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QLogic Corporation (NASDAQ:QLGC)

F4Q09 (Qtr End 03/29/09) Earnings Call Transcript

April 30, 2009 5:30 pm ET

Executives

Simon Biddiscombe – SVP and CFO

H.K. Desai – Chairman and CEO

Analysts

Aaron Rakers – Stifel Nicolaus

Samuel Wilson – JMP Securities

Amit Daryanani – RBC Capital Markets

Min Park – Goldman Sachs

Harsh Kumar – Morgan Keegan

Kaushik Roy – Wedbush Morgan

Mark Moskowitz – JPMorgan

Jason Noland – Robert W. Baird

Glenn Hanus – Needham & Company

Rajesh Ghai – ThinkEquity

John Punk [ph] – BMO Capital Markets

Operator

Good day and welcome to the fourth quarter fiscal year ‘09 QLogic earnings announcement conference call. Today’s call is being recorded. At this time, I would like to turn the conference over to Mr. Simon Biddiscombe, Chief Financial Officer. Please begin when ready.

Simon Biddiscombe

Thank you, Rebecca. Good afternoon and welcome to QLogic’s fourth quarter and fiscal year 2009 earnings conference call. Joining me on the call today is H.K. Desai, our Chief Executive Officer. I will begin the call with a review of the fourth quarter financial results.

And in addition provide some commentary on our full-year financial results. H.K. will follow with an overview of today’s announced acquisition of NetXen, a business update and close with 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 of the financial performance of the company based on our current expectations. These comments are subject to significant 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 fourth quarter earnings press release issued earlier 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 investment securities, net gains or losses on trading securities, gain on sale of shares of publically traded company and the related income tax effects and changes in the valuation allowances for deferred tax assets.

The reconciliation of GAAP net income to non-GAAP net income and a summary of the non-GAAP adjustments are included in our earnings press release. All of the references we will make on our call today relate to non-GAAP results unless otherwise stated.

Our revenue in the fourth quarter ended March 29, 2009, was $130.5 million, a decrease of 18% from the same quarter last year. This revenue was within our forecasted range of $130 million to $140 million provided during the third quarter earnings conference call.

Our fourth quarter revenue from host products, which are comprised primarily of Fibre Channel and iSCSI host bus adaptors and InfiniBand host channel adaptors was $88.4 million and decreased 20% from $110.3 million recorded in the fourth quarter of last year.

Fourth quarter revenues from network products, which are comprised primarily of Fibre Channel and InfiniBand switches was $25.1 million and decreased 9% from $27.5 million recorded in the fourth quarter of last year. Our fourth quarter revenue from silicon products comprised of Fibre Channel and iSCSI protocol chips was $13.7 million and decreased 2% from $13.9 million recorded in the fourth quarter of last year.

Our revenue from royalty and service was $3.4 million. Our fourth quarter gross margin of 67.7% declined from 69.8% recorded in the fourth quarter of last year. Our gross margin was consistent with the forecasted range of 67% to 68% provided during our third quarter earnings conference call.

The decrease in our gross margin was primarily due to the fact that we recognized a significant one-time royalty benefit in the fourth quarter of fiscal 2008, which as expected did not reoccur, and also from a less favorable product mix.

Next, I would like to cover our fourth quarter operating expenses. Total operating expenses were $53.3 million, down 5% from $56.1 million reported in the fourth quarter last year. Engineering expenses in the fourth quarter of $29.9 million increased 1% from a year ago and increased as a percentage of revenue from 18.6% to 22.9%.

Sales and marketing expenses in the fourth quarter of $17 million decreased 14% from a year ago and increased as a percentage of revenue from 12.4% to 13%. G&A expenses in the fourth quarter of $6.4 million decreased from $6.7 million a year ago and were 4.9% of revenue in the current quarter.

Operating profit in the fourth quarter declined 37% to $35.1 million versus a year ago and decreased as a percentage of revenue from 34.7% to 26.9%. Interest and other income was $2.6 million in the fourth quarter. Our income tax rate for the fourth quarter of 35% resulting in an annual rate for the full fiscal year of 32.3% consistent with the annual forecast of tax rate of approximately 32% provided during our third quarter earnings conference call.

Our fourth quarter net income of $24.5 million or $0.20 per diluted share declined from $37.7 million or $0.28 in the prior year. This represented a net profit margin of 18.8% in the current quarter. Our fourth quarter net income per diluted share was within our forecasted range of $0.19 to $0.23 provided during the third quarter earnings conference call. This represents the 55th 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 fourth quarter, we generated $58 million of cash from operations. The company’s cash and investment securities were $378.3 million at the end of the fourth 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 $39 million of the company’s common stock at an average price of $11.44 pursuant to our stock repurchase program.

Since 2003, we have repurchased nearly $1.3 billion of the company’s common stock under programs authorized by our Board of Directors. Receivables of $68.5 million at the end of the fourth quarter decreased from $87.5 million at the end of the December quarter. DSO at the end of the March quarter improved to 48 days compared to 49 days at the end of the December quarter.

Based on hub [ph] arrangements at our OEM customers and our current customer and channel mix we expect DSO in the future will range from 45 to 55 days. Annualized inventory turns for the fourth quarter was 4.2 compared to 6.9 turns for the December quarter.

