Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

James M. McCluney - Chief Executive Officer and Director

Michael J. Rockenbach - Chief Financial Officer, Principal Accounting Officer, Executive Vice President, Secretary and Treasurer

Jeffrey W. Benck - President and Chief Operating Officer

Analysts

Vlad Rom - Crédit Suisse AG, Research Division

Aaron C. Rakers - Stifel, Nicolaus & Co., Inc., Research Division

Andrew J. Nowinski - Piper Jaffray Companies, Research Division

Rajesh Ghai - Craig-Hallum Capital Group LLC, Research Division

Bill C. Shope - Goldman Sachs Group Inc., Research Division

Glenn Hanus - Needham & Company, LLC, Research Division

Srini Nandury

Emulex (ELX) Q3 2013 Earnings Call May 2, 2013 4:30 PM ET

Operator

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

James M. McCluney

Thank you, operator. Good afternoon, everybody, and welcome to Emulex's Third Quarter Fiscal Year 2013 Conference Call. I'm Jim McCluney, CEO of the company, and with me today are Jeff Benck, our President and COO; and Mike Rockenbach, our CFO. Mike will start off with prepared remarks for the third quarter results, and I will follow with my comments on the current business climate and the Endace business. And Jeff will provide more color on the results for the quarter, the Endace integration and our key initiatives over the next couple of quarters. I'll close off our prepared remarks with some summary comments and observations, and then we'll open the line for questions. So with that, over to you Mike.

Michael J. Rockenbach

Thanks, Jim. By now, you should have Emulex's third quarter 2013 earnings release, which was issued earlier this afternoon. If you do not have a copy, the press release is available in the Investor Relations section of our website at www.emulex.com.

The press release in this presentation contains forward-looking statements including, but without limitations, statements regarding Emulex's business, operations, ongoing patent litigation and related mitigation efforts, the recent acquisition of Endace and the anticipated financial results for our fourth quarter of fiscal 2013 and beyond. These statements are subject to a number of risks and uncertainties, and our actual results may differ materially from those discussed in the forward-looking statements. Those risks and uncertainties are highlighted in our earnings release and under the heading Risk Factors and Emulex's most recent annual report on Form 10-K and quarterly reports on Form 10-Q. We undertake no obligation to update the forward-looking statement.

During the call, when we use any historical non-GAAP financial measure, you will find the reconciliation to the most directly comparable GAAP financial measure in our earnings release. All of the references we will make today relate to our non-GAAP results unless stated otherwise. Today's conference call is being webcast, and the recording will be available on the Emulex website through April 2014.

I would also like to remind participants that if you decide to ask a question, it will be included in both our live transmission, as well as any future use of the recording.

Now let me review our preliminary results for the quarter. Sales for our third quarter came in at $117 million, which included $5 million from our newly acquired Network Visibility Products, or NVP. Excluding Endace's NVP products, the 120 -- the $112 million in revenues was at the midpoint of our guidance of $110 million to $114 million provided on our earnings call in January.

Diluted earnings per share of $0.20 included a $0.06 benefit related to the retroactive portion of the federal R&D tax credit. Excluding this benefit, our results were at the high end of our guidance of $0.12 to $0.14.

Taking a look at revenues by product line, let me start off with our new product line, which we are calling Network Visibility Products or NVP. The NVP product line is our family of network visibility and intelligent network recording products which were added to our portfolio and included in our financial results with the acquisition of Endace on February 26, 2013. Net revenues for this stub period contributed to $5 million or 4% of our Q3 results.

Before I continue with the review of the third quarter, let me take a minute to provide some color on our expectations for NVP going forward. Endace is a New Zealand based company, so on a stand-alone basis, their financial reporting was prepared in accordance with International Financial Reporting Standards or IFRS. And as a U.S. based company, Emulex reports in accordance with the U.S. GAAP. There are a number of differences between the 2 methodologies, so the historical comparisons aren't as meaningful as you would normally see.

In addition, the accounting treatment for an acquisition requires that the deferred revenue on the balance sheet associated with maintenance support is written down to the estimated cost to service such revenue at the time of acquisition. Taking these factors into account, we expect the NVP will comprise as much as 8% of our fourth quarter revenue, and looking forward, we expect it to expand to more than 10% of our total business in the next fiscal year.

Now let me continue on with the review of our third quarter results. Our second product line is Network Connectivity Products, or NCP, which represented 73% of our net revenues this quarter. The NCP product line consists of Fibre Channel and Ethernet products that are used to connect servers and storage arrays to a Fibre Channel storage area network or through an Ethernet network.

NCP net revenues totaled $85 million, which was down from the seasonally strong quarter in Q2 and from the comparable quarter of the prior year. On our last earnings call, we highlighted that during the March quarter, or 10Gb revenues would see some residual impact from the burn-off of the 10Gb LOM inventory, and 10Gb revenues for the third quarter were essentially flat with the second quarter. With the inventory burn largely behind us now, we expect to see 10Gb revenues grow in Q4.

Net revenues for our Storage Connectivity Products or SCP totaled $21 million, accounting for 18% of revenues for the quarter. SCP revenues decreased 8% sequentially and 25% from the third quarter of last year, which had benefited from some end-of-life sale. Net revenues for our Advanced Technology and Other Products or ATP were $6 million.

