News Column

EMULEX CORP /DE/ - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations.

August 28, 2014

The following discussion and analysis should be read in conjunction with the "Selected Financial Data" included in Part I, Item 6, and the consolidated financial statements and the accompanying notes included in Part IV, Item 15 of this Annual Report on Form 10-K. This discussion and analysis contains certain forward-looking statements. The realization of which may be impacted by various factors including, but not limited to, the "Risk Factors" included in Part I, Item 1A of this Annual Report on Form 10-K. Executive Overview Emulex designs and markets high speed network connectivity, monitoring, and management products, providing solutions for global networks that support enterprise, cloud, government and telecommunications and enable end-to-end application visibility, optimization and acceleration in the data center. The world's leading server and storage OEMs depend on our broad range of products to help build high performance, highly reliable, and scalable Fibre Channel Storage Area Networks (SAN) and Ethernet Converged Networking solutions, and our products can be found in the data centers of nearly all Fortune 1000. Our monitoring and management solutions, including our portfolio of network visibility and recording products, provide organizations with complete network performance management at speeds up to 100 Gb Ethernet. With our acquisition of Endace, we have two business operating segments consisting of three product lines. Our Connectivity Segment consists of our legacy Emulex products and includes Network Connectivity Products (NCP) and Storage Connectivity and Other Products (SCOP). Our Visibility Segment consists of our Network Visibility Products (NVP) that were acquired through the Endace acquisition. Customers in the NCP market use our industry standard Fibre Channel and Ethernet solutions to provide server Input/Output (I/O) and target storage array connectivity to create networks for mission-critical enterprise and cloud data centers. These products enable servers to reliably and efficiently connect to Local Area Networks (LANs), SANs, and Network Attached Storage (NAS) by offloading data communication processing tasks from the server as information is delivered and sent to the network. Our products use industry standard protocols including Fibre Channel Protocol (FCP), Internet Protocol (IP), Transmission Control Protocol (TCP)/IP, internet Small Computer System Interface (iSCSI), NAS, and Fibre Channel over Ethernet (FCoE). Our Ethernet products include our OneConnect® Converged Network Adapters (CNAs), Local Area Network on Motherboard (LOM) application specific integrated circuits, and custom form factor solutions for OEM blade servers that enable high performance, scalable networks and convergence. Our Fibre Channel based products include LightPulse® Host Bus Adaptors (HBAs), Fibre Channel application specific integrated circuits (ASICs), and custom form factor solutions for OEM blade servers. SCOP includes our InSpeed®, switch-on-a-chip (SOC) and backend connectivity, bridge, router products, Pilot™ Integrated Baseboard Management Controllers (iBMC), certain legacy products and other products and services. SCOP is deployed inside storage arrays, tape libraries, and other storage appliances, and connect storage controllers to storage capacity, delivering improved performance, reliability, and connectivity. SCOP uses industry standard protocols including Fibre Channel, Serial Attached Small Computer Interface (SAS), and Serial Advanced Technology Attachment (SATA), and support the broadest range of Hard Disk Drive (HDD) and Solid State Disk (SSD) technologies. NVP consists entirely of the recently acquired Endace® family of network visibility and recording infrastructure products that address NRM for high speed networks. Our NVP products include EndaceProbe™ Intelligent Network Recorder, 31 -------------------------------------------------------------------------------- EndaceVision™, EndaceODE™ Open Application Platform, EndaceAccess™ Network Visibility Head-End system, EndaceFlow™ NetFlow Generator Appliance and EndaceDAG Data Capture Cards. We rely almost exclusively on OEMs and sales through distribution partners for our Networking segment revenue and sales to end-users and through distribution partners for our Visibility segment revenue. Our significant OEM customers include the world's leading server and storage providers, including Cisco, Dell, EMC, Fujitsu, HDS, Hewlett-Packard, Hitachi, Huawei, Intel, IBM, NEC, NetApp, Oracle, and Xyratex. Our significant distributors include ASI, Avnet, BT, Digital China Technology Limited, Info X, Ingram Micro, Macnica, Netmarks, SYNNEX, Tech Data, and TED. The market for networking infrastructure solutions is concentrated among large OEMs, and as such, a significant portion of our revenues are generated from sales to a limited number of customers. As of June 29, 2014, we had a total of 1,122 employees. We use a 52 to 53 week fiscal year that ends on the Sunday nearest to June 30. Therefore, every fifth or sixth fiscal year will be a 53-week fiscal year. The last 53 week fiscal year was fiscal 2011. Exit and Disposal Activities During the fourth quarter of fiscal 2014, we recorded restructuring charges of approximately $1.1 million, primarily consisting of workforce reductions. The severance related charges are expected to be substantially paid in cash by the first quarter of fiscal 2015. During the second quarter of fiscal 2014, we initiated a restructuring plan designed to streamline business operations and reduce operating expenses. The restructuring actions include a reduction in workforce of approximately 15%, the consolidation of certain engineering facilities, and the closure of our Bolton, Massachusetts facility. The total restructuring charge was approximately $8.1 million. During the fourth quarter of fiscal 2013, we took certain actions with respect to our operations, primarily consisting of workforce reductions, and recorded approximately $2.7 million in severance costs during fiscal 2013, the majority of which was paid in July 2013. See Note 8, "Restructuring," in the notes to consolidated financial statements in Part IV, Item 15(a) of this Annual Report on Form 10-K for details of the restructuring actions taken during fiscal 2014 and 2013. Business Combinations On February 26, 2013, we acquired 89.6% of the outstanding common stock and all of the outstanding stock options of Endace for cash consideration of approximately $110.4 million. As of April 25, 2013, we had acquired the outstanding noncontrolling interest for approximately $12.0 million and obtained 100% ownership of Endace. Our consolidated financial statements include the results of operations for Endace commencing as of the acquisition date. Emulex's software-defined convergence architecture and Endace's network visibility infrastructure are expected to provide customers with new and innovative ways to solve the challenges of network complexity and ensure application-level performance at speeds of 10Gb and beyond. Endace was a New Zealand based company that was publicly traded on London AIM Stock Exchange as of February 26, 2013, and subsequently delisted effective March 27, 2013. Endace provides network visibility infrastructure including network monitoring appliances, network analytics software and ultra-high speed network access switching. Emulex's software-defined convergence architecture and Endace's network visibility infrastructure are expected to provide customers with new and innovative ways to solve the challenges of network complexity and ensure application-level performance at speeds of 10Gb and beyond. The ability of Endace's network visibility technology to record, visualize and monitor network traffic provides customers with the ability to dynamically optimize application delivery across the infrastructure. The combination of Emulex's and Endace's technology is expected to provide customers the solutions to connect, monitor and manage high-performance networks. Product Redesign Activities and Potential Royalty Obligations Broadcom Corporation (Broadcom) filed a consolidated patent infringement suit against us during fiscal 2010. After a nearly three week trial that ended October 6, 2011, the jury reached a partial verdict involving two out of the six patents. The Court determined that one of the patents (U.S. Patent 7,058,150) [the '150 patent] had been infringed by us, and the jury rendered an advisory verdict on October 12, 2011 to the Court that it is not invalid, and awarded approximately $0.4 million in damages with respect to that patent. The jury reached a unanimous verdict of non-infringement on another patent relating to Emulex Fibre Channel switch products. A mistrial was declared concerning the remaining four patents for which no unanimous verdict was reached. On December 15, 2011, the Court issued judgments as a matter of law (JMOL) that the two patents, on 32 -------------------------------------------------------------------------------- which the jury had rendered advisory verdicts, were not invalid. On December 16, 2011, the Court issued an additional JMOL that one of the patents (U.S. Patent 7,471,691) [the '691 patent] had been infringed by us. On March 16, 2012, the Court issued a decision concerning injunctive relief for the '150 and the '691 patents. The decision provided, in part, for a sunset period of 18 months relating to the '150 patent, starting on October 12, 2011. The decision further provided for a sunset period of 18 months relating to the '691 patent, starting on December 16, 2011. The sunset period allows us to sell the affected products to existing customers for specific customer devices, subject to limitations relating to when the products had been qualified and when certain firm orders had been placed. On April 3, 2012, the Court issued a permanent injunction (2012 Permanent Injunction) which, with respect to both the '150 and the '691 patents, further describes the prohibited activities, contains sunset provision terms including royalty rates and computations, limits the territory to allow sales of products that are manufactured outside the U.S. to customers located outside the U.S., permits design around efforts including modifications and design, development, and testing to eliminate infringement, and permits service and technical support for certain products. Through June 29, 2014, we have incurred approximately $21.7 million, in mitigation, product redesign and appeal related expenses of which approximately $4.5 million, $8.6 million and $3.6 million were recorded during fiscal 2014, 2013, and 2012, respectively. The Company expects to incur incremental mitigation, product redesign, and appeal related expenses during fiscal 2015 up to $1 million, to be recorded within operating expenses. Engineering and development costs will include expenses for activities to redesign, design around, modify, design, develop, test and requalify certain of our affected products during the sunset period, and to implement our end of life processes in the U.S. for certain other affected products. Sales and marketing costs are likely to include expenses for customer support, pre-production samples, education and training, and other miscellaneous costs. In addition, we have agreed to participate in certain customer royalty obligations arising under their licensing agreements with Broadcom related to certain Emulex infringing products. Through June 29, 2014, the Company has recorded approximately $4.4 million in cost of sales related to such customer obligations, of which approximately $3.4 million and $0.9 million related to such payments were recorded to cost of sales in fiscal 2014 and 2013, respectively. The Company may incur additional amounts related to these obligations of approximately $5 million in future periods, all of which will reduce gross margins in the periods accrued. Effective March 30, 2014, Emulex and Broadcom entered into a Dismissal and Standstill Agreement (the "Dismissal Agreement") pursuant to which Emulex and Broadcom entered into certain understandings with respect to the outstanding claims relating to and arising out of the patent infringement suit. Pursuant to the terms of the Dismissal Agreement, we agreed to pay Broadcom a non-refundable, non-cancelable dismissal and standstill fee in the amount of $5 million reflected in the accompanying financial statements in General and Administrative expense. See Note 10 "Commitments and Contingencies," in the notes to the consolidated financial statements under the caption "Litigation" in Part IV, Item 15(a) of this Annual Report on Form 10-K for additional information. Results of Operations for Emulex Corporation and Subsidiaries The following discussion and analysis should be read in conjunction with the selected consolidated financial data set forth in Item 6 - "Selected Consolidated Financial Data," and our Consolidated Financial Statements and notes thereto included elsewhere in this Annual Report on Form 10-K. All references to years refer to our fiscal years ended June 29, 2014, June 30, 2013 and July 1, 2012, as applicable, unless the calendar year is specified. The following table sets forth certain financial data for the years indicated as a percentage of net revenues. 33 --------------------------------------------------------------------------------