Inventory at the end of the quarter was $40.3 million and increased sequentially from $30.2 million at the end of the December quarter. This inventory increase is almost entirely attributable to a successful contract manufacturer transition that we completed during the quarter in order to provide greater scalability. As a contract manufacturer transition was completed by the end of the fourth quarter. We expect that our inventory will decline to approximately $13 million at the end of the June quarter.

Now let me summarize the results for the full-fiscal year. Revenue for fiscal year 2009 was a record $633.9 million, a 6% increase from fiscal year 2008. Our revenue from host products for this period was $440.9 million up 1% from the prior year and our revenue from network products was a $117.6 million, up 16% from fiscal 2008. Our revenue from silicon products was $61.4 million, an increase of 39% from fiscal 2008.

Non-GAAP net income was $154.2 million or $1.20 per diluted share for fiscal year 2009 and represented a net profit margin of 24.3%. During the fiscal year 2009, we generated $221.3 million of cash from operations and purchased 15.8 million shares of our common stock for $205.5 million.

Turning now to the current environment and our responses. It is clear that the macro economic slow down we have experiencing is continuing at this time. It is also clear that enterprise spending on IT infrastructure is proving slow to recover. During the fourth quarter, we continued the actions commenced during the third fiscal quarter aimed at further reducing our cost structure for fiscal year 2010, while protecting the engineering investment necessary to achieve the corporate goals and strategies we have previously outlined.

These measures include a further reduction in headcount, which has been completed along with other employee compensation and benefit measures for fiscal year 2010 such as the elimination of our annual merit increase and the elimination of our 401-K match. We believe we now have our expense structure scaled appropriately for fiscal 2010. We expect total operating expenses including the operating expenses for NetXen to be approximately $215 million for fiscal year 2010, down 3% year-over-year.

Turning now to the outlook for our first fiscal quarter, which includes approximately two-months of NetXen. We expect total revenue for the June quarter to be in the range of $120 million to $130 million. We expect revenue from the combination of the host and network products to be approximately flat. We expect revenue from silicon products to decline sequentially. Due to the potential variation in product mix, we expect gross margin for the June quarter to range from 66% to 67%.

Based on this outlook, combined with the planned operating expenses of approximately $55 million and a projected annual tax rate of approximately 30%, we expect to achieve non-GAAP earnings per diluted share of approximately $0.16 to $0.20 in the June 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 the earnings press release.

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

H.K. Desai

Thanks Simon. I would like to start this portion of the call with a discussion of today’s announced acquisition of NetXen followed by a discussion of our business results and our regular update on strategic initiatives. Today, we announced the completion of the acquisition of NetXen, an established market leader and innovator in enterprise 10 gig Ethernet technology.

We have been engaged with them for several months in various activities. Our conclusion was that NetXen provides a significant complimentary intellectual property and expertise. This will result in QLogic be in better positions to address a wide range of emerging customer requirements in converged network markets.

NetXen’s existing products and technology have already gained acceptance from leading server OEM’s with several products activity shipping. NetXen has been highly focused on next generation Ethernet technology for the past seven years and bring us approximately 90 additional employees roughly half in the US and half in India.

We are impressed with the technical expertise of the NetXen team and welcome them to the QLogic family. QLogic is paying approximately $21 million for NetXen subject to certain closing adjustments. We currently expect revenue from NetXen acquisitions to be approximately $5 million in fiscal year 2010. We look forward to updating you in the future on our product strategies associated with end resulting from this acquisition.

I will now turn to comments on our business results. Despite a very challenging macro economic environment in the second half of our fiscal year, QLogic delivered record revenues of $634 million in fiscal year 2009 with growth in each of our network host and silicon product families.

We also delivered record profitability with net income of $154 million and diluted earnings per share of $1.20. Our revenue in the fourth quarter was $130.5 million a sequential decrease of 20%. Sequentially, revenues from host products were down 21%, network products down 24%, and silicon products down 17%.

Now I will close with an update on our strategic initiatives. Despite the challenging macroeconomic conditions, we are confident that our goals and business strategies are fundamentally sound and our strategic initiatives remain unchanged. We have previously discussed three strategic initiatives, specifically Fibre Channel over Ethernet or FCoE, Fibre Channel, and InfiniBand.

Our focus and investment on these initiatives is as important as ever to ensure that we are optimally positioned for growth and continued market leadership when the economy recovers. Now I’d like to give you an update on each of these initiatives.

In FCoE, we achieved our critical industry leading milestone during the most recent quarter with a public launch of our all new 8100 series converged network adaptors or CNAs based on our internally developed single chip silicon. This network plus architecture the world’s first fully integrated CNA on a chip incorporates memory, processors, and in its hard disk with no external component requirements and is specifically designed for space and power constrained environments such as blade servers and high-density storage systems.

The network plus architecture uses same Fibre Channel stack, Storage APIs and management tool as our industry leading Fibre Channel adopters. Our Fibre Channel stack is the most widely used stack with more than 6 million ports having been deployed.

