4,815     (84 )% 
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

Total net revenues

   $ 372,814         100   $ 329,177         100   $ 43,637        13
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

 

 

 

We believe the increase in Asia Pacific net revenues and decrease in EMEA and rest of the world net revenues as a percentage of total net revenues for the nine months ended April 1, 2012 compared to the nine months ended March 27, 2011 was primarily due to our OEM customers continuing to migrate towards using contract manufacturers that are predominately located in Asia Pacific. The United States net revenues as a percentage of total net revenues essentially remained unchanged. However, as we sell to OEMs and distributors who ultimately resell our products to their customers, the geographic mix of our net revenues based on billed-to location may not be reflective of the geographic mix of end-user demand or installations.

Gross Profit. Gross profit consists of net revenues less cost of sales. Our gross profit was as follows (in thousands):

 

Gross Profit

Nine Months Ended

April 1, 2012

 

Percentage of

Net Revenues

 

Nine Months Ended

March 27, 2011

 

Percentage of

Net Revenues

 

Increase/

(Decrease)

 

Percentage

Points Change

$215,753

  58%   $181,319   55%   $34,434   3%

Cost of sales includes the cost of producing, supporting, and managing our supply of quality finished products. Cost of sales also included approximately $18.9 million and $24.6 million of amortization of technology intangible assets for the nine months ended April 1, 2012 and March 27, 2011, respectively, with approximately $15.5 million and $11.9 million being related to the ServerEngines acquisition in the nine months ended April 1, 2012 and March 27, 2011, respectively. Approximately $1.0 million and $1.3 million of share-based compensation expense was included in cost of sales for the nine months ended April 1, 2012 and March 27, 2011, respectively. Gross margin percentage was favorably impacted due to

 

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Table of Contents

higher volume and product mix which was partially offset by approximately $0.5 million in royalty expenses related to the Permanent Injunction granted by the Court to Broadcom on March 16, 2012, approximately $0.4 million of patent litigation damages to Broadcom as a result of the Jury’s determination rendered on October 12, 2011 for the sales of affected products from the beginning of the sunset periods through April 1, 2012, and approximately $2.3 million of additional expedite and freight charges in connection with our activities to mitigate the impact of the recent floods in Thailand at one of our contract manufacturers. We do not expect to incur any significant costs related to such flood mitigation activities for the remainder of the fiscal year. Although gross margin improved in the first nine months of fiscal year 2012, we expect the trend toward increased sales of lower margin products to continue in the future.

Engineering and Development. Engineering and development expenses were as follows (in thousands):

 

Engineering and Development

Nine Months Ended

April 1, 2012

  

Percentage of

Net Revenues

   Nine Months Ended
March 27,  2011
   Percentage of
Net Revenues
   Increase/
(Decrease)
   Percentage
Points Change

$121,307

   33%    $122,592    37%    $(1,285)    (4)%

Engineering and development expenses for the nine months ended April 1, 2012 compared to the nine months ended March 27, 2011 decreased approximately $1.3 million, or 1%. Approximately $7.8 million and $12.7 million of share-based compensation expense were included in engineering and development costs for the nine months ended April 1, 2012 and March 27, 2011, respectively, with approximately $1.6 million and $5.8 million being related to the ServerEngines acquisition in the nine months ended April 1, 2012 and March 27, 2011, respectively. Engineering and development headcount increased to 641 at April 1, 2012 from 629 at March 27, 2011. The increase in headcount resulted in a net increase of approximately $4.6 million in salary and related expenses primarily due to recognizing nine months of salary and related expenses from the ServerEngines acquisition during the current nine months ended April 1, 2012 compared to seven months of salary and related expenses in the prior year period. The decrease in expenses during the nine months ended April 1, 2012 was also due to lower depreciation of approximately $1.3 million, lower non-recurring engineering, prototypes, and related costs associated with new product development of approximately $0.5 million, partially offset by an increase in performance-based compensation of approximately $1.1 million. As a result of the Permanent Injunction granted by the Court to Broadcom on March 16, 2012, we expect to incur incremental engineering and development expenses to redesign our impacted products over the next 12 to 15 months. See “Product Redesign Activities” elsewhere in Part I, Item 2 of this Form 10-Q.

Selling and Marketing. Sales and marketing expenses were as follows (in thousands):

 

Selling and Marketing

Nine Months Ended

April 1, 2012

  

Percentage of

Net Revenues

   Nine Months Ended
March 27,  2011
   Percentage of
Net Revenues
   Increase/
(Decrease)
   Percentage
Points Change

$45,774

   12%    $42,282    13%    $3,492    (1)%

Selling and marketing expenses for the nine months ended April 1, 2012 compared to the nine months ended March 27, 2011 increased approximately $3.5 million, or 8%. Approximately $2.9 million and $3.6 million of share-based compensation expense were included in selling and marketing costs for the nine months ended April 1, 2012 and March 27, 2011, respectively. Selling and marketing headcount increased to 150 at April 1, 2012 from 138 at March 27, 2011. The increase in headcount resulted in a net increase of approximately $1.6 million in salary and related expenses as compared to the same period in fiscal 2011. The remaining increase in selling and marketing expenses during the nine months ended April 1, 2012 was primarily due to an increase in marketing and advertising costs of approximately $1.9 million and an increase in performance based compensation of approximately $0.8 million. As a result of the Permanent Injunction granted by the Court to Broadcom on March 16, 2012, we expect to incur incremental sales and marketing expenses to requalify and recertify our impacted products with customers over the next 12 to 15 months. See “Product Redesign Activities” elsewhere in Part I, Item 2 of this Form 10-Q.

General and Administrative General and administrative expenses were as follows (in thousands):

 

General and Administrative

Nine Months Ended

April 1, 2012

  

Percentage of

Net Revenues

   Nine Months Ended
March 27,  2011
   Percentage of
Net Revenues
   Increase/
(Decrease)
   Percentage
Points Change

$29,808

   8%    $43,388    13%    $(13,580)    (5)%

General and administrative expenses for the nine months ended April 1, 2012 compared to the nine months ended March 27, 2011 decreased approximately $13.6 million, or 31%. Approximately $6.7 million and $13.7 million of share-based compensation expense were included in general and administrative costs for the nine months ended April 1, 2012 and March 27, 2011, respectively, with approximately $2.5 million and $9.5 million being related to the ServerEngines acquisition in the nine months ended April 1, 2012 and March 27, 2011, respectively. General and administrative headcount

 

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Table of Contents

decreased slightly to 139 at April 1, 2012 from 141 at March 27, 2011. Although headcount decreased slightly as of the end of the current nine months period ended April 1, 2012, salary and related expenses increased approximately $0.9 million compared to the same period in fiscal 2011. The remaining change was primarily due to a decrease in litigation costs of approximately $6.0 million, which included reimbursements received from our suppliers related to the Broadcom litigation of approximately $2.1 million, and the non-recurrence of acquisition related costs that were incurred in the same period in fiscal 2011 for the acquisition of ServerEngines of approximately $1.2 million.

Amortization of Other Intangible Assets. Amortization expense was as follows (in thousands):

 

Amortization of Other Intangible Assets

Nine Months Ended

April 1, 2012

 

Percentage of

Net Revenues

 

Nine Months Ended

March 27, 2011

 

Percentage of

Net Revenues

 

Increase/

(Decrease)

 

Percentage

Points Change

$4,967

  1%   $7,571   3%   $(2,604)   (2)%

Amortization of other intangible assets for the nine months ended April 1, 2012 compared to the nine months ended March 27, 2011 decreased by approximately $2.6 million, or 34%. The decrease was primarily due to a lower intangible assets balance at the beginning of the current nine month period as a result of certain intangible assets being fully amortized during the first quarter of fiscal 2012.

In-Process Research and Development Impairment. In-process research and development impairment represents impairment of an in-process research and development intangible asset (IPR&D). Our impairment of in process research and development was as follows (in thousands):

 

In-Process Research and Development Impairment

Nine Months Ended

April 1, 2012

 

Percentage of

Net Revenues

 

Nine Months Ended

March 27, 2011

 

Percentage of

Net Revenues

 

Increase/

(Decrease)

 

Percentage

Points Change

$ —

    $6,000   2%   $(6,000)   (2)%

We did not record any impairment charges for in-process research and development during the nine months ended April 1, 2012. During the nine months ended March 27, 2011, the business climate for the product associated with the IPR&D from the acquisition of a privately-held company in fiscal 2010 deteriorated significantly as the technology was no longer expected to be designed into customer products and was determined to be other than temporary and thus, the entire amount of the IPR&D of approximately $6.0 million was impaired during the nine months ended March 27, 2011.

Non-operating Income (Expense), net. Non-operating income (expense), net, was as follows (in thousands):

 

Non-operating Income (Expense), net

Nine Months Ended

April 1, 2012

 

Percentage of

Net Revenues

 

Nine Months Ended

March 27, 2011

 

Percentage of

Net Revenues

 

Increase/

(Decrease)

 

Percentage

Points Change

$325

    $(9,794)   (3)%   $10,119   3%

Our non-operating income (expense), net, for the nine months ended April 1, 2012 compared to the nine months ended March 27, 2011 increased approximately $10.1 million, or 103%. The increase in non-operating income (expense), net was primarily due to a non-recurring impairment charge of approximately $9.2 million related to our equity investment in a privately-held company during the nine months ended March 27, 2011. During the nine months ended March 27, 2011, the business climate of the privately-held company deteriorated significantly as the technology was no longer expected to be designed into customer products and was determined to be other than temporary and thus, the fair value of the privately-held company was deemed to be zero. As a result, the entire investment of approximately $9.2 million in the privately-held company was impaired. The net increase was also due to foreign exchange gains of approximately $0.3 million combined with the absence of a one-time charge recorded in the prior year period for the settlement of our notes receivable from ServerEngines in connection with the acquisition in August 2010, as required by the authoritative guidance for business combinations of approximately $0.4 million.

 

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Table of Contents

Income Taxes. Income taxes were as follows (in thousands):

 

Income Taxes

Nine Months Ended

April 1, 2012

 

Percentage of

Net Revenues

 

Nine Months Ended

March 27, 2011

 

Percentage of

Net Revenues

 

Increase/

(Decrease)

 

Percentage

Points Change

$(2,292)

    $17,608   5%   $(19,900)   (5)%

Income taxes for the nine months ended April 1, 2012 compared to the nine months ended March 27, 2011 decreased approximately $19.9 million. Our effective tax (benefit)/expense rate was approximately (16%) and 35% for the nine months ended April 1, 2012 and March 27, 2011, respectively. The decrease in our effective tax rate for the nine months ended April 1, 2012 compared to the nine months ended March 27, 2011 was primarily due to a platform contribution transaction entered into by our U.S. and international subsidiaries during the same period of the prior year which resulted in incremental tax expense of approximately $36.7 million in fiscal 2011. Also contributing to the decrease in our effective tax rate for the nine months ended April 1, 2012 was a reduction in non-deductible stock based compensation expense related to the ServerEngines acquisition that was partially offset by higher projected worldwide income and an increase in the mix of earnings from U.S. versus international locations.

