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Emulex Corporation (NYSE:ELX)

F4Q09 (Qtr End 6/30/09) Earnings Call Transcript

August 6, 2009 5:00 pm ET

Executives

Jim McCluney – President and CEO

Mike Rockenbach – EVP and CFO

Jeff Benck – EVP and COO

Analysts

Rajesh Ghai – ThinkEquity

Paul Mansky – Canaccord Adams

Mark Moskowitz – JPMorgan

Aaron Rakers – Stifel Nicolaus

Kaushik Roy – Wedbush Morgan

Glenn Hanus – Needham & Co.

Operator

Good day and welcome to today’s Emulex Corporation fourth quarter conference. Today’s call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to the President and Chief Executive Officer, Mr. Jim McCluney. Please go ahead, sir.

Jim McCluney

Thank you, operator. Good afternoon everybody and welcome to Emulex’s fourth quarter fiscal year 2009 conference call. I’m Jim McCluney, President and CEO of the company, and with me today are Jeff Benck, our COO; Mike Rockenbach, our CFO; and Steve Berg, our Senior Vice President of Corporate Development.

Mike will start off with prepared remarks for the fourth quarter 2009 results, I will follow with my comments on the quarter and a discussion of our markets, and Jeff will talk about our progress on the company’s operating plan. Finally, I will provide some summary points and then open the line for questions. Over to you Mike.

Mike Rockenbach

Thanks Jim. By now, you should have Emulex’s fourth quarter 2009 earnings release, which we issued earlier this afternoon. If you do not have a copy, the press release is available in the Investor Relations section of our Web site at www.emulex.com.

The press release in this presentation contains forward-looking statements including but without limitation statements regarding Emulex’s business, operations and anticipated financial results for the first quarter of fiscal 2010 and beyond. These statements are subject to risks and uncertainties and our actual results may differ materially from those discussed in the forward-looking statements. Those risks and uncertainties include economic conditions, market growth, IT spending patterns, changes in technology, evolving industry standard, competitive pressures, pricing pressures and fluctuations in OEM ordering pattern, the estimated total available market size, the ability to address these markets with available technology in a timely fashion, research and development activities, the inability to achieve the expected benefits from our globalization initiatives, and the risks and uncertainties described in Emulex’s SEC reports filed under the Securities Exchange Act of 1934, including Forms 8-K and under the heading Risk Factors in Emulex’s most recently Annual Report on Form 10-K and quarterly reports on Form 10-Q.

Furthermore, Broadcom Corporation unsolicited takeover proposal to acquire all the company’s outstanding common shares and any related litigation has created additional uncertainty and may have an adverse effect on the company’s operations. We undertake no obligation to update the forward-looking statements and investors should also be aware that Emulex will not disclose in its Q&A or in conversations afterwards any material or financial data that was not already disclosed in its conference call or its press release.

In addition, during this call, when we use any historical non-GAAP financial measure defined by the SEC and Reg G, you will find a reconciliation to the most directly comparable GAAP financial measure in our press release available on our Investor Relations Web site. All of the references we will make today will relate to our non-GAAP results unless stated otherwise.

Today’s conference call is being webcast and a recording will be available on the Emulex Web site through August 2010. 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 this recording.

Now let me talk about our results. Sales for the fourth quarter ended June 28, 2009 totaled $79.3 million, a sequential increase of 1% and a decrease of 30% from the prior year’s quarter. Revenue came in at the high end of our fourth quarter guidance of $73 million to $80 million provided in April and exceeded the estimate of $78 million to $79 million revenue from our July 9 preliminary earnings release.

Fully diluted earnings per share for Q4 totaled $0.09, an increase of 80% from the $0.05 reported in Q3 and a decrease of 59% from the $0.22 reported in the fourth quarter of the prior quarter. Our fourth quarter fully diluted EPS exceeded our guidance of $0.01 to $0.05. EPS for the quarter benefitted from favorable operating performance on the gross margin line and operating expense line complemented by a favorable tax rate related to the implementation of our globalization initiatives during 2009.

Taking a look at revenues by product line, I’ll begin with our host server products or HSP, which consists primarily of Fibre Channel Host Bus Adapters or HBAs, 10-gigabit Ethernet converged network adapters or CNAs, custom form factor mezzanine cards for blade servers and ASICs used in server application. HSP revenues totaled $62.8 million, an increase of 6% sequentially and a decline of 26% from the fourth quarter of last year. Revenue from HSP board level products for the fourth quarter increased 5% sequentially representing a 5% increase in units and an 8% increase in ports. The ASP for board level products including standalone HBAs, CNAs and mezzanine cards was flat with the third quarter. Year over year revenues declined 27% representing a 22% decline in units and 15% decline in ports. ASP declined by 7% from a year ago, which is below our expected annual decline rate of 12% to 15%.

Dual channel increased 12% on a sequential basis and increased to 58% of our HSP forward-level products. Mezzanine card revenues increased 11% sequentially but declined by 3% year-over-year. Finally, HSP ASIC revenues increased 27% sequentially and 55% year-over-year.

Our second product line, Embedded Storage Products or ESP, encompasses SATA bridges and routers, Fibre Channel embedded SOCs and root switches, as well as single and multi-protocol embedded controller products for enterprise class storage systems. ESP revenues for the fourth quarter totaled $16.4 million, representing a decrease of 16% sequentially and 42% from the prior year’s period.

As we have discussed over the past few quarters, ESP is a component business for primarily the contract manufacturers for our storage OEM customers. The combination of tighter IT budgets and an increased focus on the balance sheet across the supply chain continued to impact demand for our ESP products during the fourth quarter. In addition, improvements in reliability and performance from lower cost SAS and SATA solutions could be driving end-users to consider valued price point solutions to meet more of their storage needs. While ESP has seen a disproportionate impact of the slow down of recent quarters, we are modeling for the ESP business to be flat to slightly up during the first quarter. We have provided a geographical and customer breakdown for our revenues as supplemental information in our press release.

