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QLogic Corp. (QLGC - Analyst Report) reported third-quarter fiscal 2014 earnings of 25 cents per share, which beat the Zacks Consensus Estimate by 6 cents. Earnings per share (including stock-based compensation but excluding one-time items) jumped 69.3% year over year and 44.3% sequentially in the reported quarter.

Quarter Details

Revenues remained flat on a year-over-year basis but increased 6.1% sequentially to $119.4 million, which was slightly better than the Zacks Consensus Estimate. Revenues were almost in line with the higher-end of management’s guided range of $114.0 million to $120.0 million.

In the quarter, Advanced Connectivity Platform (strategic server and storage connectivity products) revenues increased 1.5% year over year and 4.7% quarter over quarter to $98.5 million. Legacy connectivity products (Fibre Channel Switch products and the 1 gig iSCSI products) revenues plunged 6.2% from the year-ago quarter but surged 12.8% sequentially to $21.0 million.

Gross margin expanded 50 basis points (bps) from the year-ago quarter and 20 bps from the previous quarter to 68.0%, which met the higher-end of management’s 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 decreased 10.8% year over year but remained almost flat on a sequential basis at $58.8 million. The year-over-year decrease was primarily due to lower engineering and development costs (down 8.3%) and sales & marketing (down 16.6%) costs. Operating expenses were slightly above management’s expectation of $56.0 million.

Operating margin was 17.0% in the third quarter compared with 12.3% in the year-ago quarter and 15.6% in the previous quarter. Net income margin was 18.5% compared with 11.6% in the year-ago quarter and 13.7% in the previous quarter.

As of Dec 31, 2013, QLogic had cash and short-term investments of $462.4 million versus $433.0 million in the previous quarter. Cash flow from operating activities was $37.4 million in the quarter.

QLogic recently announced partnership with Brocade Communications (BRCD - Snapshot Report). The company also acquired Brocade's Fibre Channel and converged network adapter business for $10.0 million.

Guidance

QLogic expects fiscal fourth-quarter 2014 revenues in the range of $110.0 million to $116.0 million. Revenues from Advanced Connectivity Platforms are forecasted to be down approximately 2% on a sequential basis.

The acquisition of Brocade’s adapter business is expected to boost revenues in the upcoming quarter. Management expect revenues from Legacy Connectivity Products to be in the range of $15.0 million to $17.0 million.

Gross margin is expected to be approximately 67.0% to 68.0%. QLogic expects to incur operating expenses of $56.0 million in the quarter

Earnings are expected to be in the range of 19 cents to 25 cents for the fourth quarter. This is much better than the Zacks Consensus Estimate of 15 cents.

Our Take

We believe that QLogic will continue to benefit from contract wins from OEMs such as Lenovo and Hewlett-Packard (HPQ - Analyst Report) in the near term. Recently, Lenovo acquired IBM’s X-86 server business. QLogic’s already expanded partnership with Lenovo will help the company to maintain its position as a key supplier to the acquired X-86 business, going forward.

Moreover, innovative product pipeline, new technologies, acquisition of Brocade’s Fibre Channel business and additional savings from its restructuring initiatives will drive profitability, going forward.

However, a tough macroeconomic 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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