For the June quarter, we will be reporting our results with the 4 same product lines. Beginning with the first quarter of FY '14, we will be using a 3 product line format. NVP and NCP will remain the same, and we will combine SCP and ATP into a single product line.

Turning to margins, our third quarter gross margins improved on both a sequential and year-over-year basis, coming in at 65% of revenues. For the fourth quarter in our core business, product mix is driving margins down slightly. However, with the full quarter results and our higher margin NVP business, we expect to maintain gross margins of 65%.

Looking forward to FY 14, we anticipate that gross margins in the core business will trend down 1% to 2% per year as we reenter the U.S. Ethernet market with our redesigned products. However, as previously mentioned, deferred services revenue were written down as part of the acquisition for our NVP business, and historically, these deferred revenues have higher gross margins. So as we rebuild this annuity revenue stream through these bookings, NVP gross margins will increase. We expect this will offset our gross margin erosion by at least 1% in fiscal 2014.

Moving on to operating expenses, OpEx for the quarter came in at $61 million or 52% of revenues, which is a sequential increase of $4 million. The inclusion of Endace's operating expenses for part of the quarter made up most of this increase. Excluding Endace, operating expenses were essentially flat compared to the December quarter. As a reminder, the start over of U.S. payroll tax matching at the beginning of the calendar year adds an incremental $2 million to our operating expense, but we were able to essentially absorb all of this increase.

Even with the incremental operating expenses from Endace, we expect to meet our previously stated goal of holding OpEx at 50% of revenues for the full fiscal year. Patent litigation expenses were well under $1 million again this quarter, primarily due to the push-off of the retrial. Looking forward, we expect quarterly patent litigation expenses will be in the $1 million to $2 million range for the remainder of the calendar year.

Operating income for the quarter was $15 million or 13% of revenues, and third quarter net income came in at $18 million or 16% of revenues. On a GAAP basis, third quarter gross margins were 58% of net revenues, and GAAP operating expenses for the quarter totaled $72 million or 62% of revenue.

GAAP operating expenses included $3 million related to the patent mitigation efforts, $1.5 million of amortization of intangibles, $5 million of equity-based compensation charges and $1 million of expense related to the recent acquisition of Endace. These charges are excluded from our non-GAAP results.

Our Q3 GAAP results are based on the preliminary purchase price allocation, which resulted in a GAAP operating loss for the quarter of $4 million and a GAAP net loss for the quarter of $7 million or 6% of revenues.

Turning to balance sheet, we exited the March quarter with $92 million in cash and investments. Before I discuss our targets for the fourth quarter of fiscal 2013, I want to again remind everyone that our public filings with the SEC and our Safe Harbor statement included in our press release discuss the risk that can affect our future performance causing actual results to differ materially from forward-looking statements. Based on the current operating environment and the recent forecast from our customers, we're modeling for revenues of $118 million to $122 million for our fourth quarter ending June 30, 2013. Using a tax rate of approximately 10%, we anticipate non-GAAP diluted earnings per share in the range of $0.11 to $0.13 for the fourth quarter.

On a GAAP basis, we expect a loss per share of $0.12 to $0.14. Our fourth quarter GAAP results will include approximately a $0.25 impact for stock-based compensation, amortization of intangibles, costs associated with the Endace acquisition and the royalty mitigation expenses and license fees associated with the patent litigation, as well as the associated tax impact in U.S. valuation allowance.

Now let me turn the call over to Jim.

James M. McCluney

Thanks, Mike. Let me share some observations on the current business climate and also provide an update on our new Endace-based Network Visibility product line.

Some of our larger OEMs and other infrastructure players have already reported results for the March quarter, and clearly the current business climate remains mixed. Combine this with our new term headwinds in the Ethernet market that we have previously discussed and you can see the we are in quite dynamic times for the company, but we are prevailing and producing solid results.

I'm pleased to report that the team did an outstanding job of staying focused on meeting our business and financial objectives for the quarter while simultaneously completing the Endace acquisition. We achieved the midpoint of our revenue guidance and the high end of EPS guidance. Looking at the fourth quarter, we are guiding for the top line to go as much as 4% over the third quarter. There will be more operational results from Jeff in a moment.

Now that we have completed the acquisition of Endace, I wanted to remind you why Endace is so strategic for us and why this is a truly exciting opportunity for Emulex and their shareholders. The thesis is very straightforward: Companies are facing a common challenge to deliver their products, business operations and customer service over a network that is secure and provides for the highest quality and the best possible customer experience. To meet this challenge, the Endace Network Visibility Products provide the essential information for next generation network management by delivering full packet capture capability.

For example, in 10Gb Ethernet networks, Endace products reduced to resolution of issues by 40%, thus, is the standard NPM solutions that don't provide 100% packet capture. And the challenge only gets harder as networks become faster and at the same time become converged, virtualized and software defined. Endace products provide a new class of network capture that we believe will be a requirement for every enterprise, cloud and network provider to meet their business demands.

Today, IT managers are suffering from what has been dubbed death by dashboard. We have dozens of single-purpose tools and detection systems that will allot them if a problem has a cog. But because their current ATM and NPM systems cannot scale the packet capture capabilities beyond 1Gb networks, IT managers are not able to resolve problems they knew exist in their network and security operations.

