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QLogic Corp. (NASDAQ:QLGC)

F3Q09 Earnings Call

January 26, 2009 5:30 pm ET

Executives

Jeanie Herbert – IR

Simon Biddiscombe – SVP & CFO

H.K. Desai - CEO

Analysts

Min Park – Goldman Sachs

Aaron Rakers – Wachovia

Harsh Kumar – Morgan Keegan

Amit Daryanani – RBC Capital Markets

Samuel Wilson – JMP Securities

Mark Moskowitz – JPMorgan

Keith Bachman – BMO Capital Markets

Shebly Seyrafi – Calyon Securities

Kaushik Roy – Pacific Growth

Glenn Hanus – Needham & Company

Scott Craig – Banc of America

Operator

Welcome to the third quarter fiscal year 2009 QLogic earnings announcement conference call. (Operator Instructions) At this time, I would like to turn the conference over the Ms. Jeanie Herbert, Senior Director of Investor Relations; please go ahead.

Jeanie Herbert

Good afternoon and welcome to QLogic third quarter fiscal year 2009 earnings conference call. On our call today are H. K. Desai, Chief Executive Officer, and Simon Biddiscombe, Senior Vice President and Chief Financial Officer. Simon will begin the call with a review of the third quarter financial results. Then H. K. will follow with an update on the business in the third quarter and progress on our strategic initiatives. Afterwards we will open the call for questions.

Certain of our comments today will include forward-looking statements regarding future events and/or projections on the financial performance of the company based on our current expectations. These comments contain certain risks and uncertainties that could cause our actual results to differ materially from those expressed in these forward-looking statements.

We refer you to the documents QLogic files with the SEC, specifically our most recent Forms 10-K and 10-Q. These documents identify important risk factors that could cause our actual results to differ materially from expectations. We do not intend to update the forward-looking statements that we make today.

In our third quarter earnings press release issued early today, we reported both GAAP and non-GAAP results. The difference between the results in fiscal year 2009 is due to stock-based compensation, acquisition-related charges, special charges, impairment of available for sale securities, net gains on trading securities, and the related income tax effects and valuation allowances for deferred tax assets. The reconciliation of GAAP net income to non-GAAP net income and a summary of our non-GAAP adjustments are included in our press release today.

All of the references we will make on our call today relate to non-GAAP results unless otherwise stated.

Now I will turn the call over to our CFO, Simon Biddiscombe.

Simon Biddiscombe

Thank you Jeanie and good afternoon. Our revenue in the third quarter ended December 28, 2008, was $163.7 million, an increase of 4% from the same quarter last year. This revenue was within our forecasted range of $160 million to $170 million provided during our second quarter earnings conference call.

Our third quarter revenue from host products which are comprised primarily of Fibre Channel and iSCSI host bus adaptors and InfiniBand host channel adaptors was $112.2 million and decreased 6% from $118.9 million recorded in the third quarter of last year.

During the third quarter our revenue from network products, which are comprised primarily of Fibre Channel and InfiniBand switches was $32.8 million and increased 18% from $27.8 million recorded in the third quarter of last year. The growth was primarily driven by our InfiniBand switches and Fibre Channel blade switches.

Our third quarter revenue from silicon products comprised of Fibre Channel and iSCSI protocol chips was $16.5 million and increased 78% from $9.3 million recorded in the third quarter of last year.

The growth was due to stronger demand for protocol chips which was partially offset by the absence of revenue from management controllers following our final shipments of these products in the second quarter.

Our revenue from royalty and service was $2.2 million. Our third quarter gross margin of 68% declined from 69.1% recorded in the third quarter of last year. The decrease in our gross margin was primarily due to product mix.

Next I’d like to cover our third quarter operating expenses. Total operating expenses were $54.6 million, up 4% from $52.8 million reported in the third quarter last year. Engineering expenses in the third quarter of $29.1 million increased 1% from a year ago and declined as a percentage of revenue from 18.2% to 17.7%.

On a full year basis we expect future engineering expenses as a percentage of revenue to be in the range of 18% to 21%. Sales and marketing expenses in the third quarter of $18.8 million increased 5% from a year ago and increased as a percentage of revenue from 11.4% to 11.5%.