Percentage of Net Revenues 2014 2013 2012 Net revenues: Network Connectivity Products 71 % 75 % 72 % Storage Connectivity & Other Products 21 22 28 Network Visibility Products 8 3 - Total net revenues 100 100 100 Cost of sales: Cost of goods sold 34 36 37 Amortization of core and developed technology intangible assets 6 5 5 Patent litigation settlement, damages and sunset period royalties 2 1 7 Total cost of sales 42 42 49 Gross profit 58 58 51 Operating expenses: Engineering and development 35 35 33 Selling and marketing 17 14 12 General and administrative 9 8 7 Amortization of other intangible assets 1 1 1 Total operating expenses 62 58 53 Operating (loss) income (4 ) - (2 ) Non-operating (expense) income, net: Interest income - - - Interest expense (1 ) - - Impairment of strategic investment - - - Other (expense) income, net - (1 ) - Total non-operating (expense) income, net (1 ) (1 ) - (Loss) income before income taxes (5 ) (1 ) (2 ) Income tax benefit (provision) (1 ) - - Net (loss) income (6 )% (1 )% (2 )% Fiscal 2014 versus Fiscal 2013 Net Revenues. Net revenues for fiscal 2014 decreased approximately $31.2 million, or 7%, to approximately $447.3 million, compared to approximately $478.6 million in fiscal 2013. Net Revenues by Product Line The following chart details our net revenues by product line for fiscal 2014 and fiscal 2013: Net Revenues by Product Line Percentage of Percentage of Increase/ Percentage 2014 Net Revenues 2013 Net

Revenues (Decrease) Change (Dollars in thousands) Net revenues: Connectivity Segment: Network Connectivity Products $ 318,940 71 % $ 360,974 75 % $ (42,034 ) (12 )% Storage Connectivity & Other Products 94,515 21 % 104,409 22 % (9,894 ) (9 )% Total Connectivity Segment 413,455 92 % 465,383 97 % (51,928 ) (11 )% Visibility Segment: Network Visibility Products 33,878 8 % 13,184 3 % 20,694 NM Total net revenues $ 447,333 100 % $ 478,567 100 % $ (31,234 ) (7 )% 34

-------------------------------------------------------------------------------- Connectivity segment revenues decreased by approximately 11% in fiscal 2014 compared to fiscal 2013. The decrease in revenues was primarily due to weakness in the UNIX server and high-end storage markets. NCP primarily consists of standup HBAs, mezzanine cards, I/O ASICs, LOMs, and UCNAs. Within NCP, Fibre Channel based product revenues accounted for the majority, ranging from 70% - 80% of total NCP revenues. Fibre Channel based product revenue decreased by approximately 16% reflecting a decrease in units shipped of approximately 13% and a decrease in average selling price of approximately 3%. The decrease in Fibre Channel based product revenues was partially offset by an increase in Ethernet based product revenues. The increase in Ethernet based product revenues of approximately 3% reflects an increase in average selling price of approximately 8% and a decrease in units shipped of approximately 5%. SCOP primarily consists of our InSpeed®, SOC and backend connectivity, bridge and router products, iBMCs, certain legacy products and other products and services. Our SCOP revenues decreased by approximately $9.9 million, or 9%, in fiscal 2014 compared to fiscal 2013, due to products entering the end-of-life phase. Revenue from backend connectivity products decreased approximately 19% and revenue from bridging products decreased approximately 8%. The Visibility segment resulted from our acquisition of Endace on February 26, 2013 and consists solely of NVP. NVP revenues in fiscal 2014 were approximately $33.9 million compared to $13.2 million during the four months from the acquisition date to the end of fiscal 2013, and include network visibility and intelligent network recording products. 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 fiscal year net revenues were as follows: Net Revenues by Major Customers Direct Total Direct and Revenues Indirect Revenues(2) 2014 2013 2014 2013 Net revenue percentage(1) OEM: EMC - - 10 % 11 % Hewlett-Packard 16 % 19 % 22 % 23 % Hon Hai Precision Industry Co., Ltd. (Foxconn Technology Group)(3) 13 % 12 % - - IBM 29 % 32 % 33 % 35 %



