| EMULEX CORP /DE/ Item 1A Risk Factors |
| Potential acquisitions or strategic investments may be more costly or less profitable than anticipated and may adversely affect the price of our company stock |
| We may pursue acquisitions or strategic investments that could provide new technologies, products, or service offerings |
| Future acquisitions or strategic investments may negatively impact our results of operations as a result of operating losses incurred by the acquired entity, the use of significant amounts of cash, potentially dilutive issuances of equity or equity-linked securities, incurrence of debt, amortization of intangible assets with determinable lives, or impairment of intangible assets |
| Furthermore, we may incur significant expenses pursuing acquisitions or strategic investments that ultimately may not be completed |
| Moreover, to the extent that any proposed acquisition or strategic investment that is not favorably received by stockholders, analysts and others in the investment community, the price of our stock could be adversely affected |
| In addition, acquisitions or strategic investments involve numerous risks, including, but not limited to: • difficulties in the assimilation of the operations, technologies, products, and personnel of the acquired company; • purchased technology that is not adopted by customers in the way or the time frame we anticipated; • diversion of management’s attention from other business concerns; • risks of entering markets in which we have limited or no prior experience; • risks associated with assuming the legal obligations of the acquired company; • minority interest in a company, resulting from a strategic investment, that could have an impact on our results; • risks related to the effect that the acquired company’s internal control processes might have on our financial reporting and management’s report on our internal controls over financial reporting; • potential loss of key employees of the company we invested in or acquired; 11 _________________________________________________________________ [46]Table of Contents • there may exist unknown defects of an acquired company’s products or assets that may not be identified due to the inherent limitations involved in the due diligence process of an acquisition; and • changes in generally accepted accounting principles regarding the accounting treatment for acquisitions to less favorable treatment than is currently allowed |
| In the event that an acquisition or strategic investment does occur and we are unable to obtain anticipated profits or successfully integrate operations, technologies, products, or personnel or acquire assets that later become worthless, our business, results of operations, and financial condition could be materially adversely affected |
| Our acquisition of Aarohi Communications, Inc |
| on May 1, 2006, as well as our recently announced proposed acquisition of Sierra Logic, Inc, involve numerous risks which may have a material adverse effect on our business and operating results |
| (Aarohi) involve numerous risks, including, but not limited to: • difficulties and expenses in assimilating and retaining employees, including integrating teams that have not previously worked together; • difficulties in creating and maintaining uniform standards, controls, procedures, and policies; • different geographic locations of the principal operations of Emulex and Aarohi and difficulties relating to management of the former Aarohi operations and personnel in India; • currency conversion exposure for payroll and other expenses of a principal product development facility in Bangalore, India; • attainment of cost efficiencies in a principal product development facility in Bangalore, India; • potential adverse reactions of existing customers and strategic relationship partners; and • difficulties with integrating Aarohi’s technology into our existing technology in a timely and efficient manner that would allow us to fully realize the benefits of this acquisition |
| In addition, our proposed acquisition of Sierra Logic, Inc |
| (Sierra Logic) may involve similar risks and uncertainties |
| Further, there may be additional risks of potentially lost revenues if we are unable to effectively integrate the businesses which may cause a disruption in the supply of products |
| The acquisition, if completed, will impact the Company’s results of operations due to increased share-based compensation expense and amortization of acquired intangible assets and in-process research and development costs |
| As a result of these and other difficulties, we may not realize the anticipated benefits of the acquisition and may encounter difficulties that could have a material adverse effect on our business and operating results or cause expectations with respect to Aarohi or, to the extent the acquisition is completed, Sierra Logic and the combined companies to be inaccurate |
| Furthermore, Aarohi’s revenue generating activities to date have been limited, and Aarohi is incurring operating losses which are expected to further dilute the Company’s earnings until new product revenue grows to a level sufficient to offset expenses, which timing the Company is unable to predict |
| Brocade announced on August 8, 2006 that a merger agreement had been entered into with McData, thus creating a potential risk to sales of intelligent network products previously provided by Aarohi to McData |
| A downturn in information technology spending in general, or spending on computer and storage systems in particular, could adversely affect our revenues and results of operations |
| The demand for our Fibre Channel products, which comprised substantially all of our net revenues, has been driven by the demand for high performance storage networking products and solutions that support enterprise computing applications, including on-line transaction processing, data mining, data warehousing, multimedia, and Internet applications |
| Any significant downturn in demand for such products, solutions, and 12 _________________________________________________________________ [47]Table of Contents applications, could adversely affect our business, results of operations, and financial condition |
| The adverse effects of any sustained downturn in information technology spending on our operating results may be exacerbated by our research and development investments, strategic investments and merger and acquisition activity, as well as customer service and support, which are expected to continue despite any such downturn |
