QLogic's CEO Presents at Barclays Capital Global Technology Conference (Transcript)

| About: QLogic Corporation (QLGC)
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QLogic Corp. (NASDAQ:QLGC) Barclays Capital Global Technology Conference Call December 7, 2011 5:00 PM ET


Jean Hu - CFO


Unidentified Analyst

Hi, we're going to get going, stay on time. We're delighted to have QLogic with us right now. They have been also good friends of ours in the industry for a long time. We're delighted to have Jean Hu here, the CFO of the Company who will do a presentation and then we'll do some Q&A. So thanks a lot. Jean?

Jean Hu

Okay. Thank you, [Ben]. Thank you, everybody for joining us this afternoon. So first is our Safe Harbor statement. So our presentation today will be subject to our Safe Harbor statement. I think I want to start our presentation with some of the key messages or takeaway points for QLogic first. The first thing is really market opportunity. We believe there is a significant growth opportunity ahead of QLogic. So what we have seen is our traditional Fibre Channel market continued to show strength and growth. More importantly, we really started to see our expansion market, which is about 10 gig Ethernet, Fibre Channel over 10 gig ethernet and the converge to switching opportunities started to grow significantly.

So when we walk through the presentation, we will talk about the fundamental drivers for this market opportunity. Second thing is that we think that QLogic is very well positioned to address this market opportunity. So our competitive advantage really comes from our strong IP portfolio and expertise in the Fibre Channel high performance area and also in the storage area network.

Our competitive advantage also comes from our incumbency. We have shipped over 10 million Fibre Channel adaptor pods during the last 16 years. And our solutions are very much software centric. So it is very sticky. So that incumbency and our IP portfolio will benefit us significantly when we forward to address the growing expansion market opportunity.

The third thing is about execution. QLogic is very much focused on execution in delivering innovations and quality product to our customers and also we are very focused on execution to deliver a strong business in the financial model. So if you look at the financial model right, that we have the one of the best financial model in the tech industry and that we have been consistently delivering this financial model.

So for the past twelve months ended October our revenue were just about $600 million and that we generated cash from operations over $200 million. We are very committed to shareholder value creation and that we have returned $1.7 billion cash to our shareholders through a stock buyback. So consistently we have been delivering the value to the bottom line. The last thing right this is really our market leadership position. We have been number one in the Fibre Channel market and we continue to gain market share for the past seven consecutive years. We also are the number one. We have a significant lead our competitor in the emerging Fibre Channel over Ethernet market.

So we will talk more about our competitive positioning in the market place. And for some of you if you are not familiar with QLogic I have a few slides about our product and the customers. So a host products account for about 72% of our revenue. The host products that typically, they sit either in a server or in a storage unit. So it is very software-centric, the IP software stack is the critical part of our product. We have been shipping for past 16 years.

Some of the examples of our host of products that include the Fibre Channel adapters, the FCoE adapters, 10-gig Ethernet adapter. We also have an InfiniBand adapters.

Networking product include our Fibre Channel switch product and also our InfiniBand switch product. Networking product is about 18% of our revenue. We also provide a silicon product for customers that, you know, they have a small volume or they want to put a silicon on their storage board. Silicon revenue is about 8% and most of the silicon product revenue actually are associated with our host of product.

Next is our customers. We have a very OEM-centric model. Our major customers are the top OEMs in the server and the storage industry. On the server side, HP, Dell, IBM and Oracle, on the storage side we have EMC and NetApp.

So the channel business is about 25%, but even that 25% channel business, some of them are really used for OEM demand fulfillment. So, overall the OEM business actually is larger than 75%. It’s very much OEM centric model.

On the end customer side, QLogic provides a high performance I/O solutions for big enterprise critical applications. So, it’s not a surprising when you look at our customers. It’s AT&T, [Federal Express] we also provide a solution for a web giant like Amazon. On the InfiniBand side, our customers are typically government or university labs, oil and gas company.

So those are our customer and the go-to market model. And now I want to just step back, to talk about the fundamental demand drivers for QLogic and technology and the product, the evolution of the data center.

