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QLogic Corporation (NASDAQ:QLGC)

F3Q11 Earnings Call Transcript

January 27, 2011 5:00 pm ET

Executives

Doug Naylor – VP, Finance and Interim CFO

Simon Biddiscombe – President and CEO

H. K. Desai – Chairman and Executive Chairman

Analysts

Amit Daryanani – RBC Capital Markets

Aaron Rakers – Stifel Nicolaus

Jayson Nolan – Robert Baird

Mark Moskowitz – JP Morgan

Keith Bachman – Bank of Montreal

Kaushik Roy – Wedbush

Katy Huberty – Morgan Stanley

Glenn Hanus – Needham & Company

Rajesh Ghai – ThinkEquity

Douglas Ireland – JMP Securities

Scott Craig – Bank of America/Merrill Lynch

Operator

Good day, everyone, and welcome to the third quarter of fiscal year ‘11 QLogic earnings announcement conference call. Today’s conference is being recorded. And at this time, it is my pleasure to turn the conference over to Mr. Doug Naylor, Vice President of Finance and Interim Chief Financial Officer of QLogic. Please go ahead, sir.

Doug Naylor

Thank you, operator. Good afternoon, and welcome to QLogic’s third quarter fiscal year 2011 earnings conference call. Joining me on the call today is Simon Biddiscombe, our President and Chief Executive Officer. I will begin the call with a review of the third quarter financial results. Simon will follow with a discussion of the current state of our business and strategic initiatives. Afterwards, we will open up the call for questions.

Certain of our comments today will include forward-looking statements regarding future events and/or projections of the financial performance of the company based on our current expectations. These comments are subject to significant risks and uncertainties that could cause our actual results to differ materially from those expressed in these forward-looking statements.

We refer you to the documents that QLogic files with the SEC, specifically our most recent forms 10-K and 10-Q. These documents identify important risk factors that could cause our actual results to differ materially from expectations. We do not intend to update the forward-looking statements that we make today.

In our third quarter earnings press release issued earlier today, we reported both GAAP and non-GAAP results. In addition, all of the references we will make on our call today relate to non-GAAP results unless otherwise stated. A reconciliation of the non-GAAP financial measures presented to the most directly comparable GAAP financial measures is available on our website under Investor Relations.

Turning now to our financial results for the third fiscal quarter ended December 26, 2010. Our revenue in the third quarter was $155.8 million, an increase of 4% from the same quarter last year. This revenue was at the high end of our forecasted range of $148 million to $156 million provided during our third quarter earnings conference call and consistent with the updated forecasted range of $155 million to $156 million provided in our preliminary third quarter results announced on January 12.

Our third quarter revenue from Host Products, which are comprised primarily of Fibre Channel adapters and converged network adapters, was $113.5 million and increased 3% from $110.4 million recorded in the third quarter of last year. Third quarter revenue from Network Products, which are comprised primarily of Fibre Channel and InfiniBand switches, was $28.9 million and increased 6% from $27.4 million recorded in the third quarter of last year.

Our third quarter revenue from Silicon Products comprised of Fibre Channel, converged networking, and iSCSI chips was $10.6 million. This revenue increased 23% from $8.7 million recorded in the third quarter of last year. Our service and other revenue was $2.7 million. Our third quarter gross margin of 67.1% improved from 66.0% recorded in the third quarter of last year, primarily due to higher volume to absorb manufacturing costs. Our gross margin exceeded our forecast of 66.0% to 66.5% provided during our third quarter earnings call, primarily due to product mix.

Next I’d like to cover our third quarter operating expenses. Total operating expenses were $54.4 million, up 2% from $53.2 million reported in the third quarter last year. Operating expenses were below our expectation. Engineering expenses in the third quarter of $29.4 million were consistent with the third quarter last year and decreased as a percentage of revenue from 19.8% to 18.9%. We expect future engineering expenses as a percentage of revenue to be in the range of 18% to 21%.

Sales and marketing expenses in the third quarter of $18.3 million increased 8% from a year ago and increased as a percentage of revenue from 11.3% to 11.7%. We expect that future sales and marketing expenses as a percentage of revenue will range from 11% to 13%. General and administrative expenses in the third quarter of $6.7 million were 4.3% of revenue. We expect that future G&A expenses as a percentage of revenue will be approximately 4%.

Operating profit in the third quarter of $50.1 million increased 11% from a year ago and increased as a percentage of revenue from 30.3% to 32.2%. Interest and other income was $800,000 in the third quarter. During the third quarter, we’ve recorded a tax benefit of $6.3 million. This tax benefit is a result of third quarter specific income tax items, including the retroactive reinstatement of the federal research tax credit that was enacted December 2010.

Our third quarter net income of $57.2 million increased 58% from a year ago and represented a net profit margin of 36.7%. Our third quarter net income per diluted share of $0.53 was significantly better than the $0.31 we achieved last year. The benefits associated with the third quarter specific income tax items that were not included in our original guidance contributed $0.13 to our earnings per diluted share.

