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Executives

Jean Hu – Senior Vice President and Chief Financial Officer

Analysts

Vlad Rom – Credit Suisse Securities

QLogic Corporation (QLGC) Credit Suisse Technology Conference Call November 28, 2012 5:00 PM ET

Vlad Rom – Credit Suisse Securities

My name is Vlad Rom from Credit Suisse IT Hardware. I have the pleasure of welcoming Jean Hu, CFO of QLogic, and Doug Naylor, VP of Finance. I’ll start off with a few questions and then open it up to the audience, so feel free to chime in. Jean, for those not familiar with QLogic’s story, can you talk about your products and end markets that you serve?

Jean Hu

Okay, thank you for inviting us and thank you for joining us this afternoon. So QLogic, we provide high-performance interconnect solutions for data center. We are the market leader in the high-performance interconnect data center in space. If you look at it today, there is tremendous explosion of data. All the data we created that needed to be processed transmitted to start, and everything needs to go through the interconnect. So there is a tremendous need for I/O performance. What we do is today we’ll provide the Fibre Channel I/O solutions, which is 8 gig, but it’s going to 16 gig and the 32 gig.

On the 10 gig Ethernet side, we provide solution today and that is going to go through the 40 gig. We also provide Fibre Channel over Ethernet solutions. We also have the networking side, the Fibre Channel Switch and the Fibre Channel over Ethernet Switch. And not long ago in September, we also announced a new technology, an exciting one, the Mt. Rainier technology, which combined our high performance adapters with flash technology to do the server-side caching cluster to caching actually, so that’s also a new segment we are getting into adjacent market.

So overall as a company, we have delivered a very consistent financial performance in the past. Our customers are major OEMs, very OEM-centric model. We are very committed on delivering shareholder value. So we have bought back $1.8 billion using cash to buyback the stock for the history of the company. So overall, we’re very excited about the future opportunity. We think the growth opportunity for us between the 10 gig Ethernet market and the flash market we are going to address using our high-performance adapter technology is going to be $3.4 billion in fiscal 2016. So it’s very exciting time for us.

Vlad Rom – Credit Suisse Securities

I think a lot of investors are trying to figure out what the macro is filling. Can you tell us what you are seeing in terms of end market demand and the kind of conversations you are having, what the people as they said 2013 end demand forecasts?

Jean Hu

Yeah, so we’re like a component supplier, right. So our customers are the major OEMs. To a certain degree, the OEMs when they need our product, they ticked out from our hub. So we are less connected with the end market. But I think everybody has seen all the earnings release from some of our major customers and from big companies like Intel, like ourselves that we see the same thing is certainly we do see the macro uncertainty and the environment are impacting the data center spending. So people are very cautious, especially the big enterprise as they tend to be more sensitive to the macro uncertainty. So that continued to be the case. I think what we have seen is just cautious about 2013.

But I think for us, I just want to add is we do have some new product cycle coming out in 2013, not only the 10-gig Ethernet aside, but also we have again a lot of a design wins on the targeted side, which a new market for us and also the Mt. Rainier Technology, which we are on track for the product announcement next year, which we will see revenue next year. So the product cycles, which hopefully we can continue to grow the revenue.

Vlad Rom – Credit Suisse Securities

Can you talk about those two revenue opportunities and how you see them coming on line? On the target side, PMC Sierra is exiting that business, so that opens up a little bit market opportunity, I think they have 70% share on that side. And then maybe after that, can you talk about Mt. Rainier, SSDs are growing very quickly. They’re being adopted very quickly in enterprise. You have a good footprint there and kind of how you see the traction there and where they potentially need to grow revenues?

Jean Hu

Yeah. So, on the targeted side, this is on the front set of storage area. Traditionally, PMC has been a major player in that market. But one technology transition to 16-gig in Fibre Channel side, we have not invested in the next-generation technology. So it’s opened the market for both QLogic and Emulex.

We have worked really hard during the past year. We’ve got a lot of a design wins that we talked about during our Analyst Day. Those market a little bit of different in the sense the design cycle is longer. You need to work with each storage OEMs to make sure the software, everything works.

