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QLogic Corporation (NASDAQ:QLGC)

F1Q08 Earnings Call

July 27, 2007 5:30 pm ET

Executives

H.K. Desai - CEO

Tony Massetti - SVP and CFO

Jeff Benck - President and COO

Analysts

Brian Mansfield - Goldman Sachs

Harsh Kumar - Morgan Keegan

Paul Mansky - Citigroup

Keith Bachman - Bank of Montreal

Dan Renouard - Robert Baird

Mark Moskowitz - J.P. Morgan

Roberta - Lehman Brothers

Presentation

Operator

Good day, everyone and welcome to the QLogic Corporation First Quarter Fiscal Year 2008 Earnings 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, Chief Executive Officer. Please go ahead, sir.

H.K. Desai

Thank you, operator. Good afternoon and welcome to QLogic's first quarter fiscal year 2008 earnings conference call. I'm H.K. Desai, Chief Executive Officer, and with me are Jeff Benck, our President and Chief Operating Officer, and Tony Massetti, our Senior Vice President and Chief Financial Officer.

Today, Tony will begin with a review of the first quarter results, and I will continue with the general discussions of the current state of our business. After that, Jeff will discuss strategic initiatives, and then we will open the teleconference for questions. Tony?

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 our 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 that QLogic files with the SEC, specifically our most recent form 10-K. These documents identify important risk factors that could cause our actual results to differ materially from expectations. We do not intend to update any of the information contained in any forward-looking statements 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 August 9, 2007 by calling 719-457-0820, or 888-203-1112, pass code 664-8418.

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 expressed written permission of QLogic.

In our first quarter earnings press release issued earlier today, we reported both GAAP and non-GAAP results. The difference between the results is primarily due to stock-based compensation expense, acquisition-related charges, and other special charges. An accounting of this difference is included in our press release.

The difference in our non-GAAP as compared to our GAAP results is $0.08 per diluted share in the first quarter, or $0.20 per diluted share non-GAAP versus $0.12 per diluted share on a GAAP basis. All of the references we will make today relate to our non-GAAP results unless otherwise stated. Our revenue in the first fiscal quarter end July 1st, 2007, was $139.8 million, an increase of 2% from the same quarter last year. This approximated the low end of our forecasted range provided during our fourth quarter earnings conference call.

Our first quarter revenue from Host Products which are comprised primarily of Fibre Channel, iSCSI Host Bus Adapters and InfiniBand Host Channel Adapters was $104.2 million, and increased 15% from $90.5 million recorded in the first quarter of last year.

The increase in our revenue from Host Products was primarily driven by HBA revenue growth of 14% from the comparable quarter last year.

Our first quarter revenue from Network Products which are comprised primarily of Fibre Channel and InfiniBand switches was $24.5 million, an increase of 33% from $18.3 million recorded in the first quarter of last year. The increase in our revenue from Network Products was primarily driven by InfiniBand switches which were added to our product portfolio in connection with our acquisition of SilverStorm Technologies in the third quarter of fiscal year 2007.

Our first quarter revenue from Silicon Products which are comprised primarily of protocol chips and management controllers was $9.6 million, and decreased 62%, from $25.4 million recorded in the first quarter of last year. The first quarter revenue for Silicon Products met our expectations and was consistent with the expected decline communicated during our fourth quarter earnings conference call.

Other revenue was comprised primarily of royalties and service revenue was $1.5 million in the first quarter. Our first quarter gross margin of 66.3%, decreased from 70.9%, recorded in the first quarter of last year. The decrease in our gross margin was primarily due to product mix, and increased manufacturing-related costs. InfiniBand products contributed to the year-over-year change in gross margin.

During the first quarter, we experienced ASP reduction on like-for-like products in our HBA portfolio of 2% which was within our expectations. Next, I would like to cover our first quarter operating expenses. Total operating expenses were $54.3 million in the first quarter, up 3% from $52.6 million reported in the first quarter of last year. The increase was primarily due to our investments in InfiniBand products.

Engineering expenses in the first quarter increased to 8% to $30 million versus a year ago and increased as a percentage of revenue from 20.4% to 21.5%. We continue to make investments in existing and new technologies, including InfiniBand and Fiber Channel over Ethernet. As a result, we are targeting engineering expense as a percentage of revenue to be in the range of 18% to 21%.

Sales and marketing expenses in the first quarter decreased 3% from a year ago to $18.5 million and declined as a percentage of revenue from 13.9% to 13.2%. We expect that future sales and marketing expenses as a percentage of revenue will range from 11% to 14%.

G&A expenses in the first quarter of $5.8 million, were consistent with the year ago and decline as a percentage of revenue from 4.2% to 4.1%. We expect that future G&A expenses as percentage of revenue will range from 3% to 4%. We continue to focus on improving efficiency in our operating expense as well as investing in critical new development programs for existing and new technologies.

During the first quarter, QLogic generated an operating profit of $38.4 million, which resulted in a 27.5% operating margin. Interest and other income was $6.3 million in the first quarter, a decrease of $0.6 million versus a year ago.