So most of the US company, right, really after major upgrade over data center was about a decade or 15 years ago. Since then the market and business condition have changed dramatically. There is a certain increased globalization, increased competition and also competitive pressure from everywhere. On the other side right there is explosion of device, the explosion for applications and also explosion for data. With all those changes they are everybody wants instant access to information. Business want the instant access to information and everyone else also want the same. So really on the technology side to meet those changes there are some major technology trends going on in the market place.

For instance the virtualization we all have heard about it. The virtualization of servers, data centers, storage network and also cloud computing and converging the network. With all those dynamics today when you feel the data center really you want the high performance processor CPU, you want high performance storage area network. Also you want the data center to be scaled up or scaled down to meet the fundamental business need. It also has to be efficient and not only efficient on the energy side, but also on the space on the cost. Fundamentally for each CIO they have the challenge to have the same cost to deliver more for their customers.

So everyone of our OEMs, we work with and we enable I/O technology have a strategy to address the fundamental demand need of the new data center. For instance HP has this converged infrastructure and EMC has the journey to the cloud. Every one of them are very committed to provide the need of the CIOs of the company and then the question really is what kind of a rule QLogic applies in those what kind of a major technology trend., The first step is virtualization. So when you talk about the virtualization, basically you have virtualized the server, which can run multi-cored CPU, run many, many workloads compared to the past. So virtualize the server really is what it does. It processes much more data and then generates even much more network traffic.

As a result today right the bottleneck is really not about a processor. Intel is a processor, it is very powerful, it’s still underutilized. The bottleneck on the server is really on the I/O side. You really need a high performance I/O to move the data through the server off the server and then back to the server. So that's really the bottleneck.

So what QLogic is providing today, we provide 8 gig Fiber Channel I/O solutions for the market, which is going to transition to a 15 gig next year and then we also provide a 10 gig Ethernet I/O solution and also Fiber Channel over 10 gig Ethernet and the InfiniBand. So all those I/O solutions, the high performance I/O the bottleneck of the I/O really creates incremental demand for QLogic technology products. But fundamentally we are the technology provider and a enabler for the OEM to provide the strategy.

Next moving to cloud computing. There are a lot of discussions about the cloud computing and the cloud computing can mean very different things for different people. There's a private cloud, there's a public cloud and its more like there is combinations of hybrid clouds. So in private clouds today, QLogic will provide all the high performance I/O to the private datacenter. And going forward we will continue to do that.

In the public cloud, that’s actually an exciting new place for us. Today, the public cloud is largely 1 gig Ethernet technology. And QLogic we actually we don’t participate in 1 gigabyte Ethernet. But going forward we have a high performance I/OE, the 1 Gig Ethernet is going through a transition to a 10 Gig Ethernet, which actually opens the incremental opportunity for QLogic. We have been investing in the 10 Gig Ethernet technology for the past five years and this new market opportunity really will provide us the incremental revenue for us going forward.

In the hybrid cloud really, what you end up having is you have some critical applications that would still continue with hosting your private data center and then you will utilize the public data center or cloud for other servers. In that case right, you are going to move with data round but even more. So fundamentally that is what the I/O, is about and that’s what we can do and we can help out OEMs.

On converged enterprise side, traditionally the data center is separated by a larger area network and the data network. The different network is managed by different team by different infrastructure but going forward really you need to simplify everything. You need to cut the cost. The critical thing to do is to converge everything on the same network.

So what we have been doing is we are the first one in the industry to come up with that type profit converged platform. We can provide as a solution to move all different traffic on the same wire, basically you will have converged in that work. It will simplify the network management, simplify the fundamental infrastructure of the data center.

So under this platform, QLogic can provide you any IP protocol you need in the data center. We can work with any hypervisor you ever have in the data center, any operating system you will have. The key differentiator for our product is really our IP software stack, which has been tested, has been deployed over a lot of the data centers, which really can work with any hardware and any software and any firmware. That is very difficult to do. We also can provide any form factors that customers that will need. Either it’s a silicon or it’s adapter, it’s very flexible.

