QLogic Corp. F3Q08 (Qtr. End 12/31/07) Earnings Call Transcript

Jan.23.08 | About: QLogic Corporation (QLGC)

Qlogic Corp. (NASDAQ:QLGC)

Q3 FY08 Earnings Call

January 23, 2008, 5:30 PM ET

Executives

H.K. Desai - CEO and Chairman of the Board

Jeff W. Benck - President and COO

Anthony J. Massetti - Sr. VP, CFO

Analysts

Paul Mansky - Citigroup Smith Barney

Mark Moskowitz - J.P. Morgan

Min Park - Goldman Sachs & Co.

Harsh Kumar - Morgan, Keegan & Company, Inc.

Aaron Rakers - Wachovia

Tom Curlin - RBC Capital Markets (US)

Clay Sumner - FBR Friedman, Billings, Ramsey & Co., Inc.

Kaushik Roy - Pacific Growth Equities

Operator

Good day, everyone, and welcome to the QLogic Corporation Third Quarter Fiscal Year '08 Earnings Announcement Conference Call. Today's conference is being recorded. At this time, I would like to turn the call over to Mr. H.K. Desai, Chief Executive Officer of QLogic. Please go ahead, sir.

H.K. Desai – Chief Executive Officer and Chairman of the Board

Thank you, operator. Good afternoon and welcome to QLogic's third 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 third quarter financial results and I'll continue with the general discussions of the current state of our business. After that, Jeff will follow with an update on our strategic initiatives and then we will open the teleconference for questions.

With that I will turn the call over to Tony. Tony?

Anthony J. Massetti - Senior Vice President, Chief Financial Officer

Thank you, H.K, and good afternoon.

By now, all of you should have seen our press release and associated financial information. And those of you viewing our financial results, some of the comments today will include forward-looking statements regarding future events and/or projections of the financial performance of the company based on our current expectations. These comments contain significant risks and uncertainties that could cause 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 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. 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 or criminal penalties. Any recording or other use or transmission of the text or audio from today's call is not allowed without the express written permission of QLogic.

In our third 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, special charges and the related income tax effects. An accounting of this difference is included in our press release. The difference in our non-GAAP as compared to our GAAP results is $0.07 per diluted share in the third quarter or $0.30 per diluted share non-GAAP versus $0.23 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 third quarter ended December 30, 2007 was a record $158 million, up slightly from the same quarter last year. Our revenue increased 13% sequentially from the September quarter and exceeded the range provided in our preliminary results announced on Wednesday, January 9. Our revenue also exceeded our original forecasted range of $147 million to $151 million provided during our second-quarter earnings conference call. Our third quarter revenue from host products, which are comprised primarily of fiber channel and iSCSI host bus adapters and InfiniBand host channel adapters was $118.9 million and increased 4% from $114.6 million reported in the third quarter last of last year. The increase in our revenue from host products is primarily driven by HPA revenue growth.

During the third quarter, our revenue from network products which are comprised primarily of Fiber Channel and InfiniBand switches was $27.8 million and increased 17% from $23.8 million reported in the third quarter of last year. The increase in our revenue from network products was primarily driven by revenue from our InfiniBand switch product portfolio which was added with our acquisition of SilverStorm Technologies, partially offset by a decline in revenue from Fiber Channel switch products from the third quarter of last year. The decrease in revenue from Fiber Channel switch products was primarily due to a decline in revenue from our legacy and end-of-life products. Our third-quarter revenue from silicon products comprised primarily of protocol chips and management controllers with $9.3 million and decreased 46% from $17 million reported in the third quarter of last year. While the decline in revenue for silicon products exceeded our expectations for the third quarter, the decline from the prior year is consistent with the overall expected trend.

Other revenue comprised primarily of royalties and service revenue was $2 million in the third quarter. Our third-quarter gross margin of 69.1% decreased from 69.6% reported in the third quarter of last year. The decrease in our growth margin was primarily due to product mix, including the increase in sales of InfiniBand products. The gross margin performance during the third quarter exceeded our forecast of approximately 67% provided during our second quarter earnings conference call.

Next I would like to cover our third-quarter operating expenses. Total operating expenses were $52.8 million in the third quarter, down 1% from $53.4 million reported in the third quarter of last year. Engineering expenses in the third quarter declined 1% to $28.7 million versus a year ago and declined as a percentage of revenue from 18.5% to 18.2%. We continue to make investments in existing and new technologies including Fiber Channel, InfiniBand, and Fiber Channel over Ethernet. As a result, we are targeting 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 million declined 7% from year ago and declined as a percentage of revenue from 12.2% to 11.4%. We expect that future sales and marketing expenses as a percentage of revenue will range from 11%to 14%. G&A expenses in the third quarter of $6.1 million increased from $5 million from the year-ago period and were 3.9% of revenue in the current quarter. We expect that future G&A expense as a percentage of revenue will be approximately 4%. We continue to focus on improving efficiency in our operating expenses while investing in a critical development programs for existing and new technologies.

During the third quarter, QLogic generated an operating profit of $56.4 million, which represented a 35.7% operating margin. Interest and other income was $4.9 million in the third quarter. The income tax rate of 33.1% for the third quarter was slightly above the annual forecasted tax rate of 32% to 33% provided during our second quarter earnings conference all. We continue to expect that our annual tax rate for fiscal 2008 will range between 32% and 33%. Our third quarter net income of $41 million or $0.30 per diluted share represented a net profit margin of 25.9%. Our third-quarter net income per diluted share of $0.30 exceeded the range provided in our preliminary results announced on January 9 and exceeded our original forecasted range of $0.23 to $0.25 per diluted share provided during our second quarter earnings conference call. This represents the 50th consecutive quarter of profitability for QLogic. Net income on a GAAP basis for the third quarter was $31.9 million or $0.23 per diluted share.