On a full year basis we expect that future sales and marketing expenses as a percentage of revenue will range from 11% to 14%. G&A expenses in the third quarter of $6.8 million increased from $6.1 million a year ago and were 4.1% of revenue in the current quarter.

On a full year basis we expect that future G&A expenses as a percentage of revenue will be approximately 4%. Operating profit in the third quarter increased 1% to $56.7 million versus a year ago and decreased as a percentage of revenue from 35.7% to 34.7%.

Interest and other income was $3.2 million in the third quarter. The income tax rate for the third quarter of 29% was better then the annual forecasted tax rate of approximately 33% provided during our second quarter earnings conference call. The favorable tax rate in the third quarter was primarily driven by the retroactive benefit of the recently reinstated US research tax credit.

We currently expect our annual tax rate for fiscal 2009 will be approximately 32%. Our third quarter net income was $42.5 million or $0.34 per diluted share an improvement from $41 million or $0.30 in the prior year.

This represented a net profit margin of 26% in the current quarter. Our third quarter net income per diluted share exceeded our forecasted range of $0.28 to $0.32 provided during the second quarter earnings conference call.

This represents the 54th consecutive quarter of profitability for QLogic. Turning now to our balance sheet, our financial position continues to be very strong especially with regard to cash flow. During the third quarter we generated $49.9 million of cash from operations. The company’s cash and marketable securities were $371.7 million at the end of the third quarter.

Our strong cash position combined with the fact that we have no debt provides financial stability and significant flexibility in these uncertain economic times.

During the quarter we purchased $98.4 million of the company’s common stock at an average price of $11.84 pursuant to our stock repurchase program. Since 2003 we have repurchased over $1.2 billion of the company’s common stock under programs authorized by our Board of Directors.

Receivables of $87.5 million at the end of the third quarter increased from $77.9 million at the end of the September quarter. DSO at the end of December quarter was 49 days compared to 41 days at the end of the September quarter.

Based on [hub] arrangements at our OEM customers and our current channel and customer mix we expect DSO in the future will range from 45 to 55 days. Annualized inventory turns for the third quarter improved to 6.9 compared to 5.9 turns for the September quarter.

Inventory at the end of the third quarter was $30.2 million and declined sequentially from $33.3 million at the end of the September quarter. Turning now to our near-term outlook.

While we are pleased with our performance for the first nine months of the fiscal year it is clear that the macroeconomic environment has become more challenging. In addition to the normal seasonal decline in revenues we would expect to see in the March quarter we are concerned about our current revenue trends and our OEM and channel customers’ business outlooks.

In response to this challenging environment during the third quarter we implemented a reduction in force, eliminating approximately 4% of our headcount. This action is expected to result in annualized cost savings of approximately $5 million. In addition we continue to proactively manage our operating expenses without impacting our key development programs.

Based on these factors, we expect total revenue for the March quarter to be in the range of $130 million to $140 million. Due to potential variation in product mix, we expect gross margin for the March quarter to range from 67% to 68%. Based on this outlook, combined with planned operating expenses of approximately $56 million and projected annual tax rate of approximately 32%, we expect to achieve non-GAAP earnings per diluted share of approximately $0.19 to $0.23 in the March quarter.

Actual results for future periods may differ materially due to a number of factors including those outlined during the course of this conference call, in the company’s filings with the SEC, and in the disclaimer statement at the end of our earnings press release.

I will now turn the call over to H.K.

H.K. Desai

Thank you Simon, despite a very challenging macroeconomic environment QLogic reported revenue in the third quarter of $163.7 million an increase of 4% from the same quarter last year and within our previously forecasted range of $160 million to $170 million.

Our third quarter net income was $42.5 million an increase of 4% over the year ago quarter and resulted in earnings of $0.34 per diluted share. This exceeded our previously forecasted EPS range of $0.28 to $0.32.

Revenue from host product for the third quarter was $112.2 million down 6% sequentially. Revenue from network products for the third quarter was $32.8 million up 10% sequentially. [InfiniBand] switch products drove most of the growth while Fibre Channel switch revenue was relatively flat.

Revenue from silicon products was $16.5 million during the third quarter up 5% sequentially primarily driven by Fibre Channel protocol chips. As expected there was no revenue from our previously announced end of life management controller products.

Despite the challenging macroeconomic conditions we are confident that our technology focus and business strategies are fundamentally sound and our strategic initiatives therefore remain unchanged.

