Summary of EMULEX CORP /DE/

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, those in the section entitled "Risk Factors" in Part II, Item 1A of this Form 10-Q included elsewhere herein. We expressly disclaim any obligation or undertaking to release publicly any updates or changes to these forward-looking statements that may be made to reflect any future events or circumstances. We wish to caution readers that a number of important factors could cause actual results to differ materially from those in the forward-looking statements. The fact that the uncertainty of the economy generally, and the technology and storage segments specifically, have been in a state of uncertainty makes it difficult to determine if past experience is a good guide to the future and makes it impossible to determine if markets will grow or shrink in the short term. The recent economic downturn and the resulting economic uncertainty for our customers and the storage networking market as a whole has resulted in a decrease in information technology spending that has and could continue to adversely affect our revenues and results of operations. Furthermore, the effect of any actual or potential unsolicited offers to acquire us may have an adverse effect on our operations. As a result of this uncertainty, we are unable to predict with any accuracy what future results might be. Other factors affecting these forward-looking statements include, but are not limited to, the following: slower than expected growth of the storage networking market or the failure of our Original Equipment Manufacturer (OEM) customers to successfully incorporate our products into their systems; our dependence on a limited number of customers and the effects of the loss of, 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 and seasonal procurement patterns of our customers; impairment charges, including but not limited to goodwill and intangible assets; changes in tax rates or legislation; the effects of terrorist activities, natural disasters and any 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; the effect of rapid migration of customers towards newer, lower cost product platforms; possible transitions from board or box level to application specific computer chip solutions for selected applications; a shift in unit product mix from higher-end to lower-end or mezzanine card 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; our ability to attract and retain key technical personnel; our ability to benefit from our research and development activities; our dependence on international sales and internationally produced products; the effect of acquisitions; changes in accounting standards; and the potential effects of global warming and any resulting regulatory changes on our business. These and other factors which could cause actual results to differ materially from those in the forward-looking statements are discussed elsewhere in this Form 10-Q, in our other filings with the Securities and Exchange Commission or in materials incorporated therein by reference.

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Executive Overview
Emulex creates enterprise-class products that connect storage, servers and networks. We are a leading supplier of a broad range of advanced storage networking convergence solutions. The world's leading server and storage providers depend on our products to help build high performance, highly reliable, and scalable storage networking solutions. Our products and technologies leverage flexible multi protocol architectures that extend from deep within the storage array to the server edge of storage area networks (SANs). Our host server products include host bus adapters (HBAs), converged network adapters (CNAs), mezzanine cards for blade servers, embedded storage bridges, routers and switches, storage Input/Output controllers (IOCs), and data center networking solutions. HBAs, CNAs, and mezzanine cards 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. Our embedded storage products include bridges, routers and switches, and IOCs, which are deployed inside storage arrays, tape libraries and other storage appliances.
Our Company operates within a single business segment that has two market focused product lines - Host Server Products (HSP) and Embedded Storage Products (ESP). HSP includes both Fibre Channel based connectivity products and Enhanced Ethernet based products that support Internet Protocol (IP) and storage networking, including Transmission Control Protocol (TCP)/IP, Internet Small Computer System Interface (iSCSI), Network Attached Storage (NAS) and Fibre Channel over Ethernet (FCoE). Our Fibre Channel based products include LightPulse® Host Bus Adapters (HBA), custom form factor solutions for OEM blade servers and ASICs. These products enable servers to efficiently connect to SANs by offloading data communication processing tasks from the server as information is delivered and sent to the storage network. Our Enhanced Ethernet based products include OneConnect Universal Converged Network Adapters (UCNAs) that enable true network convergence.
ESP includes our InSpeed®, FibreSpy®, IOC solutions, switch-on-a-chip (SOC) and bridge and router products. Embedded storage switches, bridges, routers, and IOCs are deployed inside storage arrays, tape libraries, and other storage appliances, connect storage controllers to storage capacity delivering improved performance, reliability, and storage connectivity.
Our Other category primarily consists of contract engineering services, legacy and other products.
We rely almost exclusively on OEMs and sales through distribution channels for our revenue. Our OEM customers include the world's leading server and storage providers, including Dell Inc. (Dell), EMC Corporation (EMC), Fujitsu Ltd. (Fujitsu), Groupe Bull (Bull), Hewlett-Packard Company (Hewlett-Packard), Hitachi Data Systems (HDS), Hitachi Limited (Hitachi), International Business Machines Corporation (IBM), LSI Corporation (LSI), NEC Corporation (NEC), Network Appliance, Inc. (NetApp), Quantum Corporation (Quantum), Sun Microsystems, Inc. (Sun), Unisys Corporation (Unisys), and Xyratex Ltd. (Xyratex). Our distribution partners include Arrow ECS Denmark A/S (Arrow), Avnet, Inc. (Avnet), Bell Microproducts, Ltd. (Bell), Info X Distribution, LLC (Info X), Ingram Micro Inc. (Ingram Micro), Macnica Networks Corporation (Macnica), Netmarks Inc. (Netmarks), Tech Data Corporation (Tech Data), and Tokyo Electron Device Ltd. (TED). The market for storage networking infrastructure solutions is concentrated among large OEMs, and as such, a significant portion of our revenues are generated from sales to a limited number of customers.
The recent economic downturn and related economic uncertainty for our customers and the storage networking market as a whole has resulted in a downturn in information technology spending that has and could continue to adversely affect our revenues and results of operations. As a result of this uncertainty, we plan to continue to closely manage our controllable expenses while investing in research and development, sales and marketing, capital equipment, and facilities in order to achieve our growth and market leadership goals. As of September 27, 2009, we had a total of 772 employees.
Our corporate headquarters are located at 3333 Susan Street, Costa Mesa, California 92626. Our periodic and current reports filed with, or furnished to, the Securities and Exchange Commission pursuant to the requirements of the Securities and Exchange Act of 1934 are available free of charge through our website (www.emulex.com) as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the Securities and Exchange Commission. References contained herein to "Emulex," the "Company," the "Registrant," "we," "our," and "us" refer to Emulex Corporation and its subsidiaries.