| Our business depends upon the continued growth of the Fibre Channel storage networking market, and our business will be adversely affected if such growth does not occur or occurs more slowly than we anticipate |
| The size of our potential market is largely dependent upon the broadening acceptance of our Fibre Channel storage networking technologies, as well as the overall demand for storage |
| We believe that our investment in the Fibre Channel storage networking market provides opportunity for revenue growth and profitability for the future |
| However, the market for Fibre Channel storage networking products may not gain broader acceptance and customers may choose alternative technologies and/or products supplied by other companies |
| Interest continues for iSCSI storage networking solutions, which may satisfy some I/O connectivity requirements through standard Ethernet adapters and software at little to no incremental cost to end users, or through iSCSI HBAs that provide bundled offload engine hardware and software |
| Such iSCSI solutions compete with Fibre Channel solutions, particularly in the low end of the market |
| In addition, other technologies such as SAS and SATA, may compete with our Fibre Channel embedded switched solutions in the future |
| Furthermore, since our products are sold as parts of integrated systems, demand for our products is driven by the demand for these integrated systems, including other companies’ complementary products |
| A lack of demand for the integrated systems or a lack of complementary products required for these integrated systems could have a material adverse effect on our business, results of operations, and financial condition |
| If the Fibre Channel storage networking market does not grow, or grows more slowly than we anticipate, attracts more competitors than we expect, as discussed below, or if our products do not achieve continued market acceptance, our business, results of operations, and financial condition could be materially adversely affected |
| Because a significant portion of our revenues are generated from sales to a limited number of customers, none of which are the subject of exclusive or long-term contracts, the loss of one or more of these customers, or our customers’ failure to make timely payments to us, could adversely affect our business |
| We rely almost exclusively on OEMs and sales through distribution channels for our revenue |
| For the fiscal year ended July 2, 2006, we derived approximately 64prca of our net revenues from sales to OEM customers and approximately 36prca from sales through distribution |
| Furthermore, as some of our sales through distribution channels consist of OEM products, OEM customers effectively generated more than 88prca of our revenue for the fiscal year ended July 2, 2006 |
| We may be unable to retain our current OEM and distributor customers or to recruit additional or replacement customers |
| Although we have attempted to expand our base of customers, including customers for embedded switching products, we believe our revenues in the future will continue to be similarly derived from a limited number of customers |
| As a result, to the extent that sales to any of our significant customers do not increase in accordance with our expectations or are reduced or delayed, our business, results of operations, and financial condition could be materially adversely affected |
| As is common in the technology industry, our agreements with OEMs and distributors are typically non-exclusive, have no volume commitments, and often may be terminated by either party without cause |
| It is increasingly commonplace for our OEM and distributor customers to utilize or carry competing product lines |
| If we were to lose business from one or more significant OEM or distributor customers to a competitor, our business, results of operations, and financial condition could be materially adversely affected |
| In addition, our OEMs may elect to change their business practices in ways that affect the timing of our revenues, which may materially adversely affect our business, results of operations, and financial condition |
| 13 _________________________________________________________________ [48]Table of Contents Our markets are highly competitive and our business and results of operations may be adversely affected by entry of new competitors into the markets, aggressive pricing, and the introduction or expansion of competitive products and technologies |
| The markets for our products are highly competitive and are characterized by rapid technological advances, price erosion, frequent new product introductions, and evolving industry standards |
| We expect that our markets will continue to attract new competition |
| Our current and potential competition consists of major domestic and international companies, some of which have substantially greater financial, technical, marketing, and distribution resources than we have |
| Additional companies, including but not limited to our suppliers, strategic partners, OEM customers, and emerging companies, may enter the markets for our storage networking products and new or stronger competitors may emerge as a result of consolidation movements in the marketplace |
| Additionally, our existing competitors continue to introduce products with improved price/performance characteristics, and we may have to do the same to remain competitive |
| Furthermore, competitors may introduce new products to the market before we do, and thus obtain a first to market advantage over us |
| Increased competition could result in increased price competition, reduced revenues, lower profit margins or loss of market share, any of which could have a material adverse effect on our business, results of operations, and financial condition |
| Alternative legacy technologies such as SCSI and PBCs compete with our Fibre Channel I/O and embedded switch products, respectively, for customers |
| Our success depends in part on our ability and on the ability of our OEM customers to develop storage networking solutions that are competitive with these alternative legacy technologies |
| Additionally, in the future other technologies that we are not currently developing may evolve to address the storage networking applications currently served by our Fibre Channel product line today, reducing our market opportunity |
