QLogic's CEO Discusses F4Q 2012 Results - Earnings Call Transcript

| About: QLogic Corporation (QLGC)

QLogic Corporation (NASDAQ:QLGC)

F4Q12 Earnings Call

May 3, 2012 5:00 p.m. ET


Jean Hu - SVP and CFO

Simon Biddiscombe - President and CEO


Bill Shope - Goldman Sachs & Co

Harsh Kumar - Stephens Inc.

Katy Huberty - Morgan Stanley


Good day and welcome to the fourth quarter fiscal year 2012 QLogic earnings announcement. As a reminder today's conference is being recorded. At this time, I would like to turn the conference over to Jean Hu, Chief Financial Officer. You may begin when ready.

Jean Hu

Thank you, operator. Good afternoon and welcome to QLogic's fourth quarter and fiscal year 2012 earnings conference call. Joining me on the call today is Simon Biddiscombe, our Chief Executive Officer. I'll begin the call with a review of the fourth quarter and full year 2012 financial results. Simon will follow with a recap of the fiscal 2012 highlights and his customary quarterly business update. We'll then open the call for questions.

Certain of our comments today will include forward-looking statements regarding future events and our projections of our financial performance based on current expectations. These comments are subject to significant risks and uncertainties that could cause our actual results to differ materially from those expressed in these forward-looking statements. We refer you to the documents QLogic files with SEC, specifically our most recent Forms 10-K and 10-Q. These documents identify important risk factors that could cause our actual results to differ materially from expectations. We do not intend to update the forward-looking statements that we make today.

In our fourth quarter earnings press release issued earlier today, we reported both GAAP and non-GAAP results. Of the reference we will make on our call today relate to non-GAAP results unless otherwise stated. A reconciliation of the non-GAAP to the GAAP financial measures is available on our website under investor relations.

At the end of February, we completed the sale of a substantially (indiscernible) asset associated with our InfiniBand business to Intel for $125 million. As a result of this transaction, we have presented the financial results of this business as discontinued operations in the financial statements for all periods included in our earnings press release. Our discussion today will focus on the financial results from our continuing operations unless otherwise noted.

Turning now to our financial result. For the fourth fiscal quarter ended April 1, 2012, our revenue in the fourth quarter was $135.1 million compared to $146.1 million recorded in the same quarter last year. This revenue was within our guidance range of $134 million to $140 million provided during our third quarter earnings call. As a reminder, the fourth quarter of fiscal 2011 included an extra week. Excluding the approximate $4 million impact of this extra week, our revenue in the fourth quarter of fiscal 2012 declined by 5% from the same quarter last year. This decline was due to a decrease in revenue from network and silicon products.

Our fourth quarter revenue from host products, which are comprised primarily of fibre channel, converged and the 10-gig Ethernet adapters, was $105.6 million compared $109 million recorded in the fourth quarter of last year. Excluding the impact of the extra week in fiscal 2011, our fourth quarter revenue from host products was flat with the same quarter last year.

Fourth quarter revenue from network products which are comprised primarily of fibre channel switches, was $16.3 million compared to $21 million recorded in the fourth quarter of last year. Our fourth quarter revenue from silicon products comprised of fibre channel, converged, 10-gig Ethernet and iSCSI chip was $13.1 million compared to $16.1 million recorded in the fourth quarter of last year.

Our fourth quarter gross margin of 68.2% declined from 69% recorded in the fourth quarter of last year, primarily due to lower volume to absorb manufacturing costs. Our gross margin exceeded our guidance of approximately 68% provided during our third quarter earnings call.

Next, I would like to cover our fourth quarter operating expenses. Total operating expenses were $55.6 million, up 3% from $54.1 million recorded in the fourth quarter of last year. Operating expenses were consistent with our expectation.

Engineering expenses in the fourth quarter of $31.4 million increased 2% from a year ago, an increase as a percentage of revenue from 21% to 23.2%. Sales and marketing expenses in the fourth quarter were $17.8 million, an increase as a percentage of revenue from 11.5% to 13.2%. G&A expenses in the fourth quarter of $6.5 million were 4.8% of revenue.

Operating income in the fourth quarter of $36.2 million was 27.1% of revenue. Interest and other income was $1 million in the fourth quarter. Our income tax rate for the fourth quarter was 7.7%, resulting in an annual rate for the full year of 14.3%. Our fourth quarter income from continuing operations of $34.7 million represented a net profit margin of 25.7%. This represents the 67th consecutive quarter of profitability for QLogic. Our fourth quarter income from continuing operations per diluted share of $0.34 exceeded the high end of our guidance range of $0.30 to $0.33 provided during our third quarter earnings call.