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Global Initiatives
As part of our global initiatives, we created an Irish subsidiary to expand our international operations by providing local customer service and support to our customers outside of the United States in the fourth quarter of fiscal 2008. In addition, Emulex granted an intellectual property license and entered into a research and development cost sharing agreement with a newly formed subsidiary in the Isle of Man. The terms of the license require, among other matters, that the subsidiary make prepayments of expected royalties to a U.S. subsidiary, the first of which was paid before the end of fiscal 2008 in the amount of approximately $131.0 million, for expected royalties relating to fiscal 2009 through 2015. These global initiatives are expected to significantly reduce our effective tax rate beginning with fiscal 2010.
Our cash balances and investments are held in numerous locations throughout the world. The cash and investments held outside of the U.S. are expected to increase, primarily in our Isle of Man and Ireland subsidiaries. Substantially all of the amounts held outside of the U.S. will be available for repatriation at any time, but under current law, repatriated funds would be subject to U.S. federal income taxes, less applicable foreign tax credits. Results of Operations
The following discussion and analysis should be read in conjunction with the condensed consolidated financial statements included elsewhere herein.

                                                  Percentage of Net Revenues
                                                      Three Months Ended
                                             September 27,           September 28,
                                                 2009                    2008
  Net revenues                                          100 %                   100 %
  Cost of sales                                          39                      37

  Gross profit                                           61                      63

  Operating expenses:
  Engineering and development                            37                      31
  Selling and marketing                                  15                      13
  General and administrative                             14                       9
  Amortization of other intangible assets                 2                       2

  Total operating expenses                               68                      55

  Operating (loss) income                                (7 )                     8

  Nonoperating income, net:
  Interest income                                         -                       2
  Interest expense                                        -                       -
  Other income, net                                       -                       -

  Total nonoperating income, net                          -                       2

  (Loss) income before income taxes                      (7 )                    10

  Income tax (benefit) provision                        (11 )                     3

  Net income                                              4 %                     7 %

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Three months ended September 27, 2009, compared to three months ended September 28, 2008
Net Revenues. Net revenues for the first quarter of fiscal 2010 ended September 27, 2009, decreased by approximately $26.2 million, or 23%, to approximately $85.5 million, compared to approximately $111.7 million for the same quarter of fiscal 2009 ended September 28, 2008. We believe the decrease in net revenues was due primarily to a downturn in information technology spending resulting from the recent global economic downturn and related economic uncertainty for our customers and the storage networking market as a whole.

