Emulex Corporation F1Q09 (Qtr End 9/30/08) Earnings Call Transcript

| About: Emulex Corporation (ELX)

Emulex Corporation (NYSE:ELX)

F1Q09 (Qtr End 9/30/08) Earnings Call Transcript

October 23, 2008, 5:00 pm ET

Executives

Jim McCluney – President and CEO

Mike Rockenbach – EVP and CFO

Jeff Benck – EVP and COO

Analysts

Clay Sumner – FBR

Min Park – Goldman Sachs

Keith Bachman – Bank of Montreal

Tom Curlin – RBC Capital

Operator

Good day, and welcome to the Emulex Corporation first quarter conference call. This call is being recorded. At this time for opening remarks and introductions, I will turn the conference over to the President and Chief Executive Officer, Mr. Jim McCluney. Please go ahead, sir.

Jim McCluney

Thank you, operator. Good afternoon, and welcome to Emulex's first quarter fiscal year 2009 conference call. I'm Jim McCluney, CEO and President of the company, and with me today are Jeff Benck, our COO, Mike Rockenbach, our CFO, and Steve Berg, our Senior Vice President of Corporate Development.

Mike Rockenbach will start off our prepared remarks with the first quarter 2009 results. I will follow with my comments in the quarter and a discussion of our markets, and Jeff will talk about our progress on the company's operating plan. After that we'll provide some concluding remarks and we'll open the line for questions. Over to you, Mike.

Mike Rockenbach

Thanks, Jim. By now you should all have Emulex's first quarter 2009 earnings release which was issued earlier this afternoon. If you do not have a copy, the press release is available in the Investor Relations section of our website at www.Emulex.com. The press release in this presentation contains forward-looking statements including but without limitation statements regarding Emulex's business, operations and anticipated financial results for the second quarter of fiscal 2009 and beyond. These statements are subject to risks and uncertainties and our actual results may differ materially from those discussed in the forward-looking statements.

Those risks and uncertainties include: economic conditions, market growth, IT spending patterns, changes in technology, evolving industry standards, competitive pressures, pricing pressures and fluctuations in OEM ordering patterns, the estimate of total available market size, ability to address these markets with available technology in a timely fashion, research and development activities, the inability to achieve the expected benefits from our globalization initiatives and the risks and uncertainties described in Emulex's SEC reports filed under the Securities Exchange Act of 1934 including forms 8K and under the heading risk factors in Emulex's most recently annual report Form 10K and quarterly reports on Form 10Q.

We undertake no obligation to update the forward-looking statements. Investors should also be aware Emulex will not disclose in its Q&A or in conversations afterwards any material financial data that is not already disclosed in its conference call or its press release.

In addition, during this call, when we use any historical non-GAAP financial measure as defined by the SEC in Reg G you will find reconciliation to the most directly comparable GAAP financial measure in our press release available on our investor relations websites. All the references we make today will be in relation to our non-GAAP results unless stated otherwise. Today's conference call is being webcast and the recording will be available on the Emulex website through October 2009. I would also like to remind participants if you decide to ask a question, it will be included in both our live transmission as well as any future use of the recording.

Sales for the first quarter ended September 28, 2008, totaled $111.7 million, a decrease of 5% from the prior year's quarter and 1% sequential decline. Q1 fully diluted earnings per share of $0.22 decreased by 19% from the $0.27 reported in the first quarter of the prior year, however EPS was flat sequentially with $0.22 reported in the prior quarter. Our top line results of $111.7 million were slightly above the high end of our first quarter guidance of $108 million to $111 million and our fully diluted EPS of $0.22 exceeded the high end of guidance of $0.18 to $0.20.

Now, let me discuss the revenue results for the quarter by product line. Beginning with host server products or HSP, which consists primarily of standard host adapters, converge network adapters or CNAs, custom form factor mezzanine cards to blade servers and ASICs used in server applications. HSP revenues totaled $81.2 million, a decline of 9% from the first quarter of last year, and down 4% sequentially.

