Here’s the entire text of the prepared remarks from QLogic’s (ticker: QLGC) Q3 2005 conference call. The Q&A is here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and we’ll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha.
[Operator]: Welcome to the QLogic Corporation second quarter fiscal year 2006 Earnings Conference Call. Just to reminder you today's call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to Mr. H.K. Desai, the Chairman, President and Chief Executive Officer. Please go ahead, sir.
[H.K. Desai, President, Chairman, CEO]
Good afternoon and welcome to QLogic's second quarter fiscal year 2006 Earnings Conference Call. I am H.K. Desai, CEO and President and with me is Anthony Massetti, Senior Vice President and Chief Financial Officer. Today, Anthony will begin with the review of the second quarter financial results, and I will continue with the general discussion of the state of our business. After that, we will open the teleconference for questions. Anthony.
[Tony Massetti, Vice President, Chief Financial Officer]
By now all of you should’ve seen our press release and associated financial information. And in addition reviewing our financial results, some of the comments today will include forward looking statements regarding the future events and our projections of the financial performance of the Company, based on our current expectations. These comments contain significant risks and uncertainties that could cause actual results to differ materially from those expressed in these forward-looking statements. We refer you to the documents that QLogic files with the SEC, specifically our most recent Forms 10-K and 10-Q's. These documents identifying important risk factors that could cause our actual results to differ materially from expectations. We do not intend to update any of the information contained in any forward-looking statements that we make today.
Today's conference call is being webcast, and a replay will be available for 12 months on the QLogic website at www.qlogic.com under investor relations. An audio replay will be available through November 2nd, by calling (719) 457-0820, passcode 9154830. Please be aware that if you decide to ask a question, it would be included in both our live transmission as well as any future use of the recording. Copyright law and international treaties protect this conference call report. Unauthorized reproduction or distribution of this report or any portion of it may result in civil and criminal penalties. Any recording or other use or transmission of the text or audio for today's call is not allowed without the explicit written permission of QLogic.
In our second quarter earnings press release, issued earlier today, we reported both GAAP and non-GAAP results. During fiscal year 2006, there was no difference between the GAAP and non-GAAP results. During fiscal year 2005, there was a relatively minor difference due to merger-related stock compensation charges. All of the references we will make today relates to the non-GAAP results for the periods noted, unless otherwise stated.
As announced in late August, we entered into a definitive agreement to sell our hard disk drive controller and tape drive controller business to Marvell Technology Group for $225 million. We expect this transaction to close by the middle of the third quarter. As a result of this transaction, we’ve presented the financial results of this business as discontinued operations and the financial statements for all periods included in our earnings press release. Our discussion today will focus on the financial results from continuing operations, unless otherwise noted.
Our revenue in the second fiscal quarter ended October 2, 2005 was a record $119 million, an increase of 16% from the same quarter last year and 3% sequentially. Our revenue from SAN infrastructure products, which are comprised of HBAs, switches and silicon, grew 21% to $110.5 million from $91.1 million recorded in the second quarter of last year. Sequentially, revenue from the SAN infrastructure products grew 3% from the June quarter. The increase in our revenue from SAN infrastructure products was primarily driven by HBA revenue growth of 22% from the comparable quarter last year and 4% sequentially.
Our switch revenue grew 52% from the same quarter last year and was flat sequentially. Our revenue from management controllers decreased 33% to $7 million from $10.5 million recorded in the second quarter of last year. Sequentially, our revenue from management controllers increased 2% in the September quarter. As we have discussed in previous earnings conference calls, we expect revenue from management controllers to decrease over time.
Other revenue, which is comprised of royalties and service revenue, was $1.5 million in the second quarter. Our September quarter gross margin of 70.6% decreased from 71.4% recorded in the second quarter of last year and was consistent with the June quarter. The declining gross margin compared to the same period last year was due to product mix and was within our expectations. Consistent with our previous guidance, we expect our gross margin during the next 12 to 18 months to be over 65%, depending on product mix.