Net Revenues by Product Line From a product line perspective, the majority of our net revenues were generated from our HSPs for the three months ended September 27, 2009 and September 28, 2008. The following chart details our net revenues by product line for the periods in question:

                                                                    Net Revenues by Product Line
                               Three Months                          Three Months
                                  Ended            Percentage           Ended            Percentage
                              September 27,          of Net         September 28,          of Net          Increase/        Percentage
(in thousands)                     2009             Revenues             2008             Revenues        (Decrease)          Change
Host Server Products          $       64,145                75 %    $       81,203                73 %    $   (17,058 )             (21 %)
Embedded Storage Products             21,274                25 %            30,364                27 %         (9,090 )             (30 %)
Other                                    108                 -                 129                 -              (21 )             (16 %)

Total net revenues            $       85,527               100 %    $      111,696               100 %    $   (26,169 )             (23 %)

HSP consists of HBAs, mezzanine cards, I/O ASICs, and UCNAs. For the three months ended September 27, 2009, our Fibre Channel based products still accounted for the vast majority of our HSP revenues. The decrease in our HSP net revenue for the three months ended September 27, 2009 compared to the three months ended September 28, 2008 was mainly due to a decrease of approximately 15% in units shipped combined with a decrease of approximately 7% in average selling price.
ESP primarily consists of our InSpeed®, FibreSpy®, input/output controller solutions, and bridge and router products. The decrease in our ESP net revenue the three months ended September 27, 2009 compared to the three months ended September 28, 2008 was primarily due to a decrease in units shipped of approximately 29% combined with a decrease in average selling price of approximately 2%.
Our Other category primarily consists of contract engineering services, legacy and other products.

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

                                                                         Net Revenues by Major Customers
                                                      Direct Revenues                      Total Direct and Indirect Revenues (2)
                                             Three Months         Three Months             Three Months                 Three Months
                                                Ended                Ended                    Ended                         Ended
                                            September 27,        September 28,            September 27,                 September 28,
                                                 2009                 2008                     2009                         2008
Net revenue percentage (1):
OEM:
EMC                                                      -                    -                           11 %                      13 %
Hewlett-Packard                                         14 %                 16 %                         15 %                      16 %
IBM                                                     24 %                 22 %                         34 %                      29 %
Other:
Info X                                                   -                   10 %                          -                         -

(1) Amounts less than 10% are not presented.

(2) Customer-specific models purchased or marketed indirectly through distributors, resellers, and other third parties are included with the OEM's revenues in these columns rather than as revenue for the distributors, resellers or other third parties.

Direct sales to our top five customers accounted for approximately 60% of total net revenues for the three months ended September 27, 2009, compared to approximately 61% for the three months ended September 28, 2008. Our net revenues from customers can be significantly impacted by changes to our customers' business and their business models.

Net Revenues by Sales Channel From a sales channel perspective, net revenues generated from OEM customers were approximately 85% of net revenues and sales through distribution were approximately 15% for the three months ended September 27, 2009, compared to approximately 78% and approximately 22%, respectively, for the three months ended September 28, 2008. The increase in OEM net revenues as a percentage of total net revenues was mainly due to our customers migrating from purchasing our products through the distribution channel toward purchasing our products through OEM server manufacturers. Net revenues by sales channel were as follows:

                                                                    Net Revenues by Sales Channel
                               Three Months                          Three Months
                                  Ended            Percentage           Ended            Percentage
                              September 27,          of Net         September 28,          of Net          Increase/        Percentage
(in thousands)                     2009             Revenues             2008             Revenues        (Decrease)          Change
OEM                           $       72,287                85 %    $       87,511                78 %    $   (15,224 )             (17 %)
Distribution                          13,211                15 %            24,118                22 %        (10,907 )             (45 %)
Other                                     29                 -                  67                 -              (38 )             (57 %)

Total net revenues            $       85,527               100 %    $      111,696               100 %    $   (26,169 )             (23 %)

We believe that our net revenues are being generated primarily as a result of product certifications and qualifications with our OEM customers, which take products directly and indirectly through distribution and contract manufacturers. We view product certifications and qualifications as an important indicator of future revenue opportunities and growth for the Company. However, product certifications and qualifications do not necessarily ensure continued market acceptance of our products by our OEM customers. It is also very difficult to determine the future impact, if any, of product certifications and qualifications on our revenues.

