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Executives

Michael J. Rockenbach – Executive Vice President and Chief Financial Officer

Analysts

Scott Smith – Morgan Stanley

Emulex Corporation (ELX) Morgan Stanley Technology, Media & Telecom Conference Call February 26, 2013 7:25 PM ET

Scott Smith – Morgan Stanley

Okay, we’re going to go ahead and get started. My name is Scott Smith, part of Morgan Stanley’s Hardware Research team. And I’m pleased to be joined on stage with Mike Rockenbach, the Chief Financial Officer of Emulex. Mike thanks for taking the time today.

Michael J. Rockenbach

Thanks Scott.

Scott Smith – Morgan Stanley

So I just want to start maybe a high level or kind of macro view of the world as you see it, I think, on your most recent conference call, you’ve noted some improvement in the broader economic environment, you’ve guided the normal seasonality for an early March to June. So, just curious in what gives you the better visibility or the confidence in that kind of a statement or there you expect normal seasonality in the first couple quarters of the year?

Michael J. Rockenbach

Well, I think as you kind of look at the front half of this calendar year, compared to how things were coming out of the summer time, we’ve, as the broader economic outlook I don’t think we’re totally out of the widget, but I think you are certainly seeing a more stable environment than we saw coming out of the summer time.

And I think part of that, at least for us is, is the environments that we go into, we’re going into, we’re part of IT spending, part of the broader IT spending, but when you look at the different pieces of IT spending, some pieces are more, more flexible than others in terms of timing, more discretionary, in terms of how you spend those things. And so, the areas that we focus on and that our products focus on are the more mission critical part of the data center and the less discretionary part of spending. So, we do rely to a certain extent on server refresh cycles and new Greenfield installations of technology, but we also rely a lot on what drives our overall business is the continued growth of digital data and the requirement to store and access that data and those parameters aren’t changing at a macro level, but I think they do change in terms of how comfortable company’s yield spending in the near-term environment.

So, I think you go through periods within that cycle where there is a little bit more uncertainty and that lends itself for tighter IT budgets, but if you are coming like we have seen over the last few years in an environment where we really haven’t globally been kind of free and clear from a spending standpoint, you really don’t have a big buildup of underutilized capacity they can absorb that for a longer period of time. And so, I think as things settle down a bit then we got passed the initial fiscal cliff and some of the other concerns, as I said coming into the back half of the calendar year, it makes for a little bit healthier environment.

Scott Smith – Morgan Stanley

You mentioned the serves cycles can be an important catalysts and there has historically been a high correlation between server units and kind of HBA growth. So, what’s your view of the server market this year, is there any catalysts that accelerates server demand or is that correlation breaking down and you are not as tied to the server market?

Michael J. Rockenbach

I think different products that we offer are more tied to server refresh cycles, they have different patterns, if you look at the 10-gig Ethernet business, Ethernets requirement on servers, now it didn’t necessarily all going to be 10-gig, but virtually all servers have some Ethernet ports on it, either 1-gig or 10-gig. So, our philosophy as we really looked at 10-gig as, 10-gig Ethernet more specifically as a convergence strategy, our view as a company a few years ago, really became more server centric and that does drive a piece of our business really the 10-gig Ethernet piece. And that’s important for where we have to be in terms of the development cycle of our ASIC. So, you’ve got to be, you’re part of that critical path for a server refresh cycle, if you’re on the Ethernet side and you need to be, your development cycle needs to be in sync with that.

And so, we talked about our business moving from a storage-centric view of the universe to more of a server-centric view of the universe. Because, Ethernet is a bigger piece of our business and that became a central theme of our strategy. When you look at the Fibre Channel piece of the business and I think FCoE over time will have similar characteristics. Is Fibre Channel was never on every server, it really only got a penetration rate of maybe 15% or 20% of the servers and the Fibre Channel tended to be at the higher end of the market.

