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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark
One)

For the quarterly period ended September 28, 2003

OR

Commission File No. 000-27221

VIXEL CORPORATION

11911 North Creek Parkway South
Bothell, Washington 98011
(425) 806-5509

(Address, including zip code, of Registrant’s principal executive offices and 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 o

     Indicate by check mark whether the registrant is an accelerated filer (as defined in rule 12b-2 of the Exchange Act). Yes x No o

     The number of shares outstanding of the Registrant’s common stock, $.0015 par value, as of October 24, 2003 was 24,919,606.

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VIXEL CORPORATION

INDEX TO FORM 10-Q FOR QUARTER ENDED SEPTEMBER 28, 2003

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

VIXEL CORPORATION
CONDENSED BALANCE SHEET
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)

The accompanying notes are an integral part of these condensed financial statements.

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VIXEL CORPORATION
CONDENSED STATEMENT OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)

The accompanying notes are an integral part of these condensed financial statements.

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VIXEL CORPORATION
CONDENSED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)

The accompanying notes are an integral part of these condensed financial statements.

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VIXEL CORPORATION

NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)

NOTE 1. BASIS OF PRESENTATION

     The accompanying condensed financial statements as of September 28, 2003 and for the three- and nine-month periods ended September 28, 2003 and September 29, 2002 are unaudited; however, in the opinion of management, the interim data includes all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the financial position, results of operations, and cash flows for the interim periods. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. Results of operations and cash flows for the interim periods are not necessarily indicative of future financial results. You should read these interim financial statements in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the audited financial statements and notes thereto included in our Annual Report on Form 10-K, as amended, for the fiscal year ended December 29, 2002.

     The preparation of condensed financial statements in accordance with accounting principles generally accepted in the United States of America and pursuant to the rules and regulations of the Securities and Exchange Commission requires management to make estimates and assumptions that affect the amounts reported in the condensed financial statements and accompanying notes. Actual results could differ materially from those estimates.

     Certain prior year amounts have been reclassified to conform to current period presentation. Reclassifications have not impacted our financial position, net loss or cash flows of the prior periods.

NOTE 2. NET LOSS PER SHARE

     Basic and diluted net loss per share represents the net loss applicable to common stockholders divided by the weighted-average number of common shares outstanding during the period presented. We have excluded outstanding convertible preferred stock, options to purchase common stock, stock subject to repurchase rights, and warrants to purchase common stock, as these securities are antidilutive for all periods presented.

     The following table sets forth the adjustments to net income resulting in net loss applicable to common stockholders (in thousands):

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     The following table sets forth the antidilutive securities excluded from the diluted net loss per share calculation for the three- and nine-month periods ended September 28, 2003 and September 29, 2002 (in thousands of shares):

NOTE 3. STOCK OPTIONS

     We account for stock option grants pursuant to the provisions of Statement of Financial Accounting Standards No. 123 “Accounting for Stock-Based Compensation” (SFAS 123). Under the provisions of SFAS 123, employee stock-based compensation expense is measured using either the intrinsic-value method as prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25), or the fair value method described in SFAS 123. Companies choosing the intrinsic-value method are required to disclose the pro forma impact of the fair value method on net income. We have elected to continue accounting for our employee and director stock-based awards under the provisions of APB 25. We account for equity grants to other than employees and directors pursuant to the fair value provisions of SFAS 123.

     Had we determined compensation expense based on the fair value of the option at the grant date for all stock options issued to employees and for shares issued to employees at a discount pursuant to the Employee Stock Purchase Plan, our net loss applicable to common stockholders and net loss per share would have been increased to the pro forma amounts indicated below (in thousands, except per share amounts):

     The stock based compensation pursuant to fair value accounting information presented has been determined as if we had accounted for our stock options issued to employees under the fair value method for all periods presented. The fair value of each option granted is estimated at the date of grant using the following weighted-average assumptions:

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NOTE 4. INVENTORIES

     Inventories consist of the following:

NOTE 5. WARRANTY

     We offer product warranties of one to five years. Warranty coverages provide for the repair or replacement of defective products, at our option. Estimated future warranty obligations related to certain products are provided by charges to operations in the period in which the related revenue is recognized and reported on the balance sheet as a component of accrued liabilities. These estimates are based on historical warranty experience and other relevant information of which we are aware. Costs associated with warranty coverage may include replacement product, parts, labor and other costs. The following table sets forth the amount of warranty accrued, expensed and utilized or adjusted during the nine-month period ended September 28, 2003.

NOTE 6. SERIES B CONVERTIBLE PREFERRED STOCK

     During February 2003 we completed an $8.0 million private placement of 3,809,524 shares of our newly designated Series B Convertible Preferred Stock at $2.10 per share. In addition, the purchasers of the Series B Convertible Preferred Stock received warrants to purchase 1,142,856 shares of common stock with a strike price of $2.63 per share and a 5 year term.

     Each share of Series B Convertible Preferred Stock is currently convertible into one share of common stock, subject to adjustment for certain dilutive events. Except as limited by law or the Certificate of Designation for the Series B Convertible Preferred Stock, the holders of Series B Convertible Preferred Stock are entitled to vote with holders of common stock at a rate of 0.8936 vote per share until holders’ shares are converted into shares of common stock. Shares of Series B Convertible Preferred Stock are convertible by the holder at any time. However, the Series B Convertible Preferred Stock automatically converts into common stock, if, at anytime after three years from the original issue date, the common stock has been traded with a volume weighted average price in excess of $7.00 per share for twenty of the previous thirty trading days with a minimum average trading volume of 200,000 shares per day. In addition, holders of Series B Convertible Preferred Stock are entitled to receive cumulative dividends at the rate of 6% per annum, payable on a quarterly basis on May 15, August 15, November 15 and February 15 of each year. Dividends on the preferred stock will be paid in shares of Series B Convertible Preferred Stock during the first year after closing and then, at our discretion, in either shares of Series B Convertible Preferred Stock or cash.

