This "Management's Discussion and Analysis of Financial Condition and Results of Operations" section should be read in conjunction with the other sections of this Annual Report on Form 10-K, including "Item 1: Business"; "Item 6: Selected Financial Data"; and "Item 8: Financial Statements and Supplementary Data." This section contains a number of forward-looking statements regarding our expectations, beliefs, intentions or strategies regarding our business, including, but not limited to, our anticipated declines in revenues from our parallel SCSI products and our serial legacy products sold to our OEM customers, the expected benefits of our recent acquisition of Aristos, the possibility that we might enter into strategic alliances, partnerships or additional acquisitions in order to scale our business, the expected impact on our future revenues of our failure to receive design wins for the next generation serial products from a significant customer, the possibility that additional significant charges may be recorded by us in the future in light of an ongoing strategic review of our business by management, the potential need to record impairment charges for other intangible assets or marketable securities based on current market conditions, the amount by which we expect to reduce our annual operating expenses due to our fiscal 2009 restructuring plans and our expected capital expenditures and liquidity in future periods. These forward-looking statements are based on our current expectations and could be affected by the uncertainties and risk factors described throughout this filing and particularly in the "Risk Factors" set forth in Part I, Item 1A of this Annual Report on Form 10-K. As a result, our actual results may differ materially from those anticipated in these forward-looking statements.

Basis of Presentation

In September 2008, we acquired Aristos, a provider of RAID technology to the data storage industry, pursuant to a Merger Agreement by and among Adaptec, Aristos, Ariel Acquisition Corp., a wholly owned subsidiary of ours, and TPG Ventures, L.P., solely in its capacity as the representative of stockholders of Aristos. The Merger Agreement provided for our acquisition of Aristos through a merger in which Aristos became our wholly-owned subsidiary. The Aristos acquisition was accounted for as a purchase business combination and, accordingly, the results of Aristos have been included in our consolidated results of operation and financial position from the date of acquisition.

In June 2008, we sold the Snap Server NAS portion of our former SSG segment, or Snap Server NAS business, to Overland Storage, Inc., or Overland. We also sold the OEM block-based portion of the systems business, to Sanmina-SCI Corporation and its wholly owned subsidiary, Sanmina-SCI USA, in January 2006, and the IBM i/p Series RAID business, to IBM in September 2005. Accordingly, we reclassified the financial statements and related disclosures for all periods presented to reflect these businesses as discontinued operations. These reclassifications had no impact on net income (loss), total assets or total stockholders' equity. Unless otherwise indicated, the following discussion pertains only to our continuing operations.

In addition, we revised our internal reporting structure in the first quarter of fiscal 2009 and now operate in one segment, in conjunction with the sale of our Snap Server NAS business in June 2008. The majority of our former SSG segment, related to the Snap Server branded file-based NAS storage systems, which were sold to end users through our network of distribution partners, solution providers, e-tailers and VARs, represented results from discontinued operations. The remaining portion of our former SSG segment, related to the block-based iSCSI storage solution products, was retained.

Overview

In fiscal 2009, our net revenues decreased 21% as compared to fiscal 2008 primarily due to the declining revenue base of our parallel SCSI products, as well as to declining sales of our serial legacy products sold to OEM customers. We expect revenues from our parallel SCSI products to continue to decline in future quarters and expect revenues from our serial legacy products sold to OEM customers to significantly decline within the next two quarters. Our gross margins in fiscal 2009 improved to 43% compared to 39% in fiscal 2008 primarily due to improved standard product contributions, favorable customer and product mixes and lower inventory-related charges. This was partially offset by the amortization of acquisition-related intangible assets. Operating expenses decreased in fiscal 2009 as compared to fiscal 2008 primarily as a result of our continued cost reductions and restructuring efforts combined with additional attrition in our workforce, partially offset by additional operating expenses incurred due to the acquisition of Aristos. Our operating results for fiscal 2009 were positively affected by tax benefits further discussed below under "Results of Operations - Income Taxes" arising from the resolution of tax disputes and the adjustment of taxes due in a prior period.