The income tax rate of 32.4% for the first quarter was lower than the forecasted tax rate of 33%, provided during the fourth quarter earnings conference call. Our first quarter net income was $30.2 million or $0.20 per diluted share, and represented a net profit margin of 21.6%. Our first quarter net income per diluted share of $0.20 was within our forecasted range of $0.19 to $0.21 per diluted share, provided during our fourth quarter earnings conference call. This represents the 48th consecutive quarter of profitability for QLogic.

Net income on a GAAP basis for the first quarter was $19 million or $0.12 per diluted share.

Our financial position continues to be strong, especially with regard to our cash flow. During the first quarter, we generated $35.5 million in cash from operations. The company's cash and marketable securities were $478.6 million at the end of the first quarter.

During the first quarter, we purchased $107 million of our common stock pursuant to our stock repurchase programs. In addition during the second quarter, we continued to execute against our current stock repurchase program. We repurchased more than $25 million of our common stock.

Receivables of $77.3 million at the end of the first quarter increased from $73.5 million at the end of the March quarter. The DSO rate in the June quarter was 50 days compared to 45 days in the March quarter. With hub arrangements at our OEM customers and greater contribution from our distribution channel, we continue to expect upward pressure in 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 first quarter of 5 turns was comparable with the 4.9 turns in the March quarter. Inventory at the end of the first quarter was $38 million and decreased sequentially from $38.9 million at the end of the March quarter.

Based on our current product portfolio, we expect that inventory levels at the end of the September quarter will be similar to the June quarter.

Our long-term outlook for our core business remains favorable. Based on current customer forecast we expect total revenue for the September quarter to be in the range of $137 million to $141 million.

Due to the potential variation in product and technology mix, we expect gross margin for the September quarter to be approximately 66%.

Considering the above revenue and gross margin expectations combined with planned operating expenses, infrastructure investments and a projected annual tax rate of approximately 33%, the current outlook is to achieve non-GAAP diluted earnings per share of approximately $0.17 to $0.19 in the September 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, and the company's filings with the SEC, and in the disclaimer statement at the end of the first quarter fiscal 2008 earnings press release.

I would now like to turn over this conference call to H.K. Desai, our Chief Executive Officer. H.K.?

H.K. Desai

Thank you, Tony. Thank you again for joining us today on our first quarter fiscal year 2008 earnings conference call. The revenue in the first quarter ended July 1st, 2007 was $139.8 million, an increase of 2% from the same quarter last year. This approximated the low end of our forecasted range provided during our fourth quarter earnings conference call.

Our diluted earnings per share for the first quarter was $0.20. This was within our forecasted range of $0.19 to $0.21 per diluted share, provided during our fourth quarter earnings conference call. Our first quarter revenue from Host Products which include Fibre Channel and iSCSI HBAs and in InfiniBand HCAs grew 15% from the year-ago quarter.

Fibre Channel HBA units shipped were up 31% from the year ago quarter, which was driven by an over 300% increase in Fibre Channel mezzanine card shipments. This strong growth in mezzanine cards outs the continued acceptance of blade servers in the market.

The product mix for the first quarter was weighted more than expected to mezzanine cards, which negatively impacted overall HBA revenue. We expect a continued gradual shift towards mezzanine cards over time.

Our first quarter revenue from network products which are comprised primarily of Fibre Channel and InfiniBand switches grew 33% from the year-ago quarter. This was led by a 32% year-over-year increase in revenue for blade server switches, and a 12% sequential increase in revenue from our InfiniBand switch products.

Revenue for Fibre Channel switches was flat from the year-ago quarter. Our first quarter revenue from Silicon products which are composed primarily of protocol chips and management controllers declined $15.8 million or 62%, from the year ago quarter. The sequential decline of $4.4 million is consistent with the range communicated during our fourth quarter earnings conference call.

Based on the industry trend of server consolidation with increasing blade server adoption and server virtualizations, we expect to see slower growth rates for our Fibre Channel HBS.

However, with our continued leadership in the blade server market, we expect to see continued growth of our revenue for mezzanine cards. We expect iSCSI HBS and InfiniBand HBS to experienced growth in fiscal 2008, but of a much smaller base.

Overall, we expect unique growth for our host products to be in the high teens, and revenue growth for our Host Products to be in the single-digits, consistent with market growth rates. With this in mind, we anticipate our revenue growth rate for Host Products to be slower than previously expected in fiscal 2008.

We expect fiscal 2008 revenue from network products to increase approximately 20%. This growth will be largely driven by our InfiniBand switch products. We don't expect Fibre Channel switch bulk revenue from tier-1 OEMs to ramp up until fiscal 2009.

As part of our long-term strategy, we are not investing in management controllers and Fibre Channel target chips. Also, the transition from chips to mezzanine cards will result in a year-over-year decline in Fibre Channel protocol chip revenue.

Overall, we expect revenue for Silicon products to decline approximately 50% in fiscal 2008.

In summary, the revenue from our non-core silicon products declined as expected. Revenue from our core business, which is comprised of host and network products, grew 18% year-over-year. We believe our existing core business, combined with the investments we are making in emerging technologies positions the company for future growth.

I would now like to turn this conference call over to Jeff Benck, our President and Chief Operating Officer.

Jeff Benck

Thank you, H.K. Good afternoon, everyone. I want to share with you highlights from the last quarter and provide you with an update on strategic initiatives that we believe will drive our revenue growth in the future.