Just like a web search engine, Endace appliances provide a new class of network search capabilities that enable every dashboard to get the exact network traffic they require to move beyond detection and into resolution of the network issues.

The Endace product line is a platform that works with network management and APM and NPM detection systems to provide just the right network traffic information for multiple environments. Many Fortune 2000 companies already deploy Endace appliances across a wide variety of verticals, including leaders in finance, cloud, broadcast media, telco and government agencies. These customers utilize Endace products for the very reasons I described, network performance and network security.

We see an accelerated growth opportunity for Emulex in this new market. And with Emulex and Endace combined, we believe we can grow the revenues for this business faster than the market. Now let me turn the call over to Jeff to give you an update on our integration progress and some of the key highlights from operations. Jeff?

Jeffrey W. Benck

Thanks, Jim. Today, I want to focus on 2 topics. First, I'd like to cover what we have already accomplished on the integration of Endace and provide some insight into our next steps for the network visibility product line, then I'll follow up with an update on our NCP business. Mike Riley, the former Endace CEO, reports directly to me as the General Manager for Emulex's Network Visibility Products. Sales, product management and engineering will continue to report directly to Mike in this new division.

We're excited about leveraging our new network recording center of excellence based in New Zealand across the rest of Emulex.

The integration is going very well, starting with key back office functions, like HR, IT and finance. But we are also centralizing corporate marketing functions for added synergies. We've already consolidated HR and Payroll for the U.S. employees, and we will see immediate savings from the elimination of duplicate costs associated with being 2 public companies, including expenses such as listing fees and Board of Director costs.

Over the next fiscal year, we will consolidate to 2 ERP systems, which will provide additional synergies from manufacturing operations and G&A.

On the sales and marketing front, we are focused on accelerating some of the initiatives that were already underway at Endace, including increasing our brand awareness, channel expansion and partner development. We are also identifying opportunities to leverage the Emulex field sales team to reach into a lot of enterprise accounts where Endace was not already present.

If you were with us for our conference call in early December, one of the things we highlighted was the strong go-to-market alignment between the 2 companies. All of Endace's sales force is focused on end users and indirect channels. While our traditional NCP business is OEM-focused, about half of our sales force is focused on the channel and end users at major global customers too. This go-to-market synergy plus our ability to accelerate geographic growth in the Endace sales force will quickly provide scale to the Endace team.

I'm particularly excited that Endace has added over 10 new enterprise class customers for their appliances just since December and our proof-of-concept pipeline is growing fast. In support of Endace's sales expansion strategy, we will surely be announcing a new head of sales for NVP. This individual is a seasoned veteran with deep experience calling on end users and building out channels, and also has extensive -- has an extensive set of end user contacts.

Turning now to NCP, let me provide some color on our current view of the Connectivity business. Our 10Gb business was flat quarter-over-quarter, as the OEM inventory we discussed on the January call took a bit longer to burn off than anticipated. With that activity essentially behind us now, we are modeling for sequential growth in our 10Gb business. Even with our headwinds, we have maintained our position as the clear #2 in 10Gb revenue share, and we are continuing to make solid progress on design wins with our redesigned ASICs with new sturdy subsystems. With these solutions, we look forward to being able to reengage with the U.S. channel, new OEMs and cloud customers this year.

We are very excited about the reception that our 40 gig products and RoCE strategy are getting with server and storage OEMs, as well as cloud customers. These customers have asked for low-latency Ethernet with a broad choice of protocols and virtualization capabilities to accelerate their networks. It's a simple story and leverages their Ethernet know-how and operational processes and, more importantly, avoids leaving them with InfiniBand as their only choice.

The market is clamoring for our new Ethernet solutions as we have assembled just the right set of differentiated capabilities in an integrated platform that the competition just can't match. Our unique advantages in virtualization, software-defined networking, Fibre Channel over Ethernet and RoCE have allowed us to secure new OEMs and next-generation platform design wins, so our momentum is building.

Lastly, our Fibre Channel business continues to perform well even though our largest server customer is experiencing some challenges. We continue to gain share over our biggest competitor for the third year in a row and have closed the GAAP between the companies to only 3 points based on the share results of the December quarter.

We experienced solid year-over-year Fibre Channel growth in the March quarter, which included strong participation by our storage target business. In fact, based on our current forecast for the full fiscal year, we would have grown our Fibre Channel plus FCoE revenues over the prior fiscal year.

According to Dell'Oro, we gained 4 points of overall Fibre Channel revenue market share over our nearest competitor for the calendar year 2012. Add this to our early leadership position to the 16-gig Fibre Channel and we believe we can continue to gain share. We are launching a number of new 16-gig Fibre Channel OEM design wins during the first half of this calendar year. While the 16-gig Fibre Channel upgrade cycle hasn't hit full stride yet, we remain excited about the prospects for our core business, given our PCI Gen 3 performance and power advantages.

Emulex continues to invest on our core storage business that is based on traditional block I/O. According to Dell'Oro and Crehan Research, the block I/O market that includes Fibre Channel and FCoE will sustain CAGR of 5% to 6% throughout 2016.

As you can imagine, we're very busy at Emulex and we are fortunate to have a dedicated team that continues to look for operating efficiencies and smarter ways to solve customer problems. Investors can rest assure that the core Emulex business will not be distracted by the Endace opportunity, and it is for this reason that we have structured NVP as a separate focused division.

