Emulex's CEO Discusses F2Q 2013 Results - Earnings Call Transcript

| About: Emulex Corporation (ELX)

Emulex Corp. (NYSE:ELX)

F2Q 2013 Earnings Call

January 31, 2013 05:00 pm ET

Executives

Jim McCluney – Chief Executive Officer

Jeff Benck – President & Chief Operating Officer

Mike Rockenbach – Executive Vice President & Chief Financial Officer

Analysts

Aaron Rakers – Stifel Nicolaus

Harsh Kumar – Stephens

Amit Daryanani – RBC Capital Markets

Vlad Rom – Credit Suisse

Mark Moskowitz – JP Morgan

Andrew Nowinski – Piper Jaffray

Paul Mansky – Cantor Fitzgerald

Bill Shope – Goldman Sachs

Glenn Hanus – Needham & Co.

Srini Nanduri – SUMMIT Research

[Yoon Pak] – BMO Capital Markets

Operator

Good day and welcome to the Emulex Corporation’s F2Q 2013 Earnings Release Conference Call. This call is being recorded. At this time for opening remarks and introductions I would like to turn the call over to the Chief Executive Officer Mr. Jim McCluney. Please go ahead, sir.

Jim McCluney

Thanks, Operator. Good afternoon, everybody, and welcome to Emulex’s F2Q 2013 Conference Call. I’m Jim McCluney, CEO of the company, and with me today are Jeff Benck, our President and COO, and Mike Rockenbach, our CFO. Mike will start off with prepared remarks for our F2Q results; I will follow Mike with my comments on the business climate, and then Jeff will provide more color on the results for the quarter and our key initiatives for the second half of F2013. I’ll close off my prepared remarks with some summary comments and observations, and then we’ll open the line for questions. Over to you, Mike.

Mike Rockenbach

Thanks, Jim. By now you should have Emulex’s F2Q 2013 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 and this presentation contain forward-looking statements including but without limitation statements regarding Emulex’s business, operations, ongoing patent litigation and related mitigation efforts, the announced intention to acquire IndUS and the anticipated financial results for our F3Q 2013 and beyond.

These statements are subject to a number of risks and uncertainties and our actual results may differ materially from those discussed in the forward-looking statements. Those risks and uncertainties are highlighted in our earnings release and under the heading “Risk Factors” in Emulex’s most recent Annual Report on Form 10(k) and Quarterly Reports on Form 10(q). We undertake no obligation to update the forward-looking statements.

During the call when we use any historical non-GAAP financial measure you will find the reconciliation to the most directly comparable GAAP financial measure in our earnings release and all of the references we will make today related to our non-GAAP results unless stated otherwise.

Today’s conference call is being webcast and a recording will be made available on the Emulex website through January, 2014. I would also like to remind participants that 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.

Now let me review our results for the quarter. Sales for our F2Q came in at $122 million which was at the midpoint of our guidance of $120 million to $124 million provided on our earnings call in October. Net revenues for the quarter increased 2% sequentially but declined 5% year-over-year primarily due to lower revenues in our storage connectivity products. Diluted earnings per share of $0.19 was within our guidance of $0.19 to $0.21 that was provided on our last earnings call.

Taking a look at revenues by product line, our network connectivity products or NCP represented 79% of our net revenues this quarter. The NCP product line consists of fiber channel and Ethernet products that are used to connect servers and storage arrays to a fiber channel storage area network or to an Ethernet network.

NCP revenues totaled $96 million which is down slightly from the $97 million reported both in F1Q and the comparable quarter the prior year. Another strong quarter in both our fiber channel and 10GB adapter channels was offset by weaker than expected revenues from 10GB LOMs. Jim and Jeff will provide some more color on our NCP revenues in a few minutes.

Net revenues for our storage connectivity products, or SCPs, totaled $23 million accounting for 18% of revenues for the quarter. SCP revenues increased over 20% sequentially but were down 18% from F2Q last year. As a reminder, we are modeling for SCP revenues to be in the $80 million to $85 million range for the full fiscal year. Net revenues for our Advanced Technology and other products were $3 million.

F2Q gross margins improved on both a sequential and year-over-year basis, coming in at 64% of revenues. We expect gross margins to remain in the 63% to 64% range for the remainder of the fiscal year. Total operating expenses for the quarter came in at $58 million or 47% of revenues, an increase of approximately $3 million over F1Q and $1 million compared to F2Q last year.

We are tracking to meet our spending goal of OPEX under 50% of revenue for the year. For the March quarter, payroll tax matching starts over again which increases our spending by approximately $2 million. Patent litigation expenses were well under $1 million in F2Q, and looking forward we expect quarterly patent litigation expenses will be in the $1 million to $2 million range for the remainder of the fiscal year. Outside of the increase in payroll tax matching and litigation expenses we’re modeling for our ongoing operating expenses to be down sequentially in the March quarter.

Operating income for the quarter was $20 million or 17% of revenue and F2Q net income came in at $17 million or 14% of revenues. Our tax rate for F2Q was 15% compared to the 13% in our model. The higher tax rate was driven by the geographical mix of revenues in the quarter. Looking forward, with the recent reinstatement of the federal R&D tax credit we’re modeling for a quarterly tax rate of approximately 8% in the second half of the fiscal year. This tax rate does not include a one-time benefit in F3Q related to the retroactive portion of the credit.

On a GAAP basis, F2Q gross margins were 59% of net revenues and GAAP operating expenses for the quarter totaled $67 million or 55% of revenues. GAAP operating expenses included $1.0 million related to the patent litigation efforts, $1.4 million of amortization of intangibles, $5.0 million of equity-based compensation charges and $2.0 million of expense related to the pending IndUS acquisition. These charges are excluded from our non-GAAP results. GAAP operating income for the quarter was $4 million and GAAP net income for the quarter was $6 million or 5% of revenues. Finally, we improved our balance sheet during the quarter, exiting December with $211 million in cash and investments.