Excluding these third quarter specific tax benefits, we achieved net income per diluted share of $0.40, which beat the high end of our forecasted range of $0.34 to $0.38 provided during our second quarter earnings call and also exceeded the $0.38 to $0.39 range provided in our preliminary third quarter results announcement. This represents the 62nd consecutive quarter of profitability for QLogic.

Turning now to our balance sheet, the company’s cash and investment securities were $343.2 million at the end of the third quarter. We continue to maintain a strong cash position and have no debt. During the third quarter, we generated $60 million of cash from operations. During the quarter, we purchased $31.5 million of the company’s common stock at an average price of $17.57. Since 2003, we have used $1.6 billion to purchase 101.5 million shares of the company’s common stock.

Receivables of $83.9 million at the end of the December quarter decreased sequentially from $86.4 million at the end of the September quarter. DSO at the end of the December quarter was 49 days and decreased from 54 days at the end of the September quarter. Inventory at the end of the December quarter was $25.9 million and increased from $24.9 million at the end of the September quarter. Annualized inventory turns for the December quarter was 7.9, up slightly from the 7.8 turns achieved in the September quarter.

Turning now to our outlook for the fourth quarter, our current fiscal year includes 53 weeks and ends on April 3, 2011. As a result, our fourth quarter will include a 14th week and our revenue will benefit from the extra week, although not on a proportional basis due to a number of factors. In our fourth quarter, we expect total revenue to be in the range of $148 million to $153 million. We expect gross margin to range from 66.0% to 66.5%.

When combined with the planned operating expenses of approximately $58 million, including the impact of the 14th week, a projected quarterly tax rate of approximately 16% and a diluted share count of approximately 107.5 million shares, we expect to achieve non-GAAP earnings per diluted share of approximately $0.32 to $0.35 in the fourth quarter. Actual results for future periods may differ materially due to a number of factors, including those outlined during the course of this conference call, in the company’s filings with the SEC and in the disclaimer statement at the end of our earnings press release.

I will now turn the call over to Simon. Simon?

Simon Biddiscombe

Thanks, Doug. In my new role, I have spent the last three months visiting customers and partners, listening to their needs, understanding their requirements, and working closely with our supporting teams. Our customers and partners reinforce the value and importance of our long-term relationships, market leadership, focus on execution, and current product portfolio strategies. It is clearer than ever that we are on the right path with our approach, focus and investments to capitalize on the significant incremental opportunities and the rapidly expanding high-performance datacenter connectivity market.

On the financial front, I’m very pleased with our execution and discipline. Our revenue in the third quarter was $155.8 million, a sequential increase of 6% and at the high end of the guidance we provided during our second quarter earnings call. On a sequential basis, revenue from Host Products grew 9% and revenue from Network Products grew 6%. Within our Host Products, our revenue from Fibre Channel adapters grew in excess of 10% and our revenue from converged adapters, including 10-gig Ethernet, grew at a significantly higher rate. I’m also very pleased that we achieved an operating margin of 32.2% during the third quarter, driven by higher than expected gross margin and lower than expected operating expenses.

During the third quarter, our net income per diluted share was $0.53, excluding the tax benefits associated with the third quarter specific income tax items that were not included in our original guidance, we achieved net income per diluted share of $0.40, which beat the high end of our forecasted range of $0.34 to $0.38 provided during our second quarter earnings call.

Now I want to share some of the highlights and accomplishments that we think are clear indicator of the progress we have made in expanding our market opportunities as well as keeping proper focus on our traditional markets. Our early investments in convergence and our time-to-market advantage for converged products has continued to result in a strengthened leadership position.

According to the most recent data published by the Dell’Oro Group in its Q3 2010 SAN Adapter Report, QLogic gained over 4 share points and was the leader of the 10-gig converged network adapter market with 62% revenue market share for calendar Q3 2010.This represents a lead over our nearest competitor of almost 27 share points. Our leadership in the 10-gig Ethernet converged network adapter market further reinforces the power and leverage of our traditional fibre channel market position and the value of incumbency.

In our last earnings call, we highlighted our October launch of the industry’s first third-generation 10-gig Ethernet converged networking portfolio named 3GCNA. Based on our Network Plus architecture, the 3GCNA portfolio features a trio of products, with a number of industry firsts for the converged networking market, including the first product with the ability to run FCoE, iSCSI and Ethernet traffic concurrently. The first product to perform switch-agnostic VM-to-VM communication within physical machines and the first product to deploy quad 1-gig and dual 10-gig Ethernet ports from a single chip using our advanced FlexLOM technology.

We continue to make very positive progress. This morning, we announced that HP has completed its qualification and is now shipping our 3GCNA products. Our 8200 series 10-gig Ethernet converged network adapters, branded HP storage works CN1000Q, and our 3200 Series 10-gig intelligent Ethernet adapters, branded HP and C523 SFP, are now tested and certified for the HP ProLiant ML and DL rackmount and tower servers. These 10-gig Ethernet adapters are designed to address the increasingly complex requirements of virtualized datacenters, cloud service providers, and the converged enterprise.