Based on the Network Plus Architecture our 1,800 series of PCI Express, CNAs are designed for next generation virtualized and unified data centers with powerful multiprocessor multiple servers. These products are available in multiple form factors including standard and Mezzanine cards supporting nearly every OS including, Windows server, Linux, AIX, Solaris, and HP-UX.

The QLogic 8100 Series CNAs also support virtualization platform such as the VMware ESX Server, Microsoft Windows Server 2008 Hyper-Versus and Citrix XenServer, as well as many hardware platforms from IBM’s PowerPC to Intel’s nil [ph].

The QLogic 8100 series CNAs are optimized for both data and storage networking virtualizations with superior 10 gig performance to handle very large quantities of virtual machines. We have been successfully working with Tier One OEM’s in integrating QLogic’s FCoE solutions into their servers and storage system for the past year and believe we have established a significant time to market advantage.

We have secured a significant number of server and storage OEM design wins for which we expect to begin production shipment next quarter. Even in this uncertain economic times, we believe the value propositions for convergence will drive customer demand. FCoE can reduce acquisition in operational cost by requiring less equipment, lowering power and cooling cost, and simplifying management.

In addition, FCoEs 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.

Turning to Fibre Channel, according to recent data from the Dell’Oro Group Q4 2008 SAN report, QLogic continued its undisputed leadership in SAN adaptors. For calendar year 2008, QLogic achieved over 53% revenue market share in Fibre Channel HBAs a full 15-point leader over our nearest competitor widening our lead by 8.4 points from 2007.

In the newest sub category for 8 gig Fibre Channel HBA products, QLogic closes out 2008 with an even more commanding 20 point lead over our nearest competitor. In the expanding blade server market for 2008, we have more than 72% share in revenue of all Fibre Channel Mezzanine cards, widening our leading this strategic market by more than 12 points.

In addition to gaining share during calendar year 2008, based on publically available results for Fibre Channel adopters we believe that we have picked up several share points in the March quarter related to our nearest competitor. Our Fibre Channel Switch initiatives realized further success with announcement of the addition of our transparent router functionality to the HP storage works, 8 gig Fibre Channel of Switch products.

The new QLogic transparent routing functionality allows any active HP storage works Fibre Channel Switch board to be configured as a transparent routing port. This functionality allows customers to control cost and improve productivity by easily managing switches while having room to scale out SAN infrastructures.

Our InfiniBand initiatives continue to deliver positive results. Our true scale QDR switch systems, the 12,000 family is in full qualification at major OEMs and will begin shipping before mid-year. Earlier this week we announced an OEM agreement with IBM for our 12,000 CD Switches targeted at the HBC market.

The QLogic 12,000 series of age [ph] and direct switches based on the companies true scale architectures includes several innovation that made the companies latest technology unparallel in every aspect including scalability and power consumptions. However true scale QBR adaptors announced last year and are on plan and we expect the combination of the two scale switches and HCS to be a solution leader in the market served by InfiniBand.

As we enter over new fiscal year, we remain committed to the goals and strategies we have set. We have scaled our business appropriately to continue to invest in next generation technologies and to establish greater incumbency with our OEM customers, while continuing to drive for strong financial performance.

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

Question-and-Answer-Session

Operator

(Operator instructions) And your first question will come from Aaron Rakers with Stifel Nicolaus.

Aaron Rakers – Stifel Nicolaus

Yes, thanks guys. Couple of questions if I can. I guess first of all on the gross margin line guiding 66% to 67% this next quarter, can you help me understand the decrease in the gross margin guidance here, is that mix shift impacts with regard to the expectations as next quarters or something else going on, and if you can also comment on what pricing will look like on the HBA side that will be helpful?

Simon Biddiscombe

So, I will take the gross margin piece first Aaron. This is Simon. You have identified upon with, there is certainly an element of this that is attributable to mix given that we expect the combination of the host and network businesses to be flat, but the silicon business to be off some. So as an element it is attributable to mix. There is also an element of it attributable to absorption of the manufacturing overhead within the organization, obviously with lower revenues, there are lower purchases of product despite that overhead across as well.

So, it is combination of the two factors, partly mix and partly absorption of the manufacturing overhead that exists within the business. Within the context of HBA pricing, nothing unusual in the most recent quarter. We continue to see the sheer economic pressure if you will from the OEMs for reduced pricing, but I wouldn't characterize there has been any more unusual than the traditional price erosion we've experienced in the business.

Aaron Rakers – Stifel Nicolaus

Fair enough. And also if I can, two other questions real quick. On the OpEx line help us understand why operating expenses given what you’ve said around what you are doing there should be up sequentially is that a sense of conservatism or is there some inputs there that don't necessarily reoccur going forward?

Simon Biddiscombe

So let me help you think about it Aaron. So we said 215 on a full-year basis okay. The $55 million in the current period is primarily because we have the absorption of NetXen to deal within the most – in the current quarter and then we haven't realized all of the benefits from all of the cost reduction activities at this point in time. But the way to think about the 215 of total OpEx that we offered is 55 million in the current. And then you should expect it to decrease roughly $1 million per quarter and maybe it is 52, 53, 52.5 the final quotes of the fiscal year, but this would be the high water mark for the current year.