Now, as we further discuss the income statement, I’d like to remind you that we will be primarily discussing our non-GAAP results, unless otherwise noted. You will find in our press release, a reconciliation of the difference between our GAAP and non-GAAP earnings, as well as a discussion of why we believe non-GAAP financials are a relevant measure of our business for investors.

Fourth quarter gross margins were 68%, compared to 66% in the March quarter and 68% a year ago. A favorable mix in products combined with a program to reduce our ongoing warranty expenses benefitted our gross margins during the quarter, and we anticipate gross margins for the first quarter will be in line with our historical rate of approximately 66%.

Looking at operating expenses; during the fourth quarter OpEx decreased to $44.6 million, compared to $48.2 million in the third quarter. Expenses decreased as a percent of revenues to 56% compared to 61% in the prior quarter. Compared to a year ago, fourth quarter operating expenses decreased by approximately $7.2 million representing a 14% reduction in quarterly expenses from a year ago. We exited the year with headcount of 758 employees compared to 853 at the beginning of the fiscal year and 815 at the end of the third quarter.

Q4 operating income of $9.4 million was up 147% sequentially, coming in at 12% of revenues compared to 5% in the third quarter. Other income decreased 93% sequentially coming in at $55,000 primarily due to exchange losses and lower interest income. With a goal of principal protection, we continue to invest in short-term government backed investments which while secure have an interest rate of less than 1%, and we anticipate a similar level of interest income in Q1.

Fourth quarter net income was $7.6 million, up 73% sequentially and down 58% from the prior year results. Our tax rate for the quarter was approximately 20%, largely due to the implementation of our globalization initiatives. You may recall for modeling purposes, we used a 41% tax rate for our guidance in April, using this rate, our fourth quarter EPS would have been approximately $0.07 per diluted share. Based on our current expectations including the geographical mix of income, we are expecting a 22% tax rate for our fiscal 2010, which reflects the ongoing benefit of our global initiatives.

Our net profit margin for the quarter was 10%, which is up from 6% in the prior quarter but down from the 16% reported in the fourth quarter of last year. For the fourth quarter on a GAAP basis, we reported an operating loss of $9.7 million and a net loss of $4.5 million or $0.06 per share. The difference between GAAP and non-GAAP income in the fourth quarter is primarily attributable to amortization of intangibles, stock-based compensation and severance and related costs as well as the costs associated with Broadcom’s unsolicited takeover proposal. FAS 123(NYSE:R) expense did not have a significant impact on GAAP diluted earnings per share this quarter due to the related tax benefits.

On a GAAP basis, Q4 R&D expenditures decreased 9% sequentially to $30.5 million compared to $33.4 million in the third quarter. Quarterly R&D spending will vary depending on the timing of new product development expenses and Q4 R&D excluded $2.1 million of stock-based compensation. Fourth quarter GAAP sales and marketing expenses were at $11.9 million, compared to $13.8 million in the third quarter. Q4 sales and marketing expenses included $1.1 million of stock-based compensation. Sequentially, GAAP G&A expenses increased to 113% to $15.6 million compared to $7.3 million in the third quarter, primarily due to $8.3 million of expenses associated with Broadcom’s unsolicited takeover proposal. Fourth quarter G&A expenses included $1.7 million of stock-based compensation.

Turning to the balance sheet; we exited the fourth quarter with total cash and investments of $302 million, this was essentially flat with the end of the third quarter. As we recently announced, the Board of Directors has reinstated $100 million share repurchase plan, which was originally approved in August of 2008. That said to the end of the fourth quarter we have been active in the market using approximately $80 million to repurchase 2 million shares of our common stock at an average price of $9.10 per share.

Fourth quarter inventory levels increased sequentially from $9.9 million to $10.7 million and our inventory turns were 11.4 exceeding our target range of 8 to 10 churns. Our receivables were $51.6 million at the end of Q4, compared to $49.4 million at the end of Q3 resulting in a slight increase in our DSOs. Depreciation in the fourth quarter decreased to $5.4 million compared to $5.9 million in the third quarter and capital expenditures during Q4 also decreased from $5.1 million to $4.2 million.

Before I discuss our targets for the first quarter of fiscal 2010, I want to again remind everyone that there are numerous risks that can affect our future performance causing actual results to differ materially from forward-looking statements. These risks are noted in our public filing with the SEC and the Safe Harbor statement at the end of our earnings release. As a result of these risks and uncertainties, we are unable to predict with accuracy what future quarter results might be, and there is no guarantee that business will reach our expectations or goals.

Based upon current market conditions, our customer’s public comments and their most recent forecasts, we believe that revenue for the first quarter ending September 27, 2009, could amount to approximately $78 million to $82 million. The midpoint of our guidance is an increase of approximately 1% of our fourth quarter results and represents a decrease of 28% from the first quarter of fiscal 2009.

While we don’t give specific guidance by product line, I want to provide a little color on trends we are seeing in the business. Within ESP, with the recent reductions in inventories at our contract manufacturers, we are expecting ESP revenues to be flat slightly after the first quarter with further improvement in the second quarter of FY ‘10. In regards to our HSP business, we continue to see stability in the forecast for OEM customers for both HBA and mezz cards combined with an increase in demand for our first-generation CNAs albeit up a small bit.

Not all of our customers have announced their quarterly results yet but many of our customers that have announced are indicating positive trends in their business going into the back half of the calendar year. Based on these comments and our own forecasts, we are modeling for a flat-to-slightly up quarter in our HSP revenues during the first quarter and meaningful sequential growth during fiscal Q2. If we see revenues in this range, we anticipate non-GAAP earnings per diluted share of $0.03 to $0.06, assuming a 22% tax rate and approximately 82 million shares outstanding.

