UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

OR

Commission File No. 001-31353

EMULEX CORPORATION

(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 is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [  ]

As of November 1, 2004, the registrant had 82,730,324 shares of common stock outstanding.

EMULEX CORPORATION AND SUBSIDIARIES

INDEX

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

EMULEX CORPORATION AND SUBSIDIARIES

See accompanying notes to the condensed consolidated financial statements.

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EMULEX CORPORATION AND SUBSIDIARIES

See accompanying notes to the condensed consolidated financial statements.

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EMULEX CORPORATION AND SUBSIDIARIES

See accompanying notes to the condensed consolidated financial statements.

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EMULEX CORPORATION AND SUBSIDIARIES

1.		Summary of Significant Accounting Policies and Basis of Presentation
		In the opinion of the Company, the accompanying unaudited condensed consolidated financial statements contain all adjustments (which are normal recurring accruals) necessary to present fairly its financial position as of September 26, 2004, and June 27, 2004, and its condensed consolidated statements of income for the three months ended September 26, 2004, and September 28, 2003, and its condensed consolidated statements of cash flows for the three months then ended. Interim results for the three months ended September 26, 2004, are not necessarily indicative of the results that may be expected for the year ending July 3, 2005. The interim financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the fiscal year ended June 27, 2004.
		New Accounting Standards
		The Emerging Issues Task Force (“EITF”) recently reached consensus on EITF 04-08, “The Effect of Contingently Convertible Debt on Diluted Earnings per Share,” which was ratified by the Financial Accounting Standards Board, or FASB, on October 13, 2004. EITF 04-08 will require the inclusion of shares related to contingently convertible debt instruments for computing diluted earnings per share using the if-converted method, even when the market price contingency has not been met. The effect of EITF 04-08 would increase the weighted average shares outstanding by approximately 8.4 million (related to the Company’s currently outstanding 0.25 percent contingent convertible subordinated notes issued in December 2003) in calculating the Company’s diluted earnings per share calculation, if dilutive. EITF 04-08 would require prior periods earnings per share amounts presented for comparative purposes to be recalculated to conform to this method. This consensus is expected to be effective for fiscal periods beginning after December 15, 2004, upon the effective date of a proposed FASB standard on earnings per share.
		In November 2003, the EITF reached an interim consensus on EITF 03-01, “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments,” to require additional disclosure requirements for securities classified as available-for-sale or held-to-maturity for fiscal years ending after December 15, 2003. In March 2004, the EITF reached a final consensus on this Issue, to provide additional guidance, which companies must follow in determining whether investment securities have an impairment, which should be considered other-than-temporary. The effective date of this consensus has been delayed pending further FASB action. EITF 03-01 is not expected to have a significant impact on the carrying value of the Company’s investments.
		Stock-Based Compensation
		The Company accounts for its stock-based awards to employees using the intrinsic value method under Accounting Principles Board (“APB”) Opinion No. 25 and related Interpretations. Stock-based awards to non-employees, if any, are recorded using the fair value method. Had the Company determined compensation cost based on the fair value at the grant date for all its stock options under Statement of Financial Accounting Standards No. 123, “Accounting for Stock Based Compensation,” the Company’s net income would have been the pro forma amounts indicated below (in thousands, except per share data):

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EMULEX CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements

The fair value of each option granted during the three months ended September 26, 2004, and September 28, 2003, was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:

		The Black-Scholes model, and other currently accepted option valuation models, were developed to estimate the fair value of freely-tradable, fully-transferable options without vesting restrictions, which significantly differ from the Company’s stock option plans. These models also require highly subjective assumptions, including future stock price volatility and expected time until exercise, which greatly affect the calculated fair value on the grant date.
2.		Business Combination
		On November 13, 2003, the Company completed the cash tender offer to acquire all outstanding shares of Vixel Corporation for $10.00 net per share, without interest. On November 17, 2003, the Company completed its acquisition of Vixel. The Company acquired Vixel to expand its Fibre Channel product line and paid $298.4 million in cash for all outstanding common stock, preferred stock and warrants of Vixel Corporation. The Company also incurred acquisition-related expenses of $6.7 million in cash. In addition, the Company issued 2.2 million stock options with a fair value of approximately $47.5 million and kept the original vesting periods for the options in exchange for the outstanding Vixel options for a total acquisition value of $352.7 million. The Company calculated the fair value of the 2.2 million stock options issued at the date of acquisition using the Black-Scholes option-pricing model. Operations of Vixel, since the acquisition, have been included within the Company’s one operating segment, networking products.
		As a result of the acquisition, the Company reduced the headcount obtained from Vixel by a total of 24 employees, 23 of whom left during fiscal 2004. The remaining employee left during the three months ended September 26, 2004.
		The total purchase and allocation among the fair values of tangible and intangible assets and liabilities (including purchased IPR&D) are summarized as follows (in thousands):

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EMULEX CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements

Intangible assets with identifiable lives are being amortized on a straight-line basis since the acquisition date for their remaining estimated lives as follows:

		The acquisition has been included in the condensed consolidated balance sheets of the Company and the operating results of Vixel have been included in the condensed consolidated statements of operations of the Company since the date that the Company gained effective control of Vixel, November 13, 2003.
		In connection with the preparation of Vixel Corporation’s tax return in the first quarter of fiscal 2005, the Company revised estimates and discovered errors related to the deferred tax assets of Vixel Corporation (acquired in November 2003). As a result, the Company recorded a $1.8 million impairment of goodwill in the three months ended September 26, 2004. Had these items been recorded in fiscal 2004, the Company’s net loss would have been $1.8 million higher, or $534.1 million, instead of $532.3 million. The Company does not believe that this $1.8 million impairment of goodwill is material to fiscal 2004 or will be material to fiscal 2005 operations or financial results. Excluding this adjustment, net income for the three months ended September 26, 2004, would have been $16.1 million.
3.		Inventories
		Inventories, net, are summarized as follows:

4.		Other Intangibles
		Other intangibles, net, are as follows:

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EMULEX CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements

The intangible assets subject to amortization are being amortized on a straight-line basis over lives ranging from two to seven years. Aggregated amortization expense for these intangibles for the three months ended September 26, 2004, was $6.5 million. For the following five full fiscal years aggregated amortization expense is expected to be (in thousands):

5.		Other Assets
		Components of other assets are as follows:

6.		Accrued Liabilities
		Components of accrued liabilities are as follows:

		Deferred revenue includes an accrual for estimated returns and allowances of $1.4 million and $1.6 million at September 26, 2004 and June 27, 2004, respectively.
		The Company provides a warranty of between one and three years on its Input/Output Fibre Channel and Internet Protocol products and provides a warranty of between one and five years on its Fibre Channel switching and traditional networking products. The Company records a provision for estimated warranty-related costs based on historical product returns and the Company’s expected future cost of fulfilling its warranty obligations.
		Changes to the warranty reserve for the three months ended September 26, 2004, and September 28, 2003, were:

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EMULEX CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements

7.		Convertible Subordinated Notes
		In fiscal 2002, the Company completed a $345.0 million private placement of 1.75 percent convertible subordinated notes due February 1, 2007. Interest is payable in cash on February 1 and August 1 of each year beginning August 1, 2002. These notes may be converted by the holder at any time into shares of the Company’s common stock at the conversion price of $53.84 per share, subject to the potential adjustments described in the terms of the notes issued. The Company may redeem the notes on or after February 5, 2005, in whole or in part. The Company incurred associated issuance costs of approximately $11.0 million.
		During the three months ended September 28, 2003, as part of a repurchase program authorized by the Company’s Board of Directors, the Company bought back approximately $93.9 million in face value of its 1.75 percent convertible subordinated notes at a discount to face value for approximately $87.3 million. The resulting net pre-tax gain of approximately $4.7 million was recorded in the three months ended September 28, 2003. Beginning in the quarter ended September 29, 2002, to date, the Company has bought back approximately $328.0 million face value of its 1.75 percent convertible subordinated notes for approximately $289.8 million, resulting in a net pre-tax gain of approximately $31.4 million recorded in prior periods. The repurchased notes were cancelled, leaving 1.75 percent convertible subordinated notes outstanding with a face value of approximately $17.0 million that, if converted, would result in the issuance of approximately 0.3 million shares. At September 26, 2004, the entire $17.0 million face amount of the outstanding 1.75 percent convertible subordinated notes remained authorized for repurchase.
		In fiscal 2004, the Company completed a $517.5 million private placement of 0.25 percent contingent convertible subordinated notes due December 15, 2023. Interest is payable in cash on June 15 and December 15 of each year beginning June 15, 2004. Under the terms of the offering, the notes will be convertible into shares of Emulex common stock at a price of $43.20 per share at the option of the holder upon the occurrence of any of the following:

•		prior to December 15, 2021, on any date during any fiscal quarter (and only during such fiscal quarter) after the fiscal quarter ending December 31, 2003, if the closing sale price of the Company’s common stock was more than 120% of the then current conversion price for at least 20 trading days in the period of the 30 consecutive trading days ending on the last day of the previous fiscal quarter;
•		on or after December 15, 2021, at all times on or after any date on which the closing sale price of the Company’s common stock is more than 120% of the then current conversion price of the notes;
•		if the Company elects to redeem the notes on or after December 20, 2008;
•		upon the occurrence of specified corporate transactions or significant distributions to holders of the Company’s common stock; or
•		subject to specified exceptions, for the ten business day period after any five consecutive trading day period in which the average trading prices for the notes for such five trading day period was less than 98% of the average conversion value of the notes during that period.

The notes will mature in twenty years and will not be callable for the first five years. Holders of the notes may require the Company to purchase the notes for cash by giving written notice within the 20 business days prior to each of December 15, 2006, December 15, 2008, December 15, 2013 or December 15, 2018 or upon a change in control. The Company incurred total associated bankers’ fees of approximately $11.6 million, which were recorded as a reduction to the proceeds from the issuance of the notes and will be accreted over the effective life of the notes, as well as $0.7 million of other associated debt issuance costs, which have been included in other assets and will also be amortized over the effective life of the notes. The effective life of the Company’s 0.25 percent contingent convertible subordinated notes due 2023 is three years, which is the period up to the first date that the holders can require us to repurchase the notes.