Before I discuss our targets for F3Q 2013 I want to again remind everyone that our public filings with the SEC and our Safe Harbor statement included in our press release discuss the risks that can affect our future performance causing actual results to differ materially from forward-looking statements.

Based on the current operating environment and the recent forecasts from our customers, we’re modeling for revenues of $110 million to $114 million on a standalone basis for our F3Q ending March 31, 2013. Once we complete the pending IndUS acquisition we will update you on our business going forward, including an updated financial model for the combined companies. We anticipate non-GAAP diluted earnings per share in the range of $0.12 to $0.14 for F3Q. Over and above this guidance we expect to see an incremental $0.06 EPS benefit related to the retroactive portion of the federal R&D tax credit and this will be a one-time benefit to our F3Q results.

On a GAAP basis we expect a loss per share of $0.10 to $0.12. Our F3Q GAAP results will include approximately a $0.30 impact from stock-based compensation, amortization of intangibles, costs associated with the pending IndUS acquisition, and the royalties, mitigation expenses and license fees associated with the patent litigation as well as the associated tax impact and US valuation allowance. Now let me turn the call over to Jim.

Jim McCluney

Thanks, Mike. I’m pleased to report another quarter of strong results in line with what we guided, despite continuing weakness in IT spending. We knew that there were a lot of economic uncertainties going into the December quarter but we called it right. Even in a tough spending environment solid execution drives positive results as we demonstrated. I’m also particularly pleased with our strong balance sheet, exiting with over $211 million in cash and investments.

While IT spending growth remains muted, the broader economic environment looks to have somewhat stabilized. However, there are still pockets of instability in the market, but when looking at our March quarter guidance we’ve allowed for normal seasonality in our fiber channel business and some residual burn off of 10GB LOM inventories. However, 10GB should grow sequentially. The June quarter should also have normal seasonality.

It is encouraging that the outlook for IT spending for the full year looks promising. Recently I saw a report from Gartner that projects worldwide IT spending for 2013 to grow more than 4% over 2012 levels. IDC concurs with these estimates and also is projecting that the year-over-year growth in worldwide enterprise storage spending by end users will be above the overall market with close to a 7% increase.

On our last call we highlighted strength in our fiber channel business during the summer quarter and we finished the year with our board-level products growing nearly 10% sequentially. The final numbers won’t be out for a few weeks but based on the reported results from our nearest competitor I’m confident we gained market share for the third consecutive quarter. Our share gains are being driven primarily by 8GB deployments and we fully expect the share gain momentum to continue with the transition to 16GB over the coming year.

Coming to Ethernet, the rate of adoption of 10GB converged networking remains below industry expectations and is clearly slower than we would have liked. Also for Emulex we have our own short-term headwinds with constraints on winning new customers in the US market due to the court injunction. And additionally we saw a sequential decrease in our 10GB LOM revenues as our OEM customers brought down inventories during the quarter.

Despite all this, on the plus side revenues from our board-level 10GB business did quite well, showing more than 10% growth year-over-year with particular strength in FCoE; and our full-year revenues for 10GB grew over 50% in 2012. We expect the [AMOS] reports will show that we held our market share in 10GB for the last calendar year.

Looking ahead, we’re driving to complete the ASIC redesign and qualification work. I also want to highlight that amendments to the injunction are in place to ensure continuity of supply beyond the sunset period, as major OEMs re-qualify the redesigned products. Getting back into the US market for new customers will be a huge lift to our prospects and we expect to get the growth engine in 10GB revenues moving again in calendar 2013.

Ethernet is at the core of datacenter networking and we continue to see opportunities to enhance our relevance in this important market. In that regard, there are two additional key areas of focus for Emulex over the next year. First, we are driving the second phase of our convergence strategy to go after the high-performance compute market with the introduction of RDMA over Ethernet in our next-generation 10GB and 40GB products.

Second, as Mike mentioned, we expect to complete the acquisition of IndUS during the March quarter. IndUS is a market leader in intelligent network visibility, guaranteeing 100% packet capture and recording. They provide IT operations with the network visibility required to maximize high-speed network performance. This acquisition will double our total addressable market and will provide an additional growth engine for Emulex. When the transaction is closed we’ll provide more information to you for modeling purposes.

So with that let me pass it over to Jeff for some more color on the quarter and a look at some of the key initiatives we are focusing on for 2013. Over to you, Jeff.

Jeff Benck

Thanks, Jim. Today I’d like to focus on three topics. First I’ll provide some more insight into our fiber channel business. Then I’ll spend some time on the customer feedback we’ve received on our updated converged networking strategy that we’ve been evangelizing with the market. Finally, I’ll close out with some comments on how our pending acquisition of IndUS strengthens our Ethernet strategy.

So let me kick off with a deeper look at the state of our fiber channel business. Exploiting our time to market advantage in 16GB over the past couple of quarters, we have launched a number of new products with our OEMs including Dell, EMC, HP, IBM, and NetApp.

For example, this quarter we expanded our offerings with Dell to include our 16GB Blade solutions for PowerEdge servers to provide end-to-end connectivity for server virtualization, cloud initiatives, and Flash-based storage systems. In addition we have forged tight partnerships with EMC and Fusion-IO marrying our 16GB fiber channel with their SSD technologies.

Del’Oro’s most recent research report reflected that we gained more than seven points of share over our nearest competitor during the first nine months of 2012. Now that the results have been announced for this quarter we know we gained market share again. Clearly, these two data points demonstrate that Emulex will gain fiber channel share for the third year in a row, contrary to recent statements made by our closest competitor.

And 2013 looks even better, driven by the 16GB transition which is just now getting underway. With a growing number of customers now shipping our 16GB offerings ahead of the competition we are well positioned to take advantage of the large number of 16GB-ready switchboards that are already installed in datacenters. We look forward to riding the strong momentum of this core business through 2013.

