QLogic Corporation

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-Q


(Mark One)
þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the quarterly period ended December 31, 2006
		or
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the transition period from to

Commission file number 0-23298

QLogic Corporation

(Exact name of registrant as specified in its charter)


Delaware	33-0537669
(State of incorporation)	(I.R.S. Employer Identification No.	)

26650 Aliso Viejo Parkway
Aliso Viejo, California 92656
(Address of principal executive office and zip code)

(949) 389-6000
(Registrant’s telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ No o

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer þ Accelerated filer o Non-accelerated filer o

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No þ

As of January 26, 2007, 159,055,028 shares of the Registrant’s common stock were outstanding.

PART I.

FINANCIAL INFORMATION


Item 1.	*Financial Statements*

QLOGIC CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS


	December 31,			April 2,
	2006			2006
	(Unaudited; In thousands, except share and per
	share amounts)

ASSETS
Current assets:
Cash and cash equivalents	$	91,643		$	125,192
Short-term marketable securities		325,413			540,448
Accounts receivable, less allowance for doubtful accounts of $1,262 and $1,239 as of December 31, 2006 and April 2, 2006, respectively		85,545			67,571
Inventories		44,464			39,440
Other current assets		36,648			46,441

Total current assets		583,713			819,092
Long-term marketable securities		138,272			—
Property and equipment, net		89,923			82,630
Goodwill		137,557			24,725
Purchased intangible assets, net		37,389			7,954
Other assets		31,218			3,306

	$	1,018,072		$	937,707


LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	33,305		$	32,160
Accrued compensation		29,493			23,520
Income taxes payable		18,606			12,920
Deferred revenue		6,645			3,662
Other current liabilities		7,829			6,091

Total current liabilities		95,878			78,353
Deferred tax liabilities		2,709			—

Total liabilities		98,587			78,353

Subsequent event (Note 7)
Stockholders’ equity:
Preferred stock, $0.001 par value; 1,000,000 shares authorized (200,000 shares designated as Series A Junior Participating Preferred, $0.001 par value); no shares issued and outstanding		—			—
Common stock, $0.001 par value; 500,000,000 shares authorized; 197,653,000 and 195,289,000 shares issued at December 31, 2006 and April 2, 2006, respectively		198			195
Additional paid-in capital		598,614			537,648
Retained earnings		970,287			883,310
Accumulated other comprehensive loss		(3,998	)		(1,799	)
Treasury stock, at cost; 38,169,000 and 33,197,000 shares at December 31, 2006 and April 2, 2006, respectively		(645,616	)		(560,000	)

Total stockholders’ equity		919,485			859,354

	$	1,018,072		$	937,707

See accompanying notes to condensed consolidated financial statements.

QLOGIC CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME


	Three Months Ended				Nine Months Ended
	December 31,		January 1,		December 31,		January 1,
	2006		2006		2006		2006
	(Unaudited; In thousands, except per share amounts)

Net revenues	$	157,611	$	129,185	$	439,601	$	363,627
Cost of revenues		50,698		36,900		139,774		105,888

Gross profit		106,913		92,285		299,827		257,739

Operating expenses:
Engineering and development		34,003		22,797		99,542		64,573
Sales and marketing		21,586		16,100		64,095		46,950
General and administrative		7,238		4,362		23,274		12,444
Purchased in-process research and development		—		—		1,910		—

Total operating expenses		62,827		43,259		188,821		123,967

Operating income		44,086		49,026		111,006		133,772
Interest and other income, net		5,646		5,151		18,332		17,381

Income from continuing operations before income taxes		49,732		54,177		129,338		151,153
Income taxes		14,278		22,496		42,361		60,696

Income from continuing operations		35,454		31,681		86,977		90,457

Discontinued operations:
Income from operations, net of income taxes		—		4,570		—		30,595
Gain on sale, net of income taxes		—		129,987		—		129,987

Income from discontinued operations		—		134,557		—		160,582

Net income	$	35,454	$	166,238	$	86,977	$	251,039

Income from continuing operations per share:
Basic	$	0.22	$	0.20	$	0.55	$	0.52

Diluted	$	0.22	$	0.19	$	0.54	$	0.51

Income from discontinued operations per share:
Basic	$	—	$	0.83	$	—	$	0.92

Diluted	$	—	$	0.83	$	—	$	0.91

Net income per share:
Basic	$	0.22	$	1.03	$	0.55	$	1.44

Diluted	$	0.22	$	1.02	$	0.54	$	1.42

Number of shares used in per share calculations:
Basic		158,532		161,317		159,516		174,426

Diluted		160,760		163,093		161,161		176,497

See accompanying notes to condensed consolidated financial statements.

QLOGIC CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


	Nine Months Ended
	December 31,			January 1,
	2006			2006
	(Unaudited; In thousands)

Cash flows from operating activities:
Net income	$	86,977		$	251,039
Income from discontinued operations, net of income taxes		—			(30,595	)
Gain on sale of discontinued operations, net of income taxes		—			(129,987	)

Income from continuing operations		86,977			90,457
Adjustments to reconcile income from continuing operations to net cash provided by continuing operating activities:
Depreciation and amortization		26,904			12,851
Stock-based compensation		22,546			175
Acquisition-related stock-based compensation		7,809			212
Purchased in-process research and development		1,910			—
Deferred income taxes		(14,643	)		(7,117	)
Provision for losses on accounts receivable		(55	)		57
Loss on disposal of property and equipment		163			130
Tax benefit from issuance of stock under stock plans		—			2,134
Changes in operating assets and liabilities, net of acquisitions:
Accounts receivable		(14,197	)		(15,894	)
Inventories		(2,915	)		(6,578	)
Other assets		1,109			3,014
Accounts payable		(2,777	)		3,056
Accrued compensation		(1,443	)		(2,276	)
Income taxes payable		5,686			22,223
Deferred revenue		2,983			1,557
Other liabilities		629			958

Net cash provided by continuing operating activities		120,686			104,959

Cash flows from investing activities:
Purchases of marketable securities		(240,441	)		(639,830	)
Sales and maturities of marketable securities		313,644			689,038
Additions to property and equipment		(23,666	)		(18,139	)
Acquisition of businesses, net of cash acquired		(142,383	)		(35,241	)
Restricted cash received from escrow		12,508			—
Restricted cash placed in escrow		(24,000	)		(12,000	)

Net cash used in continuing investing activities		(104,338	)		(16,172	)

Cash flows from financing activities:
Proceeds from issuance of stock under stock plans		31,063			12,394
Tax benefit from issuance of stock under stock plans		6,288			—
Payoff of line of credit assumed in acquisition		(1,632	)		—
Purchase of treasury stock		(85,616	)		(414,999	)

Net cash used in continuing financing activities		(49,897	)		(402,605	)

Net cash used in continuing operations		(33,549	)		(313,818	)

Cash flows from discontinued operations:
Net cash provided by operating activities		—			32,719
Net cash provided by investing activities, including proceeds from sale		—			181,336

Net cash provided by discontinued operations		—			214,055

Net decrease in cash and cash equivalents		(33,549	)		(99,763	)
Cash and cash equivalents at beginning of period		125,192			165,644

Cash and cash equivalents at end of period	$	91,643		$	65,881

See accompanying notes to condensed consolidated financial statements.

QLOGIC CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1. Basis of Presentation

In the opinion of management of QLogic Corporation (QLogic or the Company), the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting solely of normal recurring accruals) necessary to present fairly the Company’s consolidated financial position, results of operations and cash flows. The accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended April 2, 2006. The results of operations for the three and nine months ended December 31, 2006 are not necessarily indicative of the results that may be expected for the entire fiscal year.

In November 2005, the Company completed the sale of its hard disk drive controller and tape drive controller business (the Business). The Business meets all of the criteria in Statement of Financial Accounting Standards (SFAS) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” to be presented as discontinued operations. As a result of the divestiture of the Business, the Company’s condensed consolidated financial statements present the operations of the Business separate from continuing operations. See Note 3 — Discontinued Operations.

In March 2006, the Company completed a two-for-one stock split through the payment of a stock dividend. As a result, share numbers and per share amounts for all periods presented in the condensed consolidated financial statements reflect the effects of this stock split.

Certain reclassifications have been made to prior year amounts to conform to the current year presentation in the accompanying condensed consolidated financial statements.


Note 2.	Business Combinations

SilverStorm Technologies, Inc.

On November 1, 2006, the Company acquired by merger all outstanding shares of SilverStorm Technologies, Inc. (SilverStorm). Cash consideration was $59.8 million, including $59.4 million for all outstanding SilverStorm common stock, vested stock options and stock warrants and $0.4 million for direct acquisition costs. SilverStorm provides end-to-end, high-performance interconnect fabric solutions for cluster and grid computing networks. The acquisition of SilverStorm expands the Company’s portfolio of InfiniBand^tm solutions to include edge fabric switches and multi-protocol fabric directors. Infiniband is a high-performance, low-latency, server area fabric interconnect. The acquisition agreement required that $9 million of the consideration paid be placed into an escrow for 15 months in connection with certain standard representations and warranties. The Company has accounted for the escrowed amount as contingent consideration and, as such, has not recorded it as a component of the purchase price as the outcome of the related contingencies is not determinable beyond a reasonable doubt. The escrowed amount is included in other assets in the accompanying condensed consolidated balance sheet as of December 31, 2006. Upon satisfaction of the contingency, the escrowed amount will be recorded as additional purchase price and allocated to goodwill.

The acquisition has been accounted for as a purchase business combination. The consideration paid in excess of the fair market value of the tangible net assets acquired, excluding the escrowed amount, totaled $49.7 million, which has been included in goodwill in the accompanying condensed consolidated balance sheet as of December 31, 2006. The Company is in the process of valuing the intangible assets acquired and expects to finalize the purchase price allocation in the first half of fiscal 2008. Upon completion of the valuation of the intangible assets acquired, amounts may be allocated to intangible assets and in-process research and development (IPR&D). To the extent a portion of the purchase price is allocated to IPR&D, the Company will recognize a charge to operating expenses for such amount. None of the goodwill resulting from this acquisition will be tax deductible. The following table

QLOGIC CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

summarizes the preliminary allocation of the purchase price to the fair value of the assets and liabilities acquired, excluding the $9.0 million of contingent consideration:


	(In thousands)

Cash	$	538
Accounts receivable		3,455
Inventories		2,109
Property and equipment		430
Goodwill		49,673
Other assets		134
Accounts payable and accrued expenses		(3,922	)
Line of credit		(1,632	)

Total preliminary purchase price allocation	$	50,785

The results of operations for SilverStorm have been included in the condensed consolidated financial statements from the date of acquisition. Pro forma results of operations have not been presented as the results of operations for SilverStorm are not material in relation to the consolidated financial statements of the Company.

PathScale, Inc.

On April 3, 2006, the Company acquired by merger all outstanding shares of PathScale, Inc. (PathScale). PathScale designed and developed system area network fabric interconnects targeted at high-performance clustered system environments. The acquisition of PathScale expanded the Company’s portfolio to include InfiniBand solutions. Consideration for this acquisition was $110.5 million, including $0.3 million related to PathScale unvested stock options assumed by QLogic. Cash consideration was $110.2 million, including $109.7 million for all outstanding PathScale common stock and vested stock options and $0.5 million for direct acquisition costs. The acquisition agreement required that $15 million of the consideration paid be placed into an escrow for 18 months in connection with certain standard representations and warranties. The Company has accounted for the escrowed amount as contingent consideration and, as such, has not recorded it as a component of the purchase price as the outcome of the related contingencies is not determinable beyond a reasonable doubt. The escrowed amount is included in other assets in the accompanying condensed consolidated balance sheet as of December 31, 2006. Upon satisfaction of the contingency, the escrowed amount will be recorded as additional purchase price and allocated to goodwill.

The Company also converted unvested PathScale stock options for continuing employees into options to purchase approximately 308,000 shares of QLogic common stock with a weighted-average exercise price of $3.00 per share. The total fair value of the options at the date of conversion was $5.2 million, calculated using the Black-Scholes option pricing model. The Company has accounted for $0.3 million of the value of the converted stock options as consideration for the acquisition to reflect the related employee services rendered through the date of the acquisition and the balance will be expensed over the remaining service period.

The acquisition has been accounted for as a purchase business combination. Based on a preliminary purchase price allocation, the Company allocated the total purchase consideration to the tangible assets, liabilities and identifiable intangible assets acquired as well as IPR&D, based on their respective fair values at the acquisition date. The excess of the purchase price over the aggregate fair values was recorded as goodwill. None of the goodwill resulting from this acquisition will be tax deductible. The following table summarizes the preliminary allocation of

QLOGIC CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

the purchase price to the fair value of the assets and liabilities acquired, excluding the $15.0 million of contingent consideration:


	(In thousands)

Cash	$	3,096
Accounts receivable		267
Other current assets		801
Property and equipment		1,315
Goodwill		71,148
Identifiable intangible assets		30,100
Other assets		255
Accrued compensation		(412	)
Other current liabilities		(1,109	)
Deferred tax liabilities		(11,573	)
In-process research and development		1,600

Total preliminary purchase price allocation	$	95,488

A summary of the purchased intangible assets acquired as part of the acquisition of PathScale and their respective estimated lives are as follows:


	Estimated
	Useful Lives
	(Years)	Amount
		(In thousands)

Intangible Assets:
Core/developed technology	2.5 - 5	$	28,400
Customer relationships	3		700
Other	1 - 3		1,000

		$	30,100

The Company is in the process of finalizing the valuation of the intangible assets acquired and expects to complete it during the fourth quarter of fiscal 2007, which may result in adjustments to the amounts recorded.