| Our operating results are difficult to forecast and could be adversely affected by many factors, and our stock price may decline if our results fail to meet expectations |
| Our revenues and results of operations have varied on a quarterly basis in the past and may vary significantly in the future |
| Accordingly, we believe that period-to-period comparisons of our results of operations are not necessarily meaningful, and you should not rely on such comparisons as indications of our future performance |
| We may be unable to maintain our current levels of growth or profitability in the future |
| Our revenues and results of operations are difficult to forecast and could be adversely affected by many factors, including, but not limited to: • changes in the size, mix, timing and terms of OEM and other customer orders; • changes in the sales and deployment cycles for our products and/or desired inventory levels for our products; • acquisitions or strategic investments by our customers, competitors or us; • timing and market acceptance of new or enhanced product introductions by us, our OEM customers and/or competitors; • market share losses or difficulty in gaining incremental market share growth; • fluctuations in product development, procurement, resource utilization and other operating expenses; • component shortages; • reduced demand from our customers if there is a shortage of, or difficulties in acquiring, components or other products, such as Fibre Channel disk drives and optical modules, used in conjunction with our products in the deployment of systems; • inability of our electronics manufacturing service providers to produce and distribute our products in a timely fashion; • difficulties with updates, changes or additions to our information technology systems; 14 _________________________________________________________________ [49]Table of Contents • breaches of our network security, including viruses; • changes in general social and economic conditions, including but not limited to natural disasters, terrorism, public health and slower than expected market growth, with resulting changes in customer technology budgeting and spending; • changes in technology, industry standards or consumer preferences; • seasonality; and • changes in our accounting or other policies resulting from the adoption of new laws, regulations or pronouncements |
| As a result of these and other unexpected factors or developments, future operating results may be from time to time below the expectations of investors or market analysts, which would have a material adverse effect on our stock price |
| Our relatively small backlog of unfilled orders, possible customer delays or deferrals and our tendency to generate a large percentage of our quarterly sales near the end of the quarter contribute to possible fluctuations in our operating results that could have an adverse impact on our results of operations and stock price |
| Historically, we have generally shipped products quickly after we receive orders, meaning that we do not always have a significant backlog of unfilled orders |
| As a result, our revenues in a given quarter may depend substantially on orders booked during that quarter |
| Alternatively, orders already in backlog may be deferred or cancelled |
| As a result of our expense levels being largely based on our expectations of future sales and continued investment in research and development, in the event we experience unexpected decreases in sales, our expenses may be disproportionately large relative to our revenues, and we may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shortfall |
| A material shortfall in sales in relation to our quarterly expectations or any delay, deferral, or cancellation of customer orders would likely have an immediate and adverse impact on our results of operations and may adversely affect our stock price |
| Our industry is subject to rapid technological change and we must keep pace with the changes to successfully compete |
| The markets for our products are characterized by rapidly changing technology, evolving industry standards, and the frequent introduction of new products and enhancements |
| Our future success depends in large part on our ability to enhance our existing products and to introduce new products on a timely basis to meet changes in customer preferences and evolving industry standards |
| Currently, new and proposed technologies such as 4, 8, and 10 Gb/s Fibre Channel solutions; 1 and 10 Gb/s Ethernet solutions; Infiniband; PCI-X 2dtta0; PCI Express; PCI Express Advanced Switching; iSCSI; SATA; SAS; and Remote Direct Memory Access (RDMA); are in development by many companies and their ultimate acceptance and deployment in the market is uncertain |
| We are developing some, but not all of these technologies, and we cannot be sure that the technologies we chose to develop will achieve market acceptance, or that technologies that we chose not to develop will be available to purchase or license from third parties or will be immaterial to our business |
| Furthermore, if our products are not available in time for the qualification cycle at an OEM it may be up to 3 years, if ever, before another qualification cycle is available to us |
| In addition, new products and enhancements developed by us may not be backwards compatible to existing equipment already installed in the market |
| If we are unable, for technological or other reasons, to develop new products, enhance or sell existing products, or consume raw materials in a timely and cost effective manner in response to technological and market changes, our business, results of operations, and financial condition may be materially adversely affected |
| 15 _________________________________________________________________ [50]Table of Contents We have experienced losses in our history and may experience losses in our future that may adversely affect our stock price and financial condition |
| Any losses, including losses caused by impairment of long-lived assets and/or goodwill, may adversely affect the perception of our business by analysts and investors, which could adversely affect our stock price |
| To the extent that we are unable to generate positive operating profits or positive cash flow from operations, our financial condition may be materially adversely affected |
| The migration of our customers toward newer product platforms may have a significant adverse effect |