Critical Accounting Policies

The preparation of our condensed consolidated financial statements requires estimation and judgment that affect the reported amounts of net revenues, expenses, assets, and liabilities in accordance with accounting principles generally accepted in the United States. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances and which form the basis for making judgments about the carrying values of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses for the periods presented. Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties.

Changes in judgments and uncertainties relating to these estimates could potentially result in materially different results under different assumptions and conditions. If these estimates differ significantly from actual results, the impact to the condensed consolidated financial statements may be material. We believe that the critical accounting policies that are the most significant for purposes of fully understanding and evaluating our reported financial results include the following:

Revenue Recognition. We generally recognize revenue at the time of shipment when title and risk of loss have passed, evidence of an arrangement has been obtained, pricing is fixed or determinable, and collectibility is reasonably assured (Basic Revenue Recognition Criteria). We make certain sales through two tier distribution channels and have various distribution agreements with selected distributors and Master Value Added Resellers (collectively, the Distributors). These distribution agreements may be terminated upon written notice by either party. Additionally, these Distributors are generally given privileges to return a portion of inventory and to participate in price protection and cooperative marketing programs. Therefore, we recognize revenue on our standard products sold to our Distributors based on data received from the Distributors and management’s estimates to approximate the point that these products have been resold by the Distributors. OEM-specific models sold to our Distributors are governed under the related OEM agreements rather than under these distribution agreements. We recognize revenue at the time of shipment for OEM specific products shipped to the Distributors when the Basic Revenue Recognition Criteria have been met. Additionally, we maintain sales related reserves for our sales incentive programs. We classify the costs of these incentive programs based on the benefit received, if applicable, as a reduction of revenue, a cost of sale, or an operating expense.

Allowance for Doubtful Accounts. We maintain an allowance for doubtful accounts based upon historical write-offs as a percentage of net revenues and management’s review of outstanding accounts receivable. Amounts due from customers are charged against the allowance for doubtful accounts when management believes that collectibility of the amount is unlikely. Although we have not historically experienced significant losses on accounts receivable, our accounts receivable are concentrated with a small number of customers. Consequently, any write-off associated with one of these customers could have a significant impact on our allowance for doubtful accounts and results of operations.

Inventories. Inventories are stated at the lower of cost, on a first-in, first-out basis, or market. We use a standard cost system to determine cost. The standard costs are adjusted periodically to represent actual cost. We regularly compare forecasted demand and the composition of the forecast against inventory on hand and open purchase commitments in an effort to ensure that the carrying value of inventory does not exceed net realizable value. Accordingly, we may have to reduce the carrying value of excess and obsolete inventory if forecasted demand decreases.

Intangible Assets and Other Long-Lived Assets. Intangible assets resulting from acquisitions or licensing agreements are carried at cost less accumulated amortization and impairment charges, if any. For assets with determinable useful lives, amortization is computed using the straight-line method over the estimated economic lives of the respective intangible assets,

 

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ranging from two to ten years. Furthermore, we assess whether our intangible assets and other long-lived assets should be tested for recoverability periodically and whenever events or circumstances indicate that their carrying value may not be recoverable. The amount of impairment, if any, is measured based on fair value, which is determined using projected discounted future operating cash flows. Assets to be disposed of are reported at the lower of the carrying amount or fair value less selling costs.

Goodwill. Goodwill is not amortized, but instead is tested at least annually for impairment, or more frequently when events or changes in circumstances indicate that goodwill might be impaired. Management considers our business as a whole to be its reporting unit for purposes of testing for impairment. The annual impairment test is performed during the fourth fiscal quarter.

We elected to early adopt the Financial Accounting Standards Board’s (FASB) Accounting Standards Update 2011-08, “Intangibles — Goodwill and Other (Topic 350): Testing Goodwill for Impairment” (ASU 2011-08) guidance during the first fiscal quarter ended October 2, 2011. There was no financial statement impact as a result of our early adoption of this guidance in the nine month period ended April 1, 2012. We will continue to perform our annual impairment test during the fourth fiscal quarter. As of April 1, 2012, the fair value of the reporting unit substantially exceeded its carrying value.

Under ASU 2011-08, we have the option to first assess the 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, we determine 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 we conclude otherwise, then we are required to perform the first step of the two-step impairment test by comparing the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill is considered not impaired; otherwise, goodwill is impaired and the loss is measured by performing step two. Under step two, the impairment loss is measured by comparing the implied fair value of the reporting unit goodwill with the carrying amount of goodwill. We also have the option to bypass the qualitative assessment under ASC2011-08 for any reporting unit in any period and proceed directly to performing the first step of the two-step goodwill impairment test. We may resume performing the qualitative assessment in any subsequent period.

Income Taxes. We account for income taxes using the asset and liability method, under which we recognize deferred tax assets and liabilities for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and for net operating loss and tax credit carryforwards. Tax positions that meet a more-likely-than-not recognition threshold are recognized in the first reporting period that it becomes more-likely-than-not such tax position will be sustained upon examination. A tax position that meets this more-likely-than-not recognition threshold is recorded at the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. Previously recognized income tax positions that fail to meet the recognition threshold in a subsequent period are derecognized in that period. Differences between actual results and our assumptions, or changes in our assumptions in future periods, are recorded in the period they become known. We record potential accrued interest and penalties related to unrecognized tax benefits in income tax expense.

As a multinational corporation, we are subject to complex tax laws and regulations in various jurisdictions. The application of tax laws and regulations is subject to legal and factual interpretation, judgment, and uncertainty. Tax laws themselves are subject to change as a result of changes in fiscal policy, changes in legislation, evolution of regulations and court rulings. Therefore, the actual liability for U.S. or foreign taxes may be materially different from our estimates, which could result in the need to record additional liabilities or potentially to reverse previously recorded tax liabilities.

Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date. A valuation allowance is recorded against any deferred tax assets when, in the judgment of management, it is more likely than not that all of or part of a deferred tax asset will not be realized. In assessing the need for a valuation allowance, we consider all positive and negative evidence, including recent financial performance, scheduled reversals of temporary differences, projected future taxable income, availability of taxable income in carryback periods and tax planning strategies to form a conclusion. Based on a review of such information, we believe that sufficient positive evidence exists in the form of historical taxable income, projections of taxable income in future years and available tax planning strategies to conclude that it is more likely than not that we would realize certain federal, foreign and state deferred tax assets. However, we believe that sufficient negative evidence exists to support that we will not be able to realize other federal and state deferred tax assets and, therefore, we continue to carry a full valuation allowance against these specific federal and state deferred tax assets.

Stock-Based Compensation. We account for our stock-based awards to employees and non-employees using the fair value method. Stock-based compensation cost is measured at grant date, based on the fair value of the award, and is recognized as expense over the requisite service period. Although we grant both unvested stock awards and stock options, the majority of the awards granted and stock based compensation recognized consists of unvested stock awards. The fair value of each unvested stock award is determined based on the closing price of our common stock at grant date. For stock options, the measurement of stock-based compensation cost is based on several criteria including, but not limited to, the valuation model used and associated input factors principally stock price volatility and award forfeiture rate and, to a lesser extent, expected

 

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term, dividend rate, and risk free interest rate. The input factors used in the valuation model are based on subjective future expectations combined with management judgment. If there is a difference between the forfeiture assumptions used in determining stock-based compensation costs and the actual forfeitures, which become known over time, we may change the assumptions used in determining stock-based compensation costs. These changes may materially impact our results of operations in the period such changes are made. See Note 10 in the accompanying notes to condensed consolidated financial statements included in this Form 10-Q for additional information and related disclosures.

Litigation Costs. We record a charge equal to at least the minimum estimated liability for a loss contingency when both of the following conditions are met: (i) information available prior to issuance of the financial statements indicates that it is probable that a liability had been incurred at the date of the financial statements and (ii) the range of loss can be reasonably estimated. Legal and other litigation related costs are recognized as the services are provided. We record insurance and other indemnity recoveries for litigation costs when both of the following conditions are met: (i) the recovery is probable and (ii) collectability is reasonably assured. The insurance recoveries recorded are only to the extent the litigation costs have been incurred and recognized in the financial statements; however, it is reasonably possible that the actual recovery may be significantly different from our estimates. There are many uncertainties associated with any litigation, and we cannot provide assurance that any actions or other third party claims against us will be resolved without costly litigation or substantial settlement charges. If any of those events were to occur, our business, financial condition and results of operations could be materially and adversely affected.

Recently Adopted and Recently Issued Accounting Standards

See Note 1 in the accompanying notes to condensed consolidated financial statements included in Part I, Item I of this Form 10-Q for a description of the recently adopted accounting standards.

Liquidity and Capital Resources

Our principal sources of liquidity consist of our existing cash balances and investments, as well as funds expected to be generated from operations. At April 1, 2012, we had approximately $271.4 million in working capital and approximately $201.5 million in cash and cash equivalents and current investments. At July 3, 2011, we had approximately $230.9 million in working capital and approximately $168.2 million in cash and cash equivalents and current investments. We maintain an investment portfolio of various security holdings, types, and maturities. We invest in instruments that meet credit quality standards in accordance with our investment guidelines. We limit our exposure to any one issuer or type of investment with the exception of U.S. Government issued or U.S. Government sponsored entity securities. Our investments consisted mostly of marketable certificates of deposit, fixed income securities and corporate bonds as of April 1, 2012 and we did not hold any auction rate securities or direct investments in mortgage-backed securities.

Our cash balances and investments are held in numerous locations throughout the world. As of April 1, 2012, our international subsidiaries held approximately 8% of our total cash, cash equivalents and investment securities, the majority of which will be used to repay obligations to U.S. affiliate entities that arise in the normal course of business and would not result in additional U.S. tax liabilities upon repatriation.

Our accounts receivable are primarily with large multinational OEM customers and denominated in U.S. dollars. As of April 1, 2012, approximately 11% of our accounts receivable are related to customers with a European billing address. However, we do not believe that the ongoing European Sovereign debt crisis will materially impact the collectability of our accounts receivable or adversely affect our financial position or liquidity.

 

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Cash Flows

The following table summarizes our cash flows:

 

     Nine Months Ended  
     April 1,
2012
    March 27,
2011
 
     (In thousands)  

Net cash provided by (used in):

    

Operating activities

   $ 48,874      $ 27,589   

Investing activities

     (17,301     (35,025

Financing activities

     (19,521     (66,768

Effect of foreign currency translation on cash and cash equivalents

     (274     238   
  

 

 

   

 

 

 

Increase (decrease) in cash and cash equivalents

   $ 11,778      $ (73,966
  

 

 

   

 

 

 

Operating Activities

Cash provided by operating activities was approximately $48.9 million during the nine months ended April 1, 2012 compared to approximately $27.6 million during the nine months ended March 27, 2011. The current period cash provided by operating activities was primarily due to net income of approximately $16.5 million, non-cash adjustments for amortization of intangible assets of approximately $23.8 million, share-based compensation expense of approximately $18.4 million, depreciation and amortization of property and equipment of approximately $13.6 million, and deferred income taxes of approximately $6.0 million, and changes in operating assets and liabilities including an increase in inventories of approximately $9.8 million, an increase in accounts receivable of approximately $ 4.0 million, and a decrease in accounts payable, accrued liabilities and other liabilities of approximately $3.6 million.

