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QLogic Corporation (QLGC)

F2Q07 Earnings Call

October 24, 2006 5:30 pm ET

Executives

H.K. Desai - Chairman, President and CEO

Tony Massetti - SVP and CFO

Analysts

Paul Mansky - Citigroup

Brian Mansfield - Goldman Sachs

Mark Moskowitz - JP Morgan

Srini Pajjuri - Merrill Lynch

Glenn Hanus - Needham & Company

Kevin Hunt - Thomas Weisel Partners

Frank Timons - Robert Baird & Company

Tom Curlin - RBC Capital Markets

Harsh Kumar - Morgan Keegan

Douglas Whitman - Whitman Capital

Presentation

Operator

Good day everyone, and welcome to the QLogic Corporation Second Quarter Fiscal Year 2007 Earnings Conference Call. Today's call is being recorded. At this time for opening remarks and introductions I would like to turn the call over to Mr. H.K. Desai, the Chairman, President and Chief Executive Officer. Please go ahead sir.

H.K. Desai

Thank you operator, good afternoon and welcome to QLogic's second quarter fiscal year 2007 earnings conference call. I am H.K. Desai, CEO and President, and with me is Tony Massetti, Senior Vice President and Chief Financial Officer. Today Tony will begin with a review of the second quarter financial results, and I'll continue with a general discussion of the state of our business. After that we will open the teleconference for questions.

Tony Massetti

Thank you, H.K. and good afternoon. By now all of you should have seen our press release and associated financial information. In addition to reviewing our financial results, some of the comments today will include forward-looking statements regarding future events and/or projections of the financial performance of the Company based on our current expectations. These comments contain significant risks and uncertainties that could cause our actual results to differ materially from those expressed in these forward-looking statements. We refer you to the documents by QLogic files with the SEC, specifically our most recent Form 10-K and 10-Q. These documents identify important risk factors that could cause actual results to differ materially from expectations. We do not intend to update any of the information contained in any forward-looking statement that we make today.

Today's conference call is being webcast and a replay will be available for 12 months on the QLogic website at www.qlogic.com under Investor Relations. An audio replay will be available through November 7, 2006 by calling 719-457-0820 or 888-203-1112, passcode 1503417. Please be aware 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. Copyright law and international treaties protect this conference call report. Unauthorized reproduction or distribution of this report, or any portion of it, may result in civil and criminal penalties. Any recording or other use or transmission of the text or audio for today's call is not allowed without the expressed written permission of QLogic.

In our second quarter earnings press release issued earlier today, we reported both GAAP and non-GAAP results. The difference between the results is primarily due to acquisition related charges and non-cash stock-based compensation charges. The stock-based compensation charges are primarily result of the requirement to commence expensing stock options in fiscal year 2007. An accounting of this difference is included in our press release. The difference in our non-GAAP as compared to our GAAP results is $0.05 per diluted share in the second quarter, or $0.24 per share non-GAAP versus $0.19 per share on a GAAP basis. All of the references we will make today relate to the non-GAAP results from our continuing operations, unless otherwise stated.

Our revenue in the second fiscal quarter ended October 1, 2006 was a record $145.3 million, an increase of 22% from the same quarter last year and 6% sequentially. This exceeds the high-end of our guidance of $139 million to $142 million given during our first quarter earnings conference call. Our revenue from SAN infrastructure products, which includes HBAs, switches, appliances, routers and silicon grew 22% to $135.3 million from $100.5 million recorded in the second quarter of last year. Sequentially revenue from SAN infrastructure products grew 6% from the June quarter. The increase in our revenue from SAN infrastructure products was primarily driven by HBA revenue growth up 26% from the comparable quarter last year.

Our switch revenue grew 18% from the same quarter last year. Our revenue from Management Controllers of $5.4 million in the second quarter declined $1.6 million from the revenue recorded in the second quarter of last year. As we have discussed during previous earnings conference calls, we expect revenue from Management Controllers to decrease overtime.

Other revenue, which is comprised primarily of royalties and service revenue, was $4.6 million in the second quarter. Our September quarter gross margin of 70.4% decreased from 70.6% recorded in the second quarter of last year and from 70.9% in the June quarter. The decrease in our gross margin was primarily due to product mix and costs associated with the transition of manufacturing to an international location of a contract manufacturer, partially offset by the effects of increased royalty during the second quarter. Consistent with our previous guidance, we expect our gross margin during the next 12 to 18 months to be over 65% depending on product mix.

During the September quarter, we experienced an ASP reduction on a like-for-like products in our HBA business of 2%. This is consistent with the amount experienced in prior quarters and within our expectations.

Next, I would like to cover second quarter operating expenses. Total operating expenses were $51.7 million in the second quarter, up 25% from $41.2 million reported in the same quarter last year. This increase is primarily due to the operating expenses of our investments in emerging markets, including storage virtualization, storage routing and InfiniBand. On a sequential basis, operating expenses declined 2% from $52.6 million reported in the first quarter.