We have previously discussed three strategic initiatives specifically InfiniBand, Fibre Channel, and Fibre Channel over Ethernet or FCoE. Our focus and investment on these initiatives is as important as they were to ensure that we are optimally positioned for the growth and continued market leadership when the economy recovers.

Now I’d like to give you an update on those initiatives. As a result of our InfiniBand initiative we announced a new series of quad rate or QDR InfiniBand switches. The 12000 family of QDR blade, edge and director switches is based on our own TrueScale switch ASIC.

The 12000 series establishes new standards for cluster performance, scalability and network utilizations.

We also announced several new relationships and installations for our InfiniBand products. On the OEM front we announced an expanded relationship with HP to build QDR IB solutions based on the new QLogic TrueScale switch ASIC.

Further we announced that Lawrence Livermore National Laboratory recently selected QLogic to provide the InfiniBand infrastructure for the Department of Energy’s new large scale supercomputer cluster project known as Hyperion.

Lastly QLogic InfiniBand host channel adapters and switches were recently deployed at the University of Oklahoma Supercomputing Center for Education and Research as part of its newest Linux cluster.

Researchers will use the cluster to study and model tornadoes.

With our new QDR InfiniBand products we expect to be more competitive and gain greater market share. Turning to Fibre Channel according to recent data from the Dell’Oro Group Q3 2008 SAN report QLogic continued its undisputed leadership in SAN adaptors by gaining market share for the sixth consecutive quarter.

QLogic once again ranked number one in every category of Fibre Channel HP revenue and [inaudible] market share. In the report QLogic achieved nearly 55% revenue market share in the Fibre Channel HBA, a full 18-point lead over our closest competitor.

In the new category for 8Gb products QLogic established a commanding lead with 61% market share, more then double our nearest competitor.

Reinforcing the wide deployment and early success of QLogic 8Gb Fibre Channel offerings to allow the entire ecosystems, we recently announced that our switches and adaptors have achieved industry certification with 35 server network storage and application vendors. IT professionals can deploy QLogic 8Gb products backed by the [inaudible] industry-wide certification.

Further reinforcing our leadership position in 8Gb we announced availability of an innovative cost effective suite of end-to-end 8Gb Fibre Channel Networking solutions for the IBM BladeCenter. This includes our 20 port 8Gb Fibre Channel SAN switch module, 8Gb Fibre Channel Pass-Thru module, plus 8Gb Fibre Channel and 1Gb internet combo [mezzanine] card.

QLogic and [inaudible] products allow IBM BladeCenter customers to better leverage VMware capabilities by deploying more server applications and virtual machines in their existing chassis.

Let me close our initiatives discussion with an update on Fibre Channel over internet. FCoE continues to represent a major market expansion [unfortunately] for us beyond storage into data networking while building on the leveraging the success we have achieved in the Fibre Channel and iSCSI and HBA markets.

In recent earnings call we discussed the significant progress we have achieved with our 8000 series converged network adaptors including general availability, customer shipments, numerous certifications, and the announcement by NetApp of the first Native FCoE storage system based on QLogic FCoE technology.

In parallel to the public activity over the past year we have been actively developing the next generation of highly integrated conversion network adaptor products. These products which will be the subject of future public announcements in 2009 are currently undergoing extensive testing by QLogic as well as multiple OEM customers.

We continue to make significant progress in our FCoE initiative and expect OEM revenue to begin in the second half of calendar 2009 and be meaningful in 2010. Even in this uncertain economic times we believe the value proposition for convergence will drive customer demand. FCoE can reduce acquisition and operation cost by requiring less equipment, lowering power and [inaudible] costs and simplifying management.

In addition FCoE’s ability to allow for either full-scale implementation or incremental change while protecting investment in existing technologies and preserving the existing software create further incentives to adoption.

In summary we are very pleased with our progress and remain confident the strategic initiatives will yield positive results for the company. We will continue to invest in key development projects, pursue [extended] market opportunities, and maximize operating efficiencies to drive market leadership and long-term success.

This concludes our prepared comments, we will now open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Min Park – Goldman Sachs

Min Park – Goldman Sachs

Can you give us your thoughts on inventory levels, specifically how much leaner are your OEM partners running these days versus a more normal period, and what kind of a pick up would you expect from a normalization of demand.