Investing Activities

Cash used in investing activities was approximately $17.3 million during the nine months ended April 1, 2012 compared to approximately $35.0 million during the nine months ended March 27, 2011. The current period usage of cash was primarily due to purchases of property and equipment of approximately $10.8 million and purchases of investments partially offset by maturities of investments that were not reinvested.

Financing Activities

Cash used in financing activities was approximately $19.5 million during the nine months ended April 1, 2012 compared to approximately $66.8 million during the nine months ended March 27, 2011. The current period usage of cash was primarily due to the purchase of treasury stock of approximately $20.1 million.

Prospective Capital Needs

In early August 2008, our Board of Directors authorized a plan to repurchase up to $100.0 million of our outstanding common stock. In April 2009, upon receipt of an unsolicited takeover proposal and related tender offer of Broadcom to acquire us, our Board of Directors elected to temporarily suspend any activity under the share repurchase plan. In light of Broadcom allowing its tender offer to expire on July 14, 2009, Emulex’s Board of Directors elected to reactivate the $100.0 million share repurchase plan effective July 15, 2009. From June 29, 2009 through April 1, 2012, the Company repurchased approximately 9.0 million shares of its common stock for an aggregate purchase price of approximately $78.4 million at an average purchase price of $8.67 per share under this plan. Approximately 2.9 million shares for an aggregate purchase price of approximately $20.1 million at an average purchase price of $6.83 per share were purchased during the nine months ended April 1, 2012. Our Board of Directors has not set an expiration date for the plan. Therefore, we may repurchase additional shares under this plan from time to time through open market purchases or privately negotiated transactions. It is expected that any future share repurchases will be financed by available cash and cash from operations.

We plan to continue our strategic investment in research and development, sales and marketing, capital equipment, and facilities. We may also consider internal and external investment opportunities in order to achieve our growth and market leadership goals, including licensing and joint-development agreements with our suppliers, customers, and other third parties. We believe that our existing cash and cash equivalents, current investments, and anticipated cash flows from operating activities will be sufficient to support our working capital needs, capital expenditure requirements and stock repurchasing expenditures for at least the next 12 months. We currently do not have any outstanding lines of credit or other borrowings.

 

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We have disclosed outstanding legal proceedings in Note 8 in the accompanying notes to condensed consolidated financial statements included in Part I, Item I of this Form 10-Q. The legal proceedings include the consolidated patent infringement lawsuit filed by Broadcom against us. This lawsuit continues to present risks that could have a material adverse effect on our business, financial condition, or results of operations, including loss of patent rights, monetary damages, and injunction against the sale of accused products. We continue to present a vigorous post-trial defense against this lawsuit, including a potential appeal of the trial verdict. We accrued the approximately $0.4 million of damages liability during our quarter ended October 2, 2011 as a result of the jury’s determination rendered on October 12, 2011 that we are to pay these damages to Broadcom. We also accrued approximately $0.5 million for royalty liabilities during our quarter ended April 1, 2012 for the sales of affected products from the beginning of the sunset periods through the end of the quarter under the Permanent Injunction granted on March 16, 2012. As a result of the Permanent Injunction, we also expect to incur incremental costs to redesign, design around, modify, design, develop, test and requalify our products that have been found to infringe on the ‘150 and ‘691 patents over the next 12 to 15 months. See “Product Redesign Activities” in Part I, Item 2 of this Form 10-Q. Also 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 Part II, Item 1A—Risk Factors, of this Form 10-Q for a description of certain risks relating to the litigation with Broadcom that could impact our liquidity and prospective capital needs.

Off-Balance Sheet Arrangements

As part of our ongoing business, we do not participate in transactions that generate material relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or for other contractually narrow or limited purposes. As of April 1, 2012, we did not have any significant off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.

Contractual Obligations and Commercial Commitments

The following summarizes our contractual obligations as of April 1, 2012, and the effect such obligations are expected to have on our liquidity in future periods. The estimated payments reflected in this table are based on management’s estimates and assumptions about these obligations. Because these estimates and assumptions are necessarily subjective, the actual cash outflows in future periods will vary, possibly materially, from those reflected in the table.

 

     Payments Due by Period
(in thousands)
 
            Remaining                                     
     Total      2012      2013      2014      2015      2016      Thereafter  

Leases (1)

   $ 10,834       $ 1,336       $ 4,232       $ 1,459       $ 1,389       $ 1,417       $ 1,001   

Purchase commitments

     57,353         57,353         —           —           —           —           —     

Other commitments (2)

     7,325         1,209         1,989         1,536         942         942         707   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total (3)

   $ 75,512       $ 59,898       $ 6,221       $ 2,995       $ 2,331       $ 2,359       $ 1,708   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Lease payments include common area maintenance (CAM) charges.
(2) Consists primarily of commitments for software licenses of approximately $4.1 million and non-recurring engineering services of approximately $1.4 million.
(3) Excludes approximately $34.0 million of liabilities for uncertain tax positions for which we cannot make a reasonably reliable estimate of the period of payment.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk

Our cash and cash equivalents are not subject to significant interest rate risk due to their short terms to maturity. As of April 1, 2012, the carrying value of our cash and cash equivalents approximated fair value.

As of April 1, 2012, our investment portfolio of approximately $58.6 million consisted primarily of marketable certificates of deposit, fixed income securities, and corporate bonds. We have the positive intent and ability to hold these securities to maturity. We did not hold any auction rate securities or direct investments in mortgage-backed securities as of April 1, 2012.

 

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The fair market value of our investment portfolio is subject to interest rate risk and would decline in value if market interest rates increased. If market interest rates were to increase immediately and uniformly by 10% from the levels existing as of April 1, 2012, the decline in the fair value of the portfolio would not be material to our financial position, results of operations and cash flows. However, if interest rates decreased and securities within our portfolio were re-invested in securities with lower interest rates, interest income would decrease in the future.

Item 4. Controls and Procedures

Under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures as required by Exchange Act Rule 13a-15(b) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures are effective.

There were no changes in our internal control over financial reporting that occurred during the three months ended April 1, 2012, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II: OTHER INFORMATION

Item 1. Legal Proceedings

The information set forth under Note 8 in the notes to the condensed consolidated financial statements under the caption “Litigation” included in Part I, Item 1 of this Form 10-Q is incorporated herein by reference.

 

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Item 1A. Risk Factors

Third party claims of intellectual property infringement could adversely affect our business.

On occasion, we receive communications from third parties alleging patent infringement, and there is always the chance that third parties may assert infringement claims against us. We are entering technology markets where we have not participated before, where there are entrenched incumbents, and where our entrance into the market is disruptive and may cause such incumbents to assert infringement claims in order to deter our competition. Any such claims, with or without merit, could result in costly litigation, cause product shipment delays, result in temporary restraining orders or injunctions concerning the sale of products in certain countries, require the redesign of products to design around asserted claims, require us to indemnify customers, or require us to enter into royalty or licensing agreements, which may or may not be available on commercially reasonable terms. Any such claims, with or without merit, may also cause customers to be deterred from purchasing products from us. We have obtained contractual commitments from our suppliers concerning the defense and indemnification of claims relating to certain technology provided by such suppliers, but we cannot be certain that such defense and indemnification obligations will be promptly honored by such suppliers. Furthermore, we have in the past obtained, and may be required in the future to obtain, licenses of technology owned by other parties. We cannot be certain that the necessary licenses will be available or that they can be obtained on commercially reasonable terms. We have participated in technology standardization activities which provide for licenses being available on reasonable and non-discriminatory terms, but we cannot be certain that such licenses will actually and promptly be made available to us. If we were to fail to obtain such royalty or licensing agreements in a timely manner and on reasonable terms, our business, results of operations, and financial condition could be materially adversely affected.

Broadcom Corporation (Broadcom) filed a consolidated patent infringement suit against us in fiscal 2010 and 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 (U.S. Patent 7,058,150) [the ‘150 patent] had been infringed by us, and the jury rendered an advisory verdict to the Court that the ‘150 patent is not invalid, and awarded approximately $0.4 million in damages related 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 on the remaining four patents for which no unanimous verdict was reached. Subsequent to the trial, the Court issued orders consistent with the advisory verdicts of invalidity, and also issued an order that one of the four remaining patents (U.S. Patent 7,471,691) [the’691 patent] had been infringed by us. On March 16, 2012, the Court issued a decision concerning injunctive relief for the ‘150 and the ‘691 patents. The decision provided, in part, for a sunset period of 18 months relating to the ‘150 patent, starting on October 12, 2011. The decision further provided for a sunset period of 18 months relating to the ‘691 patent, starting on December 16, 2011. The affected products for the ‘150 patent include the BE2, BE3, XE201, and SOC 442 ASICs, products containing them, and products not colorably different from them. The affected products for the ‘691 patent include the SOC 320, SOC 422, and SOC 442 ASICs, products containing them, and products not colorably different from them. The sunset period allows Emulex to sell the affected products to existing customers for specific customer devices, subject to limitations relating to when the products had been qualified and when certain firm orders had been placed. The decision further provided for Emulex to pay a royalty of nine percent on all sales of such products made during the sunset period. The decision also provided that foreign sales (outside the U.S.) are beyond the scope of the suit. On April 3, 2012, the Court issued a Permanent Injunction which, with respect to both the ‘150 and ‘691 patents, further describe the prohibited activities, contain sunset provision terms including royalty rates and computations, limit the territory to allow sales of products that are manufactured outside the U.S. to customers located outside the U.S., permit design around efforts including modifications and design, development, and testing to eliminate infringement, and permit service and technical support for certain products. The Permanent Injunction refers to an Appendix to that Order, but no appendix was included when the Permanent Injunction was issued on April 3, 2012. The Appendix is to identify the permitted sunset sales, which would include the existing Emulex customers, the particular customer platform and the Emulex product or devices. On April 23, 2012, the Court stated that the Appendix is to be in final form by June 4, 2012. On April 4, 2012, we filed a notice of appeal. On April 12, 2012, the Court scheduled the start of the re-trial relating to the ‘194 family of patents that the previous jury could not reach a unanimous verdict on for April 2, 2013. The previous trial involved the following patents in the ‘194 family: U.S. Patent 6,424,194, Claim 1; U.S. Patent 7,486,124, Claim 5; and U.S. Patent 7,724,057, Claim 42, all of which pertain to circuitry used to deserialize signals. See Note 8 in the notes to the condensed consolidated financial statements under the caption “Litigation” in Part I, Item 1 of this Form 10-Q.