Engineering expenses in the second quarter increased 32% to $28.2 million versus a year ago, and increased as a percentage of revenue from 18% to 19.4%. On a sequential basis, engineering expenses in the second quarter increased 1%. We will continue to support existing and future technology development with engineering expenses as a percentage of revenue ranging from 17% to 20%. Sales and marketing expenses in the second quarter increased 15% from a year ago to $18 million, and declined as a percentage of revenue from 13.1% to 12.4%. On a sequential basis sales and marketing expenses declined 5%. We expect that future sales and marketing expenses as a percentage of revenue will range from 11% to 14%. G&A expenses in the second quarter of $5.5 million increased by $1.3 million from a year ago, and increased as a percentage of revenue from 3.5% to 3.8%. G&A expenses declined $0.3 million sequentially. We expect that future G&A expenses as a percentage of revenue will range from 3% to 4%. We continue to focus on improving efficiencies in our operating expenses, while investing in critical new development programs for existing and new technologies.

In the September quarter, QLogic generated an operating profit of $50.6 million, an increase of 18% versus last year. On a sequential basis operating profit increased $6.3 million, or 14%. During the September quarter, operating profit margin was 34.8%. Interest and other income was $5.8 million in the second quarter, a decrease of $0.3 million versus a year ago, and a decrease of $1 million from the June quarter. The income tax rate for the second quarter was 32%. This rate improved from the 34.1% for the first quarter as a result of benefits associated with the Company's international operations. Our second quarter income from continuing operations increased 26% to $38.3 million, or $0.24 per diluted share, in the second quarter of last year when the Company recorded income from continuing operations of $30.5 million, or $0.17 per diluted share. On a sequential basis income from continuing operations increased $4.7 million, or 14%, from $33.7 million, or $0.21 per diluted share. Our income from continuing operations as a percentage of revenue in the second quarter was 26.4% compared to 25.6% reported in the same quarter last year and 24.6% the June quarter.

Our second quarter diluted income per share from continuing operations was $0.02 above the high-end of the forecasted range of $0.20 to $0.22 per share, provided during our first quarter conference call. This represents the 45th consecutive quarter of profitability for QLogic. Our GAAP net income for the second quarter was $30.4 million, or $0.19 per diluted share.

Now let me summarize the results for the first six months of fiscal year 2007. Revenue for the first six months of fiscal 2007 was $282 million, an increase of $47.5 million, or 20% from the comparable period of fiscal 2006. Our revenue from SAN infrastructure products for this period was $262.7 million, up 21% from the comparable period last year. Gross margin for the first six months of fiscal 2007 was 70.6%, consistent with the comparable period last year. Operating income for the first six months of fiscal 2007 increased 12% to $94.8 million from $84.7 million the comparable period of last year. Income from continuing operations for the first six months of fiscal 2007 was $72 million, an increase of $13.2 million, or 22%, from the comparable period of last year. Income from continuing operations per share on a diluted basis was $0.45, an increase of $0.13 over the comparable prior year period. Net income on a GAAP basis for the first six months of fiscal 2007 was $51.5 million, or $0.32 per share on a diluted basis.

Our financial position continues to be strong, especially with regard to our cash flow. During the second quarter, we generated $39 million cash from operations. The Company's cash and short-term investment balance was $537 million at the end of the second quarter. During the second quarter, we repurchased $56 million of our common stock pursuant to our current stock repurchase program. Since fiscal year 2003, we have repurchased a total of $646 million of the Company's common stock under programs authorized by our Board of Directors. Second quarter receivables of $69.5 million declined $1.6 million from $71.1 million at the end of the June quarter. The DSO rate in the September quarter was 44 days compared to 47 days in the June quarter. With a growing trend toward hub arrangements with our OEM customers, and greater contribution from our distribution channel, we continue to expect upward pressure on our DSO performance. Based on our current customer and channel mix, we expect DSO in the future will range from 45 to 55 days.

Annualized inventory turnover in the September quarter was 3.9 turns, consistent with the June quarter. Inventory at the end of the second quarter was $43.7 million, an increase from $41.3 million at the end of the June quarter. As previously anticipated, we expect the transition of 4-Gig technology will continue during the December quarter. This will result in a decline in 4-Gig inventory, which will be offset by an increase in acquisition related inventory. Therefore we expect inventory levels at the end of December quarter to be similar to the September quarter.

As previously announced, we entered into a definitive agreement to acquire SilverStorm Technologies, for approximately $60 million. This acquisition is expected to close within 30 days upon the satisfaction of customary closing conditions. Our long-term outlook for our core business remains favorable. Based on a foundation of design wins and existing markets, as well as emerging markets, we expect to see continued growth in our revenue for SAN infrastructure products. Based on current customer forecasts, we expect total revenue in the December quarter to be in the range of $154 million to $160 million. This range assumes minimal revenue contribution from Pascal and no revenue contribution from SilverStorm. Due to the potential variation of product and technology mix, we expect gross margin for the December quarter to be approximately 70%.Considering the above revenue and gross margin expectations, combined with planned operating expenses, infrastructure investments and a projected tax rate of approximately 33%, the current outlook is to achieve non-GAAP diluted earnings per share of approximately $0.25 to $0.27 in the December quarter.