| As our customers migrate from one platform to the enhanced price/performance of the next platform, we may experience reduced revenue, gross profit, or gross margin levels associated with lower average selling prices or higher relative product costs associated with improved performance |
| While we regularly compare forecasted demand for our products against inventory on hand and open purchase commitments, to the extent that customers migrate more quickly than anticipated, the corresponding reduction in demand for older product platforms may result in obsolete inventory and related charges which could have a material adverse effect on our financial condition and results of operations |
| Any failure of our OEM customers to keep up with rapid technological change and successfully market and sell systems that incorporate new technologies could adversely affect our business |
| Our revenues depend significantly upon the ability and willingness of our OEM customers to commit significant resources to develop, promote, and deliver products that incorporate our technology |
| In addition, if our customers’ products are not commercially successful, it would have a materially adverse effect on our business, results of operations, and financial condition |
| The success of our Intelligent Network Products (INP) depends upon their introduction into systems to replace older generation technology, and those products may not be successful if such introductions are delayed |
| Rapid changes in the evolution of technology, including the unexpected extent or timing of the transition from HBA solutions or embedded switch box solutions to lower priced ASIC solutions, could adversely affect our business |
| Historically, the electronics industry has developed higher performance ASICs that create chip level solutions that replace selected board level or box level solutions at a significantly lower average selling price |
| We have previously experienced this trend and expect it to continue in the future |
| If this transition is more abrupt or is more widespread than anticipated, there can be no assurance that we will be able to modify our business model in a timely manner, if at all, in order to mitigate the effects of this transition on our business, results of operations, and financial position |
| If customers elect to utilize lower end HBAs in higher end environments or applications, our business could be negatively affected |
| Historically, the majority of our Fibre Channel revenue has come from our high-end server and storage solutions |
| If customers elect to utilize lower end HBAs in higher end environments or applications, our business could be negatively affected |
| Advancement of storage disk capacity technology may not allow for additional revenue growth |
| Storage disk density continues to improve rapidly and at some point in the future, the industry may experience a period where the increase in storage disk capacity may equal or exceed the growth rate of digital data |
| This would result in a situation where the number of units of disk drives may flatten out or even decrease |
| Our growth in revenue depends on increasing units to offset declining average selling prices |
| 16 _________________________________________________________________ [51]Table of Contents A decrease in the average unit selling prices and/or an increase in the manufactured cost of our products could adversely affect our revenue, gross margins and financial performance |
| Furthermore, we may provide pricing discounts to customers based upon volume purchase criteria, and achievement of such discounts may reduce our average unit selling prices |
| To the extent that growth in unit demand fails to offset decreases in average unit selling prices, our revenues and financial performance could be materially adversely affected |
| Although historically we have achieved offsetting cost reductions, to the extent that average unit selling prices of our products decrease without a corresponding decrease in the costs of such products, our gross margins and financial performance could be materially adversely affected |
| Furthermore, as the majority of our products are manufactured internationally, cost reductions would be more difficult to achieve if the value of the US dollar deteriorates |
| Moreover, if the manufactured cost of our products were to increase due to inflation or other factors, our gross margins and financial performance could be materially adversely affected |
| Delays in product development could adversely affect our business |
| We have experienced delays in product development in the past and may experience similar delays in the future |
| Prior delays have resulted from numerous factors, which may include, but are not limited to: • difficulties in hiring and retaining necessary employees and independent contractors; • difficulties in reallocating engineering resources and other resource limitations; • unanticipated engineering or manufacturing complexity, including from third party suppliers of intellectual property such as foundries of our ASICs; • undetected errors or failures in software, firmware, and hardware; • changing OEM product specifications; • delays in the acceptance or shipment of products by OEM customers; and • changing market or competitive product requirements |
| Given the short product life cycles in the markets for our products and the relatively long product development cycles, any delay or unanticipated difficulty associated with new product introductions or product enhancements could have a material adverse effect on our business, results of operations, and financial condition |
| Our joint development activities may result in products that are not commercially successful or that are not available in a timely fashion |
| We have engaged in joint development projects with third parties in the past and we expect to continue doing so in the future |
| Joint development can magnify several risks for us, including the loss of control over development of aspects of the jointly developed products and over the timing of product availability |
| Accordingly, we face increased risk that joint development activities will result in products that are not commercially successful or that are not available in a timely fashion |
| During April 2003, we announced a joint development activity with Intel relating to storage processors that integrate SATA, SAS, and Fibre Channel interfaces within a single architecture |