And Fibre Channel and correspondingly FCoE is going into a very risk reverse part of the data center. So, what we saw with Fibre Channel and what we still see with our Fibre Channel businesses is it’s actually not tied into be there at the time of the server launch, it’s kind of the opposite side of it, the servers need to be there for the data center guys to be able to deploy a new type of Fibre Channel architecture, our new speed of Fibre Channel cards. So, it tends to Fibre Channel tends to lag the server refresh cycle.

So, when you look at it today, Romley platforms got launched last year you’re just now starting to see the ramp in 16-gig Fibre Channel, which we released earlier during last calendar year. So that’s a cycle that lags the server refresh cycle you need the servers to be there, before you’re going to see a new deployment. And in the case of 16-gig, it was meaningful, because you had a new generation of PCI architectures come out. So you really needed that to be available before you can really take full advantage of 16-gig as a platform in the Fibre Channel. So they do have a little bit different deployment pattern and it’s driven by kind of where we are in the cycle and to the ultimate end consumer of our technology is.

Scott Smith – Morgan Stanley

I think, there were some concerns and maybe that Romley didn’t really drive a demand people are hoping for last year, it sounds like that’s not quite sure view or am I miss characterizing that?

Michael J. Rockenbach

No, I think that’s true, I think it is true that we have seen some benefit from Romley, but we haven’t seen, I think manually or specifically, but as an industry I think we’ve seen there’s much of an uptick as we expected. And…

Scott Smith – Morgan Stanley

But it’s still in front of you, it sounds like…

Michael J. Rockenbach

It’s still in front of us for 16-gig Fibre Channel, 10-gig Ethernet little bit harder to tell, one of the things that we saw as a potential for a real advantage with Romley refresh with 10-gig is, as I say with Fibre Channel it’s kind of always an accessory it was never down on the motherboard with the Nehalem launch 10-gig Ethernet was down on the motherboard, but really it was down on the motherboard and blade, so you saw in our business you saw a pretty significant uptick particularly on the LOM side with the blade deployment of the Nehalem and the expectation was that Romley should be a better platform because not only do you see as moving to 10-gig at the motherboard level, but Rack-Mount and servers were going to get 10-gig and they have a lot more slots so ultimately you should be able to pull more I/O with those deployment of 10-gigs in Racks and we have seen our board level business do pretty well, but not as well as we really have expected when we looked at Romley refresh cycle a couple of years ago.

Scott Smith – Morgan Stanley

Do you think Ivy Bridge, how does that factor into the another catalyst or not really a big factor in your view?

Michael J. Rockenbach

I think it’s, well I guess it’s another opportunity for catalysts, but what we’ve tried to do is we look at our business is, I think you got to put yourself in a position to be successful as the market is successful, but ultimately we focused on making sure that we can manage the variables that are within our control and specifically for us that’s our operating expenses, to make sure that we’re not getting ahead of ourselves so that we get into a position where we just don’t have a sustainable long-term business model.

So, if you look back at what we’ve done in the past, we’ve made conscious decisions to invest at various different times in the cycle and to cut our expenses in other point in time.

So, we’re really focused a couple years ago on getting ahead of the market with 10-Gig as a convergence strategy. And so, the timing of that happen to be right when everything was slowing down in 2008, 2009 so we did cut some expenses in some areas, but we saw that as an opportunity to get ahead of the market and so, we continue to make investments at a time when maybe other people were being more cautious and I think that ultimately paid off for us pretty well to be able to get the position that we have in 10-Gig and come over the other side.

So, we over the last year or so, we’ve been able to hold our operating expenses on a non-GAAP basis down around $60 million or less on a quarterly basis, so we’ve really tried to manage the things that we can to ultimately position us to be successful as different opportunities come up. I think Ivy Bridge is another opportunity where now you’re in the third generation of servers that 10-gig will be deployed on and as time goes by as you’re trying to sell these products or the OEMs are trying to sell these products into an inherently risk averse in consumer the longer the technology is out in the marketplace, the more stable it gets the more, the more environment it’s been and the more robust the software and the drivers get and I think you reach a point of critical mass where you tip that over to get those end users more comfortable deploying that technology and as I think with Emulex a little bit better economic environment is certainly going to help for us than everybody else.