(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. (3) Hon Hai Precision Industry Co., Ltd. is a contract manufacturer that performed manufacturing for some of our OEM customers. Direct sales to our top five customers accounted for approximately 65% and 71% of total net revenues for fiscal years 2014 and 2013, respectively. Direct and indirect sales to our top five customers accounted for approximately 76% and 81% of total net revenues for fiscal years 2014 and 2013, respectively. Our net revenues from customers can be significantly impacted by changes to our customers' business and their business models. Net Revenues by Sales Channel



Net revenues by sales channel were as follows:

35 --------------------------------------------------------------------------------

Net Revenues by Sales Channel Percentage of Percentage of Increase/ Percentage 2014 Net Revenues 2013 Net Revenues (Decrease) Change (Dollars in thousands) OEM $ 374,270 84 % $ 421,530 88 % $ (47,260 ) (11 )% Distribution 57,066 13 % 50,181 11 % 6,885 14 % End-users and Other 15,997 3 % 6,856 1 % 9,141 NM Total net revenues $ 447,333 100 % $ 478,567



100 % $ (31,234 ) (7 )%

The decrease in OEM net revenues for fiscal 2014 compared to fiscal 2013 reflected a decrease of approximately 12% in in both NCP and SCOP revenues. The increase in distribution net revenues during 2014 compared to fiscal 2013 was primarily due to NVP net revenues generated through distribution partners, partially offset by a decrease of approximately 10% in NCP net revenues generated through distribution partners. The increase in end-users and other net revenues during fiscal 2014 compared to fiscal 2013 was primarily due to NVP net revenues generated from end-users. We believe that a majority of our net revenues are driven by product certifications and qualifications with our OEM customers, which take products directly and indirectly through distribution and contract manufacturers. Although we view product certifications and qualifications as an important indicator of future revenue opportunities and growth for the Company, they 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. Net Revenues by Geographic Territory Our net revenues by geographic territory based on billed-to location were as follows: Net Revenues by Geographic Territory Percentage of Percentage of Increase/ Percentage 2014 Net Revenues 2013 Net Revenues (Decrease) Change (Dollars in thousands) Asia Pacific $ 264,771 59 % $ 284,064 60 % $ (19,293 ) (7 )% United States 114,427 26 % 121,719 25 % (7,292 ) (6 )% Europe, Middle East, and Africa 65,286 14 % 66,457 14 % (1,171 ) (2 )% Rest of the world 2,849 1 % 6,327 1 % (3,478 ) (55 )% Total net revenues $ 447,333 100 % $ 478,567



100 % $ (31,234 ) (7 )%

The decrease in revenues across all territories was due to a decrease in NCP net revenues. Asia Pacific net revenues as a percentage of total revenues remained relatively consistent compared to fiscal 2013 as our OEM customers continue to migrate towards using contract manufacturers that are predominately located in Asia Pacific. However, since 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 by segment for fiscal 2014 and fiscal 2013 were as follows (dollars in thousands): Gross Profit 2014 Gross Profit Margin 2013



Gross Profit Margin Increase/(Decrease) Percentage Change Connectivity $ 241,068

58 % $ 272,061 58 % $ (30,993 ) - % Visibility 19,929 59 % 6,739 51 % 13,190 8 % Total Gross Profit $ 260,997 58 % $ 278,800 58 % $ (17,803 ) - % Cost of sales includes the cost of producing, supporting, and managing our supply of quality finished products. Approximately $0.7 million and $1.0 million of share-based compensation expense and approximately $24.9 million and $21.8 million of amortization of technology intangible assets were included in cost of sales for fiscal 2014 and fiscal 2013, respectively. Our consolidated gross margin percentage was comparable to the prior year due to favorable product mix partially offset by an increase in royalty expense of approximately $2.5 million related to the amended 2012 Permanent Injunction. We will continue to recognize amortization expense for technology intangible assets over their remaining useful lives, patent license fees related to the Settlement Agreement over the remaining patent license term (which expires on July 1, 2020) 36 -------------------------------------------------------------------------------- and royalty expense and other costs related to the amended 2012 Permanent Injunction and certain customer licensing agreements with Broadcom related to the amended 2012 Permanent Injunction. We expect our consolidated and Connectivity gross margin percentage to trend downward as the portion of our revenues generated from lower margin products increases as a percentage of total revenues, primarily due to a shift within our product mix. Engineering and Development. Engineering and development expenses consist primarily of salaries and related expenses for personnel engaged in the design, development, and support of our products. These expenses also include third-party fees paid to consultants, prototype development expenses, and computer service costs related to supporting computer tools used in the design process. Expenses for fiscal 2014 and fiscal 2013 were as follows (dollars in thousands): Engineering and Development Percentage of Percentage of Increase/ Percentage 2014 Net Revenues 2013 Net Revenues (Decrease) Points Change $155,909 35% $168,446 35% $(12,537) -% Engineering and development expenses for fiscal 2014 compared to fiscal 2013 decreased by approximately $12.5 million, or 7%. Approximately $5.6 million and $9.8 million of share-based compensation expense was included in engineering and development costs for fiscal 2014 and fiscal 2013, respectively. New product development decreased by approximately $7.9 million in fiscal 2014 compared to the prior year. Additionally, salary and related expenses decreased approximately $2.6 million due to a reduction in headcount. During fiscal 2014, we recorded approximately $5.7 million in severance costs, which were offset by cost reductions previously taken and efforts to controls costs. Selling and Marketing. Selling and marketing expenses consist primarily of salaries, commissions, and related expenses for personnel engaged in the marketing and sales of our products, as well as samples, trade shows, product literature, promotional support costs, and other advertising related costs. Expenses for fiscal 2014 and fiscal 2013 were as follows (dollars in thousands): Selling and Marketing Percentage of Percentage of Increase/



Percentage

2014 Net Revenues 2013 Net Revenues (Decrease) Points Change $77,757 17% $66,235 14% $11,522 3% Selling and marketing expenses for fiscal 2014 increased approximately $11.5 million, or 17%, compared to fiscal 2013. Approximately $3.9 million and $3.6 million of share-based compensation expense was included in selling and marketing costs for fiscal 2014 and fiscal 2013, respectively. Salary and related expenses and commissions increased approximately $6.8 million and $2.4 million, respectively, primarily due to the acquisition of Endace in February 2013 and approximately $1.5 million of severance costs. Further, pre-production samples increased approximately $2.0 million related to our mitigation activities for the 2012 Permanent Injunction. General and Administrative. Ongoing general and administrative expenses consist primarily of salaries and related expenses for executives, financial accounting support, human resources, administrative services, professional fees, and other corporate expenses. Expenses for fiscal 2014 and fiscal 2013 were as follows (dollars in thousands): General and Administrative Percentage of Percentage of Increase/ Percentage 2014 Net Revenues 2013 Net Revenues (Decrease) Points Change $41,115 9% $38,893 8% $2,222 1% General and administrative expenses for fiscal 2014 compared to fiscal 2013 increased approximately $2.2 million, or 6%. Approximately $5.1 million and $7.4 million of share-based compensation expense was included in general and administrative costs for fiscal 2014 and fiscal 2013, respectively. General and administrative expenses increased due to the $5 million dismissal and standstill fee payable to Broadcom pursuant to the Dismissal Agreement. See Note 10, "Commitments and Contingencies," in the notes to consolidated financial statements in Part IV, Item 15(a) of this Annual Report on Form 10-K. In addition, rent expense increased approximately $2.8 million due to approximately $0.7 million in contract termination costs, the expansion of facilities in India, and the full year impact of the Endace acquisition. The increase in general and administrative expenses was partially offset by a decrease of approximately $3.0 million in legal and accounting fees related to the acquisition of Endace acquisition in the prior year. Amortization of Other Intangible Assets. Amortization of other intangible assets consists of amortization of intangible assets such as patents, customer relationships, and tradenames with estimable lives. Our amortization expense for fiscal 2014 and fiscal 2013 was as follows (dollars in thousands): 37 --------------------------------------------------------------------------------