All of these environments require 10-gig Ethernet line rate throughput for virtualized data and storage traffic, support for concurrent protocols, and low CPU utilization to allow for extreme mobility of virtual machines. The QLogic 3GCNA portfolio addresses these requirements very effectively. We are also fully engaged with all leading server and storage OEMs that will result in a number of additional 3GCNA programs come into revenue over the course of 2011. We will announce the specifics of these as they occur.

As part of our strategy to partner with Ethernet switch band is looking to offer their customers the benefits of network convergence. In November, we announced that we would provide Avaya with our 10-gig Ethernet converged network switching technology, code named Bullet, to support Avaya’s new virtual enterprise network architecture. Specifically, we will be introducing a new 8-port converged network switching module that simplified networking by adding fibre channel over Ethernet capabilities to provide access to virtual and physical servers to Ethernet LANs and fibre channel SANs over a single high-speed 10-gig Ethernet data park. These enhanced capabilities mix combined Avaya-QLogic solution ideally suited for cloud computing environments, virtualized data centers, and converged enterprise.

Our InfiniBand momentum continued in November, when we announced that our 7300 series QDR InfiniBand host channel adapters, how to establish new world records for message rate performance at both host and cluster levels. The 7300 series adapters achieved cluster message rate performance of over 86 million messages per second, 2.3 times higher than comparable InfiniBand adapters. Message rate performance directly relates to the performance of an HPC application and its ability to scale more effectively. Using end to end solutions based on QLogic, InfiniBand products, customers will be able to run their applications faster as well as receive better price per performance results.

While convergence and 10-gig Ethernet are our expansion opportunities. Our traditional fibre channel storage area network in markets continue to be very successful and important business for us. We will continue to invest in products for the SAN for many years to come. Growing our market share in fibre channel adapters is and will continue to be an important priority for us. Our fibre channel adopter market share continues to be very strong.

Based on the most recent Dell’Oro data, we maintained our leading 54% revenue market share in fibre channel adapters through the first three quarters of calendar 2010. The same is for the full year 2009 share. We will continue to stay focused on share growth, a very significant point to note from the report is that to date, we have shipped 43% more full and 8-gig ports than our nearest competitor. Significant and growing competitors’ advantage for us as users transaction to converge the product.

With 8-gig fibre channel now represent an increasing majority of the ports shipped, the development of our old portfolio for 16-gig, the next fibre channel link speed is well underway. Last quarter, we announced our full support for the 16-gig fibre channel standard, ratified by the MC technical committee. We are committed to fielding a full portfolio of backward compatible 16-gig products maintained in the highest degree of software compatibility, interoperability and value. And providing investment protection talks for high performance SAN customers who choose fibre channel as solution to the requirements.

In closing, I’m very optimistic with regard to the future of our company. We have an unmatched foundation for success, world-class execution, and a winning strategy. The markets we serve are healthy, and for the foreseeable future, we do not expect to see the volatility we have experienced in recent years. As I said in my opening comments, it is clear to me that we are on the right path with our focus and enhancements to capitalize on the significant incremental opportunities in the rapidly expanding high performance datacenter connectivity market. ]

This concludes our prepared remarks. Joining us for the Q&A session is our Executive Chairman, H.K. Desai.

Question-and-Answer Session

Operator

Our first question will come from Amit Daryanani with RBC Capital Markets.

Amit Daryanani – RBC Capital Markets

Thanks. Good afternoon, guys. Just couple of questions. First off, March quarter, I know you guys talked about the extra week. Could you just talk about what implication that has on the OpEx? It seems a little heavy at $58 million.

Doug Naylor

If you take the $54 million we did last quarter, Amit, you had a couple of million dollars for the reset of all the payroll-related taxes for the beginning of the fiscal year. And then there’s about $2 million associated with the extra week. So it’s roughly two that you would naturally see for the beginning of the new calendar year and then roughly two associated with the extra week.

Amit Daryanani – RBC Capital Markets

All right. And then, how about on the revenue line, how much would you estimate the revenue benefit would be actually?

Simon Biddiscombe

Here is what I think is happening, Amit. I think this is as close to a normal seasonal guide, as you can imagine. Okay? So I think if you take out the effect of the extra week, I think at the midpoint our guidance is down approximately 5%, which is very consistent with normal seasonality. The actual guidance at the midpoint is down 3%. Okay? And what you can’t do is take revenues, divide by 13 and multiple by 14. Okay? And let me explain to you why you cannot do that. Number one is, as we think about the specific activity associated with that time of the quarter where you’ve got that incremental week, that’s pretty slow week generally.

A lot of the activity associated with hub poles and direct business has already occurred prior to that very last week of the quarter. As our OEM customers pulled product in order to integrate it and configure it and so on. So that’s part number one. Part number two is it has no impact in the channel whatsoever given that for the channel we recognized 90 days worth of revenue and it’s based on a calendar quarter in every instance anyway. Okay? So we’ve been around and around on precisely how to explain to you the implications. I think that’s how best to read as we sit here at this point in time.