Scott Smith – Morgan Stanley

If we look at your Fibre Channel business you’ve gained share for the last couple quarters years, however you’re I’m not sure (inaudible) exactly, but you’ve gained some share, so can you just talk about what’s been driving your success in that business and from my understanding in the Fibre Channel business and you’ve kind of alluded to is that share shifts are relatively slow, people stick with their incumbent vendor, incumbent vendor they don’t change just because there is lower price ports. So can you talk about what’s really driving it and how you are able to gain share?

Michael J. Rockenbach

Well, I think, we did gain a lot of share in the last year, I think this is the third year that we’ve gained some market share, but last year was probably more meaningful market share, shift than we’ve really seen in quite a while and the part that we think makes it interesting is that wasn’t because of the technology shift, that share shift gain was really dominated by 8-gig deployment which has been in the marketplace for a couple of years. So, we do think with 16-gig coming up that we had some time to market advantage. From a competitive standpoint the other guys have 16-gig out there now, but we had more time on the bench. So, I think that gives us some optimism about how we can perform and hopefully gain more share next year. But the share shifts that we did gain were really with existing technology. And so, I think one of the things that helped contribute to that is along with our strategy to kind of take more of the server-centric deal of the universe.

As I mentioned earlier, over the last couple of years, we also really changed a big piece of our go-to-market strategy by moving from being a U.S. centric company to more of a global company. And so, it was coming about in the combinational ways there was a couple of acquisitions we did they gave us some R&D presence in India, which helped us from the development standpoint.

But also, as we move more towards the server side of the house and LOMs down on the motherboard, we were seeing a pretty significant shift in our revenue outside the U.S. as well. And also in the last couple of years, the IT spending there has been other parts of the globe have been growing faster than the U.S. market and we really felt like we’re try to align our sales people in the country, in those environments.

So, if you look at us a few years ago, we had the U.S. operations where corporate headquarters is and then we had a pretty good size operation in the U.K. from the sales standpoint and they were really running the U.K. office was handling sales for all of Europe and we were doing most of Asia from the U.S.

Over the last four years, we’ve now opened subsidiaries in country with people in China, Singapore, Japan, France more recently Brazil, so we’ve got people on the ground where these decisions are being made. And so, when you’re in an environment where there is really in Fibre Channel, I think it’s similar in Ethernet the OEMs aren’t sole sourcing anything, there is always going to be competition, there is always going to be co-qualification if not today it’s eventually and the OEMs are in the business of selling servers and storage.

And so, in a lot of respects they are kind of indifferent whether they sell us or our competitors card and you can see that and how they price it, they price it the same to the end user, so they really, they’re really not creating a differentiation in the marketplace between us and our competition.

So to the extent that end-users have standardized on one of us or the other you are going to kind of get those by default as long as you’re there in time, but I think where it’s a Greenfield installation or in particularly big environments where they maybe use us in certain applications and the other guys in different applications you have the opportunity to do Share Shifts by being in country and helping them pick you versus the other guy all the things being equal. And so, I think, we think certainly that that’s been the contributing factor to what’s giving us the ability to shift share in the marketplaces is by being on the ground and really winning those on a deal-by-deal basis.

And so, you are not differentiated on price, there is certainly some feature differences, but maybe in Fibre Channel at this stage of the game not enough to really be kind of a killer app so, you got to be something that’s a little bit more kind of be on the street to accomplish that and part of the reason why we built that out from a sales organization standpoint was in preparation for the 10-gig Ethernet business, because that is an area where ultimately the channel is going to be a bigger part of that and I think it’s an area where, because historically other than from the OEM side, I think they see us as an Ethernet company at the end user level they don’t necessarily see us that way.

So, having those people in country to be able to win those opportunities on a business by business basis was part of our strategy for the Ethernet side and that certainly, I think helped us out more recently on the Fibre Channel side as well.

Scott Smith – Morgan Stanley

Okay. It kind of leads into my next question which is why your recent acquisition or pending acquisition of Endace, can you just describe the philosophy behind entering a new market, can you talk a little bit about building up sales force as I think this requires a change in go to market strategy, so can you talk about what kind of OpEx is involved and just lot of the details around the acquisition?