I’d now like to turn the call over to Jim, who will give you more color on the quarter and an update on the company’s strategy.

Jim McCluney

Thanks, Mike. I will start by providing some comments on our business in Q4, next I will give an update on our markets and the overall IT spending environment, and then I will talk a bit of corporate strategy. After that I will pass it over to Jeff for an operational review as well as some product discussion and his take on Emulex’s progress in the converged networking market and then we will take some questions.

In the June quarter, the entire Emulex team performed very well. We successfully managed through the challenges created by soft economy and our employees stayed focused on business execution despite a lot of external distractions. Just after the quarter ended, we issued a press release highlighting some of our accomplishments, which included reaching the high end of and in some cases exceeding the financial guidance we posted to investors back in April. The detailed release today highlights many areas of the business that we executed positively on during the quarter.

Reviewing our financials, we delivered a revenue of $79.3 million, which was at the top end of the Q4 guidance and exceeded consensus. HSP revenue was $62.8 million up 6% from Q3, which was an excellent performance in what was a difficult sales environment. As we anticipated, our embedded business continued to be challenging. HSP revenue was $16.4 million, down 16% sequentially.

During the quarter we worked through a number of issues and we believe we have likely reached a baseline from which we can return to sequential growth. Gross margins continued to be in the high 60s while total operating expense came in at its lowest level since Q2 of 2007 and we have succeeded in lowering operating expenses in absolute dollars in every quarter during fiscal year 2009. The combination of strong gross margins, lower sequential expenses, and a lower tax rate allowed us to exceed our EPS guidance and consensus for the quarter.

In the core Fibre Channel market we continued to battle over market share and I feel confident that we have assembled the right team and created the right go-to-market strategy to gain market share versus our nearest competitor. Many of the plans that the team has put into place over the last few quarters are now starting to have a positive impact. By virtue of the fact that we grew our Host product revenue by over 6%, our Host revenue of our nearest competitor declined sequentially and confidently gained market share this quarter. Going forward there are many reasons to be optimistic that we will continue to gain share. Jeff will provide more color on this during his commentary.

Turning to the IP spending environment, in general IP spending in fiscal Q4 appeared to have been relatively flat with Q3. However, the last quarter was executed in a more stable and predictable way in terms of product demand and customer engagement than in the prior quarter. Looking forward to the second half of the calendar year, we expect IT spending to continue to be somewhat muted. So far we have some improvement in ability, we are not modeling for a V shaped recovery but rather we anticipate a more gradual ramp in product demand. In terms of IT spending priorities, the most recent Goldman Sachs survey indicates storage and servers at the top area of pent-up demand. In addition virtualization and data security two key Emulex focus areas remain amongst the highest priority technologies for IT managers. As we look forward to fiscal Q1, which is normally a seasonally dull quarter, our guidance of $78 million to $82 million in revenue and $0.03 to $0.06 in EPS reflects our view that the business has somewhat stabilized.

Changing gears, let me now elaborate on our overall corporate strategy. The first part of our strategy is to establish Emulex as a dominant player in converged datacentre networking. Our vision of the converged datacentre based on Enhanced 10 gigabit Ethernet technology is one unifying theatre and storage networking over a single wire. The promise of a converged network will be realized in less complexity, less infrastructure, reduced cabling, lower power consumption, and in simpler management. All of this creates a compelling value proposition for IT managers. Fundamental to our strategy is our product offering OneConnect our revolutionary 10 gigabit Ethernet Universal Converged Network Adapters or UCNA platform and OneCommand, our convergence management framework. These products are unique in the marketplace, unmatched by our competition. We have received tremendous feedback from industry press, analysts and partners alike and our OEM customers are voting with their design wins awards.

So we believe that we have a differentiated product portfolio with a broader surf capabilities integrated on a single chip. We have already created the potential for market leadership with 14 design wins on major platforms with tier one OEMs. This is well ahead of the competition. It is important to know that this market is still at an early stage and we expect many more severance and storage platforms to transition to converged technologies in the future. This will create even more opportunity for Emulex to expand the design wins and based on this we expect to secure a leading share in this new market segment. Converged networking opens up a large high growth incremental market opportunity for Emulex. The converged networking product that we have announced, or have in development today are by themselves enough to double Emulex’s total addressable market within five years. Projecting on our recent design wins we have a line of sight on an incremental $150 million in revenue from this opportunity by fiscal year 2012.

The other part of our strategy is to maintain a strong core business. It is our view to Fibre Channel while maturing is likely to remain a very important technology for years to come. If you think about it, we have an installed base to build upon of nearly 7 million Fibre Channel ports and 61 million embedded ports, which we can upgrade and expand. So we will continue to invest appropriately in our Fibre Channel and embedded business. An example of this is investing in product innovation and differentiation to the solutions focusing on virtualization, data security and network diagnostics. These will differentiate us from our competitors and provide incremental value to our OEMs and end users. The continued implementation of this corporate strategy will result in high growth profitable enterprise. Instrumental to this is a plan to maintain attractive gross margins, keep expenses in check and create go-to-market synergies between our core and converged products to deliver improved profitability and shareholder return. As we go forward, I will keep you posted on our progress.

Now, let me turn it over to Jeff.

Jeff Benck

Thanks, Jim. As you have heard from Mike and Jim’s comments, operationally we performed very well in the quarter. We gained share in our core business and we also continued to make solid progress driving our converged networking strategy. Of particular important highlight in the quarter was the continuing work the team did on expense reduction. We were able to reduce total operating expense by over $3.5 million sequentially and over $7.2 million from Q4 of fiscal 2008. We accomplished this by prioritizing our activities and executing only those with the greatest return to our business. For example, we became more efficient in the use of our sales and marketing spend providing a large impact in the marketplace for fewer dollars spent. The area in which we have been most successful are in building brand preference, global expansion, addressing vertical markets and winning new customers. Overall we improved the balance of our cost against our revenues during the quarter, which is a corporate mandate and we will remain diligent in improving our operational efficiency as we go forward.