Obviously, we're excited about the future opportunities we see with our Network Visibility Product line, but it goes beyond that as we see other ways to leverage our strength in Ethernet connectivity to provide a new class of integrated solutions that will connect, monitor and manage networks in a world of software-defined infrastructure. I look forward to updating you on our progress on the next conference call or at upcoming conferences. With that, let me pass it back to Jim.

James M. McCluney

Thanks, Jeff. Before we take your questions, I'll give you a few closing comments. The current business environment does remain challenging, but we have made our objectives for the March quarter. We have over $90 million cash in the balance sheet, and we're guiding for top line growth of up to 4% for June.

Our addressable market in Ethernet is somewhat compressed at the moment, but we are well down the path on the product redesign efforts, and we have continuity of supply for our major OEMs. Also, the market is eagerly awaiting our next generation Ethernet products, which will be out later this year.

The integration of Endace is going very well. We have already accomplished a lot in the first 60 days, and we've got a number of specific goals and objectives in the sales and marketing area that we are driving. And we look forward to updating you on our progress over the coming quarters.

So with that, I'll now open the line for your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] And we'll go right to our first question from Vlad Rom with Credit Suisse.

Vlad Rom - Crédit Suisse AG, Research Division

This is for Mike and Jeff. I was just wondering, it seems like you guys are rolling up the Endace acquisition into your guidance. And if it weren't for that, the numbers would be a little bit light. I'm assuming that's caused by some of the Ethernet weakness. Can you talk to the persistence of that weakness as we head through this year, please?

James M. McCluney

Yes, we -- as we -- in the comments, I don't know if you caught it exactly, Vlad, our Ethernet, we see up sequentially in the quarter. We do see our SCP coming down a bit, and Fibre Channel is slightly down quarter-to-quarter. The Fibre Channel, we -- a couple of the server OEMs have made announcements of their results and certainly see the -- a little bit of softness in the storage realm. Although, collectively, both FCoE and Fibre Channel together have block storage alternatives looks to continue to grow year-over-year. So when you look at this quarter's forecast as we guide, our Ethernet business actually is helping in the sense that it's growing sequentially. We do have headwinds there as we've talked about due to litigation and engagement in new customers that we look to dissipate as we get our new products in the market. But that will give you at least a little sense of what's happening in the June quarter.

Operator

And our next question comes from Aaron Rakers with Stifel, Nicolaus.

Aaron C. Rakers - Stifel, Nicolaus & Co., Inc., Research Division

I guess going back on to the same topic. When you guys look at Endace I know that you had set the guide at 8% of this quarter's revenue, which should be about 9.5% plus or minus in terms of revenue of $1 million. But to set the basis for fiscal '14 at 10% contribution, how are you looking at that? Are you looking at the street expectations for fiscal '14? And again, another way of asking it is what is your assumption as we look in the fiscal '14 on the core business in terms of growth?

James M. McCluney

Well, we haven't been modeling fiscal '14. I think we were trying to just give you an idea of some of the mix that would -- in contribution, that Endace would bring to our business. We really only have given guidance obviously for the June quarter and given you a little bit specificity on Endace as well. Mike, I don't know if you want to add some?

Michael J. Rockenbach

Yes, I think -- yes, we're looking at it in terms of how we think the business will model. And at a macro level, as we mentioned, we're going to combine SCP and ATP going forward. I think you see that business, it's probably trending down a little bit for the reasons we've talked about with SCP over the past year or so. And in terms of NCP, I think that's obviously a solid business and makes up the bulk of our revenue. But at least for the first half of the year, we'll still be working through the mitigation fees. So I think that's -- that'll be a bit of a dampener on revenue growth, at least for the next couple of quarters. On the other hand, we do have a good stream of business with Network Visibility Products with Endace, and part of that being driven by the rebuilding of the annuity stream of deferred revenue for maintenance and services that's going to help us out. So I think we'll be in a better position obviously when we get to August to model the full business. But we want to give you some parameters as how to think about it, yes, on a relative basis to the overall business.

Aaron C. Rakers - Stifel, Nicolaus & Co., Inc., Research Division

Let me ask you a different way. When you guys had announced the acquisition, I think Endace was running at about $19 million or $20 million for that 6-month period prior. Do you expect that revenue off the base of 9 point -- whatever, $9.5 million in the June quarter to grow on a sequential basis throughout fiscal 2014?

James M. McCluney

Yes, we do.

Jeffrey W. Benck

And one thing I would note, though, is, as I mentioned, you do have differences in terms of the reporting. Biggest piece being that we essentially wrote off the balance sheet portion of the deferred revenue. So that $19 million isn't really kind of the starting point on an apples-to-apples basis.

Aaron C. Rakers - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And then final question for me. How do we think about the flow-through of Endace in terms of the -- how we should model gross margin through the course of the next couple of quarters?

Jeffrey W. Benck

Let me take that. Yes, as I said -- and I think if you look at that type of business and Endace is your touchpoint business, they tend to have higher gross margins in general because you're doing more of the heavy lifting as opposed to what you see in an OEM business model like ours. The other thing is we get to rebuild that annuity stream, and that tends to have higher gross margins than the overall product revenue. So I think it's -- obviously, it varies a little bit depending on the mix of the products because they do have several different products. But we do expect that the gross margins are going to improve as we go throughout the fiscal year, and that's part of the reason why we talked about in our core business and we've been talking about this for the last few years, we expect that business gross margins trend down 1 to 2 points over time per year. We think for next fiscal year that at least, essentially half of that or more is going to be offset by the growth of the NVP business, as well as the rebuilding of this annuity stream with higher gross margins.