Let me start with some highlights. During the first quarter, several of our Fibre Channel Network Products were introduced by major OEM. Core-to-edge 10 gigabyte networks are now supported by EMC. Our portfolio of switches, are now available from Hitachi Data Systems and QLogic Intelligent Pass-Thru Modules are now available from IBM.

Let me provide some additional details; EMC qualified 10 gigabyte QLogic standby Fibre Channel switches for use with EMC Clarion and EMC Symmetrix, DMX network storage systems.

With US qualification of the QLogic 10 gigabit backbone between SANbox 9000 Series Core Switches and SANbox 5000 Series Stackable Switches, EMC customers can now deploy scalable high performance core-to-edge storage networks from QLogic.

In addition, HCS is now offering the SANbox 9000 to its customers providing them a new class of director switch that takes less rack space, less power and cooling than any other director switch available today, all at a fraction of the cost.

With the addition of the SANbox 9000, HCS is now offers the complete QLogic Fibre Channel switch portfolio including the SANbox 5600 Series Stackable Switches, and the SANbox 1400 Head Switches.

IBM is offering the Intelligent Pass-Thru Module to its BladeCenter customers delivering an innovative cost effective solution for networking storage embedded environment.

In the past, BladeCenter customers had two choices for storage connectivity; They could implement one vendor's full fabric switch and set up the single vendor fabric or as a tradeoff in functionality implement a lower-cost optical Pass-Thru Module offerings multi vendor interoperability.

With the QLogic Intelligent Pass-Thru Module, using industry standard NPIV and QLogic transparent switch technology, businesses can now have the best of both worlds.

A low cost multi-vendor, interoperable solution that delivers all the functional advantages of full fabric switching.

The first quarter was also highlighted by a major milestone achieved by our InfiniBand network products; In June, QLogic announced that it shipped over 40,000 double data rate or DDR in InfiniBand switch ports.

QLogic is delivering it end-to-end portfolio of DDR InfiniBand products designed for the most demanding high-performance computing clusters, in which the performance to the cluster interconnects defines overall application performance.

Finally, the first quarter was highlighted by the continued market share leadership over Fibre Channel HBAs, as well as recognition for the superior performance of all our Fibre Channel HBAs and InfiniBand HBAs.

According to the world, in the first quarter of calendar 2007, QLogic remained the number one supplier of Fibre Channel HBAs with a 44.5% revenue market share, and a 46.7% port market share. In the first quarter, QLogic 4 gigabit Fibre Channel HBAs, together with HP Integrity Superdome servers, achieved a world record TPC-C benchmark score of over 4 million transactions per minute, and HP-UX 11ienvironment.

QLogic also announced its InfiniBand Host Channel adapters outperformed the competition based on the new standard performance evaluation core, or spec suite, that measures the performance of parallel computing systems and clusters running message-passing interface applications.

The cluster with QLogic HCAs had a spec core 13% better than the competition. The interconnect scalability of QLogic InfiniBand HCAs and switches enabled a 32 core to 56 core speed-up that was 16% better than the competition.

Now, I would like to provide an update on two strategic initiatives that we believe will help drive our future revenue growth. High performance computing and Fibre Channel over internet. High performance computing is an important market for QLogic, because of its growth potential.

According to IDC's worldwide InfiniBand forecast published in May, the compounded annual growth rate from 2006 to 2011 for double data rate InfiniBand switches is forecast to be 59.7%. While the compounded annual growth rate for double data rate HCAs is forecast to be 51.3%.

Today, I.T. managers responsible for supporting high performance computing environments are seeking solutions for performance, manage ability, and ease of use. In addition, business performance computing is emerging as a new class of workload that uses HPC Clusters in the enterprise.

This proliferation of HPC applications, along with the increasing demand for storage, places QLogic in a unique position to provide end-to-end solutions that include switching and host adapters, from core to edge, for both enterprise and HPC. Our HPC market opportunity is driven by market and customer requirements in two key areas.

First, best in class performance as demonstrated by our most recent spec results, and then simplicity, where we transform the customer's experience from a do it yourself project to receiving a complete HPC networking solution from a single supplier. We do this today with our SAN solutions and will leverage this experience into our HPC portfolio.

Today we are providing InfiniBand switches and HCAs, as well as, the software needed to deliver a complete HPC network. The next step is enabling inter connection with other networks in the enterprise.

We expect to accomplish this in the near future with general availability of our InfiniBand gateways to Fibre Channel and Ethernet networks. Fibre Channel over Ethernet, or FCoE, is an important technology for QLogic because of its potential to offer Ethernet-based storage networking with the performance needed for data centers.

In addition, FCoE will expand our addressable market to data networking, as well as fully leverage the depth of our technology and install base Fibre Channel adapter port. FCoE host adapters will be capable of serving as storage adapters and data networking adapters.

We expect customers to deploy FCoE adapters from QLogic primarily as storage adapters but to expand their use to include data networking. We believe iSCSI, has a strong affinity to S&P customers because of the large disparity between the performance of one gigahertz SCSI and 4 gigabit Fibre Channel.

