Looking to Future Pays Now

Every online transaction, e-mail and Web page needs to be captured, stored and retrieved somewhere, and emerging technology to speed up that process has the stock of Costa Mesa-based Emulex Corp. skyrocketing.

In the last year, the company’s stock has zoomed 1,620%, going from a low of $8.09 to close at $139.25 on Friday on Nasdaq, making it one of the hottest technology stocks in that period. By comparison, the technology-laden Nasdaq composite index gained 68% in the same period.

Emulex is one of a handful of relatively small companies developing next-generation technology that alleviates bottlenecks in computer networks, essentially widening the rivers down which data flow.

“Emulex was one of the first companies to commit resources to this new technology,” said Edward M. Frymoyer, head of EMF Associates, a consulting firm in Half Moon Bay. “They bet the company on it, and it’s paid off handsomely for them.”

The technology, called fiber channel, connects computer workstations, mainframes, supercomputers and storage devices to one another. It is part of an industrywide shift from the current standard, called small computer systems interface, or SCSI.

Fiber channel is being inserted into numerous networking and storage components. Emulex, which has 132 employees, has strong positions in two of those areas: hubs, which join communications lines in a central location, and host adapters, which store data services, such as e-mail and Web sites, that are available for other computers on a network to use.

A look at Emulex’s financial results doesn’t hint at a burgeoning technology powerhouse. The company’s $68.5 million in revenue for fiscal 1999, which ended in June, are lower than the $148.9 million the company posted when sales peaked a decade ago. After posting a loss in 1998 of $10.8 million, the company recovered this year to earn $5.3 million.

But the mix of the company’s sales has shifted toward the higher-margin and fast-growing fiber channel products.

Emulex had been investing heavily in the technology for several years, long before it was certain that fiber channel would be accepted as the replacement for SCSI, a technology that is 15 years old and continues to make up most of the market.

As recently as last year, fiber channel made up less than a third of the company’s revenue, with its bread-and-butter product being printer servers. Last quarter, however, fiber channel products, which have much higher profit margins, made up more than 75% of the company’s sales.

But the competition is near by. Literally.

Emulex not only shares a courtyard with its main competitor, QLogic Corp., it shares its history: Emulex spun off QLogic five years ago as Emulex restructured to focus on networking technologies.

QLogic, meanwhile, concentrated on storage products.

Networking and storage technologies recently have converged because of increasing use of large data warehouses, pitting Emulex against its offspring in the market for fiber channel host adapters.

Now, QLogic’s market value of $3.1 billion exceeds that of its one-time parent Emulex, which the market values at $2.5 billion.

But even though the child has grown up to be bigger than its parent and a formidable foe, Emulex officials say they don’t regret spinning off the company.

“If we were still together, we would not be the companies that we are today because we would be struggling with the road map and going in too many directions,” said Emulex President and Chief Executive Paul Folino, who was hired in 1993 to execute the spinoff of QLogic. “It was a complex business and a very difficult story to tell to the investment community. The technology itself was difficult to define as it was.”

When Emulex began investing heavily in fiber channel five years ago, the expectations were great, but they often went unmet.

“There was a time when only a few of us in the industry even knew how to spell it,” Folino said.

Now, fiber channel industry revenues across the industry are blowing away the projections, with EMF Associates recently raising its estimate to more than $30 billion a year in 2003, with the hubs and host adapter markets in which Emulex competes accounting for $4 billion.

The increase in fiber channel revenues comes as the cost of storage has been plummeting, making it more of a commodity. Companies such as Irvine-based Western Digital Corp., the third-largest independent hard-drive manufacturer, have been hit with losses as prices have been slashed.

“You can buy storage for a few cents per megabyte now, but it will cost 40 cents a megabyte to manage it and it’s an on-going cost, and that’s what fiber channel is going after,” Frymoyer said.

To keep its fiber channel products from similarly becoming a commodity, Emulex has allowed its customers, primarily large companies such as IBM Corp. and Compaq Computer Corp., to license and customize Emulex’s systems.

Once the Emulex components, which generally cost $1,000 or more, are embedded in customers’ computers, Emulex is in a strong position to have its components locked in to future versions of those computers.

The customization lets those systems “achieve significant performance enhancements over generic solutions,” wrote Glenn Hanus, a financial analyst with Needham & Co., in a recent report. “This makes Emulex more difficult for a competitor to displace.”

Most financial analysts rate Emulex either a “buy” or “strong buy,” with several of them recently raising their forecasts on either the company’s expected earnings for the year or the price target for the company’s stock.

The consensus among analysts is that Emulex’s per-share earnings this quarter will nearly quintuple the 5 cents a share the company earned during the same period last year, according to Zack’s Investment Research.

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Times staff writer Jonathan Gaw can be reached at [email protected].

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Emulex Rockets

Shares of Costa Mesa-based Emulex Corp. have soared 1,620% in the last 12 months. The company is a leader in developing fiber channel technology.

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Source: Bloomberg News