Amit Daryanani – RBC Capital Markets

It seems like a really good explanation. When I look at 2011, I don’t (inaudible) guide, but when you look at the demand dynamics, where do you think server unit growth could be in 2011? And then what are the puts and takes conceivably for you guys to essentially grow stronger than that number over time?

Simon Biddiscombe

When we think about server units, Amit, we are often using the same starting point as you are in terms of the units. Right? And I think we’re looking high-single digits at this point in time for the rate of growth of server units in 2011 over 2010. I think there were some new Gartner numbers that got published just a couple of days ago. As we look at the incremental opportunities for QLogic, clearly there is a tremendous amount of it that’s about growth, that’s way in excess of those numbers for products that serve the 10-gig Ethernet market and all the things converged.

So I think as we look forward, there are significant parts of our business that are going to grow rates in excess of the underlying server market that we serve at this point in time. I think as I look at the InfiniBand market, as I look at the fibre channel switch market and our ability to capture share, those offer significant incremental opportunity as well. So, as I look at the underlying markets, yes, I think there is a high-single digit rate of growth associated with server market, and we’re going to continue to drive efforts that push QLogic down those types of numbers.

Amit Daryanani – RBC Capital Markets

Perfect. Thanks a lot.

Operator

Moving on to Aaron Rakers with Stifel Nicolaus.

Aaron Rakers – Stifel Nicolaus

Yes, thanks, guys. A couple questions as well. First, just looking at the reported results, I think your silicon revenue at somewhere around $10 million was slightly less than, and I think you guys had alluded to, flat sequential guidance. So, first, can you talk a little bit about that, what’s going on there and whether – how you’re thinking about that here going forward?

Simon Biddiscombe

I don’t think it has changed in our perspective, Aaron. I mean, we told you roughly flat. We delivered $10.6 million, right? So $12 million instead of $10.6 million is $1.4 million or so. It’s about $1.5 million bounced (inaudible) somewhat. As we look forward, I think it’s going to continue to average roughly a $12 million number. This puts and takes, it’s always lumpy because of the long lead-time associated with the silicon part of the business generally. But nothing that quotes as Manny can sue [ph]. I think if you look back historically, there have been things that came negative to silicon line, to manage and control a business.

We were selling fibre channel products into the back end of storage. We were selling fibre channel products to people who built their own mezzanine cards. As I look at what we shipped toward, there’s really nothing that’s going away as we look forward. And in fact, when you think about things like the Bullet ASIC, which is our converged switch chip that we sell to the likes of an HP, with an angst desire today, I bet 3Com from the past as well. There’s opportunity on the silicon line. No doubt about it. But we continue to think about it as roughly $12 million per quarter.

Aaron Rakers – Stifel Nicolaus

Okay, good. And then following up on the opportunities with Avaya 3COM and I think even some others that you had alluded to at the Analyst Day, how are we to think about the ramps of those? Are those more back half of calendar 2011?

Simon Biddiscombe

As we look at where the products are shipping at this point in time, in particular, clearly HP has been buying that product for a number of quarters at this point in time – a couple of quarters at this point in time. And I would expect to see activity with HP arriving that solution ramp, A, sooner than the other participants in the market; and B, I would expect it to be a much large contributor to growth and I would expect to see from an Avaya or a 3Com – it's a module of 3Com, but 3Com part of the business any point soon.

Aaron Rakers – Stifel Nicolaus

All right. And then final question from me just on a model, 16% tax rate, is that what we are to assume going forward?

Doug Naylor

For fiscal 2012, we are looking at 17%.

Aaron Rakers – Stifel Nicolaus

17%. Thank you.

Operator

Moving on to Jayson Nolan with Robert Baird.

Jayson Nolan – Robert Baird

Thank you. Simon, as you look at some of the newer products, Ethernet and converged products, do you have more visibility there and do you see a nice uptick in business in the June quarter, something that you liked to talk about.

Simon Biddiscombe

Well, I think we have to see in the March quarter seriously. I think when we think about the growth associated with the products serve in, all things converged in 10-gig Ethernet, I think we’re going to see an improvement in the business in the March quarter. And then I think we’re going to see improvements on a quarter-to-quarter basis. But I do think the next major inflection point is when Romley-based servers start shipping, and that’s not going to be until late this calendar year. Right? So when every – not every, but when many servers are shipping with 10-gig technology in the box when you buy them, that’s when you’re going to start to see a real inflection in 10-gig and converged technologies and that’s later this year. But between now and then, I think we’re going to see very nice rates of growth on a quarter-to-quarter basis. We said in the prepared remarks that the rate of growth that we saw in converged products last quarter was well in excess of the rate of growth that we saw for the fibre channel products, and that was north of 10% itself. Right? So it’s on a reasonable trajectory and continues to grow.

Jayson Nolan – Robert Baird

Okay. Fair enough. And on gross margin, is it fair to assume flat to down in fiscal ’12, just given the product mix?