Turning now to our balance sheet. Our cash and marketable securities were $538 million at the end of the fourth quarter of which $187 million was held in the United States. We continue to maintain a very strong cash position and have no debt. During the fourth quarter, we generated $32 million of cash from operations. We remain committed to our stock buyback and during the quarter we purchased $24 million of company’s common stock.

Receivables were $76.6 million at the end of the fourth quarter and decreased from $82.2 million at the end of the third quarter. DSO at the end of the fourth quarter was 52 days compared to 50 days at the end of the third quarter. Inventory was $19.7 million at the end of the fourth quarter. Annualized inventory turns for the fourth quarter was 8.7 compared to 8.9 turns achieved in the third quarter.

Now let me summarize the results for the full fiscal year 2012. As a reminder, fiscal year 2011 included 53 weeks. Revenue for fiscal 2012 was $559 million consistent with the fiscal 2011. Revenue from our host products was $430 million and grew 2% from the prior year. Operating income for fiscal 2012 of $162 million was 29% of revenue.

Income from continuing operations for fiscal 2012 was $142 million or $1.39 per diluted share. The net profit margin for fiscal 2012 was 25.5%. During the fiscal year, we generated free cash flow of over $133 million and purchased 8.6 million shares of our common stock of $128 million at an average price of $14. 95. Consistent with the last several years, we returned substantially all our free cash flow to shareholders through our stock repurchase program.

Before turning to our outlook, I would like to discuss the impact of current server refresh cycle on our business. Romley-based servers were announced in early March by all leading server OEMs. While certain OEMs were able to commence volume shipment immediately, others were not commenced shipment until later this quarter. This has created a pause in demand for servers which in turn has created a pause in demand for our products. This pause adversely impacted our fourth quarter revenue and will continue to impact our revenue in the first quarter.

Turning now to our outlook, for the first quarter of fiscal 2013, we expect revenue to be in the range of $130 million to $135 million. At the middle point of this guidance, revenue from host and network products is expected to be up approximately 1%. We expect revenue from silicon products to be approximately $9 million.

During the first quarter, we expect gross margin to be approximately 68%. When combined with planned operating expenses of approximately $59 million, a projected tax rate for the first quarter of approximately of 17% and a diluted share count of approximately 99 million shares, we expect to achieve non-GAAP earnings per diluted share from continuing operations of $0.26 to $0.28 in the first 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 our filing with SEC and in the disclaimer statement at the end of our earnings press release.

I will now turn the call over to Simon. Simon?

Simon Biddiscombe

Thanks Jean. My comments today will include a discussion of our business highlights and accomplishments for fiscal 2012 as well as the most recent quarter. Fiscal 2012 was highlighted by great execution, continued market leadership and disciplined financial management. The recent sale of our InfiniBand business resulted in improved focus on high growth opportunities in converged networking, Ethernet and storage networking as well as allowing for incremental investment in new opportunities to expand our server markets.

On the financial front, we delivered revenues of $559 million in fiscal 2012. Very pleased with our strong gross, operating and net profit margin performance. During fiscal 2012 we achieved a gross margin of 68.8%, an operating margin of 29% and a net profit margin of 25.5%. Our revenue in the fourth quarter was $135.1 million, down 5% sequentially and consistent with normal seasonality for the March quarter. In addition, we achieved income from continuing operations per diluted share of $0.34 which exceeds the high end of the guidance range.

Now turning to my customary business update. 18 months ago we outlined our strategy of adaptive convergence. Our strategy remains focused on converged and Ethernet products for expansion, capitalizing on significant end-user trends in virtualized data centers, the cloud, Web 2.0 and the converged enterprise and fully leverages the strengthened leadership of our traditional storage networking business. We are as confident as ever in our strategy.

In the recently completed quarter, we made several key announcements that are strong indicators of the progress we have made. In early March, we announced our 8200 series 10-gig converged network adapters were shipping with the new Dell PowerEdge 12 generation servers based on Intel Romley processors. QLogic and Dell are driving next-generation server I/O virtualization with unique flexible networking technologies, including simultaneous multi-protocol processing and QLogic’s NIC partitioning.

Our 8200 series is available as part of the Dell PowerEdge Select Network Adapter family, including PCI Express and mezzanine versions for PowerEdge rack, tower and blade servers. They complement the higher compute density and increased number of I/O operations that can be generated by the new higher performance servers and address the increasingly complex requirements of virtualized data centers, cloud and the converged enterprise.