Our future revenue growth is largely dependent on the success of our new and future products, obtaining new OEM design wins, fulfilling our obligations on current OEM design wins, and growing our market share in the channel. In September 2008, we acquired Aristos for a purchase price of $38.9 million, paid an additional $1.4 million related to a management incentive pool as of March 31, 2009 and have an obligation to pay up to an additional $1.0 million related to the remaining management incentive pool, which is contingent upon the employment of certain Aristos employees. Subsequent to year-end, we paid an additional $0.7 million related to this management incentive pool. We expect that the acquisition of Aristos will allow us to expand into adjacent RAID markets that we believe provide us with opportunities for growth, including blade servers, enterprise-class external storage systems and performance desktops, and will provide us with a strong ASIC roadmap. This acquisition should also enable us to pursue new OEM opportunities and expand our future channel product offerings containing unified serial technologies. For example, in October 2008, we announced a design win from IBM for our RSP technology, which was enabled by the Aristos acquisition. However, we cannot predict the extent to which the potential benefits of this acquisition will offset the declining OEM revenue from our serial legacy products and our parallel SCSI products considering our loss in market share and the potential adverse impact on our business of current economic conditions. We will continue to seek additional growth opportunities beyond those presented by our existing product lines by entering into strategic alliances, partnerships or acquisitions of technologies or businesses in order to scale our business, and we will evaluate structural alternatives that have the potential to achieve additional stockholder return. We will also continue to evaluate our existing product portfolio, operating structure and markets to determine the future viability of our existing products and market positions. Due to the deterioration of macroeconomic conditions, which has impacted, and will likely continue to impact, information technology spending, we could experience reduced sales of our products and services over the next several quarters.

We expect our selling, marketing and administrative expense to decline in fiscal 2010 based on the anticipated cost savings we expect to obtain from the reductions in workforce we implemented in fiscal 2009. We expect our research and development expense to increase in future periods as we invest further in the development of our technology in order to pursue other opportunities. We also expect our expenses to increase in future periods as we record amortization expense for the intangible assets we acquired from the Aristos acquisition, which is recorded in "Cost of revenues" and "Amortization of acquisition- related intangible assets" in the Consolidated Statements of Operations.

In addition, in July 2008, we entered into a three-year strategic development agreement with HCL Technologies Limited, or HCL, to provide product development and engineering services for our product portfolio. Under the terms of the agreement, HCL agreed to employ certain of our former engineering employees, who will work exclusively on our engineering projects.

We implemented a restructuring plan in the first quarter of fiscal 2009 that was designed to reduce our operating expenses due to a declining revenue base, streamline our operations and better align our resources with our strategic business objectives. The total cost incurred for the first quarter of fiscal 2009 restructuring plan was $3.8 million, which was recorded in fiscal 2009. In the third quarter of fiscal 2009, we initiated additional actions to minimize expenses as our business began to be impacted by the deterioration of macroeconomic conditions. The total cost incurred for the third quarter of fiscal 2009 restructuring plan was $2.1 million, which was recorded in fiscal 2009, related to severance and benefits for employee reductions primarily in sales and marketing. The costs incurred associated with these two plans were recorded in "Restructuring charges" in the Consolidated Statements of Operations. In light of an ongoing strategic review of our business by management, additional significant restructuring or impairment charges may be recorded by us in the future.

In the fourth quarter of fiscal 2009, we recorded a goodwill impairment charge of $16.9 million, based on our annual review of goodwill, primarily due to our net book value exceeding the implied fair value, combined with a significant and continued decline in the market value of our common stock. If the deterioration of macroeconomic conditions continues to worsen and our business performance declines, we may be required to record impairment charges for other intangible assets or long-lived assets in the future. Our marketable securities may also decline in value and such decline may be deemed to be other-than-temporary, which would require us to record an impairment charge that would adversely impact our financial results.