The Company also entered into performance plans with certain former PathScale employees who became employees of QLogic as of the acquisition date. The performance plans provide for the issuance of QLogic common stock based on the achievement of certain performance milestones and continued employment with QLogic. In connection with the performance plans, the Company recognized $2.1 million and $6.4 million of compensation expense during the three and nine months ended December 31, 2006, respectively, and could recognize up to $8.4 million of additional compensation expense through April 2010.

The results of operations for PathScale have been included in the condensed consolidated financial statements from the date of acquisition. Pro forma results of operations have not been presented as the results of operations for PathScale are not material in relation to the consolidated financial statements of the Company.

Troika Networks

In November 2005, the Company completed the purchase of substantially all of the assets of Troika Networks, Inc. (Troika) for $36.5 million in cash and the assumption of certain liabilities. The acquisition has been accounted for as a purchase business combination. The assets acquired included intellectual property (including patents and trademarks), inventory and property and equipment. Troika developed, marketed and sold a storage services

QLOGIC CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

platform that hosted third-party software solutions. The acquisition of Troika expanded the Company’s product line and, through the acquired intellectual property, enhanced certain of the Company’s current products, thereby providing greater functionality to customers. The consideration paid in excess of the fair market value of the tangible net assets acquired totaled $34.8 million. Based on a preliminary purchase price allocation in the fourth quarter of fiscal 2006, the Company had recorded goodwill of $20.7 million and core technology of $3.6 million and recognized a charge of $10.5 million for IPR&D. During the first quarter of fiscal 2007, the Company finalized its valuation of the intangible assets acquired resulting in an increase in core technology of $7.7 million, an increase in IPR&D of $0.3 million and a corresponding decrease in goodwill of $8.0 million. As this acquisition was an asset purchase, the goodwill resulting from this acquisition will be tax deductible.

The Company also entered into a performance plan with certain former Troika employees upon employment with QLogic. The performance plan provides for the issuance of QLogic common stock based on the achievement of certain performance milestones and continued employment with QLogic. In connection with the performance plan, the Company recognized $0.3 million and $1.5 million of compensation expense during the three and nine months ended December 31, 2006, respectively, and could recognize up to $4.3 million of additional compensation expense through November 2009.

The results of operations for Troika have been included in the condensed consolidated financial statements from the date of acquisition. Pro forma results of operations have not been presented as the results of operations for Troika are not material in relation to the consolidated financial statements of the Company.

In-Process Research and Development

During the nine months ended December 31, 2006, purchased in-process research and development includes $0.3 million related to the acquisition of Troika and $1.6 million related to the acquisition of PathScale. The amounts allocated to IPR&D were determined through established valuation techniques used in the high technology industry and were expensed upon acquisition as it was determined that the underlying projects had not reached technological feasibility and no alternative future uses existed.

The fair value of the IPR&D for each of the acquisitions was determined using the income approach. Under the income approach, the expected future cash flows from each project under development are estimated and discounted to their net present values at an appropriate risk-adjusted rate of return. Significant factors considered in the calculation of the rate of return are the weighted-average cost of capital and return on assets, as well as the risks inherent in the development process, including the likelihood of achieving technological success and market acceptance. Each project was analyzed to determine the unique technological innovations, the existence and reliance on core technology, the existence of any alternative future use or current technological feasibility, and the complexity, cost and time to complete the remaining development. Future cash flows for each project were estimated based on forecasted revenue and costs, taking into account product life cycles, and market penetration and growth rates.

The IPR&D charge includes only the fair value of IPR&D performed as of the respective acquisition dates. The fair value of core/developed technology is included in identifiable purchased intangible assets. The Company believes the amounts recorded as IPR&D, as well as core/developed technology, represent the fair values and approximate the amounts an independent party would pay for these projects at the time of the respective acquisition dates.


Note 3.	Discontinued Operations

In November 2005, the Company completed the sale of its hard disk drive controller and tape drive controller business to Marvell Technology Group Ltd. (Marvell) for cash and 1,961,000 shares of Marvell’s common stock, adjusted for a two-for-one stock split on July 25, 2006. During the fourth quarter of fiscal 2006, the Company sold 1,051,000 shares, adjusted for the stock split, of the Marvell stock received in the transaction. The remaining shares

QLOGIC CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

are accounted for as available-for-sale marketable securities and are included in short-term marketable securities in the accompanying condensed consolidated balance sheets.

The agreement also provided for $12.0 million of the consideration to be placed in escrow for a period of twelve months with respect to certain standard representations and warranties made by the Company. During fiscal 2006, the Company included the escrowed amount in the calculation of the gain on sale of the Business due to the Company’s assessment that compliance with the representations and warranties was determinable beyond a reasonable doubt. The escrowed amount was included in other current assets in the accompanying condensed consolidated balance sheet as of April 2, 2006. The Company received the $12.0 million escrowed amount and $0.5 million in related interest during the three months ended December 31, 2006.

Income from discontinued operations consists of direct revenues and direct expenses of the Business, including cost of revenues, as well as other fixed and allocated costs to the extent that such costs were eliminated as a result of the transaction. General corporate overhead costs have not been allocated to discontinued operations. A summary of the operating results of the Business included in discontinued operations in the accompanying condensed consolidated statements of income is as follows:


	Three Months Ended				Nine Months Ended
	December 31,		January 1,		December 31,		January 1,
	2006		2006		2006		2006
	(In thousands)

Net revenues	$	—	$	13,181	$	—	$	94,674

Income from operations before income taxes	$	—	$	7,519	$	—	$	47,825
Income taxes		—		2,949		—		17,230

Income from operations, net of income taxes	$	—	$	4,570	$	—	$	30,595

Gain on sale before income taxes	$	—	$	213,869	$	—	$	213,869
Income taxes		—		83,882		—		83,882

Gain on sale, net of income taxes	$	—	$	129,987	$	—	$	129,987

There were no assets or liabilities related to discontinued operations as of December 31, 2006 or April 2, 2006.


Note 4.	Marketable Securities

The Company’s marketable securities are invested primarily in debt securities, including government securities, corporate bonds and municipal bonds. The Company also holds shares of common stock in Marvell which were received in connection with the sale of the hard disk drive controller and tape drive controller business (see Note 3). All of the Company’s marketable securities are classified as available for sale and are recorded at fair value, based on quoted market prices. The Company’s available-for-sale marketable securities are classified as current or long-term based on management’s intent regarding their availability for use in current operations. Unrealized gains and losses, net of related income taxes, are excluded from earnings and reported as a separate component of other comprehensive income (loss) until realized. The Company recognizes an impairment charge when the decline in the fair value of an investment below its cost basis is judged to be other-than-temporary.

As of December 31, 2006, the fair value of certain of the Company’s debt securities and the Marvell common stock was less than their cost basis. Management reviewed various factors in determining whether to recognize an impairment charge related to these unrealized losses, including the financial condition and near term prospects of the issuer of the marketable security, the magnitude of the unrealized loss compared to the cost of the investment, the length of time the investment has been in an unrealized loss position and the Company’s ability to hold the

QLOGIC CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

investment for a period of time sufficient to allow for any anticipated recovery of market value. Based on this analysis, the Company’s management believes that the unrealized losses in its marketable securities are temporary in nature and therefore no impairment charge has been recognized. However, if the Marvell common stock held by the Company, remains in an unrealized loss position, it may be necessary for the Company to recognize an impairment charge. As of December 31, 2006 the Marvell common stock held by the Company had an unrealized loss of $2.7 million (net of related income taxes of $1.6 million).


Note 5.	Inventories

The components of inventories are as follows:


	December 31,		April 2,
	2006		2006
	(In thousands)

Raw materials	$	9,804	$	13,810
Finished goods		34,660		25,630

	$	44,464	$	39,440


Note 6.	Goodwill and Purchased Intangible Assets

Goodwill

A rollforward of the activity in goodwill during the nine months ended December 31, 2006 is as follows:


	April 2,					December 31,
	2006		Activity			2006
	(In thousands)

Acquisition
PathScale	$	—	$	71,148		$	71,148
SilverStorm		—		49,673			49,673
Troika		20,651		(7,989	)		12,662
Other		4,074		—			4,074

	$	24,725	$	112,832		$	137,557

QLOGIC CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Purchased Intangible Assets

Purchased intangible assets consists of the following:


	December 31, 2006						April 2, 2006
	Gross				Net		Gross				Net
	Carrying		Accumulated		Carrying		Carrying		Accumulated		Carrying
	Value		Amortization		Value		Value		Amortization		Value
	(In thousands)

Acquisition-related intangibles:
Core/developed technology	$	39,700	$	7,677	$	32,023	$	3,610	$	201	$	3,409
Customer relationships		700		175		525		—		—		—
Other		1,000		200		800		—		—		—

		41,400		8,052		33,348		3,610		201		3,409

Other purchased intangibles:
Technology-related		4,596		1,722		2,874		4,102		1,024		3,078
Other		2,000		833		1,167		2,000		533		1,467

		6,596		2,555		4,041		6,102		1,557		4,545

	$	47,996	$	10,607	$	37,389	$	9,712	$	1,758	$	7,954

The Company amortizes intangible assets that have definite lives on a straight-line basis over the estimated useful lives of the related assets ranging from one to five years. Amortization expense related to core/developed technology acquired and other purchased technology-related intangible assets is included in cost of revenues in the accompanying condensed consolidated statements of income. The Company recorded amortization expense related to intangible assets of $2.7 million and $8.9 million, respectively, during the three and nine months ended December 31, 2006, and $0.3 million and $0.9 million, respectively, during the three and nine months ended January 1, 2006.

The following table presents the estimated future amortization expense of intangible assets as of December 31, 2006:


Fiscal	(In thousands)

2007 (remaining three months)	$	2,781
2008		11,364
2009		9,581
2010		7,705
2011		5,958

	$	37,389


Note 7.	Treasury Stock

In November 2005, the Company’s Board of Directors approved a stock repurchase program that authorized the Company to purchase up to $200 million of its outstanding common stock for a two-year period. During the nine months ended December 31, 2006, the Company purchased 5.0 million shares of its common stock under this program for an aggregate purchase price of $85.6 million. As of January 29, 2007, the Company had purchased an additional 0.6 million shares of its common stock under this program for an aggregate purchase price of $10.9 million.

QLOGIC CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Repurchased shares have been recorded as treasury shares and will be held until the Company’s Board of Directors designates that these shares be retired or used for other purposes.


Note 8.	Comprehensive Income

The components of comprehensive income are as follows:


	Three Months Ended				Nine Months Ended
	December 31,		January 1,		December 31,			January 1,
	2006		2006		2006			2006
	(In thousands)

Net income	$	35,454	$	166,238	$	86,977		$	251,039
Other comprehensive income (loss):
Change in unrealized gains/losses on available-for-sale marketable securities		328		4,749		(2,199	)		5,261

	$	35,782	$	170,987	$	84,778		$	256,300


Note 9.	Share-Based Payment

As of the beginning of the first quarter of fiscal 2007, the Company adopted SFAS No. 123 (revised 2004), “Share-Based Payment,” which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and non-employee directors including stock options, restricted stock units and stock purchases under the Company’s Employee Stock Purchase Plan (the ESPP) based on estimated fair values. SFAS 123R supersedes SFAS No. 123, “Accounting for Stock-Based Compensation,” and Accounting Principles Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. SFAS 123R also amends SFAS No. 95, “Statement of Cash Flows,” and requires the benefits of tax deductions in excess of recognized compensation cost be reported as a financing cash inflow, rather than as an operating cash inflow as required under previous literature.

The Company adopted SFAS 123R using the modified prospective transition method and consequently has not retroactively adjusted results from prior periods. Under this transition method, compensation cost associated with stock-based awards recognized beginning in fiscal 2007 includes: (1) amortization related to the remaining unvested portion of stock-based awards granted prior to the adoption of SFAS 123R based on the grant date fair value estimated in accordance with the original provisions of SFAS 123; and (2) amortization related to stock-based awards granted subsequent to the adoption date based on the grant date fair value estimated in accordance with the provisions of SFAS 123R. SFAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company recognizes stock-based compensation expense on a straight-line basis over the requisite service period, which is the offering period for the ESPP and the vesting period for stock options and restricted stock awards.

SFAS 123R requires companies to estimate the fair value of share-based payment awards on the date of grant. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the Company’s consolidated financial statements. The Company’s determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by the Company’s stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, the Company’s expected stock price volatility over the term of the awards and actual and projected employee stock option exercise behaviors. Option-pricing models were developed for use in estimating the value of traded options that have no vesting or hedging restrictions and are fully transferable. However, the Company’s employee stock options have certain characteristics that are significantly different from traded options. Changes in the subjective assumptions can materially affect the estimate of their fair value.

QLOGIC CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Incentive Compensation Plans

The Company may grant to employees and directors options to purchase shares of the Company’s common stock under the QLogic 2005 Performance Incentive Plan (the 2005 Plan). Prior to the adoption of the 2005 Plan in August 2005, the Company granted options to purchase shares of the Company’s common stock under the QLogic Corporation Stock Awards Plan (the Stock Awards Plan) and the QLogic Corporation Non-Employee Director Stock Option Plan (the Director Plan). Additionally, the Company has issued options on an ad hoc basis from time to time and has assumed stock options as part of acquisitions.

The Stock Awards Plan and the 2005 Plan provide for the issuance of incentive and non-qualified stock options, restricted stock units and other stock-based incentive awards for officers and employees. The Stock Awards Plan and the 2005 Plan permit the Compensation Committee of the Board of Directors to select eligible employees to receive awards and to determine the terms and conditions of awards.

In general, stock options granted to employees under the Stock Awards Plan and the 2005 Plan have ten-year terms and vest over four years from the date of grant.

During fiscal 2007, the Company granted restricted stock units to employees and non-employee directors under the 2005 Plan. Restricted stock units represent a right to receive a share of stock at a future vesting date with no cash payment from the holder. In general, restricted stock units granted under the 2005 Plan vest over four years from the date of grant for employees and over three years from the date of grant for non-employee directors.