     In the event of our liquidation, dissolution or winding up, the holders of Series B Convertible Preferred Stock, are generally entitled to receive a liquidation preference over the holders of Common Stock equal to the greater of (i) $2.10 per share of Series B Convertible Preferred Stock held and any declared but unpaid dividends, and (ii) the

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amount that would have been paid to the holders of Series B Convertible Preferred Stock had such preferred shares been converted to Common Stock immediately prior to such liquidation, dissolution or winding up.

     On or after the date occurring seven years from the original issue date, the holders of a majority of the then outstanding shares of Series B Convertible Preferred Stock may require us to redeem the outstanding shares of Series B Preferred Stock at the original issuance price of $2.10 per share plus any accrued but unpaid dividends. As a result of the holders’ right to demand redemption, the Series B Convertible Preferred Stock has been classified outside of stockholders’ equity on the balance sheet on the mezzanine between total liabilities and stockholders’ equity.

     We received approximately $7.8 million, net of issuance costs, from the sale and issuance of our Series B Convertible Preferred Stock and warrants to purchase common stock. We allocated $6.7 million of the net proceeds to the Series B Convertible Preferred Stock and $1.1 million to the warrants based on their relative fair values on the date of issuance pursuant to Accounting Principles Board Opinion No. 14 “Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants.” The fair value used to allocate net proceeds to the Series B Convertible Preferred Stock was based upon a valuation that considered, among other things, the closing price of the common stock on the date of closing, the impact of the preferred stock on market capitalization on an as converted basis, dividend rights, liquidation preferences and redemption rights. The fair value used to allocate the net proceeds to the warrants to purchase common stock was based on a Black Scholes valuation model and the following assumptions: exercise price $2.63; no dividends; term of 5 years; risk free interest rate of 3.02%; and volatility of 107.4%.

     In accordance with the provisions of EITF 98-5 “Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios” and EITF 00-27 “Application of Issue No. 98-5 to Certain Convertible Instruments,” we separately valued the in-the-money conversion feature embedded in the Series B Convertible Preferred Stock and allocated $3.2 million of the proceeds allocated to the preferred stock to this embedded beneficial conversion. The allocation further reduced the carrying value of the Series B preferred stock and increased additional paid-in capital by a corresponding amount. The beneficial conversion feature will be amortized as a deemed dividend with a corresponding increase in the carrying value of the Series B Convertible Preferred Stock over the period to stated redemption as described in EITF 00-27. In light of our retained deficit, the deemed dividend is currently recorded to additional paid in capital. The following table sets forth the calculation used in determining the amount of the beneficial conversion feature (in thousands, except per share amounts):

     The aggregate of $1.1 million of proceeds allocated to the common stock warrants issued in conjunction with the offering, the $3.2 million value assigned to the embedded beneficial conversion and the $0.2 million of allocated transaction costs, was recorded as additional paid in capital resulting in an initial net carrying amount of the Series B Convertible Preferred Stock of $3.5 million. The resulting $3.5 million carrying amount reflects a discount of $4.5 million from the $8.0 million to be paid to holders of the Series B Convertible Preferred Stock upon mandatory redemption that may occur anytime after February 14, 2010. This $4.5 million discount from the $8.0 million redemption amount plus any accrued but unpaid dividends which increase the redemption amount will be accreted using the effective yield method, up to the earlier of the stated redemption date or conversion of the preferred shares into common. In the event that the preferred stock is converted into common stock prior to the stated redemption date, any unaccreted beneficial conversion amounts will be recorded immediately as a lump-sum deemed dividend and reflected in net loss applicable to common stockholders.

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     During July 2003, we registered, on behalf of certain stockholders, 1,286,560 shares of common stock underlying the conversion of 946,000 of the 3,809,524 shares of Series B Convertible Preferred Stock issued, 283,800 of the 1,142,856 shares of common stock that may be issued upon the exercise of warrants, and 56,760 shares of common stock that may be issued upon conversion of shares of Series B Convertible Preferred Stock issued as dividends. During August 2003, the stockholders for whom the shares of common stock were registered converted their shares of Series B Convertible Preferred Stock into shares of our common stock. As previously noted, the conversion of the preferred stock into common stock prior to the stated redemption date results in the immediate recognition of the remaining beneficial conversion amounts for the shares converted. During the quarter ended September 28, 2003, certain stockholders converted 960,495 shares of Series B Convertible Preferred Stock into shares of common stock. This transaction resulted in the recognition of a deemed dividend of $1.1 million due to unaccreted beneficial conversion amounts relating to the converted shares. The deemed dividend was recorded to additional paid in capital and as a component of net loss applicable to common stockholders

NOTE 7. NOTES RECEIVABLE FROM STOCKHOLDERS

     During January 2003, we repurchased 1,359,160 shares of common stock at $2.47 per share from two of our officers in a non-cash transaction and collected cash of approximately $236,000 from the officers in full satisfaction of the principal and unpaid interest balances of the officers’ notes totaling $3.6 million. Of the 1,359,160 shares repurchased by the company, 300,592 shares were granted to an officer within six months of the repurchase. In accordance with the provisions of EITF 00-23 “Issues Related to the Accounting for Stock Compensation under APB Opinion No. 25 and FASB Interpretation No. 44” the repurchase of the 300,592 shares resulted in a non-cash compensation charge to earnings during the first quarter of 2003 of $364,000.