From a product line perspective, our Host Server Product succeeded the expectations we had going into the quarter. We were encouraged that our HSP revenues grew by 6% quarter to quarter supported by sequential improvement through both channel and OEM route. Furthermore, linearity during the quarter was more typical of a normal economic environment, which points to market stabilization. The key industry growth drivers that kicked in at the end of the quarter were the transition in Intel’s long anticipated flat core Xeon processor 5500 series also known as Nehalem. The timing of the general availability of the Xeon 5500 may have resulted in a pause in March quarter server purchases while customers waited for this latest processor technology. These new systems coupled with 8-gigabit Fibre Channel are ideally suited for deploying virtualization.

Now that there is general availability from the server OEMs, we could see the release of some pent-up demand, which could be a driver for our HSB business. Concurrent with this launch, IBM and HP introduced our 8 gig mezzanine card with their Nahalem processor based blade system. This fills out our 8 gig Fibre Channel matrix as nearly all OEMs are now shipping 8 gig enabled Rack and Blade servers. Looking forward, we have continued to invest in differentiated offerings and new technology. The case in point, we have recently received the industry’s first 16 gig Fibre Channel OEM design win. This demonstrates continued investment by us and our OEMs in our core Fibre Channel business and also highlights our strategy as being first to market with new technologies.

The final point I want to make on HSP is that we are confident that when the 2Q ’09 dolor report comes out later this month, it will show emulated scheme share in Fibre Channel adapters for the quarter and further it will reflect cumulative share gain over our largest competitor for the last nine months. This validates the success of our updated go-to-market plans that we introduced at the end of 2008. Also of importance, we are challenging the competition for the market share lead in 8 gig Fibre Channel product shipped. Link speed transitions have traditionally been an opportunity for share gain and so far we are neck and neck with our key competitor in terms of 8 gig Fibre Channel product shift. If that trend continues as a transition from 4 to 8 gig product accelerates, it should ultimately result in a bigger market share for Emulex.

Lastly, in Blade servers, which is still the fastest growing server segment, we grew our mezzanine card business 28% in our last fiscal year versus the industry growth rate of 6% as forecasted by IDC. These few points clearly demonstrate that we are gaining share in the important server growth area.

Now turning to Embedded Storage Products, we have worked through a lot of challenges and we now see the business stabilizing. As we mentioned last quarter the end of life for one of our root switches at a key customer is having a negative impact on revenue but should conclude within the next few quarters. Even with absorbing this decline in sales, we expect to show flat-to-modest growth next quarter. Looking out a little further we are confident in the prospects of our ESP business for a number of reasons. First, we are seeing strong demand for our new SAS bridging products and there are opportunities to leverage our bridge technology to accelerate the adoption of solid state drive in the enterprise. Second, we are seeing increasing demand from our storage OEM customers to leverage our systems expertise and provide forward level products that serves the traditional embedded ASIC solution.

Now I would like to provide some further color on Jim’s comments regarding our converged networking strategy and how we see this important transition occurring in the market. The latest trends in storage, servers, and networking all point to converged networking being the next major inflection point in the IT industry. Service with new multicore processors and the tremendous growth in virtualization are driving higher I/O needs. At the same time, datacentre managers are dealing with power, cooling and real estate challenges all are facing reducing budgets. Correspondingly storage growth continues unabated driven by a variety of demands that range from retention, regulatory requirements, security, and the exponential growth in data. Concurrently networking is going through some very big changes with new capabilities driven by Fiber Channel over Ethernet and enhancements in the Ethernet protocol, which enables the convergence of data and storage network. The industry leaders in both service and networking have rallied behind these new standards and there is no competitive alternative being contemplated. As we have discussed the opportunity to reduce cables, eliminate switches, reduce power and consolidate infrastructure while providing more bandwidth makes the transition to converged networks compelling for all customers particularly in a tight IT spending environment. Our latest technology in this space will enable a more efficient datacentre built on a converged network that leverages enhanced Ethernet at its core. Our products support a variety of protocols, are simpler to manage and most importantly will save customers’ money. It is no surprise we keep so much interest from our OEM for our converged network products and why we believe the data centre transition to 10 gig is happening right now.

So we have established why we believe in this new market, so let me now explain why we are winning. We listen to our customers starting several years ago we laid out a vision and strategy for converged networks that leverages our long hardened Fibre Channel technology with its huge installed base, a new business model to compete in industry standard highline products, the right technology partnerships, and a differentiated product strategy that provides unmatched flexibility and value. Couple this with our scale and global presence and our ability to effectively support multinational OEM customers; it is clear we have a recipe for success that is very hard for competitors to emulate.

Our new UCNA products are enabling us to participate in an expanded set of opportunities including 10 gigabit network interphase cards, 10 gig ISCSI adapters and 10 gig CNAs from mezzanine, stand up, and alarm form factors. Our second generation CNA inclusion is the only inclusion in the industry based on the single integrated chip that enables the hardware to fully offload all three protocols TCP/IP, ISCSI and MCOE and leverages a proven Fibre Channel stack. In addition our OneCommand convergence management platform enables virtual services, unified management and easy upward integration into OEM management tools.

Today, we are leading the way in this exciting new segment as demonstrated by an early traction we have gotten with our customer. In 4Q, we shifted approximately 1 million in CNA products and based on orders we already have on the books we expect our revenue from CNA to at least double this quarter. This is the ultimate validation of our strategy and the strength of our products. As we introduce our next-generation offerings based on our OneConnect UCNA, we already have the six tier one 10 Gig Ethernet NIC placements, four 10 Gig iSCSI placements, and four 10 Gig FCoE placements, with many more RFQs to come, setting the stage for explosive growth for Emulex in this segment.