We anticipate 10 gigabit Fibre Channel over Ethernet will deliver the performance needed in the date center. Because of the importance today of protecting data, we believe the customers are extremely conservative about their approach to network storage technology and understand the benefits of deploying improvements offer stack.

With almost 3 million QLogic Fibre Channel HBA ports deployed, we expect customers to protect their investment in Fibre Channel storage and embrace FCoE adapter technology from QLogic because of compatibility with their existing QLogic Fibre Channel solutions.

In summary, we continue to execute a strategy to build our systems interconnect solutions business. While revenue from our silicon products declined, we believe our investments in 8 gigabit Fibre Channel, InfiniBand, and FCoE technologies will result in higher growth in the future.

Thank you operator. At this time, we will open the line for questions.

Question-and-Answer Session

Operator

Thank you very much, sir. The question-and-answer session will be conducted electronically. (Operator instructions). And we will take the first question from Laura Conigliaro with Goldman Sachs.

Brian Mansfield - Goldman Sachs

Hi, guys. This is actually Brian Mansfield joining in for Laura right now. I've got two questions. The first would be, geographically results of the US growing about 0% in the June quarter, and previously, in the last conference call, you've mentioned that you are concerned about the overall enterprise spending environment. I just wanted to see how much of your lowered guidance and your outlook for the year and HBAs and switches. Is this a result of the overall spending environment, versus relative share gains? And then I have one more after that?

H.K. Desai

Hi, Brian. This is H.K. If you look at our results, we kind of were struggling to meet our high end of the guidance for last three quarters in a row and we look at the numbers December we made the mid range and March was the low end and March is a seasonal quarter.

We believe that there was seasonal quarter I think what we are seeing is that when we look at these numbers and what we say in the script, what is happening is that our HBA, our Host Products, the growth rate, what we predicted to be around 14% before. And now, we see it is going to be mid-to-high single digits.

And the key driving force behind the number we look at is really the mezz card growth rate which is converting from a rack model servers to the blade server so we see a tremendous growth of the mezz card, but the ASP between the mezz card and the standard HBA is down, so overall our revenue growth is declining because of that.

And I think that were driving I think server also is driving attach it for declining for the Fibre Channel HBA. So we look at the number and that's why we bring our guidance down from 14% to about mid-to-high single-digits for the HBS. So I think this is more to the trend of what is happening in our market, versus the enterprise spending.

Brian Mansfield - Goldman Sachs

It's not a shift in share…

H.K. Desai

Yeah, it's not also shift in the share, right. For example, we said that we expect in '08 or unit growth for the HBA, but for the host part should be about high teens. It is more the pricing of the ASP, the mix of the products.

Brain Mansfield - Goldman Sachs

Okay. And then moving on to the second question, your gross margins, obviously bringing the target down to the 66 level. It is obviously being impacted by your increasing mix of InfiniBand. I was wondering if you could take us through a little bit more about specifically you mentioned last quarter, a dollar amount for your overall InfiniBand business.

And maybe you could do that for this quarter, and just as we move forward through the year what is it going to take to get that margin going up north, I think you said 26% gross margin last quarter in that business, are you going to have to change the procurement of silicon going forward? What can you do there to increase that gross margin?

Tony Massetti

Sure, Brian. This is Tony. So, we've recategorized the revenue for better visibility into the business this quarter. And we have put the InfiniBand switch and the Fibre Channel switch together in the network category and in the host category, HCAs and Host Bus Adapters. So, we are not going to provide a consolidated InfiniBand number going forward, because we don't feel its meaningful.

But consistent with our discussion on the last earnings conference call, we did see a healthy improvement in gross margins in InfiniBand products. So we're making progress there. And as always as we get the cost of the silicon that we need to be competitive in the market then we don't see a need to develop our own silicon.

Brian Mansfield - Goldman Sachs

Okay. Thank you.

Tony Massetti

Thanks.

Operator

Our next question comes from Harsh Kumar with Morgan Keegan.

Harsh Kumar - Morgan Keegan

Hi, couple of questions. First of all, kind of going back to the earlier question, do you think that there is anything going on, H.K., in the broader market that is causing maybe your business to get affected? Or is it just simply, simply put, what's going on with the mezzanine card host bus adapter business?

H.K. Desai

Yeah I mean I think if you, Harsh, if you look at our business, and just let's talk about the Host Products, because that is our core, and if you look at last few years, particularly last two to three years, and we grew 20, more than 20%. So the last three years, year-over-year, and you see the trend in that business in '01, we started gaining market share tremendously we also see we are the first one to investment in the Blade server so we have legs up there.

Then we see a upgrade cycle for PCI-X PCI. 2.0, VC upgrade for PCI expressed. We saw upgrade cycle for 4-gig and also the from [non roster to roster]. So, all those trends coming together over three years and I think that was giving us a lot of growth. And now what happened is we see a negative trend and when we have a market share of 60, 70, and 80, and 90 percent with the customers, particularly on OEMs.

We don't expect to see that kind of market share growth. So that is a negative trend for us going forward. You look at also the mezzanine kind of the blade server growing, which is an ASP, difference from the standard SBA and the mezzanine card, that's also a negative trend. So I think those are the one which is impacting to the short term. If you look at the long term, there is a couple of upgrade cycles coming up.