H.K. Desai

We don’t have any inventory issues because we have a [hub] level management with all the OEM’s either for the HP or the switch products. If you look at our general OEM, its HP, IBM, Dell, we have a hub level element so there is no inventory issues at all. We just have to fulfill the hub requirements and then they take the product when they are ready to ship. So we don’t have an issue.

On the Channel side, the same thing because we also count on our sell through so there is no inventory issue at all on any of the, so we don’t really have, only areas we can have inventory issues is really the silicon because the lead times are very high.

Min Park – Goldman Sachs

On your silicon product revenue it was up nearly 80% year-over-year, even without the management controller business, can you just help us think about how we should think about the trend of this business going forward because you have seen some volatility in the past. Are we at sustainable levels at this point or do you expect to see more volatility quarter over quarter.

H.K. Desai

I think we can, I think because the management, there are two areas of concern we had last year. We see some choppy performance because of the two events. One is [inaudible] management controllers and also the converts on the mass card from a silicon business to the mass card business. I think those couple of quarterly issues so that’s behind us now.

The key is going to be, the businesses can still be choppy in the sense of because of the long lead time which can be 12 to 16 weeks, it is going to be, its not going to be a stable revenue every quarter. But what we see in the business overall that I think will stabilize the revenue now, and we might start growing that probably in the second half of 2009 because if we can get success on the FCoE technology we can start growing the business.

I think we have a quite good base right now on the silicon business.

Min Park – Goldman Sachs

On your operating expense cuts, your OpEx actually came in below what you were targeting for the December quarter, so is the $5 million annualized savings going to be a run rate at the current OpEx levels or did you already see some of that benefit in the quarter.

Simon Biddiscombe

We did enjoy some small part of the benefit in the December quarter. The actions actually took place in late November so we saw some small part of the benefit but its clear that we have more yet to enjoy.

Operator

Your next question comes from the line of Aaron Rakers – Wachovia

Aaron Rakers – Wachovia

When you look at the guidance that you have given, call it the mid point down about 17 or 18% sequentially, can you help us understand how you’re thinking about that with regard to your specific segments as you look at the March quarter?

Simon Biddiscombe

We’re not going to provide segment-by-segment guidance as such. I think we’ve given careful consideration to all of the trends that we’re seeing within the business at this point in time as we’ve developed the 130 to 140--revenue range. I think H.K. made it clear in his prepared comments that we did a very good job of continuing to take share through the most recent Dell’Oro information that’s available with regard to the Fibre Channel HBA business and so on.

We’re not going to go down to the level of providing guidance by the product family.

H.K. Desai

I think its kind of difficult to do in this macro environment, to break down the HBA or the switch levels or any of this other technology. Its going to be very difficult for us to do these things. What we have done is we look at the normal trend in March which is always the down quarter, we look at the current revenue trend, we also look at the OEM, and channel partner what our business outlook is.

We also look at all the other technology companies which we already announced their earnings and give some guidance, so I think we took a lot of data and we said this is probably the best thing for us right now. To go in more detail I think this environment, is almost impossible.

Aaron Rakers – Wachovia

On the share repurchase program looks like you have maybe $10 or $12 million remaining in your current authorization maybe you can update us there in terms of the management’s thoughts around share repurchase and whether we should be thinking that the company in this environment will continue to be active and obviously have to look to another authorization at some point.

Simon Biddiscombe

We actually have that other authorization already. If you look at the level of repurchase last quarter, your number was pretty good. I think we had $10 million left as of December 31 on the old program. But if you go back to a press release we published in the November timeframe the Board actually approved a new $300 million two-year buyback program at that point in time.

Aaron Rakers – Wachovia

I’d like to get your understanding around FCoE and what you’re calling a potential significant incremental market opportunity, if I look at the traditional HBA market and how I’m seeing the FCoE CNA’s position, it looks like it could in a lot of cases be a replacement over time to the HBA. I’d like to get a better understanding of what you really see as incremental to your business with the evolution of FCoE.

H.K. Desai

I think the key is going to be what I said, what we all have said, that what is, beside the traditional storage connections for us, for FCoE, we also [inaudible] expand our market in the data networking. How successful we’re going to be on that area, we don’t know yet but I think at least we can expand our market. We can protect our market on the storage side because the software base is going to remain the same for Fibre Channel and FCoE.