Let me conclude with some key points before I pass it back to Jim. Over the past couple of quarters our company has done a good job of weathering tough economic times. We've made difficult decisions of weathering – we've made difficult decisions when we had to and we are coming through the leaner, more efficient organization with strong operating leverage.

The company is also in a much stronger competitive position than it was even a year ago with a broader product portfolio and design wins across the board in Fibre Channel, FCoE, 10 GigE, and iSCSI, as well as SAS and SATA on the embedded side. As I reflect what’s in front for us, it is clear the company has many opportunities for profitability growth in new and very large markets. We are fortunate to have the technology and partnerships required to succeed, and this is allowing us to build an exciting future for our company.

With that let me pass it back to Jim.

Jim McCluney

Thanks, Jeff. Good job. So let me conclude with some summary points. We are very pleased with our overall execution during the June quarter, in addition to meeting or exceeding our revenue and earnings targets, our focus on controllable expenses, and maintaining a strong balance sheet resulted in a solid financial performance.

We gained market share in HSP in Q4, and we expect that we will continue to make gains. ESP seems to have stabilized in terms of end-user demand and we expect some growth in the September quarter. Our leadership position in the 10 Gig converged network market is playing out well for us. Our traction with next-generation technology design wins puts the company in a very strong position for future growth. And lastly, the December quarter guidance of $78 million to $82 million in revenues and $0.03 to $0.06 in diluted EPS is reflective of the fact that we are starting to see some consistency in the market.

So that concludes our prepared remarks. And with that we have time to take questions. So operator, if you could please go ahead and open the line.

Question-and-Answer Session

Operator

(Operator instructions) Our first question will come from Rajesh Ghai with ThinkEquity.

Rajesh Ghai – ThinkEquity

Yes, thanks. Congrats on the strong quarter. So looking at the guidance, you mentioned the ESP business was witnessing some inventory destocking and you thought it was going to be flat to up. Then you said that the HSP business also seemed to be stabilizing, and given that you're closest competitor have guided to 0.3% [ph] upside on the HBA business. And I'm just wondering why the 1% guide up in terms of revenue for this quarter. It seems very conservative. Can you just comment on what do you see out there that makes you so conservative?

Mike Rockenbach

This is Mike. Let me start and then maybe Jim and Jeff can add in. I don't think we are being overly conservative on that. You know the midpoint of our guidance is up 1% for the total company. We guided up to $82 million at the high end. I think within our business as within our competitor's, it's not all just HBAs. One other things we talked about in our script was we did have a pretty strong quarter in ASIC IOCs, which are in there as well. So there is a few different pieces in there when you look at it on a sequential basis. As you think, we see and feel pretty good about the HBA market. But historically, the summer has been one of the slower quarters with December quarter being stronger. So I think certainly from where we are at in the quarter we feel pretty good. The comments from our customers on their calls, ones that have answered have also been – I think with a little bit more positive tone. But I think it's – the quarter is still not over yet. So –

Jim McCluney

I think we feel confident in the ranges that we are giving you. And obviously our intent is to execute against those ranges.

Rajesh Ghai – ThinkEquity

Okay, great. Turning towards something that Jeff mentioned about pent-up demand in the server market, server OEMs have, specifically IBM, has started messaging the benefits of a server refresh to its customers. And obviously with the introduction of the Nehalem chip and the upcoming server – Windows Server upgrade cycle and averages of service being three years, it appears there is a server refresh cycle around the corner. Have you gotten any sense from your OEM customers as to – they've started – begun preparing for this pent-up demand of this upcoming server refresh cycle or is it too early to say? And if you have any sense of timing when it could occur, when it could begin, that would be great.

Jeff Benck

Yes, this is Jeff. The reason we added to script the comment about Nehalem is because we do believe that there was a little bit of pause there. Customers are really anticipating the new quad core Intel processor. Those products are not shifting from the OEMs. So there is a potential for a bit of a pickup as I mentioned with some pent-up demand. We also think we are seeing strong traction in our 8 Gig products. So when you consider those new Intel platforms coupled with folks wanting to deploy virtualization and the growth in virtualization offering, that could be a driver for our 8 Gig platform. So we'll start to see what happens this quarter as we work through because that product is – now those Nehalem platforms are now shipping at the OEMs. We’ve got strong qualifications of our 8 Gig across the products ranges at the server folks. In fact, couple of the blade offerings just started to ship last quarter, as those OEMs brought those products to market concurrent with Nehalem. So –

Mike Rockenbach

Just starting, I think some of our larger customers have indicated some improvement in the back half of this calendar year. So I think all eyes will be on the IT spend in the December quarter. And I think having these refreshes, there is – could capitalize people to upgrade their systems, which we would all like to see obviously.

Rajesh Ghai – ThinkEquity

Okay. And one question on the converged networking market. You have some advantage over your nearest competitor as far as the LAN [ph] form factor is concerned. Now given that this Fibre Channel over Ethernet market doesn't seem to be picking up right away, do you think you can convert that advantage that you have right now into revenue? Or do you think it won't matter because by the time your closest competitor will probably get caught up?

Jeff Benck

No. I mean, when we look at – we got strong traction in design wins. We talked a lot about that. Obviously we got to bring those products to market. We've been pretty open about our traction in that space. The thing that I think – when you mentioned LAN for example, we talked about integrating 10 Gig. You know that that's going to take off because it's not a question of being an option. Those platforms as they integrate their technology standards. So you really see it pickup there. So we are expecting not only growth with converged networking in Fiber Channel over Ethernet, but also 10 Gig Ethernet on its own. Not the 10 Gig that's traditionally been in the market, but really an enhancement to that. As you look at the capability to put other protocols like iSCSI, offload, and FCoE on top of that. So we are confident that convergence is happening now. Lot of drivers for that. Frankly the tough economic times make people look for ways to save money and consolidate, and that's a potential for us. Not going to happen overnight. We said that we would start to see initial products in the second half of this year, and then in the next year we will see more momentum in our product lines shipping converged products. But we are very optimistic about this space in our release.