| Under the agreement, we will develop the protocol controller hardware, firmware, and drivers |
| Intel will integrate its Intel^® Xscale^TM microarchitecture as the core technology for the new processors and will manufacture the processors on its 90 nm process technology |
| This activity has risks resulting from the licensing of technology to Intel and from increased development costs |
| 17 _________________________________________________________________ [52]Table of Contents A change in our business relationships with our third party suppliers or our electronics manufacturing service providers could adversely affect our business |
| We rely on third party suppliers for components and the manufacture of our products, and we have experienced delays or difficulty in securing components and finished goods in the past |
| Delays or difficulty in securing components or finished goods at reasonable cost may be caused by numerous factors including, but not limited to: • discontinued production by a supplier; • required long-term purchase commitments; • undetected errors, failures or production quality issues, including projected failures that may exceed epidemic failure rates specified in agreements with our customers or that may require us to make concessions or accommodations for continuing customer relationships; • timeliness of product delivery; • sole sourcing and components made by a small number of suppliers, including the inability to obtain components and finished goods at reasonable cost from such sources and suppliers; • financial stability and viability of our suppliers and EMS providers; • changes in business strategies of our suppliers and EMS providers; • increases in manufacturing costs due to lower volumes or more complex manufacturing process than anticipated; • disruption in shipping channels; • natural disasters; • inability or unwillingness of our suppliers or EMS providers to continue their business with us; • environmental, tax or legislative changes in the location where our products are produced or delivered, including implementation of European Union Directives 2002/95/EC (RoHS) and 2002/96/EC (WEEE), with the RoHS directive limiting the concentration of certain materials (lead, chromium, etc) that may be contained in electronic products placed on the European market after July 1, 2006, and the WEEE directive requiring certain recycling markings and recycling procedures for electronic products placed on the European market after August 13, 2005; • difficulties associated with foreign operations; and • market shortages |
| There is a risk that we will not be able to retain our current suppliers or change to alternative suppliers |
| An interruption in supply, the cost of shifting to a new supplier or EMS providers, disputes with suppliers or EMS providers, or the cost associated with a long-term purchase commitment could have a material adverse effect on our business, results of operations, and financial condition |
| As we have transitioned the material procurement and management for our key components to our EMS providers, we face increasing risks associated with ensuring product availability |
| Further, an adverse inventory management control issue by one or more of our third party suppliers could have a material adverse effect on our business, results of operations, and financial condition |
| LSI Logic announced on May 15, 2006, that it consummated the sale of certain assets associated with its semiconductor wafer fabrication facilities in Gresham, Oregon to SCI, a wholly owned subsidiary of ON Semiconductor Corporation |
| In connection with that sale, LSI Logic entered into a wafer supply and test service agreement with SCI pursuant to which SCI will manufacture and provide semiconductor wafer products to LSI Logic and its customers for an initial period of 2 years |
| The entire term of the agreement is 6 years |
| This manufacturing facility, at which certain ASICs are manufactured for us, and the transition of 18 _________________________________________________________________ [53]Table of Contents such facility creates a risk of disruption in our supply of certain ASICs should the announced plans of LSI Logic for uninterrupted service of customers not be achieved |
| If our intellectual property protections are inadequate, it could adversely affect our business |
| We believe that our continued success depends primarily on continuing innovation, marketing, and technical expertise, as well as the quality of product support and customer relations |
| At the same time, our success is partially dependent on the proprietary technology contained in our products |
| We currently rely on a combination of patents, copyrights, trademarks, trade secret laws, and contractual provisions to establish and protect our intellectual property rights in our products |
| For a more complete description of our intellectual property, please see the information under Part I — Item 1 — “Intellectual Property |
| ” We cannot be certain that the steps we take to protect our intellectual property will adequately protect our proprietary rights, that others will not independently develop or otherwise acquire equivalent or superior technology, or that we can maintain such technology as trade secrets |
| In addition, the laws of some of the countries in which our products are or may be developed, manufactured, or sold may not protect our products and intellectual property rights to the same extent as the laws of the United States, or at all |
| Furthermore, we enter into various development projects and arrangements with other companies |
| In some cases, these arrangements allow for the sharing or use of our intellectual property |
| Our failure to protect our intellectual property rights could have a material adverse effect on our business, results of operations, and financial condition |
| Ongoing lawsuits present inherent risks, any of which could have a material adverse effect on our business, financial condition, or results of operations |
| Such potential risks include the continuing expenses of litigation, the risk of loss of patent rights, the risk of injunction against the sale of products incorporating the technology in question, counterclaims, attorneys’ fee liability, and the diversion of management’s attention from other business matters |
| For more information on legal proceedings related to Emulex, see Part I, |