So I think we can protect our investment there and we can also potentially expand our market.

Operator

Your next question comes from the line of Harsh Kumar – Morgan Keegan

Harsh Kumar – Morgan Keegan

Gross margin came down a little bit, was that mostly utilization of the company and assets, or was there something else in there?

Simon Biddiscombe

It was primarily mix. Think about the change in the business, the switch business growing, HBA business slightly down so it was primarily mix that drove the gross margin.

Harsh Kumar – Morgan Keegan

The 18% guidance decline roughly, is that your view of the market decline or is there anything specific that QLogic is seeing in some product line or the other, could you just elaborate on that?

H.K. Desai

I think it’s the same thing I said, when we considered the guidance we, this is very, very difficult to do in this environment, what’s going on, things changing every day. You guys all know about that. And I think what we have done is we know what’s the March decline is normally, this is knowledge in the March quarter. We also look at the revenue trend so far what’s going on in our business. We also look at our OEM and channel partners business, what’s going on in their business.

We also have seen all the public announcement all of the companies are doing. I think we look at all the data and we said I think this is probably the best range we can give right now.

Harsh Kumar – Morgan Keegan

One thing that you didn’t talk about was ASP’s, I take it they were pretty normally off as they should be 2, 3%.

Simon Biddiscombe

That’s right, we didn’t see anything unusual in line with our expectations.

Harsh Kumar – Morgan Keegan

Its pretty tough out there, we’re seeing like you said, any positives you could point to outside of technology, in your conversations with customers or behavior or anything like that that stands out as when this thing might do a U turn on us.

H.K. Desai

I don’t know, you guys know better then we do in this area. I think we know about what’s going on in our business. We are on top of what’s going on. I think our indicator, the best indicator we have is the OEM’s and we talk to them, we watch them, what’s going on and what’s happening. So really care about the OEM business and we can probably figure out what happened in our business. We’re watching it very closely but we know as much as everybody else knows.

Operator

Your next question comes from the line of Amit Daryanani – RBC Capital Markets

Amit Daryanani – RBC Capital Markets

On your operating line, I think you are guiding it to be up about $1.5 million for the March quarter even though sales are going to be down about 17%, I would assume that some part of variability on the OpEx line that would actually take it lower, can you just talk about what are the offsets that are impeding that?

Simon Biddiscombe

The bridge from where we were to where the number is going to be is fairly straightforward. First and foremost we get some benefit, some incremental benefit in the March quarter from the reduction in force that we took in November. That is unfortunately weighed by the reset of all the payroll taxes for the company on behalf of the employees for the March quarter. That impacts us come January 1st, right.

So the impact from payroll tax resets and so on, it weighs the impact of the cost reduction in the March quarter and OpEx creeps up.

Amit Daryanani – RBC Capital Markets

I guess I’m trying to think about, if sales are down 17%, at least in your sales and marketing line you would have some variable cost control on there so I’m trying to understand why is that not flowing through in the March quarter. What isn’t the sales and marketing number maybe lower.

Simon Biddiscombe

If you look at the way the sales and marketing line stepped down in the December quarter versus the prior quarter there was a very significant step down and that was attributable to the compensation [plans] of the sales organization primarily and third parties to a certain extent as well around the lower revenue number.

So there is an element of it that has already been well contemplated within the context of the sales and marketing line. We didn’t break it down and suggest to you what it might do in the March quarter so we haven’t told you how we think engineering is going to change, how we think sales and marketing is going to change, and how we think G&A is going to change.

Suffice it to say we think in total its going to be $56 million.

Amit Daryanani – RBC Capital Markets

Could you just update us on the 8Gb product line, what is that as a percent of the units at this point and just on that line, are you seeing a slowdown maybe the 8Gb adoption because of the macro environment at this point.

H.K. Desai

What we’re seeing is everything starting the momentum on the 8Gb product even though its slower because of the macroeconomic impact, where we start seeing, and we have all the qualifications is the [inaudible] and the 35 servers and network and storage vendors qualified so all the qualifications is done for us and I think OEMs start shipping the product so we’ll start seeing the ramp in the 8Gb product now.

Amit Daryanani – RBC Capital Markets

What was it as a percent of sales in this quarter?

