A leading supplier of high performance network infrastructure solutions, QLogic Corporation ( QLGC - Analyst Report ) reported third quarter 2012 earnings of 31 cents (excluding one-time charges, but including stock-based compensation expense) handily beating the Zacks Consensus Estimate by six cents.

However, earnings per share (EPS) declined 36.0% year over year, primarily due to weak revenue growth and operating margin contraction in the reported quarter.

Quarter Details

Total revenue decreased 2.0% year over year to $152.7 million but was ahead of the Zacks Consensus Estimate of $150.0 million and was at the higher end of management’s guided range of $145.0 million to $155.0 million. The year-over-year decline was primarily attributed to weak growth across half of its segments during the quarter.

Host Products (comprising primarily fiber channel converged and 10-Gig Ethernet adapters) decreased 0.7% from the year-ago quarter to $112.7 million (73.8% of the total revenue in the quarter). Network products (fiber channel and InfiniBand switches) also declined 15.7% year over year to $24.4 million (16.0% of the total revenue in the quarter).

Silicon products (fiber channel converged 10-Gig Ethernet and iSCSI protocol chips) shot up 17.1% from the year-ago quarter to $12.4 million (8.2% of the total revenue in the quarter). Service revenues climbed 15.1% year over year to $3.1 million (2.0% of the total revenue in the quarter).

Gross profit decreased 2.1% year over year to $101.8 million. Gross margin remained flat on a year-over-year basis at 66.7%, and was within management’s guided range of 66.0% to 67.0%.

Total operating expense increased 7.8% year over year to $67.2 million, primarily due to higher engineering and development cost (up 11.3%) and sales & marketing expense (up 7.0%). Operating expense exceeded management’s expectation of $60.0 million, which hurt the company’s operating profit during the quarter.

Operating profit in the third quarter declined 17.0% year over year to $34.6 million. Operating margin decreased from 26.7% a year ago to 22.6% in the reported quarter. Non-GAAP net income was $30.8 million compared with $51.3 million in the year-ago quarter.

Balance Sheet

As of January 1, 2012, QLogic had cash and short-term investments of $395.8 million versus $391.0 million in the previous quarter. At the end of the quarter, the company had no debt on its balance sheet. QLogic generated $52.3 million in cash from operations in the reported quarter.

Divestiture

Most recently, QLogic announced the sale of its InfiniBand business to Intel Corp. ( INTC - Analyst Report ) for $125.0 million in cash. The sale is expected to be closed by the end of the fourth quarter. QLogic believes that the sale will allow the company to focus more on high growth opportunities in converge networking, enterprise Ethernet and storage networking products, thereby boosting top-line growth going forward.

Guidance

QLogic expects fourth quarter 2012 revenue in the range of $134.0 million to $140.0 million. Management expects host and network products to decline 4.0% sequentially. Revenue from Silicon Products is expected in the range of $11.0 million to $12.0 million.

Gross margin is expected to be approximately 68.0%, while QLogic expects to incur operating expenses of $56.0 million. Non-GAAP EPS is expected in the range of 30 cents to 33 cents for the fourth quarter.

Recommendation

We believe that QLogic will benefit from major OEM customer wins and increased focus on its key strategic initiatives (post the InfiniBand sale) over the long term. Moreover, QLogic has gained significant traction in the fiber channel adaptor market and the 10Gb Ethernet adapters market, primarily driven by strong customer demand over the last 12 months.

However, we believe that the third quarter beat was already factored in the stock. We believe that QLogic’s top-line growth will take some time to rebound and is quite dependent on the ramp of Intel’s Romley servers. Meanwhile, a slowdown in IT spending can hurt QLogic going forward. Further, tough competition from Emulex Corp. ( ELX - Snapshot Report ) and Broadcom Corp. ( BRCM - Analyst Report ) will act as a headwind for the stock.

We continue to maintain a Neutral recommendation on a long-term basis (6–12 months). Currently, QLogic has a Zacks #3 Rank, which implies a Hold rating on a short-term basis.