Our GAAP diluted earnings per share in the December quarter is expected to continue to differ from the non-GAAP diluted earnings per share primarily due to acquisition related charges and non-cash charges associated with stock-based compensation. Upon completion of the acquisition of SilverStorm and the related purchase price allocation, a portion of the purchase price will likely be allocated to in-process research and development, or IPRD, and intangible assets. Accordingly, we will recognize a charge to operating expenses for the amount of the IPRD and amortization of intangible assets. As a result of the uncertainties associated with the timing of the acquisition and the allocation of the purchase price, we're unable to estimate the effect that this will have on our GAAP diluted earnings per share in the December quarter. However, excluding the impact that the pending SilverStorm acquisition will have on our GAAP diluted earnings per share, we currently expect that the difference between GAAP and non-GAAP diluted earnings per share will be approximately $0.06 per share in the December quarter. Actual results for future periods may differ materially due to a number of factors, including those outlined during the course of this conference call in the Company's filings with the SEC and in a disclaimer statement at the end of our second quarter fiscal 2007 earnings press release. I would now like to turn over this conference call to H.K. Desai, our CEO and President.

H.K. Desai

Thank you, Tony. We're very pleased with our performance this past quarter. In addition to achieving 45 consecutive quarters of profitability, we have again set a new record for revenue. Revenue in the second quarter of fiscal year 2007 was $145.3 million, up 22% from the comparable quarter last year and 6% sequentially. Second quarter revenue exceeded the high-end of our guidance of $139 million to $142 million provided during our first quarter earnings conference call. Our diluted earnings per share for the second quarter was $0.24, which exceeded the high-end of our guidance of $0.20 to $0.22 per share provided during our first quarter conference call.

During the second quarter, revenue from SAN infrastructure products, which primarily includes host bus adapters, switches, appliances, routers and silicon continue to grow. For the second quarter, revenue from SAN infrastructure products was $135.3 million, an increase of 22% from the comparable quarter last year and 6% sequentially. Driven by the ongoing transition from direct attached storage to SANs, growth in blade server shipments, and the overall growth in SAN capacity and requirements, our SAN HBA revenue continues to grow. Our HBA revenue, which includes both Fibre Channel and iSCSI technology, grew 26% from the comparable quarter last year and 10% sequentially.

For the first half of fiscal 2007, HBA revenue has grown 23% from the same period a year ago. This is well above our anticipated SAN growth expectations, which have targeted in the mid teens. The HBA revenue performance in the fiscal 2007 is consistent with the growth rates we have experienced over the past couple of years. HBA revenue grew 21% year-over-year in the fiscal 2006, and grew 22% year-over-year in the fiscal 2005. The most recent share data as reported by Dell'Oro shows that QLogic Fibre Channel HBA revenue market share for the first six months of calendar year 2006 was 49%, which is an increase of 5 points over the December 2005 quarter. This is 11 points higher than our nearest competitor. With our tremendous success in 4-Gig design wins with all Tier 1 OEMs, more rapid transitions to 4-Gig than our competitors, and 10% sequential HBA revenue growth this past quarter, we anticipate that we will continue to gain market share against our nearest competitors during the second half of 2006.

While there are no independent analyst report for the adoption of iSCSI and TCP offload HBAs, we believe that we're the market share leader in this sector. Our iSCSI HBA revenue, which is still small, more than doubled from the year ago quarter. iSCSI continues to gain tractions in small and medium businesses. We believe that the offload technology will be in greater demand as the interface speed grows to 10 gigabit. Our success in the iSCSI market sector, combined with our success in Fibre Channel HBAs, strengthens our position as the market leader for SAN storage interconnects. Our InfiniBand HCA business is just beginning to gain tractions. We have six design wins with the Tier 1 OEMs, and we expect to start shipping product for these OEMs during the second half of fiscal 2007. Revenue from InfiniBand products for the second quarter was less than $1 million.

As expected, Fibre Channel switch revenue has accelerated. Overall second quarter switch revenue grew 18% from the comparable quarter last year and 9% sequentially. In October, we started production, shipments of our new SANbox 9000 multilayer, multiprotocol core switch. Early product reviews from end-users, channel partners and OEMs indicate that QLogic SANbox 9000 will meet the demanding RAS requirements of the Fibre Channel core switch market. With higher density per U, lower power consumptions, and a 50% lower cost reported than our competitors, we are well-positioned to compete in the core switch market.

In the addition of the SANbox 9000 to our portfolio, we will be a total supplier to the Fibre Channel switch market with chassis, edge and blade switch solutions. Along with the proposed industry consolidation this will provide QLogic additional opportunity with OEMs and channel partners. We are pleased with the performance of our Switch group, and we continue to expect annual growth to be in excess of 20%.

