Is Emulex Slowing Down?

Emulex Corp. (NYSE: ELX), despite reporting good results for its third quarter on Thursday, saw its stock get brutally hammered today as investors responded to the host bus adapter vendor's weaker-than-expected outlook for the current quarter and beyond (see Emulex Breaks Even in Q3).

Shares of Emulex were down 20.5 percent, to $19.39, in midday trading amid a generally down market.

Also hurting the stock today were two downgrades by Wall Street analyst firms. RBC Capital Markets downgraded Emulex to Underperform from Sector Perform; and Thomas Weisel Partners changed its rating from Peer Perform to Underperform on the expectation of lower revenue growth.

"Our analysis of HBA market share gain exhaustion supports a cautious view of Emulex's future HBA revenue growth vis--vis investor expectations, and successful execution in new segments is far from certain," wrote Thomas Weisel analyst Jason Ader in a research note today.

Emulex reported revenues of $79.6 million for the quarter ended March 30, 2003, up 4 percent sequentially. It posted a net loss of $248,000, essentially breaking even, in line with Wall Street expectations. Emulex executives noted that it was the company's sixth consecutive quarter of growth.However, for the June quarter, Emulex projected revenue in the range of $80 million to $82 million, which would be at most a 3 percent sequential uptick and below analyst expectations. The company did not provide guidance for the rest of 2003.

Paul Folino, Emulex's chairman and CEO, told analysts on a conference call yesterday that the company was being conservative in its outlook because of many macroeconomic factors beyond its control.

"You've heard this story before," he said. "The geopolitical environment out there, the economy, questions of whether Bush's tax package will get implemented now -- there are so many variables at an economic level, et cetera, that we're going to continue to be very conservative on how we approach guidance on the revenue line."

Several analysts took away from Emulex's muted guidance that the company -- which controls about half of the Fibre Channel HBA market, followed by QLogic Corp. (Nasdaq: QLGC) in a strong second place -- has tapped out its high-growth potential and is now in danger of potentially losing market share.

"The potential for OEM share loss remains a concern for us," wrote RBC analyst Steve Denegri in a note today. Specifically, RBC believes Emulex could lose business with Hewlett-Packard Co. (NYSE: HPQ), which is expected to phase out legacy Compaq Tru64 Unix customers in favor of the HP-UX server line, "where Emulex has no HP design win presence."But not everyone was downbeat on Emulex's forecast. Shebly Seyrafi of A.G. Edwards reiterated his Buy rating on shares of Emulex. "As the leading player in a fast-growing category, we believe Emulex is poised to post strong rates of growth going forward," he wrote in a note today. "We are concerned about growth in FQ4 due to company guidance; however, there are several factors which could support growth," including the expectation that EMC Corp. (NYSE: EMC) and IBM Corp. (NYSE: IBM) -- two key OEMs -- will be up sequentially.

Meanwhile, Emulex executives said its Thor dual-channel 2-Gbit/s Fibre Channel controller chip is "in OEMs' hands today" but would not speculate on when it might be generally available in systems from those partners. Folino said Thor is "complementary" to the application-specific integrated circuits (ASICs) it plans to co-develop with Intel Corp. (Nasdaq: INTC), due out in 2004, and he noted that Emulex is still a partner with LSI Logic Corp. (NYSE: LSI) -- at least, for now -- which supplies components for the Thor chip (see Intel, Emulex Join at the Chip and Emulex Debuts 'Thor').

Emulex CFO Mike Rockenbach also briefly discussed the new corporate headquarters the company is building in Costa Mesa, Calif. He said its construction will cost about $40 million over an 18-month period; Emulex is shooting to move in to the new building by the end of the year.

In addition, Emulex announced yesterday that it has reached a tentative settlement of class-action shareholder lawsuits that were filed in 2001. The company will pay $39.5 million in exchange for all claims to be dismissed and will record a receivable for approximately 32 percent of that amount, with an after-tax charge of about $16.7 million to be recorded in the third fiscal quarter (see Emulex Settles Shareholder Suits).

— Todd Spangler, US Editor, Byte and Switch