Amortization of Other Intangible Assets Percentage of Percentage of Increase/ Percentage 2014 Net Revenues 2013 Net Revenues (Decrease) Points Change $6,375 1% $5,935 1% $440 -% Amortization of other intangible assets for fiscal 2014 compared to fiscal 2013 increased by approximately $0.4 million, or 7%. The increase was primarily due to an increase in amortization of other intangibles assets associated with assets acquired from Endace, partially offset by a decrease due to a lower unamortized intangible assets balance at the beginning of fiscal 2014 as a result of certain intangible assets being fully amortized in fiscal 2013. Non-operating (Expense) Income, net. Non-operating (expense) income, net, consists primarily of interest income, interest expense, and other non-operating income and expense items. Our non-operating (expense) income, net for fiscal 2014 and fiscal 2013 was as follows (dollars in thousands): Non-operating (Expense) Income, Net

Percentage of Percentage of (Increase)/ Percentage 2014 Net Revenues 2013 Net Revenues Decrease Points Change $(6,027) (1)% $(4,874) (1)% $(1,153) -% Our non-operating (expense) income, net, for fiscal 2014 compared to fiscal 2013 increased by approximately $1.2 million primarily due to interest expense and amortization of issuance costs and debt discount of approximately $5.8 million related to the Convertible Senior Notes issued in November 2013 (see Note 11, "Convertible Senior Notes," in the notes to consolidated financial statements in Part IV, Item 15(a) of this Annual Report on Form 10-K) offset by a non-recurring foreign exchange transaction loss in the prior year of approximately $4.7 million related to the cash consideration paid to acquire Endace. Income taxes. Our income tax provision for fiscal 2014 and fiscal 2013 was as follows (dollars in thousands): Income Taxes Percentage of Percentage of Increase/ Percentage 2014 Net Revenues 2013 Net Revenues (Decrease) Points Change $3,346 (1)% $(369) -% $3,715 (1)% Income tax expense for fiscal 2014 was approximately $3.3 million, compared to income tax benefit of approximately $0.4 million. We generate the majority of our taxable earnings in countries other than the U.S., our tax expense and effective tax rates reflect the mix of our earnings and losses in our U.S. and various international jurisdictions, including India, Ireland, Isle of Man and New Zealand, as well as our valuation allowance recorded against our U.S. deferred tax assets. The change in our effective tax rate between years was primarily driven by tax expense of $3.2 million related to taxable unrealized currency exchange gain resulting from outstanding inter-company loans and a tax expense of $1.2 million related to nondeductible interest from our issuance of convertible debt. This tax expense was partially offset by a reduction to our tax expense of approximately $0.9 million related to uncertain tax positions being effectively settled during the fiscal year. We may recognize taxable income/loss on the unrealized foreign exchange gains/losses on our intercompany loans for tax reporting purposes in the future. We have made no provision for U.S. income taxes or foreign withholding taxes on the earnings of our foreign subsidiaries as these amounts are intended to be indefinitely reinvested in operations outside the U.S. We also do not forecast discrete events, such as a settlement of tax audits with governmental authorities or changes in tax laws, due to their inherent uncertainty. Fiscal 2013 versus Fiscal 2012 Net Revenues. Net revenues for fiscal 2013 decreased approximately $23.2 million, or 5%, to approximately $478.6 million, compared to approximately $501.8 million in fiscal 2012. 38 -------------------------------------------------------------------------------- Net Revenues by Product Line The following chart details our net revenues by product line for fiscal years 2013 and 2012: Net Revenues by Product Line Percentage of Percentage of Increase/ Percentage 2013 Net Revenues 2012 Net

Revenues (Decrease) Change (Dollars in thousands) Net revenues: Connectivity Segment: Network Connectivity Products $ 360,974 75 % $ 362,315 72 % $ (1,341 ) - % Storage Connectivity & Other Products 104,409 22 % 139,454 28 % (35,045 ) (25 )% Total Connectivity Segment 465,383 97 % 501,769 100 % (36,386 ) (7 )% Visibility Segment: Network Visibility Products 13,184 3 % - - % 13,184 NM Total net revenues $ 478,567 100 % $ 501,769



100 % $ (23,202 ) (5 )%

Networking segment revenues decreased by approximately 7% in fiscal 2013 compared to fiscal 2012. The decrease in revenues was primarily due to continuing weakness in the server and storage technology markets resulting from continuing concern over the global macroeconomic climate. Fibre Channel based product revenues, which accounted for approximately 70% - 80% of total NCP revenues for fiscal 2013 and fiscal 2012 increased by approximately 2% primarily an increase in units shipped of approximately 8% partially offset by a decrease in average selling price of approximately 7% in fiscal 2013 compared to fiscal 2012. Ethernet based product revenues decreased by approximately 8% primarily due to a decrease in units shipped of approximately 29%, arising principally from lower customer demand for 10Gb LOM products as customers consumed residual inventory purchased in fiscal 2012, as well as the impact of the 2012 Permanent Injunction. This decrease was partially offset by an increase in average selling price of approximately 16% due to a change in product mix. Our SCOP revenues decreased by approximately $35.1 million, or 25%, in fiscal 2013 compared to fiscal 2012. This decrease was primarily due to a decline in backend connectivity product shipments due to last-time buys of certain products reaching end of life during fiscal 2012. The Visibility segment resulted from our acquisition of Endace on February 26, 2013 and consists solely of NVP. NVP revenues in fiscal 2013 were approximately $13.2 million during the four months since the acquisition date compared to no revenues in fiscal 2012, and include network visibility and intelligent network recording products. 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 fiscal year net revenues were as follows: Net Revenues by Major Customers Direct Total Direct and Revenues Indirect Revenues (2) 2013 2012 2013 2012 Net revenue percentage(1) OEM: EMC - - 11 % - Hewlett-Packard 19 % 22 % 23 % 24 % Hon Hai Precision Industry Co., Ltd. (Foxconn Technology Group)(3) 12 % - - - IBM 32 % 32 % 35 % 37 %



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

39 --------------------------------------------------------------------------------



(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. (3) Hon Hai Precision Industry Co., Ltd. is a contract manufacturer that performed manufacturing for some of our OEM customers. Direct sales to our top five customers accounted for approximately 71% and 70% of total net revenues for fiscal years 2013 and 2012, respectively. Direct and indirect sales to our top five customers accounted for approximately 81% of total net revenues for both fiscal years 2013 and 2012. Our net revenues from customers can be significantly impacted by changes to our customers' business and their business models. Net Revenues by Sales Channel