During the three months ended September 26, 2004, the Company’s Board of Directors expanded the Company’s repurchase program to include up to $200 million aggregate par value of the Company’s issued and outstanding 0.25 percent contingent convertible subordinated notes at a discount to par value. On August

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EMULEX CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements

		25, 2004, the Company repurchased approximately $153.0 million of its 0.25 percent convertible subordinated notes at a discount to face value, spending approximately $137.2 million. The resulting net pre-tax gain of $13.1 million from the repurchase of these 0.25 percent convertible subordinated notes was recorded in the three months ended September 26, 2004. The repurchased notes were cancelled, leaving 0.25 percent convertible subordinated notes outstanding with a face value of approximately $364.5 million that, if converted, would result in the issuance of approximately 8.4 million shares. At September 26, 2004, approximately $47 million aggregate par value of the Company’s 0.25 percent contingent convertible notes remained authorized for repurchase.
8.		Commitments and Contingencies
		Litigation
		On May 23, 2003, Vixel filed a patent infringement action against Brocade Communications Systems, Inc. in the United States District Court for the Northern District of California, Civil Action No. C-030-02446. The complaint states that Brocade is infringing U.S. Patent No. 6,185,203, entitled “Fibre Channel Switching Fabric,” U.S. Patent No. 6,118,776, entitled “Methods and Apparatus for Fibre Channel Interconnection of Private Loop Devices,” and U.S. Patent No. 6,470,007, entitled “Interconnect System for Fibre Channel Arbitrated Loop Including Private Loop Devices,” through the unauthorized manufacture, use, sale and offering for sale of various storage area network switching products, including but not limited to, Brocade’s Silkworm switch products. Brocade denied infringement and challenged the validity of the patents referenced. Brocade also challenged the enforceability of those patents. In the suit against Brocade, Vixel was seeking unspecified past damages, potential future royalties, or, alternatively, injunctive relief.
		On September 24, 2004, Emulex Corporation and Brocade Communications Systems, Inc. entered into a settlement including a litigation standstill agreement whereby Emulex and Brocade agreed to dismiss without prejudice their claims and counterclaims against each other in the pending patent infringement case in the United States District Court for the Northern District of California entitled Vixel Corporation. v. Brocade Communications Systems, Inc., Civil Action No. C-030-02446. The settlement included the formation of a strategic relationship under which the parties are to work together to pursue mutual objectives. Under the litigation standstill agreement both parties preserved their respective rights, no restrictions of any kind were imposed on either party’s ability to sell products, no licenses were granted by either party, no money was exchanged, and they agreed to a three year standstill during which neither party may initiate litigation against the other party with respect to certain of their respective patents.
		On November 15, 2001, prior to the Company’s acquisition of Vixel Corporation, a securities class action was filed in the United States District Court in the Southern District of New York as Case No. 01 CIV. 10053(SAS), Master File No. 21 MC 92 (SAS) against Vixel and two of its officers and directors and certain underwriters who participated in the Vixel initial public offering in late 1999. The amended complaint alleges violations under Section 10(b) of the Exchange Act and Section 11 of the Securities Act and seeks unspecified damages on behalf of persons who purchased Vixel stock during the period October 1, 1999 through December 6, 2000. In October 2002, the parties agreed to toll the statute of limitations with respect to Vixel’s officers and directors until September 30, 2003, and on the basis of this agreement, Vixel’s officers and directors were dismissed from the lawsuit without prejudice. During June 2003, Vixel and the other issuer defendants in the action reached a tentative settlement with the plaintiffs that would, among other things, result in the dismissal with prejudice of all claims against the defendants and their officers and directors. In connection with the possible settlement, those officers and directors who had entered tolling agreements with the plaintiffs agreed to extend those agreements so that they would not expire prior to any settlement being finalized. Although Vixel approved this settlement proposal in principle, it remains subject to a number of procedural conditions, as well as formal approval by the court.
		On October 9, 2003, before the Company’s acquisition of Vixel, a purported class action lawsuit was filed in King County Superior Court of the State of Washington against Vixel and each of Vixel’s directors and certain unnamed individuals (the “Vixel Parties”), entitled Russell Fink v. Vixel Corporation, et al., Case No. 03-2-37226-9SEA. The complaint made general allegations that, among other things, Vixel’s directors breached their fiduciary duties to Vixel stockholders in connection with the approval of the merger with Emulex and

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EMULEX CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements

		sought to enjoin the tender offer and have the merger agreement declared unlawful, among other forms of relief. On November 7, 2003, the Vixel Parties entered into a memorandum of understanding for a $0.7 million settlement with the plaintiff in the class action suit pursuant to which the parties have agreed to settle the action, subject to court approval. The $0.7 million was recorded as general and administrative expense during the three months ended December 28, 2003. Formal settlement documents were signed on May 5, 2004 and the plaintiff has completed discovery as agreed to by the parties. In August 2004, final court approval was obtained for the settlement of the Fink v. Vixel litigation, and the Company paid the $0.7 million settlement. Subsequent to the three months ended September 26, 2004, the Company received a $0.3 million reimbursement from its insurer relating to the Fink v. Vixel litigation.
		Beginning on or about February 20, 2001, the Company and certain of its officers and directors were named as defendants in a number of securities class action lawsuits filed in the United States District Court, Central District of California, Case No. SACV-01-219 GLT (ANx). The plaintiffs in the actions represent purchasers of the Company’s common stock during various periods ranging from January 18, 2001, through February 9, 2001. The complaints alleged that the Company and certain of its officers and directors made misrepresentations and omissions in violation of sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended. The complaints generally seek compensatory damages, costs and attorney’s fees in an unspecified amount. In addition, the Company has received inquiries about events giving rise to the lawsuits from the SEC and the Nasdaq Stock Market. On April 22, 2003, the Company entered into two Memoranda of Understanding agreeing to terms of settlement for both the class action and derivative litigation. The settlement was approved and $39.5 million held in escrow was paid to the plaintiffs. Gateway Partners filed a challenge to the allocation of settlement funds among the plaintiffs and adequacy of the settlement notice, and a hearing on such challenge was scheduled for November 22, 2004. During the three months ended March 28, 2004, the Company reached an agreement with one of its insurers, under which the Company received $10.0 million less $2.0 million previously paid by the insurer for the defense of the securities class action lawsuits, resulting in a net payment to the Company of $8.0 million. In July 2004, the Company obtained an arbitration award against two of its insurers, and subsequently collected a total of $9.5 million plus $0.3 million in interest. As amounts received exceeded the $5.1 million receivable reflected on the Company’s books, the Company recorded a reduction in general and administrative expenses during the three months ended September 26, 2004, of $4.4 million, as well as interest income of $0.3 million.
		Ongoing lawsuits present inherent risks, any of which could have a material adverse effect on the Company’s business, financial condition or results of operations. Such potential risks include the continuing expenses of litigation, counterclaims and attorneys’ fee liability.
		Additionally, the Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company’s consolidated financial position, results of operations or liquidity.
		Other Commitments and Contingencies
		The Company has entered into purchase agreements for key inventory components, and as of September 26, 2004, the Company’s remaining purchase obligation for these key components was $4.6 million. The Company’s total remaining inventory purchase obligation as of September 26, 2004, was $18.1 million.
9.		Earnings per Share
		Basic net income per share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted net income per share is computed by dividing adjusted net income by the weighted average number of common shares outstanding during the period increased to include, if dilutive, the number of additional common shares that would be outstanding if the potential common shares from stock option plans and convertible subordinated notes had been issued. The dilutive effect of outstanding stock options is reflected in diluted net income per share by application of the treasury stock method. The dilutive effect of convertible subordinated notes is reflected in diluted net income per share by application of the if-converted method. The following table sets forth the computation of basic and diluted net income per share:

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EMULEX CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements

The antidilutive options were excluded from the computation of diluted net income per share because the options’ exercise price was greater than the average market price of the common shares during the three months ended September 26, 2004 and September 28, 2003. The effect of the Company’s 1.75 percent convertible subordinated notes is included in the calculations above. The effect of the Company’s 0.25 percent contingent convertible subordinated notes issued in December 2003 was excluded as these are contingent convertible subordinated notes and did not meet the criteria for conversion into common stock during the three months ended September 26, 2004. However, EITF 04-08 would require the inclusion of shares related to contingently convertible debt instruments for computing diluted earnings per share using the if-converted method, even when the market price contingency has not been met. See note 1 for more information on EITF 04-08.

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

Forward-Looking Statements

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

Actual future results could differ materially from those described in the forward-looking statements as a result of a variety of factors, including those discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations set forth below, and, in particular, the subsection entitled “Risk Factors.” These factors include risks related to the fact that the economy generally, and the technology and storage segments specifically, have been in a state of uncertainty making it difficult to determine if past experience is a good guide to the future and making it impossible to determine if markets will grow or shrink in the short term. Our results have been significantly impacted by a widespread slowdown in information technology investment that has also pressured the storage networking market that is the mainstay of our business. A continued downturn in information technology spending could adversely affect our revenues and results of operations. As a result of this uncertainty, we are unable to predict with any accuracy what future results might be. Other factors affecting these forward-looking statements include, but are not limited to, the following: slower than expected growth of the storage networking market or the failure of our Original Equipment Manufacturer, or OEM, customers to successfully incorporate our products into their systems; our dependence on a limited number of customers and the effects of the loss of, or decrease or delays in orders by, any such customers, or the failure of such customers to make payments; the emergence of new or stronger competitors as a result of consolidation movements in the market; the timing and market acceptance of our or our OEM customers’ new or enhanced products; the variability in the level of our backlog and the variable booking patterns of our customers; the effects of terrorist activities, natural disasters and resulting political or economic instability; the highly competitive nature of the markets for our products, as well as pricing pressures that may result from such competitive conditions; our ability and the ability of our OEM customers to keep pace with the rapid technological changes in our industry and gain market acceptance for new products and technologies; the effect of rapid migration of customers towards newer, lower cost product platforms; possible transitions from board or box level to application specific integrated circuit, or ASIC, solutions for selected applications; a shift in unit product mix from high-end to lower-end products; a decrease in the average unit selling prices or an increase in the manufactured cost of our products; delays in product development; our reliance on third-party suppliers and subcontractors for components and assembly; any inadequacy of our intellectual property protection or the potential for third-party claims of infringement; inadequacy of our system of internal controls; our ability to attract, retain and motivate key technical personnel; our dependence on foreign sales and foreign-produced products; the effect of acquisitions; impairment charges; and changes in tax rates or changes in accounting standards, including changes in the accounting treatment of employee stock options and contingent convertible debt.