Mike Rockenbach

If I could just add. I think the key thing is what you sell in the 10 Gig. The uniqueness in our product offering is people can move to FCoE when they are ready because this is going to be a 10 Gigabit Ethernet backbone. And this will – with iSCSI, we are starting to see a lot more interest in iSCSI offload at 10 Gig bandwidth than at 1, at least for full offload. So that’s another opportunity for the company. So the mix may vary a little bit depending on routes, but looking at the platforms that were [ph] designed in on, we feel very confident that our technology is going to be in there. And then people will have the opportunity to choose their protocol of choice, and when they want to implement the Emulex technology, there is in there.

Rajesh Ghai – ThinkEquity

Thanks for thanking my questions.

Mike Rockenbach

Okay.

Operator

Our next today will come from Paul Mansky with Canaccord Adams.

Paul Mansky – Canaccord Adams

Jim, Mike, Jeff, good afternoon. Thanks for taking the question. I wanted to go back and spend a minute, if we could, on some of the Fibre Channel HBA market share commentary. Correctly me if I'm wrong, but with respect to historical share shifts obviously there's been a couple of times, i.e., you entering the mezz card market, you penetrating Sun, but by and large the share shift is dominated disproportionately by the health of underlying server form factors associated with your products, right? So, as we think about some of the commentary provided this afternoon and some of the specific programs Jim you alluded to that's been put in place to help drive share, how do we think about that in context of the implications for those underlying server form factors? Are you taking share from QLogic in form factors they've historically been more tightly associated with, etc., etc.?

Jim McCluney

Yes, I think it's – Paul, good question. I think we've traditionally been very strong in the UNIX and high-end enterprise and obviously we've been – our objective is to have better penetration of X56 market. And I think what we have messaging here is that – and particularly as we transition to 8 Gig, we are kind of leveled the playing field a little bit. I think you noticed from Dell'Oro numbers last quarter, we were kind of neck and neck with our nearest competitor in terms of market share in 8 Gig. And as that product ramps up, we've got deeper design wins there, we've got more simultaneous releases of their products along with our competitors. So it gives us a better opportunity to compete. And the other thing, over time we are looking at, the tremendous traction and penetration on the converged networking will actually cause some back draft and pull for those Fibre Channel products as well because it’s the same stack in there, particularly on FCoE. And so we see a halo effect there. But – and also – I will ask Jeff to comment on this. I think we will get a much more laser like focus on where we are putting our sales and marketing dollars. And it is lot like – it is less peanut butter. As we said, we have moved a lot of attention from some of the storage HBA vendors to these X56 platforms. And they are also – a lot of the platforms obviously where we are winning convergence as well. So, Jeff, I don't know anything else you want to add.

Jeff Benck

Yes. I think we are seeing some of the programs we’ve put in place get a little bit of win behind them. And that helped us some too with marketing and sales efforts. I don't want to detail that too much because it is a competitive environment, but we are seeing benefit there. A lot of focus, as Jim mentioned, on X56, but blades is a particular area that is high-growth that we are seeing good traction. In the last fiscal year we grew faster than the industry there. That will continue to be important. We are real focused on 8 Gig and how that happens, as Jim mentioned, we have a lot – we are in a better footing as far as – across OEMs. And that is not just limited to X56 guys, but also the UNIX platforms. So as that grows, that will be important. And as we continue to expand our team and our resources globally, we think there is opportunity in emerging countries and emerging areas, where there is not as much presence for us to continue to gain.

Paul Mansky – Canaccord Adams

If I can ask just one more, and thank you for that. Given the commentary around Nehalem previously, can you provide us some context relative to what you are hearing vis-a-vis messaging out of the server OEMs around the 8 core Nehalem, and whether or not we should anticipate a potential – another pause in front of that ultimate product transition as well?

Jeff Benck

I think Nehalem is a pretty – seems to be a pretty popular product. I will refrain from saying top co. But I think it is an exciting product for customers. I think when you look at it transitioning across the higher-end server platforms, I think the step function though was with its first introduction as they integrated memory controller into the processor, and some of these high-volume platforms come out with it. So I don't personally anticipate as much of a change with the Octo-Core stuff. But, you know it is Moore's Law. They're going to continue to crank out new platforms. This was a particularly important launch here that just – we just got through in the last – the beginning of this calendar year.

Paul Mansky – Canaccord Adams

Great. Thanks for that color. I appreciate it.

Operator

We will hear from Mark Moskowitz with JPMorgan.

Mark Moskowitz – JPMorgan

Yes, well, thank you, good afternoon. Two questions, if I could. I may have missed this, I do apologize. But did you talk about the drivers of the gross margin outperformance in the June quarter, or were there – can you just give us a little color there? I'm just trying to figure out if there is any one-time adjustments or warranty reserve amounts that maybe impacted that favorably, even though it was even though it was down.

Mike Rockenbach

Yes, this is Mike. We did have some adjustments to our warrantee strategy, basically in terms of how we are repairing our boards. So that took down our warranty accrual, which was a one-time benefit in Q4. It gave us little better gross margins than our average for the year. We also had a pretty favorable mix of products within the quarter with a particularly large jump in dual-channel, I think, on a relative basis. So I think that gave us a little bit better gross margins that we had modeled for earlier on the call back in April. And in terms of where we expect to be in Q1, we think it’s going to be more like our average was in the full year 2009, which is in the approximately 56% range.

Mark Moskowitz – JPMorgan

If we try to normalize, what would be the June quarter gross margins have been? Mike, would it have been closer to the 66% or been below or –

Mike Rockenbach

It would have been below 66%. I don't know exactly what it would be, but it would be somewhere between 66% and 67%, just depending on how it would have rounded. So I think it would have been probably a little bit closer to 57%.