Net revenues by sales channel were as follows:

Net Revenues by Sales Channel Percentage of Percentage of Increase/ Percentage 2013 Net Revenues 2012 Net



Revenues (Decrease) Change

(Dollars in



thousands)

OEM $ 421,530 88 % $ 455,141 91 % $ (33,611 ) (7 )% Distribution 50,181 11 % 46,385 9 % 3,796 8 % End-users and Other 6,856 1 % 243 - % 6,613 NM Total net revenues $ 478,567 100 % $ 501,769



100 % $ (23,202 ) (5 )%

The decrease in OEM net revenues for fiscal 2013 compared to fiscal 2012 reflected a decrease of approximately 25% in SCOP revenues. The increase in distribution net revenues during 2013 compared to fiscal 2012 was primarily due to NVP net revenues generated through distribution partners, partially offset by a decrease of approximately 4% in NCP net revenues generated through distribution partners. The increase in end-users and other net revenues during fiscal 2013 compared to fiscal 2012 was primarily due to NVP net revenues generated from end-users. Net Revenues by Geographic Territory Our net revenues by geographic territory based on billed-to location were as follows: Net Revenues by Geographic Territory Percentage of Percentage of Increase/ Percentage 2013 Net Revenues 2012 Net Revenues (Decrease) Change (Dollars in thousands) Asia Pacific $ 284,064 60 % $ 286,572 57 % $ (2,508 ) (1 )% United States 121,719 25 % 137,504 28 % (15,785 ) (11 )% Europe, Middle East, and Africa 66,457 14 % 76,394 15 % (9,937 ) (13 )% Rest of the world 6,327 1 % 1,299 - % 5,028 NM Total net revenues $ 478,567 100 % $ 501,769



100 % $ (23,202 ) (5 )%

We believe the decrease in the percentage of revenue in the United States and Europe, Middle East and Africa continues to be driven by the continuing migration of our OEM customers' production to contract manufacturers predominately located in Asia Pacific. We expect this trend to continue. However, since 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. Our gross profit by segment for fiscal 2013 and fiscal 2012 were as follows (dollars in thousands):



Gross Profit

2013 Gross Profit Margin 2012



Gross Profit Margin Increase/(Decrease) Percentage Change Connectivity $ 272,061

58 % $ 255,835 51 % $ 16,226 7 % Visibility 6,739 51 % - - 6,739 NM Total Gross Profit $ 278,800 58 % $ 255,835 51 % $ 22,965 7 % 40

-------------------------------------------------------------------------------- Cost of sales includes the cost of producing, supporting, and managing our supply of quality finished products. Approximately $1.0 million and $1.3 million of share-based compensation expense and approximately $21.8 million and $24.0 million of amortization of technology intangible assets were included in cost of sales for fiscal 2013 and fiscal 2012, respectively. Of these amounts, approximately $1.2 million of amortization of technology intangible assets in fiscal 2013 related to Endace. The increase in our gross profit was primarily due to the non-recurrence of certain one-time expenses incurred during fiscal 2012 that are discussed further below. During fiscal 2013, we recorded sunset period royalty and patent license fee amortization expenses of $5.0 million related to the Settlement Agreement entered into with Broadcom on July 3, 2012 compared to $37.3 million in fiscal 2012. The $37.3 million was comprised of $36.8 million patent litigation settlement expense, $0.4 million patent litigation damages and $0.1 million of sunset royalty expense. During fiscal 2012, we also incurred approximately $2.3 million of additional expedite and freight charges in connection with our activities to mitigate the impact of the October 2011 flooding in Thailand that affected one of our contract manufacturers. The additional expenses in fiscal 2012 were partially offset by higher volume and favorable product mix during each year. We will continue to recognize license fee amortization related to the Settlement Agreement entered into with Broadcom on July 3, 2012, over the remaining nine year patent license term and increased royalty expense related to the amended injunction during fiscal 2014. We also expect the trend toward increased sales of lower margin products to continue in the future. Engineering and Development. Engineering and development expenses for fiscal 2013 and fiscal 2012 were as follows (dollars in thousands): Engineering and Development Percentage of Percentage of Increase/



Percentage

2013 Net Revenues 2012 Net Revenues (Decrease) Points Change $168,446 35% $163,552 33% $4,894 2% Engineering and development expenses for fiscal 2013 compared to fiscal 2012 increased by approximately $4.9 million, or 3%. Approximately $9.8 million and $11.9 million of share-based compensation expense were included in engineering and development costs for fiscal 2013 and fiscal 2012, respectively. Engineering and development expenses increased due to increased salary and related expenses of approximately $5.9 million related to headcount and severance costs of approximately $1.7 million. Product redesign expenses also increased by approximately $4.7 million related to our mitigation activities for the 2012 Permanent Injunction. The year over year increase was partially offset by a decrease in outside services and consulting of approximately $2.9 million as well as lower tool and software license costs resulting from optimized usage and improved pricing. Selling and Marketing. Selling and marketing expenses for fiscal 2013 and fiscal 2012 were as follows (dollars in thousands): Selling and Marketing Percentage of Percentage of Increase/ Percentage 2013 Net Revenues 2012 Net Revenues (Decrease) Points Change $66,235 14% $59,990 12% $6,245 2% Selling and marketing expenses for fiscal 2013 increased approximately $6.2 million, or 10%, compared to fiscal 2012. Approximately $3.6 million of share-based compensation expense was included in selling and marketing costs for both fiscal 2013 and fiscal 2012. Salary and related expenses increased by approximately $5.5 million due to an increase in headcount, partially due to the Endace acquisition in February 2013. Also included in the increase in salary and related expenses was $0.6 million of severance costs. Further, selling and marketing expenses increased due to increases of approximately $1.3 million in performance-based compensation, approximately $0.7 million in travel expenses, approximately $0.6 million in depreciation expense and approximately $0.4 million in outside services. The net increase in selling and marketing expenses was partially offset by a decrease in advertising costs of approximately $3.5 million. General and Administrative. General and administrative expenses for fiscal 2013 and fiscal 2012 were as follows (dollars in thousands): General and Administrative Percentage of Percentage of Increase/ Percentage 2013 Net Revenues 2012 Net Revenues (Decrease) Points Change $38,893 8% $35,658 7% $3,235 1%



General and administrative expenses for fiscal 2013 compared to fiscal 2012 increased approximately $3.2 million, or 9%. Approximately $7.4 million and $5.4 million of share-based compensation expense were included in general and