Readers should carefully review these cautionary statements since they identify certain important factors that could cause actual results to differ materially from those in the forward-looking statements and from historical trends and are in addition to other factors discussed elsewhere in this Form 10-Q, in our filings with the Securities and Exchange Commission or in materials incorporated therein by reference. We caution the reader, however, that these lists of risk factors may not be exhaustive. We expressly disclaim any obligation or undertaking to release publicly any updates or changes to these forward-looking statements that may be made to reflect any future events or circumstances.

Executive Overview

Emulex Corporation is the world leader in Fibre Channel host bus adapters, or HBAs, and delivers a broad range of intelligent building blocks, including embedded storage switches and Input/Output, or I/0, controllers for next generation storage networking systems. HBAs are the data communication products that enable servers to connect to storage networks by offloading communication-processing tasks as information is delivered and sent to the storage network. Embedded storage switches and I/0 controllers are deployed inside storage arrays, tape libraries and other storage appliances, delivering improved performance and reliability and storage connectivity. The demand for our

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Fibre Channel products has been driven by the demand for high-performance storage networking products and solutions that support enterprise-computing applications. We rely almost exclusively on OEMs and sales through distribution channels for our revenue. Our products have been selected by the world’s leading server and storage providers, including Dell, EMC, Fujitsu Ltd., Fujitsu Siemens, Bull, Hewlett-Packard, Hitachi Data Systems, IBM, NEC, Network Appliance, Quantum Corp., StorageTek, Sun Microsystems, Unisys and Xyratex. Our distribution partners include ACAL, Avnet, Bell Microproducts, Info-X, Netmarks, Tech Data, Tidalwire and Tokyo Electron. In addition, we include industry leaders Brocade, Computer Associates, Intel, McDATA, Microsoft and VERITAS among our strategic partners. The market for storage networking products is concentrated among large OEMs and, as such, a significant portion of our revenues is generated from sales to a limited number of customers.

Despite the downturn in information technology spending in general and the computer and storage systems in particular, we believe that our investment in the storage networking market represents our greatest opportunity for revenue growth and profitability for the foreseeable future. Although we did reduce our headcount by 27 in August in an effort to realign our resources, we continue to, and currently plan to invest in capital equipment and increase research and development spending to deliver leading-edge products to our customers, including four gigabit per second connectivity solutions, increased Linux offerings, and products focused on the small to medium business markets. We focus on on-time development of leading-edge next-generation products and on-time deliveries of current products to our customers and high-quality, cost-effective manufacturing to ensure that we continue having the gross margin and operating margins necessary to sustain profitability and cash flow from operations to fund our future business needs. As of September 26, 2004, we had a total of 487 employees.

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

Business Combination

On November 13, 2003, we completed the cash tender offer by Aviary Acquisition Corporation, our wholly owned subsidiary, to acquire all outstanding shares of Vixel Corporation for $10.00 net per share, without interest. On November 17, 2003, we completed our acquisition of Vixel. We acquired Vixel, a leading supplier of embedded switch ASIC’s and subsystems for the storage networking market, to expand our Fibre Channel product line and paid $298.4 million in cash for all outstanding common stock, preferred stock and warrants of Vixel Corporation. We also incurred acquisition-related expenses of $6.7 million in cash. In addition, we issued 2.2 million stock options with a fair value of approximately $47.5 million and kept the original vesting periods for the options in exchange for the outstanding Vixel options for a total acquisition value of $352.7 million. We calculated the fair value of the 2.2 million stock options issued at the date of acquisition using the Black-Scholes option-pricing model. The operations of Vixel, since its acquisition, are included within the Company’s one operating segment, networking products. Additional information is contained below under “Impairment of Goodwill.”

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Results of Operations

The following discussion and analysis should be read in conjunction with the Condensed Consolidated Financial Statements included elsewhere herein.

Three months ended September 26, 2004, compared to three months ended September 28, 2003

Net Revenues. Net revenues for the first quarter of fiscal 2005 ended September 26, 2004, decreased by $11.4 million, or 13 percent, to $73.2 million, compared to $84.6 million for the same quarter of fiscal 2004 ended September 28, 2003.

The following chart details our net revenues by product line for the three months ended September 26, 2004 and September 28, 2003:

Net Revenues by Product Line

From a product line perspective, net revenues generated from our Fibre Channel products for the three months ended September 26, 2004, were $73.2 million, a decrease of $10.9 million, or 13 percent, compared to Fibre Channel product revenues of $84.1 million for the three months ended September 28, 2003, and represented substantially all of our net revenues. We believe that our net revenues from our broad range of Fibre Channel Input/Output, or I/O, and switching products are being generated primarily as a result of our product certifications and qualifications with OEM customers, which generate both direct OEM sales and indirect sales through distribution. Our IP networking

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products consist of both our iSCSI products, which have not completed development, as well as legacy VI and cLAN products. We expect that our VI, cLAN and traditional networking products, which have all entered end-of-life status, will contribute negligible revenues to succeeding quarters. We do not expect material revenue from iSCSI products for the foreseeable future.

     In addition to direct sales, some of our larger OEM customers purchased or marketed products indirectly through distributors, resellers or other third parties. Customers whose direct net revenues, or total direct and indirect net revenues (including customer-specific models purchased or marketed indirectly through distributors, resellers and other third parties), exceeded 10 percent of our net revenues were as follows:

Net Revenues by Major Customers

(1)

Amounts less than 10 percent are not presented.

(2)

Customer-specific models sold indirectly are included with the OEM’s revenues in these columns rather than as revenue for the distributors, resellers or other third parties.

Direct sales to our top five customers accounted for 62 percent of total net revenues for the three months ended September 26, 2004, compared to 74 percent for the three months ended September 28, 2003, and we expect to be similarly concentrated in the future. Our net revenues from our customers can be significantly impacted by changes to our customers business, as well as changes in the business models of our customers. Our EMC-specific models are sold both directly to EMC and indirectly through distributors such as Info-X and Tidalwire. As a result, for the three months ended September 26, 2004, and September 28, 2003, direct revenues attributable to EMC were less than 10 percent, but direct and indirect revenues attributable to EMC were greater than 10 percent of total net revenues. Under EMC’s upcoming Select Program, a portion of the sales of our EMC-specific models will no longer be sold through EMC’s distribution partners, but instead will be directly purchased by EMC from Emulex. These direct purchases will remain in our inventory and will not be recognized as revenue until they are shipped out to EMC’s customers, whereas purchases of EMC-specific models made by EMC’s distribution partners are recognized as revenue upon shipment and title transfer to these distributors. During the three months ended September 26, 2004, as the level of inventory held by EMC’s distribution partners was decreased in preparation for EMC’s Select Program, fewer EMC-specific models were sold to EMC’s distribution partners, reducing our revenue.

The following chart details our net revenues by sales channel for the three months ended September 26, 2004, and September 28, 2003:

Net Revenues by Sales Channel

From a sales channel perspective, net revenues generated from OEM customers were 70 percent of total net revenues and sales through distribution were 30 percent in the three months ended September 26, 2004 compared to net revenues from OEM customers of 57 percent and sales through distribution of 43 percent in the three months ended

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September 28, 2003. The decrease in distribution sales is primarily due to the reduced sales of EMC-specific models to EMC’s distribution partners as discussed above.

The following chart details our net domestic and international revenues based on billed-to location for the three months ended September 26, 2004, and September 28, 2003:

Net Domestic and International Revenues

We believe the decreases in domestic net revenues were principally due to the reduced sales of EMC-specific models to EMC’s distribution partners as discussed above. Because we sell to OEMs and distributors who ultimately resell our products to their customers, the geographic mix of our net revenues may not be reflective of the geographic mix of end-user demand or installations.

Gross Profit. Cost of sales included the cost of production of finished products as well as support costs and other expenses related to inventory management, manufacturing quality and order fulfillment. In the three months ended September 26, 2004, gross profit decreased $12.3 million, or 22 percent, to $44.0 million, from $56.3 million in the three months ended September 28, 2003. The decrease in gross profit in the three months ended September 26, 2004, compared to the three months ended September 26, 2003, was primarily due to lower net revenues and production volumes and the increased mix of lower margin Fibre Channel switch business acquired in the acquisition of Vixel Corporation in November 2003. For the three months ended September 26, 2004, and September 28, 2003, cost of sales included only $38 thousand and $4 thousand of amortized deferred stock-based compensation expenses, respectively. Gross margin decreased from 67 percent for the three months ended September 28, 2003, to 60 percent for the three months ended September 26, 2004. This decrease in gross margin is also due primarily to lower production volumes of HBAs as we temporarily curtailed production to reduce inventory, spreading our fixed manufacturing costs across fewer units during the three months ended September 26, 2004, compared to the three months ended September 28, 2003, as well as to the increased mix of Fibre Channel switches which carry lower gross margins than HBAs. Additionally, the three months ended September 28, 2003, included a benefit of $1.8 million as previously-reserved one gigabit per second excess and obsolete inventory was sold.

Engineering and Development. Engineering and development expenses consisted primarily of salaries and related expenses for personnel engaged in the design, development and technical support of our products. These expenses included third-party fees paid to consultants, prototype development expenses and computer services costs related to supporting computer tools used in the engineering and design process. Engineering and development expenses were $20.2 million and $16.3 million in the three months ended September 26, 2004, and September 28, 2003, representing 28 and 19 percent of net revenues in each period, respectively. Engineering and development expenses increased by $3.9 million, or 24 percent, in the three months ended September 26, 2004, compared to the three months ended September 28, 2003. This increase was primarily due to the inclusion of the engineering and development expenses associated with our acquisition of Vixel. Since we completed our integration of Vixel’s day-to-day operations during the three months ended March 28, 2004, we no longer separately track former-Vixel operations. However, the expenses associated with the former-Vixel operations are estimated to account for approximately $2.7 million, or approximately 70 percent of the overall $3.9 million increase. The remaining increase was due to our continued investment in Fibre Channel I/O and IP engineering and development, which represented substantially all of our engineering and development efforts and expenses prior to the acquisition of Vixel. Engineering and development expenses included $0.5 million and $0.4 million of amortized deferred stock-based compensation expenses for the three months ended September 26, 2004, and September 28, 2003, respectively. Due to the technical nature of our products, engineering support is a critical part of our strategy during both the development of our products and the support of our customers from product design through deployment into the market. We intend to continue to make significant investments in the technical support and enhancement of our current products, as well as the continued development of new products. Engineering expenses can fluctuate significantly from quarter to quarter depending on several factors, including, but not limited to, non-recurring

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engineering charges associated with new product introduction schedules, hiring patterns and depreciation of capital equipment.