Operator

Next, we have a question from Andrew Nowinski with Piper Jaffray.

Andrew J. Nowinski - Piper Jaffray Companies, Research Division

I guess just first, if you could clarify the normal seasonality for the Fibre Channel products in the June quarter. I thought that was in the 0 to plus 2% range, typically?

Jeffrey W. Benck

Yes, I think that's a pretty fair assessment.

Andrew J. Nowinski - Piper Jaffray Companies, Research Division

Okay. So then on your comments, I guess, on -- of guiding it, expecting to be down slightly on a sequential basis. I know I saw a softness in the storage market in Q1 from a number of vendors: IBM, EMT and Brocade last night. But I guess what's giving you caution to guide -- to expect this softness to continue into Q2?

Jeffrey W. Benck

Well, I think you got to break down the pieces of it. I think for us, SAP, it is -- we're expecting that to decline in the June quarter. I think when we look at NCP as a whole, that that's more in line with what we've seen historically from a seasonal standpoint.

James M. McCluney

With -- in this case, we're mix shifting a bit more to Ethernet.

Jeffrey W. Benck

Yes, that's right.

Andrew J. Nowinski - Piper Jaffray Companies, Research Division

Okay, got you. And then is there any way you could provide me a little more color in terms of the sequential rollout you're expecting from 10Gb? Are you talking low single digits, high single digits, or a couple of digits perhaps?

James M. McCluney

We don't usually give it that way. Maybe a couple of detail, but I think it's sufficient to say that it's a little -- it's a bit high on the Fibre Channel group this quarter for sure, this upcoming quarter.

Andrew J. Nowinski - Piper Jaffray Companies, Research Division

Okay, last question for me. I just want to ask on the OEM side. It was down 12% year-over-year, 8% sequentially this quarter. I guess, where you've seen deals at these OEM partners pushing out? Or and if -- the guidance doesn't suggest that the business is going to come back in Q2, but just wondering what you saw there on the OEM side?

Jeffrey W. Benck

I think we saw -- we certainly saw OEMs with some softness, but the business held up pretty well in the sense that we're able to get to where -- above the -- above midpoint of our guidance. So it wasn't like it was a horrific environment by any means, but I think people were working hard to close deals in the OEM pipeline. It did -- it wasn't particularly heavy back-end loaded. So I would say it was not that different than what we normally see. But we have seen some pretty cautious guidance coming from some of these guys looking to the June quarter. And, of course, you've seen those announcements in the last few days, and then we have there -- and they put on their forecast to us.

Michael J. Rockenbach

So one thing I'd add is when you think of the Network Visibility Products, none of that's OEM. That's all end user and distribution, so that's going to make those compares a little bit different than what we were doing on a stand-alone basis, where it essentially is all OEM with very -- but not all, at very little of our -- our core business was going through the channel before.

Operator

[Operator Instructions] Next is, we'll go to Rajesh Ghai with Craig-Hallum.

Rajesh Ghai - Craig-Hallum Capital Group LLC, Research Division

So recognizing that you expect your 10Gb revenue to go up in Q4, can you assume that all the constraints of the Broadcom mitigation are behind us? And in general, can you update us on the impact of the Broadcom mitigation with the 10Gb going forward?

Jeffrey W. Benck

Sure, let me tackle that one. I think as we -- the sunset period has ended, and you see that we continue to ship our 10Gb products. And as we filed on our 10-Q in February 1, that we said that the kind of impairment injunction permits major OEMs to obtain continued supply beyond the sunset period, which gives them time to requalify the redesign products that we're putting out there. So we do have the continuity to supply. Obviously, this -- we anticipated a retrial of the patents that the jury -- it was not a result of the jury verdict. That has been pushed out to November. So we're preparing for that retrial on November 5 in 2013. And from an expense perspective, I think Mike said in the call that we're kind of modeling for $1 million to $2 million on litigation expenses a quarter till we get through this.

Rajesh Ghai - Craig-Hallum Capital Group LLC, Research Division

All right. And as far as Fibre Channel is concerned, I think my math appears it was down 6% year-on-year on the NCP side, 14% Q-on-Q. And you expect it to be down again next quarter despite the 16-gig Fibre Channel upgrade cycle, which you commented is pretty healthy. So I'm just kind of curious, do you sort of see this trend continuing or do you expect 16-gig to a rest at some point in time?

Michael J. Rockenbach

Well, we actually saw our Fibre channel up year-over-year in March. So I'm not sure...

Rajesh Ghai - Craig-Hallum Capital Group LLC, Research Division

Okay, I'll take that. Q-on-Q was down, and you expect it to be down again?