41 -------------------------------------------------------------------------------- administrative costs for fiscal 2013 and fiscal 2012, respectively. Included in general and administrative expenses was an increase of approximately $3.0 million in legal and accounting costs related to the Endace acquisition and an increase of approximately $1.4 million in other legal and consulting expenses, partially offset by a decrease of approximately $3.5 million in litigation costs related to our ongoing patent litigation dispute with Broadcom. Salary and related expenses increased by approximately $1.0 million compared to fiscal 2012, due to an increase in headcount, primarily related to the acquisition of Endace in February 2013. Amortization of Other Intangible Assets. Amortization of other intangible assets expense for fiscal 2013 and fiscal 2012 was as follows (dollars in thousands): Amortization of Other Intangible Assets Percentage of Percentage of Increase/ Percentage 2013 Net Revenues 2012 Net Revenues (Decrease) Points Change $5,935 1% $6,569 1% $(634) -% Amortization of other intangible assets for fiscal 2013 compared to fiscal 2012 decreased by approximately $0.6 million, or 10%. The decrease was primarily due to a lower unamortized intangible assets balance at the beginning of fiscal 2013 as a result of certain intangible assets being fully amortized in fiscal 2012. The decrease was partially offset by an increase of approximately $0.4 million in amortization of other intangibles assets associated with assets acquired from Endace. Non-operating (Expense) Income, net. Our non-operating (expense) income, net for fiscal 2013 and fiscal 2012 was as follows (dollars in thousands): Non-operating (Expense) Income, Net Percentage of Percentage of Increase/ Percentage 2013 Net Revenues 2012 Net Revenues (Decrease) Points Change $(4,874) (1)% $432 -% $(5,306) (1)% Our non-operating (expense) income, net, for fiscal 2013 compared to fiscal 2012 decreased by approximately $5.3 million primarily due to a non-recurring foreign exchange transaction loss of approximately $4.7 million related to the cash changes in the value of the British Pound Sterling (GBP) relative to the U.S. Dollar (USD) between the date the funds to acquire Endace were converted to GBP and the dates the funds were disbursed. Income taxes. Our income tax provision for fiscal 2013 and fiscal 2012 was as follows (dollars in thousands): Income Taxes Percentage of Percentage of Increase/ Percentage 2013 Net Revenues 2012 Net Revenues (Decrease) Points Change $(369) -% $1,578 -% $(1,947) -% Our effective tax expense/(benefit) rate was approximately (7%) and 17% for fiscal 2013 and fiscal 2012, respectively. The change in our effective tax expense rate for fiscal 2013 compared to fiscal 2012 was primarily due to the continuing impact of our previously recorded U.S. deferred tax asset valuation allowance, the impact of our fiscal 2013 U.S. losses that will be carried back to prior tax years, and changes in the mix of earnings in international versus U.S. tax jurisdictions. We continue to generate the majority of our taxable earnings in countries other than the U.S., including India, Ireland, and Isle of Man, where such earnings are generally subject to significantly lower tax rates than the U.S. We expect this trend to continue in the future. We have made no provision for U.S. income taxes or foreign withholding taxes on the earnings of our foreign subsidiaries as these amounts are intended to be indefinitely reinvested in operations outside the U.S. As a result of the global scope of our operations and the complexity of global tax and transfer pricing rules and regulations, the tax liabilities in each of the countries in which we operate may differ materially from our estimates and impact our expected tax rate in the future. In addition, our future effective tax rate may be impacted by other items including newly enacted tax legislation, stock-based compensation, uncertain tax positions and examinations by various tax authorities. Critical Accounting Policies The preparation of our consolidated financial statements requires estimation and judgment that affect the reported amounts of net revenues, expenses, assets, and liabilities in accordance with accounting principles generally accepted in the United States. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances and which form the basis for making judgments about the carrying values of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses for the periods presented. Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties. 42 -------------------------------------------------------------------------------- Changes in judgments and uncertainties relating to these estimates could potentially result in materially different results under different assumptions and conditions. If these estimates differ significantly from actual results, the impact to the consolidated financial statements may be material. We believe that the critical accounting policies that are the most significant for purposes of fully understanding and evaluating our reported financial results include the following: Inventories. Inventories are stated at the lower of cost, on a first-in, first-out basis, or market. We use a standard cost system to determine cost. The standard costs are adjusted periodically to represent actual cost. We regularly compare forecasted demand against inventory on hand and open purchase commitments in an effort to ensure that the carrying value of inventory does not exceed net realizable value. Accordingly, we may have to reduce the carrying value of excess and obsolete inventory if forecasted demand decreases. Intangible Assets and Other Long-Lived Assets. Intangible assets resulting from acquisitions or licensing agreements are carried at cost less accumulated amortization and impairment charges, if any. For assets with determinable useful lives, amortization is computed using the straight-line method over the estimated economic lives of the respective intangible assets, ranging from one to twelve years. Acquired in-process research and development (IPR&D) is recorded at fair value as an indefinite-lived intangible asset at the acquisition date until the completion or abandonment of the associated research and development efforts or impairment. IPR&D projects relate to in-process projects that have not reached technological feasibility as of the acquisition date and have no alternative future use. Upon completion of development, acquired in-process research and development assets are transferred to finite-lived intangible assets and amortized over their useful lives. We assess whether our intangible assets and other long-lived assets should be tested for recoverability whenever events or circumstances indicate that their carrying value may not be recoverable. The amount of impairment, if any, is measured based on fair value, which is determined using projected discounted future operating cash flows. Assets to be disposed of are reported at the lower of the carrying amount or fair value less selling costs. Goodwill. Goodwill is recorded as the difference, if any, between the aggregate consideration paid for an acquisition and the fair value of the acquired net tangible and intangible assets. Goodwill is not amortized, but instead, is tested at least annually for impairment, or more frequently when events or changes in circumstances indicate that goodwill might be impaired. In assessing goodwill impairment for each of its reporting units, we have the option to first assess the qualitative factors to determine whether the existence of events or circumstances leads to a determination that the fair value of such reporting unit is less than its carrying amount. The Company's qualitative assessment of the recoverability of goodwill considers various macro-economic, industry-specific and company-specific factors. These factors include: (i) severe adverse industry or economic trends; (ii) significant company-specific actions, including exiting an activity in conjunction with restructuring of operations; (iii) current, historical or projected deterioration of the Company's financial performance; or (iv) a sustained decrease in the Company's market capitalization below its net book value. If, after assessing the totality of events or circumstances, we determine it is unlikely that the fair value of such reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. However, if we conclude otherwise, then we are required to perform the first step of the two-step impairment test by comparing the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill is not considered impaired; otherwise, goodwill is considered impaired and the loss is measured by performing step two. Under step two, the impairment loss is measured by comparing the implied fair value of the reporting unit goodwill with the carrying amount of goodwill. We also have the option to bypass the qualitative assessment and proceed directly to performing the first step of the two-step goodwill impairment test. We may resume performing the qualitative assessment in any subsequent period. Fair value of our reporting units is determined using the market approach, the income approach, or a combination thereof. Under the market approach, fair value is based on peer multiples and applying an appropriate control premium. The control premium used in the market approach or a combined approach is determined by considering control premiums offered as part of acquisitions that have occurred in the reporting units' comparable market segments. Under the income approach, fair value is dependent on a discounted cash-flow analysis. The material assumptions used in performing the discounted cash-flow analysis include our operating forecasts, which are based on historical data, various internal estimates, and a variety of external sources, and are developed as part of our regular long-range planning process, as well as revenue growth rates, terminal value and risk-commensurate discount rates. The discount rates are based on estimates of a market weighted-average cost-of-capital for the reporting unit, as well as a specific assessment of the risk inherent in the respective reporting units, and were estimated to be 19% for the Connectivity reporting unit and 21% for the Visibility reporting unit. The Company based its fair value estimates on assumptions it believes to be reasonable, but are inherently uncertain. The annual impairment test is performed during the fourth fiscal quarter. Our recent impairment test indicated that our Connectivity reporting unit's fair value exceeded its carrying value by approximately 6%, or $31.3 million and our Visibility reporting unit's fair value exceeded its carrying value by approximately 7%, or $8.0 million. 43 --------------------------------------------------------------------------------