Selling and Marketing. Selling and marketing expenses consisted primarily of salaries, commissions and related expenses for personnel engaged in the marketing and sales of our products, as well as trade shows, product literature, promotional support costs and other advertising-related costs. Selling and marketing expenses were $7.4 million and $4.6 million in the three months ended September 26, 2004, and September 28, 2003, representing 10 and five percent of net revenues, respectively. Selling and marketing expenses increased by $2.8 million, or 61 percent, in the three months ended September 26, 2004, compared to the three months ended September 28, 2003. This increase was primarily due to the inclusion of the selling and marketing expenses associated with our acquisition of Vixel. Similar to engineering and development expenses, we no longer track former-Vixel operations separately. However, the expenses associated with the former-Vixel operations are estimated to account for approximately $1.4 million, or approximately 49 percent of the overall $2.8 million increase. Additionally, selling and marketing expenses related to personnel; travel and entertainment; and advertising and other promotions for the three months ended September 26, 2004, increased by approximately $0.3 million, $0.3 million and $0.5 million, respectively, compared to the same period of the prior year. For the three months ended September 26, 2004, selling and marketing expenses included $0.2 million of amortized deferred stock-based compensation expenses. For the three months ended September 28, 2003 selling and marketing expenses included $0.1 million of amortized deferred stock-based compensation expenses. As a portion of selling and marketing expenses, such as selling and marketing employees’ base compensation and amortized deferred stock-based compensation expense, is not driven directly by increases or decreases in net revenues, the expenses have fluctuated as a percent of net revenues.

General and Administrative. Ongoing general and administrative expenses consisted primarily of salaries and related expenses for executives, financial accounting support, human resources, administrative services, professional fees and other associated corporate expenses. General and administrative expenses were $(0.4) million in the three months ended September 26, 2004. General and administrative expenses for the three months ended September 26, 2004, included a $4.4 million reduction related to reimbursement received from our insurance carriers during the three months ended September 26, 2004, in excess of our receivable. This reimbursement is related to the shareholder litigation settled and recorded as general and administrative expense in our fiscal year ended June 29, 2003. General and administrative expenses for the three months ended September 26, 2004, excluding this $4.4 million insurance reimbursement would have been $4.0 million, or five percent of net revenues, compared to $3.7 million, or four percent of net revenues, for the three months ended September 28, 2003. This would represent an increase of $0.3 million, or nine percent, in the three months ended September 26, 2004, excluding the insurance recovery, compared to the three months ended September 28, 2003. The increase includes general and administrative expenses associated with our acquisition of Vixel. Similar to other operating expenses, we no longer track former-Vixel operations separately. However, the expenses associated with the former-Vixel operations are estimated to account for approximately $0.2 million of the increase in general and administrative expenses. For the three months ended September 26, 2004, general and administrative expenses included $0.5 million of amortized deferred stock-based compensation expenses. For the three months ended September 28, 2003, general and administrative expenses included $37 thousand of amortized deferred stock-based compensation expenses.

Amortization of Other Intangibles. Amortization of other intangibles included the amortization of intangible assets with estimable lives related to the acquisitions of Vixel in November 2003 and Giganet in March 2001, as well as the purchase of the technology assets of Trebia Networks in October 2003. For the three months ended September 26, 2004, amortization of other intangibles was $6.5 million, or nine percent of net revenues. Amortization of other intangibles for the three months ended September 28, 2003, only include the acquisition of Giganet and was $1.5 million, or two percent of net revenues. The $5.1 million increase in amortization of other intangibles for the three months ended September 26, 2004, in comparison to the same three month period of the prior year was due to the addition of amortization related to the Vixel acquisition and the purchase of the technology assets of Trebia Networks.

Impairment of Goodwill. On June 30, 2004, we announced that tepid demand experienced in the fourth fiscal quarter of 2004 from two of our customers, resulted in lower than expected revenue, earnings and cash flows in the fourth fiscal quarter of 2004 and was expected to result in lower sequential revenue, earnings and cash flows in the first fiscal quarter of 2005. These events and circumstances resulted in a subsequent drop in our stock price, which indicated a potential impairment might have occurred. As a result, we conducted a FAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” analysis, as well as a FAS 142, “Goodwill and Other Intangible Assets,” analysis, including a second step goodwill impairment test. The results of the FAS 144 analysis indicated that our long-lived assets were not impaired. However, the FAS 142 analysis indicated that goodwill was impaired. This determination was made at the reporting unit level and consisted of two steps. First, the fair value of our only

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reporting unit was determined, based on a market approach, and compared to its carrying amount. Next, as the carrying amount exceeded the fair value, the second step of FAS 142 was performed. The implied fair value of goodwill was determined by allocating the fair value in a manner similar to a purchase price allocation, in accordance with FAS 141, “Business Combinations.” As a result of this FAS 142 analysis, on September 9, 2004, we concluded that a $583.5 million charge for goodwill impairment should be recorded as of June 27, 2004. After recording this impairment charge, there was no goodwill remaining on our balance sheet as of June 27, 2004. In connection with the preparation of Vixel Corporation’s tax return in the first quarter of fiscal 2005, we revised estimates and discovered errors related to the deferred tax assets of Vixel Corporation (acquired in November 2003). These events resulted in a revision to Vixel’s purchase price allocation to decrease net deferred tax assets and increase goodwill, which was impaired. This resulted in a $1.8 million impairment of goodwill charge for the three months ended September 26, 2004. Had these items been recorded in fiscal 2004, our net loss would have been $1.8 million higher, or $534.1 million, instead of $532.3 million. We do not believe that this $1.8 million impairment of goodwill is material to fiscal 2004 or will be material to fiscal 2005 operations or financial results. Excluding this adjustment, net income for the first quarter of fiscal 2005 would have been $16.1 million.

Nonoperating Income. Nonoperating income consisted primarily of interest income, interest expense and other non-operating income and expense items such as the gains on the repurchase of convertible subordinated notes. Our nonoperating income increased by $8.5 million to $14.8 million in the three months ended September 26, 2004, from $6.2 million in the three months ended September 28, 2003. The $8.5 million increase in nonoperating income was primarily due to a gain of $13.1 million on the repurchase of $153.0 million face value of our 0.25 percent contingent convertible subordinated notes in the three months ended September 26, 2004, compared to a gain of $4.7 million on the repurchase of $93.9 million face value of our 1.75 percent convertible subordinated notes in the three months ended September 28, 2003. Additionally, interest income increased $0.5 million to $3.0 million in the three months ended September 26, 2004, compared to $2.5 million in the three months ended September 28, 2003, primarily due to the receipt in the three months ended September 26, 2004, of $0.3 million of interest related to the insurance reimbursement discussed below in Liquidity and Capital Resources. Interest expense increased by $0.3 million associated with our outstanding convertible subordinated notes to $1.3 million in the three months ended September 26, 2004, compared to the three months ended September 28, 2003.

Income Taxes. In the three months ended September 26, 2004, we recorded a tax provision in the amount of $8.9 million, or approximately 38 percent of our income before income taxes. In the three months ended September 28, 2003, we recorded a tax provision in the amount of $13.8 million, or approximately 38 percent of our income before income taxes.

Critical Accounting Policies

The preparation of the financial statements requires estimation and judgment that affect the reported amounts of net revenues, expenses, assets and liabilities. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances and which form the basis for making judgments about the carrying values of assets and liabilities. Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. If these estimates differ significantly from actual results, the impact to the financial statements may be material.

We have identified the following as critical accounting policies: revenue recognition; allowance for doubtful accounts; goodwill, other intangibles and long-lived assets; inventories; income taxes and stock-based compensation.

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

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Furthermore, we provide a warranty of between one and three years on our I/O Fibre Channel and Internet Protocol products and provide a warranty of between one and five years on our Fibre Channel switching and traditional networking products. We record a provision for estimated warranty-related costs based on historical product return rates and management’s estimates of expected future costs to fulfill warranty obligations.

Allowance for Doubtful Accounts. We maintain an allowance for doubtful accounts based upon historical write-offs as a percentage of net revenues. Although we have not experienced significant losses on accounts receivable historically, our accounts receivable are concentrated with a small number of customers. Consequently, any write-off associated with one of these customers could have a significant impact on our allowance for doubtful accounts and results of operations.

Goodwill, Other Intangibles and Long-Lived Assets. Other intangibles resulting from the acquisitions of Vixel and Giganet and the purchase of the technology assets of Trebia Networks are carried at cost less accumulated amortization. For assets with determinable useful lives, amortization is computed using the straight-line method over the estimated economic lives of the respective intangible assets, ranging from two to seven years. In accordance with Statement 142, goodwill and other intangibles that have indeterminate lives will be tested for impairment based on discounted cash flows and market capitalization at least annually, but also on an interim basis if an event or circumstance indicates that it is more likely than not that an impairment loss has been incurred. Our annual impairment test occurs during our fourth fiscal quarter each year.

Additionally, Statement 144, under which the recoverability of long-lived assets is assessed by determining whether the carrying value of an asset can be recovered through projected undiscounted future operating cash flows over its remaining life whenever events or changes in circumstances indicate that we may not be able to recover the asset’s carrying value, such as when tepid fiscal fourth quarter of 2004 demand from two of our customers and a subsequent drop in our stock price resulted in an indication of impairment to our goodwill and other intangible assets. The amount of impairment, if any, is measured based on fair value, which is determined using projected discounted future operating cash flows. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.

At the end of June 2004, events and circumstances, including tepid fiscal fourth quarter of 2004 demand from two of our customers coupled with a subsequent drop in our stock price, indicated that a potential impairment of goodwill existed. As a result, we conducted a Statement 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” analysis, as well as a Statement 142, “Goodwill and Other Intangible Assets” analysis, including a second step goodwill impairment test. The result of the Statement 144 analysis indicated that none of our long-lived assets had been impaired. Any future impairment loss could materially and adversely affect our financial position and results of operations. However, the Statement 142 analysis indicated that all of our goodwill, which was in excess of $580 million, was impaired.

Inventories. Inventories are stated at the lower of cost on a first-in, first-out basis or market. We use a standard cost system for purposes of determining cost. The standards are adjusted periodically to ensure they represent actual cost. We regularly compare forecasted demand and the composition of the forecast against inventory on hand and open purchase commitments in an effort to ensure the carrying value of inventory does not exceed net realizable value. Accordingly, we may have to record reductions to the carrying value of excess and obsolete inventory if forecasted demand decreases, as we have previously, including an excess and obsolete inventory charge of $13.6 million during the three months ended September 30, 2001.