Aaron Rakers – Stifel Nicolaus

Fair enough. And then final question if I can with regards to the acquisition? Can you help I guess a lot of questions around Broadcom and Emulex going on right now and it appears as the acquisition is somewhat similar in terms of the positioning standpoint, can you help us and then maybe compare and contrast NetXen relative to what Emulex has been doing with regard to server engines and then even what Broadcom's vision is, is it something similar?

H.K. Desai

Let me. I don't know about what is their strategy and it don't want to comment on what they're doing, but let me tell you what we are doing here. So, if you look at, we have announced our QLogic 8100 series converged network adaptors and Mezzanine cards with the significant design wins, this is based on our internally developed silicon's for last couple of years, we worked under silicon and we say that this is going to go, it is that the OEM right now in the qualification and you can start shipping sometime next quarter, earliest.

Next Gen has a 10 gig Ethernet mix how Tier 1 saw OEM design wins and are shipping today. Next Gen also a 10 gig Ethernet long as a Tier 1 server volume design, we just began shipping. What we are trying to do with the combination is that we have a very widely deployed Fibre Channel/FCoE and iSCSI stack, which is deploying the industry for several years. And Next Gen long design wins will address – this combination will address the emerging converged long market for the enterprise servers.

So, I think that is a one benefit to the combination. The second benefit of the combination is that also Next Gen has our 10-gig to capability their off-road in the 10-gig in the silicon and QLogic's widely deployed iSCSI stack for the target customers, so we can also address for 10-gig target markets. So, I think these are two couple of benefits with the combination.

Aaron Rakers – Stifel Nicolaus

Very helpful, thank you.

Operator

And our next question will come from Samuel Wilson with JMP Securities.

Samuel Wilson – JMP Securities

Hi good afternoon, a couple of small questions and then one sort of big one. First, what was head count for the quarter?

Simon Biddiscombe

Exiting the March quarter it was 940-ish, 944, I think Sam, I mean in addition to that we have obviously picked up 90 heads associated with NetXen. So, 944 exiting the quarter, the March quarter and then you would that 90 heads to that.

Samuel Wilson – JMP Securities

Okay. And then can you give us a sense on channel inventory levels, do you think our revenues this quarter where at all influenced by OEM partners taking down inventory levels?

H.K. Desai

I don't there is, we have no inventory with OEMs, as far as the HBA’s and the switch are concerned because we have hub arrangement with them, so they pull from the hub vendor ownership. So, there is no OEM inventory, they carry for our products. The only inventory we can have is usually the silicon because that is the one with the subcontractor. So, I don't think there is any issue on the OEM inventory.

Samuel Wilson – JMP Securities

Got it. And then my sort of bigger question for you H.K. is, if Broadcom is successful in buying Emulex can you just sort of think how will that change industry dynamics for you QLogic?

H.K. Desai

You know it is like, it just happened in the Fibre Channel you know when it started there were about 25 HBA supply and eventually it came down to three for several years and then eventually came down to choose. So, I think there will be consolation happened because now we view two technologies, either storage versus data converging on the Ethernet. So, I think there is going to be some consolation happen and we want to be one of the suppliers and we want to survive that to what we have in Fibre Channels and I think that's the reason we acquire NetXen, so we have more technology now.

Samuel Wilson – JMP Securities

Do you think the pricing dynamics and some of those things will change in the market or do you think they will be somewhat the way they are today?

H.K. Desai

It is like you know, what everyone is thinking that it is the margin is determined by the wires, which is Ethernet versus Fibre Channel, it is not really, the margin is determined by the application you run. So, if you look at Ethernet, if you look at the Fibre Channel, which will give you a storage, and storage has a lot of software involved in this thing. So, at the beta front it is extremely difficult, so we still believe that we'll be able to maintain the margin.

Samuel Wilson – JMP Securities

Okay, thank you.

Operator

Moving on, we will hear from Amit Daryanani with RBC Capital.

Amit Daryanani – RBC Capital Markets

Thanks, good afternoon guys. Just a couple of questions, one on NetXen, just talk about how much for impact is it on your OpEx lines in the next quarter and then secondly I believe that probably qualified at some of your bigger customers, but specifically are they qualified Sun as well?

Simon Biddiscombe

So, we're not breaking out the impact they've had on operating expenses Amit. What we have decided to do is give you the outlook for the year inclusive of NetXen and obviously inclusive of the cost reduction activities that we as QLogic have undertaken over the course in the last quarter, in fact it is six months if you include the stuff that started as early as November. So, we are now going to break out the very specific costs associated with NetXen. Surprise to say, on a year-over-year basis, even absorbing NetXen OpEx is still going to be down by approximately 3%. The second part of your question, say it again.

H.K. Desai

I think I can answer it, it is NetXen Ethernet stack is qualified at HP and IBM.

Amit Daryanani – RBC Capital Markets

All right. So we have a potential to get together with some of the other vendors I guess, right?

H.K. Desai

Yes, definitely.

Amit Daryanani – RBC Capital Markets

And then just, just on the inventory uptick, just to make sure I get this clear, I mean essentially you saw a big bump up is it transitioning your contract manufacturers and that should skill [ph] down as the new one ramps up next quarter?