The cycle is long, but it’s very sticky business once you get into it. Different OEMs all started their platform at the different time. We do start to think the early next year, we will start to see some of the platforms start to ramp up, over the years it’s going to continue to go; so overall market actually is quite big. We estimated about $160 million in fiscal 2015 our time. And we hope we can get a majority over the share.

Vlad Rom – Credit Suisse Securities

How do you think about the sequencing of revenue ramp in that in just terms of next year coming online and what you see that ladder looking like?

Jean Hu

Yeah, I think the different OEMs they introduced different platforms at a different time. Some of them are very aggressive. They probably will push the 16 gig transition much faster. And I think our advantage is really, our solution can do not only the Fibre Channel over Ethernet and the 10 gig Ethernet and offload. So it’s uniquely suitable for this market. I think, the storage customers actually they tend to be a slower adapting new technology compared to the server side. So it will take time. The next 18 months probably is more for the major ramp-up you’ll start to see.

Vlad Rom – Credit Suisse Securities

And then on the Mt. Rainier side, there is a lot of works being done in terms of enterprise and caching assess fees, can you talk about a little bit about your solution there, how you see the market opportunity and the revenue ramp on that side?

Jean Hu

Yeah, so it’s a really exciting new technology we introduced in September. If you look at the Mt. Rainier technology really what we have done is combined our high-performance adapter with flash to address the server-side of caching, but it’s clustered. If you look at it today’s solution, it’s a single server captive and it’s really best on a single server. What we are able to do is address the shared cache cluster application.

As many of you know, the enterprise application, majority of them are shared caching, shared clustered application, so when you can pool the cache and share the cache among different servers that really can accelerate the performance of the database as the critical applications. And so that’s the first thing. It’s the differentiated factor for us.

Secondly, the deployment model for us is very simple. There is no need to change the environment, the network or the storage side. Our adapter is transparent to the system, to the storage, and all the operating systems too. We have the single driver. Right now at today’s deployment, they have different drivers they have to use. But for us it’s our QLogic adapter driver with additional software that can handle the caching, manage the SSD and managing the networking side.

Overall, it’s a very exciting new technology. We haven’t seen anybody has that. We got tremendous interest with the Tier 1 both storage and the server OEMs. And also we got interest from Web 2.0 companies, cloud, and even the ODMs. So right now we are really in the stage of engaging with customers, we’re on track to announce our product early next year. So typically for us when we announce our product then you will start to see revenue going forward. So we are quite excited about that.

Vlad Rom – Credit Suisse Securities

So do you think that, is it start to becoming material in mid 2013?

Jean Hu

I think we’ll start to see revenue starting summer of 2013 and the ramp up. The market opportunity we estimate, it will be easily $500 million in 2015. And then the question is really, how we can ramp up the revenue get the traction from the marketplace.

Vlad Rom – Credit Suisse Securities

Have there been kind of design products specifically for that or you’re on your way to that with Mt. Rainier?

Jean Hu

We have not announced anything.

Vlad Rom – Credit Suisse Securities

Okay. There’s been a lot talk about kind of the adapter side, what’s going on in the server side? But can you talk about the opportunity in terms of FCoE and the switching side there?

Jean Hu

Okay. So we typically have not talked a lot about our networking business on the switching side. So our strategy in the switching side has always been we’ll work with OEMs leverage our Fibre Channel and the Fibre Channel over Ethernet switching technology and IP to enable our OEMs to compete with Cisco and Brocade. That strategy is really working. We have all the major design wins with the top OEMs. Some of them we announced like HP, IBM and some of them we have announced. But those are major OEMs that we also like Huawei in China; we have a major engagement with them.

So all those attractions really when you think about overall data center space, they converge the network in the next several years, it’s going to grow significantly. I think from a certain perspective Cisco is really driving through there. You’ll see as effort I think HP, IBM and other Dells that they are all really trying to compete in this market. We’re quite excited about our design win opportunities and I think right now it’s really later next year, we actually going to see some of the design wins. We’ve been working for a while. We’ll start to see revenue too. So that’s really exciting.