Now let me summarize the results for the first nine months of fiscal year 2008. Revenue for the first nine months of fiscal 2008 was $438.1 million compared to $439.6 million in the same period last year. Our revenue from Host Products for this period was $327.6 million, up 7% from the comparable period last year, and the revenue from network products was $74.2 million, up 19% from the comparable period last year. These increases in revenue during the first nine months of fiscal 2008 were offset by the expected decline in revenue from Silicon Products.

Non-GAAP net income was $103.6 million or $0.71 per diluted share for the first nine months of fiscal 2008 and represented a net profit margin of 23.7%. Net income on a GAAP basis for the first nine months of fiscal 2008 was $73.4 million or $0.50 per diluted share. Our financial position continues to be strong especially with regard to our cash flow. During the third quarter, we generated $59.8 million of cash from operations. The company's cash and marketable securities was $378.4 million at the end of the third quarter.

During the third quarter, we purchased $63.5 million of the company's common stock pursuant to our April 2007 stock repurchase program. In addition, during the fourth quarter, we completed the stock repurchase program with the purchase of more than $11 million of our common stock. During the third quarter, our Board of Directors approved a new stock repurchase program that authorized us to purchase up to additional $200 million of outstanding common stock over the next two years. Since 2003, we have repurchased over $1 billion of the company's common stock under programs authorized by the Board of Directors.

Receivables of $75.6 million at the end of the third quarter increased from $72.2 million at the end of the September quarter. The DSO rates in the December quarter was 44 days compared to 47 days in the September quarter. Based on hub arrangements at our OEM customers and our current customer and channel mix, we expect DSO in the future will range from 45 days to 55 days. Annualized inventory turnover in the third quarter of 6.3 turns improved from 5.1 turns in the September quarter. Inventory at the end of the third quarter was $31.2 million and decreased sequentially from $35.1 million at the end of September quarter. We expect that inventory levels at the end of the March quarter to be consistent with the December quarter.

The long-term outlook for our core business remains favorable. Based on current customer forecasts, March quarter seasonality and economic uncertainty, we expect total revenue for the March quarter to be in the range of $147 million to $151 million. Due to the potential variation in product and technology mix, we expect gross margin for the March quarter to be approximately 68%. Considering the above revenue and gross margin expectations combined with planned operating expenses, infrastructure investments and a projected annual tax rate between 32% and 33%, the current outlook is to achieve non-GAAP earnings per diluted share of approximately $0.25 to $0.27 in the March quarter. Actual results for future periods may differ materially due to a number of factors, including those outlined in the course of this conference call and in the company's filings with the SEC and in disclaimer statement at the end of our third 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 – Chief Executive Officer and Chairman of the Board

Thank you, Tony.

QLogic reported strong financial performance during the third quarter with revenue and earnings per diluted share above the high-end of our previous forecast. Revenue in the third quarter was a record $158 million. This revenue exceeded our original forecasted range of $147 million to $151 million provided during our second quarter conference call and was also above the range provided in our announcement of preliminary results. Our earnings per diluted share for the third quarter of $0.30 exceeded our original forecasted range of $0.23 to $0.25 provided during our second quarter conference call and was also above the range provided in our announcement of preliminary results. This represents the 50th consecutive profitable quarter for QLogic.

Third quarter revenue for the Host Products was $118.9 million, up 14% sequentially and was driven primarily by a 13% increase in Fiber Channel HBA revenue. During the December quarter, 86% of our Fiber Channel HBA revenue came from 4-Gig products. According to the Dell'Oro third quarter 2007 SAN report, QLogic gained market share in every major Fiber Channel HBA category for both June and September quarters. Dell'Oro reported that QLogic HBA revenue share increased from 43.4% in the March quarter to 44.4% in the June quarter and further increased to 47.6% in the September quarter. Our market share for HBA ports also increased from 45.8% in the March quarter to 48% in the June quarter and to 50.9% in the September quarter. For mezzanine cards, Dell'Oro reported that QLogic revenue market share increased from 46.1% in the June quarter to 62.2% in the September quarter.

Third quarter revenue for network products was $27.8 million, up 27% sequentially. This increase was primarily driven by our Fiber Channel and InfiniBand switch product lines. Revenue from both Fiber Channel and InfiniBand switch products increased more than 20% sequentially. Third quarter revenue for Silicon Products was $9.3 million, down $2.2 million sequentially. We continue to expect our revenue from Silicon Products to gradually decline over time. For the first nine months of fiscal year 2008, revenue from Host Product was up 7% and revenue from Network Products was up 19% over the comparable period last year. This was offset by a 52% year-over-year decline in revenue from Silicon Products.

In November, we announced that Tony Massetti, our CFO will be leaving to join NCR in late January. Our search for a new CFO is underway. After Tony's departure, Doug Naylor, our current Vice President of Finance, will become the interim CFO. Tony has been a valuable contributor to the QLogic management team. The Board and I are very appreciative of his leadership, dedication and expertise over the past five years. He built a strong finance team along with sound financial processes and controls. We want to wish Tony well in his new endeavors and thank him for his commitment to QLogic. Tony, good luck to you.