The channel business continues to be an important growth driver for QLogic. Overall channel revenue for SAN infrastructure products increased 24% from the year ago quarter and 16% sequentially. For the second quarter, the channel accounted for 29% of our HBA and switch revenue. During the December quarter, we will complete our international partner conferences with events in Europe, China and Japan. We're including our worldwide channel expansion, and believe that these efforts will continue to strengthen our market leadership in this area, and continue to fuel our overall market share gains.

Transition to 4-Gig HBA technologies is tracking to our expectations. Revenue from 4-Gig Fibre Channel HBA is accelerating. For the second quarter, 4-Gig HBAs represented 36% of the Fibre Channel HBA product revenue, which was 105% sequential increase. We continue to expect over 50% of our HBA revenue to come from 4-Gig Fibre Channel HBAs in the December quarter.

Now, let me give you some of our recent highlights. During the first quarter of fiscal 2007, we entered the InfiniBand market with the acquisitions of PathScale. PathScale provides us access to the new and rapidly growing server area fabric market. To complete the portfolio and enable us to provide an end-to-end solutions to our OEMs and channel partners, we recently entered into a definitive agreement to acquire SilverStorm Technologies. SilverStorm's designs and manufactures an InfiniBand based out of switch solutions that address the performance and I/O requirements of their center environments that utilize clustered topologies. This important acquisition follows our strategy of entering new rapidly growing markets through the acquisition of technology. According to IDC, the combined opportunity for both InfiniBand switches and HCS is nearly $1 billion in 2010. Anticipating the successful completion of our SilverStorm acquisitions, QLogic's new term will be nearly $5 billion in 2010, and our compounded annual growth rate of 20%. Our key to success in the SAN market is the ability to qualify your products with the leading storage and infrastructure suppliers in the market.

In September, Cisco Systems and EMC both qualified QLogic SANbox Fibre Channel switch models for IBM BladeCenter with MDS 9000 Series multilayer directors and fabric switches from Cisco. EMC qualified the combination of QLogic switches and the Cisco MDS 9000 series for use with EMC, DMX, and EMC CX series network storage systems. This qualification will strengthen QLogic's market share leadership for Fibre Channel blade switch in blade server environments. For the eighth consecutive year, QLogic was named to Forbes 200 Best Small Companies list. The Company ranked number 5 in the market value and number 12 in profit growth.

In August 2005, we announced the divestiture of our HDC and tape control business. At that time, we established a new strategy that focused on SAN infrastructure and high-performance server interconnects. Our strategy was to expand into adjacent markets through internal development and the acquisitions of key technology. A year later, the strategy is working well; both QLogic's revenue and earnings per growth have accelerated. For the first six months of this fiscal year, revenue grew 20% and earning grew 22% from the comparable period last year these growth was achieved without meaningful revenue contribution from the new markets with continued growth in existing markets combined with incremental revenue opportunity from new markets, we believe we are well positioned for accelerated revenue growth.

Thank you, operator we are ready for questions.

Question-and-Answer Session

Operator

(Operator Instructions). And we'll hear first from Paul Mansky of Citigroup.

Paul Mansky - Citigroup

Hi its great quarter and great outlook. As I look at the royalty number that just about doubled sequentially, presumably the highest margin business you have, HBAs outperformed, and yet the blended gross margins were down a little bit on a sequential basis. Can you walk-through in a little bit more granularity the dynamics that are taking place in the margin line or the revenue and margin line?

Tony Massetti

Sure Paul. So, we talked about in the script that margins are down about 50 basis points due to product mix, as well as some onetime costs associated with the transition of contract manufacturing from U.S. to non-U.S operations and that was less than $1 million, but that did affect our margins in the quarter. Also, you're right; royalty was up about 2 million in the quarter. We said that in prior calls that royalty from time-to-time as we will see an increase in the royalty, but the normal run-rate there is probably around $1.5 million. The other thing you should note is that Management Controllers were also down -- at a very high margin, offsetting the increase in royalty revenue. So, those -- lot of moving parts in margins, but consistent with our guidance on the June call we've talked about gross margins being approximately 70%, and we were just over 70%.

Paul Mansky - Citigroup

Yeah, I don't mean to split hairs there on that one. Now, as we look at the outlook on December, are you expecting -- baked into that outlook are you expecting a comparable performance from the revenue -- from the royalty line item?

Tony Massetti

No, I think the royalty should get back down to a more normal run-rate of $1.5 million to $2 million.

Paul Mansky - Citigroup

So, as we look at that, contributors to the upside relative to consensus is that primarily HBA or switches, or a balance between the two?

Tony Massetti

Both.

H.K. Desai

Both.

Paul Mansky - Citigroup

Great. Thank you.

H.K. Desai

And Paul, we also said our guidance that what we gave is $154 million to $160 million. We're counting minimum revenue from the PathScale, and no revenue at all from SilverStorm.