One is going to be 8-gig of which cycle coming up sometime in '09, and FY '09. And there is also a upgrade cycle coming up for the FCOE, so I think that was the positive signal coming from the future, but I see are through issue for the short term for us, it is a general trend. And also in server virtualization, and those are the negative trends I think which is impacting the business.

Harsh Kumar - Morgan Keegan

That's helpful, H.K. And then switch kind of commercialization you talked that we are not expecting anything to happen any time soon, this year particularly and I think you had qualifications in the EMC and IBM and what do you think is the push back? Are they not ready or something with respect to pricing that's not working out?

H.K. Desai

What we are doing is we are looking at our business and we say this is what is happening on the host products and what we are seeing on the network products is that we expect to grow that and about 20% in FY '08. The reason we're saying this, what we're doing is a lot of the growth is going to come from IB, because this is a new product for this year. And that is a growth is going to come in we kind of not putting too much emphasis in the growth for the fibre and switches till we start seeing some traction.

We keep talking about this traction for a long time. So now what we decided to say, we don't expect, even though we will see some growth in the fibre and switches but in our plan we are assuming that, that let expect, let's assume that we don't want to go much fibres and switches in FY '08. And the reason is also because of now we have a full line of the products, which we didn't have before, but because of the directed platform, it is a longer sales cycle, it is a longer qualification cycle, and also convince the OEMs, it is a longer cycle. So we decided that let's assume right now at least for FY '08, for all of our planning that we won't see too much growth in the Fibre Channel switch.

Harsh Kumar - Morgan Keegan

That's pretty fair. That's it for me. I will come back later. Thanks, guys.

Operator

Your next question comes from Paul Mansky with Citigroup.

Paul Mansky - Citigroup

Actually, a couple of questions and then just a comment. On the host product challenges, I just want to get some clarification here, your comments regarding this isn't a share issue, but a secular trend issue, are you saying that you would anticipate your primary competitor to echo similar view when they report regarding the blade cannibalization?

H.K. Desai

I really don't know what my competitor is going to do and I don't think I can make any comment on that.

Paul Mansky - Citigroup

Can you comment specifically on how you view your position relative to HP UNIX?

H.K. Desai

I think I can give you some number I got from my team here, anyway for the share.

Tony Massetti

So for HP, we grew our 4-gigabit position by five share points at HP. So when we look at our HBA share, in aggregate, we're pretty confident of our position with HP.

Paul Mansky - Citigroup

Does that include, did you grow that sequentially?

Tony Massetti

Yes. That was the sequential growth.

Paul Mansky - Citigroup

Okay.

H.K. Desai

And I mean if you look at --

Tony Massetti

I'm sorry. That was the share growth.

H.K. Desai

Sequential, yes. 4-gig sequential. We have over five points with HBA and if you look at the X series HBAs including the standard and mezz. We are 20% unit growth sequentially, and SAN is the one we lost, one share point of the 4-gig. That's the numbers. So I don't see really, Paul, when you have 60, 70, 80 and 90% market share with some of this tier-1 OEMs, you lose one or two point some place and we going to gain one and two points that is not going to make difference. I think it's a secular trend is going to make difference in the business.

Paul Mansky - Citigroup

What about maybe an update on your efforts over on the P series. How we tracking there?

H.K. Desai

We can't make any comment on that.

Paul Mansky - Citigroup

Okay. And then on the switch side, just kind of following up on that last comments obviously we're now looking at 20% growth, and presumably, there might even be, some down side risk even to that number it looks as though we've gone somewhat cold on the OEM opportunities on the 9,000 specifically, excluding anything from the IB side, just talking on the 9,000. Was that I mean is that something which you are going to have there you have going to do a design tweak and sort of reengage is that opportunity off the table or is it just simply slipping out a few additional quarters?

H.K. Desai

Paul ,if you look let me make a correction. When I say 20% on Network Products group, that's including both Fibre Channel switches and IBM switches and I don't see any lower trend on to that. I think we are more conservative on that 20%, because we are counting not too much growth in the Fibre Channel switches. We are really putting most of the growth is coming from the IB, year-over-year.

So, I don't think there is any down side in the 20% growth. I think the key is going to be for the Fibre Channel. So we decide in order let's look at the number and for FY '08, don't plan for much growth into the Fibre Channel switches and the reason like I said what we're finding out is that I mean there is lot of course you on the Fibre Channel switches, there is a lot of market opportunity but what we're finding out is it is taking a lot more on the director last quarter for the sales cycles and the qualification cycle or the convention to the OEM together on the supplier. So I mean it take thing lot more.

Tony Massetti

It is fair to say though I mean you mentioned the design tweak. The product is a leadership product. We don't see a need to change the product to accommodate what OEMs are looking for. It is a differentiated offering in the sense it is very dense and modular and scalable and its what power some of the that we think that were differentiates its position in the market but its so it is not product centric thing its H.K. was saying. The qualification at that level and the complexity of that type of product, it does take time.

Paul Mansky - Citigroup

So if I could, just to kind of roll all of this comment together, if we try to map our comments today, versus our comments, this time a quarter ago, where we were looking for InfiniBand to grow, to about 25 to $30 million business, this year, is that still a firm number for you?