Under the terms of the 2005 Plan, as amended, new directors receive an option grant, with an exercise price equal to the fair market value at the date of grant, to purchase 50,000 shares of common stock of the Company upon election to the Board. The 2005 Plan provides for annual grants to each non-employee director (other than the Chairman of the Board) of options to purchase 16,000 shares of common stock and 3,000 restricted stock units and annual grants of options to purchase 50,000 shares of common stock and 8,000 restricted stock units to any non-employee Chairman of the Board. All stock options and restricted stock units granted to directors under the Director Plan and the 2005 Plan have ten-year terms and vest over three years from the date of grant.

In connection with the acquisition of PathScale, the Company assumed the PathScale, Inc. 2001 Equity Incentive Plan (the PathScale Plan). Options assumed in the acquisition are subject to the terms of the PathScale Plan. These options have ten-year terms from the original grant date and generally vest over four years from the date of grant. No further shares can be granted under the PathScale Plan.

The Company also entered into share-based performance plans in connection with the acquisitions of PathScale and Troika. See Note 2 — Business Combinations.

As of December 31, 2006, options to purchase 24.6 million shares and 1.7 million shares of common stock were held by employees and directors, respectively, and 0.9 million and 18,000 restricted stock units were held by employees and directors, respectively. Shares available for future grant were 10.7 million under the 2005 Plan as of December 31, 2006. No further shares can be granted under the Stock Awards Plan or the Director Plan.

QLOGIC CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

A summary of stock option activity for the nine months ended December 31, 2006 is as follows:


						Weighted-
				Weighted-		Average
				Average		Remaining		Aggregate
	Number of			Exercise		Contractual		Intrinsic
	Shares			Price		Term (Years)		Value
	(In thousands)							(In thousands)

Outstanding at beginning of period		24,854		$	20.90
Options assumed as part of acquisition		308			3.00
Granted		4,321			18.42
Exercised		(2,028	)		13.08
Forfeited (cancelled pre-vesting)		(703	)		15.80
Expired (cancelled post-vesting)		(420	)		27.25

Outstanding at end of period		26,332		$	20.92		6.4	$	91,368

Vested and expected to vest at end of period		25,028		$	21.12		6.3	$	84,961

Exercisable at end of period		17,476		$	23.20		5.2	$	42,633

A summary of restricted stock unit activity for the nine months ended December 31, 2006 is as follows:


				Weighted-
				Average
	Number of			Grant Date
	Shares			Fair Value
	(In thousands)

Outstanding and unvested at beginning of period		—		$	—
Granted		968			18.82
Vested		—			—
Cancelled		(26	)		18.09

Outstanding and unvested at end of period		942		$	18.84

Stock-Based Compensation Expense

SFAS 123R requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The fair value of stock options granted during the three and nine months ended December 31, 2006 and shares to be purchased under the ESPP have been estimated at the date of grant using a Black-Scholes option-pricing model. The weighted-average fair value and underlying assumptions are as follows:


	Three Months Ended						Nine Months Ended
	December 31, 2006						December 31, 2006
				Employee						Employee
				Stock						Stock
	Stock			Purchase			Stock			Purchase
	Options			Plan			Options			Plan

Fair value	$	7.61		$	4.24		$	8.28		$	4.16
Expected volatility		41	%		28	%		46	%		29	%
Risk-free interest rate		4.6	%		5.1	%		4.9	%		5.0	%
Expected life (years)		5.0			0.25			5.0			0.25
Dividend yield		—			—			—			—

Restricted stock units granted were valued based on the closing market price on the date of grant.

QLOGIC CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Stock-based compensation expense for stock options, restricted stock units and employee stock purchases recognized under the provisions of SFAS 123R for the three and nine months ended December 31, 2006 was $7.5 million ($6.1 million after tax) and $22.5 million ($18.4 million after tax), respectively. Share-based compensation costs capitalized as part of the cost of assets for the three and nine months ended December 31, 2006 were not material.

As of December 31, 2006, there was $73.6 million of total unrecognized compensation costs related to outstanding stock-based awards. These costs are expected to be recognized over a weighted average period of 2.4 years.

During the three and nine months ended December 31, 2006, the grant date fair value of options vested totaled $6.0 million and $17.0 million, respectively. During the three and nine months ended December 31, 2006, the intrinsic value of options exercised totaled $14.0 million and $16.1 million, respectively. Intrinsic value of options exercised is calculated as the difference between the market price on the date of exercise and the exercise price multiplied by the number of options exercised.

The Company currently issues new shares to deliver common stock under its share based payment plans.

Pro Forma Information Under SFAS 123 for Periods Prior to Fiscal 2007

Prior to the adoption of SFAS 123R, the Company accounted for stock-based awards to employees and non-employee directors using the intrinsic value method in accordance with APB 25, and related interpretations, and adopted the disclosure only alternative allowed under SFAS 123, as amended.

The fair value of stock-based awards granted has been estimated at the date of grant using the Black-Scholes option-pricing model. The following table shows pro forma net income as if the fair value method of SFAS 123 had been used to account for stock-based compensation expense:


	Three Months			Nine Months
	Ended			Ended
	January 1, 2006			January 1, 2006
	(In thousands, except per share amounts)

Net income, as reported	$	166,238		$	251,039
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects		—			105
Deduct: Stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects		(7,025	)		(21,404	)

Pro forma net income	$	159,213		$	229,740

Net income per share:
Basic, as reported	$	1.03		$	1.44
Diluted, as reported	$	1.02		$	1.42
Basic, pro forma	$	0.99		$	1.32
Diluted, pro forma	$	0.98		$	1.30

QLOGIC CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Note 10. Interest and Other Income, Net

The components of interest and other income, net are as follows:


	Three Months Ended						Nine Months Ended
	December 31,			January 1,			December 31,			January 1,
	2006			2006			2006			2006
	(In thousands)

Interest income	$	6,290		$	5,715		$	19,091		$	18,572
Loss on sale of marketable securities		(772	)		(564	)		(1,620	)		(1,184	)
Other		128			—			861			(7	)

	$	5,646		$	5,151		$	18,332		$	17,381


Note 11.	Income Per Share

The following table sets forth the computation of basic and diluted income per share:


	Three Months Ended				Nine Months Ended
	December 31,		January 1,		December 31,		January 1,
	2006		2006		2006		2006
	(In thousands, except per share amounts)

Income from continuing operations	$	35,454	$	31,681	$	86,977	$	90,457
Income from discontinued operations		—		134,557		—		160,582

Net income	$	35,454	$	166,238	$	86,977	$	251,039

Shares:
Weighted-average shares outstanding — basic		158,532		161,317		159,516		174,426
Dilutive potential common shares		2,228		1,776		1,645		2,071

Weighted-average shares outstanding — diluted		160,760		163,093		161,161		176,497

Income from continuing operations per share:
Basic	$	0.22	$	0.20	$	0.55	$	0.52

Diluted	$	0.22	$	0.19	$	0.54	$	0.51

Income from discontinued operations per share:
Basic	$	—	$	0.83	$	—	$	0.92

Diluted	$	—	$	0.83	$	—	$	0.91

Net income per share:
Basic	$	0.22	$	1.03	$	0.55	$	1.44

Diluted	$	0.22	$	1.02	$	0.54	$	1.42

Stock-based awards, including stock options and restricted stock units, representing 17,266,000 and 18,930,000 shares of common stock have been excluded from the diluted income per share calculations for the three and nine months ended December 31, 2006, respectively, and 17,170,000 and 17,210,000 shares of common stock have been excluded from the diluted income per share calculations for the three and nine months ended January 1, 2006, respectively. These stock-based awards have been excluded from the diluted income per share calculations because their effect was antidilutive. Contingently issuable shares of the Company’s common stock pursuant to performance plans associated with certain acquisitions are included, as appropriate, in the calculation of diluted income per share as of the beginning of the period in which the respective performance conditions are met.


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

This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our unaudited condensed consolidated financial statements and related notes. This Management’s Discussion and Analysis of Financial Condition and Results of Operations also contains descriptions of our expectations regarding future trends affecting our business. These forward-looking statements and other forward-looking statements made elsewhere in this report are made in reliance upon safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements include, without limitation, descriptions of our expectations regarding future trends affecting our business and other statements regarding future events or our objectives, goals, strategies, beliefs and underlying assumptions that are other than statements of historical fact. When used in this report, the words “anticipates,” “believes,” “can,” “continue,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “should,” “will” and similar expressions or the negative of such expressions are intended to identify these forward-looking statements. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of several factors, including, but not limited to those factors set forth and discussed in Part II, Item 1A “Risk Factors” and elsewhere in this report. In light of the significant uncertainties inherent in the forward-looking information included in this report, the inclusion of this information should not be regarded as a representation by us or any other person that our objectives or plans will be achieved. We do not intend to update or revise these forward-looking statements, whether as a result of new information, future events or otherwise.

Overview

We design and develop storage network infrastructure components sold to original equipment manufacturers, or OEMs, and distributors. We produce host bus adapters, or HBAs, Fibre Channel blade switches, Fibre Channel stackable switches and other fabric switches. In addition, we design and develop storage routers for bridging Fibre Channel and Internet Small Computer System Interface (SCSI), or iSCSI, networks and storage services platforms that provide performance improvements to third-party and OEM storage management software that has been ported to the platform. All of these products address the storage area network, or SAN, connectivity infrastructure requirements of small, medium and large enterprises. We also design and develop InfiniBand^tm host channel adapters, or HCAs, and switches that provide connectivity infrastructure for clustered server fabrics in high-performance computing and enterprise-clustered database markets. Finally, we sell management controller chips for use in entry-level servers and storage subsystems. We serve our customers with solutions based on various connectivity technologies including Fibre Channel, InfiniBand, iSCSI and SCSI.

Our ability to serve the storage industry stems from our highly leveraged product line that addresses virtually every connection point in a SAN infrastructure solution. On the server side of the SAN, we provide Fibre Channel and iSCSI HBAs, and HBA technology on the motherboard (“Fibre Down^tm” technology). Connecting servers to storage, we provide the network infrastructure with a broad line of Fibre Channel switches.

Our products are sold directly to OEMs and to authorized distributors. Our products are incorporated in a large number of solutions from OEM customers, including Cisco Systems, Inc., Dell Computer Corporation, EMC Corporation, Hitachi Data Systems, Hewlett-Packard Company, International Business Machines Corporation, Network Appliance, Inc., Sun Microsystems, Inc. and many others.

Share-Based Payment

Business Combinations

On November 1, 2006, we acquired by merger all outstanding shares of SilverStorm Technologies, Inc. (SilverStorm). Cash consideration was $59.8 million, including $59.4 million for all outstanding SilverStorm common stock, vested stock options and stock warrants and $0.4 million for direct acquisition costs. SilverStorm provides end-to-end, high-performance interconnect fabric solutions for cluster and grid computing networks. The acquisition of SilverStorm expands our portfolio of InfiniBand solutions to include edge fabric switches and multi-protocol fabric directors. Infiniband is a high-performance, low-latency, server area fabric interconnect. The acquisition agreement required that $9 million of the consideration paid be placed into an escrow for 15 months in connection with certain standard representations and warranties. We have accounted for the escrowed amount as contingent consideration and, as such, have not recorded it as a component of the purchase price as the outcome of the related contingencies is not yet determinable beyond a reasonable doubt. Upon satisfaction of the contingency, the escrowed amount will be recorded as additional purchase price and allocated to goodwill.

The acquisition has been accounted for as a purchase business combination. The consideration paid in excess of the fair market value of the tangible net assets acquired, excluding the escrowed amount, totaled $49.7 million, which has been included in goodwill as of December 31, 2006. We are in the process of valuing the intangible assets acquired and expect to finalize the purchase price allocation in the first half of fiscal 2008. Upon completion of the valuation of the intangible assets acquired, amounts may be allocated to intangible assets and in-process research and development (IPR&D). To the extent a portion of the purchase price is allocated to IPR&D, we will recognize a charge to operating expenses for such amount.

On April 3, 2006, we acquired by merger all outstanding shares of PathScale, Inc. (PathScale). PathScale designed and developed system area network fabric interconnects targeted at high-performance clustered system environments. The acquisition of PathScale expanded our portfolio to include InfiniBand solutions. Consideration for this acquisition was $110.5 million, including $0.3 million related to PathScale unvested stock options assumed by QLogic. Cash consideration was $110.2 million, including $109.7 million for all outstanding PathScale common stock and vested stock options and $0.5 million for direct acquisition costs. The acquisition agreement required that $15 million of the consideration paid be placed into an escrow for 18 months in connection with certain standard representations and warranties. We accounted for the escrowed amount as contingent consideration and, as such, have not recorded it as a component of the purchase price as the outcome of the related contingencies is not yet determinable beyond a reasonable doubt. Upon satisfaction of the contingency, the escrowed amount will be recorded as additional purchase price and allocated to goodwill.

We also converted unvested PathScale stock options for continuing employees into options to purchase approximately 308,000 shares of QLogic common stock with a weighted-average exercise price of $3.00 per share. The total fair value of the options at the date of conversion was $5.2 million, calculated using the Black-Scholes option pricing model. We have accounted for $0.3 million of the value of the converted stock options as consideration for the acquisition to reflect the related employee services rendered through the date of the acquisition.

The acquisition has been accounted for as a purchase business combination. Based on a preliminary purchase price allocation, we allocated the total purchase consideration to the tangible assets, liabilities and identifiable intangible assets acquired as well as IPR&D based on their respective fair values at the acquisition date. The excess of the purchase price over the aggregate fair values resulted in goodwill of $71.1 million being recorded. Identifiable intangible assets included core/developed technology, customer relationships and other intangible assets and totaled $30.1 million. Identifiable intangible assets are amortized on a straight-line basis over their respective estimated useful lives ranging from one to five years. We also recognized a charge of $1.6 million for IPR&D. We are in the process of finalizing the valuation of the intangible assets acquired and expect to complete it during the fourth quarter of fiscal 2007, which may result in adjustments to the amounts recorded.