     As of September 28, 2003, all notes receivable from stockholders had been settled in full.

NOTE 8. Note Payable

     On September 23, 2003 Vixel entered into a loan and security agreement with a lending institution for a $5.0 million credit facility that provides $2.5 million of capital equipment financing and up to $2.5 million of financing for general corporate use. The facility includes customary covenants and is collateralized by all of our tangible and intellectual property assets. Due to the loan agreement being entered into less than three business days from our quarter end, the lending institution agreed to defer the effective date of certain loan covenants, through the issuance of a waiver of those covenants, to provide for the administrative implementation of the agreement. The $2.5 million capital equipment portion of the facility is available to borrow from for twelve months after signing with each borrowing maturing 36 months from the date of borrowing with monthly payments of principal and interest calculated at a variable rate of up to Prime plus 1.50%. Approximately $1.4 million was borrowed from the equipment facility during the quarter. The $2.5 million general use facility bears interest of Prime plus 0.75% and is available until and matures on September 23, 2004 and includes borrowing limits based on receivables. As of September 28, 2003 no amounts have been borrowed from this facility and approximately $2.1 million was available for borrowing based on the borrowing base calculation set-forth in the loan and security agreement.

NOTE 9. RECENT ACCOUNTING PRONOUNCEMENTS

     During June 2001, the FASB issued Statement of Financial Accounting Standards No. 143 “Accounting for Obligations Associated with the Retirement of Long-Lived Assets” (SFAS 143). The provisions of FAS 143 apply to all entities that incur obligations associated with the retirement of tangible long-lived assets. SFAS 143 is effective for financial statements issued for fiscal years beginning after June 15, 2002. Under SFAS 143, a liability for an asset retirement obligation (i.e. liability) is recognized at fair value during the period in which it is incurred. The offset to the liability is capitalized as a component of the carrying amount of the asset bringing rise to the future retirement obligation. We adopted SFAS 143 effective December 30, 2002, the beginning of our 2003 fiscal year. Our adoption of SFAS 143 did not impact our financial position, results of operations or cash flows for the three- or nine-month periods ended September 28, 2003.

     During December 2002, the FASB issued Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure” (SFAS 148). SFAS 148 amends the guidance set forth in Statement of Financial Accounting Standard No. 123 “Accounting for Stock-Based Compensation” (SFAS 123) and

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provides guidance for companies that elect to change their accounting for employee stock based compensation to the fair value method of accounting. The statement also expands and increases the frequency of the existing disclosure requirements to require more prominent and quarterly disclosure of the effects of stock based compensation pursuant to the provisions of SFAS 123. We adopted SFAS 148 effective December 30, 2002 and have included the expanded interim disclosures in the footnotes to our condensed financial statements contained herein. Our adoption of SFAS 148 did not impact our financial position, results of operations or cash flows for the three- or nine-month periods ended September 28, 2003.

     During May 2003, the FASB issued Statement of Financial Accounting Standards No. 150 “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (SFAS 150). SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity and requires that such financial instruments that are within its scope be classified as a liability or an asset. SFAS 150 is effective for us for financial instruments entered into or modified after May 31, 2003 and for fiscal periods beginning after June 15, 2003 for existing financial instruments. During October 2003, the FASB voted to defer the provisions of paragraphs 9 and 10 of SFAS 150 as they apply to mandatorily redeemable noncontrolling interests. We will evaluate the applicability of any changes to these provisions upon their reissuance. As we have not issued financial instruments that fall within the scope of SFAS 150, in its current form, there was no impact to our financial position, results of operations or cash-flows as a result of the issuance of this pronouncement.

NOTE 10. SUBSEQUENT EVENT

     On October 8, 2003, we announced the signing of a definitive agreement for Emulex Corporation to acquire us. Under the terms of the agreement, Emulex will acquire all of our outstanding shares of preferred and common stock for $10 per share in cash, through a cash tender offer. Shares not acquired by Emulex in the tender offer will be acquired in a second step merger in which our remaining stockholders will receive the same cash price per share as that paid in the tender offer. In addition, Emulex will assume all of our existing vested and unvested stock options. Our board of directors has unanimously approved the acquisition and has voted to recommend that our stockholders accept the tender offer and tender their shares. In addition, a principal stockholder has agreed to tender shares representing approximately 11% of the fully diluted shares in support of the transaction. The tender offer is expected to be completed during November 2003, subject to regulatory approvals and certain closing conditions, including the tender of a majority of our shares of capital stock on a fully-diluted basis.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

     The following discussion should be read in conjunction with the unaudited condensed financial statements in Item 1 of this report and with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the audited financial statements and notes thereto included in our Annual Report on Form 10-K, as amended, for the fiscal year ended December 29, 2002.

     This document contains forward-looking statements that involve risks and uncertainties. The statements contained in this report that are not purely historical are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue,” the negative of such terms or other comparable terminology. These statements are only predictions and actual events or results may differ materially. Some of the risks and uncertainties that may affect future results are discussed under the caption “Factors That May Affect Results of Operations and Financial Condition” in Item 7 of our Annual Report on From 10-K, as amended, for the fiscal year ended December 29, 2002.

     Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of the forward-looking statements. We are under no duty to update any of the forward-looking statements after the date hereof to conform such statements to actual results or to changes in our expectations.

OVERVIEW

     We provide comprehensive Fibre Channel-based technologies and products for data storage solutions and storage networking applications. Our offering consists of a variety of new embedded storage switch and SAN interconnect products that connect computers to data storage devices in a network configuration. Our new embedded storage switch products are based on a switch-on-a-chip, or SOC. This SOC can be embedded in a variety of data storage devices to enhance performance, improve availability, and increase the reliability of these devices. This new switching technology can be sold in chip, blade or box form to original equipment manufacturers, or OEMs, for inclusion in their solutions.