Revenue from board level products for the first quarter declined 9% year-over-year however units increased 3% and ports grew by 11%. Sequentially ports for our HSP board level products declined by 2%, units declined by 3% and revenues decreased by 5% from the fourth quarter. On a sequential basis ASPs declined by 3%. The average selling price for board level products including both standalone HBAs, CNAs and mezzanine cards declined 12% year-over-year which is in line with our expected annual ASP decline rate of 12% to 15%.

Dual channel mix increased slightly on a sequential basis now representing more than 45% of fiber channel HBA revenues. We continue to experience good revenue growth on mezzanine cards for the blade server market with revenue growth of 5% sequentially and over 70% year-over-year. With our blade server mezzanine cards continuing to show significantly faster growth in the market, we believe these results are a clear indication that we are building momentum for share gains in this important market.

Finally, HSP ASICs revenues nearly doubled sequentially, partially offsetting the decline in our board level products as one of our OEM customers continue to show strength from a server refresh during the quarter. Our second product line embedded storage products, or ESP, encompasses SATA bridges and routers, fiber channel embedded SOCs and route switchers as well as single and multiprotocol embedded controller products for enterprise class storage systems.

ESP revenues for the first quarter totaled $30.4 million, representing an increase of 7% sequentially and 8% over the prior year's period. Our embedded products increased to 27% of total revenues coming in slightly ahead of our expectations. This is up from 25% in the fourth quarter and 24% in the Q1 of last year. We have provided a geographical and customer breakdown for our revenues and supplemental information in our press release.

As we further discuss the income statement I'd like to remind you we would be primarily discussing our non-GAAP results unless otherwise noted. You'll find in our press release a reconciliation of the difference between our GAAP and non-GAAP earnings, as well as discussion of why we believe non-GAAP financials are relevant measure for our business for investors.

First quarter gross margins of 67% were in line with our expectations for the quarter and we expect to show comparable margins for the second quarter. As we previously discussed over the next several years we expect our embedded products and our mezzanine cards will grow faster than standard HBAs, accordingly we're modeling business with the expectation that over time our gross margins will trend down as these lower margin products become a larger portion of our revenues. While we expect some benefit from our recent shift to contract manufacturers to Thailand and the continued growth of dual channel HBAs during the December quarter, we expect gross margins will start to trend down as we enter into calendar year 2009.

Turning to operating expenses, during the first quarter OpEx decreased 4% sequentially to $49.9 million. Expenses decreased as a percent of revenue to 45% compared to 46% in the prior quarter. As you may recall from our remarks during the August earnings call it is our intention to keep our expenses aligned with revenue expectations. We did make some changes within the organization that resulted in a reduction of our total headcount. We exited the first quarter with a total of 794 employees, a net decrease of 59 people from Q4. Jim and Jeff will provide more color on these changes.

With our focus on managing our expenses Q1 operating income of $25.3 million was up 2% sequentially coming in at 23% of revenues compared to 22% in the fourth quarter. However, on a year over year basis, operating margin was down about four percentage points resulting lower revenues and higher operating expenses which were partially offset by improved gross margin contribution.

Other income increased slightly sequentially coming in at $2.2 million due to favorable exchange gains offsetting lower interest income. With the goal of principal protection, we continue to invest in short term government backed investments which while secure have relatively low interest rate. With our lower cash balances, we anticipate interest income in Q2 will be approximately $1.8 million. First quarter net income was $17.9 million about flat sequentially and a decrease of 22% from the prior year results.

Our tax rate for the quarter was approximately 35% compared to 37% we modeled in our August call. The 35% reflect the benefit from our international operations which we expect will continue throughout fiscal 2009. Our net profit margin for the quarter was 16% which was essentially flat with the prior quarter but down from the 19% reported in the first quarter last year.

For the first quarter on a GAAP basis, we report operating income of $9.2 million, net income of $7.1 million and diluted EPS of $0.09. The difference between GAAP and non-GAAP income in the first quarter is primarily attributable to amortization of intangibles, stock-based compensation and settlements from associated costs. FAS 123(NYSE:R) expense reduced $0.06 per diluted share this quarter.