So, now lets look at our competitive position in this market. In the traditional fiber channel market, we have been number one for many, many years and keep gaining market share during the last seven consecutive years. And our market share for the last nine months in 2011, is about 54% to 55%. Again, we gained a market share in this market.

So this is our traditional market. We’re very proud of our quality of our product and how we work with the customer.

The next one is the new emerging fiber channel over Ethernet market. In this market, it’s very early. Right now, it’s very small. But if you look at the market share, we certainly have a significant market share lead, compared to our next largest competitor. And here the key thing is right. IP software stack we use in our FCoE side. It’s very similar and identical to the IP software stack we have been using for past 16 years in the fiber channel side. So, it’s very much tested and a matured software stack in the data center.

Now lets look at the expansion market, which is about the 10-gig Ethernet and the converged network. In this market, the market has started to grow significantly. We actually, this year, will become number two, next to Intel. In this particular market we have about 15% of market share and this is really exciting opportunity for us. It is a new one and we are very pleased to be at our current competitive positioning that we have.

It is very fragmented right now. There are lot more players just like any new technology, initially you always have a lot of the players but once you’re going through ramp-up of process then you will have a consolidation with the players. We certainly believe we are going to be a while for the players, which are continue to get market share here.

So this is what we talk about the industry support solution on the converge flag. Basically you can move the IP iSCSI and FCoE traffic on a single 10-Gig Ethernet wire. And here is an example as to why all those technology trend benefited Qlogic.

So right now what you can see is a server five years ago, basically a server with, probably about a 10 Gig I/O need and the way the cloud computing, especially with the CPU’s performance are pushing up the curve. What you are having today is a similar server with virtualization, running many workload and many applications and I/O need is almost like seven to eight times. It is very similar configuration with server, that is the I/O needed today. So usually need a 90 gig I/O today to moving the traffic through the data network and that’s why it is so important to deploy QLogic’s products and why our IP is so important for the data center.

We have been shipping to all the major OEM with our 10 gig Ethernet internet solution, fiber channel over 10 Gig Ethernet and fiber channel solutions and we are very proud of our strong customer relationship with all the major OEMs.

And here are some of the examples of deployment of converged network.

Fundamentally, even in our own datacenter we deploy converged network. What it does is really it reduces operation cost, reduce in OpEx; but it can provide them all services to your enterprise customers.

The next one is our Fibre Channel switch side of the business. So this is the business and our strategy here is really to leverage our Fibre Channel network technology. We don't want to become Ethernet switch company. So what we do is we typically work with Ethernet switch suppliers and leverage our Fibre Channel iSCSI and FCoE capability to provide a converged solution for the marketplace and this market is really starting to grow significantly. So we are very excited about this market opportunity.

And in this market the customer, we provide solution typically to HP, IBM and also the new companies like Huawei. They are getting really aggressive in this market too. And of course here we compete with a difficult Cisco and Brocade. We are a small player in this market, but we are starting to gain more momentum and attraction in this market.

We also actually have an InfiniBand business. We don't talk much it, but its actually very interesting business. Our performance in the QDR side is very strong. We have been gaining market share during the last two quarters and there's also some very interesting applications on the storage side storage side with Oracle, with EMC. So it’s an exciting opportunity going forward for us.

Now let's look at our market opportunity. So this is our fiscal year; so in fiscal 2011 our market opportunity is about $2 billion and we believe in the next four or five years it’s going to grow to about $4 billion. The bulk of the line is Fibre Channel. So a lot of people have been talking about the demise of Fibre Channel for a long time.

But in realty, in 2010 Fibre Channel shipped more product than it ever had historically. And this year, for the year-to-date number it surpassed the same period of last year. So the Fibre Channel, the demand for Fibre Channel technology for critical applications and infrastructure continue to be very strong. It’s going to grow low single digit and it’s going to spread out in the future. So that’s the greater part here.