Michael J. Rockenbach

Quarter-to-quarter is down seasonally. We obviously have one big customer in the UNIX space that is using -- normally has a weaker March, and this is probably our toughest quarter when it comes to that from that standpoint. We will say that the 16-gig Fibre Channel uptick, we're still in the low single digit as far as the percent of shipments be 16-gig. That's still kind of in front of us. In fact, we've got -- I was just looking at a summary earlier this week where we've got dozen -- literally more than a dozen of programs launching in the first half of this year on 16-gig with a variety of different OEMs. So I think that upgrade cycle is clearly still in front of us. We're just at the front end of it. We're well positioned with that. We have said that the Fibre Channel business, look Dell'Oro, looking at some of the reports. On its own, it is predicted to have a slight decline, below 5% level of decline through the year. I will tell you, we've gained share, which really put us in a great position. Just to give you an example, we were at 37% share at the end of March last year. We ended the year at 46%. So that is just a huge chunk of share gain, 9 points. Now in this March quarter, will we get back a little bit? It's still going to be a tremendous year-over-year improvement from where we were last year, and that's really helped us grow and mute any decline in the Fibre Channel business. And then, as we look at Fiber Channel and FCoE together as block I/O alternatives, the -- take Crehan or Dell'Oro, 5% to 6% growth on the year. So...

James M. McCluney

Yes, I think that's a very important consideration. What we care about is moving block I/O as well as FIO. And we're fairly agnostic with some device -- Fibre Channel over Ethernet card or a pure Fibre Channel card, it gives us great margin contribution either way. Obviously, we'll get some constraints on the FCoE because of the injunction. But I think Jeff mentioned in the call that this fiscal year, over last fiscal year, we have grown that level of traffic that we're shipping into the marketplace. So that's the key way to be looking at this, and we expect over time some Fibre Channel customers to migrate to FCoE. And our strategy was to be a key player in Ethernet, as some maybe, a lot of traffic, and there's the file traffic. And so we're ready for that with the LOM and Ethernet offering, as well. So I think we can show for the I/O over time, we'll get a larger share of wallet irrespective of your profit growth.

Rajesh Ghai - Craig-Hallum Capital Group LLC, Research Division

Got it. So my last question was, Jeff, you mentioned you're hiring a new head of sales for Endace and you have -- building up channels and you -- given that you've owned Endace for over a month now, what are your views in terms of how much incremental investment you need to make and go-to-market to really get this -- the NVP business going, going forward?

Jeffrey W. Benck

Yes. I'll tell you, some of this around -- just executing the plan, Mike Riley had sort said in place as CEO, he had every intention of bringing the head of sales on. He had added some marketing staff last year. It was kind of in his plans. So the good news is we didn't have to throw a lot of more investment that we want because we're sensitive to accretion here. But we did just hire a superstar, really a big name that you guys will see. We'll probably announce it sometime next week, so excited about that. I think that's going to bring a level of discipline and operational execution just to help coming from a smaller company. Did some real good cost incentives. I think there's opportunities with all the accounts that we're in that they're not, and that activity is already underway and put some things in place there. But we have a focused team, and their marketing and sales investment had some modest growth planned in it, and we're really just kind of supporting that and consolidating corporate marketing. And the demand gen process is really I think an area where we can have some significant value with my team that knows how to do that pretty well. So I think those are a couple of key initiatives we talked about. We certainly see opportunity more through the channel. I would tell you, the channel contribution is not as high. It's 20%. It could be more than that for sure, and I think Mike realizes that. We could do more with partners. We have a couple of good partner now since coming up, that are pretty exciting as far as people tapping into our network recording tools and some of the analytics that go around that. We're going to be more relevant as a platform of choice to do this recording piece. So there's just tremendous amount of activity underway but pretty excited about the potential here and just getting access to all the customers and the marquee customer list they have, whether it be in government or in telecommunications or the enterprise, it's pretty exciting. It really is a pretty exciting business.

Operator

And our next question comes from Bill Shope with Goldman Sachs.

Bill C. Shope - Goldman Sachs Group Inc., Research Division

I had a clarification in this financial impact, in addition to what you've already provided. You mentioned the impact on revenues for the March quarter, as well as the fact that it increased your OpEx a bit. Can you give me an idea of what the gross margin in that EPS impact was for the quarter?

Michael J. Rockenbach

Gross margins. It was below our corporate average because you had a stub period and we didn't have the deferred revenues, so I think it was somewhere in the 50s. That's not typical of where it's going to be. More typical gross margins is north of the 65% corporate average. As I said, it's going to raise our averages. So it always depends on product mix that, I think in general, it's in the high 60s and beyond that [indiscernible] depending on the product mix. I think it was a little bit of a loss on the operating line for the quarter, but there was a tax benefit that made it additive slightly to EPS. So I think it was really dependent on the timing of when we actually closed. I think it's fairly close to what we were expecting in terms of the business.

Bill C. Shope - Goldman Sachs Group Inc., Research Division

Okay, that's fair. And then you talked about the requal process a few times and the overall progress of the injunction issue. But can you just remind me you where you stand it terms of the OEMs requalifying the products? I mean, how much longer do you think we have through this period of uncertainty, and how do you think that should impact revenues over the next few quarters?

Michael J. Rockenbach

Part of the -- part of this requal effort is all worked on the redesigned chips, and then we kind of have said we've been making solid progress there. And we're sensitive about sharing all the details given the competitive nature of what we're embarking on here. But we also have these -- and part of it is our work, but part of it is also OEMs and their natural qualification cycle that might line up well with the Intel Server launch. So we look at Ivy Bridge as sort of the next server transition here. Different people but at different dates on there, but that's kind of the effort window where we're focused on to get qualifications completed and such. And then we've got some new products too that may not necessarily be tied into a particular launch. If you're with a cloud customer, they are not quite as focused on the Intel transitions. But that should give you at least a general sense of how that should play out with the Ethernet business.