Now let me move on to my second topic, our Ethernet growth strategy. While we enjoy a strong 10GB Ethernet business as the number two provider in terms of revenue, we believe there’s a lot of room for further growth as we’re still in the early stages of 10GB adoption across the server landscape. In order to help drive adoption we have been developing solution bundles with switch partners that provide a 10GB reference architecture ready for deployment.

A good example of these partnerships is our recent announcement with NRTL where we announced the partnership of our OneConnect Network Acceleration Adapters and FastStack Software. NRTL is a provider of high-speed 10GB and 40GB Ethernet switches that are purpose-built for high performance compute environments and in combination with our OCe12000 adapters, network latency can be cut in half, unlocking faster transactional performance. Add to this 10GB Ethernet opportunity our ability in 2013 to start realizing the benefit of our multi-year investments in leading edge 40GB converged networking solutions, including the addition of RDMA and other contemporary features, and we’re obviously very excited about our prospects.

Customer feedback on our high-performance 40GB Ethernet solution with RDMA strategy has been very positive, as customers are gravitating to RoCE instead of iWARP and see RoCE as an alternative to the sole-sourced InfiniBand market. This coupled with our low latency architecture, FCoE hardware offload and virtualization accelerators provide us a distinct advantage in the high-performance networking market.

As we spend more time with customers deploying high-speed networks, we have seen the need for tools to not only help make these connections but also provide the ability to monitor these same high-performance networks and ensure quality of service. It’s the opportunity to provide solutions for the whole connectivity lifecycle that led us to IndUS.

IndUS is redefining network performance management with a hardware-accelerated approach to provide industry-leading network visibility beyond the reach of software-only solutions. Server virtualization, network convergence, and the migration from physical to virtual networks are three key trends in IT that are driving the importance of I/O in the datacenter. Running multiple protocols adds a level of complexity that requires tools that haven’t previously been available.

As customers move to the cloud and no longer control their compute resources, having the ability to measure performance, ensure quality of experience and guarantee security become opening stakes. Traditional NPM tools fail in network performance to provide alerts when network performance degrades. But IndUS provides the capability to record and analyze 100% of the traffic patterns across the entire network at speeds up to 100GB.

Together we will provide true end-to-end connectivity, monitoring, and management, and we are uniquely positioned for the next phase of the NPM market that we are calling network visibility management. Over the past few weeks the IndUS and Emulex teams have been working together on integration plans to ensure that the transition is seamless, and I look forward to giving you further updates on our progress over the coming quarters.

Now let me turn the call back over to Jim for some closing comments.

Jim McCluney

Okay, thanks Jeff. Before we take your questions let me leave you with a few closing thoughts. First of all, the demise of the fiber channel market continues to be greatly exaggerated. Customers are still buying; we are gaining market share and the 16GB transition will be very good for us. Despite headwinds we believe we held our market share in 10GB for 2012 and we look forward to getting back into the US market to pursue new 10GB customers in fast-growing segments.

We continue to expand our market reach to high-growth areas with our pending acquisition of IndUS which will double our addressable market. So all in all I’m feeling very bullish about the company’s prospects as we manage our way through the next few quarters. So with that I’ll open the line for your questions. Operator?

Question-and-Answer Session

Operator

Thank you. (Operator instructions.) And we’ll go first to Aaron Rakers with Stifel Nicolaus.

Aaron Rakers – Stifel Nicolaus

Yeah, thanks guys for taking the questions – a couple real quick. First of all, can you give me the contribution of the 10GB solutions in the quarter?

Jeff Benck

We don’t specifically break it out but we can kind of give you directionally that we were down sequentially as we talked about due to some inventory burn on the LOM part of the business. Maybe to give you a little better perspective, for our full year basis for 2012 we saw that business grow about 30% year-to-year.

Aaron Rakers – Stifel Nicolaus

Okay. And when I look at your OEM business it looks like it grew about 1% on a sequential basis. Over the last three years it’s grown, obviously well north of that – I t think actually up into the high teens. Can you talk a little bit about your OEM customers there? Obviously you talked about a 10GB burn off of inventory. Is there something going on at either of your two big OEMs that caused the disconnect on what would historically have been a much higher sequential growth rate?

Jim McCluney

Well, I think as we pointed out on the last call when we gave our guidance, we saw some general weakness in the market. As it comes out we have this inventory burn off in 10GB and also SCP came in a little bit stronger than we’d anticipated, but by and large it was kind of in line with where we thought. Obviously we knew some of the micro things we’re seeing, for instance 10GB Ethernet, some pockets of quite substantial growth there particularly in the Web 2.0 and cloud arenas which have a different supply chain and go to market models than the traditional OEMs. So I think that’s kind of impacting how servers are procured and the I/O behind them. So there may be some micro things as well. Jeff, I don’t know if you’ve any other comments related to that?

Jeff Benck

No, I think in general I guess we’ve seen the OEMs, some of the large OEMs maybe have given up a little bit of share to other server vendors. We’ve seen growth with the local Chinese OEMs that has grown more significantly. But I think Jim’s comments were kind of spot on.

Aaron Rakers – Stifel Nicolaus

Okay, thank you.

Operator

And we’ll go next to Harsh Kumar with Stephens.

Harsh Kumar – Stephens

Hey Jim, I think if I heard you correctly I think you mentioned that activity was up or you’re seeing signs of increased activity going forward, but you’re still choosing to kind of guide to standard seasonality. I’m trying to make some sense out of that guidance relative to your commentary. I’m curious if you can help me understand if you’re leaving room or if there’s something else going on outside of the LOM burn off?

Jeff Benck

Yeah, let me start and then if Jim wants to add anything. So I think what we’re seeing, and I think the point we’re trying to make is the overall prospects for the full year 2013 look good. It’s stabilized in the front half of the year relative to where, I think if you were looking at expectations back in the September timeframe the outlook was much more at least uncertain in terms of where spending was going. So I think the point we’re trying to make is hey, it looks stabile in the front part of the year. With the exception of the LOMs we see kind of a normal seasonality. For the full year, the forecasts are good but we don’t want to get ahead of ourselves on spending and based on what we see at least over the next quarter we think that’s the right way to look at the business.