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     Our SOC incorporates our InSpeed^TM technology, which is our patents pending advanced switching architecture that results in a single chip capable of handling multiple Fibre Channel devices. The InSpeed SOC can be embedded into storage enclosure devices such as redundant array of independent disks, or RAID, enclosures, tape libraries, network attached storage environments and next generation storage systems to enhance the performance and scaling of these solutions as well as improve device reliability, availability and serviceability. We are also using the InSpeed SOC in Fibre Channel switches and blades that can be embedded by OEMs in their storage solutions. This technology can also be used to offer high performance, low cost switches for entry level SANs. Revenue from InSpeed-based products represented approximately 76% of our revenue for the first nine-months of fiscal 2003 and 77% of our revenue for the three-month period ended September 28, 2003.

     We derive substantially all of our revenue from the sale of Fibre Channel products, including embedded storage switch products, and SAN switches and hubs to a limited number of OEMs. During the third fiscal quarter of 2003 HP Corporation represented 55.1% of revenue, compared with the same period of 2002 during which HP and Avid Technology represented 60.4% and 12.4% of revenue, respectively. During the first nine-months of 2003 HP represented 54.4% of revenue, compared with the same period of 2002 during which HP and Avid represented 34.5% and 14.7% of revenue, respectively. No other customers represented greater than 10% of revenue during the periods noted. While we are seeking to diversify our customer base and expand the portion of our revenue that is derived from sales through various distribution channels, we anticipate that our operating results will continue to depend on volume sales to a relatively small number of OEMs.

     We have outsourced our switch and hub box product manufacturing, fulfillment and repair operations and most of our materials management to Suntron Corporation (“Suntron”). We purchase certain components directly from suppliers and resell them to Suntron at our cost and recognize no revenue from these transactions. We also outsource the manufacturing of our SOCs to third-party manufacturers that provide these components for inclusion in our product assemblies.

Pending Acquisition of Vixel

     On October 8, 2003, we announced the signing of a definitive agreement for Emulex Corporation to acquire us. Under the terms of the agreement, Emulex will acquire all of our outstanding shares of preferred and common stock for $10 per share in cash, through a cash tender offer. Shares not acquired by Emulex in the tender offer will be acquired in a second step merger in which our remaining stockholders will receive the same cash price per share as that paid in the tender offer. In addition, Emulex will assume all of our existing vested and unvested stock options. Our board of directors has unanimously approved the acquisition and has voted to recommend that our stockholders accept the tender offer and tender their shares. In addition, a principal stockholder has agreed to tender shares representing approximately 11% of the fully diluted shares in support of the transaction. The tender offer is expected to be completed during November 2003, subject to regulatory approvals and certain closing conditions, including the tender of a majority of our shares of capital stock on a fully-diluted basis.

Critical Accounting Policies

General

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses for the reporting periods presented. Management reviews the estimates and assumptions used for financial reporting each period and has discussed the development, selection and disclosure of these estimates and assumptions with the Audit Committee of the Board of Directors. Actual results could differ materially from those estimates and future changes to such estimates or assumptions used could materially and adversely affect the financial statements. Amounts in the financial statements, which are particularly susceptible to changes in estimates in the near term, include the recoverability of goodwill, the allowance for doubtful accounts, warranty reserves and inventory valuation.

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Revenue Recognition

     We recognize revenue when it is realized or realizable and earned. We consider revenue realized or realizable and earned when there is persuasive evidence of an arrangement, the product has been delivered to the customer, the sales price is fixed or determinable and collectibility is reasonably assured.

     Product is delivered to a customer when shipped or the customer takes possession of the product. Our products ship freight on board-shipping point via customer provided transport carrier. Under circumstances in which we maintain product inventories at third party facilities where a customer may take delivery on a just-in-time basis, delivery occurs and legal title to the product transfers to the customer, when the customer takes physical possession of the inventory. Once a product is shipped or removed from a just-in-time inventory facility, the product may not be returned for credit or refund.

     We defer the recognition of revenue for sales subject to price protections or stock rotation rights offered to select customers until the expiration of such protections or rights. Price protections provide customers credit for recent purchases in the event of product price reductions while stock rotation rights provide for the return of a limited portion of the customer’s prior quarter purchases in exchange for credit to be applied to future purchases. We defer the portion of sales subject to price protections or stock rotation rights based on estimated utilization of such rights. Deferred revenue, to the extent not utilized, is recognized into revenue upon the expiration of the rights.

Valuation of Long-Lived Assets Including Goodwill and Purchased Intangible Assets

     We review property and equipment and goodwill for impairment whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. Our asset impairment review assesses the fair value of the assets based on the future cash flows the assets are expected to generate. An impairment loss is recognized when estimated undiscounted future cash flows expected to result from the use of the asset plus net proceeds expected from disposition of the asset (if any) are less than the carrying value of the asset. This approach uses our estimates of future market growth, forecasted revenue and costs, expected periods the assets will be utilized and appropriate discount rates. Such evaluations of impairment of long-lived assets including goodwill are an integral part of, but not limited to, our strategic reviews of our business and operations performed in conjunction with restructuring actions. When impairment is identified, the carrying amount of the asset is reduced to its estimated fair value. Deterioration of our business in the future could lead to impairment adjustments. Those impairment adjustments could materially and adversely impact the results of operations for the period in which those adjustments are recorded.