Tony Massetti

If you combine our core business, which is host products, which we expect mid to high single digits, which includes the Fibre Channel iSCSI and HBA and also the InfiniBand HCA we lump in that one side and on the network products, we said about 20%, so if you combine those two, you will be at about 8 to 10%.

Paul Mansky - Citigroup

High single digits.

Tony Massetti

High single digits growth year-over-year on the core products. And then we will decline of about 50% or more on the Silicon side.

Paul Mansky - Citigroup

So I guess and then ultimately and I will see the floor here after this but I guess it all kind of speaks to my ultimate point here as we're sitting here trying to understand not only the both the challenges that you're facing as you go through the transition, but also the opportunities.

I think it is really important that we maintain a level of consistency as it relates to targets, expectations and breakout. I mean do you anticipate any additional tweaks from a revenue bucket, or you know, or growth targets per revenue bucket as we go through the next few quarters?

Tony Massetti

If you know I think we've given better visibility to the business with the way we've categorized revenue, Paul, so I don't see any tweaks at this time to how we report revenue. Growth targets, we think we're on the conservative side, and portrayed them the best we can see at this point, so this is our best visibility at this point.

H.K. Desai

And if you look at these things, like I said before, Paul, if you look at the last two or three quarters, you always assume one quarter you have a slowdown business, you believe maybe it is the one OEM, if you look at the second quarter, you say well, this is not, and you look at the third quarter.

I mean you struggle and you go and look at what is happening in the markets and it has to be secure trends like you said, it can be anything related to the markets, because we are not seeing that. I mean it's some, our competitor might say that hey, we grow 30% on something, somewhere, anyway, but if you go from a low number, we file all the data from our sales team and we are not losing any markets, we loss one or two points here and there, it's not going to change the business like that.

So, it is the trend. When we look at mezz card, this is going to tremendously 300% and then 31% this quarter sequential or something. And then you start realizing the trend is changing and I think it is going more towards the mezz card, blade server and also eventually I think the server virtualization has also I think impacted the business.

So, I think that's what happened. And I think, like I said, we have tremendous growth because of so many upgrade cycles came in. So, 4-gig and the PCI Express and non-roster to roster, gaining market share, mezz card. So, all of those things were driving our business tremendously and now I think it come to the reality this is what happening. So, we are like, what we seeing is, for example, mid-to-high single-digits really growth is really just like the market growth. That's what the numbers are. So I think that's maybe coming down to now.

Paul Mansky - Citigroup

Okay, great. Thanks for the further color.

Operator

We will move next to Keith Bachman with the Bank of Montreal

Keith Bachman - Bank of Montreal

Hi, guys. Based on your revenue outlook for September, and some of the comments you made for December I'm sorry, for the longer term outlook, do you think that just directionally December will be up, flat, or down from your September revenue guidance?

H.K. Desai

I mean we don't give guidance for, we are giving guidance only for one quarter, and then we give our colors for the whole year. But seasonally, normally, we have seen it's always a sequence of growth for the December quarter, because of the all the OEMs also it was just not which is the strong in December.

Keith Bachman - Bank of Montreal

Thanks. And then going back to Paul's question, I'm not sure I got a clear answer from it. On the switch side of the business, the Fibre Channel switches, you've been engaged with a couple of OEMs that I think are generally understood to be IBM and EMC, are those doors closed or those opportunities still in front of you and just pushed back?

H.K. Desai

We are engaging with more than those two names you gave, and we are engaging with all 10 OEMs and I cannot make comment about any OEMs here.

Keith Bachman - Bank of Montreal

Okay. You had a special charges in the quarter. What was that for? It wasn't labeled as anything but a special charge.

H.K. Desai

Sure. That was a consolidation of our iSCSI and 10-GigE projects, so the charge was in part for contract-related costs, and in part for employee-related costs. So it's about a $2 million charge, in the GAAP results.

Keith Bachman - Bank of Montreal

Thanks. And are you going to provide you've changed the way you represent the revenues in terms of the buckets. Are you going to provide us with a historical categorization so we can do comparisons going forward, try to queue our models up here.

H.K. Desai

We will, Keith, over time, as we file our SEC docs, those will be included in our Ks and Qs.

Keith Bachman - Bank of Montreal

Okay. I just want to ask a couple more. I would expect, based on the outlook that your stock would be down here sharply tomorrow morning. You guys have talked about your intent as it relates to buyback, even at times commenting on where your price is. Could you update us based on how you're thinking about the buyback relative to the comments you just made on the outlook of your business?

H.K. Desai

Sure. In the June quarter, we repurchased $107 million of stock. Subsequent to the end of the quarter, we've repurchased another 25 million or so. That leaves us approximately $200 million left on the $300 million buyback. That was announced in early April, Keith. So we have been, I think fairly aggressive over the last two quarters, on buyback, and I would expect that would be active on the buyback in the current quarter as well.

Keith Bachman - Bank of Montreal

Let me sneak one more in if I can and then I will leave the floor. And H.K., you just talked about your revenue, I want to make sure that I understand it, if you do the host side, plus the switching, you indicated the combination was high single digits. Let's just call it 8 to 10% for now. And then you said something after that. I think you said the controller business --

H.K. Desai

The Silicon products declined 50%, more than 50%.