On a GAAP basis Q1 R&D expenditures increased 4% sequentially to $34.8 million compared to $33.4 million in the fourth quarter. Q1 R&D ended at $3.1 million in stock-based compensation. Quarterly R&D spending varies, depending on the time your new product development expenses however with the actions taken in the first quarter R&D spending excluding stock-based compensation was essentially flat.

First quarter GAAP sales and marketing expenses were $14.5 million compared to $15.7 million in the prior quarter, Q1 sales and marketing expenses included $1 million of stock-based compensation. GAAP G&A expenses decreased sequentially to $9.4 million from the $11.5 million reported in Q4, and this includes $2.3 million of stock-based compensation.

Turning to the balance sheet, we exited the first quarter with total cash investments of $294 million, this represents a decrease of $56 million from the end of the fourth quarter. The decrease in cash reflects approximately $41 million [ph] in tax payments primarily associated with our globalization initiatives, we also spent approximately $40 million completing our share repurchase program approved in 2006. We are now expecting our share count to be 82 million shares in the second quarter.

First quarter inventories were relatively flat essentially at $19.4 million, and our inventory turns of 8.6 were comparable to Q4 levels and remain in the low end of our target range of eight to 10 turns. Our Q1 receivables decreased sequentially by $4.7 million to $56.9 million compared to a revenue decrease of only $1 million. Depreciation in the first quarter increased slightly to $5.3 million compared to $5.1 million in the fourth quarter, and capital expenditures decreased in Q1 to $7.6 million compared to $10.1 million in the fourth quarter.

Before I discuss our targets for the second quarter of fiscal 2009, I want to again remind everyone there are numerous risks that can affect our future performance, causing actual results to differ materially from forward-looking statements. These risks are noted in our public filings with the SEC and the Safe Harbor statement at the end of our earnings press release. As a result of these risks and uncertainties we're unable to predict with accuracy what future quarterly results might be and there's no guarantee business will reach our expectations or goals.

Based upon current market conditions our customers public comments and our most recent forecasts, we believe that revenue for the second quarter ending December 28, 2008, could amount to approximately $111 million to $116 million, which represents a sequential change of essentially flat to up 4% and decline of 11% to 15% from the prior year second quarter. If we achieve revenue in this range we anticipate non-GAAP earnings per diluted share of $0.20 to $0.23, assuming a 35% tax rate.

Our press release provides a reconciliation of GAAP to non-GAAP financials. I'll now turn the call over to Jim, who will give you our overview of our progress, some color on the quarter and update on the company strategy.

Jim McCluney

Thanks, Mike. Overall I'm pleased with what with accomplished during Q1. We executed well in what has been a very challenging environment delivering $111.7 million in revenue and $0.22 of EPS, $0.03 above first call estimates. However, there should be no surprise to anyone for the series of dramatic events in the financial services sector over the past several quarters has had an impact of spending on key market vertical.

In addition it appears that the distress in the credit and equity markets are spilling over into the broader economy causing a drag on IT spending. It is difficult to assess the degree to which the ongoing disruption will impact our business but budget tightening and purchasing delays are already being felt and is likely to extend beyond 2008 and into 2009. The corresponding reduction in visibility across the entire business has led us to increase our guidance ranges for the December quarter.

Looking to our business by product line, HSP revenue of $81.2 million declined 9% from the same quarter last year from 4% sequentially. Although we continue to be impacted by softness in spending, along with the shift in end-user buying patterns leaning more towards server OEMs from storage OEMs, where we have traditionally been dominant, HSP revenues were in line with expectations for the first quarter.

As we discussed in our August earnings call, Emulex has achieved a broader range of qualifications than ever before at key server OEMs, such as IBM, HP, Sun and Dell. In addition over the past several months we have moved to rebalance our resources towards several vendors under corresponding distribution channels. While we still have not reached the point for several OEM revenues increase have fully offset the decline on the storage side, we are making progress. We are highly focused on regaining share in this market and Jeff will discuss this further during his remarks.

Turning to ESP, revenue came in at $30.4 million up 8% year-over-year and 7% sequentially, performing a little better than we had modeled. Over the past year, the results in this business have been choppy as a large number of new product launches went to market roughly the same time.