Operator

And next we have a question from Glenn Hanus with Needham & Company.

Glenn Hanus - Needham & Company, LLC, Research Division

So just following up on that last question. So Ethernet should be up sequentially in the June quarter. And then, with -- you're probably might be -- might you be down then sort of in September and then the Ivy Bridge starts to kick in the around the end of the year, that -- is that -- so you might have a couple of flatter down quarters in Ethernet or not?

James M. McCluney

Well, I think we'll start seeing normal seasonality given that we're still constrained from adding new customers for the Ethernet business to get the reworked product out. And as Jeff says, we're going to target some of the Intel business that it's almost like -- look at the second half of the calendar year. It's getting all these things staged and will follow probably a normal seasonality there and then take it off from there, because if you remember when we were unfettered by injunctions, we were enjoying fairly substantial growth in our Ethernet business. And obviously, that's what we'd like to get back to.

Glenn Hanus - Needham & Company, LLC, Research Division

Okay. And on the Storage Connectivity side, I think you've given annual outlooks there in the past. Are you still at -- I forgot what you said last time, $80 million to $85 million?

Jeffrey W. Benck

Yes, when you look at -- Glenn, this is Jeff. As we look to the remainder of this year, we think that $80 million is a good number. But then we are expecting to see it come down about as much as 10% next year. As we look into the next year, we talked about this business being a cash cow business, that is going to, over time, decline. It looks like it might have a little longer tail than we predicted. But as we look at next fiscal year, we're looking at that 10% kind of range, plus or minus, a little bit, just to give you sense of what SCP looks like.

Glenn Hanus - Needham & Company, LLC, Research Division

Can you comment a little more on -- the target side sounded like that might -- could be picking up sooner than expected, or can you elaborate a little bit on the target side?

Michael J. Rockenbach

The target is kind of an NCP rate. So we talked about the contribution of target in Fibre Channel in the March quarters. So that business is -- there's certainly some new target launches, and we're going to have 16-gig actually starting this quarter where we had one prior, so we have at least a couple more then we'll start to launch this quarter. But when you look at SCP, it's more the back-end connectivity and the bridge business that converts Fibre Channel to SaaS or SaaS to SATA. And from what...

Glenn Hanus - Needham & Company, LLC, Research Division

I understand that. I was just -- I was shifting gears, yes.

Michael J. Rockenbach

Oh, okay. 'I'm sorry. I'm sorry.

Glenn Hanus - Needham & Company, LLC, Research Division

So -- yes, so I mean that seems to be supporting the NCP number over the next few -- for the next few quarters, should we start to see the target continue to ramp quarter on quarter over the next few quarters now?

Michael J. Rockenbach

Yes, we still -- we should see it start to ramp in the back half. As people get in the market, we will see some growth there that should be reflected on the Fibre Channel line as we go through the back half of the year.

Operator

And next, we have a question from Srini Nandury with Summit Research.

Srini Nandury

You've been -- you noted previously that the 10Gb adoption has been slower than most industry analyst expectations. Can you give us some of the reasons why it's been slow?

Jeffrey W. Benck

Yes, I can talk to that. It's Jeff. It's interesting at blade, we're seeing maybe 75% attach. We do really well there given our integrated solutions with some of the big server OEMs. But when we go look at the rack attach rate, it's sub 10% right now. So that's concerning to us. It's not been what we thought Romley would be with that. Some of the reasons we think driving that is the lower-cost switch ecosystems they have. In blades, you got the integrated switches and no optics, so it's pretty cost-effective to go to 10Gb. But in the rack service, you have the externals, which the prices have been up there. There are a couple of new low-cost switches that launched in -- right at the end of year that we think will help drive that. The only thing that's a contributor is the modular LAN on motherboard solutions with modular daughter cards for rack. OEMs kind of priced them a bit high. They priced a more like option solution than integrated chip-down solutions. And that sort of bearing as well on the attach rate of 10Gb for those server platforms. So those are couple of reasons why we think the 10Gb market hasn't been growing quite as fast as we might have initially anticipated.

Srini Nandury

Okay. As you see going forward, the Web 2.0 versus your traditional data centers, where do you see your biggest opportunity for 10Gb?

Jeffrey W. Benck

A couple of things. I think we can participate more deeply in the OEMs across the top 10 OEMs. We're heavily penetrated in several -- or more than several, let's say half. But there's opportunity there, but we've also talked a lot about the cloud customers that may not go traditionally through the classic OEMs. And there's a lot of interest in 40 gig, and RoCE and cloud customers have really engaged with what capabilities are there and pretty excited about it. And the Web 2.0 cloud guys seem to be moving faster on deployment than what we're seeing with the rack servers I just mentioned. And today, we're not shipping in that right now because of the injunction limitations. But another area that we see 10Gb opportunity is in China -- in China and Taiwan. And the Chinese OEMs, particularly the ones that are also looking to grow multinational are a big opportunity for us. And we've got strong business with Huawei and with Lenovo, and those are a couple of the guys there that are doing quite well.