Allowance for Doubtful Accounts

     We evaluate the collectibility of our trade receivables based on a combination of factors. We regularly analyze our significant customer accounts, and, should we become aware of a specific customer’s inability to meet its obligations to us, we record a specific reserve for bad debt to reduce the related receivable to the amount we reasonably believe is collectible. We also record reserves for bad debt for all other customers based on a variety of factors including the length of time the receivables are past due, the financial health of the customer, macroeconomic considerations and historical experience. If circumstances related to specific customers change, our estimates of the recoverability of receivables could be further adjusted, possibly adversely and materially, and adjustments, whether favorable or unfavorable, would be recorded during the period in which the change in circumstances is identified.

Warranty Provision

     We provide for the estimated cost of product warranties at the time revenue is recognized. While we engage in extensive product quality programs and processes, including actively monitoring and evaluating the quality of our contract manufacturer and other suppliers, our estimated warranty obligation is affected by product failure rates, product failures outside of our historical experience, and other costs incurred in correcting a product failure. We

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believe that our current warranty reserve is appropriate. However, projected product failure rates or costs could differ adversely and materially from our estimates, and revisions to the estimated warranty reserve would be required during the period in which changes in estimates are identified.

Inventory

     Inventory is carried at the lower of standard cost (which approximates current cost using a first in, first out cost flow assumption) or estimated net realizable value. We perform detailed assessments of our inventory each period, which includes reviewing, among other factors, demand requirements and product life cycle plans. Based on our analyses, we record adjustments to inventory for excess, or obsolescence, when appropriate, to reflect inventory at its net realizable value. Revisions to our inventory adjustments may be required if actual demand or product life cycles differ from our estimates, and could adversely and materially impact our statement of operations during the period in which such adjustment is necessary.

RESULTS OF OPERATIONS

     The following table sets forth the percentage of total revenue represented by selected items from the unaudited Condensed Statement of Operations. This table should be read in conjunction with the unaudited Condensed Financial Statements included elsewhere herein.

RESTRUCTURING

     During April 2002, we adopted and implemented a restructuring plan to reduce our cost structure and focus on our InSpeed-based product development and sales. As a result of the plan, we recorded restructuring charges of $1.7 million, net of adjustments. The restructuring plan included, among other charges, a charge of $0.9 million for the consolidation of space within our Bothell, Washington corporate headquarters and our engineering facility in Irvine, California. This charge included the costs associated with the idle facility space at these locations for the remainder of the lease terms. At December 29, 2002 the $0.6 million of accrued restructuring liability remaining was related solely to excess facilities at our Bothell, Washington location through the first quarter of fiscal 2005. During the nine-month period ended September 28, 2003 the restructuring liability was reduced to $0.4 million due to lease payments made on our Bothell facility.

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SALE OF ASSETS

     On April 15, 2002, we closed a transaction with Fujitsu Software Technology Corporation, d/b/a Fujitsu Softek, involving the acquisition by Fujitsu Softek of our SAN management software assets, including our SAN management software, SAN InSite™, associated intellectual property and key development team resources. Upon closing of the transaction we received $2.5 million and a note for $2.5 million, which became due and was collected with accrued interest on January 15, 2003. In addition, we have the right to receive up to an additional $5.0 million from sales of Fujitsu Softek products based on SAN InSite during the four-year period after the closing. Net of associated costs and expenses, we recorded a gain on sale from this transaction of $4.4 million during the second quarter of 2002.

THREE-MONTH PERIOD ENDED SEPTEMBER 28, 2003 COMPARED WITH THE THREE-MONTH PERIOD ENDED SEPTEMBER 29, 2002

     Revenue. Revenue during the three-month periods ended September 28, 2003 and September 29, 2002 was derived from our InSpeed, hub and switch products. Revenue increased 28% to $6.4 million from $5.0 million for the three-month periods ended September 28, 2003 and September 29, 2002, respectively. The $1.4 million increase was due to a $2.3 million increase in revenue from our InSpeed family of products offset by declines in our hub and non-InSpeed switch products. InSpeed products represented 77% of revenue for the three-month period ended September 28, 2003 compared with 53% for the three-month period ended September 29, 2002. Revenue generated by our non-InSpeed products declined an aggregate of 38% to $1.5 million from $2.4 million for the three-month periods ended September 28, 2003 and September 29, 2002, respectively.

     Cost of revenue. Cost of revenue includes the cost to acquire finished products from a third party manufacturer of our products, expenses we incur related to inventory management, product quality testing, customer order fulfillment, and provisions for warranty expenses and inventory obsolescence. Cost of revenue increased 28% to $3.2 million from $2.5 million for the three-month periods ended September 28, 2003 and September 29, 2002, respectively. This $0.7 million increase was due primarily to the 28% increase in revenue. Margins on sales increased to 50.0% of revenue in the current period compared with 49.3% during the same period in the prior year. The improvement in margins is due to higher-margin InSpeed products comprising a larger percentage of total revenue during the three-month period ended September 28, 2003 compared with the three-month period ended September 29, 2002.

     Research and development expenses. Research and development expenses consist primarily of salaries and related expenses for personnel engaged in the design, development and sustaining engineering of our products, consulting and outside service fees, costs for prototype and test units and other expenses related to the design, development, testing and enhancement of our products. Research and development expenses increased 32% to $3.0 million from $2.3 million for the three-month periods ended September 28, 2003 and September 29, 2002, respectively. This increase is primarily due to $0.4 million increase in compensation related costs, $0.1 million increase in design engineering and prototype expenses, and $0.1 million increase in facility costs. The increase in compensation costs reflects increased staffing and use of temporary contract personnel.

     We believe that continued investment in research and development is an essential element of our strategic objectives to design quality products while reducing costs. We expect research and development expenses to continue to represent a significant portion of our overall operating expenses during the remainder of 2003 as a result of expenses incurred in the development of enhancements to existing products and development of future product offerings.