H.K. Desai

We don’t break down that.

Operator

Your next question comes from the line of Samuel Wilson – JMP Securities

Samuel Wilson – JMP Securities

What was headcount at the end of the quarter?

Simon Biddiscombe

Headcount was about 980 employees.

Samuel Wilson – JMP Securities

Just a qualitative question, how would you compare your visibility when you talk to your customers today versus I want to say normal times, like 18 months, two years ago, when you talk to them, how much information do they convey and how good do you feel about the information that they’re conveying right now.

H.K. Desai

Its always difficult, you know our business because we have a lot of turn business because of this hub arrangement we have with OEMs. They give us a forecast and I think the difference is that forecast is normally stable when they give it in the beginning of the quarter and they update every week or every few weeks but I think now the question is really [when] the forecast that change every three or four weeks anyway.

I don’t think visibility is [inaudible] but I think the forecast can change.

Samuel Wilson – JMP Securities

When they give you forecast changes the last quarter, the December quarter, were the changes you were seeing throughout the quarter significantly, the standard deviation changes, the amount of change, was it significantly larger then you would traditionally get?

H.K. Desai

I won’t say for the December quarter but we can see probably in this quarter. We’ll see a couple of changes like that .

Operator

Your next question comes from the line of Mark Moskowitz – JPMorgan

Mark Moskowitz – JPMorgan

Can you talk a little more about your accounts receivable, you DSO’s in terms of the uptake, how much of that was driven by linearity versus maybe a shift in your OEM versus channel activity during the quarter and did you talk about channel as a percent of revenues?

Simon Biddiscombe

No we didn’t break down the percentage of revenues that go through the channel but suffice it to say it was a little less then it had been in previous quarters and continues to go down primarily because there are certain products that we sell today such as mezz cards that aren’t fulfilled through the channels.

As it relates to the DSO it was certainly a little less linear within the context of the quarter. We did see more activity at the end of December that contributed to achieving the revenues that we did. Obviously that wasn’t collectible at the very end of the quarter. I think the other part that didn’t help anybody at the end of the quarter was the fact that many of our partners on the customer side were actually shut down for an extended period of time so it was a little more difficult then normal to actually collect cash from many of the customers that exist.

So kind of twofold, a little less linear on the revenue such that DSO’s [parked] up and a little more difficult to collect the cash given shutdowns.

Mark Moskowitz – JPMorgan

As far as the annualized cost reductions or cost savings of approximately $5 million can you give us a little color in terms of where we should think about the revenue base that supports that, what level below your current range should we think about as far as a quarterly run rate in terms of revenues for that profile.

Simon Biddiscombe

We’ve given the targets on an annual basis and we think that’s the best way to do it at this point in time so we’ve explained that we expect engineering to be in the 18 to 20% range of revenues, we expect sales and marketing to be in that 11 to 14% and G&A to be roughly 4%. And today roughly midpoint in the guidance throughout that would manifest itself as 26% operating income so that’s essentially the way we’re thinking about the model at this point in time.

There’s strong desire on the part of the management team to get that number back to the 30% range on a full year basis.

Mark Moskowitz – JPMorgan

In terms of just the visibility I know its always difficult given where you sit in the food chain, but for those OEM customers or partners where you are, with the actual formulation of installations with what the customer and the interaction there, what have you gotten from the customer angle in terms of are these big purchasers out there, are their budgets more fluid as we start the year? Is there going to be any sort of formulation in terms of a budget implementation process this year in terms of by the March quarter we kind of know where budgets sit for 2009 or is there going to be a situation where no one really knows until they maybe move through the first half of the year where budgets are going to be.

H.K. Desai

I think because we are not really tied to the end user so its very difficult for us to look at what, from the end user perspective. What we do is the best we can do is that we are very close to the OEMs and we try to be, we try to reduce our cycle time getting the forecast from them and we target that. It’s the best we can do anyway and I think what we have seen is that normally when they give you the forecast for the whole quarter in the beginning of the quarter, normally they come within a reasonable range, maybe one can go slightly down and one can go better then the forecast so its kind of average out for us from the top line perspective.

What we start seeing is that they are kind of changing the forecast more frequently in January. So I think that’s the biggest change. So I think what its saying that they really don’t know exactly what’s going on too so they’re going to come to us and give us more forecast and update what’s going on.