Simon Biddiscombe

Yes. So we went through a contract manufacturer transition in the March quarter, we moved that to one and into another and as a result of that we ended up taking from the contract manufacturer certain raw materials and finished goods at the end of March that will be transitioned into the new contract manufacturer over the course of the June quarter. So, we essentially will let go in the inventory for a short period of time when we were eight of the one, but not fully into the other. So, once we put that inventory into the correct location, we will see our theological inventory backed down to a more traditional $30 million kind of range, come the end of the quarter.

Amit Daryanani – RBC Capital Markets

Got it, thanks a lot guys.

Simon Biddiscombe

Appreciate it.

Operator

From Goldman Sachs, we will hear from Min Park.

Min Park – Goldman Sachs

Yes, great, thanks very much. It seems like you gained a pretty healthy chunk of market share this quarter basically for sure key competitor down the sheet, I mean HP revenues are pretty weak year-over-year, so you can just give us a bit more color on what you're seeing as far as demand? Linearity may be month-to-month and what you might be seeing in the first part of the June quarter please?

Simon Biddiscombe

Sure, Min, this is Simon. I think when you look at the server numbers that are right there, it is very clear that the macro is driving a tremendous amount of the issue that is being experienced by the server vendors and that obviously trickles going to us as a storage HBA vendors in this case, so whilst we were very pleased to have been able to pick up share versus the principal competitor in March there is no doubt that the macro impact on the total HBA market is something that we are both suffering from at this point in time.

In terms of the trends in the quarter, as we said on a previous earnings call, January was particularly weak. February and March were certainly more stable, although the end of March didn't deliver the type of performance that we would expect to have seen very much in that very end period. Current trends within the context of April, we built all of that into the guidance that we have provided. So, I wish then to tell you how things have progressed over the course of the last few weeks, we think we have captured everything that we need to within the context of $120 million to $230 million worth of revenues.

Min Park – Goldman Sachs

Okay, great. And then, can you give us a sense of how Fibre Channel revenue performed versus your other protocols?

H.K. Desai

I think similar because most of our revenue even in the host side is Fibre Channel versus iSCSI. So I think it is a similar number.

Min Park – Goldman Sachs

It is a similar number, okay. And then just lastly, again on the acquisition, it seems that one of the reasons why you're looking at this is just for NetXen's 10 gigabit technology and then if I look at your competitors CAN that is out there that's been qualified with OEMs, our understanding of that is actually is fully multiprotocol including 10 gig with offload engines. So, are you still, does this acquisition suggest that you are actually still kind of catching up to Emulex’s product or is this for next-generation product that you are seeing down the road?

H.K. Desai

What we are seeing is – what we are doing is that we have our own silicon, I think the key really is that we have our own internal developed silicon, which we are releasing with our 8100 series converged network adapters and there we will be start shipping, so there is a qualification, it is going on to the customer. What we are saying is that going in the future there is another market, which is so-called a enterprise long for the converged networks. When the LAM is that they also want to run on the Fibre Channel protocol. So NetXen has a qualification done for their LAM and we want to port our stack onto the NetXen silicon so we can also provide the functionality for the lam. The second thing is also what we are missing in our product is the off-load for the 10 gig iSCSI and if you look at our one gig iSCSI, we have deployed almost all the target customers and we are looking for the 10 gig with off-load, so we tell you the NetXen silicon's we can port our one big port, which is widely deployed and we can address the target market.

Min Park – Goldman Sachs

Great, thank you very much.

Simon Biddiscombe

Thanks, Min.

Operator

From Morgan Keegan, we will hear from Harsh Kumar.

Harsh Kumar – Morgan Keegan

Hi guys, couple of questions. NetXen looks like mostly a technology acquisition, HK said 5 million revenues total, does it have any revenues at this point in time or are you looking out in the future for revenues?

Simon Biddiscombe

No, H.K. Harsh, did say that it is 5 million over the course of the fiscal year, the impact in the current is minimum.

Harsh Kumar – Morgan Keegan

And what is your plan for accretion for this company or should we not look at that way and look at it is as a technology acquisition again?

Simon Biddiscombe

You shouldn't think about it in terms of accretion and dilution. That is not the right way to think about what we have here. You should think about it within the context of the technology that we've acquired. The broader market that we're able to serve as a result of the technology we've acquired and the fact that it will result in QLogic been able to serve a bigger Sam as we move forward.

Harsh Kumar – Morgan Keegan

Okay, got it. And then your competitors gave out a couple of design win numbers, a handful of them five or six, if I get exactly, do you have any design wins right now for 8100 or is too early to ask?

H.K. Desai

I said Harsh, they will be start shipping the product next quarter.

Simon Biddiscombe

In production, next quarter.

Harsh Kumar – Morgan Keegan

Okay, fair enough. And then last question from me, are you seeing Brocade having any impact whatsoever and the host was set at aftermarket or is this – or is it just kind of planning at this point in time?

H.K. Desai

The only thing I can tell that we haven't seen any impact on our business.

Harsh Kumar – Morgan Keegan

Got it, thanks, guys.

Operator

And moving on, from Wedbush Morgan we will hear from Kaushik Roy.

Kaushik Roy – Wedbush Morgan

Thank you. My questions are also on FCoE and CNAs, are you selling any CNAs today or can you comment what kind of revenues you are expecting from CNAs in let’s say this fiscal year, if you cannot comment what your revenues might be, can comment what the trend [ph] may look like in the next 12 months?