We also entered into performance plans with certain former PathScale employees who became employees of QLogic as of the acquisition date. The performance plans provide for the issuance of our common stock based on the achievement of certain performance milestones and continued employment with QLogic. In connection with the performance plans, we recognized $2.1 million and $6.4 million of compensation expense during the three and nine

months ended December 31, 2006, respectively, and could recognize up to $8.4 million of additional compensation expense through April 2010.

In November 2005, we completed the purchase of substantially all of the assets of Troika Networks, Inc. (Troika) for $36.5 million in cash and the assumption of certain liabilities. The assets acquired included intellectual property (including patents and trademarks), inventory and property and equipment. Troika developed, marketed and sold a storage services platform that hosted third-party software solutions. The acquisition of Troika expanded our product line and, through the acquired intellectual property, enhanced certain of our current products, thereby providing greater functionality to our customers. The consideration paid in excess of the fair market value of the tangible net assets acquired totaled $34.8 million. Based on a preliminary purchase price allocation in the fourth quarter of fiscal 2006, we recorded goodwill of $20.7 million and core technology of $3.6 million and recognized a charge of $10.5 million for IPR&D. During fiscal 2007, we finalized our valuation of the intangible assets acquired resulting in an increase in core technology of $7.7 million, an increase in IPR&D of $0.3 million and a corresponding decrease in goodwill of $8.0 million.

In addition, we entered into a performance plan with certain former Troika employees upon their employment with QLogic. The performance plan provides for the issuance of our common stock based on the achievement of certain performance milestones and continued employment with QLogic. In connection with the performance plan, we recognized $0.3 million and $1.5 million of compensation expense during the three and nine months ended December 31, 2006, respectively, and could recognize up to $4.3 million of additional compensation expense through November 2009.

Discontinued Operations

In November 2005, we completed the sale of our hard disk drive controller and tape drive controller business, or the Business, to Marvell Technology Group Ltd. (Marvell) for cash and shares of Marvell’s common stock. As a result of this transaction, all financial information related to the Business has been presented as discontinued operations. The following discussion and analysis excludes the Business and amounts related to the Business unless otherwise noted.

Third Quarter Financial Highlights and Other Information

A summary of the key factors and significant events which impacted our financial performance during the third quarter of fiscal 2007 are as follows:


	•	Net revenues of $157.6 million for the third quarter of fiscal 2007 increased sequentially by $12.3 million, or 8%, from $145.3 million in the second quarter of fiscal 2007.

	•	Gross profit as a percentage of net revenues was 67.8% for the third quarter of fiscal 2007, compared to 68.5% for the second quarter of fiscal 2007. We continue to expect downward pressure on our gross profit percentage as a result of changes in product mix, as well as declining average selling prices. There can be no assurance that we will be able to maintain our gross profit percentage consistent with historical trends and it may further decline in the future.

	•	Operating income as a percentage of net revenues increased to 28.0% for the third quarter of fiscal 2007 from 27.0% in the second quarter of fiscal 2007.

	•	Income from continuing operations of $35.5 million, or $0.22 per diluted share, in the third quarter of fiscal 2007 increased from $30.4 million, or $0.19 per diluted share, in the second quarter of fiscal 2007. Income from continuing operations included stock-based compensation expense, acquisition-related charges and the related income tax effects totaling $9.4 million for the third quarter of fiscal 2007 and $7.9 million for the second quarter of fiscal 2007.

	•	Cash and cash equivalents and marketable securities of $555.3 million at December 31, 2006 increased $18.7 million from the balance at the end of the second quarter of fiscal 2007. During the third quarter of fiscal 2007, we generated $42.2 million of cash from continuing operations, received $12.5 million from escrow in connection with the sale of our hard drive controller and tape drive controller business, received


		$25.5 million in proceeds from stock option exercises, and completed the previously announced acquisition of SilverStorm for $59.8 million.


	•	Accounts receivable was $85.5 million as of December 31, 2006, compared to $69.5 million as of October 1, 2006. Days sales outstanding (DSO) in receivables increased to 49 days as of December 31, 2006 from 44 days as of October 1, 2006. Our DSO as of December 31, 2006 is consistent with normal seasonality for our third fiscal quarter and is comparable to 50 days as of the end of the third quarter of fiscal 2006. Our accounts receivable and DSO are primarily affected by linearity of shipments within the quarter and collections performance. Based on our customers’ procurement models and our current customer mix, we expect that DSO will range from approximately 45 to 55 days. There can be no assurance that we will be able to maintain our DSO consistent with historical trends and it may increase in the future.

	•	Inventories were $44.5 million as of December 31, 2006, compared to $43.7 million as of October 1, 2006. Our annualized inventory turns in the third quarter of fiscal 2007 increased to 4.6 from the 4.2 turns in the second quarter of fiscal 2007.

Results of Operations

Net Revenues

A summary of the components of our net revenues is as follows:


	Three Months Ended						Nine Months Ended
	December 31,			January 1,			December 31,			January 1,
	2006			2006			2006			2006
	(In millions)

Net revenues:
SAN Infrastructure Products	$	152.5		$	120.4		$	415.1		$	338.2
Management Controllers		2.5			6.1			14.9			20.0
Other		2.6			2.7			9.6			5.4

Total net revenues	$	157.6		$	129.2		$	439.6		$	363.6

Percentage of net revenues:
SAN Infrastructure Products		97	%		93	%		95	%		93	%
Management Controllers		1			5			3			6
Other		2			2			2			1

Total net revenues		100	%		100	%		100	%		100	%

The global marketplace for SANs continues to expand in response to the information storage requirements of enterprise business environments, as well as the emerging market for SAN-based solutions for small and medium-sized businesses. This market expansion has resulted in increased volume shipments of our SAN Infrastructure Products. However, the SAN market has been characterized by rapid advances in technology and related product performance, which has generally resulted in declining average selling prices over time. Our revenues have generally been favorably affected by increases in units sold as a result of market expansion, increases in market share and the release of new products. The favorable effect on our revenues as a result of increases in volume has been partially offset by the impact of declining average selling prices.

Our net revenues are derived primarily from the sale of SAN Infrastructure Products. Net revenues increased 22% to $157.6 million for the three months ended December 31, 2006 from $129.2 million for the three months ended January 1, 2006. This increase was primarily the result of a $32.1 million, or 27%, increase in revenue from SAN Infrastructure Products, partially offset by a $3.6 million decrease in revenue from Management Controllers. The increase in revenue from SAN Infrastructure Products was primarily due to a 42% increase in the quantity of Fibre Channel and iSCSI HBAs sold partially offset by a 7% decrease in average selling prices of these products, and a 20% increase in the quantity of Fibre Channel switches sold partially offset by a 7% decrease in average selling prices of Fibre Channel switches. Revenue from Management Controllers decreased 58% from the same

period in the prior year due primarily to a 63% decrease in units sold. We expect revenue from Management Controllers to continue to decrease over time, as these products are not part of our core business and we are not investing in the development of new products. Net revenues for the three months ended December 31, 2006 included $2.6 million of other revenue. Other revenue, which includes royalties, non-recurring engineering fees and service fees, is unpredictable and we do not expect it to be significant to our overall revenues.

Net revenues increased 21% to $439.6 million for the nine months ended December 31, 2006 from $363.6 million for the nine months ended January 1, 2006. This increase was primarily the result of a $76.9 million, or 23%, increase in revenue from SAN Infrastructure Products. The increase in revenue from SAN Infrastructure Products was primarily due to a 39% increase in the quantity of Fibre Channel and iSCSI HBAs sold partially offset by a 9% decrease in average selling prices of these products, and a 26% increase in the quantity of Fibre Channel switches sold partially offset by an 11% decrease in average selling prices of Fibre Channel switches. Revenue from Management Controllers decreased $5.1 million, or 26%, from the same period in the prior year due primarily to a 28% decrease in units sold. Net revenues for the nine months ended December 31, 2006 included $9.6 million of other revenue.

A small number of our customers account for a substantial portion of our net revenues, and we expect that a limited number of customers will continue to represent a substantial portion of our net revenues for the foreseeable future. Our top ten customers accounted for 80% of net revenues during the nine months ended December 31, 2006 and 77% of net revenues during the fiscal year ended April 2, 2006. Three of our customers each represented 10% or more of net revenues for fiscal 2006, and these same three customers continued to be the only customers representing 10% or more of net revenues for the nine months ended December 31, 2006.

We believe that our major customers continually evaluate whether or not to purchase products from alternative or additional sources. Additionally, customers’ economic and market conditions frequently change. Accordingly, there can be no assurance that a major customer will not reduce, delay or eliminate its purchases from us. Any such reduction, delay or loss of purchases could have a material adverse effect on our business, financial condition or results of operations.

Revenues by geographic area are presented based upon the country of destination. Net revenues by geographic area are as follows:


	Three Months Ended				Nine Months Ended
	December 31,		January 1,		December 31,		January 1,
	2006		2006		2006		2006
	(In millions)

United States	$	78.8	$	68.4	$	236.2	$	199.1
Europe, Middle East and Africa		38.7		31.6		96.7		83.7
Asia-Pacific and Japan		29.7		27.7		86.8		78.7
Rest of the world		10.4		1.5		19.9		2.1

Total net revenues	$	157.6	$	129.2	$	439.6	$	363.6

Gross Profit

Gross profit represents net revenues less cost of revenues. Cost of revenues consists primarily of the cost of purchased products, assembly and test services, and costs associated with product procurement, inventory management and product quality. A summary of our gross profit and related percentage of net revenues is as follows:


	Three Months Ended						Nine Months Ended
	December 31,			January 1,			December 31,			January 1,
	2006			2006			2006			2006
	(In millions)

Gross profit	$	106.9		$	92.3		$	299.8		$	257.7
Percentage of net revenues		67.8	%		71.4	%		68.2	%		70.9	%

Gross profit for the three months ended December 31, 2006 increased $14.6 million, or 16%, from gross profit for the three months ended January 1, 2006, primarily due to the increase in net revenues. The gross profit

percentage for the three months ended December 31, 2006 was 67.8% and declined from 71.4% for the corresponding period in the prior year. This decrease in gross profit percentage was due primarily to $2.2 million of amortization expense for intangible assets related to our acquisitions of PathScale and Troika and $0.5 million of stock-based compensation related to the adoption of SFAS 123R in the current fiscal year. The decline in gross profit percentage was also impacted by an unfavorable shift in product and technology mix, as well as a decrease in the average selling prices of our products.

Gross profit for the nine months ended December 31, 2006 increased $42.1 million, or 16%, from gross profit for the nine months ended January 1, 2006, primarily due to the increase in net revenues. The gross profit percentage for the nine months ended December 31, 2006 was 68.2% and declined from 70.9% for the corresponding period in the prior year. This decrease in gross profit percentage was due primarily to $7.5 million of amortization expense for intangible assets related to our acquisitions of PathScale and Troika and $1.4 million of stock-based compensation related to the adoption of SFAS 123R in the current fiscal year.

Our ability to maintain our current gross profit percentage can be significantly affected by factors such as the results of our investment in engineering and development activities, supply costs, the worldwide semiconductor foundry capacity, the mix of products shipped, the transition to new products, competitive price pressures, the timeliness of volume shipments of new products, the level of royalties received and our ability to achieve manufacturing cost reductions. We anticipate that it will be increasingly difficult to reduce manufacturing costs. Also, royalty revenues have been and continue to be unpredictable. As a result of these and other factors, it may be difficult to maintain our gross profit percentage consistent with historical trends and it may decline in the future.

Operating Expenses

Our operating expenses are summarized in the following table:


	Three Months Ended						Nine Months Ended
	December 31,			January 1,			December 31,			January 1,
	2006			2006			2006			2006
	(In millions)

Operating expenses:
Engineering and development	$	34.0		$	22.8		$	99.5		$	64.6
Sales and marketing		21.6			16.1			64.1			47.0
General and administrative		7.2			4.4			23.3			12.4
Purchased in-process research and development		—			—			1.9			—

Total operating expenses	$	62.8		$	43.3		$	188.8		$	124.0

Percentage of net revenues:
Engineering and development		21.6	%		17.7	%		22.7	%		17.8	%
Sales and marketing		13.7			12.5			14.6			12.9
General and administrative		4.6			3.3			5.3			3.4
Purchased in-process research and development		—			—			0.4			—

Total operating expenses		39.9	%		33.5	%		43.0	%		34.1	%

Engineering and Development. Engineering and development expenses consist primarily of compensation and related benefit costs, development-related engineering and material costs, occupancy costs and related computer support costs. During the three months ended December 31, 2006, engineering and development expenses increased to $34.0 million from $22.8 million for the three months ended January 1, 2006. Engineering and development expenses during the three months ended December 31, 2006 included $3.0 million of stock-based compensation related to the adoption of SFAS 123R in the current fiscal year. In addition, engineering and development expenses increased during the three months ended December 31, 2006 from the comparable period in the prior year due to increases of $3.9 million in employment costs, $1.1 million in depreciation and equipment

costs and $1.8 million of acquisition-related stock-based compensation charges, which were primarily due to our acquisitions.

During the nine months ended December 31, 2006, engineering and development expenses increased to $99.5 million from $64.6 million for the nine months ended January 1, 2006. Engineering and development expenses included $8.3 million of stock-based compensation related to the adoption of SFAS 123R in the current fiscal year. In addition, engineering and development expenses increased during the nine months ended December 31, 2006 from the comparable period in the prior year due to increases of $12.0 million in employment costs, $6.0 million of acquisition-related stock-based compensation charges, $3.8 million in depreciation and equipment costs and $1.6 million in external engineering costs associated with new product development, which increases were primarily due to our acquisitions.