Srini Nandury

I have one last question on the Fibre Channel. You've been claiming the last 3, 4 quarters that you've been getting share from your largest competitor in the Fibre Channel business. And can you give us some of the reasons why your products are outperforming in the market?

Michael J. Rockenbach

Yes. First of all, we've claimed that Dell'Oro and Crehan has really canonized that. It's not just us making a claim. You can look at the industry results. But some of the reasons why that we believe we've been gaining is we do have great technology. We certainly had a time-to-market lead in 16-gig. We've got a lower power product that's faster than the competition. In 8Gb, our success with Ethernet is actually giving us some lift in the OEM's customers. We figured out pretty early on that it's better together if you buy our Ethernet products. You might be interested in our Fibre Channel if you weren't buying them before. I also think we've clearly figured out how to influence end users beyond just selling into the OEMs, and our focus on regional managers that can talk to end users and drive the relevance has helped us there. So it's been a number of things. It's been a lot of hard work by the team, but it's really helped in a market that isn't growing as fast as it used to, but we've certainly enjoyed even in the March quarter, year-on-year growth because of those gains.

Operator

And next, we have a follow-up question from Vlad Rom with Credit Suisse.

Vlad Rom - Crédit Suisse AG, Research Division

Jeff, I was wondering, do you think that by running the operations of Endace and Emulex somewhat distinctly, there's potential for you to underinvest in the Endace business? Just because looking at it, there's a potential source of funds with your R&D dollars. I mean, you have a very good 40 gig solution. You're working on a 100-gig. So that looks like it's -- there's a long ramp on the 16-gig side, so that probably doesn't need too much R&D. So there could be a potential for you to invest pretty heavily in Endace. And the market's growing 10%, so potentially you can grow that business, orders of magnitude, if you invest enough in it. So how are you thinking about that? Just kind of [indiscernible] of investment.

Jeffrey W. Benck

Okay. Let me first talk about that a little bit, and I'll let Jim comment, too, and he's got strong beliefs here. Part of the reason for showing this separately, breaking these divisions out, is we can absolutely look at the contribution and we can look at -- it keeps us from creating that bad behavior you said where we overinvest in a mature market because if we're managing these down to an operating level and understand the contribution then we appreciate the fact that early on, we may invest further. And one of the things that we've talked to Mike Riley a lot about and spend time on is with the synergies that we're gaining there, we're reinvesting to help grow his business. We're not looking for all of those to drop to the bottom line, and that's what's allowing him to scale sales and marketing and do the right things he need to do there. At the same time, we're going to continue to look at operational expense against the revenue in the classic business lines. And the fact that we have independent run in those a bit separately, Jim and I, at the corporate level, can move those investments. But we really want the team to have the discipline to say this is a mature -- this is a more mature business in Fibre Channel, a growth business in 10Gb and 40 Gb, and a growth business in Endace, and make sure we put the right investments on those product lines.

James M. McCluney

Yes, I will just support what Jeff's saying. A combination of focus in the businesses because they are somewhat different in go-to-market from synergies, as Jeff described. But we will continue to invest where the opportunities are. And I view the Endace thing is a great product. Let me add it in their R&D because they don't have huge spikes because of the FX because of all that [indiscernible] base. So this is a channel investment and initially going to leverage everything that the rest Emulex has to grow there. And if we see opportunities for further business in a very rapidly growing market, we're going to go after it for sure. In over -- as Jeff says, we continue to ensure we’ve done a great job over the last year to making sure that expenses in the NCP, SCP are very much in line with the top line, and we'll continue to do that. And the whole thrust here is -- on Endace is to invest to grow. And we've got a multiyear plan on how we would like to do that and where we would like to do it. So I think you're absolutely right, and it's important to put money where the growth is, where the profitability will be. So...

Vlad Rom - Crédit Suisse AG, Research Division

Okay. So have you guys set internal revenue growth targets for that business?

James M. McCluney

Yes. Things we talked about], yes, we -- let me tell you when we went through the acquisition process, a lot of discussions was on this total potential in this new market over time. And we've got hopefully some great ideas of how to expand that business faster than that market, with some of the disruptive technologies that Endace has developed. And candidly, for a small company did really well, but then of the kind of reach that we can provide them. So as I said, this is a channel expansion, so stay tuned. We'll keep you updated on it as we go forward.

Operator

And this concludes our question-and-answer session. I would like to turn the call back over to Mr. Rockenbach for any further or closing remarks.

Michael J. Rockenbach

Thank you, operator. Thanks everyone for your participation in Emulex's Third Quarter 2013 Conference Call. For a wrap-up tonight, I want to let you know that over the next few weeks, we are currently scheduled to attend the following investor conferences. We'll be in New York to present at the Barclays Global Technology Conference on May 22nd. On May 29, we'll be in Minneapolis for the Craig-Hallum Conference. On June 4, we'll be back in New York for the Stevens Conference. And on June 5, we'll be in San Francisco for the BofA Merrill Lynch Conference. We look forward to speaking with you on one of these upcoming investor events or on our Fourth Quarter Earnings Call in August. Thank you, and good night.

Operator

And this does conclude our conference for today. We thank you again for your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Emulex Management Discusses Q3 2013 Results - Earnings Call Transcript
This Transcript
All Transcripts