Simon Biddiscombe

So if I remember what we said at the Analyst Day, we said start with fiscal ’12 at 66% and we continue to do very well, we continued to exceed our expectations on the gross margin line. And I think if you start with 66%, then hopefully we’ll be in a position to be able to do better than that as we move through fiscal 2012.

Jayson Nolan – Robert Baird

Okay I leave it there. Thank you.

Operator

Mark Moskowitz with JP Morgan has our next question.

Mark Moskowitz – JP Morgan

Thank you. Good afternoon. Two quick questions here. One, Simon, could you talk a little more about how we should think about the host business going forward here? Just given that the growth that we try to reconcile what Emulex (inaudible) your growth, it’s kind of under-performing in your last couple quarter. How does that dovetail with the March guidance in fiscal 2012?

Simon Biddiscombe

Go ahead, Mark, finish it.

Mark Moskowitz – JP Morgan

That’s fine. That’s –

Simon Biddiscombe

I’m not going to try and reconcile my numbers to Emulex’s on a quarter-to-quarter basis. It’s not always easy to tell what’s in each of our number, because in their host numbers they’ve got silicon. I separate my silicon, and you can’t always tell the trends by just looking at the numbers that we provide to you. Typically, they always see a stronger December quarter based on one of their specific customers that always does very well in that period. I think you go back to the share numbers, Mark. Right? Fundamentally, the share we had through the first nine months of the year was north of 54%, exactly the same share as we had in the prior year. And there will always be puts and takes on a quarter-to-quarter basis.

We’ve had six consecutive years of share growth, and we’ll see what the final Dell’Oro numbers look like when they shake out over the course of next few weeks. The second point I’d make is, as we look at some of the share numbers around the most critical platforms that we ship into, we have no sense that we’re losing a share in any of our critical platforms where we have enjoyed a far higher market share than Emulex. So there’s no concern around share, Mark. There will always be puts and takes around individual platforms that are ramping more strongly in one quarter that they may enjoy and we enjoy and vice versa.

Mark Moskowitz – JP Morgan

Okay. And the second question is kind of two-part, if you will, forgive me. But in terms of these newer markets around converged and Ethernet, do you expect to see similar sourcing dynamics where the first source gets 60% to 70% of the business and the second source gets the remainder? And then the second part of this question is, now you kind of got the heavy R&D lifting out of the way, should we think about there being some wiggle room with R&D later this year, early next year on these new products?

Simon Biddiscombe

Answering the first one, Mark, with regard to how we see this market evolving, when you look at 10-gig Ethernet and the converged offerings, there’s going to be two or three players across all the major OEMs, across all the major platforms. And we each offer something that is slightly different from the other in terms of the technology. We’ve said in our prepared remarks today and we’ve said in the past, we think incumbency is incredibly important when it comes to fibre channel, fibre channel over Ethernet, the lead that we have in the fibre channel market that has manifested itself as a very significant lead in the true converged market where FCoE is running on the 10-gig wire.

When you look at some of the subsequent announcements around 10-gigE, I’m very comfortable that we are sustaining the level of share that we would expect to have with 10-gigE technology in the same way as we had with fibre channel technology historically. So we work extraordinarily hard to make sure that we are well positioned with our technology across all of the major server and storage OEMs. And as we’ve said many times, every one of those is engaged around QLogic technology.

H. K. Desai

Mark, this is H.K. And I think the key really is going to be, if you look at this stuff and you start the new technology adoptions, as always there is an adjustment in the strategies and then sometime you are driven by OEMs. And then over long-term, you are driven by the markets. And whoever executes flawlessly over long-term is the one who’s going to be successful. If you look at the fibre channel, we were the third player in this one. We own only 14% market share and then we grew over time and we executed really well, and we make our strategy correct for the markets and we are about – and we have our own [ph] markets. So it all depends on what’s going to happen next about two to three years. I think the two to three years is where you’ll settle down and see who’s going to be a winner.

Mark Moskowitz – JP Morgan

Thank you.

Operator

Our next question will come from Keith Bachman with Bank of Montreal.

Keith Bachman – Bank of Montreal

Hi, guys. Thanks, Simon, for that help on the 14th week. I have two questions. Number one, if you could talk a little bit about InfiniBand, how we should be thinking about that? And I’m not just asking about the March quarter. I’m just thinking about it as we look out over the course of calendar year ’11.

Simon Biddiscombe

It continues to be a growing market, Keith. And I think, as we think about the market, we’ve historically served with IB technology, which is primarily being HPC. When we think about some of the incremental markets that exist in clustering technology and scale-out type technologies, there are more and more incremental opportunities for QLogic with InfiniBand technology being used in what I’ll call non-traditional HPC markets. Substantially all the revenues we enjoy today are HPC. But as we think about the incremental sets of opportunities, there are more and more literally on a day-to-day basis, that take advantage of InfiniBand in new technologies that were not there one year ago, two years ago and three years ago and so on. So I think that’s a market that will continue to grow as we move forward.

Keith Bachman – Bank of Montreal

Did IB grow in calendar year ’10?