Vlad Rom – Credit Suisse Securities

Just kind of going to back to that’s kind of the server vendors, it seems like the white box guys and non-traditional server vendors are getting increasing traction in the market. Can you talk about the work that you’ve done there in terms of diversifying your customer base?

Jean Hu

Yeah, that’s a very good question. If you look at the server vendor market, the landscape has really changed quickly. I think traditionally, you really have the major OEMs that we know they come for like majority of the market. Today, the dynamics is so different. You will have all the Web 2.0 company. Some of them can buy 250,000 servers a year, which like a small OEM. And Intel also commented on that, it’s really the structure has changed it dramatically.

So those Web 2.0 companies, they typically don’t go to the big OEMs to buy their servers. They tend to design their own. They go to Taiwan. The white box makers like Quanta withdraw, and they will make it for them. So you do see that market, a lot of people estimate, it’s probably close to 2 million units each year, so it’s quite tremendous. And the other thing we have seen is really is to Cisco, say Cisco coming up, you see Lenovo and a lot of China emerging OEMs, they are getting more and more market share and squeeze the top players, the traditional players.

So I think the landscape will continue to change. For us, we have been working with all those emerging OEMs for a while. They are very important to customers, for us. We do see their revenue start to increase, and on the Taiwan ODM side, we are actively engaged with them, and also the Web 2.0 companies. So the model has changed certainly, and we have been adapting our model to change to that change to capture the other piece of this market and not just as a traditional OEM.

Vlad Rom – Credit Suisse Securities

There has been a lot of data on this. How are you thinking about Fibre Channel growth over time and what are the factors that you kind of input to get your estimates in terms of assumptions?

Jean Hu

Yeah, so Fibre Channel market, I think we got asked this question most. If you look at a Fibre Channel market, we have always said, it’s the mature market. The technology has been around for quite a while. It’s mature, but our view has always been the Fibre Channel technology continued to be the choice for critical applications and infrastructure.

So if you look at in today’s market, the explosion of the data certainly, you have all the social media, all the music sharing, photo sharing, those are tremendous and day to day in structure data, those are growing significantly. But if you look at the volume over the critical application data, those also grow. So people continue to choose Fibre Channel technology as the choice.

So overall, if you look at our Fibre Channel adapter shipment 2009, 2010, 2011, each year it has actually gone up. And so this year certainly, it’s more cyclical from our view is the macroeconomic uncertainty does impact the overall IT spending, especially the high-end big enterprises like they use Fibre Channel technology, so that gets impacted. But what we think going forward is continue to be a flat market, it’s a mature market, flat maybe down a little bit for next several years, so that’s our view.

And we continue to talk to other customers and we get the same feedback. It’s tremendous that they deployed. If you look at this year, it’s estimated the overall Fibre Channel storage system side of spending is going to be $10 billion. It’s still like a 60% of the overall storage spend. So it continued to be a tremendous technology and if you look at past 20 years, it’s estimated, there is $100 billion invested in the infrastructure. So we do believe the longevity of Fibre Channel, but we know it’s a mature technology.

Vlad Rom – Credit Suisse Securities

It seems like server networking is getting a lot more diverse. There is 1-gig E, 10-gig E, Fibre Channel FCoE. Do you think that sets the stage for more modular LOM? How do you see that market evolving?

Jean Hu

Yeah, that’s very, very good point. Actually, it already happened, if you look at the Romley server cycle, we talked about it before is all the major OEMs they actually adopted modular LOM approach. It’s exactly the point you are saying is, it’s the flexibility, because the application in the data center, it’s very diverse where you have a 1-gig, you have a 10-gig, you have a Fibre Channel over Ethernet, you have a brand preference and the customers and also you have low latency Ethernet different flavor of things to really address different applications in data center that really is exactly the point.

It’s modular delta card kind of form factor. So people can have the flexibility to choose the different technology they need. Actually, it’s always the QLogic’s view about that delta card approach and we have been stick with that and I think this trend actually is going to benefit the QLogic tremendously going forward.