Keith Bachman - Bank of Montreal

Okay. So if you do all of that math, you will come out with some kind of revenue number that reflects what?

H.K. Desai

I mean I think we are not giving any full year guidance or something we always give a quarter guidance and I think we give color to that I think people can update their model.

Keith Bachman - Bank of Montreal

Okay. Really where I was trying to go though is on the margin side, and Tony how do you going to talking about base on all those puts an takes to the business, less switch revenue and how should we be thinking about the margin structure, even if you just want to give some directional comments, up, down, sideways either on a growth or operating basis?

Tony Massetti

Sure. So gross margins at 66.3, for the September quarter, Keith. We were forecasting about 66%. I think you can plan on, depending on mix, a lot of moving parts, as you know in our gross margin line, but flat to slightly down, over the next couple of quarters, depending on product mix. We don't expect a large variation, either up or down at this point.

Keith Bachman - Bank of Montreal

And then your OpEx against that?

Tony Massetti

Sure. I think expense should be fairly flat at about 56 million or so. We were at 54 in the current quarter. We're planning for approximately 56 in the September quarter. We have NRE that we expect in September and some going rate headcount expenses. And then engineering should be fairly flat over the balance of the year, and the only variable that I can see is revenue-related expenses or some sales expenses. So, I think operating margins should be fairly flat from here.

Keith Bachman - Bank of Montreal

Thank you.

Operator

Our next question comes from Dan Renouard with Robert Baird.

Dan Renouard - Robert Baird

Thanks. Can you give us the sequential growth rates of those of the host category and the major switch category in the quarter?

H.K. Desai

Dan, we've reported the year-to-year numbers, on the press release, and we talked about them in the script, and we don't have the sequentials with us, so we haven't published those, and we're not speaking of those today.

Dan Renouard - Robert Baird

Okay. And then can you give us what last year's number was in these new categories?

H.K. Desai

Sure. It is just part of the press release, Dan. Do you want me to read those off to you?

Dan Renouard - Robert Baird

If its you're saying for last year, not last year's quarter, I mean for the entire year.

H.K. Desai

Yeah, again, we will publish those over time, Dan, with the 10-Qs, as we file those. So we will make those available when we have them ready for the SEC filings.

Dan Renouard - Robert Baird

Okay. I mean obviously its challenging to you guys give directional comments on growth rates and it is hard for us to model them if we don't know what the relevant compare was though.

H.K. Desai

Well, that's why we report the year-to-years right now quarter-to-quarter.

Dan Renouard - Robert Baird

Okay. I'm just saying for the year, we're all trying to figure out what you're guiding to for the year or what you're suggesting the year might look like at and difficult for us to do that without knowing what last year.

H.K. Desai

Yeah I understand. And we will do the best we can to make those available to you in the near term.

Dan Renouard - Robert Baird

Okay. And then, can you guys talk to PathScale at a very at a high level. How’s that acquisition, you guys acquired them 16 months ago or so. Would you say that acquisition has been a success? Is it still to be determined? Or how should we think about that technology acquisition?

Tony Massetti

I mean we invest in this technology, we were little behind some of the silicon technology, and we tried to catch up with that I think we are progressing little slower than what we expected. But we are going to continue to invest into that, and the customers are asking for second supplier, and there is only one supplier. So, I'm sure that we will be successful over the long term.

Dan Renouard - Robert Baird

Okay. That's helpful. Thank you.

Operator

We will move next to a question from Mark Moskowitz with J.P. Morgan.

Mark Moskowitz - J.P. Morgan

Yes, good afternoon. A few questions, maybe you can get back to some of the confusion over the new product categories and I guess you don't want to give us the prior quarter's numbers, whatever reason, but why are you not going to have a consolidated InfiniBand number going forward for both the Silicon, as well as the products just given that InfiniBand, as Jeff attested earlier, seems to be a pretty important growth driver for the company going forward?

H.K. Desai

Certainly now I think it is very important to us. We're trying to give the best visibility to the business that we can, Mark. Just two ways to categorize this. It is by technology, by putting all InfiniBand in one line and all of fibre in another, or categorize it by product, right, Networking versus host? We felt, and based on input from investors, that better visibility into the business would be putting the in InfiniBand and the Fibre Channel switch businesses together, which is the networking group, and putting the host products together, which is the host products group. So we think that providing a third breakout with all InfiniBand would be confusing.

Mark Moskowitz - J.P. Morgan

Okay. And then how long does QLogic anticipate it will take until the InfiniBand solutions that you're able to offer are on par or better than the combined end to end solutions of both Cisco and Dell, I know have you some holes relative to those two players.

H.K. Desai

I mean I don't think this as a whole, because if you’re looking at our offering, we have end-to-end solutions with our DDR switches and either guys know or not, but SilverStorm always also offer a Mellanox HCA solutions. So, we providing end-to-end solution, whether it is our switches, which is using the Mellanox switch silicon. And we also offer, some customers wants Mellanox HCA, we offer that too, and we offer the PathScale HCA also. So, we have a complete end-to-end solution compared with all the competitors.