Specific risks related to the Broadcom infringement suit include:

 

   

Design changes (sometimes referred to as design-arounds) that may be used as alternatives for the two patents, for which there have been findings of infringement, may present unforeseen technical problems for implementation and/or result in significant internal design costs, as well as third party non-recurring engineering costs;

 

   

The interpretation of the provisions of the Permanent Injunction maybe unfavorable to us, resulting in part because of the complexity of the business practices used by our customers, including a large quantity of different customer product models, customer platforms, and design configurations, and the complexity of the supply chains, support implementations, and product distribution networks used by our customers, each of which may result in the need for further hearings before the Court;

 

   

The content of the Appendix to the Permanent Injunction may be unfavorable to us;

 

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The sunset period may not be long enough to permit us, our suppliers, our OEM customers and end users to implement, test, qualify, and certify replacement products containing design changes that eliminate the patent infringement;

 

   

The Court may determine that we have not adequately proven the extent of the injuries that may occur to our customers and the end users due to a sunset period that is too short, and the Court may not modify the Permanent Injunction to provide for a longer time period;

 

   

The Court may determine that we have not adequately proven reasons for delays in completing product redesigns and retesting, and the Court may not modify the Permanent Injunction to provide for a longer time period;

 

   

Our sales and support for products sold outside the United States may be made subject to the Permanent Injunction, although such sales were previously found to be outside the scope of the suit;

 

   

Our continuing support and sales for products previously provided to customers and end users may be made restricted by the Permanent Injunction, although technical support is not prohibited by the Permanent Injunction for products subject to the jury verdict award of damages, or permitted under the sunset period;

 

   

The Permanent Injunction provisions limiting sunset period sales by when each customer qualified our products and when each customer first submitted its orders to us for products, and provisions requiring written certification by customers, may cause our customers to not provide new product opportunities to us;

 

   

The Permanent Injunction royalties may make our costs too high to meet market pricing requirements set by our customers;

 

   

There may be technical resource and equipment availability shortages impeding our ASIC component suppliers from completing chip spins, and our OEM customers and end users from completing testing of redesigned products;

 

   

Our suppliers, on whom we rely for SerDes changes for chip spins, may require more time than what is available under the sunset periods in order to complete redesigns of clock and data recovery (CDR) in SerDes modules;

 

   

The re-trial may result in significant additional defense costs, and the outcome for such a re-trial is uncertain, but may include a further injunction and may result in further product redesign activity;

 

   

Broadcom could file additional lawsuits against us, asserting additional claims from the same patents involved in the lawsuit, or additional patents, or file other proceedings with commissions such as the International Trade Commission;

 

   

Any appeals we make with respect to the determinations made by the jury or the Court may not be successful; any requests for stay of the Permanent Injunction that we make pending the resolution of any appeal may not be granted; and royalties we pay pending an appeal may not be promptly reimbursed to us even if we are successful with any appeal;

 

   

Any settlement terms we may reach in the suit brought by Broadcom may be less favorable to us than were settlements in other patent litigation involving companies;

 

   

We may reach a settlement of the lawsuit brought by Broadcom, and incur a settlement burden, but Broadcom may not assert the patents against our competitors, thus leaving us with a competitive disadvantage relative to future business that may not be borne by our competitors;

 

   

Delays in the time taken to reach any settlement in the suit brought by Broadcom may cause us to expend additional defense costs until a settlement is reached;

 

   

Broadcom may be unwilling to settle the suit with us for strategic or tactical reasons that we are unable to determine;

 

   

The supply to our customers in the United States may be disrupted by the Permanent Injunction affecting our Ethernet based products that include our BE2 or BE3 chips, and the combined Ethernet based and 16 Gbps Fibre Channel based products that include our XE201 (formerly Lancer) chip, and our InSpeed® embedded switch products and pass through modules that include our SOC 320, SOC 422, or SOC 442 chips (collectively referred to as the affected products);

 

   

Our total net revenues may be reduced by our inability to sell the affected products in the United States after any injunction; and

 

   

A settlement in the suit brought by Broadcom may never be reached, and a permanent injunction may be issued and remain in place for the life of the patents in the lawsuit.

 

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See “We are dependent on sole source and limited source third party suppliers and EMS providers for our products” elsewhere in this Item 1A—Risk Factors.

Ongoing lawsuits, such as the action brought by Broadcom, present inherent risks, including 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, including substantial costs and difficulties in implementing design changes and the associated customer re-qualification thereof and/or maintaining favorable working relationships with our suppliers of SerDes modules; counterclaims, attorneys’ fees, and diversion of management’s attention from other business matters. Such lawsuits and the related risks thereof could have a material adverse effect on our business, financial condition, or results of operations.

The current macro- economic downturn continues to result in a reduction in information technology spending.

The demand for our network storage products has been driven by the demand for high performance storage networking products and solutions that support enterprise computing applications, including on-line transaction processing, data mining, data warehousing, multimedia, and Internet applications. The current economic downturn and related disruptions in world credit and equity markets, as well as the European debt crisis, have resulted in a global downturn in spending on information technology. If the continuing downturn in the economy results in significant reductions in the demand for such products, solutions, and applications, it will adversely affect our business, results of operations, and financial condition in the near term and possibly beyond. The adverse effects of any sustained reductions in information technology spending on our operating results may be exacerbated by our research and development investments, strategic investments and merger and acquisition activity, as well as customer service and support, which we may need to continue despite any such reductions in demand.

Our business is highly competitive.

The markets for our products are highly competitive and are characterized by rapid technological advances, price erosion, frequent new product introductions, and evolving industry standards. We expect that our markets will continue to attract new competition. Our current and potential competition consists of major domestic and international companies, some of which have substantially greater financial, technical, marketing, and distribution resources than we have. Additional companies, including but not limited to our suppliers, strategic partners, Original Equipment Manufacturer (OEM) customers and emerging companies, may enter the markets in which we compete and new or stronger competitors may emerge as a result of consolidation in the marketplace. Additionally, our existing competitors continue to introduce products with improved price/performance characteristics, and we may have to do the same to remain competitive. Furthermore, competitors may introduce new products to the market before we do, and thus obtain a first to market advantage over us. Increased competition could result in increased price competition, reduced revenues, lower profit margins or loss of market share, any of which could have a material adverse effect on our business, results of operations, and financial condition.

A significant portion of our business depends upon the continued growth of the networking market.

The size of our potential market is largely dependent on the overall demand for networking products and in particular upon the broadening acceptance of our converged network technologies. We believe that our investment in multi-protocol solutions that address the high performance needs of the converged networking market provides the greatest opportunity for our future revenue growth and profitability. However, the market for converged networking products may not gain broader acceptance and customers may choose alternative technologies that we are not investing in, and/or products supplied by other companies. Interest continues for other storage networking technologies such as Internet Small Computer Systems Interface (iSCSI), which may satisfy some Input/Output (I/O) connectivity requirements through standard Ethernet adapters and software at little to no incremental cost to end users. These software only iSCSI solutions compete with our Network Connectivity Products, particularly in the low end of the market. We have also launched Converged Network Adapters (CNAs) using Fibre Channel over Ethernet (FCoE) or iSCSI protocols which may be used by the same customers impacting our network product revenues more than we anticipate. Furthermore, since our products are sold as parts of integrated systems, demand for our products is driven by the demand for these integrated systems, including other companies’ complementary products. A lack of demand for the integrated systems or a lack of complementary products required for these integrated systems to be deployed could have a material adverse effect on our business, results of operations, and financial condition. If the converged networking market does not grow, grows more slowly than we anticipate, declines, attracts more competitors than we expect as discussed above, or if our products do not achieve continued market acceptance, our business, results of operations, and financial condition could be materially adversely affected.

 

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A significant portion of our revenue is generated from sales to a limited number of customers, none of which are subject to exclusive or long-term contracts.

We rely almost exclusively on OEMs and sales through distribution channels for our revenue. For the three and nine months ended April 1, 2012, respectively, we derived approximately 92% and 90% of our net revenues from sales to OEM customers and approximately 8% and 10% from sales through distribution. Furthermore, as some of our sales through distribution channels consist of OEM products, OEM customers effectively generated approximately 96% and 94% of our revenue for the three and nine months ended April 1, 2012, respectively. Moreover, direct and indirect sales to our top five customers (including customer-specific models purchased or marketed indirectly through distributors, resellers and other third parties) accounted for approximately 82% and 81% of our net revenues for the three and nine months ended April 1, 2012, respectively. If we are unable to retain our current OEM and distributor customers, recruit additional or replacement customers, or timely collect amounts due from our customers, or if demand from our customers is reduced due to difficulties in their ability to acquire components or other products such as microprocessors, disk drives, switches and optical modules used in conjunction with our products or in the deployments of their products, our business, results of operations, and financial condition could be materially adversely affected.

As is common in the technology industry, our agreements with OEMs and distributors are typically non-exclusive, have no volume commitments, and often may be terminated by either party without cause. It is increasingly commonplace for our OEM and distributor customers to utilize or carry competing product lines. If we were to lose business from one or more significant OEM or distributor customers to a competitor, our business, results of operations, and financial condition could be materially adversely affected. In addition, our OEMs may elect to change their business practices in ways that affect the timing of our revenues, which may materially adversely affect our business, results of operations, and financial condition.

Although we continue to expand our base of customers, we believe our revenues in the future will still be derived from a limited number of customers. As a result, to the extent that sales to any of our significant customers do not increase in accordance with our expectations or are reduced or delayed, our business, results of operations, and financial condition could be materially adversely affected.

Our operating results are difficult to forecast resulting in significant fluctuations from quarter to quarter.

Our revenues and results of operations have varied on a quarterly basis in the past and may vary significantly in the future. Accordingly, we believe that period-to-period comparisons of our results of operations are not necessarily meaningful, and you should not rely on such comparisons as indications of our future performance. We may be unable to maintain our current levels of growth or profitability in the future. Our revenues and results of operations are difficult to forecast and could be adversely affected in any given quarter by many factors, including, but not limited to:

 

   

Changes in the size, mix, timing and terms of OEM and/or other customer orders;

 

   

Changes in the sales and deployment cycles for our products and/or desired inventory levels for our products;

 

   

Acquisitions or strategic investments by our customers, competitors or us;

 

   

Timing and market acceptance of new or enhanced product introductions, including the timing of server chipset refresh cycles related to new server chipsets, such as Intel Corporation’s Romley chipset, by us, our OEM customers and/or competitors;

 

   

Market share losses or difficulty in gaining incremental market share;

 

   

Reduced demand from our customers if there is a shortage of, or difficulties in acquiring, components or other products, such as microprocessors, disk drives, switches, and optical modules, used in conjunction with our products in the deployment of systems;

 

   

Seasonality;

 

   

Changes in general social and economic conditions, including but not limited to natural disasters, terrorism, public health crises, slower than expected market growth, reduced economic activity, delayed economic recovery, loss of consumer confidence, increased energy costs, adverse business conditions and liquidity concerns, concerns about inflation or deflation, recession, and reduced business profits and capital spending, with resulting changes in customer technology budgeting and spending;

 

   

Fluctuations in product development, procurement, resource utilization and other operating expenses;

 

   

Anticipated efficiencies resulting from increased revenues may be less than expected or not achieved at all;

 

   

Difficulties controlling unanticipated costs, including operating expenses, as revenues increase;

 

   

Inability of our electronics manufacturing service providers or suppliers to produce and distribute our products in a timely fashion;

 

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Difficulties with updates, changes or additions to our information technology systems; and

 

   

Breaches of our network security, including viruses.