We believe continued investments in engineering and development activities are critical to achieving future design wins, expansion of our customer base and revenue growth opportunities. We expect engineering and development expenses will continue to increase in the future as a result of continued and increasing costs associated with new product development.

Sales and Marketing. Sales and marketing expenses consist primarily of compensation and related benefit costs, sales commissions, promotional activities and travel for sales and marketing personnel. Sales and marketing expenses increased to $21.6 million for the three months ended December 31, 2006 from $16.1 million for the three months ended January 1, 2006. The increase in sales and marketing expenses was due primarily to $1.8 million of stock-based compensation related to the adoption of SFAS 123R in the current fiscal year, increases in employment costs of $1.2 million, acquisition-related stock-based compensation charges of $0.5 million, and a $1.5 million increase in promotional costs, which included the costs for our worldwide partner conferences, trade shows and other marketing programs.

Sales and marketing expenses increased to $64.1 million for the nine months ended December 31, 2006 from $47.0 million for the nine months ended January 1, 2006. The increase in sales and marketing expenses was due primarily to $5.9 million of stock-based compensation related to the adoption of SFAS 123R in the current fiscal year, increases in employment costs of $5.1 million and acquisition-related stock-based compensation charges of $1.7 million, and a $2.2 million increase in promotional costs, which included the costs for our worldwide partner conferences, trade shows and other marketing programs.

We believe continued investments in our sales and marketing organizational infrastructure and related marketing programs are critical to the success of our strategy of expanding our customer base and enhancing relationships with our existing customers. As a result, we expect sales and marketing expenses will continue to increase in the future.

General and Administrative. General and administrative expenses consist primarily of compensation and related benefit costs for executive, finance, accounting, human resources, legal and information technology personnel. Non-compensation components of general and administrative expenses include legal and other professional fees, facilities expenses and other corporate expenses. General and administrative expenses increased to $7.2 million for the three months ended December 31, 2006 from $4.4 million for the three months ended January 1, 2006 primarily due to $2.2 million of stock-based compensation related to the adoption of SFAS 123R in the current fiscal year and an increase of $0.6 million in employment costs, partially offset by decreased bad debt expense of $0.5 million. In addition, during the three months ended January 1, 2006, we received a $0.7 million reimbursement from an insurance carrier related to the settlement of a prior legal matter.

General and administrative expenses increased to $23.3 million for the nine months ended December 31, 2006 from $12.4 million for the nine months ended January 1, 2006 primarily due to $7.0 million of stock-based compensation related to the adoption of SFAS 123R in the current fiscal year, an increase of $1.9 million in employment costs and an increase of $1.1 million in accounting and legal fees.

In connection with the growth of our business, we expect general and administrative expenses will increase in the future.

Purchased In-Process Research and Development. In connection with our acquisitions of PathScale and Troika, we expensed $1.9 million for IPR&D during the three months ended July 2, 2006. The amounts allocated to IPR&D were determined through established valuation techniques used in the high technology industry and were expensed upon acquisition as it was determined that the underlying projects had not reached technological feasibility and no alternative future uses existed. We have not completed the valuation of the intangible assets related to our acquisition of SilverStorm. To the extent a portion of the purchase price is allocated to IPR&D, we will recognize a charge to operating expenses for such amount.

Interest and Other Income, Net

A summary of the components of our interest and other income, net is as follows:


	Three Months Ended						Nine Months Ended
	December 31,			January 1,			December 31,			January 1,
	2006			2006			2006			2006
	(In millions)

Interest income	$	6.3		$	5.7		$	19.1		$	18.6
Loss on sale of marketable securities		(0.8	)		(0.5	)		(1.6	)		(1.2	)
Other		0.1			—			0.8			—

	$	5.6		$	5.2		$	18.3		$	17.4

Non-operating income is comprised primarily of interest income related to our portfolio of marketable securities. As of December 31, 2006, the Marvell common stock held by us had an unrealized loss of $2.7 million (net of related income taxes of $1.6 million). If these securities remain in an unrealized loss position, it may be necessary for us to recognize an impairment charge.

Income Taxes

Our effective income tax rate related to continuing operations decreased from 39% in fiscal 2006 to an estimated rate of 33% for fiscal 2007. The decrease in the estimated annual effective tax rate for fiscal 2007 is primarily due to a greater percentage of worldwide income being attributable to foreign operations and taxed in jurisdictions outside of the United States, the settlement of routine tax exams and expiration of the federal statute of limitations on an open tax year. The estimated annual effective income tax rate of 33% computed in the third quarter of fiscal 2007 decreased in comparison to the second quarter of fiscal 2007 primarily due to benefits associated with the retroactive reenactment of the federal research credit signed into law on December 20, 2006 (Tax Relief and Health Care Act of 2006) and the expiration of the federal statute of limitations on an open tax year. For the remainder of fiscal year 2007, we expect our effective tax rate to continue to benefit from our investment in foreign operations. However, our effective tax rate may be negatively impacted by the tax effects of acquisitions, including the acquisition of SilverStorm, and the implications surrounding the adoption of SFAS 123R. Furthermore, given the increased global scope of our operations, and the complexity of global tax and transfer pricing rules and regulations, it has become increasingly difficult to estimate earnings within each tax jurisdiction. If actual earnings within each tax jurisdiction differ materially from our estimates, we may not achieve our expectation for our effective tax rate.

Liquidity and Capital Resources

Our combined balances of cash and cash equivalents and marketable securities was $555.3 million at December 31, 2006, compared to $665.6 million at April 2, 2006. The decrease in cash, cash equivalents and marketable securities was due primarily to the acquisitions of PathScale and SilverStorm and purchases of our common stock pursuant to our stock repurchase program, partially offset by our cash generated by operations. We believe that our existing cash and cash equivalent balances, short-term marketable securities and cash flows from operating activities will provide sufficient funds to finance our operations for at least the next 12 months. However, it is possible that we may need to supplement our existing sources of liquidity to finance our activities beyond the next 12 months or for the future acquisition of businesses, products or technologies. In addition, our future capital requirements will depend on a number of factors, including changes in the markets we address, our revenues and the related manufacturing and operating costs, product development efforts and requirements for production capacity. In order to fund any additional capital requirements, we may seek to obtain debt financing or issue additional shares of our common stock. There can be no assurance that any additional financing, if necessary, will be available on terms acceptable to us or at all.

Cash provided by operating activities was $120.7 million for the nine months ended December 31, 2006 and $105.0 million for the nine months ended January 1, 2006. Cash provided by operating activities increased notwithstanding a decrease in income from continuing operations as non-cash charges (depreciation and amortization, stock-based compensation, acquisition-related charges, deferred income taxes and other) increased $36.2 million from the prior year. Operating cash flow for the nine months ended December 31, 2006 reflects our income from continuing operations of $87.0 million and net non-cash charges of $44.6 million, offset by a net increase in the non-cash components of working capital of $10.9 million. The increase in the non-cash components of working capital was primarily due to a $14.2 million increase in accounts receivable and a $2.9 million increase in inventories, partially offset by a $3.0 million increase in deferred revenue, all associated with the expansion of our business. In addition, the timing of payment obligations resulted in a $2.8 million decrease in accounts payable, excluding the accounts payable assumed from SilverStorm, offset by a $5.7 million increase in income taxes payable.

Cash used in investing activities was $104.3 million for the nine months ended December 31, 2006 and consisted of net cash outflows of $107.1 million for the acquisition of PathScale and $59.3 million for the acquisition of SilverStorm, including the $15.0 million and $9.0 million placed in escrow, respectively, and additions to property and equipment of $23.6 million, partially offset by net sales and maturities of marketable securities of $73.2 million and the receipt of $12.5 million from an escrow account related to the sale of our hard disk drive controller and tape drive controller business. During the nine months ended January 1, 2006, cash used in investing activities of $16.2 million included net cash outflows of $35.2 million for the acquisition of Troika, additions to property and equipment of $18.2 million, and $12.0 million placed in escrow related to the sale of our hard disk drive controller and tape drive controller business, partially offset by net sales and maturities of marketable securities of $49.2 million.

As our business grows, we expect capital expenditures to increase in the future as we continue to invest in machinery and equipment, more costly engineering and production tools for new technologies, and enhancements to our corporate information technology infrastructure.

Cash used in financing activities of $49.9 million for the nine months ended December 31, 2006 resulted primarily from our purchase of $85.6 million of common stock under our stock repurchase program and the repayment of a $1.6 million line of credit assumed in the SilverStorm acquisition, partially offset by $31.0 million of proceeds from the issuance of common stock under our stock plans, and a related $6.3 million tax benefit. During the nine months ended January 1, 2006, the $402.6 million of cash used in financing activities resulted from the use of $415.0 million for the purchase of common stock under our stock repurchase programs, partially offset by $12.4 million of proceeds from the issuance of common stock under our stock plans.

Since fiscal 2003, our Board of Directors has approved various stock repurchase programs that authorized us to repurchase up to an aggregate of $750 million of our outstanding common stock. The most recent program was approved in November 2005 and authorized us to repurchase up to $200 million of our outstanding common stock. During the nine months ended December 31, 2006, we purchased 5.0 million shares for an aggregate purchase price of $85.6 million under the November 2005 plan. As of December 31, 2006, there was $104.4 million remaining

available under the November 2005 plan. Since fiscal 2003, we have purchased a total of $645.6 million of our common stock under programs authorized by our Board of Directors.

We have certain contractual obligations and commitments to make future payments in the form of non-cancelable purchase orders to our suppliers and commitments under operating lease arrangements. A summary of our contractual obligations as of December 31, 2006, and their impact on our cash flows in future fiscal years, is as follows:


	2007
	(Remaining
	three months)		2008		2009		2010		2011		Thereafter		Total
	(In millions)

Operating leases	$	1.0	$	3.6	$	2.3	$	1.4	$	0.9	$	0.8	$	10.0
Non-cancelable purchase obligations		44.0		2.1		—		—		—		—		46.1

Total	$	45.0	$	5.7	$	2.3	$	1.4	$	0.9	$	0.8	$	56.1

Additionally, we have entered into an operating lease for a facility in Minnesota, which is currently under construction. The facility is expected to be completed during our third quarter of fiscal 2008. The future minimum lease payments associated with this lease are dependent upon the final cost of construction and accordingly have not been presented in the table above. However, based on preliminary estimates, we expect to pay approximately $18 million over the ten and a half year lease term.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires us to make estimates and judgments that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net revenues and expenses during the reporting period. We base our estimates on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. We believe the accounting policies described below to be our most critical accounting policies. These accounting policies are affected significantly by judgments, assumptions and estimates used in the preparation of the financial statements and actual results could differ materially from the amounts reported based on these policies.

Revenue Recognition

We recognize revenue from product sales when the following fundamental criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the price to the customer is fixed or determinable and (iv) collection of the resulting accounts receivable is reasonably assured.

For all sales, we use a binding purchase order or a signed agreement as evidence of an arrangement. Delivery occurs when goods are shipped and title and risk of loss transfer to the customer, in accordance with the terms specified in the arrangement with the customer. The customer’s obligation to pay and the payment terms are set at the time of delivery and are not dependent on the subsequent resale of our product. However, certain of our sales are made to distributors under agreements which contain a limited right to return unsold product and price protection provisions. We recognize revenue from these distributors when the product is sold by the distributor to a third party. At times, we provide standard incentive programs to our distributor customers and account for such programs in accordance with Emerging Issues Task Force (EITF) Issue No. 01-9, “Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products).” Accordingly, we account for our competitive pricing incentives, which generally reflect front-end price adjustments, as a reduction of revenue at the time of sale, and rebates as a reduction of revenue in the period the related revenue is recorded based on the specific program criteria and historical experience. Royalty and service revenue is recognized when earned and receipt is reasonably assured.

For those sales that include multiple deliverables, we allocate revenue based on the relative fair values of the individual components as determined in accordance with EITF Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables.” When more than one element, such as hardware and services, are contained in a single arrangement, we allocate revenue between the elements based on each element’s relative fair value, provided that each element meets the criteria for treatment as a separate unit of accounting. An item is considered a separate unit of accounting if it has value to the customer on a standalone basis and there is objective and reliable evidence of the fair value of the undelivered items. Fair value is generally determined based upon the price charged when the element is sold separately. In the absence of fair value for a delivered element, we allocate revenue first to the fair value of the undelivered elements and allocate the residual revenue to the delivered elements. In the absence of fair value for an undelivered element, the arrangement is accounted for as a single unit of accounting, resulting in a deferral of revenue recognition for the delivered elements until all undelivered elements have been fulfilled.

We sell certain software products and related post-contract customer support (PCS), and account for these transactions in accordance with Statement of Position (SOP) 97-2, “Software Revenue Recognition,” as amended. We recognize revenue from software products when the following fundamental criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the price to the customer is fixed or determinable and (iv) collection of the resulting accounts receivable is probable. Revenue is allocated to each element based upon vendor-specific objective evidence (VSOE) of the fair value of the element. VSOE of the fair value is based upon the price charged when the element is sold separately. Revenue allocated to each element is then recognized when the basic revenue recognition criteria are met for each element. If we are unable to determine VSOE of fair value for PCS, the entire amount of revenue from the arrangement is deferred and recognized ratably over the period of the PCS. Amounts accounted for in accordance with SOP 97-2 have not yet been significant, but could be material in the future.

Amounts billed or payments received in advance of revenue recognition are recorded as deferred revenue.

An allowance for doubtful accounts is maintained for estimated losses resulting from the inability of our customers to make required payments. This reserve is determined by analyzing specific customer accounts and applying historical loss rates to the aging of remaining accounts receivable balances. If the financial condition of our customers were to deteriorate, resulting in their inability to pay their accounts when due, additional reserves might be required.