Now, I would like to turn the call over to Jeff Benck, our President and Chief Operating Officer to discuss our strategic initiatives. Jeff?

Jeff W. Benck - President and Chief Operating Officer

Thank you H. K. Good afternoon.

During our second quarter earnings conference call, I outlined our strategy to apply QLogic's expertise in storage, data and server networking to help enterprises transform their data centers into more efficient, consolidated and virtualized computing environments. I talked about the opportunity that Fiber Channel over Ethernet holds to the IT industry enabling the consolidation of storage and data network on to a single converged fabric. I then discussed our initiatives for the data center of the future based on 8-Gig Fiber Channel, InfiniBand and Fiber Channel over Ethernet technologies. So, let me give you an update on each technology and the progress we’ve made.

Virtualization is driving a greater demand for bandwidth in the data center. We believe that 8-Gig Fiber Channel is the technology refresh required to meet the increasing performance requirements of the new data center. Currently, industry analysts project 11% revenue CAGR for our Host Products for 2007 through 2011. For the same period, they also project 11% revenue CAGR for our Network Product. This growth will be driven by the continued trend toward network storage and high-performance computing environment.

We believe we are ahead of the competition with our 8-Gig Fiber Channel products and we expect to be first to market with both HBAs and switches. Our 8-Gig Fiber Channel HBA and switch products have been deployed with end-users for several months. For 8-Gig Fiber Channel HBAs, we have been in qualification at all tier-1 OEMs. We expect to start shipping products this quarter. Our Fiber Channel switch revenue grew more than 20% sequentially this quarter as we continue to gain traction in blade servers and offset declines due to end-of-life products, including McDATA Blade Switches. We expect our first to market position with 8-Gig switch products will help us maintain this momentum. Currently, we have secured 12 design wins for our 8-Gig Fiber Channel products with tier-1 OEMs. We have many additional certifications in process with tier-1 and tier-2 customers.

In the fast growing area of high-performance computing, InfiniBand continues to be the preferred server networking technology based on its low latencies, low-cost and industry-standard adoption. Industries such as oil and gas, manufacturing, media and entertainment and life sciences are becoming significant users. IDC's revenue CAGR projections for 2007 through 2011 is 28% for InfiniBand HCAs and 41% for InfiniBand switches. As mentioned before, revenue from InfiniBand switches was up more than 20% sequentially, partially due to our continued success in winning large cluster opportunities. As HPC workload continue to expand in the commercial account and new HPC applications are developed, we believe QLogic is well positioned to participate in this fast-growing market.

When we look to the next generation of IT technology, customers are focused on consolidating of storage and data network. We believe the solution is Fiber Channel over Ethernet. Queue logic introduced the industry's first converged network adapter based on 10-Gig Ethernet technology. Our first FCoE product is capable of supporting both Ethernet and Fiber Channel protocols on a single adapter with seamless integration. We are presently sampling our converged network adapters and believe we have a time to market advantage. We expect FCoE will start gaining traction in calendar year 2009.

We are very excited about our R&D investments in new technologies and the corresponding products we are introducing in 8-Gig Fiber Channel, InfiniBand and FCoE technologies. We believe these technologies will not only facilitate the next wave of IT innovation, they represent the future growth opportunities for QLogic. This concludes our prepared remarks. Operator, we will now open the call for questions.

Question and Answer

Operator

Thank you. [Operator Instructions]. And we will take our first question of the afternoon from Paul Mansky at Citi Investment Research. Please go ahead.

Paul Mansky - Citigroup Smith Barney

Yeah. I have a couple of questions. I guess first off to, Tony, congratulations again on the new post and best of luck to you. H. K., you have been a bit more balanced in your view on the macro versus the bulk of the tech CEOs actually for a quite a while now. Can you maybe update us as it relates to how you are managing the company relative to your macroeconomic expectations set over the coming year?

H.K. Desai – Chief Executive Officer and Chairman of the Board

I mean, Paul, we have a strong December quarter better than we’ve expected. It's a 14% sequential growth in the Host Products and 27% sequential growth in the Network Products. So the December quarter was better than what we expected. We see a momentum in our business last couple of quarters and particularly when the Silicon decline is kind of getting behind us. What we expect is what we have done for the March quarter that we expect the seasonality in the March quarter which normally will be 2%, 3%, around 2% to 4%. What we have done is we have given a guidance which is approximately mid-single digits and we have considered little macro level impact on this. So, this will be a little conservative guidance than what we'd have given you otherwise.

Paul Mansky - Citigroup Smith Barney

Okay. Thanks. Now, on the expense lines, it looks like we nudged up the R&D range by about a point and moved to the higher end of the prior 3% to 4% G&A range. Should we read anything into this or are there any specific programs that we are looking at or is this more just kind of fine tuning as we move along?

Anthony J. Massetti - Senior Vice President, Chief Financial Officer

Yeah, Paul, the range, the 18% to 21% range, engineering as a percent of revenue is consistent with the past several quarters. When we made the investments in InfiniBand several quarters ago, we increased the range by 1 point. In the quarter actually we dropped down significantly as a percent of revenue versus prior quarters; we're just over 18% on the R&D line. So, we're seeing some leverage in the operating model as you can tell by the nearly 36% operating margin in the quarter. So, I think in the upper teens is probably a good place to model for engineering. And then G&A around 4%, we've made some investments there with bringing on a COO and some other investments, so around 4% is probably a good place to model.

Paul Mansky - Citigroup Smith Barney

Jeff, you are good for a point.