Income Taxes. We account for income taxes using the asset and liability method, which recognizes deferred tax assets and liabilities for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. We regularly review historical and anticipated future pre-tax results of operations to determine whether we will be able to realize the benefit of our deferred tax assets. A valuation allowance is required to reduce the potential deferred tax asset when it is more likely than not that all or some portion of the potential deferred tax asset will not be realized due to the lack of sufficient taxable income.

Stock-Based Compensation. We account for our stock-based awards to employees using the intrinsic value method. Stock-based awards to non-employees, if any, are recorded using the fair value method. See note 1 of the Condensed Consolidated Financial Statements for more information. We have no plans to adopt the fair value provisions of Statement 123 until required to under new accounting standards, such as those being considered under the Financial

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Accounting Standards Board’s Exposure Draft for Share-Based Payment, for all stock awards. If we were required to account for all stock-based awards based on the fair value method, it would have a material non-cash impact on our results of operations.

Liquidity and Capital Resources

As of September 26, 2004, we had $416.4 million in working capital and $557.3 million in cash and cash equivalents, current investments and long-term investments. At June 27, 2004, we had $486.8 million in working capital and $655.4 million in cash and cash equivalents, restricted cash, current investments and long-term investments. Our cash and cash equivalents decreased by $82.1 million to $110.0 million as of September 26, 2004, from $192.1 million as of June 27, 2004. The decrease in cash and cash equivalents was due to our financing activities, which used $135.7 million. The cash and cash equivalents used by financing activities were partially offset by our operating and investing activities, which provided $40.8 million and $12.8 million of cash and cash equivalents, respectively.

In the three months ended September 26, 2004, operating activities provided $40.8 million of cash and cash equivalents compared to using $3.0 million in the three months ended September 28, 2003. The primary reason for the increase in cash provided by operating activities for the three months ended September 26, 2004 was net income of $14.3 million adjusted for non-cash reconciling items, the most significant of which were amortization of other intangibles, depreciation and amortization of property and equipment, deferred income taxes, a gain on the repurchase of our 0.25 percent contingent convertible subordinated notes, and a recovery related to insurance reimbursement on shareholder litigation settlements. Additionally, decreases in inventories and accounts and other receivables, partially offset by a decrease in accounts payable and accrued liabilities, increased our net cash provided by operating activities. Net cash used in operating activities of $3.0 million for the three months of the prior year included an increase of restricted cash related to litigation settlements of $39.5 million.

In the three months ended September 26, 2004, investing activities provided $12.8 million of cash and cash equivalents, as the amount of investment maturities out paced the purchases of new investments. For the three months ended September 28, 2003, investing activities provided $24.3 million of cash and cash equivalents, as the amount of investment maturities was again higher that the purchases of new investments. Additionally, during the three months ended September 26, 2004, Emulex spent $3.2 million on additions to property and equipment compared to spending $10.5 million during the same period of the prior year. The additions to property and equipment in the prior year included amounts related to the building of our new corporate headquarters.

Financing activities used $135.7 million of cash and cash equivalents in the three months ended September 26, 2004. This decrease in cash and cash equivalents was primarily due to the repurchase of $153.0 million in face value of our 0.25 percent contingent convertible subordinated notes at a net discount, spending $137.2 million. For the three months ended September 28, 2003, financing activities used $86.1 million of cash and cash equivalents due primarily to the repurchase of $93.9 million in face value of our 1.75 percent convertible subordinated notes at a discount, spending $87.3 million.

As of September 26, 2004, Emulex had approximately $17.0 million in face value of its 1.75 percent convertible subordinated notes due 2007 outstanding. Interest on these notes is payable in cash on February 1 and August 1 of each year. These notes may be converted by the holder at any time into shares of the Company’s common stock at the conversion price of $53.84 per share, subject to the potential adjustments described in the terms of the notes issued. The Company may redeem the notes on or after February 5, 2005, in whole or in part.

As of September 26, 2004, Emulex had approximately $364.5 million in face value of its 0.25 percent contingent convertible subordinated notes due 2023 outstanding. Interest is payable in cash on June 15th and December 15th of each year. Under the terms of the offering, the notes will be convertible, at the option of the holder and subject to the satisfaction of certain conditions, into shares of Emulex common stock at a price of $43.20 per share. Holders of the notes may require us to purchase the notes for cash by giving written notice within the 20 business days prior to each of December 15, 2006, December 15, 2008, December 15, 2013, and December 15, 2018. See note 7 to the condensed consolidated financial statements contained herein for more information.

We entered into purchase agreements for inventory, and as of September 26, 2004, our remaining inventory purchase obligation for these items was $18.1 million, including $4.6 million related to key inventory components.

On October 9, 2003, before our acquisition of Vixel, a purported class action lawsuit was filed in King County Superior Court of the State of Washington against Vixel and each of Vixel’s directors and certain unnamed individuals (the “Vixel Parties”), entitled Russell Fink v. Vixel Corporation, et al., Case No. 03-2-37226-9SEA. The

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complaint made general allegations that, among other things, Vixel’s directors breached their fiduciary duties to Vixel stockholders in connection with the approval of the merger with Emulex and sought to enjoin the tender offer and have the merger agreement declared unlawful, among other forms of relief. On November 7, 2003, the Vixel Parties entered into a memorandum of understanding for a $0.7 million settlement with the plaintiff in the class action suit pursuant to which the parties have agreed to settle the action, subject to court approval. The $0.7 million was recorded as general and administrative expense for the three months ended December 28, 2003. Formal settlement documents were signed on May 5, 2004 and the plaintiff has completed discovery as agreed to by the parties. In August 2004, final court approval was obtained for the settlement of the Fink v. Vixel litigation, and we paid the $0.7 million settlement. Subsequent to the quarter ended September 26, 2004, we received a $0.3 million reimbursement from our insurer relating to the Fink v. Vixel litigation.

In July 2004, we obtained an arbitration award against two of its insurers related to class action and derivative suits settled in 2003, and subsequently collected a total of $9.5 million plus $0.3 million in interest during the quarter ended September 26, 2004. As the amounts received exceeded the $5.1 million receivable reflected on our books, we recorded a reduction in general and administrative expenses during the three months ended September 26, 2004, of $4.4 million, as well as interest income of $0.3 million.

As part of our commitment to storage networking product development, including Fibre Channel, which includes our recent acquisition of Vixel Corporation, and IP Networking, we expect to continue our investments in property and equipment, most notably for additional engineering equipment, and continued enhancement of our global IT infrastructure.

We believe that our existing cash and cash equivalents balances, facilities and equipment leases, investments and anticipated cash flows from operating activities will be sufficient to support our working capital needs and capital expenditure requirements for at least the next 12 months.

As described above, the following summarizes our contractual obligations at September 26, 2004, and the effect such obligations are expected to have on our liquidity and cash flow in future periods:

(1)

The principal payment related to the remaining outstanding 0.25 percent contingent convertible subordinated notes of $364.5 million is shown as a payment in the period for the two fiscal years ending June 2008 above as holders of these 20-year notes may require us to purchase the notes for cash by giving us written notice as early as 20 business days prior to each of December 15, 2006, December 15, 2008, December 15, 2013, and December 15, 2018.

(2)

Fiscal year ending July 3, 2005.

(3)

Fiscal years ending July 2, 2006, and July 1, 2007.

(4)

Fiscal years ending June 29, 2008, and June 28, 2009.

Risk Factors

A downturn in information technology spending in general or spending on computer and storage systems in particular could adversely affect our revenues and results of operations.

The demand for our Fibre Channel products, which represents substantially all of our net revenues, has been driven by the demand for high-performance storage networking products and solutions that support enterprise computing applications, including on-line transaction processing, data mining, data warehousing, multimedia and Internet

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applications. Any significant downturn in demand for such products, solutions and applications, such as the slowdown experienced beginning in early 2001 and tepid demand experienced in mid calendar 2004, could adversely affect our business, results of operations and financial condition. The adverse effects of any sustained downturn in information technology spending on our operating results may be exacerbated by our research and development investments, strategic investments and merger and acquisition activity, as well as customer service and support, which are expected to continue despite any such downturn.

Our business depends upon the continued growth of the Fibre Channel storage networking market, and our business will be adversely affected if such growth does not occur or occurs more slowly than we anticipate.

The size of our potential market is largely dependent upon the acceptance of our Fibre Channel storage networking technologies, as well as the overall demand for storage. We believe that our investment in the Fibre Channel storage networking market represents our greatest opportunity for revenue growth and profitability for the foreseeable future. However, the market for Fibre Channel storage networking products may not gain broader acceptance and customers may choose alternative technologies and/or products supplied by other companies. Recently, interest has re-emerged for iSCSI storage networking solutions, which may satisfy some I/0 connectivity requirements through standard Ethernet adapters and software at little to no incremental cost to end users. Such iSCSI solutions are likely to compete with Fibre Channel solutions, particularly in the low end of the market. In addition, other technologies such as Serial Attached SCSI or SAS, may compete with our Fibre Channel embedded switched solutions in the future. Furthermore, since our products are sold as parts of integrated systems, demand for our products is driven by the demand for these integrated systems, including other companies’ complementary products. A lack of demand for the integrated systems or a lack of complementary products required for these integrated systems could have a material adverse effect on our business, results of operations and financial condition. If the Fibre Channel storage networking market does not grow, or grows more slowly than we anticipate, attracts more competitors than we expect, as discussed below, or if our products do not achieve continued market acceptance, our business, results of operations and financial condition could be materially adversely affected.

Because a significant portion of our revenues are generated from sales to a limited number of customers, none of which are the subject of exclusive or long-term contracts, the loss of one or more of these customers, or our customers’ failure to make timely payments to us, could adversely affect our business.

We rely almost exclusively on original equipment manufacturers, or OEMs, and sales through distribution channels for our revenue. For the three months ended September 26, 2004, we derived approximately 70 percent of our net revenues from OEMs and 30 percent from sales through distribution. Furthermore, because some of our sales through distribution channels consist of OEM products, OEM customers effectively generated more than 86 percent of our revenue for the year ended June 27, 2004. We may be unable to retain our current OEM and distributor customers or to recruit additional or replacement customers.