We record provisions against revenue and cost of revenue for estimated product returns and allowances such as competitive pricing programs and rebates in the same period that revenue is recognized. These provisions are based on historical experience as well as specifically identified product returns and allowance programs. Additional reductions to revenue would result if actual product returns or pricing adjustments exceed our estimates.

Inventories

Inventories are valued at the lower of cost, on a first-in, first-out basis, or market. We write down the carrying value of our inventory to market value for estimated obsolete or excess inventory based upon assumptions about future demand and market conditions. We compare current inventory levels on a product basis to our current sales forecasts in order to assess our inventory balance. Our sales forecasts are based on economic conditions and trends (both current and projected), anticipated customer demand and acceptance of our current products, expected future products and other assumptions. If actual market conditions are less favorable than those projected by management, additional write-downs may be required.

Income Taxes

We utilize the asset and liability method of accounting for income taxes. We record liabilities for probable income tax assessments based on our estimate of potential tax related exposures. 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.

Differences between actual results and our assumptions, or changes in our assumptions in future periods, are recorded in the period they become known.

Deferred income taxes are recognized for the future tax consequences of temporary differences using enacted statutory tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Temporary differences include the difference between the financial statement carrying amounts and the tax bases of existing assets and liabilities and operating loss and tax credit carryforwards. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date.

We assess the likelihood that our deferred tax assets will be recovered from future taxable income. To the extent management believes that recovery is more likely than not, we do not establish a valuation allowance. An adjustment to income would occur if we determine that we are able to realize a different amount of our deferred tax assets than currently expected.

Share-Based Payment

As of the beginning of the first quarter of fiscal 2007, we adopted Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004), “Share-Based Payment,” which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and non-employee directors including stock options, restricted stock units and stock purchases under our Employee Stock Purchase Plan (ESPP) based on estimated fair values. SFAS 123R supersedes SFAS No. 123, “Accounting for Stock-Based Compensation,” and Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and related interpretations. SFAS 123R also amends SFAS No. 95, “Statement of Cash Flows,” and requires the benefits of tax deductions in excess of recognized compensation cost be reported as a financing cash inflow, rather than as an operating cash inflow as required under the previous accounting pronouncements. This requirement may reduce future net operating cash flows and increase net financing cash flows.

We adopted SFAS 123R using the modified prospective transition method and consequently have not retroactively adjusted results from prior periods. Under this transition method, compensation cost associated with stock-based awards recognized beginning in fiscal 2007 includes: (1) amortization related to the remaining unvested portion of stock-based awards granted prior to the adoption of SFAS 123R based on the grant date fair value estimated in accordance with the original provisions of SFAS 123; and (2) amortization related to stock-based awards granted subsequent to the adoption date based on the grant date fair value estimated in accordance with the provisions of SFAS 123R. SFAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. We recognize stock-based compensation expense on a straight-line basis over the requisite service period, which is the vesting period for stock options and restricted stock unit awards and the offering period for the ESPP.

SFAS 123R requires companies to estimate the fair value of share-based payment awards on the date of grant. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in our consolidated financial statements. The determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, the expected stock price volatility over the term of the awards and actual and projected employee stock option exercise behaviors. Option-pricing models were developed for use in estimating the value of traded options that have no vesting or hedging restrictions and are fully transferable. However, our employee stock options have certain characteristics that are significantly different from traded options. Changes in the subjective assumptions can materially affect the estimate of their fair value.

Goodwill and Purchased Intangible Assets

We account for goodwill and other intangible assets in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets.” Goodwill is recorded as the difference, if any, between the aggregate consideration paid for an acquisition and the fair value of the net tangible and intangible assets acquired. The amounts and useful lives

assigned to intangible assets acquired, other than goodwill, impact the amount and timing of future amortization, and the amount assigned to in-process research and development is expensed immediately.

SFAS 142 requires that goodwill and other intangible assets that have indefinite lives not be amortized but instead be tested at least annually for impairment, or more frequently when events or changes in circumstances indicate that the assets might be impaired, by comparing the carrying value to the fair value of the reporting unit to which they are assigned. A two-step test is used to identify the potential impairment and to measure the amount of impairment, if any. The first step is to compare 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 considered not impaired; otherwise, goodwill is 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 with the carrying amount of goodwill. We perform the annual test for impairment as of the first day of our fiscal fourth quarter and utilize the two-step process.

Other intangible assets consist primarily of technology acquired or licensed from third parties, including technology acquired in business combinations. Other intangible assets that have definite lives are amortized on a straight-line basis over the estimated useful lives of the related assets ranging from one to five years.

New Accounting Pronouncements

In June 2006, the Financial Accounting Standards Board (FASB) issued Interpretation (FIN) No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109.” FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. We are currently assessing the impact FIN 48 will have on our consolidated financial statements.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. SFAS 157 also simplifies and codifies previous guidance on fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. We are currently assessing the impact SFAS 157 will have on our consolidated financial statements.

In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) No. 108, “Financial Statements — Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements.” SAB 108 expresses the SEC staff’s view on quantifying financial statement misstatements and requires registrants to assess the impact of prior year uncorrected errors, even if previously considered immaterial, on the current year financial statements through an evaluation of the impact of correcting such errors on both the current year income statement and balance sheet. If the misstatement is material to the current year financial statements, the prior year financial statements should be corrected, even though such revision was and continues to be immaterial to the prior year financial statements. Correcting prior year financial statements for immaterial errors does not require previously filed reports to be amended and may be made the next time the prior year financial statements are filed. Restatement is only required if the prior year financial statements were materially misstated. SAB 108 is effective for fiscal years ending after November 15, 2006. We are currently assessing the impact SAB 108 will have on our consolidated financial statements.


Item 3.	*Quantitative and Qualitative Disclosures About Market Risk*

We maintain a marketable securities investment portfolio of various holdings, types and maturities. In accordance with our investment guidelines, we only invest in instruments with high credit quality standards and we limit our exposure to any one issuer or type of investment. We also hold shares of Marvell common stock that were received in connection with the sale of our hard disk drive controller and tape drive controller business. The shares of Marvell common stock are equity securities and, as such, inherently have higher risk than the marketable securities in which we usually invest. We do not use derivative financial instruments.

Our cash and cash equivalents are not subject to significant interest rate risk due to the short maturities of these instruments. As of December 31, 2006, the carrying value of our cash and cash equivalents approximates fair value.

Our investment portfolio consists primarily of marketable debt securities, including government securities, corporate bonds, municipal bonds, asset and mortgage-backed securities, and other debt securities, which principally have remaining terms of three years or less. Consequently, such securities are not subject to significant interest rate risk. In addition, we currently hold 910,000 shares of Marvell common stock with a cost basis of $23.97 per share. As of December 31, 2006, the fair value of this stock was $19.19 per share. Marketable equity securities for high technology companies, such as Marvell, historically have experienced high volatility. Shares of Marvell common stock have traded between $16.32 and $35.32 during the twelve months ended December 31, 2006.

All of our marketable securities are classified as available for sale and, as of December 31, 2006, unrealized losses of $4.0 million (net of related income taxes) on these securities are included in accumulated other comprehensive loss.


Item 4.	*Controls and Procedures*

As of the end of the quarter ended December 31, 2006, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures, as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2006 to ensure that information required to be disclosed by us in reports that are filed or submitted under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms. There was no change in our internal control over financial reporting during our quarter ended December 31, 2006 that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II.

OTHER INFORMATION


Item 1A.	*Risk Factors*

There have been no material changes in our risk factors from those disclosed in Item 1A of our Annual Report on Form 10-K for the fiscal year ended April 2, 2006, which was filed with the Securities and Exchange Commission on June 5, 2006.

The current risk factors are set forth below.

Our operating results may fluctuate, in future periods, which could cause our stock price to decline.

We have experienced, and expect to experience in future periods, fluctuations in sales and operating results from quarter to quarter. In addition, there can be no assurance that we will maintain our current gross margins or profitability in the future. A significant portion of our net revenues in each fiscal quarter results from orders booked in that quarter. Orders placed by major customers are typically based on their forecasted sales and inventory levels for our products. Fluctuations in our quarterly operating results may be the result of:


	•	the timing, size and mix of orders from customers;

	•	gain or loss of significant customers;

	•	customer policies pertaining to desired inventory levels of our products;

	•	negotiated rebates and extended payment terms;

	•	changes in our ability to anticipate in advance the mix of customer orders;

	•	levels of inventory our customers require us to maintain in our inventory hub locations;

	•	the time, availability and sale of new products;

	•	changes in the mix or average selling prices of our products;

	•	variations in manufacturing capacities, efficiencies and costs;

	•	the availability and cost of components, including silicon chips;

	•	warranty expenses;

	•	variations in product development costs, especially related to advanced technologies;

	•	variations in operating expenses;

	•	adjustments related to product returns;

	•	changes in effective income tax rates, including those resulting from changes in tax laws;

	•	our ability to timely produce products that comply with new environmental restrictions or related requirements of our OEM customers;

	•	actual events, circumstances, outcomes and amounts differing from judgments, assumptions and estimates used in determining the value of certain assets (including the amounts of related valuation allowances), liabilities and other items reflected in our consolidated financial statements;

	•	changes in accounting rules, such as the change requiring the recording of compensation expense for employee stock options and other stock-based awards commencing in the first quarter of our 2007 fiscal year;

	•	changes in our accounting policies;

	•	increases in energy costs;


	•	general economic and other conditions affecting the timing of customer orders and capital spending; or

	•	changes in the global economy that impact information technology spending.

Our quarterly results of operations are also influenced by competitive factors, including the pricing and availability of our products and our competitors’ products. Although we do not maintain our own silicon chip manufacturing facility, portions of our expenses are fixed and difficult to reduce in a short period of time. If net revenues do not meet our expectations, our fixed expenses could adversely affect our gross profit and net income until net revenues increase or until such fixed expenses are reduced to an appropriate level. Furthermore, announcements regarding new products and technologies could cause our customers to defer or cancel purchases of our products. Order deferrals by our customers, delays in our introduction of new products, and longer than anticipated design-in cycles for our products have in the past adversely affected our quarterly results of operations. Due to these factors, as well as other unanticipated factors, it is likely that in some future quarter or quarters our operating results will be below the expectations of public market analysts or investors, and as a result, the price of our common stock could significantly decrease.

We expect gross margin to vary over time, and our recent level of gross margin may not be sustainable.

Our recent level of gross margin may not be sustainable and may be adversely affected by numerous factors, including:


	•	increased price competition;

	•	changes in customer, geographic or product mix;

	•	introduction of new products, including products with price-performance advantages;

	•	our inability to reduce production costs;

	•	entry into new markets or the acquisition of new businesses;

	•	sales discounts;

	•	increases in material or labor costs;

	•	excess inventory and inventory holding charges;

	•	changes in distribution channels;

	•	increased warranty costs; and

	•	how well we execute our business strategy and operating plans.

Our revenues may be affected by changes in IT spending levels.

In the past, unfavorable or uncertain economic conditions and reduced global IT spending rates have adversely affected the markets in which we operate. We are unable to predict changes in general economic conditions and when global IT spending rates will be affected. Furthermore, even if IT spending rates increase, we cannot be certain that the market for SAN and server interconnect solutions will be positively impacted. If there are future reductions in either domestic or international IT spending rates, or if IT spending rates do not increase, our revenues, operating results and financial condition may be adversely affected.

Our stock price may be volatile.

The market price of our common stock has fluctuated substantially, and there can be no assurance that such volatility will not continue. Several factors could impact our stock price including, but not limited to:


	•	announcements concerning our competitors, our customers, or us;

	•	quarterly fluctuations in our operating results;

	•	differences between our actual operating results and the published expectations of analysts;


	•	introduction of new products or changes in product pricing policies by our competitors or us;

	•	conditions in the markets in which we operate;

	•	changes in market projections by industry forecasters;

	•	changes in estimates of our earnings by industry analysts;

	•	overall market conditions for high technology equities;

	•	rumors or dissemination of false information; and

	•	general economic and geopolitical conditions.

In addition, stock markets have experienced extreme price and volume volatility in recent years and stock prices of technology companies have been especially volatile. This volatility has had a substantial effect on the market prices of securities of many public companies for reasons frequently unrelated to the operating performance of the specific companies. These broad market fluctuations could adversely affect the market price of our common stock.

Our business is dependent on the continued growth of the SAN market and if this market does not continue to develop and expand as we anticipate, our business will suffer.

A significant number of our products are used in SANs and, therefore, our business is dependent on the SAN market. Accordingly, the widespread adoption of SANs for use in organizations’ computing systems is critical to our future success. SANs are often implemented in connection with the deployment of new storage systems and servers. Therefore, our future success is also substantially dependent on the market for new storage systems and servers. Our success in generating revenue in the SAN market will depend on, among other things, our ability to:


	•	educate potential OEM customers, distributors, resellers, system integrators, storage service providers and end-user organizations about the benefits of SANs;

	•	maintain and enhance our relationships with OEM customers, distributors, resellers, system integrators and storage system providers;

	•	predict and base our products on standards which ultimately become industry standards; and

	•	achieve interoperability between our products and other SAN components from diverse vendors.

Our financial condition will be materially harmed if we do not maintain and gain market or industry acceptance of our products.

The markets in which we compete involve rapidly changing technology, evolving industry standards and continuing improvements in products and services. Our future success depends, in part, on our ability to:


	•	enhance our current products and develop and introduce in a timely manner new products that keep pace with technological developments and industry standards;

	•	compete effectively on the basis of price and performance; and

	•	adequately address OEM customer and end-user customer requirements and achieve market acceptance.