During the September quarter, we experienced an ASP reduction on like-for-like products in our HBA business of approximately 1.5%. This is consistent with the amounts experienced in prior quarters and within our expectations.
Next, I would like to cover second-quarter operating expenses. Total operating expenses were $41.2 million in the second quarter, up 13% from the $36.4 million reported in the same quarter last year. On a sequential basis, operating expenses was up 4% from $39.5 million reported in the first quarter. Engineering expenses in the second quarter increased 11% to $21.4 million versus a year ago and decreased as a percentage of revenue from 18.8% to 18%. On a sequential basis, engineering expenses in the second quarter increased 5%. We will continue to support existing and future technology development with engineering expenses as a percentage of revenue ranging from 16% to 19%.
Sales and marketing expenses in the second quarter increased 20% from a year ago to $15.6 million, and increased as a percentage of revenue from 12.7% to 13.1%. On a sequential basis, sales and marketing expenses increased 3%. We expect that future sales and marketing expenses as a percentage of revenue will range from 11% to 14%.
G&A expenses in the second quarter of $4.2 million were flat versus a year ago and decreased as a percentage of revenue from 4.1% to 3.5%. G&A expenses were up $0.3 million sequentially. We expect our future G&A expenses as a percentage of revenue will range from 3% to 4%. We continue to focus on improving efficiency in our operating expenses while investing in critical new development programs for existing and new technologies.
In the September quarter, QLogic generated an operating profit of $42.8 million, an increase of 17% versus last year. The second quarter operating profit margin of 36% increased over the second-quarter level of last year of 35.8%. On a sequential basis, operating profit increased $0.8 million. The operating profit margin of 36% in the September quarter decreased from 36.3% in the June quarter.
Interest and other income was $6.1 million in the second quarter, an increase of $1.9 million versus a year ago and consistent with the June quarter. The increase in interest and other income from the prior year was primarily attributed to higher average cash and investment balances and favorable interest rate changes.
The income tax rate declined to 37.7% during the second quarter, compared to 41.2% in the June quarter, primarily due to the favorable resolution of a routine tax examination during the quarter. The annual income tax rate for the remaining two quarters and the full year of fiscal year 2006 is expected to be approximately 39% to 40%.
Our second quarter income from continuing operations increased 12% to $30.5 million from $0.34 per diluted share from the second quarter of last year, when the Company recorded income from continuing operations of $27.2 million or $0.29 per diluted share. Our income from continuing operations as a percentage of revenue in the second quarter was 25.6%, compared to 26.6% reported in the same quarter last year. On a sequential basis, income from continuing operations increased $2.2 million, from $28.3 million reported last quarter, primarily due to the decline in income tax rate.
Our net income, which includes results from discontinued operations for the second quarter, increased 14% to $43 million or $0.48 per diluted share from the second quarter of last year, when the Company recorded net income of $37.7 million or $0.40 per diluted share. On a sequential basis, net income increased $1.2 million from the $41.8 million reported last quarter.
Our second quarter diluted net income per share, which includes discontinued operations, was $0.03, above the high end of the forecasted range of $0.42 to $0.45 per share provided during our first quarter conference call. This represents the 41st consecutive quarter of profitability for Qlogic.
Our financial position continues to be strong, especially with regard to our cash flow. During the second quarter, we generated $31 million of cash from continuing operations. The Company's cash and short-term investment balance was $634 million at October 2, 2005.
During the second quarter, we repurchased $247 million of our common stock on the open market. In October, we repurchased an additional $103 million of our common stock, thereby completing the current $350 million stock repurchase plan announced in August 2005. The total number of shares for the $350 million stock repurchase was 10.4 million shares. Since fiscal year 2003, we’ve repurchased a total of $550 million of the Company's common stock under programs authorized by our Board of Directors.