Mark Moskowitz – JPMorgan

Okay. Then just on the international or the globalization efforts, obviously it is helping out your tax rate going forward. I just want to get a sense in term of where you guys feel you are there in terms of investments. Have you made the investments, and now you're just waiting for the customers to materialize, or is there still work to be done there? I am just trying to get a sense of any sort of growth dynamics that could help out, not only the top line but maybe the tax rate going forward.

Jim McCluney

There are two questions in there.

Mike Rockenbach

Let me talk to the implementation piece. From an implementation standpoint, we completed all of that implementation over the last year. You might recall back in Q4 of the prior fiscal year 2008, we had a large tax payment related to the buy-in as we started that implementation and then we got it all up and running. I think we completed it pretty much in the second quarter 2009. And then the tax rate in Q4 was really the final true-up on the buy-in amounts and the transfer pricing in the cost sharing agreement. So on a go forward basis, we think that 22% rate is our rate for the year. Obviously, like we have seen from time to time, there is allowances that get reversed when a potential audit period goes away or things like that. But, in general, we think that is our rate going forward given the current mix of business with – I think roughly 60% of business is international today. So the operation itself is fully staffed, fully operational. All the subsidiaries are set up and we are running the business, and I think meeting all of our customer expectations.

Jeff Benck

The only thing – let me just comment on it. I talked about the globalization a little bit from sales marketing. We are not done with what we want to do there. But you've got to separate that from our operations that we established that are fully online and running. So more opportunity there in emerging geos, and then outside of the US and the other countries, we are off going at that opportunity. And there is more to be had from sales and marketing effort.

Mark Moskowitz – JPMorgan

Okay. Thank you. And just say this from a sideline perspective. It is refreshing to see that the company was not distracted by some of the hostile bid activity that we saw earlier in the summer time, so congratulations there.

Jim McCluney

Thanks, Mark. That is appreciated. I think the team did an extremely good job and didn't take their eye off the operational ball at all.

Operator

Our next question will come from Aaron Rakers with Stifel Nicolaus.

Aaron Rakers – Stifel Nicolaus

Yes, thanks for taking the question. A couple of questions actually; I guess on the guidance front, if I look at what you have laid out top and bottom line, and then taking the gross margin assumption, you guys did a great job managing expenses it looks like last quarter. But really to get back to the range that you are talking about in EPS, it looks like it is assuming you really get back as much as half of those expense savings that you saw last quarter. So were there some items that are non-recurring in your expense reduction last quarter? Why should we think that expenses tick back up a decent amount it looks going into the September quarter?

Mike Rockenbach

That is a good question. No, there wasn't any one-time reductions that were favorable in Q4. Actually, it is kind of a little bit the opposite. In Q1, as you mentioned, we think we are going to go back to more normalized gross margin lines, so that accounts for part of the difference. The other thing is this is – we are doing our audit now, so we have more audit expenses in the G&A line. We are also expecting that we will have a little bit higher legal expenses in the quarter just related to the normal business than we had in Q4. And then the other driver is really timing of expenses in R&D. And we've got a lot of activities going on, as Jeff talked about, in both the first and second generation CNAs that are going to have some samples and development costs in Q1. But having said that, I think what our expectation is that we will see expenses tick up in the summertime because of some very specific things, as we get into the December quarter we think expenses will come back down a little bit. So I think it is more of some one-time things that hit us in Q1 as opposed to one-time favorability in Q4. But that’s what you are seeing in terms of our guidance.

Aaron Rakers – Stifel Nicolaus

Okay, helpful. Then two follow-ups real quick. On the Embedded Storage product side, I guess I can understand that we have burnt off inventory. Can you help us understand though longer-term when we think about the secular shift to SAS and SATA drives, how should we be thinking about – I guess, any color on what that represents in terms of Fibre Channel to SATA bridges within the ESP division that could continue to come under pressure from that secular headwind?

Jeff Benck

Yes, this is Jeff. I think when you look at this – when you look at the ESP business, we did see some competition from alternative solutions on our Fibre Channel business. And we talked about the SATA penetration at the low end of the storage platforms. We talked about that before. That does have some impact on our Fibre Channel-based products. We also had this route switch at one customer, this end-of-life thing that for the next two quarters will be a drag – negative drag on revenue. But even with that we look at being flat to slightly up this quarter, and going forward see some sequential growth. Then when you look longer a little bit further out we still are investing in our systems and solutions initiative. We talked about before doing board platforms for some of our customers. So as we get to the backend of our fiscal year, that stuff starts to come to market. That is going to be a growth driver for us. The other you mentioned our bridging technology. We are developing some new SAF bridge products Fiber Channel to SAF, SAF to SATA that will allow us to participate in the fast growth. As we get into the second half of the year, we’ll also see those products in the market. So, we will get to participate in that. So, we are confident as we look out that there are growth drivers there. But it is true that we have seen some impact of lower storage system going native from SAF to SATA and then this bridge switch business and license.

Aaron Rakers – Stifel Nicolaus

Final question from me. I know you guys are kind of pushed to put out kind of targets looking all the way out of fiscal 2012. Can you help us understand longer term as CNA’s ramp, what your assumptions were around the gross margin profile looking out further down the road with kind of converged networking playing out?

Mike Rockenbach

Yes. This is Mike. Let me take a jab at that. I think as we look at the market, you have got some different dynamics. I think in terms of the UCNAs, the FCoE product are going to have gross margins that are probably more similar to what we see in the traditional Fiber Channel HBA markets. Then the straight 10 Gig Ethernet wins that we have and may be ISCSI are going to have lower gross margins. So our expectation is that gross margins are going to come down over time, given that mix. But I think we still, as we get out into that FY11, FY12 I think we are still going to have a pretty healthy gross margin. The nice thing on our business is as you have seen in the past is with an OEM based business it leverages out very well. So, even with the expectation of gross margins coming down we get a lot of leverage having a platform that we can substantiate several different ways for a variety of different OEMs. So you get a lot of leverage in our model because we don’t have a lot of variable expenses that are tied to revenue kind of hurts us when things slow down but definitely gives us a lot of leverage on the way up.