Simon Biddiscombe

I don’t have calendar year numbers with me. If you look at –

H. K. Desai

Yes, I think it did, absolutely. Yes. My colleague is nodding yes.

Keith Bachman – Bank of Montreal

All right. Well, my next question then is just trying to get some contacts. The silicon products and other roughly flat for the next couple quarters. I would assume that host grows better than normal seasonality over the next couple of quarters and networking is a little less than that. But I just want to try to get some color on the sequential growth patterns that we should be thinking about for those sorts of network.

Simon Biddiscombe

Yes. So what we would tell you, Keith, is if you pick the midpoint of the guidance, you should assume that essentially the entire business or each of the lines that we disclose performs roughly consistently with that. We’re not going to call it host line versus the network line and suggest they are going to do different things here in the near term.

Keith Bachman – Bank of Montreal

Okay. Thank you, guys.

Simon Biddiscombe

Pleasure.

Operator

We’ll now hear from Kaushik Roy with Wedbush.

Kaushik Roy – Wedbush

Thanks. Congratulations on the good quarter.

Simon Biddiscombe

Thanks, Kaushik.

Kaushik Roy – Wedbush

One clarification and a question. You mentioned in host products, fibre channel HBAs were up 10% sequentially.

Simon Biddiscombe

In excess of 10%.

Kaushik Roy – Wedbush

Yes. And CNAs were up more than 10%. But overall, it grew only – the host products grew only 9%. Does that mean that HBAs were down sequentially?

Simon Biddiscombe

Yes. But don’t forget, there’s –

Kaushik Roy – Wedbush

(inaudible) give us a color on what happened or why –?

Simon Biddiscombe

Kaushik, you’ve got to be careful. That’s not the only thing in that. There’s – again, I think you’re trying to do a comparison between by host line and somebody else’s host line. And I’ve got other things in my host line that not everybody has. So, whether it’s InfiniBand host channel adapters, whether it’s 1-gig iSCSI adapters, we have elements to our host line that not all our competitors do. And they do not necessarily all move in the same direction at the same time.

Kaushik Roy – Wedbush

Okay. And then can you give us some color on the pricing environment and gross margin? What are the drivers of gross margin specifically when it comes to the converged products and IB products?

Simon Biddiscombe

So let’s start with the overall pricing environment. I would characterize an environment where the OEMs are always wishing to extract the greatest price reductions that they can. I think when we look into the quarter that just ended from a pricing perspective, what we saw was entirely consistent with what we’ve seen over the last couple of years in terms of per-quarter ASP erosions like-for-like products. Okay? So there was nothing unusual in the pricing environment over the course of the last quarter specifically. As we look at our 10-gig and converged products, we’ve laid that out in the past.

If you’re looking at a converged product that has FCoE, iSCSI, all flavors of all protocols, you are looking at an ASP that is higher than a fibre channel product. And the less and less functionality, the lower the number of protocols that you are requesting from us, the lower the ASP becomes. Right? So you’ll get then ultimately to a 10-gig Ethernet adapter that has a lower ASP than anything else that we sell from an adapter perspective. So, no change in the pricing, Kaushik. It’s exactly as we’ve laid it out for you in the past.

Kaushik Roy – Wedbush

And in IP, your competitor, they are guiding down gross margin possibly because of aggressive pricing environment. Do you see that or you don’t?

Simon Biddiscombe

Yes, I think we – yes, we do. That’s a market that’s clearly evolved and will continue to evolve with the coming together of Mellanox and Voltaire. As we think about our participation in that market, as we think about the significant performance advantages we have with our QDR products, as alluded to in the commentary. Right? I think we’ve got world-class products in the market and we’re clearly not the leader from a market share perspective. And we intend to shift that dial as we move forward. And if that means that pricing is a part of how we compete, if that means it gets a little bit harder for some of the competition, then that’s okay.

Kaushik Roy – Wedbush

Okay, great. Thank you.

Simon Biddiscombe

Thanks.

Operator

We’ll now hear from Katy Huberty with Morgan Stanley.

Katy Huberty – Morgan Stanley

Hi, good afternoon, guys. Simon, curious about whether you picked up any incremental optimism on either total IT spending or server spending trends in the customer meetings that you mentioned you had over the course of the last quarter. Did that influence your view relative to what the IDCs and Gartners of the world are saying about either overall demand or what seasonality might look like as we go through the year?

Simon Biddiscombe

Yes. I mean, clearly it was a topic of conversation in every meeting, Katy. And as I think about – you almost have to go through it OEM-by-OEM and think about the products they have in the market they share. At this point in time, their expectations for changes in share as you move forward and so on. But I think generally, as I look at what each of the major server OEMs that we’ve talked to is expecting, those IDC and Gartner numbers are probably pretty close, up high-single digits. It feels like it’s consistent with what most people thinking at this point in time.

Katy Huberty – Morgan Stanley

Okay. And then this is a follow-up. In October, you and H.K. had mentioned that the December quarter head gotten off to a good start. What’s the linearity look like as you wrapped up the December quarter? And how did the first quarter start?