Jim McCluney

And candidly our fiber channel business pretty much historically goes down in the March quarter, and it’s not going down any more or less than it has before. And as I mentioned we see 10GB Ethernet growing into the quarter but yeah, we see a little bit of a tail of some continued inventory burn off on the LOM side in particular. So that’s the framework for the guidance.

Harsh Kumar – Stephens

Fair enough, fair enough. And just as a follow-up, your main competitor reported not too long ago and they seemed to indicate that they weren’t seeing – and I don’t expect you to comment for them, but they seemed to indicate that they were not seeing or seeing much better than normal seasonality. I’m curious if you have anything to say about that or any color on your own business?

Jeff Benck

Let me start, this is Jeff. The only comment I’d make on that is we’ve been gaining share against our largest competitor in the one market we compete with them. I think our business over time looks less and less like them as they head in different directions than we do and we participate more fully in the Ethernet space. From a fiber channel performance, we love the way the team has executed and gained share in multiple sequential quarters now in a row.

I would just put an end cap on 2012 frankly where we know we’ve gained for the third year in a row, and we’ll shortly see that get shared by the analysts like Del’Oro in the coming weeks. And I can tell you, we have the highest share in fiber channel we’ve had since 2004 so we’re feeling pretty bullish about that particularly given our lead in 16GB.

The other guys have a product in market but we’ve been much further ahead in qualifications. We’ve announced twice as many products and you’ll see more announcements in the first half. So if the other guys are pointing to fiber channel as strength we’re going to equally see that.

Jim McCluney

I agree with everything Jeff said. Candidly I think they’ve been coming off a pretty low December so it’s an easier compare. And secondly at least I was picking up that the strength was coming in the network products, not necessarily in the I/O side. So we’ll see. We’ll see what happens in March and as Jeff said, I think we’re feeling pretty good about our prospects there. So we’ll take it from there.

Harsh Kumar – Stephens

Fair enough. And my last question and then I’ll get back in queue, is would you care to update us on the chip sort of makeover process that you’ve been working on? We’re getting fairly close to the deadline if you will when you have to have an alternative arrangement in place.

Jim McCluney

Well, as we always say we don’t like to go into specific details for competitive reasons, but needless to say we’re working real hard to hit the OEMs’ transitions. There will all be different plans, and the things I pointed out on the call that there was some amendments to the injunction for an executive insurance policy, if you would, to ensure continuity there because the qualification processes vary from OEM to OEM. But it’s certainly front and center of our focus over the next few months.

Harsh Kumar – Stephens

Fair enough, guys, thank you.

Operator

And we’ll go next to Amit Daryanani with RBC Capital Markets.

Amit Daryanani – RBC Capital Markets

Yep, good afternoon guys, a couple of questions from my side. First, to start with when I look at the guidance down 8%, can you talk about is it reasonable to think that the network connectivity business would be down kind of 5%, 6% which means storage is around 20, 21 in quarterly run rate? And then within that how do you see 10GB Ethernet track on a sequential basis?

Mike Rockenbach

This is Mike; let me take that. So what we see in network connectivity, and I think we talked about it in our prepared remarks. We see normal seasonality in the fiber channel piece of the business. We had another terrific quarter in December, gained a lot of share so pretty typical that we see fiber channel come down kind of in the mid-teens on a sequential basis in the March quarter off of that high number.

We do think there’s maybe $3 million more of LOM inventory that’s going to burn off in March but even after taking that into consideration we expect 10GB to be up sequentially. So yeah, I think we’re pretty close to in line with what we would normally see, and then for the rest of the business kind of SCP and ATP combined, we see that as relatively flat with December, so that’s kind of how we see the quarter shaping up.

Amit Daryanani – RBC Capital Markets

Got it. That’s helpful to get that breakdown. And then if I just look at the 10GB E business and you talked on the inventory issue that you’re going to have to contend with in the March quarter, can you maybe just talk about are you fairly certain it’s a one quarter issue and not a longer correction issue? And then secondly when you talked about how some of the lawsuits especially with Broadcom were impacting the 10GB Ethernet out of the business, can you just get a little bit into it? Are you unable to go after customers at this point or are you seeing existing customers having to deal themselves away from you? Maybe if you can dig into that a little bit that would be helpful.

Jim McCluney

Let me start with your last question and then pass it to Jeff. Obviously one impact of the injunction was we weren’t able to go after any new customers here in the US. That’s [kept us out of] some key growth areas in the US where you know, we know we can compete there and that’s part of us looking forward to getting back into the market once we get our reworked products out and qualified and available. So that has somewhat constrained our ability. The injunction has constrained our ability to compete here in the US. It obviously hasn’t impacted foreign sales there as well, so that’s kind of it in a micro picture. Jeff can pick up the inventory piece.

Jeff Benck

Yeah, you mentioned the one quarter. I think we’d say it’s two quarters, right, because we were impacted in December and then Mike spoke to $3 million in March. When you say “What’s going on there?” – a bit slower adoption of 10GB than sort of anticipated, particularly on the rack systems. I would say we’ve seen that. I think there was some uncertainty during the year due to the injunction that maybe had some effect on buying habits, so we don’t have complete clarity but I think we do have a really good understanding of the inventory situation.

We never kind of like this stuff because it does make our 10GB business a little up and down but overall we feel comfortable where we’re at. I think the sequential growth kind of speaks to the 10GB coming back a bit, and then as you look around going forward at design wins and some of the activity going on, particularly activity in some of the growth markets like China we feel pretty good about the growth prospects for our 10GB businesses.

Jim McCluney

And I think it’s fair to say our [loss] should be behind us in March.