In recent quarters we're seeing demand for these new products stabilize somewhat as end user sales rather than stocking orders have become the main driver. Our goals for ESP are to grow revenue by capitalizing on current design wins to take advantage of increasing number of bridging opportunities to support upcoming transitions in disk formats and protocols and to execute on the new systems and solutions businesses that we have won.

Switching topics, let me update you on some of the plans we shared with you last quarter to get the business back on the right track, regain share, and drive long-term diversification and growth.

During the quarter we took action to reduce spending to be more in line with the comp revenue outlook. The more significant and immediate stand we took was to lower head count. Emulex exited Q1 with 794 employees, compared to the 853 we had at the end of Q4. While the reduction in force is tough for any company, it was very well managed and it was the right choice for the health of the business, and also prudent given the environment we are in today. We will remain in close control of variable expenses and tightly manage capital outlays [ph].

We continue to align our business more closely with our customers and opportunities for growth on a global basis. This includes reshaping and expanding our global supply chain and sales and marketing capabilities. We recently opened up a new international headquarters in Ireland to coordinate these activities and we expect the transition associated with this expansion to be substantially completed by the end of the calendar year.

During the first quarter, we also increased our footprint in the Asia-Pacific region, we added a sales office in Japan supporting the key OEM customers. We also recently doubled the space in our Bangalore engineering design center allowing us to expand our international R&D capabilities. These globalization efforts will help us better service our customers, tap into our broader engineering resource space, create a more efficient corporate structure and expand the platform for which to access faster growing emerging markets. And lastly we took steps to improve demand visibility. We're now working even more closer with the customers and manufacturing partners to improve real time access to the data we need to better manage our business.

Now, let me turn to my overall expectations for the coming quarters. As I mentioned at the outset, the IT spending environment has eroded over the past several quarters with some fairly dramatic forecast revisions during recent months. The most common (inaudible) model forecast IT spending budgets to grow 2.3% in 2009, down from the previous forecast of 5.8%. This comes off an already weak 2008 number resulting from a series of downward revisions that started in the back half of 2007.

On the bright side a recent survey I read suggests that storage is expected to be the strongest category of IT spending. So while the near term visibility is challenging, I believe Emulex is well positioned from a marketing perspective to weather the storm.

From a financial model perspective, there are a couple of additional positives. During the past quarter we were active in the open market completing the last $40 million of a share repurchase program we put in place in December 2006. During the past two years we have purchased over eight million shares or approximately 10% of our total outstanding. Looking forward the board has approved a follow-on program which authorizes an additional 100 million [ph] of share repurchases. Our reduced share count and lower effective tax rate resulting from international expansion will be a boost to EPS performance over time.

Looking beyond calendar 2008, we're staying focused on key strategic initiatives. We're investing internally on innovative new business opportunities that will help fuel revenue expansion in the years to come. We are leveraging our global initiatives to tap into high growth emerging markets, better align ourselves with our partners and customers and we are broadening both our customer base and product set to drive diversification. So with that, let me turn this over to Jeff for some more color on the operations this quarter and business opportunities for the rest of fiscal 2009.

Jeff Benck

Thanks, Jim. The target we set for ourselves last quarter was to make sure that the organization was aligned at three objectives, which are: efficient execution, growth and diversification, and market leadership. The first topic I want to comment on is efficient execution. We completed a significant restructuring across our operations during the first quarter. One objective of the restructuring was the speed decision making and we accomplished this by flattening the organization and removing some management layers. A result of these changes was a 7% reduction in work force.

We managed through this change without disrupting our road maps, customers or performance in the quarter. While there has been some additional erosion in IT spending projections in recent weeks, we believe that we have taken the correct action to keep spending in line with our business model.

A further objective of the restructuring was to create cohesive and dynamic marketing and sales organization. We intend to improve marketing effort by spending our dollars more effectively to provide market share leverage and mind share with IT decision-makers. We recently added resources charged with building more dynamic marketing plans, improving our collateral and revamping our web presence. Beyond these actions we also shifted additional sales head count to our server OEMs and added resources to tap into higher growth emerging markets.

