Monday, June 21, 1999

Emulex Corp.
(Nasdaq: EMLX)
Phone: 714-662-5600
Website: www.emulex.com
Price (6/18/99): $87 1/4


The reason Emulex has performed exceptionally well over the past few months can be described in six words -- fibre channel, fibre channel, fibre channel.

For the non-techies reading this, fibre channel is largely regarded as the next standard for letting computers communicate with their networks and peripherals. Think of it as broadband for PCs and their networks. Guess who is one of the premier developers of fibre channel? Of course, it's Emulex, and shareholders in the company have ridden the excitement over the new technology all the way to the bank.

This time last year the stock was in the mid-single digits and many viewed the company as just another networking equipment firm that had fallen on hard times. Sales were essentially flat and the company reported a fairly hefty $2.08 per share loss in the first calendar quarter of 1998.

But then the furor over fibre channel started to catch on, and by the fourth quarter of last year the company had resumed its sales growth as its fibre channel products started really flying out the door. The first quarter of this year saw the fibre channel products continue to show robust growth (nearly tripling in a year), and quarterly earnings were up to $0.20 per share, the best showing of any quarter in the past four years.

The company then announced that it was cashing in on Wall Street's excitement about fibre channel's potential and was going to offer 2.0 million new shares to the public. This secondary brought the company another $115 million or so worth of fertilizer to grow its fibre channel business. The obligatory "buy" rating was issued by the underwriters soon after the offering was completed, and the stock has continued its electrifying performance.


Based in the Los Angeles suburb of Costa Mesa, Emulex is one of the leading developers and suppliers in the emerging fibre channel technology market. Fibre channel is a communications standard that has numerous applications in the computing and networking arenas. The standard allows extremely fast communications between computers in a network and their peripherals. The technology is largely accepted as the preeminent computer communications interface, positioned to replace the SCSI standard.

Emulex also sells a line of traditional networking products that are not related to fibre channel. The older products allow printers and other devices to be used over networks. In the last quarter, shipments of these legacy products were down 8% compared to the year before while sales of fibre channel products were up 61%.

The company had a secondary offering of shares in May of this year. In the offering, 2.1 million shares were sold at $63.25 a pop, with 2.0 million of those sold by the company to raise cash.

FINANCIAL FACTS Income Statement 12-month sales: $62.0 million 12-month income: $2.6 million* 12-month EPS: $0.35* Profit Margin: 4.2% Market Cap: $711.9 million (*Excluding charges) Balance Sheet * Cash: $5.0 million Current Assets: $31.1 million Total Assets: $34.8 million Current Liabilities: $16.7 million Long-term Debt: None Total Liabilities: $18.9 million (*As of Mar. 28, 1999. The company has since had a secondary offering) Ratios Price-to-earnings: 249.3 Price-to-sales: 11.5


Unless one was very technically inclined, finding Emulex early would have been a difficult task. While it's a widely held opinion that fibre channel will be the next standard for network and computer peripheral communications, it wasn't always that way. Unless one commonly uses the words "gigabit" or "bandwidth utilization" and "arbitrated loops," fibre channel in general and Emulex in particular just weren't things the average investor knew about.

Regardless, there were some signs that Emulex was perhaps ready to take flight last year. Emulex is among the most prominent makers of fibre channel equipment, and the increasing enthusiasm over the technology was sure to help Emulex's cause. As they say, a rising tide raises all ships. One only needs to look at a charts of some of Emulex's competitors such as Ancor (Nasdaq: ANCR) and Interphase (Nasdaq: INPH) to see this is true.


There's no doubt that the future for fibre channel is bright, but it is still uncertain exactly where the cards will fall between Emulex and its competitors. Emulex may be one of the leading fibre channel companies, but it is far from the only supplier. Riding a hot technology alone does create long-term value if continually forced to compete for market share.

History is also not on Emulex's side. The company has fallen on hard times over the past decade and is significantly smaller than it once was. In 1991 Emulex had $152.9 million in sales and 871 employees, and today each of those figures are about a third of what they once were. The company's profitability has also been extremely cyclical. Going back to 1989 the company has had profitable years in all the odd-numbered years and typically larger losses in the even-numbered years. One year of profits does not help much if it is followed by a year of losses.

Regardless, Emulex looks like it might break out of its profitability cycle. Analysts are calling for the company to earn $1.25 per share for fiscal 2000, which would be the first time Emulex has shown two straight years of profits since George Bush was elected. That also puts Emulex trading at over 60x forward earnings estimates, which is not cheap.

The secondary offering the company pulled off in May certainly does raise the floor to the stock. The company now has roughly $15 per share in debt-free cash and more than enough liquidity to grow its fibre channel business. More importantly, the company's future looks brighter than it has in many years. Wall Street has obviously factored much of the company's expected fortunes into today's price, and interested investors might do best to wait for some price weakness before jumping in.

--Paul Larson

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