Jeff Benck

Yeah, absolutely.

Amit Daryanani – RBC Capital Markets

I guess just finally a clarification: in the December quarter can you quantify how much was the inventory headwind for you guys? I know you said $3 million in March but can you just give me that number for December as well?

Jeff Benck

Yeah, we think it was approximately $6 milliion.

Amit Daryanani – RBC Capital Markets

Alright, thank you.

Operator

And we’ll go next to Vlad Rom with Credit Suisse.

Vlad Rom – Credit Suisse

Thank you. Jeff, I’m just trying to figure this out and I’m trying to get more clarity on this. I don’t mean to dwell on the topic. I guess the concern is that Intel doesn’t really have a server cycle right now, so if server vendors are basically asked to re-qualify new LOMs on the servers there could potentially be a seam in the June and September quarter (inaudible) on that. Are you saying that that won’t happen and that’s going to be a smooth transition with the new LOM products? Just to follow up on that.

Jeff Benck

Well, of course our intent is to provide redesigned products and help the customers with that transition. We have unique capabilities in the market which is one of the reasons why the OEMs work with us, not that there’s not multiple vendors in the market – there are and we always expected that, but some of the capability around virtualization and some of the performance characteristics are unique to us. And you know, there’s a reason why the OEMs kind of want to drive continuity with us and we’re working really hard to make it easy for them to do that and kind of maintain the position we have.

So it’s a complicated market and there’s a lot of moving parts but as Jim kind of said, there’s been some effort around ensuring that continuity beyond the April timeframe and then we’re working very diligently on the transition to redesign the next-gen products.

Vlad Rom – Credit Suisse

Makes sense. And then I’m just trying to figure out the anatomy of the 16GB cycle because I guess I’m trying to understand how 16GB ramps and 8GB continues because every good cycle has kind of a long tail on the legacy product and then you have a ramp on the new stuff. What do you expect to see on the 8GB versus the 16GB as we kind of head through 2013 and 2014? Thank you.

Jeff Benck

You know, you look at the analysts they say that 16GB will be 30% of actually 2013. I’d say that’s a little bullish, a little more bullish than what we’ve seen but we’re shipping material. Revenue is more than a few million in 16GB already so it’s in the ramp mode, and as we get into 2013 I think each quarter sequentially it’ll grow. I can tell you we’ve got a gaggle of 16GB announcements that we’re going to make in the first half of this year. In fact not the first but one of the larger target customers is going to launch in the first half so we’re going to see that incremental opportunity.

And you know, I would say we won’t be completely through all the OEMs launching both storage and server probably until second half but I think we’ll see good sequential growth. But even if we hit the analysts’ estimate we’d still be 70% 8GB. And it typically takes these transitions two and a half to three years to get to kind of where you’re shipping more of the new product. So I think we see 16GB kind of following along on the same path, but hopefully that gives you at least a sense of how we see it ramping.

Vlad Rom – Credit Suisse

Yep that’s great, thank you.

Operator

And we’ll go next to Mark Moskowitz of JP Morgan.

Mark Moskowitz – JP Morgan

Yes, thanks, good afternoon. I apologize if this has been asked already but I’m just trying to again figure out the 10GB LOM weakness. Was it driven by US-based OEMs versus Chinese-based OEMs or was that a characterization of some other issue with respect to the quarter? And I have a follow-up.

Jeff Benck

No, it wasn’t Chinese-based OEMs – they’re not impacted by the US injunction unless they’re shipping in the US. So we have multinational OEMs that ship around the world, and the folks that have some inventory certainly ship in the US. And they’re some of our larger OEMs, so I hope that answers your question.

Jim McCluney

Yeah, as Jeff mentioned earlier, we think it’s a combination of look at the 10GB ramping slower than anticipated. And of course with chips, you want to have plenty of chips on hand because they’re going down on motherboards and that kind of thing – that and maybe some hedging against the potential of injunction I think is what caused this. So I think it’s a combination of market forces and maybe some specific things.

Jeff Benck

Yeah, the only thing I’d add to that is it is concentrated. It’s not across all OEMs – it’s concentrated. We don’t like to single a customer out, we’re not going to get specific but it’s pretty concentrated, the inventory position that we have here.

Mark Moskowitz – JP Morgan

Okay, and then just as a follow-up to that – I appreciate the color there – in terms of the slower adoption is that based on market dynamics, competitive dynamics? Is it based on maybe you were penetrating certain use cases or service loads and had thought it was going to expand to a broader, more mainstream use case and that’s not playing out yet?

Jeff Benck

I could give you a little color on that. I think Blades are kind of where we expected them to be. Of course you know, Blades had started to go more 10GB even in the last generation of the Intel platforms. I think on the rack side with the opportunity to have these integrated 10GB solutions we kind of anticipated we’d see a much bigger take up there… I’d say the market because I don’t think it’s unique to us, but we’d expect that.

But I will tell you the pricing we see around, the solution is still being priced at a premium and I certainly think that’s having an impact. I also think the switch port pricing is having an impact, maybe to a little lesser extent but switch ports are not coming down as fast as the server ports or the adapter ports that we develop, so that has a bearing on that as well. I don’t think… This is going to solve itself but it’s going to take not only movements in price but just time. As bandwidth needs continue to grow I’m sure we’ll see a natural transition there.

We do think that some of the cloud providers are starting to deploy 10GB. Obviously in the US that’s an upside opportunity going forward because of our restrictions in that market today. They seem very interested in our technology. Obviously we’re looking forward to the new stuff, not what’s currently there because of those restrictions. So you might see pockets of strength there but I would still say it’s pockets; it’s not broad-based everywhere there. But that’s the dynamic we see going on.