Results of Operations

The following table sets forth the items in the Consolidated Statements of Operations as a percentage of revenues:

                                                                                    Years Ended March 31,
                                                                        ----------------------------------------
                                                                            2009          2008          2007
                                                                        ------------  ------------  ------------
Net revenues                                                                    100 %         100 %         100 %
Cost of revenues (inclusive of amortization of
   acquisition-related intangible assets)                                        57            61            66
                                                                        ------------  ------------  ------------
   Gross margin                                                                  43            39            34
                                                                        ------------  ------------  ------------
Operating expenses:
    Research and development                                                     23            23            22
    Selling, marketing and administrative                                        30            35            24
    Amortization of acquisition-related intangible assets                         1             2             2
    Restructuring charges                                                         5             4             2
    Goodwill impairment                                                          15            --            --
    Other charges (gains), net                                                   --            (2)            1
                                                                        ------------  ------------  ------------
         Total operating expenses                                                74            62            51
                                                                        ------------  ------------  ------------
Loss from continuing operations                                                 (31)          (23)          (17)
Interest and other income, net                                                   18            22            11
Interest expense                                                                 (1)           (3)           (1)
                                                                        ------------  ------------  ------------
Loss from continuing operations before income taxes                             (14)           (4)           (7)
Provision for (benefit from) income taxes                                        (2)            0           (26)
                                                                        ------------  ------------  ------------
Income (loss) from continuing operations, net of taxes                          (12)           (4)           19
                                                                        ------------  ------------  ------------
Discontinued operations, net of taxes:
    Loss from discontinued operations, net of taxes                              (1)           (3)           (8)
    Gain on disposal of discontinued operations, net of taxes                     4             0             3
                                                                        ------------  ------------  ------------
         Income (loss) from discontinued operations, net of taxes                 3            (3)           (5)
                                                                        ------------  ------------  ------------
Net income (loss)                                                                (9)%          (7)%          14 %
                                                                        ============  ============  ============


Net Revenues.


                                                                  Percentage             Percentage
                                                        FY2009      Change      FY2008     Change      FY2007
                                                     ------------ ----------   --------- ----------   ---------
                                                                     (in millions, except percentage)
Net revenues                                       $       114.8        (21)% $   145.5        (36)% $   227.1

Fiscal 2009 compared to Fiscal 2008

Net revenues decreased by $30.7 million in fiscal 2009 compared to fiscal 2008, primarily due to a decline in sales volume of our parallel SCSI products of $27.5 million and an overall decline in sales volume of our serial products sold to OEM customers of $9.3 million. This was partially offset by an increase in average selling prices and sales volumes of our serial products sold to channel customers of $6.9 million, due to increased acceptance of these products. The decline in sales volume of our parallel SCSI products was primarily attributable to the industry transition from parallel to serial products, in which we have a lower market share. The decline in sales volume of our serial legacy products sold to OEM customers was primarily attributable to the fact that certain OEM customers have moved to other suppliers to obtain the next generation serial technologies. We expect net revenues for our parallel SCSI products to continue to decline in future quarters, and expect net revenues from our serial legacy products sold to OEM customers to significantly decline within the next two quarters. However, we expect to gain future opportunities to sell serial products to OEMs, due in part to the Aristos acquisition, but our ability to capitalize on these opportunities may be adversely impacted by a reduction in IT spending as a result of current economic conditions.

Fiscal 2008 compared to Fiscal 2007

Net revenues decreased by $81.6 million in fiscal 2008 compared to fiscal 2007, primarily due to a decline in sales of our parallel SCSI products of $78.5 million, a decline of $18.3 million in sales of our legacy SATA products sold primarily to OEM customers, and to a lesser extent, a decrease of $12.6 million as we exited a business of a previous segment at March 31, 2007 due to OEMs incorporating other connectivity technologies directly into their products, the increased level of competition entering the market, and the complexities of the retail channel. This was partially offset by an increase in sales of our unified serial products of $27.8 million.

