Sour Outlook for Emulex

In a likely bad omen for the storage industry's financial results this quarter, at least three analysts in the past week have weighed in with negative expectations for Emulex Corp. (NYSE: ELX).

Thomas Curlin of RBC Capital Markets downgraded Emulex's rating to Sector Perform from Outperform, while raising its risk from Average to Above Average. Meanwhile, Shaw Wu of American Technology Research and Glenn Hanus of Needham & Co. issued research notes expressing doubts about Emulex's ability to meet revenue expectations.

In April, Emulex missed expectations for the past quarter while giving lower guidance than expected for the current quarter (see Emulex Short on Revenue). Product launches set for the second half of the year were blamed for a soft first half, but now it looks as though Emulex will have a tough time hitting even its reduced guidance.

If Emulex is struggling, that's a bad sign for storage in general. Along with QLogic Corp. (Nasdaq: QLGC), Emulex dominates the Fibre Channel HBA market and has OEM relationships with nearly all the major storage system vendors. So what's wrong?

Shifting relationships with several storage vendors and anticipated weak sales by Hewlett-Packard Co. (NYSE: HPQ) are the major causes of pessimism (see HP Storage Share Slips). Curlin writes that Emulex could get hurt by HP's delaying its rollout of SMB SAN systems to July. He believes HP is also discounting existing SAN products in advance of the SMB launch.Emulex will also likely lose ground to QLogic with the new, low-end SAN system that EMC Corp. (NYSE: EMC) and Dell Computer Corp. (Nasdaq: DELL) are co-branding. Although EMC will sell HBAs from both vendors, Dell will only include QLogic HBAs on its low-end system (see EMC, Dell Get Small With SATA and Emulex Offers HBAs with EMC). Dell will likely sell more of those systems than EMC, because it already has a strong presence in the SMB market.

Wu writes that industry checks show slower-than-expected sales in enterprise systems at HP in June, which he expects to hurt Emulex. Wu dropped estimates for the quarter to $99 million in revenue and $0.24 earnings per share, down from previous estimates of $101 million and $0.25. He did not downgrade Emulex's rating, because he expects strong second-half performance on systems from EMC, HP, and IBM Corp. (NYSE: IBM).

Hanus wrote in a research note that he suspects Emulex and QLogic are struggling to meet revenue expectations for the quarter. In fact, he is cautious about the entire storage networking industry this quarter.

Nobody from Emulex has publicly shared in the pessimism. During a June 15 presentation at a Bear Stearns conference, Emulex president Jim McCluney and CFO Mike Rockenbach said there was no change in the guidance they gave in April, which projected revenue between $100 million and $103 million and $0.25 EPS.

McCluney said Emulex expects long-term growth to come from increased sales of embedded switches from the 2003 acquisition of Vixel, as well as the expansion of Fibre Channel SANs into the SMB market (see Emulex Drops Cash for Vixel and Emulex Ships 2M InSpeed Ports). As for iSCSI, which Emulex has approached coolly, he said they are watching the market closely but "don't think it's quite there yet" (see Emulex Slaps iSCSI).All the pessimism has taken a toll on Emulex's stock price. It dropped from just over $16 last Wednesday to $14.24 by midafternoon today.

Dave Raffo, Senior Editor, Byte and Switch