Simon Biddiscombe

So linearity was good. Actually it was slightly better if you look at it from a total shipped plus backlog perspective. The linearity last quarter was a little better, and I would characterize that more specifically as being the month of November was better than the middle month of any individual quarter would typically be. We aren’t talking about a couple of points here and that kind of thing, but now January is off to a good start. No doubt about it. And we’re always cautious as we move here and things like Chinese New Year in the month of February and so on. But January is off to a good start.

Katy Huberty – Morgan Stanley

Thank you.

Simon Biddiscombe

Pleasure.

Operator

Glenn Hanus with Needham & Company has the next question.

Glenn Hanus – Needham & Company

Good afternoon. Could you maybe, Simon, give us a little more context around the HP announcement today and how meaningful that might be as a part of your 10-gigabit Ethernet ramp over the next few quarters?

Simon Biddiscombe

It’s a very important element of how we think about the market generally and the ramp of the revenue stream over the next few quarters. I think if you look at what we announced today, both in terms of the converged network adapter and the 10-gig intelligent Ethernet adapter, those are critical positions to have at HP. We have always told you that with time we would have our products both on the converged and Ethernet adapter side, qualified all of the major OEMs, and this was another line in the sand that we have to get past to prove that to you. And as we look forward, it’s clearly going to be an important part of how this business continues to grow as we move into the next couple of quarters.

Glenn Hanus – Needham & Company

Following up on Keith’s question, could you talk about the fibre channel switching business and how to think about that over the next year?

Simon Biddiscombe

Yes. If you look at the fibre channel market over the course of the next year, on the switch side, it’s not a market that’s expected to have significant growth associated with it. For us, it continues to be a big share capture. So we still have less than 10% share in the fibre channel switch market in total. We always have believed we have compelling products in the market, and we’ve always had them in the market at compelling price points as well. For us, it’s about achieving share shift away from the two other significant incumbents in the market toward QLogic. And as we’ve explained in the past, tremendous amount of that is about how we engage with the principal OEMs. So I’m optimistic that we will continue to see share shift in our favor as we move through 2011, calendar 2011. And we’re working hard to make sure that happens.

Glenn Hanus – Needham & Company

Maybe on operating expenses, you came in under plan there. How should we model that over the next few quarters?

Simon Biddiscombe

So we’re going to [ph] give you the current quarter plan at $58 million. We’ll come back to you with a full year view when we get to the next call. We’ll give you a view for 2012.

Glenn Hanus – Needham & Company

Thank you.

Simon Biddiscombe

Thanks.

Operator

Rajesh Ghai with ThinkEquity has the next question.

Rajesh Ghai – ThinkEquity

Yes, thanks. Simon, you mentioned that the Romley server refresh could be an inflection point for your converged products and 10-gig Ethernet products. So I just wanted you to compare your expectations of the impact of the Romley server vis-à-vis the impact of the Nehalem refresh, which was obviously very strong for your business in 2009. And also I wanted to follow up and ask you why only converged network, why not the HBAs?

Simon Biddiscombe

Well, I think it’s – there's a dual effect, right? So the analogy is a difficult analogy doing the take, Rajesh, because if you go back to the first part of the Nehalem refresh in late calendar 2009, you had not only new servers come into market, but you had the beginning of the recovery in IT spend from an economic perspective and you also had budget flush that occurred in the fourth quarter of 2009 – fiscal calendar 2009. So, pulling out any individual effect from the three things that drove the business, that quarter is very difficult. Okay? But clearly what we saw then was primarily a fibre channel refresh.

And if you look at the second part of the Nehalem refresh, which is the EX part, if you will, that had I think a bigger impact on our business and that’s why when you look at some of the sequential numbers you’ve seen over the course of the last couple of quarters, the rate of growth of our fibre channel business has been better than the rate of growth of the server market. Why? Because when you deploy those technologies – EX based technologies, you are often attaching fibre channel adapters and then converged adapters at higher rates than you are in the low core Intel processors. So, as I look forward to Romley, I think regardless of which technology is the technology of choice, QLogic is going to be there able to support every protocol on every wire. Right? So whether customers continue to buy 8-gig going to 16-gig fibre channel or whether they are buying 10-gig Ethernet or converged products running on a 10-gig wire, we’re going to be there with every major OEM with products that serve the needs of our customers and end users.

Rajesh Ghai – ThinkEquity

Great. And talking about your 3GCNA, which obviously used to be a very compelling design. Where do you think that could ramp in terms of revenue going forward?

Simon Biddiscombe

It will start immediately. So we’ve had some revenues over the course of the last quarter as we began shipping those products in the channel and so on. You will start seeing revenues immediately, as we said in our prepared remarks associated with the HP instrument of this morning, and then you will continue to see other OEMs using the solution both on the server side and the storage side as we continue to move through 2011.

Rajesh Ghai – ThinkEquity

Okay, great. And what are your assumptions for fibre channel and 10-gig in your guide for the fourth quarter?