Jeff W. Benck - President and Chief Operating Officer

[inaudible]

Paul Mansky - Citigroup Smith Barney

And the last one just real quickly, H.K., we've kind of watched the Fiber Channel transition, and it took about five years for Fiber Channel to really hit momentum in the market, it took 6 to 7 years for iSCSI. And FCoE, now we are calling for it to be basically a two-year ramp. What would you say is different about FCoE relative to those two prior protocols in that accelerated adoption?

H.K. Desai – Chief Executive Officer and Chairman of the Board

I mean, you know, it's like... I don't think I can predict what is the FCoE real transition is going to be. I think what... I think the biggest advantage that FCoE has is that the infrastructure. Particularly, if you look at the software segment, the Fiber Channel happened... there is… you need to have a completely different software stack plus the management also took a long time. I think what we are doing with FCoE is running the Fiber Channel protocol over the Ethernet, so all the software investment the enterprise customer has, all the drivers, either it is Linux or the Windows or anything, or they on Unix, they can keep exactly the same software drivers, either it is ours or our competitor which we two have about almost 80% of the market share. So, I think that's the one biggest advantage. And the management also, we can use the same management software we have from the Fiber Channel. So, that may be the reason we can probably get the traction maybe a little faster.

Jeff W. Benck - President and Chief Operating Officer

Lack of disruption, we think, is the key, backward compatibility as well.

Paul Mansky - Citigroup Smith Barney

Yeah, perfect. Thanks for the color. I appreciate it.

Anthony J. Massetti - Senior Vice President, Chief Financial Officer

Thank you, Paul.

Operator

And we will go next to Mark Moskowitz at J.P. Morgan. Please go ahead.

Mark Moskowitz - J.P. Morgan

Yes, hi. Good afternoon. I also echo Mr. Mansky’s good wishes to you as far as your new post Tony. Good luck.

Anthony J. Massetti - Senior Vice President, Chief Financial Officer

Thank you, Mark.

Mark Moskowitz - J.P. Morgan

Couple of questions here, if we could maybe talk about the macro here for a second, are there any concerns that some of your storage customers maybe engineered a budget flash, maybe amplified the budget flush in terms to spend it or lose it because they are concerned about budget cuts here in the first half of '08?

H.K. Desai – Chief Executive Officer and Chairman of the Board

I don't think we have seen any budget flush. I mean we were a little surprised with the December performance, but I think it’s more maybe related to what we've performed last couple of quarters. I think we have started seeing the momentum in our business, and I think we've seen that…I haven't seen any budget flush, and I don't think we expect anything the first couple of quarters.

Mark Moskowitz - J.P. Morgan

And then as far as the upward bias in terms of the HBA revenue trajectory, how have the transition with the mezzanine cards played out there? Is this a part of why you're seeing the upside there with mezzanine card transition’s kind of over, and that lower ASP configuration now has kind of worked itself out and virtualization is maybe driving some higher [inaudible]?

H.K. Desai – Chief Executive Officer and Chairman of the Board

I think mezzanine card is complete anyway, so we've... that transition is complete now and I think we'll be seeing some traction because of that. But I think what we're seeing is, it not only mezzanine card or standard HBA or single port, the dual port, we somehow see this... pretty good tractions in the December quarter. I mean you have 13% sequential growth in our Fiber Channel HBA business. So I think it was tremendous, it’s much better than what we have expected.

Mark Moskowitz - J.P. Morgan

Okay, and then just lastly, can you... can you maybe contextualize more the InfiniBand market in terms of the win rates that QLogic is experiencing and who QLogic is facing in terms of InfiniBand?

Jeff W. Benck - President and Chief Operating Officer

So, we continue to make progress in the InfiniBand space. The competitors obviously are Voltaire and Cisco there. When you look at our progress, we've kind of been in line with what we've guided several quarters ago and we continue to work with some of the large OEMs on opportunities as well as supporting some of that business directly through the channel. And really the HPC workload continues to grow even in enterprise accounts which is kind of what I mentioned in the discussion, so while it is HPC specific, a lot of enterprise accounts in oil and gas and some of the other verticals are seeing the need for the high-performance server networking and then we are flowing into the trend.

Mark Moskowitz - J.P. Morgan

And then as a follow-up, Jeff, can you maybe just give us a little more color in terms of your optimism around InfiniBand, are you seeing more uptake because of your channel focus or because of one or two OEMs that are helping you around?

Jeff W. Benck - President and Chief Operating Officer

I would say it is across both, it's not specific to the channel or the OEM partnership. But we just… we have really an end to end solution there with both host and switch, and we're very focused on this space, and we continue to build our capabilities round our product line. So, we did introduce some new DDR switches last quarter and that has helped us, and we continue to be pretty focused in these opportunities with our sales force and with our engineering effort. So, that's why I think against the competition we stack up pretty well and we continue to move on, obviously, there is opportunities for share gain coming from where we sat in the market.

H.K. Desai – Chief Executive Officer and Chairman of the Board

And also, it took us about a year or so, but Mark we are also seeing... really good quality products particularly on the DDR side, and I think that's also kind of helping us getting traction, so either it’s channel or the OEM.

Mark Moskowitz - J.P. Morgan

Okay, thank you.

Operator

We'll go next to Min Park at Goldman Sachs.

Min Park - Goldman Sachs & Co.

Yes, thank you. Just a couple of questions please. First, can you provide a little bit more detail on your target by segments? I guess, specifically, do you think your switch business has once again outperformed the overall corporate growth on a sequential basis?