     Selling, general and administrative expenses. Selling, general and administrative expenses consist primarily of salaries, commissions and related expenses for personnel engaged in marketing, sales, finance and information technology support functions, as well as professional fees, allowance for doubtful accounts receivable, and expenses related to various marketing activities. Selling, general and administrative expenses decreased 7% to $2.6 million from $2.8 million for the three-month periods ended September 28, 2003 and September 29, 2002, respectively. This $0.2 million decrease is primarily due to a $0.5 million decrease in compensation related costs offset by $0.2

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million in increased professional services and $0.1 million in increased travel costs. As a percentage of revenue, selling, general and administrative expenses decreased to 41% from 57% for the three-month periods ended September 28, 2003 and September 29, 2002, respectively, due to increased revenues and decreased expenses during the third quarter of 2003.

     Amortization of intangible assets. No amortization of intangible assets was recorded for the three-month period ended September 28, 2003 as all intangible assets became fully amortized during previous periods. This compares to amortization of $0.1 million recorded during the three-month period ended September 29, 2002. Goodwill is not amortized, but is subject to periodic impairment testing. No impairment of goodwill was noted during the periods presented.

     Amortization of stock-based compensation. No amortization of stock based compensation was recorded for the three-month period ended September 28, 2003 as all deferred stock compensation had been fully amortized during previous periods. This compares to amortization of $0.1 million recorded during the three-month period ended September 29, 2002.

NINE-MONTH PERIOD ENDED SEPTEMBER 28, 2003 COMPARED WITH THE NINE-MONTH PERIOD
ENDED SEPTEMBER 29, 2002

     Revenue. Revenue during the nine-month periods ended September 28, 2003 and September 29, 2002 was derived from our InSpeed, hub and switch products. Revenue increased 23% to $17.9 million from $14.5 million for the nine-month periods ended September 28, 2003 and September 29, 2002, respectively. This $3.4 million increase was due to a $9.0 million increase in revenue from our InSpeed family of products offset by declines in our hub and non-InSpeed switch products of $4.6 million and a decline in engineering and service revenue of $1.0 million. InSpeed products represented 76% of revenue for the nine-month period ended September 28, 2003 compared with 32% for the nine-month period ended September 29, 2002.

     Cost of revenue. Cost of revenue includes the cost to acquire finished products from a third party manufacturer of our products, expenses we incur related to inventory management, product quality testing, customer order fulfillment, and provisions for warranty expenses and inventory obsolescence. Cost of revenue increased 20% to $9.1 million from $7.6 million for the nine-month periods ended September 28, 2003 and September 29, 2002, respectively. This $1.5 million increase was due primarily to the 23% increase in revenue partially offset by improved margins. Margins on sales increased to 49.5% of revenue during the current period compared with 47.4% during the same period in the prior year. The improvement in margins is due to higher-margin InSpeed products comprising a larger percentage of total revenue during the nine-month period ended September 28, 2003 compared with the nine-month period ended September 29, 2002.

     Research and development expenses. Research and development expenses consist primarily of salaries and related expenses for personnel engaged in the design, development and sustaining engineering of our products, consulting and outside service fees, costs for prototype and test units and other expenses related to the design, development, testing and enhancement of our products. Research and development expenses increased 4% to $8.5 million from $8.2 million for the nine-month periods ended September 28, 2003 and September 29, 2002, respectively. This $0.3 million increase is primarily due to a $0.5 million increase in engineering design, software and prototype expenses and $0.1 million increase in facility costs offset by $0.3 million in compensation related expense reductions primarily due to the sale of our SAN management software assets combined with implementation of our restructuring plan, both of which occurred during the second quarter of 2002.

     Selling, general and administrative expenses. Selling, general and administrative expenses consist primarily of salaries, commissions and related expenses for personnel engaged in marketing, sales, finance and information technology support functions, as well as professional fees, allowance for doubtful accounts receivable, and expenses related to various marketing activities. Selling, general and administrative expenses remained steady at $8.3 million for the nine-month periods ended September 28, 2003 and September 29, 2002. As a percentage of revenue, selling, general and administrative expenses decreased to 47% from 57% for the nine-month periods ended September 28, 2003 and September 29, 2002, respectively, due to increased revenues during fiscal 2003.

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     Amortization of intangible assets. Amortization of intangible assets recorded for the nine-month period ended September 28, 2003 was $54,000 compared with $0.3 million recorded during the nine-month period ended September 29, 2002. This decrease is due to all intangibles becoming fully amortized during early 2003. Goodwill is not amortized, but is subject to periodic impairment testing. No impairment of goodwill was noted during the periods presented.

     Amortization of stock-based compensation. Amortization of stock based compensation decreased 80% to $0.1 million from $0.5 million for the nine-month periods ended September 28, 2003 and September 29, 2002, respectively. During 2003 all remaining deferred stock compensation was fully amortized.

LIQUIDITY AND CAPITAL RESOURCES

     Since inception, we have financed our operations primarily through the sale of common and preferred stock with aggregate proceeds of approximately $124.3 million. Additionally, we have financed our operations through bank financing, capital equipment lease lines, working capital credit facilities, notes payable, $6.9 million in net cash received from the sale of our laser diode fabrication facility and gigabit Ethernet product line and $4.7 million in net cash received from the sale of our SAN management software assets. Our principal sources of liquidity at September 28, 2003 consisted of $13.0 million in cash and cash equivalents, $9.2 million in liquid investments, and $3.2 million of available borrowing on our credit facility.