Second quarter receivables of $64.4 million were up $5.4 million from the $59 million at the end of the first quarter. The DSO rate in the September quarter was 49 days, compared to 47 days in the June quarter. With a growing trend toward hub arrangements with our OEM customers and greater contribution from our distribution channel, we continue to expect upward pressure on our DSO performance. Based on our current customer and channel mix, we expect DSO in the future will range between 45 to 55 days. Annualized inventory turnover of 5.5 turns in the September quarter is consistent with the June quarter. Inventory at the end of the quarter was $25.2 million, an increase from the $24.9 million at the June quarter end.
Our long-term outlook for our core business remains favorable. Based on a foundation of design wins in existing markets, as well as the emerging SMB and other markets, we expect to see sequential growth in our revenue for SAN infrastructure products. As previously expected, we believe that our revenue from management controllers will be flat to slightly down. Therefore, we expect total revenue in the December quarter to be in the range of $121 to $125 million. Due to the potential variation of product and technology mix, we expect gross margin for the December quarter to be in the range of 69% to 70%.
Considering the above revenue and gross margin expectations, combined with plant operating expenses, infrastructure investments and continued higher tax rate, the current outlook is to achieve diluted earnings per share from continuing operations of approximately $0.32 to $0.35 in the December quarter. Actual results for future periods may differ materially, due to a number of factors, including those outlined during the course of this conference call, in the Company's filings with the SEC and the disclaimer statement at the end of our second quarter fiscal 2006 earnings press release. I would now like to turn over this conference call to H.K. Desai, our CEO and Chairman and President.
[H.K. Desai, President, Chairman, CEO]
Thank you again for joining us today in our second-quarter earnings conference call. I am pleased to announce QLogic's 41st consecutive quarter of profitability and a new record for revenue from continuing operations. The revenue for the second quarter ended October 2, 2005, which excludes the results of the discontinued hard disk drive controller and tape drive controller business, was $119 million, up 16% year-over-year and 3% sequentially. Our second quarter diluted earnings per share for continuing operations was $0.34, which was an increase of $0.05 over the year-ago quarter, an increase of $0.03 sequentially.
As indicated in our August 29th investor call, the SAN infrastructure components market is anticipated to grow at a compounded annual growth rate of 20% to 25%, achieving a TAM of $3.6 billion in 2008. Moving forward, we will concentrate our focus on this higher growth market.
For the second quarter, our revenue from SAN infrastructure products, which is comprised of HBAs, switches and silicon, was $110.5 million. The SAN infrastructure product revenue grew 21% from the year-ago quarter and 3% sequentially. In the second quarter, revenue from our non-strategic management controller products was $7 million. Other revenue, which includes royalty and services, was $1.5 million in the second quarter.
QLogic continues to expand its SAN storage customer footprint with Fibre Channel and iSCSI HBAs. Total Fibre Channel and iSCSI HBA port shipments, which exclude Fibre Down products for blade servers, grew 36% from the year-ago quarter and 5% sequentially. Our HBA product revenue grew 22% over the year-ago quarter and 4% sequentially.
According to Gartner's most recent Fibre Channel SAN components report, combined Fibre Channel and accelerated iSCSI SAN components revenue will experience compounded annual growth rate of 19% over the next three years. We are very well positioned to benefit from this growth opportunity.
Over the last several years, our Fibre Down silicon business has provided strategic advantage that we leverage to increase our HBA market share. With 4-Gig technology, we have started transitioning from providing Fibre Down silicon products to providing mezzanine cards for blade servers. We have achieved three design wins for blade server mezzanine cards at major OEMs. The replacement of Fibre Down silicon with the mezzanine cards will result in an overall net increase to revenue. We anticipate that this transition will take place over the next 12 to 18 months.
The footprint for QLogic's Fibre Channel switch products also continues to expand. In the second quarter, port shipments of our blade switches and SANbox 5000 series of switches, compared to the year-ago quarter, grew 61% and 119%, respectively. On a sequential basis, port shipments of our blade switch and SANbox 5000 series switches grew 8% and 18%, respectively.