H.K. Desai

So let me, Kaushik the key really is that we are working on the CNA for last about 2 to 3 years, so we are working on their own silicon, I think that is a key in turning to our silicon. Because we believe that in this market my experience is that if you don't have a tool IP is one of silicon and the other is software you should be out of the business, you should not be even because you'll have a lot of impact on the margin. I look at iSCSI time frame three years ago, you might long time ago, and everybody who doesn't have their own silicon they did not survive, I mean there are so many HBA supplier. So our strategy is that we want to make sure that we are one silicon, we are working with the customers, we are designing and they are going to start shipping in production if the schedules stay in next quarter. So, it is difficult to predict what the revenues going to be because it is a brand-new market, so we don't know when they will get the traction, but we expect some revenue little revenue in 2010 and meaningful revenue will come in 2011.

Simon Biddiscombe

What I would add to that Kaushik is the fact that nothing changes with regard to the QLogic FCoE positions that we talked to you through over the course of the last year. There is no change to what we've previously communicated.

NetXen as we have said brings adjacencies that we think are a very nice fit for us in terms of broadening the market in certain technologies, but they bring along with them so nothing changes with regard to anything we've ever told you about our internally developed FCoE solutions.

Kaushik Roy – Wedbush Morgan

And H.K. you mentioned that the margins for CNAs is determined by applications, so you may be able to maintain margins, but there will be more vendors in this market more than just two like in Fibre Channels, so do you still expect margins to be into the high or mid-60s or do you think because there'll be more vendors as you may?

H.K. Desai

Well I mean if you look at you considering storage versus what the (inaudible) running the storage, if you look at the iSCSI the adapted marginal was always mid-60s, if you look at Fibre Channel vendor and also Fibre Channel vendor when they started Fibre Channel in 1997 there were about 25 different suppliers and eventually came down to three and two. So, on this one also I'm not saying that margin is going to be 70 or 65, I cannot predict that anyway because the volume is going to be different. So, I think it is really – what we've believe in the way the storage is, I think we'll be able to there will be reasonable margin in this.

Kaushik Roy – Wedbush Morgan

And then are you planning to build Ethernet switches that are FCoE aware because you have the FC switching technology?

H.K. Desai

Yes I said what we are doing our strategy on the switching is that we have a Fibre Channel stack for the switching technology so we are working, we are partnering with some of the companies and will provide them the technology either with silicon or as a module or building the box, but we are not going to go, currently we have no plan to blow with Ethernet switching.

Kaushik Roy – Wedbush Morgan

Last question. So, what is your relationship with Juniper right now, are doing some kind of joint development work or on the Fibre Channel switching or if you can comment that will be helpful, thank you.

H.K. Desai

I think you know more than us on this thing anyway. But I really cannot make any comment on those things.

Kaushik Roy – Wedbush Morgan

Okay, great, thanks.

Simon Biddiscombe

Thanks, Kaushik.

Operator

And from J.P. Morgan and we will hear from Mark Moskowitz.

Mark Moskowitz – JPMorgan

Yes thank you. Good afternoon. I don't mean you flipped on but it kind of builds some similar questions and just trying to get a greater sense H.K. you talked earlier about Fibre Channel HBAs has collapsed for than 20, 25 vendors over the lifecycle here and now there is only two in Brocade coming in but, you know when I think of the CMA, it sounds like it is becoming more or less a McCord on stair really. Does that really more or less undermine your HBA dominance in the firmware side more than the ASIC side and how should we think about that from a competitive take off here, are we going to see rather that the contraction, but actually the expansion of the competitive landscape going forward now and what are your thoughts there?

H.K. Desai

I think the key for us is that really we are expanding the market now right because we're going into the – towards storage and the data networking. I think the margin question – it is not the wire determining the margin, it is the application you run the wires, like I say. I think the storage is the one because of the software and the management software and all those requirements it always have better margin than Ethernet, now when it all combines together actually it is very difficult to predict, but I think it is going to be lot of opportunity for lot of new players in this market.

Mark Moskowitz – JPMorgan

Okay and then shifting gears over to the network side as far as the InfiniBand side of the world, the year-over-year comp doesn’t seem to be too bad and specifically given the environment, can you just talk about how much of that was related to new customer wins and what verticals or regions those wherein versus a channel fill based from the new product you've introduced.

Simon Biddiscombe

Very little of it has been based on the new products we’ve introduced to date Mark. Those really are hitting the market as we speak. So whilst they were introduced to head of Supercomputer ’08 it back in the October November time frame it is only now that they're beginning to go into production. So, essentially everything that we sell continues to be the older generation of products let's say. We continue to serve a broad set of verticals and that continues to be education, it continues to be those enterprise markets where these solutions are deployed, but I wouldn't characterize any of the year-over-year growth that we've experienced has been from significant new OEM relationships from being of significant new markets that we are participating in nor from being significant new products.

