A leading supplier of high performance network infrastructure solutions, QLogic Corp. (QLGC) reported second quarter 2011 results (both earnings and revenues) that marginally beat the Zacks Consensus Estimate.
Revenues of $146.5 million were slightly above the Zacks Consensus Estimate of $146.0 million, and earnings per share of 26 cents (including stock-based compensation but excluding one-time charges) beat the Zacks Consensus Estimate of 25 cents by a penny.
Despite the upbeat results, share price fell 1.61% in after hours trading, following the company’s announcement that the Chief Executive Officer Mr. H. K. Desai would step down from the position of CEO and will remain the Chairman of the Board of Directors. The company said Mr. Simon Biddiscombe, the Chief Financial Officer, would take over the role of the company’s CEO. The transition is expected to be effective November 15, 2010.
Revenue Details
Second quarter 2011 revenues of $146.5 million were up 11.5% year over year and up 2.7% sequentially. Revenues were in line with management’s guidance of $146 million to $147 million asupdated during the preliminary second quarter results announced on October 7.
Demand for the hosting and networking products remained strong in the quarter. By segment, Host Products (fiber channel adapters and converge network adapters) generated 71.1% of total revenue, increasing 10.8% from the year-ago quarter to $104.2 million. Network products (fiber channel and InfiniBand switches), which generated 18.6% of total revenue, increased 11.2% year over year to $27.2 million.
Silicon products (fiber channel and iSCSI protocol chips) contributed 8.5% to total revenue and increased 29.6% from the year-ago quarter to $12.4 million. Silicon product revenues were in sync with management’s expectation. Royalty & Service revenues, comprising the remaining 1.8%, decreased 19.5% from the year-ago quarter to $2.7 million.
The sequential increase in revenues was primarily attributable to a sequential growth in each of its Host Products, Network Products and Silicon Products. On a sequential basis, revenue from Host Products grew 2%, revenue from Network Products grew 6% and revenue from Silicon Products grew 5%.
By geography, the U.S. was the largest region for the company in the quarter, with a 46.8% revenue share. Revenues increased 17.1% from the year-ago quarter, a clear indication that the company’s domestic business is turning around.
The Asia/Pacific and Japan, the second largest region, was up 5.1% year over year and contributed 26.2% to total revenue. Europe, Middle East and Africa (EMEA), which generated around 21.3% of total revenue in the quarter, saw a growth in revenues of 12.4% year over year. Approximately, 5.7% of total revenue came from the rest of the world (ROW), down 3.1% year over year.
Net Income
The pro forma net income was $36.6 million, or 25.0% of sales, compared with $25.1 million, or 19.1% of sales in the year-ago quarter. The second quarter 2011 pro forma estimate excludes restructuring charges, amortization of intangibles, acquisition-related charges and stock-based compensation expenses on a tax-adjusted basis.
EPS on a pro forma basis was 34 cents, an increase of 61.9% from 21 cents in the year-ago quarter, above the high-end of management’s expectations of 32 cents to 33 cents, updated on October 7. This represented the 61st consecutive quarter of profitability for QLogic. EPS is driven by higher than expected gross margin and lower than expected operating expenses.
Pro forma earnings excluding one-time charges, but including stock-based compensation expense were 26 cents, up from 14 cents reported in the year-ago period, and 1 cent above the Zacks Consensus Estimate of 25 cents. Sequentially, earnings per share were up 2 cents from 23 cents reported last quarter.
Operating Performance
The gross margin for the quarter was 66.8%, up 130 basis points from the year-ago quarter, primarily due to increased volume, partially offset by higher manufacturing costs. Gross margin in the quarter exceeded management’s guidance of 65.5% to 66%, primarily due to a favorable product mix.
Operating expenses of $53.6 million were up 1.0% from $52.8 million recorded in the year-ago quarter and were slightly below Qlogic’s expectations. QLogic benefited from lower engineering and development expenses, which decreased 3.0% from the year-ago period, and decreased as a percentage of revenues, from 22.6% to 19.7%. QLogic expects engineering expenses as a percentage of revenues to be in the range of 18% to 21% going forward.
Sales and marketing expenses in the quarter increased 7.0% from the year-ago quarter, but fell, as a percentage of revenues, from 13.1% to 12.6%. QLogic expects sales and marketing expenses, as a percentage of revenues, to be in the range of 11.0% to 13.0%. G&A expenses in quarter were 4.3% of revenues. The company expects G&A expenses, as a percentage of revenues, to be approximately 4%, moving forward.
Operating margin was 30.2% on a non-GAAP basis, up 490 bps from 25.3% recorded in the year-ago quarter, as most of the components of cost, E&D, S&M and G&A, increased on a dollar basis, but decreased, as a percentage of sales, resulting in a higher operating margin. Operating profit of $44.3 million in the quarter soared 33.0% from the year-ago quarter.
The income tax rate for the fourth quarter was 20.6%. QLogic expects the tax rate to be approximately 18%, going forward.
Balance Sheet
QLogic ended the quarter with cash and short-term investment balance of $304.0 million, down $44.6 million from the previous quarter. At the end of the quarter, the company had no debt. QLogic generated $26.6 million of cash from operations, down from $30.6 million in the previous quarter.
DSOs at the end of the September quarter deteriorated to 54 days compared with 48 days at the end of the June quarter. Management expects DSOs to range from 50 days to 55 days, going forward. Inventory at the end of the September quarter was $24.9 million and increased sequentially from $24.4 million. Annualized inventory turns for the September quarter totaled 7.8x, in sync with the previous quarter.
In August, the Board of Directors authorized the repurchase of an additional $200 million of stock. The company spent $70.9 million on the repurchase of shares at an average price of $16.23 in the second quarter 2011. Since 2003, QLogic has used $1.6 billion to repurchase 99.7 million shares.
Guidance
In the third quarter of fiscal 2011, QLogic expects total revenue of $148 million to $156 million, in line with the Zacks Consensus Estimate of $155 million.
Management expects gross margin to be in the range of 66.0% to 66.5%, operating expenses of $55 million and a tax rate of 18% and diluted share count of approximately 108 million shares, resulting in a non-GAAP EPS of 34 cents to 38 cents for second quarter of fiscal 2011.
We believe that QLogic will benefit from major OEM customer wins, market share gains and increased focus on its key strategic initiatives over the long term. However, weak near-term demand trends and a slower-than-expected growth in enterprise IT spending are a concern. Moreover, tough competition from Emulex Corp. (ELX), Broadcom Corp. (BRCM) and Brocade Communications Systems Inc. (BRCD) will act as a headwind for the stock.
Currently, QLogic has a Zacks #3 Rank, which implies a short-term Hold rating (for the next 1-3 months). Over the long term, we have a Neutral rating on the stock.
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