Mark Moskowitz – JP Morgan

And then just my last question, bigger picture either for Jim or Jeff: server virtualization benefited from a pretty major investment cycle on the part of a lot of CIOs as they’ve tried to optimize their datacenters over the past three to five years. Obviously we’ve all seen the weakness here at VMware recently; we’ll see how that plays out over the next couple of quarters. But are you seeing any sign, I know it’s tough where you sit but still I’m sure you’re talking to a lot of different folks out there in the field and in the customer base, where maybe there’s starting to be a philosophical shift where they’re going spend more of their IT dollars on other key priorities away from virtualization – maybe away from network storage? They’re still important priorities but maybe they’ve down ticked a couple notches – are you seeing that yet or is that a concern?

Jeff Benck

I think [SAN] connectivity or network storage driven by virtualization was probably the killer app for 8GB and still continues to be a key driver. What’s interesting is we look at 16GB and beyond, just the explosion in growth in storage really has kind of run on unabated whether it’s virtualized or not, so we still see pretty strong demand there. So I think we’re going to have more than one catalyst for faster I/O adoption.

I would also say SSDs and storage arrays are starting to have an impact and we’ve got some of our 16GB customers asking for 16GB because of the latency and the bandwidth capabilities that SSDs are driving. So while we also see some of the VMware slowing down some I think we’ve got enough other things driving demand for us that I/O still seems to be a key focus. And I don’t think, well at least from our analysis we don’t see some long-term secular slowdown based on that. And I think it’s because we see other things that are upsides for us.

Mark Moskowitz – JP Morgan

Thank you.

Operator

And we’ll take our next question from Andrew Nowinski of Piper Jaffray.

Andrew Nowinski – Piper Jaffray

Good afternoon, just a few quick follow-ups. On the inventory burn off, was that related to products that are on the sunset list?

Jim McCluney

Yes.

Andrew Nowinski – Piper Jaffray

And then I guess to ensure continuity of supply I guess are your OEMs, the efforts that you’re doing with your OEMs – would they just license directly from Broadcom and then build up inventory of those products right now?

Jim McCluney

I can’t go into the details of what’s going to be arranged. I think it was more to ensure that all of these qualification cycles are different, and we just said “Why take a risk? Let’s make sure we can keep shipping the qualified products out.”

Andrew Nowinski – Piper Jaffray

Right, so I guess why would they be burning off inventory and not building inventory if they want to assure continuity of supply? I guess that’s what I don’t understand.

Jeff Benck

Well, I think the point is now that we can assure continuity of supply they don’t need to hold the inventory, which is why they’re burning it off.

Andrew Nowinski – Piper Jaffray

Okay, gotcha. And then just last question from me, just a clarification: I think your comment about normal seasonality in the June quarter, was that a total revenue comment?

Jim McCluney

Yeah, that was a revenue comment, yes.

Jeff Benck

Total revenue, yeah.

Andrew Nowinski – Piper Jaffray

Okay, very good. Thank you.

Operator

And we’ll go next to Paul Mansky with Cantor Fitzgerald.

Paul Mansky – Cantor Fitzgerald

Great, thanks for taking the question. Mike, can you quantify for us in aggregate, and I’m not talking about litigation or royalty expense but from a design and qualification perspective, what the re-spend is costing you per quarter at the OPEX line?

Mike Rockenbach

It’s been relatively low over the last quarter or two – I think it’s been around $1 million maybe. The more meaningful piece of the expense is in the next quarter, in March and then in the June quarter as we get back parts and then get through the qual cycles.

Paul Mansky – Cantor Fitzgerald

Okay, alright.

Mike Rockenbach

As you can imagine there’s not a lot of expense on the designing it part – it’s getting the part turned and qual’d.

Paul Mansky – Cantor Fitzgerald

Absolutely, so we can probably think about modeling that back out by certainly September and definitely by the December quarters?

Mike Rockenbach

Yeah.

Paul Mansky – Cantor Fitzgerald

Okay. And then lastly, I could be wrong but I don’t think we’ve heard much about the 16GB in a target side opportunity. I know your primary competitor is suggesting that that looks like a bit of a longer ramp now. Can you give us an update on what you’re thinking about vis-à-vis that market?

Jeff Benck

We think it’s upside for us because while we had target business in 8GB and before we’ve got some incremental design wins. I think we see it pretty similar to our largest competitor although maybe earlier because I did mention that we expect in the next quarter to see, it’ll probably happen at the beginning of next quarter, but one of the larger target customers that we have – that’s incremental business that we will see launch next quarter and we’ve got a number of other design wins in the pipe. And we feel pretty good about that and it’s an area we put explicit focus on even with some of the smaller storage customers, one of which we’ve already launched.

So we haven’t announced it because they’re sensitive to that but we’ve got pretty good momentum here. I heard somebody, one of our competitors characterize it as $160 million – I don’t know where that number comes from. We’ve been thinking of it more in terms of a $100 million kind of opportunity, maybe a little bit bigger. But we certainly see it. We don’t talk about it as much but we’ve been winning in that space.

Paul Mansky – Cantor Fitzgerald

Right, and it seems as though everybody is expecting more than their fair share of that market which seems to be a bit mutually exclusive. As you look at the design wins that you have right now, how would you rank your positioning with respect to that incremental opportunity?

Jeff Benck

I think that it’s really a jump ball between two of us because the guy that had all the business stepped away from that space, and I think us and our largest competitor had a little bit and we’re both going after everything. So I’ll say I feel good about our position. I don’t know if you can call one or two at this point yet because I’ve seen their list of, or what they said about their list of design wins – we’ve got a list that looks very similar. So right now I’d say it’s a jump ball.

Paul Mansky – Cantor Fitzgerald

Okay, great. Thanks for that, I appreciate it.

Mike Rockenbach

Paul, the one thing I wanted to add to the other comments on the mitigation, on the ASIC, is that’s in our GAAP expenses. They’re excluded from our non-GAAP expenses as you think about the model further out.

Operator

And we’ll take our next question from Bill Shope of Goldman Sachs.