We believe that to remain competitive in the future, we will need to continue to develop new products, which will require a significant investment in new product development. Our competitors are developing alternative technologies, which may adversely affect the market acceptance of our products. Although we continue to explore and develop products based on new technologies, a substantial portion of our revenues is generated today from Fibre Channel technology. If alternative technologies are adopted by the industry, we may not be able to develop products for new technologies in a timely manner. Further, even if alternative technologies do augment Fibre Channel revenues, our products may not be fully developed in time to be accepted by our customers. Even if our new products are developed on time, we may not be able to manufacture them at competitive prices or in sufficient volumes.

We depend on a limited number of customers, and any decrease in revenue or cash flows from any one of our customers could adversely affect our results of operations and cause our stock price to decline.

A small number of customers account for a substantial portion of our net revenues, and we expect that a limited number of customers will continue to represent a substantial portion of our net revenues in the foreseeable future. Our top ten customers accounted for 80% and 77% of net revenues for the nine months ended December 31, 2006 and the fiscal year ended April 2, 2006, respectively. We are also subject to credit risk associated with the concentration of our accounts receivable. The loss of any of our major customers could have a material adverse effect on our business, financial condition or results of operations.

Our customers generally order products through written purchase orders as opposed to long-term supply contracts and, therefore, such customers are generally not obligated to purchase products from us for any extended period. Major customers also have significant leverage over us and may attempt to change the terms, including pricing and payment terms, which could have a material adverse effect on our business, financial condition or results of operations. This risk is increased due to the potential for some of these customers to merge with or acquire one or more of our other customers. As our OEM customers are pressured to reduce prices as a result of competitive factors, we may be required to contractually commit to price reductions for our products before we know how, or if, cost reductions can be obtained. If we are unable to achieve such cost reductions, our gross margins could decline and such decline could have a material adverse effect on our business, financial condition or results of operations.

Our business may be subject to seasonal fluctuations and uneven sales patterns in the future.

Many of our OEM customers experience seasonality and uneven sales patterns in their businesses. For example, some of our customers close a disproportionate percentage of their sales transactions in the last month, weeks and days of each quarter; and some customers experience spikes in sales during the fourth calendar quarter of each year. Since a large percentage of our products are sold to OEM customers who experience seasonal fluctuations and uneven sales patterns in their businesses, we could continue to experience similar seasonality and uneven sales patterns. In addition, as our customers increasingly require us to maintain products at hub locations near their facilities, it becomes easier for our customers to order products with very short lead times, which makes it increasingly difficult for us to predict sales trends. In addition, our quarterly fiscal periods often do not correspond with the fiscal quarters of our customers, and this may result in uneven sales patterns between quarters. It is difficult for us to evaluate the degree to which the seasonality and uneven sales patterns of our OEM customers may affect our business in the future because the historical growth of our business may have lessened the effects of this seasonality and these uneven sales patterns on our business in the past.

Competition within our product markets is intense and includes various established competitors.

The markets for our products are highly competitive and are characterized by short product life cycles, price erosion, rapidly changing technology, frequent product improvements and evolving industry standards. In the Fibre Channel HBA market, we compete primarily with Emulex Corporation. In the iSCSI HBA market, we compete primarily with Broadcom Corporation. In the Fibre Channel switch products market, we compete primarily with Brocade Communications Systems, Inc. and McDATA Corporation. In the InfiniBand HCA market, we compete primarily with Mellanox Technologies, Ltd. In the InfiniBand switch market, we compete primarily with Voltaire, Inc. We may also compete with some of our computer and storage systems customers, some of which have the capability to develop products comparable to those we offer.

We need to continue to develop products appropriate to our markets to remain competitive as our competitors continue to introduce products with improved characteristics. While we continue to devote significant resources to research and development, these efforts may not be successful or competitive products may not be developed and introduced in a timely manner. Further, several of our competitors have greater resources devoted to securing semiconductor foundry capacity because of long-term agreements regarding supply flow, equity or financing agreements or direct ownership of a foundry. In addition, while relatively few competitors offer a full range of SAN and server interconnect products, additional domestic and foreign manufacturers may increase their presence in these markets. We may not be able to compete successfully against these or other competitors. If we are unable to

design, develop or introduce competitive new products on a timely basis, our future operating results will be materially and adversely affected.

We expect the pricing of our products to continue to decline, which could reduce our revenues, gross margins and profitability.

We expect the average unit prices of our products (on a product to product comparison basis) to decline in the future as a result of competitive pricing pressures, increased sales discounts, new product introductions by us or our competitors, or other factors. If we are unable to offset these factors by increasing sales volumes, or reducing product manufacturing costs, our total revenues and gross margins may decline. In addition, to maintain our gross margins we must maintain or increase current shipment volumes, develop and introduce new products and product enhancements, and continue to reduce the manufacturing cost of our products. Moreover, most of our expenses are fixed in the short-term or incurred in advance of receipt of corresponding revenue. As a result, we may not be able to decrease our spending to offset any unexpected shortfall in revenues. If this occurs, our operating results and gross margins may be below our expectations and the expectations of investors and stock market analysts, and our stock price could be negatively affected.

Our distributors may not adequately distribute our products and their reseller customers may purchase products from our competitors, which could negatively affect our operations.

Our distributors generally offer a diverse array of products from several different manufacturers and suppliers. Accordingly, we are at risk that these distributors may give higher priority to selling products from other suppliers, thus reducing their efforts to sell our products. A reduction in sales efforts by our current distributors could materially and adversely impact our business or operating results. In addition, if we decrease our distributor-incentive programs (i.e., competitive pricing and rebates), our distributors may temporarily decrease the amounts of product purchased from us. This could result in a change of business habits, and distributors may decide to decrease the amount of product held and reduce their inventory levels, which could impact availability of our products to their customers.

As a result of the aforementioned factors regarding our distributors or other unrelated factors, the reseller customers of our distributors could decide to purchase products developed and manufactured by our competitors. Any loss of demand for our products by value-added resellers and system integrators could have a material adverse effect on our business or operating results.

We are dependent on sole source and limited source suppliers for certain key components.

We purchase certain key components used in the manufacture of our products from single or limited sources. We purchase application specific integrated circuits, or ASICs, from a single source, and we purchase microprocessors, certain connectors, logic chips, power supplies and programmable logic devices from limited sources.

We use forecasts based on anticipated product orders to determine our component requirements. If we overestimate component requirements, we may have excess inventory, which would increase our costs. If we underestimate component requirements, we may have inadequate inventory, which could interrupt the manufacturing process and result in lost or deferred revenue. In addition, lead times for components vary significantly and depend on factors such as the specific supplier, contract terms and demand for a component at a given time. We also may experience shortages of certain components from time to time, which could also delay the manufacturing processes.

We depend on our relationships with silicon chip suppliers and other subcontractors, and a loss of any of these relationships may lead to unpredictable consequences that may harm our results of operations if alternative supply sources are not available.

We currently rely on multiple foundries to manufacture our semiconductor products either in finished form or wafer form. We generally conduct business with these foundries through written purchase orders as opposed to long-term supply contracts. Therefore, these foundries are generally not obligated to supply products to us for any specific period, in any specific quantity or at any specific price, except as may be provided in a particular purchase

order. If a foundry terminates its relationship with us or if our supply from a foundry is otherwise interrupted, we may not have a sufficient amount of time to replace the supply of products manufactured by that foundry. As a result, we may not be able to meet customer demands, which could harm our business.

Historically, there have been periods when there has been a worldwide shortage of advanced process technology foundry capacity. The manufacture of semiconductor devices is subject to a wide variety of factors, including the availability of raw materials, the level of contaminants in the manufacturing environment, impurities in the materials used and the performance of personnel and equipment. We are continuously evaluating potential new sources of supply. However, the qualification process and the production ramp-up for additional foundries have in the past taken, and could in the future take, longer than anticipated. New supply sources may not be able or willing to satisfy our silicon chip requirements on a timely basis or at acceptable quality or unit prices.

We have not developed alternate sources of supply for some of our products. A customer’s inability to obtain a sufficient supply of products from us, may cause that customer to satisfy its product requirements from our competitors. Constraints or delays in the supply of our products, due to capacity constraints, unexpected disruptions at foundries or with our subcontractors, delays in obtaining additional production at the existing foundries or in obtaining production from new foundries, shortages of raw materials or other reasons, could result in the loss of customers and have a material adverse effect on our results of operations.

LSI Logic Corporation has recently announced a transaction to acquire Agere Systems, Inc. Both LSI Logic Corporation and Agere Systems, Inc. are QLogic suppliers. This transaction, if completed, will reduce the number of companies we can use to produce our semiconductor products.

Our products are complex and may contain undetected software or hardware errors that could lead to an increase in our costs, reduce our net revenues or damage our reputation.

Our products are complex and may contain undetected software or hardware errors when first introduced or as newer versions are released. We are also exposed to risks associated with latent defects in existing products. From time to time, we have found errors in existing, new or enhanced products. The occurrence of hardware or software errors could adversely affect the sales of our products, cause us to incur significant warranty and repair costs, divert the attention of our engineering personnel from our product development efforts and cause significant customer relations problems.

The migration of our customers toward new products may result in fluctuations of our operating results.

As new or enhanced products are introduced, including the transition from 2Gb to 4Gb Fibre Channel products, we must successfully manage the transition from older products in order to minimize the effects of product inventories that may become excess and obsolete, as well as ensure that sufficient supplies of new products can be delivered to meet customer demands. Our failure to manage the transition to newer products in the future or to develop and successfully introduce new products and product enhancements could adversely affect our business or financial results. When we introduce new products and product enhancements, we face risks relating to product transitions, including risks relating to forecasting demand, as well as possible product and software defects. Any such adverse events could have a material adverse effect on our business, financial condition or results of operations.

Historically, the electronics industry has developed higher performance ASICs, which create chip level solutions that replace selected board level or box level solutions at a significantly lower average selling price. We have previously offered ASICs to customers for certain applications that have effectively resulted in a lower-priced solution when compared to an HBA solution. This transition to ASICs may also occur with respect to other current and future products. The result of this transition may have an adverse effect on our business, financial condition or results of operations. In the future, a similar adverse effect to our business could occur if there were rapid shifts in customer purchases from our midrange server and storage solutions to products for the small and medium-sized business market or if our customers shifted to lower cost products that could replace our HBA solutions.

If our internal control over financial reporting does not comply with the requirements of the Sarbanes-Oxley Act, our business and stock price could be adversely affected.

Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluate periodically the effectiveness of our internal control over financial reporting, and to include a management report assessing the effectiveness of our internal controls as of the end of each fiscal year. Section 404 also requires our independent registered public accounting firm to attest to, and report on, management’s assessment of our internal control over financial reporting.

Our management does not expect that our internal control over financial reporting will prevent all errors or frauds. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, involving us have been, or will be, detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple errors or mistakes. Controls can also be circumvented by individual acts of a person, or by collusion among two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and we cannot assure you that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies and procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to errors or frauds may occur and not be detected.

Our management has determined that our disclosure controls and procedures were effective as of December 31, 2006 and that there was no change in our internal control over financial reporting during our quarter ended December 31, 2006 that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. However, we cannot assure you that we or our independent registered public accounting firm will not identify a material weakness in our internal controls in the future. A material weakness in our internal control over financial reporting would require management and our independent registered public accounting firm to evaluate our internal controls as ineffective. As we acquire companies and expand operations into foreign locations, integrating and managing the internal controls process becomes more complex, requires additional resources and creates additional risk that our internal controls will not operate as designed. If our internal control over financial reporting is not considered adequate, we may experience a loss of public confidence, which could have an adverse effect on our business and our stock price.

Environmental compliance costs could adversely affect our net income.

Many of our products are subject to various laws governing chemical substances in products, including those regulating the manufacture and distribution of chemical substances and those restricting the presence of certain substances in electronic products. We could incur substantial costs, or our products could be enjoined from entering certain countries, if our products become non-compliant with environmental laws.

We face increasing complexity in our product design and procurement operations as we adjust to new and future requirements relating to the materials composition of our products, including the restrictions on lead and certain other substances that apply to specified electronic products put on the market in the European Union as of July 1, 2006 (Restriction of Hazardous Substances Directive, or RoHS) and similar legislation in China. In addition, recycling, labeling and related requirements have already begun to apply to products we sell in Europe. Where necessary, we are redesigning our products to ensure that they comply with these requirements as well as related requirements imposed by our OEM customers. We are also working with our suppliers to provide us with compliant materials, parts and components. If our products do not comply with the European substance restrictions, we could become subject to fines, civil or criminal sanctions, and contract damage claims. In addition, we could be prohibited from shipping non-compliant products into the European Union, and required to recall and replace any products already shipped, if such products were found to be non-compliant, which would disrupt our ability to ship products and result in reduced revenue, increased obsolete or excess inventories and harm to our business and customer relationships. We also must successfully manage the transition to RoHS-compliant products in order to minimize

the effects of product inventories that may become excess or obsolete, as well as ensure that sufficient supplies of RoHS-compliant products can be delivered to meet customer demand. Failure to manage this transition may adversely impact our revenues and operating results. Various other countries and states in the United States have issued, or are in the process of issuing, other environmental regulations that may impose additional restrictions or obligations and require further changes to our products. These regulations could impose a significant cost of doing business in those countries and states.

We could also face significant costs and liabilities in connection with product take-back legislation. The European Union has enacted the Waste Electrical and Electronic Equipment Directive, which makes producers of electrical goods financially responsible for specified collection, recycling, treatment and disposal of past and future covered products. The deadline for the individual member states of the European Union to enact the directive in their respective countries was August 13, 2004 (such legislation, together with the directive, the “WEEE Legislation”). Producers participating in the market became financially responsible for implementing these responsibilities beginning in August 2005. Similar legislation has been or may be enacted in other jurisdictions, including in the United States, Canada, Mexico, China and Japan, the cumulative impact of which could be significant.