Geographical Revenues and Customer Concentration


Geographical Revenues:                                                          FY2009     FY2008      FY2007
-----------------------------------------------------------------              --------- ----------   ---------
North America                                                                        35 %       37 %        40 %
Europe                                                                               32 %       29 %        28 %
Pacific Rim                                                                          33 %       34 %        32 %
                                                                               --------- ----------   ---------
Total Revenues                                                                      100 %      100 %       100 %
                                                                               ========= ==========   =========

Our North America revenues decreased as a percentage of our total revenues by 2% in fiscal 2009 compared to fiscal 2008 primarily due to a decline in product sales to our OEM customers and to our customers shifting their third party manufacturing locations from North America to international sites, and, to a lesser extent, increased sales and acceptance of our serial products sold to our channel customers at our international locations.

Our combined international revenues increased as a percentage of total revenues to 63% in fiscal 2008 from 60% in fiscal 2007. The increase was primarily due to the release of new SATA and SAS products in the third quarter of fiscal 2008 for which the European markets had a more rapid adoption rate.

A small number of our customers account for a substantial portion of our net revenues. In fiscal 2009, IBM accounted for 36% of our total net revenues. In fiscal 2008, IBM accounted for 40% of our total net revenues. In fiscal 2007, IBM and Dell accounted for 38% and 15% of our total net revenues, respectively.

Gross Margin.


                                                                  Percentage             Percentage
                                                        FY2009      Change      FY2008     Change      FY2007
                                                     ------------ ----------   --------- ----------   ---------
                                                                     (in millions, except percentage)
Gross Profit                                       $        49.4        (13)% $    56.6        (26)%      76.4
Gross Margin                                                  43 %                   39 %                   34 %

Our gross margin is impacted by amounts recorded in cost of revenues, which primarily consists of direct product costs, manufacturing support costs, shipping and handling costs, warranty costs, inventory-related charges and amortization of acquisition-related intangible assets. The improvement in gross margin in fiscal 2009 compared to the fiscal 2008 was due to improved standard product contributions as a result of our end-to-end supply chain efficiencies and a reduction to our inventory-related charges by $3.8 million. In addition, the improvement in gross margins was also due to a shift in revenue mix from OEM to channel customers, with channel customers having higher average margins, and a favorable product mix in the channel. This was offset by the amortization of acquisition-related intangible assets of $2.5 million related to the purchased intangible assets for core and existing technologies and backlog from the acquisition of Aristos.

The improvement in gross margin in fiscal 2008 compared to fiscal 2007 was due to improved standard product contributions as a result of our continued focus on product component costs, including the impact of favorable pricing negotiations with our suppliers and efficiencies gained with our contract manufacturer. We also experienced favorable product mix, primarily driven by an increase in channel versus OEM revenue. Our inventory-related charges also decreased by $4.8 million in fiscal 2008 compared to fiscal 2007. This was partially offset by certain operational costs that are relatively fixed being spread over a smaller revenue base.

Research and Development Expense.


                                                                  Percentage             Percentage
                                                        FY2009      Change      FY2008     Change      FY2007
                                                     ------------ ----------   --------- ----------   ---------
                                                                     (in millions, except percentage)
Research and Development Expense                   $        26.9        (21)% $    34.0        (31)% $    49.5

Research and development expenses primarily consist of salaries and related costs of employees engaged in ongoing research, design and development activities and subcontracting costs. Our investment in research and development primarily focuses on developing new products for external storage, storage software and server storage markets. We also invest in research and development of new technologies, including iSCSI, SATA and SAS. A portion of our research and development expense fluctuates depending on the timing of major project costs such as prototype costs. Although we have experienced declines in research and development expense from fiscal 2007 to fiscal 2009, we expect our research and development expense to increase in future periods as we invest further in the development of our technology in order to pursue other opportunities.