H.K. Desai – Chief Executive Officer and Chairman of the Board

We gave the number. Like we said, our Network Products, which include Fiber Channel and IB switches grew 27% sequentially. And we also said both Fiber Channel and IB switches grew more than 20% sequentially. We grew our Host Products 14% sequentially, which was driven by 13% sequential growth for Fiber Channel HBA. So I mean, it’s all across, we had good performance. I think the negative was like our Silicon Product declined by $2.2 million, which still is slightly more than what we expected.

Min Park - Goldman Sachs & Co.

Right. But, going forward, are you still expecting the same type of momentum from the switch business that will be able to outperform the overall corporate growth?

H.K. Desai – Chief Executive Officer and Chairman of the Board

I mean in the long-term what you're saying that, yes, we expect. Particularly, it’s driven by the IB Switch growth rate and we expect that, yes, will momentum will come from both Network and the Host.

Jeff W. Benck - President and Chief Operating Officer

The market opportunity is certainly larger per IDC and some of the analyst for the switch... for the InfiniBand switch base.

Min Park - Goldman Sachs & Co.

I guess I was looking more specifically to the next quarter?

H.K. Desai – Chief Executive Officer and Chairman of the Board

I mean if you look at the… when we give a guidance for March is a seasonal quarter. So we expect decline both in the Fiber Channel and the HBA Host Products and also on the switch side. We expect a sequential decline on both business because of seasonality.

Min Park - Goldman Sachs & Co.

Okay.

H.K. Desai – Chief Executive Officer and Chairman of the Board

Into the December quarter.

Min Park - Goldman Sachs & Co.

Okay. And given that you're... you kind of outperformed sequentially on the switch platform, your gross margin coming in higher was definitely some upside, can you just quantify some of the drivers of that. I mean was it more from operating efficiency and uplift in margins for the whole switch platform or is it just better volume?

Anthony J. Massetti - Senior Vice President, Chief Financial Officer

Sure, Min. So, there are many moving parts in gross margin, of course. But the... we saw an 80 basis point improvement in gross margin sequentially from 68.3 to 69.1, and that was primarily driven by improvement in our manufacturing cost. So, we're working all aspects of manufacturing cost, we have been for the last several quarters. And if you go back to Q1, our gross margins were 66.3 and Q1 to Q2 we saw a two point improvement. So, the team has done a good job working manufacturing cost over the last three quarters.

Min Park - Goldman Sachs & Co.

Okay, great. Thank you very much.

Anthony J. Massetti - Senior Vice President, Chief Financial Officer

You're welcome.

Operator

And we will go next to Harsh Kumar at Morgan Keegan.

Harsh Kumar - Morgan, Keegan & Company, Inc.

Yeah. Hi, guys. First of all, Tony, I enjoyed working with you over all these years and best of luck to you.

Anthony J. Massetti - Senior Vice President, Chief Financial Officer

Thank you, Harsh.

Harsh Kumar - Morgan, Keegan & Company, Inc.

Couple of questions, guys. It seems like, on a fundamental basis, your company is doing a lot better in the second half, it did a lot better in the second half than the first half. I was wondering if there has been a cultural change? Jeff is making everything happen here. Could you just maybe comment on, first of all, the huge out performance in December? Is some of it [inaudible], any explanation would be helpful.

H.K. Desai – Chief Executive Officer and Chairman of the Board

Yeah. I think first couple of quarters in the beginning I think what we did was we make adjustment and one of the mistake we made was the projections on our Host growth. We thought we can be going 13%, 14%, we can outperform the market. So, I think that is the first adjustment we have to make. And the second one is the Silicon decline, I think now it is slowing down. Third one is particularly on the Fiber Channel switch side, the decline for McDATA products is also slowing down now anyway. So, I think all those things behind us now, and that's where we start growing. And regaining the market share on the Host products, in particularly in the Fiber Channel HBA, just like I talk about in my script, we are gaining really good tractions on the IB switches. It takes time, by the time we acquire the company, it’ll take about a year to 18 months to get integrated, so we will start seeing this benefit of our investment.

Harsh Kumar - Morgan, Keegan & Company, Inc.

H.K, at this time I believe you guys are still buying the ASIC for the InfiniBand switches from an outside vendor. I know historically you guys have always tried to have your own IP, could you maybe comment on what your plans are relative to just owning the silicon?

H.K. Desai – Chief Executive Officer and Chairman of the Board

I mean, I think broadly speaking, we have a... I think Tony talked about last quarter the three different ways… I mean three things we are trying to. We have to improve the InfiniBand margin. I think we have to bring it at least to the same level as the Fiber Channel switches for the switch side, and I think we said that we are working in three areas, one is the supply chain and manufacturing integrations when we acquired the SilverStorm. I think that benefiting us improving the margin. Volume ramp is also helping us. And the third one which is a big impact is the silicon pricing. And we are continuing to make progress on the first two. With the last one, we are disappointed with the progress on silicon pricing. So, we are not getting the pricing from our supplier what we like. And so I think we have to look at long-term what we do and we can… we are thinking three different ways. One way we can go and look some alternative suppliers for the silicon, we can do some joint development, or third one is we can build our own anyway. So, we have to look at all three options and figure out long-term what we're going to do, because we are not getting the better pricing from the supplier.

Harsh Kumar - Morgan, Keegan & Company, Inc.