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

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

Because we depend on foreign customers and suppliers, we are subject to international economic, regulatory, political and other risks that could harm our financial condition and results of operations.

International revenues accounted for 46% and 45% of our net revenues for the nine months ended December 31, 2006 and the fiscal year ended April 2, 2006. We expect that international revenues will continue to account for a significant percentage of our net revenues for the foreseeable future. In addition, a significant portion of our inventory purchases are from suppliers that are located outside the United States. As a result, we are subject to several risks, which include:


	•	a greater difficulty of administering and managing our business globally;

	•	compliance with multiple and potentially conflicting regulatory requirements, such as export requirements, tariffs and other barriers;

	•	differences in intellectual property protections;

	•	potentially longer accounts receivable cycles;

	•	currency fluctuations;

	•	export control restrictions;

	•	overlapping or differing tax structures;

	•	political and economic instability; and

	•	general trade restrictions.

Our international sales are invoiced in U.S. dollars and, accordingly, if the relative value of the U.S. dollar in comparison to the currency of our foreign customers should increase, the resulting effective price increase of our

products to such foreign customers could result in decreased sales. There can be no assurance that any of the foregoing factors will not have a material adverse effect on our business, financial condition or results of operations.

Moreover, in many foreign countries, particularly in those with developing economies, it is common to engage in business practices that are prohibited by regulations applicable to us, such as the Foreign Corrupt Practices Act. Although we implement policies and procedures designed to ensure compliance with these laws, our employees, contractors and agents, as well as those companies to which we outsource certain of our business operations, may take actions in violation of our policies. Any such violation, even if prohibited by our policies, could have a material adverse effect on our business.

We may engage in mergers, acquisitions and strategic investments and these activities may adversely affect our results of operations and stock price.

Our future growth may depend in part on our ability to identify and acquire complementary businesses, technologies or product lines that are compatible with ours. Mergers and acquisitions involve numerous risks, including:


	•	uncertainties in identifying and pursuing target companies;

	•	difficulties in the assimilation of the operations, technologies and products of the acquired companies;

	•	the existence of unknown defects in acquired companies’ products or assets that may not be identified due to the inherent limitations involved in the due diligence process of an acquisition;

	•	the diversion of management’s attention from other business concerns;

	•	the failure of markets for the products of acquired companies to develop as expected;

	•	risks associated with entering markets or conducting operations with which we have no or limited direct prior experience;

	•	risks associated with assuming the legal obligations of acquired companies;

	•	risks related to the effect that acquired companies’ internal control processes might have on our financial reporting and management’s report on our internal control over financial reporting;

	•	the potential loss of current customers or failure to retain acquired companies’ customers;

	•	the potential loss of key employees of acquired companies; and

	•	the incurrence of significant exit charges if products acquired in business combinations are unsuccessful.

Further, we may never realize the perceived benefits of a business combination. Future acquisitions by us could dilute stockholders’ investment and cause us to incur debt, contingent liabilities and amortization/impairment charges related to intangible assets, all of which could materially and adversely affect our financial position or results of operations.

We have made, and could make in the future, investments in technology companies, including privately held companies in a development stage. Many of these private equity investments are inherently risky because the companies’ businesses may never develop, and we may incur losses related to these investments. In addition, we may be required to write down the carrying value of these investments to reflect other than temporary declines in their value, which could have a materially adverse effect on our financial position and results of operations.

If we are unable to attract and retain key personnel, we may not be able to sustain or grow our business.

Our future success largely depends on our key engineering, sales, marketing and executive personnel, including highly skilled semiconductor design personnel and software developers. If we lose the services of key personnel or fail to hire personnel for key positions, our business would be adversely affected. We believe that the market for key personnel in the industries in which we compete is highly competitive. In particular, periodically we have experienced difficulty in attracting and retaining qualified engineers and other technical personnel and

anticipate that competition for such personnel will increase in the future. We may not be able to attract and retain key personnel with the skills and expertise necessary to develop new products in the future or to manage our business, both in the United States and abroad.

Beginning with fiscal 2007, we are required to recognize compensation expense related to employee stock options, restricted stock units and our employee stock purchase plan. There is no assurance that the expense that we are required to recognize measures accurately the value of our share-based payment awards and the recognition of this expense could cause the trading price of our common stock to decline.

Effective as of the beginning of the first quarter of fiscal 2007, we adopted Statement of Financial Accounting Standards (SFAS) No. 123R, “Share-Based Payment,” which requires the measurement and recognition of compensation expense for all stock-based compensation based on estimated fair values. As a result, starting with fiscal 2007, our operating results contain a charge for stock-based compensation expense related to employee stock options, restricted stock units and our employee stock purchase plan. This charge is in addition to stock-based compensation expense we have recognized in prior periods related to acquisitions and investments. The application of SFAS 123R generally requires the use of an option-pricing model to determine the fair value of share-based payment awards. This determination of fair value is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, our expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors. Option-pricing models were developed for use in estimating the value of traded options that have no vesting or hedging restrictions and are fully transferable. Because our employee stock options have certain characteristics that are significantly different from traded options, and because changes in the subjective assumptions can materially affect the estimated value, in management’s opinion the existing valuation models may not provide an accurate measure of the fair value of our employee stock options. Although the fair value of employee stock options is determined in accordance with SFAS 123R using an option-pricing model, that value may not be indicative of the fair value observed in a willing buyer/willing seller market transaction.

As a result of the adoption of SFAS 123R, beginning with fiscal 2007, our earnings will be lower than they would have been had we not been required to adopt SFAS 123R. This will continue to be the case for future periods. We cannot predict the effect that this adverse impact on our reported operating results will have on the trading price of our common stock.

Decreased effectiveness of equity compensation could adversely affect our ability to attract and retain employees.

We have historically used stock options and other forms of equity-related compensation as key components of our total rewards employee compensation program in order to align employees’ interests with the interests of our stockholders, encourage employee retention, and provide competitive compensation packages. In recent periods, many of our employee stock options have had exercise prices in excess of our stock price, which reduces their value to employees and could affect our ability to retain or attract present and prospective employees. As a result of our adoption of SFAS 123R in the first quarter of fiscal 2007, the use of stock options and other stock-based awards to attract and retain employees may be limited. Moreover, applicable stock exchange listing standards relating to obtaining stockholder approval of equity compensation plans could make it more difficult or expensive for us to grant stock-based awards to employees in the future, which may result in changes in our equity compensation strategy. These and other developments relating to the provision of equity compensation to employees could make it more difficult to attract, retain and motivate employees.

We may experience difficulties in transitioning to smaller geometry process technologies.

We expect to continue to transition our semiconductor products to increasingly smaller line width geometries. This transition requires us to modify the manufacturing processes for our products and to redesign some products as well as standard cells and other integrated circuit designs that we may use in multiple products. We periodically evaluate the benefits, on a product by product basis, of migrating to smaller geometry process technologies. Currently, most of our products are manufactured in 0.25, 0.18 and 0.13 micron geometry processes. In addition, we

have begun to develop certain new products with 90 nanometer (.09 micron) process technology. In the past, we have experienced some difficulties in shifting to smaller geometry process technologies or new manufacturing processes, which resulted in reduced manufacturing yields, delays in product deliveries and increased expenses. We may face similar difficulties, delays and expenses as we continue to transition our products to smaller geometry processes.

Our proprietary rights may be inadequately protected and difficult to enforce.

Although we have patent protection on certain aspects of our technology in some jurisdictions, we rely primarily on trade secrets, trademarks, copyrights and contractual provisions to protect our proprietary rights. There can be no assurance that these protections will be adequate to 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. There also can be no assurance that any patents we possess will not be invalidated, circumvented or challenged. In addition, we have trademark protection in a number of jurisdictions. We have taken steps in several jurisdictions to enforce our trademarks against third parties. No assurances can be given that we will ultimately be successful in protecting our trademarks. The laws of certain countries in which our products are or may be developed, manufactured or sold, including various countries in Asia, may not protect our products and intellectual property rights to the same extent as the laws of the United States or at all. If we fail to protect our intellectual property rights, our business would be negatively impacted.

Disputes relating to claimed infringement of intellectual property rights may adversely affect our business.

We have received notices of claimed infringement of intellectual property rights in the past and have been involved in intellectual property litigation in the past. There can be no assurance that third parties will not assert future claims of infringement of intellectual property rights against us with respect to existing and future products. In addition, individuals and groups have begun purchasing intellectual property assets for the sole purpose of making claims of infringement and attempting to extract settlements from companies such as ours. Although patent and intellectual property disputes may be settled through licensing or similar arrangements, costs associated with these arrangements may be substantial and the necessary licenses or similar arrangements may not be available to us on satisfactory terms or at all. As a result, we could be prevented from manufacturing and selling some of our products. In addition, if we litigate these kinds of claims, the litigation could be expensive and time consuming and could divert management’s attention from other matters. Our business could suffer regardless of the outcome of the litigation. Our supply of silicon chips and other components can also be interrupted by intellectual property infringement claims against our suppliers.

Unavailability of third-party licenses could adversely affect our business.

Many of our products are designed to include software or other intellectual property licensed from third parties. It may be necessary in the future to seek or renew licenses relating to various aspects of these products. There can be no assurance that necessary licenses will be available on acceptable terms, if at all. The inability to obtain certain licenses or to obtain such licenses on favorable terms, or the need to engage in litigation regarding these matters, could have a material adverse impact on our business, operating results and financial condition.

If we fail to carefully manage the use of “open source” software in our products, we may be required to license key portions of our products on a royalty free basis or expose key parts of source code.

Certain of our software (as well as that of our customers) may be derived from “open source” software that is generally made available to the public by its authors and/or other third parties. Such open source software is often made available to us under licenses, such as the GNU General Public License, or GPL, which impose certain obligations on us in the event we were to distribute derivative works of the open source software. These obligations may require us to make source code for the derivative works available to the public, and/or license such derivative works under a particular type of license, rather than the forms of licenses customarily used to protect our intellectual property. In the event the copyright holder of any open source software were to successfully establish in court that

we had not complied with the terms of a license for a particular work, we could be required to release the source code of that work to the public and/or stop distribution of that work.

Unanticipated changes in our tax provisions or adverse outcomes resulting from examination of our income tax returns could adversely affect our net income.

We are subject to income taxes in the United States and various foreign jurisdictions. Our effective tax rates have recently been and could in the future be adversely affected by changes in tax laws or interpretations thereof, by changes in the mix of earnings in countries with differing statutory tax rates, by discovery of new information in the course of our tax return preparation process, or by changes in the valuation of our deferred tax assets and liabilities. Our effective tax rates are also affected by intercompany transactions for licenses, services, funding and other items. Additionally, we are subject to the continuous examination of our income tax returns by the Internal Revenue Service and other tax authorities which may result in the assessment of additional taxes. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes. However, there can be no assurance that the outcomes from these continuous examinations will not have a material adverse effect on our financial condition or results of operations.

In June 2006, the Financial Accounting Standards Board issued Interpretation (FIN) No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109.” FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. We are currently assessing the impact FIN 48 will have on our financial statements. There is a risk that the adoption of FIN 48 could result in a cumulative adjustment to retained earnings and future interperiod effective tax rate volatility.

Computer viruses and other forms of tampering with our computer systems or servers may disrupt our operations and adversely affect net income.

Despite our implementation of network security measures, our servers are vulnerable to computer viruses, break-ins and similar disruptions from unauthorized tampering with our computer systems. Any such event could have a material adverse effect on our business, operating results or financial condition.

Our facilities and the facilities of our suppliers and customers are located in regions that are subject to natural disasters.

Our California facilities, including our principal executive offices, our principal design facilities and our critical business operations are located near major earthquake faults. We are not specifically insured for earthquakes, or other natural disasters. Any personal injury or damage to the facilities as a result of such occurrences could have a material adverse effect on our business, results of operations or financial condition. Additionally, some of our products are manufactured or sold in regions which have historically experienced natural disasters. Any earthquake or other natural disaster, including a hurricane or tsunami, affecting a country in which our products are manufactured or sold could adversely affect our results of operations.


Item 6.	*Exhibits*

Exhibits


Exhibit No.

	10	.1	Change in Control Severance Agreement between QLogic Corporation and H.K. Desai.* (incorporated by reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8-K filed on November 13, 2006).
	10	.2	Change in Control Severance Agreement between QLogic Corporation and Anthony J. Massetti.* (incorporated by reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8-K filed on November 13, 2006).
	31	.1	Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	31	.2	Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	32		Certification of Chief Executive Officer and Chief Financial Officer pursuant to Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended, and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


*		Compensation plan, contract or arrangement required to be filed as an exhibit pursuant to applicable rules of the Securities and Exchange Commission.

EXHIBIT INDEX


Exhibit No.

	10	.1	Change in Control Severance Agreement between QLogic Corporation and H.K. Desai.* (incorporated by reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8-K filed on November 13, 2006).
	10	.2	Change in Control Severance Agreement between QLogic Corporation and Anthony J. Massetti.* (incorporated by reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8-K filed on November 13, 2006).
	31	.1	Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	31	.2	Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	32		Certification of Chief Executive Officer and Chief Financial Officer pursuant to Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended, and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


*		Compensation plan, contract or arrangement required to be filed as an exhibit pursuant to applicable rules of the Securities and Exchange Commission.


		Page

PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements:
	Condensed Consolidated Balance Sheets at December 31, 2006 and April 2, 2006		1
	Condensed Consolidated Statements of Income for the three and nine months ended December 31, 2006 and January 1, 2006		2
	Condensed Consolidated Statements of Cash Flows for the nine months ended December 31, 2006 and January 1, 2006		3
	Notes to Condensed Consolidated Financial Statements		4
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		16
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		28
Item 4.	Controls and Procedures		29

PART II. OTHER INFORMATION
Item 1A.	Risk Factors		30
Item 6.	Exhibits		42
	Signatures		43
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32