Turning to the topic of growth and diversification, I would first like to share some details on our international expansion strategy. Our plan includes redistributing our operations throughout the world with a specific focus on growing our presence in EMEA and Asia Pacific. From a sales perspective we have had some early success in adding and converting key resellers in Europe to bolster our presence and we expect these relationships to expand with our sales and marketing focus in these geographies.

In manufacturing operations we have moved more of our production closer to where demand for our products is growing. We've been supplying products to benchmark Malaysia for the past several years and during the first quarter we transitioned manufacturing from benchmark Mexico to benchmark Thailand.

At the beginning of October our new international headquarters in Ireland came online with more than 50% of revenues outside of the US including over 30% in the EMEA, this operation is a key part of our commitment to providing regional support to our customers. Our diversification strategy is supported by new efforts that are being incubated internally, and as we have done in the past, we will continue to pursue strategic partnerships to create new solutions in the market.

We also see a unique opportunity with our CNAs to pursue incremental business in the data networking space that is created by convergence. Furthermore, our new system and solutions business allows us to add more value to our storage OEMs offerings and correspondingly grow our business with them.

The third objective I'd like to discuss is market leadership. When I spoke to you last quarter, I commented that a strong product set is essential for accomplishing our goal of market share growth. Emulex continues to have a solid flow of product announcements, qualifications, partnerships and design wins.

We remain well positioned for the fiber channel transition and see deployment and certification momentum continuing over the next few quarters. We expect this revenue to ramp throughout fiscal 2009, as these design wins go into production. In the first quarter we announced that Sun is selling Emulex 8Gb HBAs across its SunFire [ph] enterprise server families and storage tech solutions. We also announced that NetApp is now shipping Emulex 8GB HBAs with its NetApp storage systems and Hitachi data systems is shipping our 8Gb HBAs with its enterprise new range storage platforms.

In that addition, our CNAs are off to a strong start. For end users of converged network, which uses the SCOE protocol translates into less complexity, lower power consumption and lower management costs. We are leveraging our fiber channel technology to allow a seamless user migration path providing for investment protection and allowing the use of existing SAN management tools. We're now shipping first generation LP21000 family of converged network adapters, which were qualified in Q1 by NetApp, EMC and VMware.

Turn to go our embedded storage business, in the first quarter we were pleased do announce Pillar Data Systems has deployed our Emulex embedded storage switches across its complete line of axiom storage systems. We also announced that 3PAR selected our fiber channel bridge for use within three part in serve storage servers.

Over the next several quarters we expect a strong flow of additional 8Gb HBA and mezz card qualifications, embedded system design-ins and CNA launches. We are also working with a number of software partners on security and virtualization solutions. In fact, VMware announced us during their alliance affiliate initiative as the only connectivity partner in the program. As you can see, there is a lot of new activity in this space. Clearly the near-term environment is cautious, but the cost and power savings of the converged network is compelling.

Our investments today in these emerging areas will enable a suite of multiprotocol products and services that will be the drivers for our future growth. While we have accomplished a lot in the past 90 days to strengthen execution, drive expansion and diversification, and improve market leadership, we still have work to do to regain share. While we have gained modest share in the blade server and X86 market, our share still lags the competition.

In response to the shift in buying patterns from storage OEMs toward server OEMs, we are redoubling our efforts to focus on these customers and their global distribution channels. The 8Gb transition coupled with marketing plans should drive gains over the coming quarters.

In summary, we have made progress on some new initiatives and we are moving in the right strategic direction. We will leverage our collective strength across the company from our host product lines to our embedded storage business into new products and markets. We will play a vital role in connecting our clients to their critical information across multiple protocols from server to storage device.

With over 25 years of history connecting servers and storage, our experience and thought leadership will drive innovation. In the coming months we will focus on increasing our brand awareness and share our vision of data center evolution. We are anticipating some new inflection points and we're building the technologies and solutions required to be successful in this new realm. At this point, let me pass it back to Jim.