Mark Moskowitz – JPMorgan

And then just lastly here, in terms of the market share commentary can you help us again kind of reconciled what QLogic's has for just what you're other major peer down the road says in terms of market sure versus the fourth quarter versus, excuse me the fourth quarter of calendar '08 versus the first quarter of calendar ‘09, it just seems like there's a lot of noise out there. Are you guys looking at differently from a port perspective versus revenue verse, please can you help us understand that?

Simon Biddiscombe

The way we look at it is revenues, okay. And, primary revenues, let me answer it that way. And the data is very clear, we captured share during the calendar year 2008. It is the case that the principal competitor did take share in the fourth quarter of 2008, okay. So, on a full-year basis we exited the year in a much better position than we entered the year as we reflected on in our prepared remarks and based on the limited information that is available at this point in time based on what's been said by us and by them over the course of last few days, based on our math it would appear that we've been able to take share away from them in the March quarter and actually that is what we expected, in our prior communications we have indicated that we did expect to take share back from them in the March quarter, and it appears to have played precisely that way.

Mark Moskowitz – JPMorgan

Is that because of one particular plat form of one particular customer arrangement?

H.K. Desai

I don't think we can even predict that.

Mark Moskowitz – JPMorgan

Okay, that is fine, thank you.

Simon Biddiscombe

Appreciated.

Operator

And moving on the way, we'll hear from Jason Noland with Robert W. Baird.

Jason Noland – Robert W. Baird

Thank you just a follow-up to the previous question, what H.K. had said and what would you share expectations be going into fiscal 2010 is your share level, where it is today sustainable?

H.K. Desai

I think it is really difficult to say that, I mean the only thing I can say historically we have gained share last three or four years in a row. Last year we gained about 8.5, 12 points, we lost some share in December quarter and then I think we gained the share back in the March quarter. I mean going forward it is very difficult to predict, I don't know, I can predict, but that won't happen. I think the only thing I can tell you that we have great products, we have 8 gig products, which is qualified everywhere, pretty good challenge business and will see what happens.

Jason Noland – Robert W. Baird

And then could you talk about the role of InfiniBand in the CNA market if any or maybe the better question is in the converged systems market?

H.K. Desai

We are focusing and we believe that InfiniBand is right now suited for the HPC market. All our focus in high focus computing market for both switches and HCA and that's where we're focusing.

Jason Noland – Robert W. Baird

Okay. And then last question from me on CNA, maybe asking the same question in a different way, but between the Ethernet vendor's and the Fibre Channel vendors I guess, which group is better positioned if at all technically and then from go to market standpoint?

Simon Biddiscombe

We obviously think it’s the Fibre Channel vendors, we saw that for an extended period of time and it would appear based on other transactions of trying to occur in the market in this point in time. Others believe that the incumbency of the Fibre Channel capability is critical to be unsuccessful in the market. The Fibre Channel capability, the software stack is incredibly sticky and as H.K. said, we've got 6 million ports of our solution deployed in the market at this point in time. That is entirely backward compatible with everything that we do in the CNA space at this point in time. So in order to be able to realize the full benefits of the converged network, it's enormously helpful if you can talk to the massive installed base of QLogic software or the competitor software actually that exists in the market this point in time. I think that's exactly why you are seeing in some of the activities that are going on at this point in time.

Jason Noland – Robert W. Baird

Thanks, guys.

Operator

(Operator instructions) And from Needham & Company, we will hear from Glenn Hanus.

Glenn Hanus – Needham & Company

Good afternoon guys. Are you willing to maybe just give us a little bit of color qualitative comment on your – you said host and network combined would be flat, should we assume both should be more or less flat or is one little stronger than the other.

H.K. Desai

I think Glenn, we have tried these in the past and we actually failed anyway. It's really – I think it's so close, so it's very difficult to predict which way it goes anyway, but I think that's what we cannot predict, which one is growth and which will be flat, so I think we will be saying that the combined is probably a better way to say that it will be flat.

Glenn Hanus – Needham & Company

Can you comment at all on this kind of the interest level and licensing your Fibre Channel switch technology to various third parties, and just the level of interest and what's been happening that you can comment over the last couple of months.

H.K. Desai

I'm not ready to make any comment on that yet.

Glenn Hanus – Needham & Company

Maybe lastly, could you summarize your view, I’m sort of asking similar question in the past but could you just kind of summarize your view of your CNA approach and architecture versus your cheap competitor?

H.K. Desai

I don't know what is the difference – I think what we are doing is that we have two prone approach on these things, we will continue our development with our 8100 Series converged network adapters and I think we have – I mean we have done with (inaudible) development and we are even started shipping that and then we want to expand the market when you're in the LAM and the motherboard for the converged networks for the enterprise that was – I think we are going with the NetXen architectures and we can run our Fibre Channel stack and iSCSI stack, which is widely deploying this, that's what they are looking for and then also use them as iSCSI target.

Glenn Hanus – Needham & Company

Okay, thank you.

Simon Biddiscombe

Thank you, Glenn.

Operator

And from ThinkEquity, we hear from Rajesh Ghai.

Rajesh Ghai – ThinkEquity

Yes, thanks for taking my questions. Your guidance for first quarter of fiscal ’10, what are your assumptions for ASP decline, server shipments and the increase in virtualization in terms of servers shipped?