Paul Mansky - Citigroup

And you said, InfiniBand was less than 1 million this quarter?

Tony Massetti

Correct.

Paul Mansky - Citigroup

Okay, right. Thank you.

Operator

Now, we will hear from Laura Conigliaro with Goldman Sachs. Ma'am your line is open.

Brian Mansfield - Goldman Sachs

This is Brian Mansfield for Laura. My question actually has to do with the pace of acquisition. As we've seen it pick-up over the past year, what can we imply that your thoughts are about your core HBA business growth?

H.K. Desai

We grew 10% sequentially. We grew 26% year-over-year and we are growing the last two years more than 20%, so we expect the continued growth of our core HBA business. We don't see any problem there at all. All our growth came, like I said in the script, the first six months, for example, it's all growth came from core business.

Brian Mansfield - Goldman Sachs

Is it a trend that we should be concerned with going forward?

H.K. Desai

No.

Brian Mansfield - Goldman Sachs

Thank you.

Operator

Moving on we will hear from Mark Moskowitz with JP Morgan.

Mark Moskowitz - JP Morgan

Yes, thank you. A few questions, if I may. The first question it really kind of builds off of Paul's as far as the upsides for the December quarter, which is quite significant. Can you give us a sense, H.K. or Tony; in terms of is there any one OEM or other type of channel partner that's lending to this upside? Particularly, I'm speaking of the EMC Select program, given some of the progress you have had there?

H.K. Desai

No, if you look at it, we have a extremely balanced growth, particularly coming from HBA and the switch in the September quarter, and we expect the same balanced growth coming from both switch and HBA in the December quarter. And also it is going to be balanced across all OEMs so, if you look at our top five customers on OEM side, four grew sequentially and one declined because of seasonality, which we have expected. And December quarter probably seasonality is normally strong for all OEMs.

Mark Moskowitz - JP Morgan

Okay, and then can you give us a sense of the EMC Select program? You made some pretty considerable investments in that opportunity the last year or so, and it seems as if you're getting a better reception. Should we think about that being a source of revenue momentum going into '07?

H.K. Desai

I think it's similar to what we have seen. I think it was similar to what happened in the future, I think it's too early to predict, but that's not where we're projecting to give our guidance.

Mark Moskowitz - JP Morgan

Okay, and then just lastly. More longer term in nature, we hear a lot about server virtualization, server consolidation. Can you maybe give us your point of view as far as updating us on how you're thinking about server virtualization, either as a catalyst or maybe a risk as more server assets are optimized overtime? What does that represent to HBAs?

Tony Massetti

At this point we see server virtualization actually as an upside. We see it drawing more of the HBAs into the marketplace, more servers that would have otherwise been direct connect are now utilizing SAN for connectivity. So, at this point we view there is an upside.

Mark Moskowitz - JP Morgan

Okay, thank you.

Operator

Now, from Merrill Lynch, we will hear from Srini Pajjuri.

Srini Pajjuri - Merrill Lynch

Thank you. First, Tony couple of clarifications. The expense guidance you gave us doesn't include the acquisition, or is this pre-acquisition?

Tony Massetti

Yeah, it's pre-acquisition, Srini.

Srini Pajjuri - Merrill Lynch

And how should we think about the expenses from the acquisition?

Tony Massetti

Well. We haven't given any guidance because it hasn't closed yet, but you can assume the same operating model that we've been talking about. So, for example, engineering 17% to 20% of revenue, sales and marketing 11% to 14%, and G&A 3% to 4%; it won't impact those E-to-R percentages.

Srini Pajjuri - Merrill Lynch

Okay, in terms of revenues, I know you said it's going to be neutral to EPS, but are they generating any revenues at all at this point?

Tony Massetti

They are, but we can't provide any color until it closes.

H.K. Desai

Yeah. That's why when we said, Tony said in the script that we said $154 million to $160 million our guidance we haven't included anything from SilverStorm. We made it very clear for that so, and we don't know when it will be closed, and we don't know what will be our strategy. So, I think we don't want to give any guidance on that.

Srini Pajjuri - Merrill Lynch

Okay. Fair enough. And then on the tax rate, Tony, it went down quite a bit in the September quarter. Is there more room for it to come down in the long run, or do you think it's going to stay around these levels?

Tony Massetti

Yeah. We had guided -- it was 34% -- 34.1% in the June quarter Srini, we guided 34% to 35% on the June call. It's at 33% annualized for fiscal '07. We booked 32% to get the annual rate down to 33%. So, we've guided 33% for the balance of the year. I think that's a good place for planning purposes.

Srini Pajjuri - Merrill Lynch

Okay. And then on the Fibre Channel switches, it looks like the growth rate; the 9% sequential is pretty good. But given the issues that you had last quarter, did you have manufacturing issues in the September quarter, and as a result is there a pent-up demand that you're going to see in December?

H.K. Desai

No, we have no issue like that. There was a one quarter issue, and there's no issue manufacturing-wise in the September quarter.