Although we have attempted to expand our base of customers, including customers for embedded switching products, we believe our revenues in the future will continue to be similarly derived from a limited number of customers, especially in light of the continuing consolidation the industry has experienced. 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, as occurred with two of our OEM customers during the three months ended June 27, 2004, our business, results of operations and financial condition could be materially adversely affected.

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

Our markets are highly competitive and our business and results of operations may be adversely affected by entry of new competitors into the markets, aggressive pricing and the introduction or expansion of competitive products and technologies.

The markets for our products are highly competitive and are characterized by rapid technological advances, price erosion, frequent new product introductions and evolving industry standards. We expect that our markets will continue to attract new competition. Our current and potential competition consists of major domestic and

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international companies, some of which have substantially greater financial, technical, marketing and distribution resources than we have. Additional companies, including but not limited to our suppliers, strategic partners, OEM customers and emerging companies, may enter the markets for our storage networking products and new or stronger competitors may emerge as a result of consolidation movements in the marketplace. Additionally, our existing competitors continue to introduce products with improved price/performance characteristics, and we have to do the same to remain competitive. Increased competition could result in increased price competition, reduced revenues, lower profit margins or loss of market share, any of which could have a material adverse effect on our business, results of operations and financial condition.

Alternative legacy technologies such as SCSI and port bypass circuits compete with our Fibre Channel I/O and embedded switch products, respectively, for customers. Our success depends in part on our own ability and on the ability of our OEM customers to develop storage networking solutions that are competitive with these alternative legacy technologies. Additionally, in the future other technologies that we are not currently developing may evolve to address the storage networking applications currently served by our Fibre Channel product line today, reducing our market opportunity.

Our operating results are difficult to forecast and could be adversely affected by many factors, and our stock price may decline if our results fail to meet expectations.

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

•		changes in the size, mix, timing and terms of OEM and other customer orders, such as those experienced from two OEM customers in the three months ended June 27, 2004;
•		changes in the sales and deployment cycles for our products and/or desired inventory levels for our products;
•		acquisitions or strategic investments by our customers, competitors or us;
•		the timing and market acceptance of new or enhanced product introductions by us, our OEM customers and our competitors;
•		market share losses or difficulty in gaining incremental market share growth;
•		fluctuations in product development, procurement, resource utilization and other operating expenses;
•		component shortages experienced by us, or reduced demand from our customers if our customers are unable to acquire components used in conjunction with our products in their deployments;
•		the inability of our electronics manufacturing service, or EMS, providers to produce and distribute our products in a timely fashion;
•		difficulties with updates, changes or additions to our information technology systems;
•		breaches of our network security, including viruses;
•		changes in general social and economic conditions, including but not limited to natural disasters, terrorism, public health and slower than expected market growth, with resulting changes in customer technology budgeting and spending;
•		changes in technology, industry standards or consumer preferences;
•		seasonality; and/or
•		changes in our accounting or other policies resulting from the adoption of new laws, regulations or pronouncements.

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

Our relatively small backlog of unfilled orders, possible customer delays or deferrals and our tendency to generate a large percentage of our quarterly sales near the end of the quarter contribute to possible fluctuations in our operating results that could have an adverse impact on our results of operations and stock price.

Historically, we have generally shipped products quickly after we receive orders, meaning that we do not always have a significant backlog of unfilled orders. As a result, our revenues in a given quarter may depend substantially on orders booked during that quarter. Alternatively, orders already in backlog may be deferred or cancelled. Also, we have typically generated a large percentage of our quarterly revenues in the last month of the quarter. Because our expense levels are largely based on our expectations of future sales, in the event we experience unexpected decreases in sales, our expenses may be disproportionately large relative to our revenues and we may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shortfall. A material shortfall in sales in relation to our quarterly expectations or any delay, deferral or cancellation of customer orders would likely have an immediate and adverse impact on our results of operations and may adversely affect our stock price.

Our industry is subject to rapid technological change, and we must keep pace with the changes to successfully compete.

The markets for our products are characterized by rapidly changing technology, evolving industry standards and the frequent introduction of new products and enhancements. Our future success depends in large part on our ability to enhance our existing products and to introduce new products on a timely basis to meet changes in customer preferences and evolving industry standards. Currently, new and proposed technologies such as four, eight and ten gigabit per second, or Gbps, Fibre Channel solutions; Infiniband; PCI-X 2.0; PCI Express; PCI Express Advanced Switching; iSCSI; Serial ATA, or SATA; Serial Attached SCSI, or SAS; and Remote Direct Memory Access, or RDMA; are in development by many companies and their ultimate acceptance and deployment in the market is uncertain. We are developing some, but not all of these technologies, and we cannot be sure that the technologies we chose to develop will achieve market acceptance, or that technologies that we chose not to develop will be available to purchase or license from third parties or will be immaterial to our business. Furthermore, if our products are not available in time for the qualification cycle at an OEM it may be up to three years, if ever, before another qualification cycle is available to us. If we are unable, for technological or other reasons, to develop new products, enhance or sell existing products, or consume existing products in a timely and cost-effective manner in response to technological and market changes, our business, results of operations and financial condition may be materially adversely affected.

We have experienced losses in our history and may experience losses in our future that may adversely affect our stock price and financial condition.

We have experienced losses in our history, including a loss of $532.3 million in fiscal 2004. Any losses, including losses caused by impairment of long-lived assets or goodwill, may adversely affect the perception of our business by analysts and investors, which could adversely affect our stock price. To the extent that we are unable to generate positive operating profits and positive cash flow from operations, our financial condition may be materially adversely affected.

The migration of our customers toward newer product platforms may have a significant adverse effect.

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

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Any failure of our OEM customers to keep up with rapid technological change and successfully market and sell systems that incorporate new technologies could adversely affect our business.

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

Rapid changes in the evolution of technology, including the unexpected extent or timing of the transition from HBA solutions or embedded switch box solutions to lower-priced ASIC solutions, could adversely affect our business.

Historically, the electronics industry has developed higher performance ASICs that create chip level solutions that replace selected board level or box level solutions at a significantly lower average selling price. We have previously experienced this trend and expect it to continue in the future. If this transition is more abrupt or is more widespread than anticipated, there can be no assurance that we will be able to modify our business model in a timely manner, if at all, in order to mitigate the effects of this transition on our business, results of operations and financial position.

If customers elect to utilize lower-end HBAs in higher-end environments or applications, our business could be negatively affected.

We supply three families of HBAs that target separate high-end, mid-range and small and medium-sized business, or SMB, markets. Historically, the majority of our Fibre Channel revenue has come from our high-end server and storage solutions. In the future, increased revenues are expected to come from SMB and midrange server and storage solutions, which have lower average selling prices. If customers elect to utilize lower-end HBAs in higher-end environments or applications, our business could be negatively affected.

A decrease in the average unit selling prices and/or an increase in the manufactured cost of our products could adversely affect our revenue, gross margins and financial performance.

In the past, we have experienced downward pressure on the average unit selling prices of our products. We may provide pricing discounts to customers based upon volume purchase criteria, and achievement of such discounts may reduce our average unit selling prices. To the extent that growth in unit demand fails to offset decreases in average unit selling prices, our revenues and financial performance could be materially adversely affected. Although historically we have achieved offsetting cost reductions, to the extent that average unit selling prices of our products decrease without a corresponding decrease in the costs of such products, our gross margins and financial performance could be materially adversely affected. Furthermore, if the manufactured cost of our products were to increase due to inflation or other factors, our gross margins and financial performance could be materially adversely affected.

Delays in product development could adversely affect our business.

We have experienced delays in product development in the past and may experience similar delays in the future. Prior delays have resulted from numerous factors, such as:

•		difficulties in hiring and retaining necessary employees and independent contractors;
•		difficulties in reallocating engineering resources and other resource limitations;
•		unanticipated engineering or manufacturing complexity, including from third-party suppliers of intellectual property including foundries of our ASICs;
•		undetected errors or failures in software and hardware;
•		changing OEM product specifications;
•		delays in the acceptance or shipment of products by OEM customers; and/or
•		changing market or competitive product requirements.

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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.

Our products are complex and may contain undetected hardware of software defects or bugs that could increase our costs, reduce our net revenues or damage our reputation.

Our products are complex and may contain undetected hardware or software defects or bugs when first introduced or as newer versions are released. We are also exposed to risks associated with latent defects in existing products. From time to time, we have found errors in existing, new or enhanced products. If any of our products contains defects or bugs, or has reliability, quality or compatibility problems, our reputation may be damaged and customers may be reluctant to buy our products, which could materially and adversely affect our ability to retain existing customers and attract new customers. In addition, these defects or bugs could interrupt or delay sales or shipment of our products to our customers. Furthermore, if any of these problems are not found until after we have commenced commercial shipment of a product, we may be required to incur additional development costs and product recall, repair or replacement costs. These problems may divert our technical and other resources from other development efforts and could result in significant warranty and repair costs.

Our joint development activities may result in products that are not commercially successful or that are not available in a timely fashion.

We have engaged in joint development projects with third parties in the past and we expect to continue doing so in the future. Joint development can magnify several risks for us, including the loss of control over development of aspects of the jointly developed products and over the timing of product availability. Accordingly, we face increased risk that joint development activities will result in products that are not commercially successful or that are not available in a timely fashion.

During April 2003 we announced a joint development activity with Intel Corporation relating to storage processors that integrate SATA, SAS and Fibre Channel interfaces within a single architecture. Under the agreement, we will develop the protocol controller hardware, firmware and drivers. Intel will integrate its Intel® Xscale™ microarchitecture as the core technology for the new processors and will manufacture the processors on its 90-nanometer process technology. This activity has risks resulting from unproven new-generation manufacturing technology, from the licensing of technology to Intel and from increased development costs.

A change in our business relationships with our third-party suppliers or our electronics manufacturing service providers could adversely affect our business.

We rely on third-party suppliers for components and the manufacture of our products, and we have experienced delays or difficulty in securing components and finished goods in the past. Delays or difficulty in securing components or finished goods may be caused by numerous factors including, but not limited to:

•		discontinued production by a supplier;
•		required long-term purchase commitments;
•		undetected errors, failures or production quality issues;
•		timeliness of product delivery;
•		sole sourcing;
•		financial stability and viability of our suppliers and EMS providers;
•		changes in business strategies of our suppliers and EMS providers;
•		increases in manufacturing costs due to lower volumes or more complex manufacturing process than anticipated;
•		disruption in shipping channels;

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•		natural disasters;
•		inability or unwillingness of our suppliers or EMS providers to continue their business with us;
•		environmental, tax or legislative changes in the location where our products are produced;
•		difficulties associated with foreign operations; and/or
•		market shortages.