Mark Moskowitz – JPMorgan

So its going to be a pretty fluid environment.

H.K. Desai

Its going to be a very fluid environment, yes.

Operator

Your next question comes from the line of Keith Bachman – BMO Capital Markets

Keith Bachman – BMO Capital Markets

You indicated that pricing was pretty normal for the December quarter for your March guidance can you give us your assumptions for the pricing environment?

Simon Biddiscombe

I think as we’ve thought about giving the guidance there are many different factors we give consideration to. Price erosion is certainly one of those factors so—

Keith Bachman – BMO Capital Markets

Is it more aggressive then--?

Simon Biddiscombe

Yes, we’ve given very careful consideration to how pricing is changing in the current environment. I think that’s fair to say.

H.K. Desai

I think what Simon is saying is we have consideration on that so even the pricing change and we want to make sure that we didn’t, the gross margin guidance that we gave it to you anyway. So I think this will still fall in the guidance range.

Keith Bachman – BMO Capital Markets

How about for the competitive landscape, any update that you can provide with [Brocade]?

H.K. Desai

We haven’t seen any different from what we have seen the last few quarters so there’s no change in competitors.

Operator

Your next question comes from the line of Shebly Seyrafi – Calyon Securities

Shebly Seyrafi – Calyon Securities

Now that your stock has come down and slightly going to open down lower tomorrow morning, do you expect to repurchase more shares then you did for example in the last quarter.

Simon Biddiscombe

Not necessarily, I think we’re giving careful consideration to total cash available within the business and the certain slowdown that we’ve seen just reflected in the guidance that we’ve provided today and so on, so I don’t necessarily think we’ll be in the market at the same level as we were in the December quarter but it remains to be seen.

Shebly Seyrafi – Calyon Securities

Is your forecast of roughly down 17 to 18% sequentially, is that based on a lot of what your business is about or more about more from say reading the papers and what the news is all about, is it, how much visibility do you have into that forecast.

Simon Biddiscombe

So its obviously not based on reading newspapers. Its based on the very specific trends we are seeing in our business and how we are seeing, as we said, the revenue trends, the traditional seasonality and the macro impact that we’re experiencing at this point in time impact where we stand today from a backlog perspective, impact the order trends that we’re seeing from customers, impact [hopefuls] and so on.

So they are very specific data points that we pay attention to on a day-to-day basis that have helped us build the model to where it is.

Shebly Seyrafi – Calyon Securities

And I guess you’re not counting on losing share so this roughly down almost 20% sequential forecast is probably indicative of the SAN space in general, is that fair?

H.K. Desai

Yes, I agree, I don’t think we expect to lose the share. We gained the share in the first three quarters, we don’t have the December number yet. But we gained about 10 share points in calendar 2008. We don’t expect to lose the share, no.

Shebly Seyrafi – Calyon Securities

Your silicon segment, now its based a lot on FCoE and CNA’s, what kind of growth forecast do you have for that segment. What can you grow, if you want to give a wide range that’s fine, but—

Simon Biddiscombe

We didn’t say that. What we indicated in our response to the first question we were asked about the silicon business was that late in 2009, calendar 2009 and beyond, we expected to see a contribution from the sales of silicon for FCoE product. The majority of the revenues today are Fibre Channel and iSCSI protocol chips, nothing essentially associated with FCoE today.

Operator

Your next question comes from the line of Kaushik Roy – Pacific Growth

Kaushik Roy – Pacific Growth

Can you give more color on the host product, its clear that HBA’s were down, but how much was it because of macro or was it more because of the shift to mezz cards from HBA’s.

H.K. Desai

I think it is not, I think its not because we are losing any share, its because of share lost, I think its because of some impact of the mezz card conversion, the blade server, and a lot of it the macro.

Kaushik Roy – Pacific Growth

So most of it was macro probably?

H.K. Desai

Some macro and some mezz card, yes. The vast majority macro.

Kaushik Roy – Pacific Growth

On HCA’s were they, my assumption is HCA’s would be highly correlated to IB switches and your IB switches did very well, so were HCA’s down or up sequentially in the December quarter?

H.K. Desai

Probably slightly up but is a very small base.