Simon Biddiscombe

What we said was, we didn’t break it right, Rajesh. What we said was just think about every disclosed product family, host networks, silicon other is performing roughly consistently with the overall guidance.

Rajesh Ghai – ThinkEquity

Okay And one last question on the InfiniBand, not to beat a dead horse, but given that the other player in that market has close to 90% share and you guys arguably have products for the competitive, as you said, perform better. What do that prevent you from gaining more significant market share and what do you doing going forward to change that?

Simon Biddiscombe

So – I'm not going to give you all the details, Rajesh, on what I’m doing to change that obviously because I don’t want to tell my competitors what I’m doing. But I think we should – I think we should be doing better than the less than 20% share that we have today. I think we have compelling products. We’ve clearly got some issues that we need to work through here in the near-term, and it’s my expectation we’re going to work through those issues. We’re going to do it aggressively, and we’re going to go compete more effectively.

Rajesh Ghai – ThinkEquity

All right. Thank you so much.

Operator

Moving on to Douglas Ireland with JMP Securities.

Douglas Ireland – JMP Securities

Thank you. Good afternoon. It was kind of a long key question. It comes from some of the research I’ve been doing. I’ve heard a lot about 10-gigabit Ethernet really taking off when you get to a copper fine. It’s being held back by being cyber based. And I’m just wondering what QLogic’s position, if that makes any difference to you as to why does and if you think that’s actually true.

Simon Biddiscombe

So, as we look at the technology you’re talking about, Doug, it’s called 10GBase-T, okay? So it is the idea of using copper instead of fibre to deploy 10-gig based technologies. There are multiple 10GBase-T solutions in the markets, say, both at the (inaudible) level and further out there, you are undoubtedly going to see products that are either multi-chip solutions or fully integrated 10GBase-T solutions with the 10-gig product that you would buy from QLogic. Right? So we recognize 10GBase-T is an important technology. It’s probably not the be-all and end-all to all users of the technology, but it’s certainly an important part of how we think about offerings moving forward.

Douglas Ireland – JMP Securities

So is there something that’s in your roadmap and not available? Is there something that you buy in? I’m sorry, I just don’t know.

Simon Biddiscombe

We’re not going to comment on that, Doug.

Douglas Ireland – JMP Securities

Okay.

Operator

Anything else, Mr. Ireland?

Douglas Ireland – JMP Securities

No, that’s good. Thank you.

Operator

Thank you. And we’ll now here from Scott Craig with Bank of America/Merrill Lynch.

Scott Craig – Bank of America/Merrill Lynch

Hey, thanks. Good afternoon. Hey, Simon, on the gross margin side of things, you keep feeding numbers here pretty consistently and you (inaudible) volume. But is there anything else going on beneath the cover that you guys are working on to make the supply chain more efficient or anything like that? And the second question is on the OpEx side. Maybe ask it in a different way, but it’s been hovering around that sort of $54 million, $55 million despite the fact that you’ve seen revenues come up nicely. But is there a revenue level that you start to see some pressure on that OpEx to go out?

Simon Biddiscombe

So let’s do the gross margin first. I think – we always work extraordinarily hard to reduce cost in our solutions to drive gross margin. Right? And as I said earlier, the OEMs rightly are always looking for ASP reductions, and we’re in a position to be able to offer those to them. But we have an operations function that does an extraordinarily good job trying to work product costs down on a quarter-to-quarter basis and operations function that is also very efficient in how it operates. And clearly, that function is a big part of cost of sales. Right? So I think we pay attention to gross margin, pay attention to the cost element of gross margin, and we work extraordinarily hard to perform at the highest level. So that’s number one.

Number two, I don’t want to leave you with the impression OpEx doesn’t go up next year. OpEx clearly is going to increase as we look into fiscal 2012 over fiscal 2011. As you correctly point out that we’ve been at this $54 million, $55 million OpEx level for an extended period of time now. Let’s call it over two years. So for over two years, we’ve been somewhere between $52 million to $55 million worth of OpEx. And that was absolutely the right thing to do as we drove through the tough economic cycle in 2009 and as we’ve been able to reinvest in the business through 2010, calendar 2010. In 2011, there’s no doubt that OpEx will pick up. And we’re finalizing our plans right now. I think from my perspective, I don’t want to get in a position where the rate of growth of OpEx is significantly in excess or in excess of the rate of growth of revenues. So we’re putting all those pieces together as we think about the now. But as we laid out at the Analyst Day, protecting that operating margin at somewhere near 30% and protecting the net margin is something that’s important to us.

Scott Craig – Bank of America/Merrill Lynch

Thank you.

Operator

Ladies and gentlemen, unfortunately that is all the time that we have for questions. Gentlemen, I’ll turn the call back to you for closing or additional remarks.

Simon Biddiscombe

That concludes our call for today. We look forward to updating you on the progress from next quarter. Thank you for your time and good bye.

Operator

Thank you. Again, ladies and gentlemen, that concludes our conference for today. We thank you all for your participation.

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