Order deferrals and cancellations by our customers, declining average sales prices, changes in the mix of products sold, shortages of materials, delays in the introduction of new products and longer than anticipated sales cycles for our products have adversely affected our business, financial condition and results of operations in the past. Despite these factors, we, along with our electronics manufacturing service (EMS) providers, maintain significant finished goods, work-in-progress and raw materials inventory to meet estimated order forecasts. If our customers purchase less than their forecasted orders or cancel or delay existing purchase orders, there will be higher levels of inventory that face a greater risk of obsolescence. If our customers choose to purchase products in excess of the forecasted amounts or in a different product mix, there might be inadequate inventory or manufacturing capacity to fill their orders.

As a result of these and other unexpected factors or developments, future operating results may be, from time to time, below the expectations of investors or market analysts, which would have a material adverse effect on our stock price.

Our industry is subject to rapid technological change.

The markets for our products are characterized by rapidly changing technology, evolving industry standards, and the frequent introduction of new products and enhancements. Our future success depends in large part on our ability to enhance our existing products and to introduce new products on a timely basis to meet changes in customer preferences and evolving industry standards. Currently, new and proposed technologies such as 16 Gb/s Fibre Channel solutions; Cloud Computing; Enterprise Flash Drives (EFDs) or Solid State Drives (SSDs); FCoE; Enhanced Ethernet; 10GbE, 40GbE, and 100GbE solutions; low latency Ethernet solutions; Data Center Ethernet; Infiniband; iSCSI; PCI-X 3.0; PCI Express 3.0; PCI Express Advanced Switching; SATA; SAS; and Remote Direct Memory Access (RDMA) over Converged Ethernet (RoCE) are in development by many companies and their ultimate acceptance and deployment in the market is uncertain. We are developing some, but not all of these technologies, and we cannot be sure that the technologies we chose to develop will achieve market acceptance, or that technologies that we chose not to develop will be available to purchase or license from third parties or will be immaterial to our business. Furthermore, if our products are not available in time for the qualification cycle at an OEM, we may be forced to wait for the next qualification cycle, which is typically three years if at all. In addition, new products and enhancements developed by us may not be backwards compatible to existing equipment already installed in the market. If we are unable, for technological or other reasons, to develop new products, enhance or sell existing products, or consume raw materials in a timely and cost effective manner in response to technological and market changes, our business, results of operations, and financial condition may be materially adversely affected.

We may be unsuccessful in our expansion into new segments of the storage and server technology market, and the costs associated with our expansion may be greater than anticipated.

To remain a significant supplier of networking technologies, we will need to continue to expand the range of products and solutions offered to our OEM customers. Expansion into other areas of the storage and server technology market, whether by acquisition or through internal growth, and the resulting increases in expenditures to support these new areas may be greater than anticipated. If we fail to successfully expand into new areas of the storage and server technology market with products that we do not currently offer, and effectively address these new market opportunities, we may lose market share and revenue opportunities to our competitors. Any such loss of opportunities or any failure by us to effectively manage the costs associated with expanding into new markets may have an adverse effect on our business and financial condition.

Further, although most of our revenues have historically been derived from products based on Fibre Channel technology, we expect to continue to grow our business by offering converged networking solutions following our recent acquisition of ServerEngines Corporation (ServerEngines). We believe that our Fibre Channel products and our converged networking solutions will, at least initially, have similar customers and other marketing requirements that should produce certain synergies and cost savings as we expand our converged network solutions business. However, if the expansion of our converged networking solutions business does not produce the synergies and cost savings with our core Fibre Channel business that we anticipate, our marketing and other business expenses relating to our converged network solutions business could be greater than anticipated and our financial condition could be adversely affected.

The timing of migration by our customers toward emerging technologies and newer product platforms varies. Any failure of our OEM customers to keep up with rapid technological change and to successfully market and sell systems that incorporate new technologies could adversely affect our business.

Our revenues depend significantly upon the ability and willingness of our OEM customers to commit significant resources to develop, promote, and deliver products that incorporate our technology. In addition, if our customers’ products are not commercially successful, it would have a materially adverse effect on our business, results of operations, and financial condition.

 

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As our customers migrate from one platform to the enhanced price/performance of the next platform, we may experience reduced revenue, gross profit, or gross margin levels associated with lower average selling prices or higher relative product costs associated with improved performance. While we regularly compare forecasted demand for our products against inventory on hand and open purchase commitments, to the extent that customers migrate more quickly than anticipated, the corresponding reduction in demand for older product platforms may result in excess or obsolete inventory and related charges which could have a material adverse effect on our financial condition and results of operations.

Our customers may elect to use lower-end HBAs in higher-end environments or applications.

We supply two families of HBAs that target separate high-end, midrange and small to medium sized business user markets. Historically, the majority of our revenues has come from our high-end server and storage solutions. In the future, increased revenues are expected to come from dual channel adapters and midrange server and storage solutions, which have lower average selling prices per port. If customers elect to utilize midrange HBAs in higher-end environments or applications, or migrate to dual channel adapters faster than we anticipate, our business and financial condition could be negatively affected.

Advancement of storage device capacity technology may not allow for additional revenue growth.

Storage device density continues to improve rapidly and at some point in the future, the industry may experience a period where the advancement in technology may increase storage device capacity to a level that may equal or exceed the need for digital data storage requirements. This would result in a situation where the number of units of storage devices required in the marketplace may level out or even decrease. Our growth in revenue depends on growth in unit shipments to offset declining average selling prices. To the extent that growth in storage device unit demand slows or decreases, our financial condition and results of operations may be materially adversely affected.

Our average unit selling prices may decrease at a faster rate than we are able to realize cost reductions in our products.

In the past, we have experienced downward pressure on the average unit selling prices of our products, and we expect this trend to continue. Furthermore, we may provide pricing discounts to customers based upon volume purchase criteria, and achievement of such discounts may reduce our average unit selling prices. To the extent that growth in unit demand fails to offset decreases in average unit selling prices, our revenues and financial performance could be materially adversely affected. Although we have historically achieved offsetting cost reductions, to the extent that average unit selling prices of our products decrease without a corresponding decrease in the costs of such products, our gross margins and financial performance could be materially adversely affected. Our gross margins could also be adversely affected by a shift in the mix of product sales to lower gross margin products. Furthermore, as our products are manufactured internationally, cost reductions would be more difficult to achieve if the value of the U.S. dollar continues to deteriorate. Moreover, if the manufactured cost of our products were to increase due to inflation or other factors and we cannot pass along the increase in our costs to our customers, our gross margins and financial performance could be materially adversely affected.

We may experience delays in our product development cycle and the introduction of new products.

We have experienced delays in product development in the past and may experience similar delays in the future. Such delays may result from numerous factors, which include, but are not limited to:

 

   

Difficulties in hiring and retaining necessary employees and independent contractors;

 

   

Difficulties in reallocating engineering resources and other resource limitations;

 

   

Unanticipated or lengthy redevelopment efforts to make design changes resulting from unintentional intellectual product infringement and related injunctions;

 

   

Unanticipated engineering or manufacturing complexity, including from third party suppliers of intellectual property such as foundries of our ASICs;

 

   

Undetected errors or failures in our products;

 

   

Changing OEM product specifications;

 

   

Delays in the acceptance or shipment of products by OEM customers; and

 

   

Changing market or competitive product requirements.

We also have engaged in product development alignment activities with customers, companies we have investments in and receivables from, and other third parties in the past, and we expect to continue doing so in the future. These product development alignment activities can magnify several risks for us, including the loss of control over development activities and the timing of product availability. Accordingly, we face increased risk that such product development alignment activities will result in products that are not commercially successful or that are not available in a timely fashion.

 

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Given the short product life cycles in the markets for our products and the relatively long product development cycles, any delay or unanticipated difficulty associated with new product introductions or product enhancements could have a material adverse effect on our business, results of operations, and financial condition.

Changes in our business model to separately charge for software may not result in expected revenue increases.

Emulex recently began charging separate license fees for software associated with our product offerings. The success of this strategy to generate software revenues is subject to numerous risks, including:

 

   

We may be unable to develop and market these new software products successfully;

 

   

The software products we develop may not be well received by customers;

 

   

Our software products may have quality problems or other defects in the early stages that were not anticipated in the design of those products; and

 

   

Software products developed and new technologies offered by others may affect demand for our products.

While revenues recognized during the nine months ended April 1, 2012 have not been significant, any failure to successfully implement this new strategy could have an adverse effect on our results of operations in the future.

We are dependent on sole source and limited source third party suppliers and EMS providers for our products.

We rely on third party suppliers for components and the manufacture of our products. A number of these components and products are only available from a single or limited number of suppliers. We also purchase certain components and products from single or limited suppliers and EMS providers to drive volume discounts. As a result, we have experienced delays or difficulty in securing components and finished goods in the past, as well as additional costs related to such issues. Delays or difficulty in securing components or finished goods at reasonable cost may be caused by numerous factors including, but not limited to:

 

   

Natural disasters, such as the significant flooding in Thailand in October 2011;

 

   

Discontinued production by a supplier;

 

   

Required long-term purchase commitments;

 

   

Undetected errors, failures or production quality issues, including projected failures that may constitute epidemic failure rates specified in agreements with our customers or that may require us to make concessions or accommodations for continuing customer relationships;

 

   

Timeliness of product delivery;

 

   

Increases in manufacturing costs due to lower volumes or more complex manufacturing process than anticipated;

 

   

Sole sourcing and components made by a small number of suppliers, including the inability to obtain components and finished goods at reasonable cost from such sources and suppliers;

 

   

Market shortages;

 

   

Changes in business strategies of our suppliers and EMS providers;

 

   

Financial stability and viability of our suppliers and EMS providers;

 

   

Inability or unwillingness of our suppliers or EMS providers to continue their business with us;

 

   

Environmental, tax or legislative changes in the location where our products are produced or delivered;

 

   

Disruption in shipping channels;

 

   

Intellectual property controversies; and

 

   

Difficulties associated with international operations.

We utilize third-party EMS providers located outside the United States to manufacture and test the majority of our products. These EMS providers also procure and manage most of the components used in our board or box level products. As a result of our reliance on third-party EMS providers, we may not be able to directly control product delivery schedules and the quality of our products which could have a material adverse effect on our business, results of operations, and financial condition. If our EMS providers are unable to respond in a timely fashion to changes in customer demand, we may be unable to produce enough products to respond to sudden increases in demand, resulting in lost revenues. Alternatively, in the case of order cancellations or decreases in demand, we may be liable for excess or obsolete inventory or cancellation charges

 

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resulting from contractual purchase commitments that we have with our EMS providers. We regularly provide rolling forecasts of our requirements to our EMS providers for planning purposes, pursuant to our agreements, a portion of which is binding upon us. Additionally, we are committed to accept delivery on the forecasted terms for a portion of the rolling forecast. Cancellations of orders or changes to the forecasts provided to any of our EMS providers may result in cancellation costs payable by us. In the past, we have been required to take delivery of materials from our EMS providers that were in excess of our requirements, and we have previously recognized charges and expenses related to such excess material. We expect that we will continue to incur such costs in the future.