There is a risk that we will not be able to retain our current suppliers or change to alternative suppliers. An interruption in supply, the cost of shifting to a new supplier or EMS providers or the cost associated with a long-term purchase commitment could have a material adverse effect on our business, results of operations and financial condition.

If our intellectual property protections are inadequate, it could adversely affect our business.

We believe that our continued success depends primarily on continuing innovation, marketing and technical expertise, as well as the quality of product support and customer relations. At the same time, our success is partially dependent on the proprietary technology contained in our products. We currently rely on a combination of patents, copyrights, trademarks, trade secret laws and contractual provisions to establish and protect our intellectual property rights in our products. For a more complete description of our intellectual property, you should read “Business — Intellectual Property” contained within our 2004 Annual Report on Form 10-K.

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

For more information on legal proceedings related to Emulex, see Part II, Item 1, “Legal Proceedings.”

Ongoing lawsuits present inherent risks, any of which could have a material adverse effect on our business, financial condition or results of operations. Such potential risks include the continuing expenses of litigation, the risk of loss of patent rights, the risk of injunction against the sale of products incorporating the technology in question, counterclaims and attorneys’ fee liability.

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

We believe that our products and technology do not infringe on the intellectual property rights of others or upon intellectual property rights that may be granted in the future pursuant to pending applications. We occasionally receive communications from third parties alleging patent infringement, and there is always the chance that third parties may assert infringement claims against us. Any such claims, with or without merit, could result in costly litigation, cause product shipment delays or require us to enter into royalty or licensing agreements, which may or may not be available. However, we have in the past obtained, and may be required in the future to obtain, licenses of technology owned by other parties. We cannot be certain that the necessary licenses will be available or that they can be obtained on commercially reasonable terms. If we were to fail to obtain such royalty or licensing agreements in a timely manner and on reasonable terms, our business, results of operations and financial condition would be materially adversely affected.

The inability or increased cost of attracting, motivating or retaining key managerial and technical personnel could adversely affect our business.

Our success depends to a significant degree upon the performance and continued service of key managers as well as engineers involved in the development of our storage networking technologies and technical support of our storage

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networking products and customers. Competition for such highly skilled employees in the communities in which we operate, as well as our industry is intense, and we cannot be certain that we will be successful in recruiting, training and retaining such personnel. In addition, employees may leave our company and subsequently compete against us. Also, many of these key managerial and technical personnel receive stock options. New regulations, volatility in the stock market and other factors could diminish the value of our stock options, putting us at a competitive disadvantage and forcing us to use more cash compensation. If we are unable to attract new managerial and technical employees, or are unable to retain and motivate our current key managerial and technical employees, or are forced to use more cash compensation to retain and motivate key personnel, our business, results of operations and financial condition could be materially adversely affected.

Our international business activities subject us to risks that could adversely affect our business.

For the three months ended September 26, 2004, sales in the United States accounted for 52 percent of our total net revenues, sales in Europe accounted for 33 percent of our total net revenues, and sales in the Pacific Rim countries accounted for 15 percent of our total net revenues. We expect that our sales will be similarly distributed for the foreseeable future. All of our sales are currently denominated in U.S. dollars. As a result, if the value of the U.S. dollar increases relative to foreign currencies, our products could become less competitive in international markets. Additionally, a significant portion of our products is produced at our EMS providers’ production facilities in Spain, Mexico and Malaysia. As a result, we are subject to the risks inherent in international operations. Our international business activities could be affected, limited or disrupted by a variety of factors, including:

•		the imposition of or changes in governmental controls, taxes, tariffs, trade restrictions and regulatory requirements;
•		the costs and risks of localizing products for foreign countries;
•		longer accounts receivable payment cycles;
•		changes in the value of local currencies relative to our functional currency;
•		import and export restrictions;
•		loss of tax benefits due to international production;
•		general economic and social conditions within foreign countries;
•		taxation in multiple jurisdictions; and/or
•		political instability, war or terrorism.

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

Potential acquisitions or strategic investments may be more costly or less profitable than anticipated and may adversely affect the price of our company stock.

We may pursue acquisitions or strategic investments that could provide new technologies, products or service offerings. Future acquisitions or strategic investments may negatively impact our results of operations as a result of operating losses incurred by the acquired entity, the use of significant amounts of cash, potentially dilutive issuances of equity or equity-linked securities, incurrence of debt or amortization of intangible assets with determinable lives. Furthermore, we may incur significant expenses pursuing acquisitions or strategic investments that ultimately may not be completed. Moreover, to the extent that any proposed acquisition or strategic investment is not favorably received by stockholders, analysts and others in the investment community, the price of our common stock could be adversely affected. In addition, acquisitions or strategic investments involve numerous risks, including:

•

difficulties in the assimilation of the operations, technologies, products and personnel of the acquired company;

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•		purchased technology is not adopted by customers in the way or the time frame we anticipated;
•		the diversion of management’s attention from other business concerns;
•		risks of entering markets in which we have no or limited prior experience;
•		A strategic investment could result in a minority interest in a company that could have an impact on our results;
•		risks related to the effect that the acquired company’s internal control processes might have on our financial reporting and management’s report on our internal controls over financial reporting; and/or
•		the potential loss of key employees of the acquired company.

In the event that an acquisition or strategic investment does occur and we are unable to obtain anticipated profits or successfully integrate operations, technologies, products or personnel that we acquire, our business, results of operations and financial condition could be materially adversely affected.

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

The stock market in general and the stock prices in technology-based companies in particular have experienced extreme volatility that often has been unrelated to the operating performance of any specific public company. The market price of our common stock has fluctuated in the past and is likely to fluctuate in the future as well. For example, during the first nine months of calendar year 2004 the market price of our common stock ranged from a low of $9.26 per share to a high of $31.30 per share. Factors that could have a significant impact on the market price of our common stock include, but are not limited to, the following:

•		quarterly variations in customer demand and operating results;
•		announcements of new products by us or our competitors;
•		the gain or loss of significant customers or design wins;
•		changes in analysts’ earnings estimates;
•		changes in analyst recommendations, price targets or other parameters that may not be related to earnings estimates;
•		rumors or dissemination of false information;
•		pricing pressures;
•		short selling of our common stock;
•		dilution resulting from conversion of outstanding convertible subordinated notes into shares of our common stock;
•		general conditions in the computer, storage or communications markets; and/or
•		events affecting other companies that investors deem to be comparable to us.

In the past, companies, including us, that have experienced volatility in the market price of their stock have been the objects of securities class action litigation. If we were to be the subject of similar litigation in the future or experience unfavorable outcomes in any of our pending litigation, as discussed in Part II, Item 1, “Legal Proceedings,” contained elsewhere herein, it could have a material adverse effect on our results of operations and financial condition.

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Terrorist activities and resulting military and other actions could adversely affect our business.

The terrorist attacks in New York and Washington, D.C. in September 2001 disrupted commerce throughout the United States and Europe. The continued threat of terrorism within the United States and Europe and the military action and heightened security measures in response to such threat may cause significant disruption to commerce throughout the world. To the extent that such disruptions result in delays or cancellations of customer orders, delays in collecting cash, a general decrease in corporate spending on information technology or our inability to effectively market, manufacture or ship our products, our business, financial condition, and results of operations could be materially and adversely affected. We are unable to predict whether the threat of terrorism or the responses thereto will result in any long-term commercial disruptions or if such activities or responses will have any long-term material adverse effect on our business, results of operations or financial condition.

Our corporate offices and principal product development facilities are located in a region that is subject to earthquakes and other natural disasters.

Our California and Washington facilities, including our corporate offices and principal product development facilities, are located near major earthquake faults. Any disruption in our business activities, personal injury or damage to the facilities in excess of our currently insured amounts as a result of earthquakes or other such natural disasters, could have a material adverse effect on our business, results of operations and financial condition.

Our shareholder rights plan, certificate of incorporation and Delaware law could adversely affect the performance of our stock.

Our shareholder rights plan and provisions of our certificate of incorporation and of the Delaware General Corporation Law could make it more difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders. The shareholder rights plan and these provisions of our certificate of incorporation and Delaware law are intended to encourage potential acquirers to negotiate with us and allow our board of directors the opportunity to consider alternative proposals in the interest of maximizing stockholder value. However, such provisions may also discourage acquisition proposals or delay or prevent a change in control, which could harm our stock price. For more information, please read note 12 to the Consolidated Financial Statements contained in our 2004 Annual Report on Form 10-K, our certificate of incorporation and Delaware law for more information on the anti-takeover effects of provisions of our shareholder rights plan.

Our system of internal controls may be inadequate.

We maintain a system of internal controls in order to ensure we are able to collect, process, summarize and disclose the information required by the Securities and Exchange Commission within the time periods specified. Any system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system are met. In addition, the design of any control system is based in part upon certain assumptions about the likelihood of future events. Because of these and other inherent limitations of control systems, there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote. Additionally, public companies in the United States are required to review their internal controls under the Sarbanes-Oxley Act of 2002. If the internal controls put in place by us are not adequate or in conformity with the requirements of the Sarbanes-Oxley Act of 2002, and the rules and regulations of the Securities and Exchange Commission, we may be required to restate our financial Statements and/or take other actions which will divert significant financial and managerial resources, as well as be subject to fines and/or other government enforcement actions.

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. New or proposed guidance related to the expensing of stock options and the treatment of contingently convertible subordinated notes as common stock equivalents could materially adversely affect our reported financial results and our stock price.

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The final determination of our income tax liability may be materially different from our income tax provisions and accruals.

We are subject to income taxes in both the United States and international jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes. In the ordinary course of our business, there are many transactions where the ultimate tax determination is uncertain. Additionally, our calculations of income taxes are based on our interpretations of applicable tax laws in the jurisdictions in which we file. Although we believe our tax estimates are reasonable, there is no assurance that the final determination of our income tax liability will not be materially different than what is reflected in our income tax provisions and accruals. Should additional taxes be assessed as a result of new legislation, an audit or litigation, if our effective tax rate should change as a result of changes in federal, international or state and local tax laws, or if we were to change the locations where we operate, there could be a material effect on our income tax provision and net income in the period or periods in which that determination is made.