The decrease in research and development expense in fiscal 2009 compared to fiscal 2008 was primarily due to reduced headcount and related expenses as a result of restructuring programs implemented in fiscal 2008 and fiscal 2009, combined with additional attrition in our workforce, which was reflected by a 52% decrease in our direct headcount for employees engaged in research and development. A portion of this reduction in direct headcount includes the former employees that were transferred to HCL. The headcount reductions in research and development also resulted in lower stock-based compensation expense of $2.0 million in fiscal 2009 compared to fiscal 2008. This was partially offset by compensation expense of $0.9 million recorded in fiscal 2009, related to the management liquidation pool established for certain former employees of Aristos pursuant to the Merger Agreement. We also incurred costs with the development of our technology to achieve new OEM design wins and to expand our channel offerings.

The decrease in research and development expense in fiscal 2008 compared to fiscal 2007 was primarily due to reduced headcount and related expenses as a result of restructuring programs implemented in fiscal years 2007 and 2008 combined with additional attrition in our workforce. This resulted in a 25% decrease in our average headcount for employees engaged in research and development. We also decreased our infrastructure spending, had fewer engineering projects outstanding and had lower stock-based compensation expense of $1.0 million in fiscal 2008 compared to fiscal 2007, primarily as a result of the decrease in headcount.

Selling, Marketing and Administrative Expense.


                                                                  Percentage             Percentage
                                                        FY2009      Change      FY2008     Change      FY2007
                                                     ------------ ----------   --------- ----------   ---------
                                                                     (in millions, except percentage)
Selling, Marketing and
    Administrative Expense                         $        35.0        (31)% $    50.4         (8)% $    54.9

Our selling, marketing and administrative expense consists primarily of salaries, including commissions. We expect our selling, marketing and administrative expense to decline in fiscal 2010 based on the anticipated cost savings we expect to obtain from the reductions in workforce we implemented in fiscal 2009.

The decrease in selling, marketing and administrative expense in fiscal 2009 compared to fiscal 2008 was primarily a result of reductions in our workforce and infrastructure spending due to the restructuring plans we implemented in fiscal 2008 and fiscal 2009, which resulted in a 39% decrease in our average headcount for employees engaged in selling, marketing and administrative functions. The headcount reductions also resulted in lower stock-based compensation expense of $0.9 million in fiscal 2009 compared to fiscal 2008. This was partially offset by compensation expense of $1.1 million related to the management liquidation pool established for certain former employees of Aristos pursuant to the Merger Agreement.

The decrease in selling, marketing and administrative expense in fiscal 2008 compared to fiscal 2007 was primarily a result of reductions of our workforce and infrastructure spending as a result of the restructuring plans we implemented in fiscal years 2007 and 2008, which resulted in a 18% decrease in our average headcount for employees engaged in selling, marketing and administrative functions. In addition, we had lower stock-based compensation expense of $0.4 million in fiscal 2008 compared to fiscal 2007 primarily due to the reduction in headcount.

Amortization of Acquisition-Related Intangible Assets.


                                                                  Percentage             Percentage
                                                        FY2009      Change      FY2008     Change      FY2007
                                                     ------------ ----------   --------- ----------   ---------
                                                                     (in millions, except percentage)
Amortization of Acquisition-
  Related Intangible Assets                        $         0.8        (70)% $     2.5        (56)% $     5.7

Acquisition-related intangible assets include patents, core and existing technologies, customer relationships, trade names, and backlog. We amortize the acquisition-related intangible assets over periods which reflect the pattern in which the economic benefits of the assets are expected to be realized, which is primarily using the straight-line method over their estimated useful lives, ranging from three to sixty months.

The decrease in amortization of acquisition-related intangible assets in fiscal 2009 compared to fiscal 2008 was primarily due to the fact that in the fourth quarter of fiscal 2008, we wrote off our intangible assets associated with our acquisition of Elipsan Limited due to a revision in our forecasts that resulted in expected negative long-term cash flows for these assets for the first time. This was offset by the amortization of purchased intangible assets from the Aristos acquisition for customer relationships of $0.8 million, which was recorded in fiscal 2009. The amortization of purchased intangible assets from the Aristos acquisition for the core and existing technologies and backlog were reflected in cost of revenues.

The decrease in amortization of acquisition-related intangible assets in fiscal . . .