We also purchase ASIC components from sole source suppliers, including LSI Corporation, Marvell Technology Group Ltd., Intel Corporation, Renesas Electronics America Inc., and Toshiba Corporation, who in turn rely on a limited number of their suppliers to manufacture ASICs, all of which create risks in assuring such component availability. While we have multiple ASIC component suppliers, we sole source each of our ASIC components, and we use the same ASIC component supplier for more than one of our ASICs. The inability of the Company or our EMS providers to obtain these ASIC components in sufficient quantities or in the desired time periods could delay the production and delivery of our products which, in turn, could result in lost revenue due to customer cancellations and have a material adverse effect on our business, results of operations, and financial condition.

The use of a sole source ASIC component supplier may create risks relating to intellectual property controversies including the need to prepare for design changes by the ASIC component supplier in response to such controversies. For example, on January 27, 2009, a patent infringement lawsuit was filed in the United States District Court in the Central District of California as Case No. CV09-00605 R (JWJx) against us by Microprocessor Enhancement Corporation and Michael H. Branigin. The complaint alleged infringement of U.S. Patent No. 5,471,593, and sought a judgment for damages, injunctive relief, and an award of attorneys’ fees and costs. The lawsuit alleged that our ASICs contained specific computer processors as pre-designed functional modules designed by a specific supplier, and that many other companies were using the same modules in ASICs. On July 1, 2010, the Court granted summary judgment of non-infringement to Emulex based on prosecution history estoppel of the patent, and the Court subsequently entered final judgment in favor of Emulex on July 13, 2010. A dismissal of the action was filed with the court on about December 8, 2010. Because of the resolution of this lawsuit, Emulex and the ASIC component supplier did not need to make any changes to the design of our ASICs.

More recently, on September 14, 2009, Broadcom Corporation 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 February 23, 2010, Broadcom filed a first amended complaint adding allegations of infringement for one additional Broadcom patent. On May 26, 2010, Broadcom Corporation filed a separate patent infringement lawsuit against the Company in the United States District Court in the Central District of California. Broadcom sought a judgment for damages, injunctive relief, and an award of attorneys’ fees and costs. See Note 8 in the notes to the condensed consolidated financial statements under the caption “Litigation” in Part I, Item 1 of this Form 10-Q. Also see “Third party claims of intellectual property infringement could adversely affect our business” elsewhere in this Item 1A—Risk Factors.

The Broadcom lawsuit includes allegations, amongst others, that our ASICs include SerDes modules obtained from our ASIC component suppliers that infringe upon Broadcom’s patents. Specifically, the allegations assert that the SerDes modules provided by our ASIC suppliers use a kind of CDR phase interpolator design covered by such patents, two of which the Court has found Emulex to be infringing. We are in the process of working with our ASIC component suppliers to redesign certain infringing ASICs in order to change out the CDR implementation, and certain of our ASICs may be superseded by redesigned ASICs containing alternative CDR designs. However, changing the CDR implementation for an existing ASIC may require a full layer metal spin. Expenses for non-recurring engineering costs paid to our suppliers for spins of other ASICs in the past have generally been in the range of $1 million to $2 million for each ASIC. Such a chip spin would require significant time and effort by our personnel and the personnel of our ASIC supplier to develop and validate the new ASIC design. These efforts generally encompass some or all of the following activities:

 

   

ASIC Development—As a fabless ASIC company, we rely heavily on our ASIC suppliers to supply us with various pre-designed functional modules for the design of our ASICs. These pre-designed functional modules are sometimes called cores, and are sole sourced from each ASIC supplier and available for specific geometries of line widths (referred to as process nodes) which are available from a particular silicon foundry. The library of pre-designed functional modules from an ASIC component supplier include computer processors (such as those from ARM, Ltd. and Tensilica Inc.), static memory, buses, SerDes (serializers/deserializers), PCIe logic, dynamic memory, and interfaces. Our engineering personnel use computer tools from the ASIC supplier and third parties such as Magma Design Automation, Inc. and Synopsys, Inc. to create application logic that combines various of the pre-designed functional modules together with Emulex custom logic in order to form the ASIC design. The particular pre-designed functional modules are sole sourced, and are each specific to a particular process node; and the same pre-designed functional modules are used by many other companies as customers of the same ASIC component supplier.

 

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Firmware and Application Development—At the same time that ASIC logic design is being developed, our engineering personnel prepare ASIC firmware that operates on the computer processor included as a pre-designed functional module in the ASIC design, and host driver software that operates on a host computer to which the ASIC will be connected. The ASIC firmware is based on the instruction set implemented by the computer processor, and that instruction set is sole sourced to the supplier of the computer processor included as a pre-designed functional module. Also, at the same time as the ASIC logic design is being developed, our engineering personnel design circuit boards and cards into which the ASIC may be inserted for testing and for connection to host computers and external networks.

 

   

Functional and Physical Design and Verification (Design & Verification)—The purpose of Design & Verification is to ensure that the ASIC design meets its specification. The Design & Verification process involves the computer simulation of the ASIC design, including the sole source pre-designed functional modules contained in the ASIC design. The ASIC component supplier assists our engineering personnel with the use of the computer tools and the performance of the Design & Verification process. Such assistance includes the implementation of a layout or tape-out of the design pattern to be created on the silicon die, and the simulation of the electrical effects of such a layout or tape-out. The preparation of a layout or tape-out involves the use of sole source computer tools which our engineering personnel do not have. Partial testing of the ASIC firmware and host drivers can be performed as a part of the Design & Verification process.

 

   

Pre-production Manufacturing—After our engineering personnel complete the Design & Verification process, the ASIC component supplier is asked to prepare the ASIC design for the production of the ASIC wafers and die at the silicon foundry. Such preparation includes the creation of multiple masks used in manufacturing of the ASIC wafers and die. The preparation of masks involves the use of sole source computer tools which our engineering personnel do not have. Once the layout and masks have been completed, the ASIC component supplier provides the masks to the silicon foundry which initiates the manufacturing of the ASIC wafers and die. Our engineering personnel provide information about the ASIC design to allow the preparation of foundry tests for the ASIC wafers and die, and for the preparation of supplier tests for the ASICs after packaging. The silicon foundry and the ASIC component supplier perform tests on the wafers and die, and causes the die to be packaged, before they are shipped to us. The initial manufacturing of the ASIC wafers is in a smaller quantity, referred to as prototypes or pre-production units, which are provided to us for further testing by us and our customers.

 

   

Design Verification and Test (DVT)—Once our engineering personnel have received prototypes or pre-production units of the ASICs, we begin the DVT process. As a part of the DVT process, we have a contract manufacturer prepare boards and cards containing the ASICs. The first phase of DVT involves bring-up testing to check the performance of the ASIC when connected to a host computer, but without extensive testing of the ASIC firmware and host driver software. The second phase of the DVT involves extensive testing of the ASIC together with its ASIC firmware and host driver software. The third phase of DVT involves exhaustive testing of the ASIC, ASIC firmware, and host driver software using a test specification requiring unfailing operation in many different host computer operating systems, including current and past versions of server computers and storage subsystems from all of our major OEM customers, using many different versions of network switches, disk, tape and solid state memory storage systems, and under network disruption and failure modes with many different permutations of error conditions and network traffic problems. The third phase of DVT takes many weeks of time. If bugs are found during DVT, our engineering personnel determine the root cause of the bug, and may make changes to the ASIC firmware and driver software to correct the bugs under an engineering change order (ECO) procedure. Such ECO changes to the ASIC firmware and driver software are followed by more limited third phase testing, referred to as regression testing, which tests the parts of the functions affected by the ECO. If the root cause review of the bug determines that the bug cannot be corrected by the ASIC firmware or driver software, then our engineering personnel determine what portion of the ASIC design needs to be changed, resulting in a chip spin. If the bug requires changes to the custom logic designed by our personnel, then we proceed with making a re-design of the applicable parts of the ASIC design. If the bug requires changes to any of the pre-designed functional modules, those changes are made by or for the ASIC component provider, and updated simulation information is provided to our engineering personnel. Once the chip has been redesigned, we go back to EVT for the changed design.

 

   

Customer Certification and Qualification—Customer certification and qualification includes testing by our OEM customers to approve our product for purchase and use with their systems. Certification and qualification testing includes exhaustive testing by the OEM of our ASIC, ASIC firmware, driver software and/or board-level applications in networks with the newest products made by the OEM, including products not yet provided to us

 

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or to end users. The certification and qualification testing by an OEM may take many weeks. If bugs are discovered during the certification and qualification testing, the bugs are reported to us, we perform a root cause analysis, and proceed with redesign as described earlier with respect to the DVT process.

As a result, the cost of implementing ASIC design changes to mitigate actual or alleged intellectual property infringement claims, and/or the failure of our customers to qualify and adopt the replacement ASIC chips could have a material adverse impact on our business, results of operations, and financial condition.

Our intellectual property protections may be inadequate.

We believe that our continued success depends primarily on continuing innovation, marketing, and technical expertise, as well as the quality of product support and customer relations. At the same time, our success is partially dependent on the proprietary technology contained in our products. We currently rely on a combination of patents, copyrights, trademarks, trade secret laws, and contractual provisions to establish and protect our intellectual property rights in our products.

We cannot be certain that the steps we take to protect our intellectual property will adequately protect our proprietary rights, that others will not independently develop or otherwise acquire equivalent or superior technology, or that we can maintain such technology as trade secrets. In addition, the laws of some of the countries in which our products are or may be developed, manufactured, or sold may not protect our products and intellectual property rights to the same extent as the laws of the United States, or at all. Furthermore, we enter into various development projects and arrangements with other companies. In some cases, these arrangements allow for the sharing or use of our intellectual property. Our failure to protect our intellectual property rights could have a material adverse effect on our business, results of operations, and financial condition. We attempt to mitigate this risk by obtaining indemnification from others, where possible.

Certain of our software (as well as that of our customers) may be derived from “open source” software that is generally made available to the public by its authors and/or other third parties. Such open source software is often made available to us under licenses, such as the GNU General Public License (GPL), which impose certain obligations on us in the event we were to distribute derivative works of the open source software. These obligations may require us to make source code for the derivative works available to the public, or license such derivative works under a particular type of license, rather than the forms of licenses customarily used to protect our intellectual property. In the event the copyright holder of any open source software were to successfully establish in court that we had not complied with the terms of a license for a particular work, we could be required to release the source code of that work to the public and/or stop distribution of that work.

We may be unable to attract, motivate or retain key managerial and technical personnel.

Our success depends to a significant degree upon the performance and continued service of key managers, as well as engineers involved in the development of our storage networking technologies and technical support of our storage networking products and customers. Competition for such highly skilled employees is intense in the communities in which we operate, as well as our industry, and we cannot be certain that we will be successful in recruiting, training, and retaining such personnel. In addition, employees may leave us and subsequently compete against us, and we may incur costs relating to their departure. Also, many of these key managerial and technical personnel receive stock-based compensation incentives as part of our employee retention initiatives. The number of shares authorized under stock based plans may be insufficient and shareholders may not approve to increase the number of authorized shares. New regulations, volatility in the stock market, and other factors could diminish the value of our stock-based compensation incentives, putting us at a competitive disadvantage and forcing us to use more cash compensation. If we are unable to attract new managerial and technical employees, or are unable to retain and motivate our current key managerial and technical employees, or are forced to use more cash compensation to retain or replace key personnel, our business, results of operations, and financial condition could be materially adversely affected.