That's pretty fair, H.K. Thank you for that clarity. Guys, also a tremendous job on the OpEx. Revenue is up, OpEx down sequentially, just want to understand, if there was any one time kind of a thing in the numbers that kept the OpEx down, or just was a just good all-round OpEx control?

Anthony J. Massetti - Senior Vice President, Chief Financial Officer

I think it was all-round good OpEx control, Harsh. We were down about 2 million sequentially. We finished December quarter about $53 million, September was about $55 million. We did have an NRE expense in the September quarter and less NRE in the December quarter, so that helped a little bit. But we... the team did a very good job on expense management in the quarter. Looking into March, we are planning for about $55 million, so that expense to pick up just a little. There's some seasonality in OpEx, payroll and insurance cost. Payroll, tax and insurance cost increased the first calendar quarter, we see that every year. So, that's worth probably about $1.5 million and then we've some other run rate expense for the other $500,000. So I think overall it was a good job in the December quarter on expense management.

Harsh Kumar - Morgan, Keegan & Company, Inc.

And last question fellows, and sorry for taking so much time. But your silicon business, 9.3 odd million dollars, what should we think of as sort of a base level sustainable run rate. If you could just break it down maybe between controllers and protocol or just help us get a gauge around what we should be looking out once it stabilizes?

H.K. Desai – Chief Executive Officer and Chairman of the Board

I think there is two type of silicon we sell, one is the protocol and other is management control of protocol. We have initiated our business and we'll target silicon business for the protocol and the management controller is approximate... I mean it's declining and I think it is end of life we announced more than two years ago. The last quarter, December quarter, we have about $1 million approximate revenue came from the management control, so it has started declining. But if you look at the overall business, we expect that by the time we done with the March quarter, we will be declining the silicon business in FY08 by almost approximate $35 million. So, that's a big decline for us, and that's what the impact. We have seen our revenue growth year-over-year. In FY09 I think we're... we reach a point where I think the decline will be slow. So, we expect probably mid-to-high single digit overall decline in FY09 anyway. So, I think there will be much less impact in our business going forward into FY09.

Harsh Kumar - Morgan, Keegan & Company, Inc.

Okay, so you said, H.K., just to be clear, you said management control is you're doing about 1 million now, is that –

H.K. Desai – Chief Executive Officer and Chairman of the Board

Yes.

Harsh Kumar - Morgan, Keegan & Company, Inc.

Okay. Fair enough. Thanks guys. Great results, great guidance.

H.K. Desai – Chief Executive Officer and Chairman of the Board

Thank you, Harsh.

Operator

We will go next to Aaron Rakers of Wachovia.

Aaron Rakers - Wachovia

Yeah, thanks guys. Hopefully... can you hear me?

H.K. Desai – Chief Executive Officer and Chairman of the Board

Yes.

Jeff W. Benck - President and Chief Operating Officer

Yes.

Aaron Rakers – Wachovia

Okay, sorry. So, a couple questions, I guess. First going back on the InfiniBand gross margin type question, I guess it looks like we're seeing some improvement there but not yet what we want to see. Is it still the target to get that InfiniBand gross margin to the corporate levels looking out I guess over the next two or three quarters. Is that still a fair assumption?

Anthony J. Massetti - Senior Vice President, Chief Financial Officer

Yes, it is, Aaron. We did see sequential improvement in InfiniBand gross margin as planned. And if you recall, back in the March call and May, we did say we’ll take four to six quarters to get IB margins comparable to the Fiber Channel margin. So, IB switch similar to Fiber Channel switch and HCA similar to HBA. So, as H.K. said, we made good progress on supply chain and manufacturing integration; volume is ramping, but we still need much better silicon pricing in order to get those margins where we want them.

Aaron Rakers - Wachovia

Is it fair to say that... are we treading close to the 50% mark right now or are we closer to 40%?

H.K. Desai – Chief Executive Officer and Chairman of the Board

Our goal is to... our goal is always to have IB HCA margin comparable to our Fiber Channel or iSCSI HBA and our IB switch comparable to our Fiber Channel switches. I mean that’s our long-term goal. It can take… I said last quarter, it can take about four quarters or so. So, I think that is what we... our goal is to achieve that.

Aaron Rakers - Wachovia

Okay, fair enough. I guess then the next question is on the SAN switching piece of your business. It looks like you guys are still at 4 Gigs. I think some of your competitors are starting to roll out the 8 Gig, one in particular on the Director- class side. When do we expect to see some moves out of you guys with moving to 8 Gig , the second half of '08?

Jeff W. Benck - President and Chief Operating Officer

This is Jeff. In my comments, we talked about actually shipping 8 Gig this quarter. So, we believe we are there. We are clearly in a leadership position as far as time market goes, and that is an opportunity for us to continue the momentum there. We’ve seem strong growth in our Fiber Channel switch business on the blade side and will have more than… our first offering will be in the RAC switch side of things with 8-Gig. We will be there this quarter.

Aaron Rakers - Wachovia

Right. And then I guess final question from me is just with regard to how to think about HPA pricing trends looking out over the next couple of quarters? With a new competitor coming into the market, are you changing your assumption that we continue to see down 2% or so sequential type decline on a like-by-like basis, is that still a fair assessment over the next several quarters?

H.K. Desai – Chief Executive Officer and Chairman of the Board

Yeah. We always said it's around 2% approximately sequential like-for-like products. And if you look at our track record, it is always between 1.5% to 2.5% decline over several quarters, and we don't expect that to change. I think we continue the same kind of decline. We don't see any price pressure on the HBA business.