Jim McCluney

Thanks, Jeff. Let me conclude with some key summary points. Our September results were in line with our expectations, if not a little better, the December quarter guidance of $111 million to $116 million in revenue and $0.20 to $0.23 in diluted EPS, is reflective of more muted seasonal growth resulting from the challenging marketing environment.

We remain committed and focused on overall business strategy and will continue to ensure the investments we are making deliver value to shareholders. We will maintain a balanced investment in our existing products, as well as in the new trends for the data center that take advantage of our expertise. We are also broadening our product portfolio and expanding our global reach into faster-growing markets, all of which will strengthen our growth prospects and reduce our business risk with a profitable business, with a strong balance sheet, an excellent customer base and loyal employees, all of which positions us to come through this uncertainty in good shape.

That concludes our prepared remarks, and so with that, we have time to take questions. Operator, please go ahead and open the line.

Question-and-Answer Session

Operator

(Operator instructions) And we'll take our first question from Clay Sumner with FBR.

Clay Sumner – FBR

Thanks very much. Mike, first on the tax rate, I know you said 35% for next quarter, should we model 35% for the rest of '09 or did you say the tax rate will be improving through fiscal '09?

Mike Rockenbach

We think you can model 35% for the rest of 2009. It might be better as we get into 2010, but we'll give you an update on that as we get toward the end of this fiscal year.

Clay Sumner – FBR

Okay. With disk erase starting to transition to SAS, and expect to keep doing that over the coming years, is there a plan to add SAS expanders to your end speed products that are part of the embedded business? How do you see that business trending over the next couple of years?

Jeff Benck

We continue to look at new opportunities in the product line. One thing that we've seen, certainly, is that the high-end and mid-range of the storage systems continues to leverage fiber channel which allows us to continue to participate with our current products. We also have some new SAS products coming to market which will allow us to participate as native SAS platforms come into the market and they want to continue to attach SAS technology into those systems.

Clay Sumner – FBR

And that would be on the expander, would you substitute for your fiber channel switch back-end switch?

Jeff Benck

Well, a lot of our switch products really serve a bridging function, and some of that transitions to our bridge technology, and depending on the design point, we'll continue to see our end speed switch products in the market along with new bridge offerings to connect both fiber channel and SAS.

Clay Sumner – FBR

Okay. And one more for me. Like similarly in your fiber channel router business, if a back plain [ph] goes to SAS, can you address SAS opportunity and are the economics any different there?

Jeff Benck

We could still participate there. As I mentioned with our SAS to SATA bridge technology we do expect over time that we will see some of our route switches come down as that technology transitions.

Clay Sumner – FBR

Okay. Thank you very much.

Operator

And we move on to our next question from Min Park with Goldman Sachs.

Min Park – Goldman Sachs

Yes, thank you, just a couple questions, please. First, can you give us a little better sense of what the linearity looks like at the end of the quarter, as well as how the business is holding up in the first few weeks in October relative to normal seasonality?

Mike Rockenbach

Yes, this is Mike. I think our business, as we've kind of gone through the last couple of years has become much more balanced in the quarters, so we don't really see a big spike in our business at the end of any of our quarters, really. So I think we saw fairly normal activity throughout the month of September, including the last couple of weeks, and I think where we're at this quarter, we're tracking pretty well to what we would expect to see relative to what we're modeling in terms of the forecast.

Min Park – Goldman Sachs

Okay. And then just given the current market conditions, as well as the lower outlook on some of your partners, for the December quarter, can you just give us a little bit more detail why you expect to see this pick up on HBAs or your better business?

Jim McCluney

This is Jim. Obviously we take a close view of the forecast from our customers, and we think that obviously a lot incentive, if anything, we're taking an appropriately conservative view of the quarter. We're well-positioned to – if we do see some upside from customers, we're well-positioned to take advantage of it. But we compile our guidance obviously from our customer forecast and our own analysis there. And as Mike said, we're tracking okay so far in the quarter.

Min Park – Goldman Sachs

And just lastly, can you give us a sense of what your channel inventories for your embedded products looks like?

Mike Rockenbach

Channel inventories for –

Min Park – Goldman Sachs

I think you mentioned previously that there was excess channel for embedded products. I just want to get a sense of is it more normal now?