Michael J. Rockenbach

Sure. So, just as a little bit of background, Endace is a New Zealand based company, they are a public company traded under London AIM Stock Exchange. So they’ve been around for about 10 years, so they’re not a start up, they are an established company, they’ve already got, they’ve already got a sales channel and what they’ve been doing is what they really do is in an Ethernet environment they provide network visibility and 100% packet capture and recording for all the traffic on a network. So you know, if you think of what we do, well I guess I should back up, they do have a different go-to-market strategy than we do. Our sales force is really there is kind of two sides to it, we’ve got OEM sales team that is focused on getting design wins of the OEMs. And that could be a repeat design win of a new Fibre Channel card that could be a brand new opportunity in Ethernet. But they’re focus on getting the OEM design wins, because if you’re not qualified by the OEMs the end users just won’t deploy it.

So that’s the first part, as we got to get qualified by the OEMs, but ultimately there is competition into the end user level, so we’ve got sales guys that are touch point either supporting systems integrators or our OEMs distribution channels or in some cases with some of the bigger end users having direct relationships with them.

So, we’re on a different side of it, where we’re trying to get people to build new networks. And this is on the other side of it, their direct sales force selling monitoring equipment and appliance into a network that’s already built.

And so, what they do is similar to what we do in the sense that they do both hardware and software. But their approach has been, look if you’re trying to manage traffic on a network it’s more than just getting an alert that says there is no data flowing down the network or an alert that’s telling you that there was a problem, it’s the ability to solve those problems.

And so, what they provide is 100% packet capture of network traffic up to a 100-gigabit. And a simple way to think of it is it’s like a DVR not only can they give you an alert that says there is a problem on the network or there is these funny looking packets you may want to take a look at, because they provide capture and record, they can replay that whole stream or they can deliver those packets to a different application that wants to look at packets first for a specific reason. So, it’s kind of the equipment of monitoring a freeway instead of taking a still shot picture of video recording it and being able to replay and tell you why you had a problem.

So, the way we see it is it’s part of a holistic approach to how you build a network, we provide the connectivity they provide the capability to monitor it and ultimately that makes it easier to manage it and because they’re dealing with networks already today, they’re deploying 100-gig equipment, they’re going to see environments and see problems that are going to be things that we need to incorporate or solve into our future products as we move our networks to be between 40-gig to 100-gig. So, it is a little bit different go-to-market strategy than we currently have, but I think the advantage that we see with this is that they’re already a well established company, we just give them the opportunity and platform to go after markets more economically than they could have on a standalone basis.

So, for them it is, it’s a direct touch point to end users and so, for example like, if they want to sell into the German market well, today they would have to use their UK guys to go visit an end-user and then there are some other time, you are not there all the time and you might be spreading those resources over various countries. Well now, we’ve already got a subsidiary there, so it’s no incremental expense for us on the management side of it, the G&A or the support side infrastructure they can drop a sales team in there and be in country.

So they have the opportunity to combine with us go after incremental markets or new markets that they can exploit more efficiently with the combination of us that’s a bigger platform and we think ultimately Over time, they have a much more tangible touch points that end users and that will ultimately help us put better features into our products that should build more I/O down the road.

Scott Smith – Morgan Stanley

How big is that TAM, and how fast as they are growing?

Michael J. Rockenbach

The overall TAM is probably growing in the 15% to 20% range they are in a particular piece of the market that’s focused on 10-gig and above. So part of that market today is at 1-gig and that’s just like in the server side, that’s declining.

So I think what makes that market interesting is if the market that doubles our addressable TAM, from where we’re at today, but it’s also a fairly fragmented market because you’ve got a bunch of you’ve a got a bunch of different solutions going after different pieces of the market what indexes approach is building appliance that’s capturing all other traffic data at line speed doesn’t slow down the network at all, and so there is much as an enabler of that technology by being able to feed packet information to different software applications they don’t necessarily own every software application there is certain ones that will make sense to be integrated just like, just like you see in a lot of different feature sets and there is other ones where they’ve got an open API that will enable other people to take advantage of the packet capture that they’re doing and let those companies focus on doing what they do best, so I think they look at it as hardware as an enabling appliance as opposed to we need to own 100% of the market, but the key differentiator is being able to capture all the packets without disrupting the floor data.