Aaron Rakers - Wachovia

All right. Thank you guys.

H.K. Desai – Chief Executive Officer and Chairman of the Board

Thank you, Aaron.

Operator

And we will now go to Tom Curlin at RBC Capital Markets. Please go ahead.

Tom Curlin - RBC Capital Markets (US)

Hey, good afternoon. Great quarter, congratulations.

H.K. Desai – Chief Executive Officer and Chairman of the Board

Thanks, Tom.

Tom Curlin - RBC Capital Markets (US)

On the 8 Gig products, can you just walk us through sort of a hypothetical road map for mix there, for example, do you think you will see 8 Gig up to 50% of volume or revenue by the end of calendar '08? Or will it take longer, could it happen faster, how does that feel?

H.K. Desai – Chief Executive Officer and Chairman of the Board

I mean I... the way our schedule is right now, we're going to go into production this quarter and will start shipping some 8 Gig HBA and 8 Gig switches. I think volume wise, it is difficult. If you look at, I think, 1 Gig to 2 Gig or a 2 Gig to 4 Gig, it take about 12 months or so to complete the rank approximately a year or so. So, I think it will start sometime in the second calendar quarter and it will take about three to four quarters, anyway. So we expect, I think… I cannot really project, but I think I expect that somewhere in end of the year, probably, somewhere between 40%, 50% coming from 8 Gig.

Tom Curlin - RBC Capital Markets (US)

Okay, so that's kind of reasonable. Obviously, there's a lot of variance around that depending on OEMs, right?

H.K. Desai – Chief Executive Officer and Chairman of the Board

I think like Jeff already said in his presentation that the key driver is really virtualization and I think virtualization require higher performance and I think that probably can drive the 8 Gig adoption.

Tom Curlin - RBC Capital Markets (US)

And the 4 Gig right now versus 2 Gig right, it's what, 90% plus of mix?

H.K. Desai – Chief Executive Officer and Chairman of the Board

We were at 86% in the December quarter.

Tom Curlin - RBC Capital Markets (US)

Okay, so that has played out. And then on the IB side, can you give us the mix of DDR versus... I guess SDR would be the name of it?

Jeff W. Benck - President and Chief Operating Officer

I’d just say the majority of what we are shipping is DDR.

Tom Curlin - RBC Capital Markets (US)

The majority... has that... has that shifted? Of course, I know you are coming from a small base, but has that shifted just over the last quarter or two, that’s kind of the inflection --?

Jeff W. Benck - President and Chief Operating Officer

Well, one thing about IB, because DDR is 10 Gig capability, there is a long tail on this stuff. So, it’s not the [inaudible] that you might see with other transitions. So, we expect as QDR comes out later this year, end of the year, kind of thing, that DDR will still have a lot of legs on it. So, those are... I would say from my experience, it’s a long transition.

Tom Curlin - RBC Capital Markets (US)

Okay. And then you said QDR, QDR really not till year-end has a catalyst?

H.K. Desai – Chief Executive Officer and Chairman of the Board

Yeah, I think, earliest would be year-end, I think probably sometime in '09.

Tom Curlin - RBC Capital Markets (US)

Okay. And then on the switching side of the business, does that feel like good traction with channel or the box business, but what about the blade business, how is that? Is that starting to recover?

Jeff W. Benck - President and Chief Operating Officer

We highlighted the blade as one of the drivers.

Tom Curlin - RBC Capital Markets (US)

Okay. So, blade is starting to... and do you think that… is that just hitting easier compares or is there some share shift among platforms and is that helping as well?

H.K. Desai – Chief Executive Officer and Chairman of the Board

I mean, I think, it's like there was impact of the McDATA transition. I think that's kind of impacted last few quarters anyway. So, I think it's a little easier compare from that perspective and we also are getting sort of share gain on the blade side, particularly on the virtual connected side.

Tom Curlin - RBC Capital Markets (US)

Okay. And then just on the macro stuff, coming back to that, do you have anybody specifically, I guess, indicating some issues there, end user level, OEM level? How much have you guys done to try to figure that out versus just watching the headlines and discounting appropriately?

H.K. Desai – Chief Executive Officer and Chairman of the Board

I mean, like I said, to be very blunt and very frank, if you... if there was no macro level impact, our guidance would have been probably 2% to 3% seasonality, because we have March quarter decline, but I think we've conceded some macro level impact. We cannot pinpoint anything right now. Actually to be very frank, we’re not seeing anything, particularly, so far in January. We have a pretty good January so far and so January looks like last year, January looks like a plus quarter… plus month of the December quarter anyway. So, we are not seeing anything from perspective, but we are cautious about macro level.

Tom Curlin - RBC Capital Markets (US)

Okay. Thank you.

Operator

And we will go next to Clay Sumner of Friedman, Billings, Ramsey. Please go ahead.

Clay Sumner - FBR Friedman, Billings, Ramsey & Co., Inc.

Thanks very much. The first question is on the inventory. You guys really brought down inventory days quite a bit from where it has been, but the relatively low DSO does suggest much of a back-end loaded quarter. So, can you just talk a little bit about what's behind the big inventory reduction I guess is the new steady state level?

Anthony J. Massetti - Senior Vice President, Chief Financial Officer

Yeah, Clay. It was down to about $31 million. Inventory built up toward the end of the last fiscal year into the June quarter, we talked a lot about that. I think it was as high as $38 million, maybe $39 million, and that was attributed to the 4 Gig transition, RoHS-compliant product, and that was a challenging transition. I think we managed it well. And we said at that time we expected to work off that inventory that we built up; over the course of the fiscal 08, we've done exactly that. So, we think for at least the next couple of quarters, low 30s is where inventory ought to be and longer-term our goal is to improve inventory turns from here.