Srini Pajjuri - Merrill Lynch

Okay, fair enough. And then finally, for H.K., on the InfiniBand market, could you generally talk about in general terms what do you think that SAN will be for 2007? And when do you expect double-digit types of revenues from this market?

H.K. Desai

So, like -- Rick is here, maybe he can answer, but like I said in my script that it's about $1 billion market, which include the HCA and the switches and the TCS. The total overall market is about $1 billion in 2010. And this is what we assuming right now that the only tractions IB will have is in the high performance computing market. We're not including anything based on the clustering for the database clustering or enterprise environment or for the financials. So, I think we have a conservative estimate right now just focusing on the HPC -- on the high performance computing it's about $1 billion [tab].

Srini Pajjuri - Merrill Lynch

I understand the [tab] is 1 billion, but what do you think the SAN is going -- from my understanding there is a startup that filed to go public, and they're doing roughly about 40 to 50 million. So, I'm just trying to understand what the total opportunity in 2007 is going to be as opposed to the total tab.

Tony Massetti

So, that 40 to 50 million is in silicon, there are multiple vendors that take that silicon and then turn around and take it into the market, so market is considerably higher than that for selling on the OEM side. So, complete products, switches, HCAs when they get sold in the market there is a significant uplift from that number.

Srini Pajjuri - Merrill Lynch

Okay, great. Thank you.

Operator

Now, we will hear from Glenn Hanus with Needham & Company.

Glenn Hanus - Needham & Company

Hi, guys nice job. On the HBAs is the number being -- maybe you could give us some comfort that the Fibre Channel HBA number is showing healthy growth, and it's not being skewed by the iSCSI is really taking off. Can you give us some color there?

H.K. Desai

Sure Glenn, let me tell you something. When we said there's a 10% sequential growth for the HBA, which include both Fibre Channel and iSCSI, if you only count Fibre Channel HBA, we still have a 10% sequential growth on the Fibre Channel HBA for the September quarter.

Glenn Hanus - Needham & Company

Okay, great, thanks. And maybe just a longer-term question, between InfiniBand, routing or virtualization, maybe you could give us a little update on timing and revenue -- rank them in terms of revenue opportunities for you and timing over the next 12 months.

H.K. Desai

Well, I think we're not -- it's difficult to predict, but what we are saying is that what we are seeing is that we are still seeing a tremendous growth in our core market, if you see our data last -- the first two quarter of the fiscal 2007 we grew about 20% in revenue, which is not including -- which is including less than $1 million revenue from the new market, which is IB. So, what we still expect continued growth in the December quarter from the core market, and I think also going forward; we are also saying that switch revenue we expect to grow around 20% plus. So -- and HBA we are growing faster than market for the last 2.5 years, and we expect continued growth on that, particularly go into the [NASCAR]. So, I think we're expecting a pretty good growth without the new technology and then when the new technology start coming into play, which can be probably sometime in the second half of '07 or particularly more into the '08, I think our growth rate can pick up if we can continue still the same growth on the core market. So, we cannot predict anything, but I think it's just a upside opportunity for us.

Glenn Hanus - Needham & Company

And maybe any more granularity on the quarter guidance between HBAs and switches, which one is growing faster, or is it balanced, any color there?

Tony Massetti

Both in excess of 20% year-on-year.

H.K. Desai

Year-on-year.

Tony Massetti

Year-on-year. Glenn.

Glenn Hanus - Needham & Company

Okay, thank you.

Tony Massetti

You are welcome.

Operator

Now, we will hear from Kevin Hunt with -- I am sorry with Thomas Weisel Partners.

Kevin Hunt - Thomas Weisel Partners

Hi, thanks. Couple of questions, follow up on the iSCSI question, is it safe to say that's just pretty immaterial still as a percent of the total HBA, like under 5%? And then on the InfiniBand side, can you maybe talk a little bit technologically about PathScale and SilverStorm? My understanding is SilverStorm was buying silicon from Mellanox. Is that going to continue to be the practice going forward? And then how the -- is there any of those two integrate against going forward?

H.K. Desai

Okay, so, yeah, you're right about those things on iSCSI, it's a very small number compared to the Fibre Channel. So, a lot of our growth is coming from Fibre Channel. On the IB side, like say we, I -- its, PathScale is HCA, which is either based on HyperTransport interface or the PCI Express, and SilverStorm is buying switch silicon from Mellanox, and we will continue doing that buying switch silicon from Mellanox once the acquisition is complete. We don't have no plan to do our own silicon.

Kevin Hunt - Thomas Weisel Partners

Okay, all right. Thanks.

Operator

Next we will hear from Frank Timons, Robert Baird & Company.

Frank Timons - Robert Baird & Company

Hi, guys thanks for taking my call. H.K., first kind of on the acquisition front, to kind of go back I think we're getting close to the anniversary of the Troika acquisition, if I'm correct then can I just maybe get your perspective on lessons learned from integrating that, and where you think that is from a maturity perspective? And then as your next acquisition, I think it is a [depends on] venture based company, what do you think is going to be maybe unique challenges to try and integrate that one?