Scott Smith – Morgan Stanley

Okay, I’ve got a couple more, but we only have a little bit of time, so I want to see if there is any questions in the audience. No? Okay, so, all right. Yeah, just following up on that, what kind of competitors would you run into with that kind of solution, but also how do your traditional OEMs feel, if they have any opinion on your offering those solutions?

Michael J. Rockenbach

That’s a great question. From a competitive standpoint, I think the competitors, two biggest competitors that they’ve seen in the market historically is the company called Napatech and NetScout. So, I think Napatech is more like a hardware focus what Endace used to do with their DAG cards, so I don’t think, they’ve quite moved up to the appliance side of it, NetScout is more on the software side of it, so different companies have taken different approaches to the market, and I think there is like any good market there is well, for big market and I think for a company like ourselves what makes the market interesting is that it’s a big market and it’s got a lot of opportunity and just by its nature, that means it’s going to attract competition, you need a differentiator within that market, so that’s really I think a similar approach to how Endace has looked at it.

And we’ve talked with our OEMs, our sales folks have talked with the OEMs and we’re not competing with our OEMs because we’re, our OEMs are providing different functions and different services, different hardware platforms I think in a lot of ways we should be an enabler for the OEMs, because we’re making it more efficient to build bigger and more complex networks by giving you visibility to make that run more efficiently.

So, ultimately, what we wanted to accomplish at Emulex is that I/O connectivity. So for us it’s not necessarily about how many servers are sold, it’s about how many servers are sold that connect to the network. So anything that puts more traffic on a network from our perspective is good, because you need more I/O, the more traffic you have, the more devices you need at the edge of the network. And for the Endace boxes, they give visibility to make that network run more efficiently and ultimately that makes it easier for end users to deploy that system.

And for the OEMs that makes it easier for the end users to consume their technology as well. So I think, I think they should see it or I think they do see it, as something that complements and it’s an enabler of building these big virtual networks that we’re all driving towards and we’re making that more efficient.

So that really isn’t a lot of, there is other independent companies that compete, but really on this network performance management it’s not an area that’s been kind of an OEM centric market as of yet, so…

Scott Smith – Morgan Stanley

I think we have time for one more if there’s anyone else. Okay. I just had one maybe to finish up and then it relates to Flash, so there’s clearly a divergence between I think your strategy between you and your closest traditional competitor. But you do have a relationship with, I think Fusion and EMC, how does Flash play into the network for you guys? Would you ever enter the caching market or how did you look at that?

Michael J. Rockenbach

Well, I think that’s an interesting market and that’s another area of I/O connectivity and anything that moves data or affects data is important and an interesting market for us I think our approach, though is we’ve just kind of looked at it from how many engineering dollars do we have, where we’re going to get the most bang for your buck so to speak and how best can we use our resources to approach that market. For the SSD market or for the Flash caching market, we just felt like a partnership was a better approach to do it. So, we can provide the I/O and we do that with our 16-gig Fibre Channel products as a partnership with other people that are already have some expertise in that market as opposed to trying to go after that market directly ourselves, we see 10-gig convergence coming down the road, 40-gig with RDMA, RDMA over converged Ethernet as just a better way for us to leverage a finite amount of engineering resources, but I think that, that is an interesting market, that’s a market that we’ve looked at before, but it’s one that we just felt for us it was best to approach it as a partnership as opposed to going at that market directly ourselves.

Scott Smith – Morgan Stanley

That makes sense. All right, unfortunately, we’re out of time. So, Mike, thanks a lot for your time today.

Michael J. Rockenbach

Thank you.

Scott Smith – Morgan Stanley

We’ll it there.

Michael J. Rockenbach

Thank you.

Question-and-Answer Session

[No Q&A Session for this event]

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