Our international business activities subject us to increased business risks.

For the three and nine months ended April 1, 2012, sales in Asia Pacific accounted for approximately 54% and 58% of our total net revenues, respectively, sales in the United States accounted for approximately 32% and 28% of our total net revenues, respectively, and sales in Europe, Middle East, and Africa accounted for approximately 14% and 14%, respectively, of our total net revenues based on billed-to address. We expect that our sales will continue to increase outside of the United States as our customers are migrating towards using contract manufacturers located internationally, predominantly in Asia Pacific. However, because we sell to OEMs and distributors who ultimately resell our products to their customers, the geographic mix of our sales based on billed-to address may not be reflective of the geographic mix of end-user demand or installations. All of our sales are currently denominated in U.S. dollars. As a result, if the value of the U.S. dollar increases relative to foreign currencies, our products could become less competitive in international markets. In addition, an increasing amount of our expenses will be incurred in currencies other than U.S. dollars, and as a result, we will be required from time to time to convert currencies to meet our obligations. Additionally, our suppliers are increasingly located outside of the U.S.,

 

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and a significant portion of our products is produced at our EMS providers’ production facilities in Thailand, Malaysia, and China. Furthermore, in the fourth quarter of fiscal 2008, we established a company in Ireland, and a significant portion of our sales and operations also occur in countries outside of the U.S. As a result, we are subject to the risks inherent in international operations. Our international business activities could be affected, limited or disrupted by a variety of factors, including, but not limited to:

 

   

Fluctuations in freight costs and potential disruptions in the transportation infrastructure for our products and components;

 

   

Longer accounts receivable payment cycles;

 

   

Increased travel, infrastructure, accounting, and legal compliance costs associated with multiple international locations;

 

   

Difficulty in locating, hiring and retaining personnel with requisite skill sets and knowledge;

 

   

Difficulty maintaining management oversight and control of remote locations;

 

   

Changes in the value of local currencies relative to our functional currency;

 

   

Costs and risks of localizing products for international countries;

 

   

Import and export restrictions;

 

   

Limitations on the amount and nature of foreign investment, including restrictions on the structure and/or permissible forms of investment;

 

   

Imposition of or changes in governmental controls, taxes, tariffs, trade restrictions, and regulatory requirements to our current or future operations;

 

   

Potential restrictions on transferring funds between countries and difficulties associated with repatriating cash generated or held outside of the U.S. in a tax-efficient manner;

 

   

Loss of tax benefits or increases in tax expenses;

 

   

Taxation in multiple jurisdictions;

 

   

Bureaucratic intrusions and delays, government corruption, political instability, war, and/or terrorism;

 

   

General economic and social conditions within international countries; and

 

   

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.

All of these factors could harm future sales of our products to international customers or production of our products outside of the United States, and have a material adverse effect on our business, results of operations, and financial condition.

Our stock price is volatile, which has and may result in lawsuits against us and our officers and directors.

The stock market in general, and the stock prices in technology based companies in particular, have experienced extreme volatility that often has been unrelated to the operating performance of any specific public company. The market price of our common stock has fluctuated in the past and is likely to continue to fluctuate in the future. For example, during calendar year 2012 through April 1, 2012, the closing sales price of our common stock ranged from a low of $7.03 per share to a high of $11.01 per share. Factors that could have a significant impact on the market price of our stock include, but are not limited to, the following:

 

   

Quarterly variations in customer demand and operating results;

 

   

The gain or loss of significant customers or design wins;

 

   

Pricing pressures;

 

   

General conditions in the computer, storage, or communications markets;

 

   

Events affecting other companies that investors deem to be comparable to us;

 

   

Announcements of new products by us or our competitors;

 

   

Offers to buy us or a competitor for a premium over recent trading prices;

 

   

Changes in analysts’ earnings estimates;

 

   

Changes in analyst recommendations, price targets, or other parameters that may not be related to earnings estimates;

 

   

Rumors or dissemination of false information; and

 

   

Short selling of our common stock.

 

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In addition, Broadcom’s initiation and subsequent abandonment of its unsolicited takeover proposal to acquire all of the shares of our common stock has resulted in volatility in the price of our common stock. Any other takeover proposal by any third party to acquire the outstanding shares of our common stock may result in further volatility in the price of our common stock. If a takeover does not occur following announcement of a takeover proposal, for any reason, the market price of our common stock may decline. In addition, our stock price may decline as a result of the fact that we have been required to incur significant expenses related to the Broadcom unsolicited takeover proposal.

In the past, companies, including us, that have experienced volatility in the market price of their stock have been subject to securities class action litigation. If we were to be the subject of similar litigation in the future or experience unfavorable outcomes in any of our pending litigation, as discussed in Note 8 in the accompanying notes to our condensed consolidated financial statements in Part I, Item I of this Form 10-Q, it could have a material adverse effect on our business, results of operations, and financial condition. Such litigation would also divert management’s attention from other business matters.

Our results of operations could vary as a result of the methods, estimates, and judgments that we use in applying our accounting policies.

The methods, estimates, and judgments that we use in applying our accounting policies have a significant impact on our results of operations. Such methods, estimates, and judgments are, by their nature, subject to substantial risks, uncertainties, and assumptions, and factors may arise over time that lead us to change our methods, estimates, and judgments. Changes in those methods, estimates, and judgments could significantly affect our results of operations.

The final determination of our income tax liability may be materially different from our income tax provisions and accruals and our tax liabilities may be adversely affected by changes in applicable tax laws.

We are subject to income taxes in both the United States and international jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes. In the ordinary course of our business, there are many transactions where the ultimate tax determination is uncertain. Additionally, our calculations of income taxes are based on our interpretations of applicable tax laws in the jurisdictions in which we file.

Our provision for income taxes is subject to volatility and could be adversely affected by numerous factors including:

 

   

Earnings being lower than anticipated in countries that have lower tax rates and higher than anticipated in countries that have higher tax rates;

 

   

Changes in allocation of income and expenses related to cost sharing arrangements, including adjustments related to changes in the corporate structure, acquisitions or law changes;

 

   

Tax effects of increases in nondeductible compensation;

 

   

Changes in transfer pricing regulations;

 

   

Changes in domestic and foreign tax laws including possible U.S. changes to the taxation of earnings of foreign subsidiaries, the deductibility of expenses attributable to foreign income and changes to foreign tax credit rules;

 

   

Changes in accounting rules or principles, including the potential adoption of international financial reporting standards (IFRS) and changes in the valuation of deferred tax assets and liabilities;

 

   

Unfavorable results from income tax audits; and

 

   

Expiration or lapses of federal and state research credits.

We have adopted transfer-pricing procedures between our subsidiaries to regulate intercompany transfers. Our procedures call for the licensing of intellectual property, the provision of services, and the sale of products from one subsidiary to another at prices that we believe are equivalent to arm’s length negotiated pricing. We have established these procedures due to the fact that some of our assets, such as intellectual property, developed in the U.S., will be utilized among other affiliated companies. If the U.S. Internal Revenue Service (IRS) or the taxing authorities of any other jurisdiction were to successfully require changes to our transfer pricing practices, we could become subject to higher taxes and our earnings would be adversely affected. Any determination of income reallocation or modification of transfer pricing laws can result in an income tax assessment on the portion of income deemed to be derived from the U.S. or other taxing jurisdiction.

Although we believe our tax estimates are reasonable, there is no assurance that the final determination of our income tax liability will not be materially different than what is reflected in our income tax provisions and accruals. Significant judgment is required to determine the recognition and measurement attribute prescribed in the accounting guidance for

 

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uncertainty in income taxes. The accounting guidance for uncertainty in income taxes applies to all income tax positions, including the potential recovery of previously paid taxes, which if settled unfavorably could adversely impact our provision for income taxes. In addition, we are subject to the continuous examination of our income tax returns by the IRS and other foreign, state and local tax authorities. We are currently under audit by the IRS for tax returns for fiscal years 2008 and 2009 and an amended return for fiscal 2007. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. There can be no assurance that the outcomes from these continuous examinations will not have an adverse effect on our operating results and financial condition.

We may fail to realize the anticipated benefits of future acquisitions and strategic investments.

Our future performance will depend in part on our ability to realize the anticipated benefits from acquisitions and strategic investments, and whether we can successfully integrate, operate and/or partner with these businesses with our existing operations in an effective and efficient manner. Integrating our operations with acquired businesses is a complex, time-consuming and expensive process and involves a number of risks and uncertainties. In addition, in order to position ourselves to take advantage of growth opportunities, we have made, and may continue to make, other strategic acquisitions that involve significant risks and uncertainties. The risks and uncertainties relating to acquisitions and/or strategic investments include, but are not limited to:

 

   

The difficulty in integrating any newly acquired businesses and operations in an efficient and effective manner;

 

   

The risk of diverting our resources and the attention of our senior management from the operations of our business;

 

   

Additional demands on management related to the increase in the size and scope of our company following the acquisition;

 

   

Difficulties in combining corporate cultures;

 

   

Difficulties in the assimilation and retention of key employees;

 

   

The risks of potential disputes concerning indemnities and other obligations that could result in substantial costs;

 

   

Unknown defects of an acquired company’s products or assets that may not be identified due to the inherent limitations involved in the due diligence process of an acquisition;

 

   

Costs and expenses associated with any undisclosed or potential liabilities of acquired businesses;

 

   

Delays, difficulties or unexpected costs in the integration, assimilation, implementation or modification of platforms, business information systems, functions, technologies and infrastructure to support the combined business, as well as maintaining uniform standards, controls (including internal accounting controls), procedures and policies;

 

   

The challenges in achieving strategic objectives, cost savings and other benefits expected from any acquisitions;

 

   

The risk that the returns on acquisitions will not support the expenditures incurred to acquire such businesses or the capital expenditures needed to develop such businesses;

 

   

The risks of entering markets in which we have less experience;

 

   

The risk that our markets do not evolve as anticipated and the technologies acquired do not prove to be those needed to be successful in those markets; and

 

   

Difficulties in maintaining relationships with present and potential customers, distributors and suppliers of the acquired business.

Furthermore, to complete future acquisitions we may need to issue equity securities, incur debt, assume contingent liabilities or have amortization expenses and write-downs of acquired assets, which could cause our earnings per share to decline.

Unsolicited takeover proposals may be disruptive to our business.

On April 21, 2009, we received an unsolicited takeover proposal from Broadcom Corporation (Broadcom) to acquire all of our outstanding shares of common stock. While Broadcom has allowed its tender offer to expire, there can be no assurance that Broadcom or another third party will not make an unsolicited takeover proposal in the future. The review and consideration of any takeover proposal may be a significant distraction for our management and employees and could require the expenditure of significant time and resources by us.