     Cash utilized by operating activities was $5.8 million for the nine-month period ended September 28, 2003, and was due primarily to our operating loss, net of non-cash expenses. Cash provided by investing activities was $3.9 million and resulted from maturities of short-term investments of $13.5 million, proceeds from the collection of a $2.5 million note receivable received in conjunction with the sale of our SAN management software assets, offset by $10.6 million of purchases of short-term investments and capital expenditures of $1.5 million. Cash provided by financing activities reflects the $7.8 million raised in conjunction with our sale of Series B Convertible Preferred Stock combined with $1.4 million of proceeds borrowed against our capital equipment credit facility, $1.2 million in sales of our common stock through our employee stock purchase plan and upon stock option exercises, and the collection of $0.4 million of stockholder notes receivable.

     As of September 28, 2003, we had an accumulated deficit of $141.6 million and have never been profitable. We plan to grow our revenue base and continue to control our expenses in order to achieve profitability. However, we cannot be certain that we will ever realize sufficient revenue to achieve profitability. Even if we do achieve profitability, we may not be able to sustain or increase profitability.

     We believe that our existing cash, cash equivalent and short-term investment balances will be sufficient to meet our cash requirements as a standalone entity for at least the next twelve to eighteen months. However, we may be required, or could elect, to seek additional funding prior to that time. Our future capital requirements as a standalone entity will depend on many factors, including our future revenue, the timing and extent of spending to support product development efforts and sales, general and administrative activities, the timing of introductions of new products, and market acceptance of our products. We cannot assure you that additional equity or debt financing, if required, will be available on acceptable terms or at all.

RELATED PARTY TRANSACTIONS

     During January 2003, we repurchased 1,359,160 shares of common stock at $2.47 per share from two officers in a non-cash transaction and collected cash of approximately $236,000 from the officers in full satisfaction of the principal and unpaid interest balances of the officers’ notes totaling $3.6 million. The note receivable arrangements were originally entered into during April and May of 1999 in connection with the exercise of stock options. Of the 1,359,160 shares 300,592 shares repurchased by the company were granted to an officer within six months of the repurchase. Therefore, these shares are subject to the provisions of EITF 00-23 “Issues Related to the Accounting for Stock Compensation under APB Opinion No. 25 and FASB Interpretation No. 44” and resulted in a non-cash compensation charge to earnings during the first quarter of 2003 of $364,000.

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     As of September 28, 2003, all notes receivable from stockholders had been settled in full.

RECENT ACCOUNTING PRONOUNCEMENTS

     During June 2001, the FASB issued Statement of Financial Accounting Standards No. 143 “Accounting for Obligations Associated with the Retirement of Long-Lived Assets” (SFAS 143). The provisions of FAS 143 apply to all entities that incur obligations associated with the retirement of tangible long-lived assets. SFAS 143 is effective for financial statements issued for fiscal years beginning after June 15, 2002. Under SFAS 143, a liability for an asset retirement obligation (i.e. liability) is recognized at fair value during the period in which it is incurred. The offset to the liability is capitalized as a component of the carrying amount of the asset bringing rise to the future retirement obligation. We adopted SFAS 143 effective December 30, 2002, the beginning of our 2003 fiscal year. Our adoption of SFAS 143 did not impact our financial position, results of operations or cash flows for the three- or nine-month periods ending September 28, 2003.

     During December 2002, the FASB issued Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure” (SFAS 148). SFAS 148 amends the guidance set forth in Statement of Financial Accounting Standard No. 123 “Accounting for Stock-Based Compensation” (SFAS 123 and provides guidance for companies that elect to change their accounting for employee stock based compensation to the fair value method of accounting. The statement also expands and increases the frequency of the existing disclosure requirements to require more prominent and quarterly disclosure of the effects of stock based compensation pursuant to the provisions of SFAS 123. We adopted SFAS 148 effective December 30, 2002 and have included the expanded interim disclosures in the footnotes to our condensed financial statements contained herein. Our adoption of SFAS 148 did not impact our financial position, results of operations or cash flows for the three- or nine-month periods ending September 28, 2003.

     During May 2003, the FASB issued Statement of Financial Accounting Standards No. 150 “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (SFAS 150). SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity and requires that such financial instruments that are within its scope be classified as a liability or an asset. SFAS 150 is effective for us for financial instruments entered into or modified after May 31, 2003 and for fiscal periods beginning after June 15, 2003 for existing financial instruments. During October 2003, the FASB voted to defer the provisions of paragraphs 9 and 10 of SFAS 150 as they apply to mandatorily redeemable noncontrolling interests. We will evaluate the applicability of any changes to these provisions upon their reissuance. As we have not issued financial instruments that fall within the scope of SFAS 150, in its current form, there was no impact to our financial position, results of operations or cash-flows as a result of the issuance of this pronouncement.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

     We maintain investment portfolio holdings of various issuers, types, and maturities, the majority of which are commercial paper and government securities. These securities are generally classified as available for sale and, consequently, are recorded on the balance sheet at fair value.

     Our investment portfolio, with a fair value of $9.2 million as of September 28, 2003, is invested in commercial paper, government securities and corporate indebtedness that could experience an adverse decline in fair value should an increase in interest rates occur. Future declines in interest rates could have an adverse impact on interest earnings for our investment portfolio. In addition, we have borrowed $1.4 million that bears interest at a variable rate up to Prime plus 1.50%. Future increases in interest rates could have an adverse impact on interest expense incurred on our borrowings. We do not currently hedge against interest rate exposures.

     All of our revenue is realized in U.S. dollars and is from customers primarily headquartered in the United States. Therefore, we do not believe we currently have any significant direct foreign currency exchange risk.