QLogic's SMB switches or 3000 series are also gaining acceptance. Although we did not ship 3000 series last year, the sequential port growth for this product family was 21%. Our expanded footprint has resulted in a 52% increase in revenue from the year-ago quarter. Switch revenue was flat sequentially from the previous quarter. This was due to our transition at our OEMs from legacy SANbox2, 8 and 16-port platform to our new SANbox 3000 and 5000 series. The ASP per port for the SANbox 3000 and 5000 switches is approximately 50% lower than the products they replace. Our continuing strength in the channel, combined with our expansion into the leading OEMs, should continue to drive revenue growth for these SAN infrastructure products.
The channel business continues to be an important growth driver for QLogic. The channel accounted for 26% of our SAN infrastructure product revenue in the second quarter. Overall, channel revenue for the SAN infrastructure product was up 52% year-over-year and 13% sequentially. We will continue to enhance our support model to deliver the highest levels of customer satisfaction for our expanding worldwide channel business. In the second quarter, we announced an agreement with Lucent to provide global support in key regions with local language and local time zone support. This demonstrates our ongoing commitment to our channel partners and customers.
Now, let me review some of our recent announcements. Yesterday, we announced that QLogic will acquire Troika Networks for $36.5 million in cash. OEMs have indicated that they have seen a growing need for cost-effective virtualization solutions. The acceleration technology we are acquiring with Troika will be integrated into entry-level and mid-range virtualization platforms from QLogic that will host leading OEM and ISPs software solutions targeted at this market.
One of the things driving QLogic's market share expansion is our comprehensive support of operating systems that drive storage-centric applications. Last quarter, we announced that QLogic's SANblade Fibre Channel HBAs, SANbox switches and SANsurfer software will now support Mac's OS X. Providing SAN connectivity to Apple's Xserve G5 servers and Xserve RAID subsystem present additional opportunity for QLogic to extend our market share growth.
Although slow to evolve, iSCSI continues to attract market attention. As a leading provider of SAN host interconnects, we expanded our solutions portfolio by announcing the first iSCSI mezzanine card for the IBM eServer BladeCenter. The iSCSI mezzanine card, which started shipping last quarter, is followed by powered by QLogic's single-chip, high-performance, TCP and iSCSI Offload Engine.
According to IDC, QLogic remains the leading supplier of blade server embedded switches in 2004. QLogic maintained its number one positions in embedded Fibre Channel switch market share, with 68.5% of revenues and 64.4% of ports shipped. Despite heavy competition, QLogic's high quality, advanced technology and brand recognition has allowed us to maintain a significant share of this rapidly growing market.
This past quarter, IBM announced the availability of the industry's first fully enabled 4-Gig SAN solution for blade servers. Developed with BladeCenter alliance partners QLogic and McData, IBM's blade offering now provides customers new levels of price, performance and flexibility. The new IBM BladeCenter 4-Gig offering features QLogic's Fibre Channel mezzanine card, the QLogic 4-Gig switch blade and McData 4-Gig switch blade.
In second quarter, we announced that our SANblade 4-Gig Fibre Channel HBAs have been qualified by EMC as E-Lab tested. The new HBAs will be used to connect EMC CLARiiON and Symantec's network storage systems to servers with high-performance PCI-X 2.0 and PCI Express slots. QLogic is leading the way to 4-Gig Fibre Channel deployment with end-to-end 4-Gig solutions.
We announced the expansion of QLogic's global support services. Enabled by our strategic relationship with Lucent Technologies, QLogic now provides global support services with in-region local language, telephone and e-mail support, as well as on-site service programs. QLogic global services are available in the following regions, Europe, Middle East and Africa, Asia-Pacific, Latin America, Japan and North America.
In summary, our continued growth in Fibre Channel and iSCSI HBAs and Fibre Channel switches, along with our expansion into iSCSI to Fibre Channel routers and the virtualization platforms will allow us to increase our footprint in the expanding SAN infrastructure market. Thank you, operator. We will now take questions.
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