Mike Rockenbach

Yes, we think they are. In fact, I think we mentioned in our remarks, I think the ESP products that part of our business actually came in a little bit ahead of our forecast. So we think the inventories are pretty well stabilized and that the business that we're seeing is reflecting the demand that's out there in the marketplace.

Min Park – Goldman Sachs

Great. Thank you.

Jeff Benck

That's really with the contract manufacturers not so much the channels.

Min Park – Goldman Sachs

Yes. Excuse me. Thank you very much.

Jeff Benck

That's okay.

Operator

And we'll take our next question from Keith Bachman from Bank of Montreal.

Keith Bachman – Bank of Montreal

Hi, guys. I had two, if I could. Mike, on the guidance, where are you seeing more of the tensions between the embedded side of the business and the host side of the business, in terms of either upside or risk? In particular on the embedded, I would think there was still some volatility with one of your larger customers there, yet it seems like the guidance is pretty conservative against that. I just want to see if there is any more color separating those from the September quarter, and I have a follow-up, please.

Mike Rockenbach

Kind of given the current of environment, I guess, I don't know that I would categorize it as more or less risk in one of the product lines versus the other. I think they've got their own – each one of them has their own dynamics.

In terms of the embedded market, that does tend to be really concentrated, more diversified than we used to be, but still we're fairly concentrated in just a couple of customers. So to the extent their business is good or bad, I think that can have a more dramatic impact on us. And then I think in the HBA market, the thing that we've been seeing in terms of server OEMs verses storage OEMs kind of taking the lead on HBA sales, have had some level of impact and then there is a fair amount of uncertainty relative to the financial vertical, which we think we tend to participate better than our competition.

So I do think certainly the September quarter for us, we ended up towards the higher end of our guidance, but that was a pretty challenging quarter overall relative to where we might have expected to be in that quarter, a couple of quarters ago. So I think we've taken everything we can into consideration in our business. I don't know that there is more or less risk in one side versus another.

Keith Bachman – Bank of Montreal

But on the embedded side would it be fair to think about what your customers is showing, that, within your forecast, you're already hair-cutting some of those numbers?

Mike Rockenbach

No, I would say we look at the macro business and as we've said, we're very focused on getting more visibility into the pipeline on the embedded side, so I don't think we've really discounted any one customer more so than others. I think we've taken into account where the demand is.

Jim McCluney

I think it is fair to say that we're taking a more conservative view at this point than some of the forecast we're getting from some of our customers.

Keith Bachman – Bank of Montreal

Okay. Fair enough. The OpEx, Mike, there was a severance cost adjustment in the September quarter. Net of that, how should we think about OpEx sequentially going from September to December on a non-GAAP basis?

Mike Rockenbach

The severance costs was in our gap numbers.

Keith Bachman – Bank of Montreal

Yes, correct.

Mike Rockenbach

And non-GAAP numbers. So, we did take an action during the September quarter, but having said that we do continue to hire and we're focused on executing our business. So we expect expenses will go up a little bit in the December quarter relative to September, but we're very focused on making sure that the dollars that we are spending are going in the right places to drive market share and innovation.

Keith Bachman – Bank of Montreal

Okay. Thanks, guys.

Jim McCluney

Thank you.

Operator

And moving on to Tom Curlin with RBC Capital.

Tom Curlin – RBC Capital

Hi, there, do you – I think it was my impression that you had some embedded programs that were supposed to ramp around mid-year and for various reasons that was at least mildly delayed and towards your end. Do you feel like those programs are now ramping or whatever issues may have been involved in the timing that's cleared up?

Jim McCluney

Yes, I think that was the customers we were referencing, Tom, moving more into the March quarter and we're still on track, there's still commitment from those particular customers to launch, but they have moved into the first half of next calendar year. We're not banking on anything for the any new customer ramps for the December quarter.

Tom Curlin – RBC Capital

And are they giving you – can you at least thematically sort of what the rationale is for deferring?