Bill Shope – Goldman Sachs

Okay great, thanks guys. I had a question on the IndUS acquisition if I could. Could you remind us of how, now that you’re working on the integration how you’re thinking about the initial go to market strategy but more importantly how that may evolve over time? And since you’ve announced it, what’s the OEM partner response been to the acquisition and is this something you see most of them partnering with you on in the early stages as you come to market with this?

Jeff Benck

Yeah, so our initial thinking on the go to market is we’re not going to screw it up. They have a go to market model that’s well understood and we’re at this point, from a sales go to market we see it as independent. We certainly see synergies across accounts and the account relationships we have but we do not intend to make big wholesale changes to their sales organization. I will say we look at international expansion.

We’re around the world. We just opened if anything our first formal subsidiary in China. We’ve got offices in Shanghai and Beijing and Shenzhen. So we see opportunity to leverage them kind of around the world. We see great opportunities in the US federal government that we think is a good upside. So we see places that we can enhance what they’re doing but right now we’re going to proceed cautiously on that aspect of integration.

But beyond that we’ve already had discussions with the team on what are some joint opportunities because we do make these connections. We own 30% of the 10GB ports for example that are out there. We’ve also identified this need for the monitor capability and it gives us kind of an end-to-end from an I/O lifecycle and we feel pretty good about the opportunity to get those together.

Your question on OEM interest: our traditional OEMs that we sell to, you can imagine a lot of them don’t offer these solutions exactly the same. When we think about OEM expansion we think that there’s guys in the network performance management space that could leverage our hardware and software platform and build analytics and solutions on top of it. So nontraditional when we think of OEM – it’s not necessarily the Hewlett Packard’s and IBM’s and folks like that that we’ll go to.

They’ve been supportive; I mean certainly we’ve briefed them all on what we’re doing here. I don’t think there’s been a lot of concern but I also don’t think they see it necessarily, you know, it would not be selling it necessarily to the same OEM customer because we sell the server and storage guys. It might be their security division in that organization and we’ll certainly have more of those discussions once we can complete the acquisition.

Jim McCluney

One of the key channels that will also open up here in the United States for the IndUS product is the government vertical. Once they become a US-registered company there’s a lot of opportunity for this kind of technology in the US government and they really haven’t had the broadest access there. They enjoy a lot of good government business overseas so there’s a few verticals there that we’ll go after but there’s still, to Jeff’s point, a lot of end user touch and a great team to do that.

Bill Shope – Goldman Sachs

Okay, great. And then my final question, more of a high level question on the operating environment. In the context of seeing more stability which I think we’re hearing from other companies as well, in the areas where you still have some pockets of weakness can you give us some color on how you’re thinking about that and particularly the swing factors you’re most focused on for the revenue guidance in the current quarter?

Mike Rockenbach

Yeah, let me take that. I think you were talking about in the prepared remarks where we said there’s still pockets of weakness – that as on the broader IT market just based on some of the recent announcements from other companies. That wasn’t related to us. In fact, we see our business stabile so that wasn’t meant as a comment that we’re seeing pockets of weakness in our business.

Jeff Benck

I think we’re seeing also folks that are maybe in tangential markets that are announcing significant changes to their business and their model. So some of it is just a reference to some of that confuses us, because we’re not seeing the same dynamics but we do certainly see these pockets of, as Mike said, weakness in the market.

Bill Shope – Goldman Sachs

Okay, that helps. Thank you.

Operator

And we’ll go next to Glenn Hanus of Needham.

Glenn Hanus – Needham & Co.

Hi, just to clarify, the total fiber channel business in the December quarter you said was up 10% quarter-on-quarter?

Mike Rockenbach

I think that was our board-level products on fiber channel and 10GB combined.

Glenn Hanus – Needham & Co.

Can you give us some color of how was the fiber channel business in December?

Mike Rockenbach

Fiber channel boards were up 10% I think we saw and ASICs were down a little bit because we had a very strong quarter… The ASICs go, a lot of that goes into the mainframes and so they tend to build those ahead. So I think in general it was kind of normal seasonality. Based on where the competitive landscape is we’re confident we gained share in December again.

Glenn Hanus – Needham & Co.

So sort of up like high-single digits overall for fiber channel?

Mike Rockenbach

Yeah, that’s pretty fair.

Jeff Benck

I think it’s important to note, Glenn, we had a very strong September, gained a ton of share and then sequentially went up from there. So it wasn’t like, you know, when Mike said seasonal it was seasonally off a stronger base which led us to this share position we think that is unprecedented for us over the last five years.

Glenn Hanus – Needham & Co.

Okay. And then did I hear you right, Mike, say that the fiber channel should be down normal seasonality for fiber channel in the March quarter and you said mid-teens?

Mike Rockenbach

Right.

Glenn Hanus – Needham & Co.

Okay. You’re thinking of that as normal seasonality, like 14%, 15% or something?

Mike Rockenbach

Yeah, I think if you look at the last three years it’s kind of ranged between 13% and 19%, so kind of the average amount of sort of mid-teens is what we normally see.

Glenn Hanus – Needham & Co.

Okay. And the upcoming Ivy Bridge release, can you comment just a little bit more high level on how you feel that may impact your 10GB business and adoption and that kind of thing?

Jeff Benck

I think Ivy Bridge, it’s interesting – it took a while for Romley to get going and for Romley, you know, Romley’s obviously in full swing in terms of deployment. We talked about the 10GB attach associated with it. I think Ivy Bridge is just a step function. I don’t see it as a major platform rip-up or change in that I think the OEMs want to focus their efforts on the follow-on to that, the bigger platform adjustments.

So I think within that we’re doing some transition within our own product lines as we’ve talked about but I don’t see a lot of platform change which is probably okay given that we’re bringing a bunch of new things out and new technologies, faster speeds and contemporary 10GB and 40GB solutions in front of that major next platform. I think that that’s good for us in the sense that there’s not a wholesale… People aren’t going to be redesigning every motherboard to support Ivy Bridge because Ivy Bridge plugs into the current systems.