Simon Biddiscombe

So we don't look at virtualization within the context of quarter-to-quarter changes, that’s too far away from the reality of what we are able to deal with from a data point, so typically as we build our guidance the assumptions are based on the forecast that we are seeing from the OEM customers and the channel customers around the volumes of HBAs that they are going to – over the course of the quarter. So we are not building it based on server assumptions because the rate of attach is growing, we are not based on virtualization assumptions, again even though if we did the rate of attachment in virtualization of the Fibre Channel HBA is actually far higher than it would be in non-virtualized environment. So, we don't think of that way, but we are far more close to the actual volumes of HBA's that are being forecast across the hubs in the channel.

Rajesh Ghai – ThinkEquity

Okay. And if you talking of the Next-Gen acquisition, your focus about 5 million revenues for fiscal ’10, is that from products that Next-Gen has currently or is that – does that include products that may be integrated into (inaudible).

H.K. Desai

No, the product we have currently.

Rajesh Ghai – ThinkEquity

And as far as the 8-gig transition for 4-gig is concerned, what’s the outlook right now, how far vis-a-vis from 50%?

Simon Biddiscombe

We are still a long way to go until we get 50%, the vast majority of what we shipped today continues to be 4-gig, but it is the case that 8-gig grew again in the March quarter, so even against a backdrop of a total HBA market the decline sequentially. The 8-gig numbers do continue to grow on quarter-to-quarter basis.

Rajesh Ghai – ThinkEquity

Okay. And talking IBM Brocade alliance was (inaudible) with millions of Ethernet side, do you see any of that kind of creeping up into the Fibre Channel HBA side also and affecting your business or do you see it's exactly going to be determined of end-user level and won’t affect your business as much.

H.K. Desai

I don't know, there is no comment from us on that.

Rajesh Ghai – ThinkEquity

Okay. And can you – from a modeling purpose, can you comment on your CapEx forecast for fiscal ’10 and about your share buyback plans?

Simon Biddiscombe

Share buyback, historically we've used some of what close to free cash flow, cash generated from operations in free cash flow, and you can see that very vividly in most recent year, in the most recent year we generated $221 million worth of cash and be bought back $205 million worth of cash. So there is really kind of no change in our perspective around how we are going to deal with the buyback. From a CapEx perspective, we are looking at somewhere kind of $30 million number.

Rajesh Ghai – ThinkEquity

Alright, thanks for taking my questions.

Simon Biddiscombe

Thanks.

Operator

And we will hear from John Punk [ph] with BMO Capital Markets.

John Punk – BMO Capital Markets

I want to ask on the last question about 8-gig, what will be the impact with the ramp in 8-gigs on your gross margins?

Simon Biddiscombe

Virtually nothing. The 8-gig gross margin is almost identical to 4-gig gross margin.

John Punk – BMO Capital Markets

Okay. Simon, on your last call you talked about your goal of reaching 30% on margins, is that primarily revenue driven or whether there are opportunities in calls for OpEx?

Simon Biddiscombe

Yes. So we still hold out for the long-term model, which is to generate 30% operating margins. Now it's very clear that in this tough environment that we are operating through in 2010, it's going to be very difficult to get a 30% type of number. However as we move forward and those revenue starts to recover, we kind of hold that as our target. The target for this business is to generate 30% operating margins and we expect with revenue recovery to get back to that. On the OpEx side, I think we are comfortable with where we are at this point in time, it's a question of seeing revenues recover.

John Punk – BMO Capital Markets

Okay, great. Thanks.

Operator

And your final question will come from Harsh Kumar with Morgan Keegan.

Harsh Kumar – Morgan Keegan

Hi, guys, just trying to understand maybe being a little picky here, why is silicon declining so much more, is it a customer issue and any kind of help and then I've got one last one as well.

Simon Biddiscombe

It’s three reasons why silicon is expected to decline over the course of the next set of quarters in reality Harsh. Number one is obviously the macro, correct. Number two is, we’ve continued to go through the mass card conversion, so previously would have sold silicon solutions, today we are selling Mezz card solutions, so the silicon revenue continues to decline and is offset by growth in the Mezz revenues. And the third part is just in the context of the target business, the conversion from Fibre Channel drives to SAS drives, which is were some of those Fibre channels’ silicon products have served capability, right. So there is really three reasons as we look into 2010 generally, macro Mezz card conversion and then Fibre Channel SAS on the drives.

Harsh Kumar – Morgan Keegan

Got it. Simon, my next question I'm going to ask is to be brave and ask you, if you want to comment if you expect to see normal seasonality that is growth in the second half this year?

Simon Biddiscombe

My crystal balls are not as good as some Harsh, I think we will hold that book for another 90 days and you can ask me the same question again in early July.

Harsh Kumar – Morgan Keegan

Very well, guys, thanks.

Simon Biddiscombe

Thank you.

Operator

And Mr. Biddiscombe, I would like to turn the conference back over to you for any additional or closing remarks.

Simon Biddiscombe

That concludes our call for today, we look forward to updating you on our progress next quarter. Thanks for your time and goodbye.

Operator

Ladies and gentlemen, that does conclude today's presentation. We do thank everyone for your participation.

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Source: QLogic Corporation F4Q09 (Qtr End 03/29/09) Earnings Call Transcript

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