H.K. Desai

So, we have a pretty good record of integrations. We have done five acquisitions before we did the Troika anyway. And we're very successful in acquisitions. We're able to keep all the key employees and key engineers. We have the same performance at Troika and the key for the Troika acquisition, like I said, is that if you want to continue on the switch market long-term we need that functionality for the storage virtualization, for the SwitchBlade, and that's reason we acquired Troika, and that's the strategy we have. And the future also I think we're very successful in integrating any company we have acquired. So, we're very confident that we will do the same thing with PathScale -- we have done the same thing with PathScale, and we will do it with SilverStorm, if that complete.

Frank Timons - Robert Baird & Company

Okay, switching gears really quickly, you have obviously done well in the blade market, being sole source for a while. Now, that there is a new entrant, do you see any change in dynamics there?

H.K. Desai

No, there is a competitor now in the switchblade market, but we still continue growth in our switchblade because the market is also growing.

Frank Timons - Robert Baird & Company

Right. And guess finally then if you lookout and think more strategically to your operating model with wanting to continue to invest R&D dollars, what do you think you can do from an international perspective to maybe take the aggregate dollars down from maybe leveraging NDA and R&D etcetera?

H.K. Desai

We always do some outsourcing; we always work with some of the companies in India if we require some resources. But we still develop -- our strategy is really still to develop our own core technology here in U.S., either it's a silicon or it's a software. We always use the resources outsourcing if we need some kind of qualification or the DVT or verification resources, or sometime we overflow, we don't have enough resources to do a certain task -- we go outsourcing. But we have no plan to really start-up our own company in India.

Frank Timons - Robert Baird & Company

Great, thanks so much.

Operator

Now, from RBC Capital Markets, we will from Tom Curlin

Tom Curlin - RBC Capital Markets

Hi, good afternoon. Great quarter, congratulations.

H.K. Desai

Thanks.

Tony Massetti

Thanks Tom.

Tom Curlin - RBC Capital Markets

In our checks it seem like you're getting a lot of momentum in VMW are environments, they are supporting iSCSI Boot from SAN now. And it seems like you guys are really the primary, or maybe the only called for that. Do you agree with that statement? Do you think that VI3 is helping to drive your iSCSI adapter momentum just on top of some of the OEM wins you have in the storage systems space?

H.K. Desai

Yeah, when we're getting -- we don't really have much competition with iSCSI and, yes, even though it's a still small market it's still -- even though we doubled our revenues it is still a very small market. Like I said, even though we grew 10% sequentially for the HBA market, we still grew 10% sequentially for the Fibre Channel too. That means iSCSI is not contributing that much on our HBA growth, so it is still a small market.

Tom Curlin - RBC Capital Markets

And if you look at your royalty revenue, obviously making great progress and without getting into names, do you -- a little bit of debate about product transitions with the OEMs they are leading to some degradation in that royalty stream. Are you aware of any architecture transition that really changes that royalty relationship?

Tony Massetti

No, Tom. Going back to Paul's question, we expect $1.5 million to $2 million in that line as a run-rate in the foreseeable future.

H.K. Desai

It can change one quarter sometime, because it depends on the product when they acquire. But we expect the same thing for a while.

Tom Curlin - RBC Capital Markets

Yeah, that's what I expected hear. I just wanted to verify. And then on the tax rate, for next year, obviously making progress with some of the international investments, why can't we assume that's headed to at least 32% versus 33% in fiscal '07?

Tony Massetti

It's early to say Tom. We will give more color on that in future conference calls. Certainly on the March call; as we have done in the last two years, we will give guidance for fiscal '08 and we will provide as much color as we can on the December call and January. But it's early to say, certainly I hope that it would come down a bit here. It's really dependant on growth in our non-U.S. revenue. So, to the extent that grows faster than the U.S., then there's opportunity to reduce the tax rate.

H.K. Desai

Yeah, there is always a possibility, but I think it's too early for us to give a guidance on that.

Tom Curlin - RBC Capital Markets

Then finally, on net interest other use of cash this quarter, so 6 million or so, is that an appropriate assumption? Maybe up a little bit or will it be down a little bit in the December quarter?

Tony Massetti

I think it will be around where it is now, Tom. Our average cash balance in the September quarter, with all the buyback -- we bought back $54.5 million of stock, so the average cash balance was down about 34 million this quarter. We will complete the SilverStorm acquisition in the December quarter, there'll be $60 million use of cash there. So, I think you can plan for approximately the same level of interest income that we saw in September.

Tom Curlin - RBC Capital Markets

I guess one more real quick one. On the SilverStorm acquisition originally that was positioned as neutral to fiscal '07 EPS. I assume that's neutral off with new guidance?

Tony Massetti

Yes.

H.K. Desai

Yes.

