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QLogic Corp (QLGC - Analyst Report) reported first quarter 2014 earnings of 10 cents per share, which beat the Zacks Consensus Estimate by 3 cents. However, earnings per share plunged 47.4% year over year and 16.7% sequentially.

Revenues

Revenues decreased 13.2% year over year and 3.2% sequentially to $113.1 million, which lagged the Zacks Consensus Estimate. Revenues were in line with the mid-point of management’s guided range of $110.0 million to $116.0 million.

The year-over-year decline was primarily due to weak growth in advanced connectivity platform and legacy connectivity platform. QLogic revised its product categories into these two new segments as a part of its restructuring efforts, which began in the first quarter of 2014.

Advanced connectivity platform (strategic server and storage connectivity products) revenues declined 13.7% year over year and 3.9% sequentially to $93.2 million. Legacy connectivity products (Fibre Channel Switch products and the 1 gig iSCSI products) revenues plunged 10.8% from the year-ago quarter but remained almost flat sequentially at $19.9 million.

Margins

Gross margin expanded 80 basis points (“bps”) from the year-ago quarter but declined 30 bps from the previous quarter to 67.6%. This was within the management guided range of 67.0% to 68.0%. The year-over-year growth was primarily due to favorable product mix in the quarter.

Total operating expense increased 0.8% year over year but decreased 1.7% on a sequential basis to $67.5 million. The year-over-year increase was primarily due to higher engineering and development costs (up 2.4%) and sales & marketing (up 2.8%) costs. Operating expense exceeded management’s expectation of $63.0 million, which hurt QLogic’s operating profit during the quarter.

Operating margin was 7.9% in the first quarter compared with 15.4% in the year-ago quarter and 9.1% in the previous quarter. Net income as a percentage of revenues was 7.6% compared with 14.3% in the year-ago quarter and 7.3% in the previous quarter.

Balance Sheet and Cash Flow

As of Jun 30, 2013, QLogic had cash and short-term investments of $431.9 million versus $579.2 million in the previous quarter. Cash flow from operating activities was $16.6 million in the quarter. QLogic bought back $24.0 million of the company’s common stock.

Guidance

QLogic expects second quarter 2014 revenues in the range of $108.0 million to $116.0 million.

Gross margin is expected to be approximately 67.0% to 68.0%. QLogic expects to incur operating expenses of $57.0 million. Earnings are expected to be in the range of 16 cents to 23 cents for the second quarter.

Restructuring activities are expected to save approximately $20.0 million of operating expenses in 2014. QLogic expects operating expenses of approximately $235.0 million for the fiscal year.

Recommendation

We believe that QLogic will continue to benefit from contract wins from OEM’s such as International Business Machines (IBM - Analyst Report) and Hewlett Packard (HPQ - Analyst Report) in the near term. Moreover, innovative product pipeline, new technologies (Mt. Rainier) and additional savings from its restructuring initiatives will drive profitability going forward.

However, a tough macro-economic environment continues to hurt server sales, which in turn may hurt top-line growth in the near term. Increasing investments in engineering and increasing competition from peers such as Cisco (CSCO - Analyst Report) will hurt profitability going forward.

Currently, QLogic has a Zacks Rank #3 (Hold).

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