Also in early March, we announced that we had been selected as the continued provider of adapter products to HP for their ProLiant Gen8 server line, also based on Intel Romley processors. These adapters are the latest in our extensive portfolio, including 10-gig Ethernet NICs, 10-gig converged network adapters and 4 and 8 gig fibre channel adapters that were selected and qualified by HP across a broad range of ProLiant Gen8 servers.

We were also pleased that we were selected to develop the first fibre channel mezzanine adapter for HP ProLiant Gen8 blade servers which is now shipping. Additional qualifications of our adaptive convergence, host and switch products have completed or are in progress with other leading server manufacturers on Romley platforms.

During the quarter, we announced that we led the fibre channel adapter market for the 8th consecutive year and yet again gained market share according to the data from the Dell'Oro Group’s Q4 2011 SAN report. With nearly 55% of total revenue share for calendar year 2011, we achieved a lead of more than 15 percentage points over our closest competitor. Also, we are confident that we gained share in the March quarter based on our primary competitor’s announced results.

Demand for our storage area network products continues to be solid and the end users continue to demonstrate a strong preference for the same supplier in ongoing fibre channel purchases and when they move to converged networking products. Our market leadership and success in the converged networking market continues and we saw a very strong growth in FCoE during the March quarter and fiscal 2012.

According to Crehan Research for calendar year 2011, we increased our non-captive FCoE adapter revenue share by nearly 2 percentage points to 54.3% and a lead of more than 21 percentage points over our closest competitor. The share is consistent with our market lead in fibre channel adapter revenue share and continues to indicate a strong preference for the value of the QLogic storage tag and converged products.

Lastly, in the broader non-captive 10-gig Ethernet adapter market, which includes FCoE, according to the Dell'Oro Group and Crehan Research, our revenue share for calendar year 2011 has increased to 15% resulting in a number two revenue share position. This accomplishment is in the market arena with a broader set of competitors, challenging competition and demanding product cycles.

Our continued market share accomplishments with our recent Romley related announcements reinforce our position in our traditional markets and demonstrate our market leadership leverage, success and further potential in our expansion markets.

Turning now to the near term, we’re currently seeing a much higher level of interest and activity for our host products. This uptick in activity is across the customer base from both existing and new customers, including our traditional OEMs, white box manufacturers and channel partners. Customer interest is centered on our multi-protocol adaptive convergence portfolio which offers customers a flexibility to power 16-gig fibre channel and 10-gig Ethernet networks, including FCoE and iSCSI from the same hardware.

We are aggressively staffing and prioritizing activities to fully seize these opportunities which are expected to drive revenues later this year. We are also seeing an increased level of interest and activity for our switch products. Our switch strategy of enabling OEM customers with uniquely available fibre channel and converged products has resulted in significant new partnerships and opportunities. These relationships have broadened our base of OEM design wins and are expected to drive switch revenue ramp in fiscal 2014.

Another important development I want to share with you is our increased focus and emphasis on the market for protocol ASICs for storage systems which we call the target ASIC market. From the early days of fibre channel, this market has been largely served by one company who supplied target ASICs to virtually all leading storage systems suppliers. In the early phases of the 16-gig technology cycle, that supplier chose not to offer a product opening the opportunities. As a result, we made conscious decisions to begin investing in both the product features and engineering capabilities required to be successful in the storage systems market.

We recognize the inherent complexities of participating in this market due to the myriad of OEM specific software implementations and corresponding the unique test requirements. Key to the opportunity is the flexibility of our current generation of products which compare with 16-gig fibre channel and 10-gig Ethernet networks including FCoE and iSCSI from the same hardware. This flexibility is highly attractive to storage systems vendors.

Our goal is to become the market leader for protocol ASICs for storage systems. We estimate the sum of this market to be in excess of $100 billion this year and growing consistently with the growth in storage systems. While we have not made any public announcements regarding design wins, I can share with you that we are well on track to achieve our goal. We are engaged with every leading storage system provider and active programs underway having won a number of very strategic design wins. We have key target design wins with the leading storage vendors in the market whose block and NAS level storage sub-systems represent the vast majority of revenue for the external controller based disk market during calendar year 2011.

In the most recent Gartner’s storage market forecast, they estimate the disk based market for five year compound growth rate in units to be 15.7%. The qualification cycle for storage systems is considerably longer than servers, so we do not expect these activities to manifest themselves as revenue in any meaningful way until fiscal 2014 as the storage system OEMs begin to introduce solutions that use our products.