Moreover, any unsolicited takeover proposal may create uncertainty for our employees and this uncertainty may adversely affect our ability to retain key employees and to hire new talent. Any such takeover proposal may also create

 

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uncertainty for our customers, suppliers and other business partners, which may cause them to terminate, or not to renew or enter into, arrangements with us. The uncertainty arising from unsolicited takeover proposals and any related costly litigation may disrupt our business, which could result in an adverse effect on our operating results. Management and employee distraction related to any such takeover proposal also may adversely impact our ability to optimally conduct our business and pursue our strategic objectives.

We have entered into Key Employee Retention Agreements with three of our current executive officers, and adopted a Change in Control Retention Plan, in which currently an additional 26 key employees participate. The participants of these retention arrangements may be entitled to severance payments and benefits, based on a period of between twelve months and two years, upon a termination of their employment by us without cause or by them for good reason in connection with a change of control of our company (each as defined in the applicable agreement or plan). These retention arrangements may not be adequate to allow us to retain critical employees during a time when a change in control is being proposed or is imminent.

Our corporate offices, principal product development facilities, EMS providers, suppliers and customers are located in regions that are subject to earthquakes and other natural disasters.

Our California facilities, which include our corporate offices and principal product development facilities, are located near major earthquake faults. Any disruption in our business activities, personal injury, or damage to the facilities in excess of our currently insured amounts as a result of earthquakes or other such natural disasters, could have a material adverse effect on our business, results of operations, and financial condition. In addition, natural disasters such as hurricanes, tsunamis, flooding, and earthquakes, such as the flooding in Thailand in October 2011 and the earthquake off the coast of Japan and the resulting tsunami in March 2011, can disrupt manufacturing operations of our EMS providers, component suppliers and customers or the downstream suppliers that are located in such impacted areas, resulting in lost revenue opportunities in the near term and/or long term.

We currently do not carry earthquake insurance. However, we do carry various other lines of insurance that may or may not be adequate to protect our business.

Our certificate of incorporation and the related provisions under Delaware law could adversely affect the performance of our stock.

Provisions of our certificate of incorporation and Delaware General Corporation Law could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our shareholders. In addition, although we do not currently maintain a shareholders rights plan, we have maintained such a plan in the past and it is possible that we may adopt a shareholders rights plan in the future should general business, market and other conditions, opportunities and risks arise. The provisions of our certificate of incorporation, Delaware law, and any shareholders rights plan are generally intended to encourage potential acquirers to negotiate with us and allow our board of directors the opportunity to consider alternative proposals in the interest of maximizing shareholder value. However, such provisions may also discourage acquisition proposals or delay or prevent a change in control, which could harm our stock price.

We may be subject to theft or misuse of our electronic data, which could result in third-party claims and harm our business and results of operations.

We may experience attempts by others that try to gain unauthorized access through the Internet to our information technology systems, such as when they masquerade as authorized users or surreptitiously introduce software. These attempts, which might be the result of industrial or other espionage, or actions by hackers seeking to harm us, our products, or our end users. We seek to detect and investigate these security incidents and to prevent their recurrence, but in some cases we might be unaware of an incident or its magnitude and effects. The theft or unauthorized use or publication of our trade secrets and other confidential business information as a result of such cyber threats could adversely affect our competitive position and reduce marketplace acceptance of our products; the value of our investment in research and development and marketing could be reduced; and third parties might assert against us or our customers claims related to resulting losses of confidential or proprietary information or end-user data, or system reliability. Any such event could have a material adverse effect on our business, results of operations, and financial condition.

Our system of internal controls may be inadequate.

We maintain a system of internal controls in order to ensure we are able to collect, process, summarize, and disclose the information required by the Securities and Exchange Commission within the time periods specified. Any system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system are met. In addition, the design of any control system is based in part upon certain assumptions about the likelihood of future events. Due to these and other inherent limitations of control systems, there can be no assurance that any

 

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design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote. Additionally, public companies in the United States are required to review their internal controls under the Sarbanes-Oxley Act of 2002. If the internal controls put in place by us are not adequate or fail to perform as anticipated, we may be required to restate our financial statements, receive an adverse audit opinion on the effectiveness of our internal controls, and/or take other actions that will divert significant financial and managerial resources, as well as be subject to fines and/or other government enforcement actions. Furthermore, the price of our stock could be adversely affected.

We may need additional capital in the future and such additional financing may not be available on favorable terms.

While we believe we have adequate working capital to meet our expected cash requirements for the next 12 months, we may need to raise additional funds through public or private debt or equity financings in order to, without limitation:

 

   

Take advantage of unanticipated opportunities, including more rapid international expansion or acquisitions of complementary businesses or technologies;

 

   

Develop new products or services;

 

   

Repay outstanding indebtedness; and

 

   

Respond to unanticipated competitive pressures.

Furthermore, because a significant portion of our investment portfolio consists of U.S. government and U.S. government sponsored entity securities, any default by the U.S. government in its obligations or any downgrade in the rating of U.S. government securities could adversely affect the value of our investment portfolio and our overall liquidity and the liquidity of our customers.

Any additional financing we may need may not be available on terms favorable to us, or at all. If adequate funds are not available or are not available on acceptable terms, we may not be able to take advantage of business opportunities, develop new products or services, or otherwise respond to unanticipated competitive pressures. In any such case, our business, results of operations, and financial condition could be materially adversely affected.

Changes in laws, regulations, and financial accounting standards may affect our reported results of operations.

New laws, regulations and accounting standards, as well as changes to and varying interpretations of currently accepted accounting practices in the technology industry might adversely affect our reported financial results, which could have an adverse effect on our stock price.

Global warming issues may cause us to alter the way we conduct our business.

The general public is becoming more aware of global warming issues, and as a result, governments around the world are beginning to focus on addressing this issue. This may result in new environmental regulations that may unfavorably impact us, our suppliers, and our customers in how we conduct our business including the design, development, and manufacturing of our products. The cost of meeting these requirements may have an adverse impact on our results of operations and financial condition.

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

In early August 2008, our Board of Directors authorized a plan to repurchase up to $100.0 million of our outstanding common stock. In April 2009, upon receipt of an unsolicited takeover proposal and related tender offer from Broadcom Corporation to acquire us, our Board of Directors elected to temporarily suspend any activity under the share repurchase plan. In light of Broadcom allowing its tender offer to expire on July 14, 2009, Emulex’s Board of Directors elected to reactivate the $100.0 million share repurchase plan effective July 15, 2009. Through April 1, 2012, the Company has repurchased approximately 9.0 million shares of its common stock for an aggregate purchase price of approximately $78.4 million at an average purchase price of $8.67 per share under this plan. We may repurchase additional shares under this plan from time-to-time in open market purchases or privately negotiated transactions. The share repurchases will be financed by available cash balances and cash from operations.

 

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Issuer Purchases of Equity Securities

 

                   Total Number of      Approximate Dollar  
                   Shares Purchased as      Value of Shares  
     Total Number      Average      Part of Publicly      that May Yet Be  
     of Shares      Price Paid      Announced Plans      Purchased under the  

Period

   Purchased      per Share      Or Programs      Plans or Programs  

January 2, 2012— January 29, 2012

     —           —           —         $ 21,619,430   

January 30, 2012 — February 26, 2012

     —           —           —         $ 21,619,430   

February 27, 2012 — April 1, 2012

     —           —           —         $ 21,619,430   
  

 

 

       

 

 

    

Total

     —           —           —         $ 21,619,430   
  

 

 

       

 

 

    

Sales of Unregistered Securities

There were no sales of unregistered securities for the three months ended April  1, 2012.

Item 4. Mine Safety Disclosures

Not applicable.

 

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Item 6. Exhibits

 

Exhibit 3.1    Certificate of Incorporation, as amended (incorporated by reference to Exhibit 3.1 to the Company’s 1997 Annual Report on Form 10-K).
Exhibit 3.2    Certificate of Amendment of Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3.4 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 2000).
Exhibit 3.3    Amended and restated Bylaws of the Company (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on October 2, 2009).
Exhibit 3.4    Amended and Restated Certificate of Designations, Preferences and Rights of Series A Junior Participating Preferred Stock of Emulex Corporation, incorporated by reference to Exhibit 3.1 to the Company’s Form 8-K filed with the Securities and Exchange Commission on January 16, 2009.
Exhibit 31A    Certification of the Principal Executive Officer Pursuant to 17 CFR 240.13a-14(a), as Adopted Pursuant to § 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 31B    Certification of the Principal Financial Officer Pursuant to 17 CFR 240.13a-14(a), as Adopted Pursuant to § 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 32    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to § 906 of the Sarbanes-Oxley Act of 2002.
101.INS*    XBRL Instance Document
101.SCH*    XBRL Taxonomy Extension Schema Document
101.CAL*    XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF*    XBRL Taxonomy Extension Definition Linkbase Document
101.LAB*    XBRL Taxonomy Extension Label Linkbase Document
101.PRE*    XBRL Taxonomy Extension Presentation Linkbase Document

 

* XBRL (Extensible Business Reporting Language) information is furnished and not filed herewith, is not a part of a registration statement or Prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: April 26, 2012

 

EMULEX CORPORATION

By:

 

/s/ James M. McCluney

 

James M. McCluney

Chief Executive Officer

By:

 

/s/ Michael J. Rockenbach

 

Michael J. Rockenbach

Executive Vice President and Chief Financial Officer

(Principal Financial and Chief Accounting Officer)

 

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EXHIBIT INDEX

 

Exhibit 3.1    Certificate of Incorporation, as amended (incorporated by reference to Exhibit 3.1 to the Company’s 1997 Annual Report on Form 10-K).
Exhibit 3.2    Certificate of Amendment of Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3.4 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended December 31, 2000).
Exhibit 3.3    Amended and restated Bylaws of the Company (incorporated by reference to Exhibit 3.2 to the Company’s Current Report on Form 8-K filed on October 2, 2009).
Exhibit 3.4    Amended and Restated Certificate of Designations, Preferences and Rights of Series A Junior Participating Preferred Stock of Emulex Corporation, incorporated by reference to Exhibit 3.1 to the Company’s Form 8-K filed with the Securities and Exchange Commission on January 16, 2009.
Exhibit 31A    Certification of the Principal Executive Officer Pursuant to 17 CFR 240.13a-14(a), as Adopted Pursuant to § 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 31B    Certification of the Principal Financial Officer Pursuant to 17 CFR 240.13a-14(a), as Adopted Pursuant to § 302 of the Sarbanes-Oxley Act of 2002.
Exhibit 32    Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to § 906 of the Sarbanes-Oxley Act of 2002.
101.INS*    XBRL Instance Document
101.SCH*    XBRL Taxonomy Extension Schema Document
101.CAL*    XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF*    XBRL Taxonomy Extension Definition Linkbase Document
101.LAB*    XBRL Taxonomy Extension Label Linkbase Document
101.PRE*    XBRL Taxonomy Extension Presentation Linkbase Document

 

* XBRL (Extensible Business Reporting Language) information is furnished and not filed herewith, is not a part of a registration statement or Prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.

 

51

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