Glenn Hanus – Needham & Co.

Okay, thank you.

Operator

We’ll go next to Srini Nanduri with Summit Research.

Srini Nanduri – SUMMIT Research

Thank you for taking my call. You know, IBM said that they expect a Power series ramp up in the June quarter, the June to September quarter. How can we model the revenue going forward and how do you see Emulex (inaudible) going forward based upon the Power 7?

Mike Rockenbach

So it varies, it really depends on how they roll it out. What we saw on the last cycle was they rolled it out in stages so we didn’t see this big dramatic shift in any one quarter. As they roll out the different platforms they do a cutover and the other thing we’ve seen with P series is because we’ve had 100% of that qualification, at least in the past they’ve been able to do really hard cutovers. So they cutover from 4GB to 8GB – it’s pretty binary. So we don’t see it as a big dramatic drop off or a big dramatic spike where people are waiting in anticipation on the I/O side. It tends to be much more of a progressive roll out as they roll a new offering through the platforms.

Jeff Benck

Let me just add to that. The one thing that I think is different for us in this one is number one, if they see upside I think we’ll see upside. If they see weakness we tend to see weakness and it has to do with our dominant share position which Mike talked about. The difference I think in this one is we’re going to have actually a bigger 10GB opportunity for us there and you know, a nice set of offerings that we’ll be able to participate more materially on the 10GB side in those platforms.

Srini Nanduri – SUMMIT Research

I have one more question, please. When you look at RoCE roadmap does Emulex expect meaningful revenue during 2013? And a follow-up onto that is can you talk about your Maricom partnership there?

Jeff Benck

Yeah, so RoCE has been an effort, we talked about it in the prepared remarks. It’s been an effort where we’ve been investing in this space and developing technology there. A lot of interest in it as an alternative to InfiniBand, building off Ethernet and not going down the path of being sole-sourced with one guy. I think from a meaningful revenue and business for us, we’ve got to get products out. We say we’re not in the market yet, it’s going to happen this year and when you look at the actual contribution we’re going to have to see how that kind of ramps up. But you know, we certainly see it not being material until the second half.

And then the other question was Maricom partnership – good partnership with Maricom on adding software value on top of our solutions, working with them on vertical stacks specifically for things like a video pump offering to go after entertainment and media; a lot of interest in the high frequency training and the kernel bypass software solutions they have. I would say the current products are not a huge amount of business but a tremendous amount of engagement and there’s a lot of effort involved in the next-gen things and continuing to enhance the software stack riding on top of Emulex ASIC technologies.

So we’re pleased so far with the level of engagement. It’s still kind of on the front end of that but the teams have been getting along great and certainly doing some interesting things together. I can’t say at this point though that it’s adding a tremendous amount of business in the short term but we’re very optimistic about the solution content in the vertical interest as we start to really differentiate ourselves in certain markets.

Srini Nanduri – SUMMIT Research

Thank you.

Mike Rockenbach

I think we have time for maybe one more question, Operator.

Operator

And our last question is from [Yoon Pak] with BMO Capital Markets.

[Yoon Pak] – BMO Capital Markets

Great, thanks. Another question on your 10GB E business: how much impact are you guys seeing from the change in your OEMs to daughter cards versus LOMs?

Jeff Benck

Well, I think I mentioned that we saw them go to daughter cards, I guess you’d call them daughter cards or modular LOMs, on the rack servers. We only had option card offerings before. We’re certainly in all of our OEMs with 10GB offerings from that standpoint. We’ve certainly seen some incremental business but also at a different price point than the option cards so without seeing tremendous attach rate growth kind of offsetting.

So from that standpoint it hasn’t been a windfall opportunity for us. That’s one of the reasons we’d like to see pricing come down and adoption go up – I think we talked a little bit about that. On the Blades, not as much change there. Yes, we have a number of Llano motherboards design wins with Romley where we’re exclusive and we don’t share that, so probably a little less sensitive to the daughter card approach there.

[Yoon Pak] – BMO Capital Markets

And can you provide what the mix in your 10GB E business is between your LOMs and your cards? And how should we think about that going forward?

Mike Rockenbach

Well, we usually don’t get to that level of granularity. What I will say is as we mentioned, where we saw the inventory build and where we’re seeing the corresponding burn off is in LOMs. And so we had quite a meaningful shift in the mix towards boards in the December quarter. We do expect some more of that inventory to be burned off, to be finished in the March quarter but we do I think see LOMs coming up a little bit as a percent of the business but it still should be heavily weighted towards cards. And we always expected cards would be a meaningful part of that because particularly when you get to racks there’s one chip down but there’s more slots for cards. So I think that’s about the only level we’d feel comfortable going into.

Jeff Benck

Maybe the only other little data point is we did see some FCoE card strength.

Mike Rockenbach

That’s true. As far as the FCoE we saw pretty good adoption or at least incremental pickup in December.

[Yoon Pak] – BMO Capital Markets

Alright thanks, that’s helpful.

Operator

And that concludes today’s question-and-answer session. Mr. McCluney, at this time I will turn the conference back to you for any additional closing remarks.

Jim McCluney

I’ll let Mike finish off the conference.

Mike Rockenbach

Alright, so thanks everyone for participating in our F2Q 2013 conference call. Just in closing I wanted to let you know that we’ve got quite a number of conferences with investors that we’re scheduled to attend over the next few weeks. We’ll be in San Francisco for three conferences this quarter – February 5th at the Stifel conference, February 26th Morgan Stanley, and Credit Suisse conference on March 5th. And then we’ll end the quarter from a conference perspective in New York with the Piper Jaffray conference on March 12th. So we’ll hopefully look forward to speaking with you at one of those investor events or on our F3Q earnings call in April. With that, thanks and goodnight.

Operator

Ladies and gentlemen, this concludes today’s conference. Thank you for your participation.

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