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

While we believe we have adequate working capital to meet our expected cash requirements for the immediate future, we may need to raise additional funds through public or private debt or equity financings in order to:

•		take advantage of unanticipated opportunities, including more rapid international expansion or acquisitions of complementary businesses or technologies;
•		develop new products or services;
•		repay outstanding indebtedness; and/or
•		respond to unanticipated competitive pressures.

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

In January 2002, we completed a $345.0 million private placement of 1.75 percent convertible subordinated notes, which are due February 1, 2007. Subsequently, we repurchased and cancelled an aggregate of $328.0 million in face value of our 1.75 percent notes, leaving approximately $17.0 million still outstanding as of September 26, 2004. In fiscal 2004, we completed a $517.5 million private placement of 0.25 percent contingent convertible subordinated notes due 2023. During the three months ended September 26, 2004, we repurchased and cancelled $153.0 million in face value of these 0.25 percent notes, leaving approximately $364.5 million still outstanding as of September 26, 2004. The holders of our 0.25 percent notes may require us to purchase the notes for cash as early as December 2006. If we have insufficient liquidity and capital resources to repay the principal amounts of our outstanding convertible notes and the notes offered hereby when due, we may be forced to raise additional funds through public or private debt or equity financings, which may not be available on favorable terms, if at all. If such financings were not available on favorable terms, our business, results of operations and financial condition could be materially adversely affected.

Conversion of our outstanding notes would dilute the ownership interest of existing stockholders.

The conversion of our notes into shares of our common stock would dilute the ownership interests of existing stockholders. Any sales in the public market of the common stock issuable upon conversion of the notes could adversely affect prevailing market prices of our common stock. In addition, the existence of the notes may encourage short selling by market participants due to this dilution or to facilitate trading strategies involving notes and common stock. See the Risk Factor “Changes in laws, regulations and financial accounting standards may affect our reported results of operations” above.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Sensitivity

At September 26, 2004, our investment portfolio consisted primarily of fixed income securities, excluding those classified as cash and cash equivalents, of $447.3 million. We have the positive intent and ability to hold these securities to maturity. Currently, the carrying amount of these securities approximates fair market value. However, the fair market value of these securities is subject to interest rate risk and would decline in value if market interest rates increased. If market interest rates were to increase immediately and uniformly by 10 percent from the levels existing as of September 26, 2004, the decline in the fair value of the portfolio would not be material to our financial position, results of operations and cash flows. However, if interest rates decreased and securities within our portfolio matured and were re-invested in securities with lower interest rates, interest income would decrease in the future.

As of September 26, 2004, we had $364.5 million face value 0.25 percent contingent convertible subordinated notes and $17.0 million face value 1.75 percent convertible subordinated notes issued and outstanding. The fair value, based on quoted market prices, of our 0.25 percent and 1.75 percent convertible subordinated notes at September 26, 2004, was $332.4 million and $17.0 million, respectively. The fair value of these notes may increase or decrease due to various factors, including fluctuations in the market price of our common stock, fluctuations in market interest rates and fluctuations in general economic conditions.

Foreign Currency

We have executed and will continue to execute transactions in foreign currencies. As a result, we may be exposed to financial market risk resulting from fluctuations in foreign currency rates, particularly the British Pound and the Euro. Given the relatively small number of foreign currency transactions, we do not believe that our potential exposure to fluctuations in foreign currency rates is significant.

Item 4. Controls and Procedures

We maintain disclosure controls and procedures designed to ensure that we are able to collect the information we are required to disclose in the reports we file with the Securities and Exchange Commission, or SEC, and to process, summarize and disclose this information within the time periods specified in the rules of the SEC. Based on their evaluation of our disclosure controls and procedures, our management, with the participation of the Chief Executive and Chief Financial Officers, has concluded that, as of the end of the period covered by this Quarterly Report on Form 10-Q, these disclosure controls and procedures were effective to ensure that we are able to record, process, summarize and report the information we are required to disclose in the reports we file with the SEC within the required time periods.

There were no changes in our internal controls over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II: OTHER INFORMATION

Item 1. Legal Proceedings

Litigation

On May 23, 2003, Vixel filed a patent infringement action against Brocade Communications Systems, Inc. in the United States District Court for the Northern District of California, Civil Action No. C-030-02446. The complaint states that Brocade is infringing U.S. Patent No. 6,185,203, entitled “Fibre Channel Switching Fabric,” U.S. Patent No. 6,118,776, entitled “Methods and Apparatus for Fibre Channel Interconnection of Private Loop Devices,” and U.S. Patent No. 6,470,007, entitled “Interconnect System for Fibre Channel Arbitrated Loop Including Private Loop Devices,” through the unauthorized manufacture, use, sale and offering for sale of various storage area network switching products, including but not limited to, Brocade’s Silkworm switch products. Brocade denied infringement and challenged the validity of the patents referenced. Brocade also challenged the enforceability of those patents. In the suit against Brocade, Vixel was seeking unspecified past damages, potential future royalties, or, alternatively, injunctive relief.

On September 24, 2004, Emulex Corporation and Brocade Communications Systems, Inc. entered into a settlement including a litigation standstill agreement whereby Emulex and Brocade agreed to dismiss without prejudice their claims and counterclaims against each other in the pending patent infringement case in the United States District Court for the Northern District of California entitled Vixel Corporation. v. Brocade Communications Systems, Inc., Civil Action No. C-030-02446. The settlement included the formation of a strategic relationship under which the parties are to work together to pursue mutual objectives. Under the litigation standstill agreement both parties preserved their respective rights, no restrictions of any kind were imposed on either party’s ability to sell products, no licenses were granted by either party, no money was exchanged, and they agreed to a three year standstill during which neither party may initiate litigation against the other party with respect to certain of their respective patents.

On November 15, 2001, prior to the Company’s acquisition of Vixel Corporation, a securities class action was filed in the United States District Court in the Southern District of New York as Case No. 01 CIV. 10053(SAS), Master File No. 21 MC92 (SAS) against Vixel and two of its officers and directors and certain underwriters who participated in the Vixel initial public offering in late 1999. The amended complaint alleges violations under Section 10(b) of the Exchange Act and Section 11 of the Securities Act and seeks unspecified damages on behalf of persons who purchased Vixel stock during the period October 1, 1999 through December 6, 2000. In October 2002, the parties agreed to toll the statute of limitations with respect to Vixel’s officers and directors until September 30, 2003, and on the basis of this agreement, Vixel’s officers and directors were dismissed from the lawsuit without prejudice. During June 2003, Vixel and the other issuer defendants in the action reached a tentative settlement with the plaintiffs that would, among other things, result in the dismissal with prejudice of all claims against the defendants and their officers and directors. In connection with the possible settlement, those officers and directors who had entered tolling agreements with the plaintiffs agreed to extend those agreements so that they would not expire prior to any settlement being finalized. Although Vixel approved this settlement proposal in principle, it remains subject to a number of procedural conditions, as well as formal approval by the court.

On October 9, 2003, before the Company’s acquisition of Vixel, a purported class action lawsuit was filed in King County Superior Court of the State of Washington against Vixel and each of Vixel’s directors and certain unnamed individuals (the “Vixel Parties”), entitled Russell Fink v. Vixel Corporation, et al., Case No. 03-2-37226-9SEA. The complaint made general allegations that, among other things, Vixel’s directors breached their fiduciary duties to Vixel stockholders in connection with the approval of the merger with Emulex and sought to enjoin the tender offer and have the merger agreement declared unlawful, among other forms of relief. On November 7, 2003, the Vixel Parties entered into a memorandum of understanding for a $0.7 million settlement with the plaintiff in the class action suit pursuant to which the parties have agreed to settle the action, subject to court approval. The $0.7 million was recorded as general and administrative expense during the three months ended December 28, 2003. Formal settlement documents were signed on May 5, 2004 and the plaintiff has completed discovery as agreed to by the parties. In August 2004, final court approval was obtained for the settlement of the Fink v. Vixel litigation, and the Company paid the $0.7 million settlement. Subsequent to the quarter ended September 26, 2004, the Company received a $0.3 million reimbursement from its insurer relating to the Fink v. Vixel litigation.

Beginning on or about February 20, 2001, the Company and certain of its officers and directors were named as defendants in a number of securities class action lawsuits filed in the United States District Court, Central District of California, Case No. SACV-01-219 GLT (ANx). The plaintiffs in the actions represent purchasers of the Company’s

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common stock during various periods ranging from January 18, 2001, through February 9, 2001. The complaints alleged that the Company and certain of its officers and directors made misrepresentations and omissions in violation of sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended. The complaints generally seek compensatory damages, costs and attorney’s fees in an unspecified amount. In addition, the Company has received inquiries about events giving rise to the lawsuits from the SEC and the Nasdaq Stock Market. On April 22, 2003, the Company entered into two Memoranda of Understanding agreeing to terms of settlement for both the class action and derivative litigation. The settlement was approved and $39.5 million held in escrow was paid to the plaintiffs. Gateway Partners filed a challenge to the allocation of settlement funds, among the plaintiffs and adequacy of the settlement notice, and a hearing on such challenge was scheduled for November 22, 2004. During the three months ended March 28, 2004, the Company reached an agreement with one of its insurers, under which the Company received $10.0 million less $2.0 million previously paid by the insurer for the defense of the securities class action lawsuits, resulting in a net payment to the Company of $8.0 million. In July 2004, the Company obtained an arbitration award against two of its insurers, and subsequently collected a total of $9.5 million plus $0.3 million in interest. As the amounts received exceeded the $5.1 million receivable reflected on the Company’s books, the Company recorded a reduction in general and administrative expenses during the three months ended September 26, 2004, of $4.4 million, as well as interest income of $0.3 million.

Ongoing lawsuits present inherent risks, any of which could have a material adverse effect on the Company’s business, financial condition or results of operations. Such potential risks include the continuing expenses of litigation, counterclaims and attorneys’ fee liability.

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

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

As noted in the following table, we did not repurchase any equity securities during the three months ended September 26, 2004. However, we did repurchase 100 proximately $153.0 million of our 0.25 percent convertible subordinated notes at a discount to face value, spending approximately $137.2 million. See note 7 to the Condensed Consolidated Financial Statements contained herein for more information.

In September 2001, our Board of Directors authorized the repurchase of up to four million shares. The repurchase plan authorized us to make purchases in the open market or through privately negotiated transactions with the timing and terms of any purchase to be determined by management based on market conditions. As of September 26, 2004, a total of 2.5 million shares had been repurchased and 1.5 million shares remain available for repurchase.

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Item 6. Exhibits

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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: November 4, 2004

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INDEX TO EXHIBITS