The following table summarizes the approximate impact that a change in these principal key assumptions would have on the estimated fair value of the Connectivity reporting unit, leaving all other assumptions unchanged:

Excess/(Shortfall) of Fair Value over Carrying Value Change (in thousands) Discount rate ± 1% $22,000 - $41,000 Terminal value multiplier ± 1% $38,000 - $24,000



The following table summarizes the approximate impact that a change in principal key assumptions would have on the estimated fair value of the Visibility reporting unit, leaving all other assumptions unchanged:

Excess/(Shortfall) of Fair Value over Carrying Value Change (in thousands) Discount rate ± 1% $1,000 - $14,000 Revenue growth projections ± 1% $14,000 - $2,000 Terminal value exit multiple ± 0.5x $13,000 - $2,000 As part of our annual test, we compare the aggregate fair value of our reporting units to the fair value of the Company as a whole based on our market capitalization. Assumptions and estimates about fair values of our goodwill are complex and subjective. They can be affected by a variety of factors, including external factors such as industry and economic trends, and internal factors such as changes in our business strategy and out internal forecasts. Our ongoing consideration of all factors described previously could result in material impairment charges in the future. Although our annual test resulted in no impairment, given the recent volatility of our market capitalization, the inherent uncertainty in forecasts, and the fact that the fair value of each reporting unit did not exceed it carrying value by a substantial margin, it is possible that our goodwill could become impaired in the near term. See Note 6, "Goodwill and Intangible Assets, Net," in the accompanying notes to consolidated financial statements included in Part IV, Item 15(a) of this Annual Report on Form 10-K for additional information. Income Taxes. We account for income taxes using the asset and liability method, under which we recognize deferred tax assets and liabilities for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and for net operating loss and tax credit carryforwards. Tax positions that meet a more-likely-than-not recognition threshold are recognized in the first reporting period that it becomes more-likely-than-not such tax position will be sustained upon examination. A tax position that meets this more-likely-than-not recognition threshold is recorded at the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. Previously recognized income tax positions that fail to meet the recognition threshold in a subsequent period are derecognized in that period. Differences between actual results and our assumptions, or changes in our assumptions in future periods, are recorded in the period they become known. We record potential accrued interest and penalties related to unrecognized tax benefits in income tax expense. As a multinational corporation, we are subject to complex tax laws and regulations in various jurisdictions. The application of tax laws and regulations is subject to legal and factual interpretation, judgment, and uncertainty. Tax laws themselves are subject to change as a result of changes in fiscal policy, changes in legislation, evolution of regulations and court rulings. Therefore, the actual liability for U.S. or foreign taxes may be materially different from our estimates, which could result in the need to record additional liabilities or potentially to reverse previously recorded tax liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date. A valuation allowance is recorded against any deferred tax assets when, in the judgment of management, it is more likely than not that all of or part of a deferred tax asset will not be realized. In assessing the need for a valuation allowance, we consider all positive and negative evidence, including recent financial performance, scheduled reversals of temporary differences, projected future taxable income, availability of taxable income in carryback periods and tax planning strategies. Based on a review of such information, we believe that insufficient positive evidence exists to support that we will more likely than not be able to realize the majority of our U.S. federal and state 44 -------------------------------------------------------------------------------- deferred tax assets. Therefore, we have recorded a valuation allowance against our deferred tax assets to the extent that they are not expected to be recoverable against taxes previously paid in available carryback periods. Litigation Costs and Contingencies. We record a charge equal to at least the minimum estimated liability for a loss contingency or litigation settlement when both of the following conditions are met: (i) information available prior to issuance of the financial statements indicates that it is probable that a liability had been incurred at the date of the financial statements and (ii) the range of loss can be reasonably estimated. The determination of whether a loss contingency or litigation settlement is probable or reasonably possible involves a significant amount of management judgment, as does the estimation of the range of loss given the nature of contingencies. Liabilities related to litigation settlements with multiple elements are recorded based on the fair value of each element. Legal and other litigation related costs are recognized as the services are provided. We record insurance and other indemnity recoveries for litigation costs when both of the following conditions are met: (i) the recovery is probable and (ii) collectability is reasonably assured. There are many uncertainties associated with any litigation, and we cannot provide assurance that any actions or other third party claims against us will be resolved without costly litigation or substantial settlement charges. If any of those events were to occur, our business, financial condition and results of operations could be materially and adversely affected. See Note 10, "Commitments and Contingencies," in the notes to consolidated financial statements in Part IV, Item 15(a) of this Annual Report on Form 10-K. Recently Adopted and Recently Issued Accounting Standards See Note 1, "Summary of Significant Accounting Policies", in the accompanying notes to consolidated financial statements included in Part IV, Item 15(a) of this Annual Report on Form 10-K for a description of the recently adopted and recently issued accounting standards. Liquidity and Capital Resources Our principal sources of liquidity consist of our existing cash balances and investments, as well as funds expected to be generated from operations. At June 29, 2014, we had approximately $213.6 million in working capital and approximately $158.4 million in cash and cash equivalents, as compared to approximately $167.7 million in working capital and approximately $105.6 million in cash and cash equivalents at June 30, 2013. In November 2013, we issued $175.0 million aggregate principal amount of 1.75% Convertible Senior Notes due November 2018. We received proceeds of $169.7 million from the issuance of the Convertible Senior Notes, net of debt issuance costs of approximately $5.3 million. Our cash balances and investments are held in numerous locations throughout the world. As of June 29, 2014, our international subsidiaries held approximately 15% of our total cash, cash equivalents and investment securities, which will be used to repay obligations to U.S. affiliate entities that arise in the normal course of business and would not result in incremental U.S. tax liabilities when paid. Cash Flows The following table summarizes our cash flows for fiscal years 2014 and 2013: 2014 2013 (In thousands) Net cash provided by (used in): Operating activities $ 47,783$ 10,597 Investing activities (15,983 ) (94,466 ) Financing activities 20,541



(11,200 ) Effect of foreign currency translation on cash and cash equivalents

461 (342 ) Increase (decrease) in cash and cash equivalents: $ 52,802 $



(95,411 )