Nonetheless our focus and investments today will set the stage for expansion into a new market opportunity for us for years to come. As was the case with the original supplier in this market, once the storage system company makes a decision and software investments to change to a new supplier, it tends to be for multiple generations. We’re excited about the potential and longevity of this market.

As we plan for the future, we already have our next-generation products under development. In addition, as we’ve previously communicated, we will bring to market highly innovative technology which will result in increased available markets and we plan an announcement shortly.

We are focused on the technology and capabilities to address next-generation needs driven by trends in cloud computing, mobile computing, Web 2.0 and the enterprise data centers. Faster link speed such as 100 gig Ethernet and 32 gig fibre channel combined with faster host speeds such as PCI Gen 4 along with improved performance, lower power, increased usability and better manageability are key to meet future customer needs.

I started my comments with a reaffirmation of our confidence in our strategy. And I will close with the same. We are on the right track to continued market leadership and expansion into non-traditional markets. Our fiscal 2012 successes and our current program activity both support this belief and confidence. Consistent with current increased activity, programs in the target market and incremental organic investments to expand our TAM, we are planning to continue to increase engineering and development expenditures in fiscal 2013 to ensure that we make the most of the opportunities and drive further growth and shareholder value.

The entire QLogic management team shares a strong optimism for the track we are on and the potential the future holds. We are all committed to drive future growth for QLogic. That concludes our prepared remarks. Operator, we will now open the call for questions.

Question-and-Answer Session


(Operator Instructions) We’ll go first to Bill Shope with Goldman Sachs.

Bill Shope - Goldman Sachs & Co

How are thinking about the Romley ramp after the June quarter pause? Is this something that you’re expecting to show fairly rapid acceleration due to pent-up demand or should we assume that this is really going to be more modest improvement before you get back on track here?

Simon Biddiscombe

So I think the September quarter is shaping up well, Bill, in that regard. So we have an expectation that substantially each OEM will have the highest volumes in production by the end of this quarter. And as we said in the prepared remarks, given how late the launch was in the March quarter and then given that certain of the OEMs either didn’t launch servers until early this quarter or won’t launch them until later this quarter, clearly we are seeing a combination of a pause of those technologies until everything is in the market.

Right, so I think we expect that we will be through substantially all of that pause in the September quarter but even in the September quarter, you won’t necessarily have all servers based on Romley technologies in the market. And that’s entirely consistent with what we’ve said in the past. Right, we said it would take 16 months for these introductions to essentially get everything into the market. And we continue to have a belief system around that.

Bill Shope - Goldman Sachs & Co

One more question if I can. Given some of the challenges that your key competitors are facing with litigation issues, how should we think about how that might impact the competitive landscape both near term and over the medium term?

Simon Biddiscombe

We wouldn’t ever comment on our competitors’ very specific issues. But I did say in my prepared remarks that we had seen an increased level of activity around our host business and that increased level of interest and activity – let me call it interest, right, so that increased level of interest and activity is attributable to multiple different factors I suspect. And we’re going to aggressively pursue each of the opportunities that are represented by every shifting market dynamic.


We’ll go next to Harsh Kumar with Stephens Inc.

Harsh Kumar - Stephens Inc.

Hey guys, Simon, I want to clarify something. I thought I heard you say you’re seeing increased activity in host and switches, and I am trying to put that in the context of your guidance. So I guess the question really is where are you seeing weakness unless I misheard something in the call?

Simon Biddiscombe

So when I talked about increased levels of interest and activity, Harsh, it was within the context of both existing and new customers, traditional OEMs, white box manufacturers, channel partners and so on for next generation technologies. But I actually went on to say in those prepared remarks that we’re going to make sure that we seize every one of those opportunities. But they are not expected to drive revenues until later this year. That’s precisely what I said.

Harsh Kumar - Stephens Inc.

And if I can just step over here and ask you about -- just separately about the 10 gigabit RAM. Your competitor talks a lot about that space. How would you characterize that? Is that something also that’s being affected clearly by Romley or is that on a track by itself that’s separate?

Simon Biddiscombe

There is multiple ways to answer that, Harsh. So first of all, from our perspective as I said in the prepared remarks, in the March quarter on a year over year basis and for the full year, we continue to see very strong growth in our 10-gig Ethernet and FCoE products. And if you look where we stand from a market share perspective, clearly we are executing well on the FCoE side. We actually extended our market lead over our nearest competitor by 4 percentage points last year. So we’re very pleased with the progress we continue to make in FCoE and in Ethernet we’re the number two provider of adapter at this point in time having achieved that position in the middle of last year.