The next line really the expansion market. It’s the one we are talking about; it’s about 10 gig Ethernet and the converged market opportunity. So this market, it was about $250 million in fiscal 2011. It’s going to grow with over $1 billion. So this market is the major thing is the product transition. Right now the larger chunk of the market is still 1 gig Ethernet and most of the analysts believe the transition by the end of 2013, the 10 gig Ethernet will cross over 50% in the marketplace. The technology has been around for a long time, but right now it’s really with Intel's Romley platform launch, it's going to be inflection point for 10 gig Ethernet adoption and the converged network technology adoption. And then you will have the converged switch side of the market and the edge PC market continue growth. So overall, it’s a very exciting marketing opportunity for us.

Just a quick financial overview of the company. If you look at the company’s history. We build one of the best models in the tech side and if you look at gross margin, it has been very constantly close to the 70% which is really a true reflection of IP value. It’s about the software; it’s about IP. That’s how you can get the gross margin at that level and consistently stay at the level. And also we are very committed to operating margins to be around 30%.

Our long-term model, with the 10 gig Ethernet revenue ramp-up, because it’s gross margin is lower than our current corporate margin. So we do foresee some margin erosion going forward, probably from 66% to 63% in next three or four years. But we’re very committed to our operating margin model and that we believe when we grow the top-line, especially on the 10 gig Ethernet, we’re going to see a significant revenue upside and the overall cost is going to leverage it to the bottom line too.

And I think in closing, really the key thing for QLogic, is we certainly have a very strong foundation in the storage area networking market and it’s coming from our IP position and our IP portfolio. It’s also coming from the incumbency and our strong relationship with OEM and also we really want to emphasize these are the execution on the track record.

If you look at QLogic’s execution history and the financial and the business model, we have been consistently de-lever; it’s a true reflection of our product and the quality of our product.

And the third thing is really we’re right in the middle of some of the major technology involvement and it’s very exciting opportunity and that we are very aligned with our OEMs, with the right strategy to address this market opportunity. So for the next several years actually, QLogic has the opportunity, it never had before, during the last several years, it’s from the expansion market about the 10 gig Ethernet adoption and the converged network.

With that, I think we still have a few minutes. I can take some questions.

Question-and-Answer Session

Unidentified Analyst

(Question Inaudible)

Jean Hu

I think for Romley launch right now people are talking about the fourth quarter of the next year, calendar year. I think for us the design wins of Romley, they were already decided a long time ago; 18 months ago. So we have a design win to all the major OEMs and major platforms. So once the launch is start I think what you would see is different OEM and launch time and different platform launch time that all will be different; but we certainly are quite comfortable with our design win portfolio and the future revenue growth.

Unidentified Analyst

Emulex was talking about gradual ramp once it ships though maybe with regard to the substantial sales boost or sales acceleration are you expecting the same kind of thing?

Jean Hu

Yeah, I think that’s our view too; it’s more of a gradual kind of increase launch for us; I think it’s largely, it’s all about the cards; it is adaptor kind of the business. The launch because of different OEM, different platform we think it’s going to take you know six months, nine months kind of like launch timeframe.

Unidentified Analyst

Any other questions for Jean? There is going to be a breakout in the (inaudible) room. I just was wondering as well if you want to expand on what your acquisition strategy maybe at this time?

Jean Hu

Yeah so, on the acquisition side right, certainly the first priority of our business is to look at the investment side, organic also acquisition. We are quite disciplined as far as we’re looking for acquisitions really that’s the right return on the capital we invest. So for us, for the current business right there is 10 gig Ethernet, converged network and the Fibre Channel, we think we have the right portfolio right now. Certainly, if there is adjacent space we can expand into, if there is right acquisition target, certainly that will be something; we have the cash, we have the capital and the balance sheet to be aggressive if it’s a right package. So that’s certainly always the first consideration. If there is no acquisition typically we actually use the cash to buyback stock.

Unidentified Analyst

Anything else? Okay, we are going to go into the (inaudible) room and Jean thanks so much. I appreciate it.

Jean Hu

Yeah, thank you. Thank you very much.

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