Clay Sumner - FBR Friedman, Billings, Ramsey & Co., Inc.

That's great.

Anthony J. Massetti - Senior Vice President, Chief Financial Officer

Did you have a follow-up question?

Clay Sumner - FBR Friedman, Billings, Ramsey & Co., Inc.

Yes, I did, yeah. On the Fiber Channel switches, last quarter you talked about... those fell about 16% year-over-year because of the McDATA end of life [ph]. This quarter they were up sequentially strongly, but were they still down about 15% year-over-year?

H.K. Desai – Chief Executive Officer and Chairman of the Board

No, it was... it was a mid-single-digit decline year-over-year.

Clay Sumner - FBR Friedman, Billings, Ramsey & Co., Inc.

Mid-single-digits, okay. And then on the... do you expect the top storage OEMs to start shipping the 8 Gig Fiber Channel switches? I just wasn’t clear about that. You said you're going to start shipment this quarter 8 Gig Fiber switches, but is that OEM stuff or channel availability?

H.K. Desai – Chief Executive Officer and Chairman of the Board

It can be channel, it can be tier-2 OEMs, it can be some tier-1 OEMs, we don't know yet. We can't say anything right now.

Clay Sumner - FBR Friedman, Billings, Ramsey & Co., Inc.

Okay. And on Fiber Channel over Ethernet, do you guys plan on just shipping the adapters or will you also do switches in that business?

Jeff W. Benck - President and Chief Operating Officer

So, we think we can participate in both sides with our technology. Also some partnerships on the switch side, we will participate in FCoE space. But our early investment clearly has been on adapters and we believe we are in a lead from a time to market standpoint there.

Clay Sumner - FBR Friedman, Billings, Ramsey & Co., Inc.

Great. Okay. Thanks very much.

Operator

And we will go next to Kaushik Roy at Pacific Growth Equities. Please go ahead.

Kaushik Roy - Pacific Growth Equities

Congratulations. Can you help us with the gross margin, I know there are a lot of moving components here, but going beyond the March quarter maybe 9, 12 months from now, how should we model gross margin? Should we model like in the high 60% range, will that be fair or --?

Anthony J. Massetti - Senior Vice President, Chief Financial Officer

Yeah. So, gross margin is again 69.1 for the December quarter. We talked about down just slightly in the March quarter to approximately 68 due to product mix. I think long term, Kaushik, looking out over a year or so, 65 or greater would be our goal depending on product mix. As we talked about, we don't expect a lot of margin erosion within our product family post versus network products with pricing being stable and we continue to work the manufacturing cost, but it's more the mix of within business as the network business grows faster than the host business over time. So, that will put some very gradual downward pressure on margin, so greater than 65 over the next year or so.

Kaushik Roy - Pacific Growth Equities

Great, thanks. And then on FcoE, H.K., you mentioned about the software stack and Intel is coming out with a software initiative for FCoE. So, does that put pressure on the server adaptor card or it doesn’t?

H.K. Desai – Chief Executive Officer and Chairman of the Board

No. I mean… I think that one of the key reason of going to the FcoE technology and support from Cisco or any of those guys is because they want to make sure that enterprise customer preserve their stack. Nobody wants to go and change their software stack, and I think it is going to be two suppliers has 80% of the share in this thing, and they are the one who will get tractions on the FcoE adaptor business.

Kaushik Roy - Pacific Growth Equities

So, for instance, iSCSI adaptor card never took off really because of the software initiative, right? Similarly, can we see something like this here or you don't see that --?

Jeff W. Benck - President and Chief Operating Officer

Well, it’s a little different because customers in Fiber Channel space are used to the performance and reliability in what the hardware initiators provide in the space. With iSCSI kind of coming from an organic start, there was sort of a Greenfield there and certainly the dynamics are a little different in that market. When you look at FCoE, the enterprise customers are really demanding that performance level, particularly as they look at consolidating both data and storage networks on a single wire, they really are asking for that kind of capability.

Kaushik Roy - Pacific Growth Equities

Yeah, I agree on that. And then last question, what about tier-1 OEM qualification for Fiber Channel switches, is that off the table now or can you –

H.K. Desai – Chief Executive Officer and Chairman of the Board

No, we are still working on. We will continue working on this thing, and like we said before, we don't see… we won’t see any traction till probably FY09.

Kaushik Roy - Pacific Growth Equities

Great, thank you.

H.K. Desai – Chief Executive Officer and Chairman of the Board

Thank you.

Operator

And we have no questions remaining in the queue. So, I would like to turn the call back to Mr. Benck for any closing comments.

Jeff W. Benck - President and Chief Operating Officer

Yes, thank you. Thank you for joining us for our third quarter fiscal year 2008 conference call. I want to note several upcoming conferences that we plan to attend. In February, we are slated to attend the Goldman Sachs Technology investment Symposium in Las Vegas. And then in early March, we are on the calendar to attend the Morgan Stanley Technology Conference in Dana Point, California. Please refer to the Investor Relations section of our website at www.qlogic.com for any updates to the conference schedule. For those of you planning to attend any of these conferences, we look forward to seeing you there. Thank you.

Operator

Thank you. That does conclude the call. We do appreciate your participation. At this time, you may disconnect. Thank you.

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