So we continue to strengthen our market share positions around adapter based 10-gig E and FCoE last quarter. They continue to be critical technologies as we move forward within the context of data center connectivity, particularly with the increasing ramp of Romley based solutions over the course of the coming quarters. So we continue to have a very strong believe system around our positions and I think the market share numbers and the growth we’ve posted are very strong.

Harsh Kumar - Stephens Inc.

My last question and then I will cede the floor. Simon, now that the InfiniBand business is gone, does that your seasonality in any way whatsoever?

Simon Biddiscombe

Maybe a little bit, Harsh but it’s not going to be significant enough that we’d call it out necessarily. I mean there was a tremendous amount of activity associated with InfiniBand that went into the federal government. And I think when we looked back on the seasonality associated with InfiniBand versus the rest of the business, the end of the federal government being a different year end than others, and there was probably a little bit but nothing that we’re going to worry about as we look forward, and part of it, Harsh, is don’t forget every number we show you will exclude InfiniBand from this point forward. So I wouldn’t be concerned about it.


We’ll go next to Katy Huberty - Morgan Stanley.

Katy Huberty - Morgan Stanley

Simon, I think you had mentioned that the midpoint of guidance would imply the host and network business up 1% sequentially. Can you just talk about what you would consider as a normal seasonality in June? And then also as it relates to June quarter, would you expect strengthening demand trend as you move through the months of the quarters that you exit June with a better run rate of demand related to Romley?

Simon Biddiscombe

So normal seasonality for host products is 1% to 2%, Katy. So the guidance – the mid-point of the guidance we’ve given you essentially the normal seasonality number. You can see in the numbers that the weakness is in silicon products – right, we said that silicon products would be essentially $9 million having just come up at $13.1 million number. I think part of that is attributable to the fact that when we sell silicon it can be earlier in the supply chain than the sale of adapters which is pretty much at the point that somebody actually ships the server to an end user. So the fact that silicon was strong last quarter was indicative of people getting ahead in the supply chain for the launches. So typical seasonality as I said is where we expect the host business to be and then the weakness is primarily associated with the silicon line.

In terms of the trend throughout the quarter, the answer is yes. I would expect that the month of June would be stronger than a typical third month of any quarter, primarily because we expect that by the end of this month essentially everybody will have the highest volume server shipping rate. So yeah I am expecting June to be a particularly strong number.


We’ll go next to Amit Daryanani with RBC Capital.

Unidentified Analyst

Hi this is Mitsy (ph) filling in for Amit here. We just want to get some clarity on the back half numbers that you are looking at. So Q-over-Q basis, December you’re up about 9%, March is down, but 5%, is there any way you guys quantify the impact of Romley there?

Simon Biddiscombe

In the December quarter of next – this year and March next year?

Unidentified Analyst

The second half of your fiscal year.

Simon Biddiscombe

No, we would never give comments beyond the current quarter. Clearly we have expectations associated with the markets that we serve around fibre channel, 10-gig Ethernet, converged, host and switch related, plus by that point in time some benefit from the introduction of new products that, as I said in my prepared remarks, we start talking about in the – very shortly. I think I said very shortly in my prepared remarks. But no, we wouldn’t give specific color. We have belief systems that say the markets that we serve both traditional and expansion markets stand to benefit significantly as we move through this year but we wouldn’t give you more than that.

Unidentified Analyst

Is there any color on OpEx for the full year?

Simon Biddiscombe

As I said, we’ve got three different sets of opportunities. There is near term opportunities associated with customers that are looking at QLogic as an alternative to other providers of technology in the markets who may be struggling with a whole series of different issues. There is opportunities associated with the target market and there is opportunities associated with the new technologies we will introduce that result in larger markets to be served moving forward. So we’re going to invest, and we’re going to invest aggressively to make sure that we make – we take advantage of the growth trajectories that we believe exist in the markets that we currently serve and will serve. So we gave you 59 for the current period, if you annualize that, you’re going to get close to 240-ish, and starting at around that kind of number and we will go from that.


And at this time we have no further questions in the queue. I’ll turn the call back over to Ms. Hu for any closing remarks.

Jean Hu

Thank you. That concludes our conference today. We look forward to updating you on our progress next quarter. Thank you very much for your time and good bye.


Ladies and gentlemen this does conclude today’s teleconference. We thank you for your participation.

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