Mark Moskowitz - J.P. Morgan

Okay. So, you’re there already. Sorry about that. And as far as the OEM partnerships, you're with SAN, but what about IBM and HP? Can you talk about IBM and HP as far as your InfiniBand opportunities?

H.K. Desai

I don't think we want to go into any detail or talk about OEMs anyway, but I think there are a lot of our opportunities right now coming from end user engagement for many times and full into channels, and even some of the OEM engagement also fulfilling into the channels.

Tony Massetti

Yes, this HPC market is a little different in the sense that, it is not all major OEM driven. We're working with major OEMs, sometimes not even through an OEM arrangement, just through a solution involved their systems and our interconnect. So it is not quite the same as the Fibre Channel opportunity, when you look at the InfiniBand technology and where it is deployed, into the customer's environment.

Mark Moskowitz - J.P. Morgan

Okay. And then I apologize, if this question already have been asked, I jumped on late, but your references in terms of virtualization having a negative impact on server trends, can you talk more about that? Because it just seems like a few weeks or a few months ago, folks were still trying to hypothesize what virtualization could mean?

Tony Massetti

Yeah. We look at this quite a bit and there are a couple of things going on which make it hard to predict exactly how it is going to completely play out. But when you consider the server consolidation that is going on in the market place both with multi-core processors along with the deployment of virtualization, which is clearly happening out there. We look at that, and we see a lot of that workload being consolidated on servers that are staying attached. In fact, it is a greater attach rate of SAN technology to those sometimes larger servers sweeping up.

But when you look at the total number of servers, it's often times decreases, because you take a bunch of small servers, and sweep it into a larger server. So we actually believe that there will be some impact and this is one of the influences over our HPA growth rates that there will be an adverse impact of the HPA opportunity through that transition, but its really hard for us to peg it, because you've got a number of factors coming together here, but we would be naive to not at least recognize that there is some dynamics going on in the service space that are playing a role here.

Mark Moskowitz - J.P. Morgan

Okay and then shifting gears to Fibre Channel directors. Maybe H.K or Jesse if you could help us understand the next 12 months and for the past 12 months haven't really evolved as maybe some had anticipated this in terms and what level of incremental R&D and SG&A as part of the bigger systems push will be required to really have an impact or have squash in the director market over the next 12 to 18 months?

H.K. Desai

I mean I think the first step was the product right. So, when you say the last 12 months, we haven't had the director class product for a year. So doing that in the fall and having that product available with some leadership attributes was sort of fundamental to be able to have those discussions with OEMs and with clients on deploying QLogic technology from core-to-edge. So that gives us sort of the platform to have those discussions with customers.

We have, we do recognize that there is a need for business development resource as to help us drive the business in the switch base, little bit different than embedded switching, or host space. And we continue to shift resources as appropriate to ensure that kind of success. But it just doesn't happen overnight. There is a lot of work to be done, and as H.K. mentioned, on the director class product. It takes quite a bit of testing and certification, you have to step through to be in a position to demonstrate to clients that the stuff is rock solid.

Mark Moskowitz - J.P. Morgan

Right. And then as that, product are eventually scaled, how should we think about the margin impact? Because I do think there is a little more hand holding in terms it is not just like a host device. In terms of HBA, we have an you some Silicon and firmware and you're packaging out the door. There is a little more contract manufacture involvement. A little more testing and assembly and how should we think about the gross margin profile?

H.K. Desai

Our thinking on gross margin, Mark, hasn't changed. I think once fully ramped, the Host Channel adapter will be comparable to the host bus adapter and the InfiniBand switch will be comparable to the Fibre Channel switch. We don't break out margins but we set our Fibre Channel switches, are comparable to the others what is out there mid upper 50s. So I think, I've seen some models around 50 for the InfiniBand switching, our thinking hasn't changed.

Tony Massetti

This is your question about your Fibre Channel?

Mark Moskowitz - J.P. Morgan

Its more on directly.

H.K. Desai

I'm talking about InfiniBand switches comparable to the Fibre Channel like Host Channel.

Tony Massetti

We gave guidance on the Fibre Channel as well.

Mark Moskowitz - J.P. Morgan

Right. Thank you.

H.K. Desai

Operator, we have time for one more question.

Operator

And we will take our final question today from Harry Blount with Lehman Brothers.

Roberta - Lehman Brothers

Hi, guys. This is [Roberta] in for Harry. Just a quick question. On your revised expectations for the core business, to what extent was that impacted by new entrants in the HBA market, if at all?

Tony Massetti

None.

Roberta - Lehman Brothers

Okay.

Tony Massetti

When you look at new entrants there, they were picking up technology from competitors who already there. So there was really no new offering in the marketplace to really list any share from.

H.K. Desai

Okay.

Tony Massetti

Okay. So, thank you for joining us for our first quarter official year 2008 conference call. We look forward to discussing our second quarter results with you at our next quarterly conference call in October. Also, we have several upcoming conferences that will be attending.

In September, we will be presenting at Citigroup's 14th Annual Global Technology Conference and the A.G. Edwards Emerging Growth Conference. Please refer to our Investor Relations website at www.qlogic.com for any updates to the conference schedule. For any of you that attending these conferences, we look forward to seeing you there. Thank you.

Operator

And this concludes today's conference call. Thank you, everyone for joining us.

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