Jim McCluney

Well, our components went for some substantial storage subsystems. There is usually a lot of moving parts there. OEM launches can be impacted by a number of factors. Technology readiness. These customers are using products that we already have in production, so they're not waiting for us for anything. It's just their readiness to launch. And the March quarter is kind of a traditional thing for both server and storage launches. So I don't think there is anything more dramatic than that happening.

Jeff Benck

Fairly long development cycle. And many times even if a customer is ready at the end of the year, it is not a great time for new product introductions. It is not uncommon to see this kind of movement.

Tom Curlin – RBC Capital

On the adaptor side of the business, I – you mentioned, of course, the issues in the financial sector. My impression, you guys have some very strong share in that sector, but it is probably also fair to say that has been an ongoing issue through the year. Right? You've been absorbing some of that already wouldn't you say in prior quarters?

Jim McCluney

We stopped messaging that even as far away as the March quarter, we started to see some weakness and that's just been rolling into over the last six months or so. So that is something that we're really keeping a very close eye on and actually staying very close to some of the actual end users in that space to look at their processing patterns over the next four to six months.

Tom Curlin – RBC Capital

If your model has essentially been absorbing that issue for at least two, if not three quarters already, right?

Mike Rockenbach

Well, I think it's – perhaps there's some different dynamics going on. As you look at that, when you look at earlier this calendar year, I think what you saw was spending slow down in that sector, and if you look at what's happened over the last couple of months, I think you've got some different dynamics. You have had consolidation which raises the question of what's going to happen to those data centers. So I think we've definitely been absorbing the contraction and the spending as the companies were standalone companies, I think there is potentially different dynamics going on right now adding on top of that slow down in spending in terms of what is going to happen to the existing data centers or potential new centers that we're planning to be built out.

So I think we'll just have to wait and see how that settles out over the next couple of quarters, but the financial sector is only one vertical and there is plenty of other places that don't have those same issues. So I think from an investment standpoint we're looking at doing two things. One is getting as much information and visibility into that financial vertical and what is going on there, as well as looking at opportunities outside of that vertical for us to grow our business.

Tom Curlin – RBC Capital

And now just final topic for the 8Gb. Can you give us a – maybe you did and I missed it, but the percent of the adaptor unit mix, I guess, that was 8Gb. And also how – where do you see the cross-over points for 8Gb right now, just thinking about adoption scenarios? When do you think we might get to a 50% mix?

Mike Rockenbach

We didn't actually give that number out, Tom, but it was single-digits in terms of volumes for this quarter. It is still pretty early stage.

Jim McCluney

Yes, I think it was looked out before. I think we saw a kind of normal kind of relatively slow ramp year. I think some of the economic dynamics may slow down a little bit further because there is a premium on the transceiver costs. So kind of some of our modeling shows that we don't expect to be much more than 15% or so by next summer. So the good news is that we're ready to move when OEMs are, all the calls are still ongoing, and the prep outages that is there. I think what we might see is particularly with the blade service, when they decide to transition, you could see a more rapid ramp there because the back plains and infrastructures are all available to them. And there is obviously no obstacle in pipe there.

Tom Curlin – RBC Capital

And do you think – and sorry, let me tuck one more in. Do you think the blade servers then are probably still three, four quarters away, middle of next year, as you mentioned, or –

Jeff Benck

Not from introduction, but I think he was talking about when you might have material impact on the transition.

Tom Curlin – RBC Capital

Okay.

Jeff Benck

But they're not in market today, so we expect that that's next up to move to 8Gb.

Tom Curlin – RBC Capital

Okay. Thank you.

Jim McCluney

You're welcome.

Operator

And there are no further questions at this time. Mr. Rockenbach, I'll turn the call back over to you for closing remarks.

Mike Rockenbach

Okay. We just want to thank everybody for your participation in Emulex first quarter 2009 conference call. Let me note that Emulex will be attending the following conferences: on December 4th, we'll be at the JPMorgan conference in New York and on December 9th, we'll be at the Barclays Capital Technology conference in San Francisco. Hope we will be able to see you at one or both of these events. Thanks again for joining us on the call and have a good evening.

Operator

And again ladies and gentlemen, that does conclude today's conference. Thank you for your participation and have a wonderful day.

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