Vlad Rom – Credit Suisse Securities

How do you think it benefits the company, because there is an argument to be made that it potentially puts the onus more on the end customer to choose their solution. It’s less default, but there are kind of make you go out in the field more and talk to customers directly or how do you see that?

Jean Hu

Yeah, good question. So first if you look at a QLogic brand in data center, we have established a very strong loyalty for the quality of our products and the brand, so we actually like that. If you ask the customers, they have been using QLogic I/O in their data center, so if you ask them to choose, they tend to choose us. So that’s really the good thing for QLogic. But on the customer side you are right, what we have found out is during the last 12 or 18 months is, we need more and more engagement directly with end customers.

In the past, we tend to just relay on major OEMs, but today what we found out, we literally have separated this sales and marketing team right now just focus on end customers talking to them, trying to find out what they need and also establish more brand recognition over the end customer space, that’s absolutely what we are doing. We have been doing that for the past 12 months and so exactly today’s market how it’s evolving.

Vlad Rom – Credit Suisse Securities

Is there any question from the audience? One of the things that you’ve done very well is returning cash to shareholders over time for share repurchases. The near-term there is some revenue headwind that restrict that ability and kind of how do you think about returning cash to shareholders and repurchases?

Jean Hu

Yeah, as a company we are very committed to return cash to shareholders. As I said earlier, we already returned $1.8 billion cash. And during the last five years we returned $1 billion cash back to shareholders. So one thing about QLogic’s model is, if you look at our model, we generated tremendous cash. Even during the last quarter, we had the revenue overall headwind and we generated $30 million free cash flow. I think during the past what we have been doing is use largely all our free cash flow to do the buyback.

I think it’s a major limitation for us actually is the offshore cash. If you look at our cash, we have a close to $490 million cash last quarter, but 80% is offshore. So that’s a major limitation. I think if you go back to the capital allocation strategy, the first thing we always want to do is try to find the organic M&A opportunities for investment. If we don’t find that opportunity certainly, we’ll continue to return the cash to shareholders then we’ll try to figure out this offshore, onshore cash challenge, every type company is facing today.

Vlad Rom – Credit Suisse Securities

One of the areas that investors are trying to figure out is how FCoE ramps from here. How do you see the ocean of that technology, does it propagate through the data center and how do you see the Fibre Channel FCoE mix working out over time?

Jean Hu

Yeah, so FCoE as a technology, adoption has been much lower than everybody thought and even than we expected. Frankly we thought it will be much faster. When you look at the dynamics of why it has been so slow, there are so many factors, right? Certainly one of the technical reason people talk about is, on a switching side. The Fibre Channel protocol can do the medical hub. So you can go through the medical hub on the switch side, but FCoE is still the single hub. If you still need a switch wonders to get together, they act together that’s certainly from technical side that’s one of the things.

Secondly, 10-gig Ethernet adoption is still very slow today, much slower to almost anticipated. You certainly need a 10-gig Ethernet to convert with 8-gig or 16-gig of Fibre Channel. Economies are weak. A lot of people will push out to this kind of a converged solution. And the other thing is frankly, it’s organizational, inside each big enterprise, if you look at the big companies, their storage area network and networking actually is a two separate organization. Sometimes they don’t even talk to each other, so when you talk about a converge, who is going to converge with whom kind of question.

So it’s quite complicated. But as a company we continue to believe in a converged network. If you think about the concept, the fundamental economic driver of converged network is eventually you need to simplify the network, then you will save the money on the network side, on the management side, don’t need a two team eventually, so economic benefit is certainly there. And in the longer-term, it’s going to happen. It just take a little bit of longer like all the other technology I guess adoption…

Vlad Rom – Credit Suisse Securities

Yeah.

Jean Hu

It’s longer than people think, but it will happen.

Vlad Rom – Credit Suisse Securities

I think that’s it for time. If you care to join us, we’re going to be in room one for a breakout session. Thank you.

Question-and-Answer Session

[No Q&A session for this event]

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