Kaushik Roy – Pacific Growth

On the gross margins, now that going forward you’re going to use your own ASIC for IB switches what type of gross margins are you getting now on IB switches and where can it get to, how much improvement you can have as you ramp up on your own switching ASIC.

H.K. Desai

We won’t see that impact until the second half of calendar 2009 and our goal is eventually to have a IB switch gross margin similar to the Fibre Channel which is about mid-50’s and that’s our goal long-term.

Kaushik Roy – Pacific Growth

And are you like in mid-40’s now or high 40’s now maybe?

H.K. Desai

Somewhere in 40’s.

Kaushik Roy – Pacific Growth

FCoE, are you seeing customers pushing out FCoE projects because of the macro slowdown or not really.

H.K. Desai

I think what we seeing is that we will start seeing some revenue that’s our projections or forecast is that we will start seeing some revenue for the FCoE in the second half of the calendar 2009 and meaningful revenue will come in 2010 and if I look, like I said in my script, that there is a value proposition for the FCoE so I think its still good for this economic environment.

Kaushik Roy – Pacific Growth

Are we getting overly optimistic because the standards have not been ratified and what I’m hearing is that it won’t be ratified until August.

H.K. Desai

I think standards are almost there. There can be minor, few tweaks and our experience in the standards in the past with any new technology is this always happens. Sometimes the final standard is not done until people start shipping the product. But I think the products are already [inaudible] those things and people are going to start shipping the product as the standard, some standard change, we can always go and update the formula software. Its not a big problem for us.

Operator

Your next question comes from the line of Glenn Hanus – Needham & Company

Glenn Hanus – Needham & Company

Should we look for the next two, continue to favor be more weighted towards the network products as we go through next year, is that, can you tell us that much?

H.K. Desai

I think its difficult to say that really. I think we are not giving you any guidance on what the break down of the revenue is going to come from. I think its difficult at least this quarter to determine what’s going on and see what happens in the June quarter. If we have some more data and more visibility we can give you that, but I think right now I think we can that we don’t know where the revenue is going to come from. We just give you the general outline where what our guidance is.

Glenn Hanus – Needham & Company

The OpEx 56, then going forward from there, should we think that you have a $5 million a year savings kind of off of that level?

Simon Biddiscombe

The $5 million is already baked into the 56 essentially so when we look at it on a quarter by quarter basis its going to be right around that $56 million as we sit here today, it won’t vary much from that.

Operator

Your next question comes from the line of Scott Craig – Banc of America

Scott Craig – Banc of America

When you look out on the next quarter on the gross margin at the midpoint quarter to quarter would be down slightly, is that all due to the pricing assumptions you made and how does mix impact that and then when you think about three months ago or so, when we first started discussing the $5 million cost savings, obviously the environment still change in the first quarter is a lot lower then you expected, is there further opportunities here for you to take cost out of the OpEx line and when would you make a decision like that, how long would the environment have to remain pretty challenged for you to make another decision on the cost saving opportunities.

Simon Biddiscombe

I think on the gross margin, 67 to 68 feels like a very appropriate range based on all of the factors that we have in front of us today. Pricing is certainly part of that cost reduction, as part of that in terms of the product cost, as is mix so don’t try to read too much into my 67 to 68 which at the midpoint as you correctly pointed out is down about half a point relative to where we ended last quarter.

There are many moving parts included in that. As it relates to cost reduction I’ll say there is no plan in place at this point in time to do anything other then commit to the 4% reduction that we implemented last November. We I believe run a very frugal ship and we continue to generate very healthy operating margins.

As I said if you take the midpoint of the range throughout the model, you end up with 26% operating margins which was below our 30% range, is still something that we continue to drive. So while there is no plan in place to implement any further cost reduction we continue to be very aware of all the opportunities to do precisely that and we’ll pay in particular attention to the way the revenue evolves as we move forward.

H.K. Desai

On the cost reduction we watch our revenue and top line where it stands, and if the changes happen and the economy is not coming back or there’s a further, we can always go and look at this thing. So we’ll look at it every quarter, every month, what’s happening and we can always adjust our business accordingly so we’ll be very watchful about that.

Operator

There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

Jeanie Herbert

Thank you all for joining our call. We look forward to updating you next quarter.

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Source: QLogic Corp. F3Q09 (Qtr End 12/28/08) Earnings Call Transcript
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