Operating Activities Cash provided by operating activities during fiscal 2014 was approximately $47.8 million compared to approximately $10.6 million for fiscal 2013. Prior year cash flows from operating activities includes a payment of $58.0 million made during fiscal 2013 related to the Settlement Agreement entered into with Broadcom on July 3, 2012. See Note 10, "Commitments and Contingencies," in the accompanying notes to consolidated financial statements under the caption, "Litigation" included in Part IV, Item 15(a) of this Annual Report on Form 10-K. The current period cash provided by operating activities also benefits from higher income tax refunds received of approximately $2.0 million in comparison to the prior year. The current period cash provided by operating activities resulted from net loss of approximately $29.5 million, non-cash adjustments for amortization of intangible assets of approximately $31.3 million, depreciation and amortization of approximately $19.0 million, share-based 45 -------------------------------------------------------------------------------- compensation expense of approximately $15.3 million, and accretion of debt discount and amortization of debt issuance costs of approximately $3.9 million related to the Convertible Senior Notes; and the timing of net working capital requirements. Investing Activities Cash used in investing activities during fiscal 2014 was approximately $16.0 million compared to approximately $94.5 million for fiscal 2013. The current period usage of cash was related to purchases of property and equipment of approximately $16.0 million. We currently expect a similar level of investment in property and equipment in the future to support our strategic objectives, although the timing may be impacted by certain project timelines and other factors. The prior period usage of cash was primarily related to our acquisition of Endace for approximately $107.7 million and purchases of property and equipment of approximately $15.7 million, offset by the maturities of investments, net of purchases, of approximately $28.9 million. Financing Activities Cash provided by financing activities for fiscal 2014 was approximately $20.5 million compared to cash used of approximately $11.2 million for fiscal 2013. During fiscal 2014, we issued $175.0 million aggregate principal amount of 1.75% Convertible Senior Notes due November 2018 partially offset by our repurchase of approximately 22.5 million of the Company's common shares for an aggregate of approximately $150.0 million. In connection with the Convertible Senior Notes, we incurred approximately $5.3 million of issuance costs. Prospective Capital Needs In November 2013, we issued $175.0 million aggregate principal amount of 1.75% Convertible Senior Notes due November 2018 (Convertible Senior Notes). Interest is payable semi-annually in arrears on May 15 and November 15 of each year, commencing May 15, 2014. The initial conversion rate is approximately 97.13 per share of our common stock per $1,000 principal amounts of the Convertible Senior Notes. The initial conversion price is approximately $10.30 per share of our common stock. See Note 11, "Convertible Senior Notes," in the notes to consolidated financial statements in Part IV, Item 15(a) of this Annual Report on Form 10-K. We used a portion of net proceeds from the offering to repurchase approximately $150.0 million of our common stock at a price per share equal to $6.68 during fiscal 2014. See Note 12, "Share Repurchase Programs," in the notes to consolidated financial statements in Part IV, Item 15(a) of this Annual Report on Form 10-K. We intend to use the remaining net proceeds from the offering and a portion of our other available capital for additional share repurchases. In November 2013, our Board of Directors approved a $200.0 million share repurchase program. At June 29, 2014, we have the authority to repurchase an additional approximately $50.0 million pursuant to this authorization. In November 2013, we announced a cost savings program designed to streamline business operations and achieve operating expense reductions. We plan to continue our cost savings program, which includes simplifying our product portfolio, discontinuing additional programs with lower returns on investment, pursuing consolidation opportunities and identifying further efficiencies which will accordingly impact our strategic investment in research and development, sales and marketing, capital equipment, and facilities. We may also consider internal and external investment opportunities in order to achieve our growth and market leadership goals, including licensing and product development alignment agreements with our suppliers, customers, and other third parties. We believe that our existing cash and cash equivalents, and anticipated cash flows from operating activities will be sufficient to support our working capital needs, capital expenditure requirements and stock repurchases for at least the next 12 months and the foreseeable future based on currently forecasted trends. We may need to pursue additional financing if our business does not generate sufficient cash flow from operations to enable us to pay the principal amount of our Convertible Senior Notes or to fund other liquidity needs. We have disclosed outstanding legal proceedings in Note 10, "Commitments and Contingencies," in the accompanying notes to consolidated financial statements included in Part IV, Item 15(a) of this Annual Report on Form 10-K, including the consolidated patent infringement lawsuit filed by Broadcom against us. On July 3, 2012, we entered into a Settlement Agreement pursuant to which both parties agreed to settle and release certain claims related to the patent infringement litigation. The Settlement Agreement provided for certain amendments to the April 3, 2012 Permanent Injunction, and dismissals of certain allegations of the lawsuit, including portions of the scheduled re-trial. We also received a worldwide limited license to the '691 patent, the '150 patent, the '194 patent and related families for certain fields of use including Fibre Channel applications. Effective March 30, 2014, Emulex and Broadcom entered into a Dismissal Agreement pursuant to which Emulex and Broadcom entered into certain understandings with respect to the outstanding claims relating to and arising out of the patent infringement suit. Pursuant to the terms of the Dismissal Agreement, we agreed to pay Broadcom a non-refundable, non-cancelable dismissal and standstill fee in the amount of $5 million. We continue to evaluate certain customer royalty obligations arising under the licensing agreements with Broadcom that could result in additional costs of approximately $5 million in future periods. Such costs will reduce gross margins in the periods accrued. See "Product Redesign Activities and Potential Royalty Obligations" in Part II, Item 7 of this Annual Report 46 -------------------------------------------------------------------------------- on Form 10-K. Also see "Third party claims of intellectual property infringement could adversely affect our business" and "We are dependent on sole source and limited source third party suppliers and EMS providers for our products" in Part I, Item 1A - Risk Factors, of this Annual Report on Form 10-K for a description of certain risks relating to the litigation with Broadcom that could impact our liquidity and prospective capital needs. Off-Balance Sheet Arrangements As part of our ongoing business, we do not participate in transactions that generate material relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or for other contractually narrow or limited purposes. As of June 29, 2014, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K. Contractual Obligations and Commercial Commitments The following summarizes our contractual obligations as of June 29, 2014, and the effect such obligations are expected to have on our liquidity in future periods. The estimated payments reflected in this table are based on management's estimates and assumptions about these obligations. Because these estimates and assumptions are necessarily subjective, the actual cash outflows in future periods will vary, possibly materially, from those reflected in the table. Payments Due by Period Total 2015 2016 2017 2018 2019 Thereafter (In thousands) Debt (1) $ 175,000 $ - $ - $ - $ - $ 175,000 $ - Debt interest (2) 13,783 3,063 3,063 3,063 3,063 1,531 - Leases(3) 19,323 6,393 5,209 3,385 2,735 1,497 104 Purchase commitments(4) 34,719 34,719 - - - - - Other commitments(5) 13,254 11,748 1,506 - - - - Total(7)(6) $ 256,079$ 55,923$ 9,778$ 6,448$ 5,798$ 178,028$ 104



(1) See Note 11, "Convertible Senior Notes," in the accompanying notes to

consolidated financial statements included in Part IV, Item 15(a) of this

Annual Report on Form 10-K.

(2) Includes only the cash payable component of interest in our Convertible

Senior Notes.

(3) Lease payments include common area maintenance (CAM) charges.

(4) Purchase commitments represent an estimate of all open purchase orders and

contractual obligations in the ordinary course of business for which we have

not received the goods or services as of June 29, 2014. Although open

purchase orders are considered enforceable and legally binding, the terms

generally allow us the option to cancel, reschedule and adjust our

requirements based on our business needs prior to the delivery of goods or

performance of services.

(5) Other commitments consist primarily of commitments for software license fees

of approximately $4.4 million, $1.5 million of non-recurring engineering

expenses and $3.8 million of the dismissal and standstill fee payable to

Broadcom. See Note 10, "Commitments and Contingencies," in the accompanying

notes to consolidated financial statements included in Part IV, Item 15(a)

of this Annual Report on Form 10-K. (6) Excludes approximately $40.2 million of liabilities for uncertain tax positions for which we cannot make a reasonably reliable estimate of the



period of payment. See Note 14, "Income Taxes," in the accompanying notes to

consolidated financial statements included in Part IV, Item 15(a) of this

Annual Report on Form 10-K.

(7) The expected timing of payments for the obligations discussed above is

estimated based on current information. Timing of payment and actual amounts

paid may be different depending on the time of receipt of goods or services

or changes to agreed-upon amounts for some obligations. Amounts disclosed as

contingent or milestone based obligations depend on the achievement of the

milestones or the occurrence of the contingent events and can vary

significantly.


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