ITEM 4. DISCLOSURE CONTROLS AND PROCEDURES

     Evaluation of Disclosure Controls and Procedures. We conducted an evaluation of our controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as of the end of the period covered by this report. Based on this evaluation, our principal executive officer and principal financial officer concluded that, as of the date of the evaluation, our disclosure controls were effective in providing reasonable assurance that the material information required to be included in our reports filed with the Securities and Exchange Commission (the “SEC”) is properly recorded, processed, summarized, and reported within the time specified periods pursuant to SEC rules. It should be noted that the design of any system of control is based

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in part upon certain assumptions, and there can be no assurance that any design will succeed in achieving its stated objectives.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

     On November 15, 2001, a securities class action was filed in the United States District Court in the Southern District of New York against two of our officers and directors and certain underwriters who participated in our initial public offering in late 1999. The complaint alleges violations under Section 10(b) of the Securities Exchange Act of 1934 and Section 11 of the Securities Act of 1933 and seeks unspecified damages on behalf of persons who purchased our stock during the period October 1, 1999 through December 6, 2000. Subsequent to the filing, the Court issued a summary judgment releasing our officers and directors from the action. During June 2003, we and the other issuer defendants in the action reached a tentative settlement with the plaintiffs that would, among other things, result in the dismissal with prejudice of all claims against the defendants and their officers and directors. Although we have approved this settlement proposal in principle, it remains subject to a number of procedural conditions, as well as formal approval by the Court.

     On March 3, 2003 we filed a patent infringement action against QLogic Corporation in the United States District Court for the District of Delaware. The complaint states that QLogic is infringing U.S. Patent No. 6,185,203, entitled “Fibre Channel Switching Fabric”, U.S. Patent No. 6,118,776, entitled “Methods and Apparatus for Fiber Channel Interconnection of Private Loop Devices”, and U.S. Patent No. 6,470,007, entitled “Interconnect System for Fibre Channel Arbitrated Loop Including Private Loop Devices”, through the unauthorized manufacture, use, sale and offering for sale of various storage area network switching products, including QLogic’s SANBox2 product. On May 23, 2003 we filed a patent infringement action against Brocade Communications Systems, Inc. in the United States District Court for the Northern District of California. The complaint states that Brocade is infringing U.S. Patent No. 6,185,203, entitled “Fibre Channel Switching Fabric”, U.S. Patent No. 6,118,776, entitled “Methods and Apparatus for Fiber Channel Interconnection of Private Loop Devices”, and U.S. Patent No. 6,470,007, entitled “Interconnect System for Fibre Channel Arbitrated Loop Including Private Loop Devices”, through the unauthorized manufacture, use, sale and offering for sale of various storage area network switching products, including Brocade’s Silkworm switch products, which include its “QuickLoop” and “Fabric Assist” product features. QLogic and Brocade have challenged the validity of the patents referenced, and Brocade has also challenged the enforceability of those patents. In both of these suits, we are seeking unspecified past damages, potential future royalties, or, alternatively, injunctive relief. We have entered the discovery phase in both of these actions and we remain committed to protecting our intellectual property.

     On October 9, 2003, a purported class action lawsuit was filed in King County Superior Court of the State of Washington against Vixel and each of Vixel’s directors, entitled Russell Fink v. Vixel Corporation, et al., Case No. 03-2-37226-9JD. The complaint makes general allegations that, among other things, Vixel’s directors breached their fiduciary duties to Vixel stockholders in connection with the approval of the merger and seeks to enjoin the tender offer and have the merger agreement with Emulex Corporation, and its acquisition subsidiary, declared unlawful, among other forms of relief. Vixel believes that the plaintiff’s claims are without merit and has retained counsel with instructions to vigorously defend it. A copy of the complaint is filed as Exhibit(e)(22) to the Schedule 14D-9 filed by us with the SEC on October 15, 2003.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)  Exhibits:

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(1)

Incorporated by reference to designated exhibits to the Registrant’s Registration Statement on Form S-1 (SEC File No. 333-81347), declared effective on September 30, 1999.

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(2)		Incorporated by reference to designated exhibits to Registrant’s current report on Form 8-K filed on November 17, 2000.
(3)		Incorporated by reference to Registrant’s current report on Form 8-K filed on February 20, 2003.
(4)		Incorporated by reference to Registrant’s current report on Form 8-K filed on October 8, 2003.

(b)  Reports on Form 8-K:

     We filed the following reports on Form 8-K during the third fiscal quarter of 2003 and through the filing of this Quarterly Report:

(i)		On July 22, 2003 Vixel filed a report on Form 8-K, which reported under Item 9 the press release entitled “Vixel Corporation Announces Second Quarter 2003 Financial Results” relating to the financial results of the quarter ended June 29, 2003.
(ii)		On October 8, 2003 Vixel filed a report on Form 8-K, which reported under Item 5 that it entered into an Agreement and Plan of Merger, with Emulex Corporation, a Delaware corporation, and Aviary Acquisition Corp., a Delaware corporation and wholly-owned subsidiary of Emulex Corporation.
(iii)		On October 21, 2003 Vixel filed a report on Form 8-K, which reported under Item 9 the press release entitled “Vixel Corporation Announces Third Quarter 2003 Financial Results” relating to the financial results of the quarter ended September 28, 2003.

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.

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EXHIBIT INDEX

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(1)		Incorporated by reference to designated exhibits to the Registrant’s Registration Statement on Form S-1 (SEC File No. 333-81347), declared effective on September 30, 1999.
(2)		Incorporated by reference to designated exhibits to Registrant’s current report on Form 8-K filed on November 17, 2000.
(3)		Incorporated by reference to Registrant’s current report on Form 8-K filed on February 20, 2003.
(4)		Incorporated by reference to Registrant’s current report on Form 8-K filed on October 8, 2003.

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