Tom Curlin - RBC Capital Markets

Great, thank you very much.

Tony Massetti

You are welcome.

Operator

Now, we will hear from Harsh Kumar, Morgan Keegan.

Harsh Kumar - Morgan Keegan

Hi, guys. First of all, great quarter, great guidance. Most of my questions have been answered, but I got a couple. OpEx was down sequentially, pretty good control there. Can you talk about what happened there or how you guys are doing it?

Tony Massetti

Well that’s right in line with what we guided Harsh. We said on the June call that there is leverage in the SG&A line going forward as revenue from the acquired companies. And we continue ramp -- so we continue to take market share on the HBA side, and grow the switch business that either or should come down over time. Also, specifically looking at the sales and marketing line, there was about $800,000 expense for the worldwide partner conference in the June quarter, which is absent in the September quarter, so that also attributed part of the decline sequentially. And then engineering was roughly flat. So it's right in line with where we guided.

Harsh Kumar - Morgan Keegan

Got it, got it okay that's helpful. And then on the InfiniBand side, on HCA particularly, when can we expect meaningful revenues guys, like $1 million or over that?

H.K. Desai

Well we say that in the September quarter, it was less than $1 million. We don't know exactly what will happen. It's a new market and new OEMs. And sometime you have design win you get some revenue and then it depends on when they go to market and when this starts in the product. We expect some revenue for the December quarter, but not much, and we're not counting too much revenue from them.

Harsh Kumar - Morgan Keegan

Fair enough H.K. And I had to get off the call for a second in the middle, but I think you might have said that HBA revenues were up 10% sequentially, did I catch that correctly?

H.K. Desai

Yes, I said HBA revenue was 10% sequentially, and which is for Fibre Channel and iSCSI. So, Fibre Channel revenue was also up 10% sequentially and 26% year-over-year.

Harsh Kumar - Morgan Keegan

Got it. So what's the H.K. what would be the biggest driver? That’s a pretty hefty number given your historical seasonality. What do you think is the biggest driver there?

H.K. Desai

I think we're gaining market share, like I said in my script. We are at 49% for the first six months, so we gained 5 points from the December. And we're about 11 points ahead of our nearest competitor. This is for the first six months. This is a six-month timeframe. And the 10% sequential growth, I think we're gaining market share on the HBA side, and we have a really balanced performance from all OEMs. Also the 4-Gig OEM design win is done. We have qualifications done. We start shipping the product. I think our rate is faster than the other competitors. I think we are just doing real good on HBA side all over with all the customers.

Harsh Kumar - Morgan Keegan

These are great results. Thanks for my questions guys.

Tony Massetti

Thanks Harsh.

Operator

And now will hear from Douglas Whitman of Whitman Capital

Douglas Whitman - Whitman Capital

Thanks for the good quarter. You guys have given a little color on it, but could you talk a little bit -- not only did you have a very good quarter, but a very solid outlook. And Talk a little bit more about is this market share gain? If you're feeling good about the environment out there, for storage, and then -- or a combination of the above?

H.K. Desai

I think it's both. I think we're feeling -- I think it all kind of depends on the forecast we get from our OEMs. And lot of our guidance is based on that. I think we're seeing a pretty good forecast. Our October is on track -- the guidance we gave. So I think it's all kind of combined together and I'm sure we're getting the market share for HBA and the switches.

Douglas Whitman - Whitman Capital

Okay and last question is, Tony, in the September quarter, which is normally more back end loaded, you brought the receivable days down even lower, kind of below what you talked about the range being. Besides your fabulous CFO work, was there greater linearity in the quarter then might have been anticipated?

Tony Massetti

Not really. I think it was mostly the fabulous CFO work. Thanks for that. No, it was -- I think the quarter was fairly linear. And the AR team does a great job, and we just had a good quarter on the collection side. Looking into December, there is some seasonality in December collections, with the holiday season. So generally the last couple of weeks of December is a little bit more challenging with collections. So we expect our DSOs to probably be in the 45 to 47 day range for December. AR is still high-quality. Nothing changes there, but it's just due to seasonality.

Douglas Whitman - Whitman Capital

Thank you.

Tony Massetti

Okay thanks.

Operator

And gentlemen, there are no further questions. I will turn it back over to you for any closing remarks.

Tony Massetti

Thank you for joining us for our second quarter fiscal year 2007 conference call. We look forward to discussing our third quarter fiscal 2007 results with you at our next quarterly conference call in January. Also, we have several upcoming conferences that we will be attending. In November, we will be presenting at the JP Morgan Small MidCap Conference and the Credit Suisse First Boston 2006 Annual Technology Conference. In December we will be presenting at the Lehman Brothers Global Technology Conference and the UBS Enterprise Technology Conference. Please refer to our Investor Relations website at www.qlogic.com, for any updates to the conference schedule. For any of you that will be attending these conferences, we look forward to seeing you there. Thank you.

Operator

That does conclude today's conference. We do thank you for your participation.

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