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Net Revenues by Geographic Territory For the three months ended September 27, 2009, United States net revenues decreased by approximately $13.0 million to approximately $26.8 million from approximately $39.8 million in the three months ended September 28, 2008. For the three months ended September 27, 2009, international net revenues (Asia Pacific, Europe, Middle East, Africa and rest of the world) decreased by approximately $13.1 million to approximately $58.8 million from approximately $71.9 million in the three months ended September 28, 2008. Our net United States and international revenues based on billed-to location were as follows:

                                                             Net United States and International Revenues
                                Three Months                          Three Months
                                   Ended            Percentage           Ended            Percentage
                               September 27,          of Net         September 28,          of Net          Increase/        Percentage
(in thousands)                      2009             Revenues             2008             Revenues        (Decrease)          Change
United States                  $       26,766                31 %    $       39,799                36 %    $   (13,033 )             (33 %)
Asia Pacific                           29,166                34 %            32,474                29 %         (3,308 )             (10 %)
Europe, Middle East, Africa            29,595                35 %            39,423                35 %         (9,828 )             (25 )%
and rest of the world

Total net revenues             $       85,527               100 %    $      111,696               100 %    $   (26,169 )             (23 %)

We believe the decrease, as a percentage of net revenues, in United States net revenues and international net revenues for the three months ended September 27, 2009 compared to the three months ended September 28, 2008 was primarily due to an increase in products being sourced by our customers to locations outside of the United States combined with a global economic slowdown that has resulted in decreased spending in general, and in the technology sector specifically. However, as 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. Gross profit consists of net revenues less cost of sales. Our gross profit for the three months ended September 27, 2009 and September 28, 2008 were as follows (in thousands):

                                              Gross Profit
 Three Months                      Three Months
    Ended          Percentage         Ended           Percentage
September 27,        of Net       September 28,         of Net         Increase/        Percentage
     2009           Revenues           2008            Revenues       (Decrease)       Points Change
$       52,106             61 %   $       69,952               63 %   $   (17,846 )                (2 )%

Cost of sales includes the cost of producing, supporting, and managing our supply of quality finished products. Cost of sales also included approximately $5 million of amortization of technology intangible assets for both the three months ended September 27, 2009 and September 28, 2008. Approximately $0.4 million and $0.3 million of share-based compensation expense was included in cost of sales for the three months ended September 27, 2009 and September 28, 2008, respectively. Gross margin decreased during the three months ended September 27, 2009 due to the loss of efficiencies resulting from lower manufacturing volume combined with a decline in average sales prices. We anticipate gross margin will trend downward over time as faster growing, lower gross margin products such as mezzanine cards for blade servers and embedded storage products become a bigger portion of our business.
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 service costs related to supporting computer tools used in the design process. Expenses for the three months ended September 27, 2009 and September 28, 2008 were as follows (in thousands):

                                      Engineering and Development
 Three Months                       Three Months
    Ended          Percentage          Ended           Percentage
September 27,        of Net        September 28,         of Net         Increase/        Percentage
     2009           Revenues            2008            Revenues       (Decrease)       Points Change
$       31,399             37 %    $       34,783               31 %   $    (3,384 )                 6 %

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Engineering and development expenses for the three months ended September 27, 2009 compared to the three months ended September 28, 2008 decreased approximately $3.4 million, or 10%. Approximately $2.5 million and $3.1 million of share-based compensation expense was included in engineering and development costs for the three months ended September 27, 2009 and September 28, 2008, respectively. As a result of organizational changes in fiscal 2009, engineering and development headcount decreased to 455 at September 27, 2009 from 464 at September 28, 2008. The decrease in headcount resulted in a net decrease of approximately $1.9 million in salary and related expenses as compared to the same period in fiscal 2009. Severance and related expenses in the current year decreased by approximately $1.1 million compared to the same period in the prior year, offset by an increase in nonrecurring engineering, prototypes, and related . . .