Aaron Rakers – Stifel Nicolaus

Okay, thank you.

Operator

Our next question comes from Kaushik Roy with Wedbush Morgan.

Kaushik Roy – Wedbush Morgan

Thank you. So, on the gross margin comment on CNA, why do you expect it to be similar to HBA? Right now it is a duopoly as it is now in CNA there are four vendors and there are maybe more, two more. I am expecting at least six vendors. So, why do you still expect the CNA to have margin similar to HBA?

Mike Rockenbach

Well, I think the part I was talking about, Kaushik, specifically the FCoE instantiation, and they are divided. So I think that in that perspective, it ends up being FCoE initiation is more likely HBA market. But you are right; in native it is more competitive. We think there are things that we can do that give us some particular advantage being first to market and we expect to have lower gross margins. The kind of trick is going to be what is the mix of those two pieces.

The other good news is we have got 14 design wins as sample set. Each of those design wins have negotiated pricing, pretty good picture going out a few years on ASP and margin so I think Mike (inaudible)based on the companies we are seeing the business as one.

Kaushik Roy – Wedbush Morgan

On the EMC, can you quantify in any way this fiscal year was down 31% and part of it was because of the demand. But can you quantify in any way what the expectations might be going forward in terms of what the growth rate might be?

Jeff Benck

We are not really going to give a full year guidance but let me kind of talk about it at a macro level. We think the business has reached a bottom, we talked about it in Q1 being flat to slightly up versus Q4 with better opportunities in the December quarter, and then when we get into the back half of the year we start to see more activities and more ramping from launches in our SNS business. So obviously the front half of the year has tough comparables to a year ago but I think as we start to look forward over the next couple of quarters on a sequential basis, we will start to see some meaningful growth.

Kaushik Roy – Wedbush Morgan

Okay great. Thanks.

Jeff Benck

And we have got time for one more question.

Operator

And our final question today will come from Glenn Hanus with Needham & Co.

Glenn Hanus – Needham & Co.

Good afternoon and congrats guys. So may be just to follow up a little more on the fiscal 2012 outlook. 600 million that you were a little bit forced to put out there, since you have filed that the 8-K what are sort of some of the puts and takes that you have seen in the market that either give you more confidence in that or maybe that has to be pulled in a little bit? Can you give some perspective on that long-term objective?

Jeff Benck

Yes. This is Jeff. I think we talked about after we put that out was that we secured a couple of additional design wins, which were contemplated high confidence, but having those closed helps a lot as far as confidence in the long term outlook. There is work we have to do in executing on those in monetizing them, but we are very confident given the interest level and watching what is happening in the industry around converged networking as well as the 10 gig what looks to be a pretty big growth happening in the 10-gig. So I think that has added to our confidence in those estimates. But there is a lot of room between now and then.

Jim McCluney

I think obviously, as Jeff said, they execute on this I think our 14 design wins are still secure. The good news is wireless is seeing some, as Jeff alluded to in his prepared remarks, that we are seeing some activity for new platforms picking up. And I think we are in a really good position to win some of that business which will help as well. I think OEMs are putting a lot of (inaudible) into this, they see this as a very, very important sector for them. So, down the road, I think there is not really any kind of technological competition. Everyone is converging and converging is the word. I think with the uniqueness of our platform nobody else is putting three verticals on top of a single chip. We know others will not do it; it will take them time to get there and we intend to stay ahead of the pack.

Jeff Benck

The other early indicators, we are pretty pleased with the traction in converged networking with our first gen products. We talked about the orders already this quarter being looking to more than doubling their revenue that we did last quarter. So, that is encouraging that there is people, there are lot of customers are interested in this technology and are starting to deploy. So that’s good first point I think.

Jim McCluney

A couple of other things we did. We did talk about two more design wins in our core Fiber Channel HBA business. Also I just think like I said it is still relatively early but in general still some of our customers that have announced they just have a pretty good time relative to where they see the business going in the near term as well. So I think there is a lot of time out there and a lot of things we got to execute on but I think there is some pretty good positive data points in the last four to six weeks.

Glenn Hanus – Needham & Co.

And lastly, I know you are at the end of CNA this quarter I guess it is going to be $2 million next quarter and just help us out when does the second generation products start shipping and should we be thinking in terms of sequential growth now over the next several quarters?

Jeff Benck

We talked about and this is consistent; we see revenue from the second gen products in the second half of the calendar year. But we said it would be material as we get to the middle of next year. So, we are going to see those second gen products ramping as we go through this fiscal year that we are in now. And then 2011 you will continue to see pretty significant growth on top of that. So that is a little bit of a timeline for those new products.

Glenn Hanus – Needham & Co.

Thank you.

Jim McCluney

Let me make a couple of closing comments. Thanks a lot for everybody for participating in our fourth quarter 2009 conference call. We’ve got a lot of activity this quarter in the coming weeks related to Investor Meetings. August 11 we’ll be at the Canaccord Adams Growth Conference in Boston. On the 12th we’ll be at the Morgan Keegan Technology Conference in New York. September 10th we’ll be at the Citigroup Technology Conference in New York, September 15th we’ll be at the Deutsche Bank Conference in San Francisco, September 16, we’ll be at the ThinkEquity Growth Conference in San Francisco as well. So look forward to speaking with you at one of these events. Thanks again for joining us on our call and have a good evening.

Operator

Thank you and that does conclude today’s conference call. Thank you all for your participation.

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