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A leading supplier of high performance network infrastructure solutions, QLogic Corporation (QLGC - Analyst Report) reported second quarter 2013 earnings of 13 cents, which beat the Zacks Consensus Estimate by 3 cents. Reported earnings include stock-based compensation expense ($7.0 million) but exclude amortization related expense ($0.2 million).

However, earnings plunged 50.6% year over year, primarily due to weak revenue growth and operating margin contraction in the reported quarter.

Quarter Details

Total revenue decreased 13.5% year over year to $118.0 million. Reported revenue was in line with the Zacks Consensus Estimate. Total revenue was well above the mid-point of management’s guided range of $115.0 million to $120.0 million. The year-over-year decline was on the back of weak growth across most of its segments during the quarter.

Host Products, Network Products and Silicon products decreased 13.4%, 7.3% and 22.6% year over year to $89.6 million, $17.6 million and $10.7 million, respectively, in the reported quarter.

Gross profit fell 15.1% year over year to $79.1 million in the reported quarter. Gross margin contracted 130 basis points (“bps”) to 67.1%, primarily due to unfavourable product mix.

Total operating expense increased 5.6% year over year to $66.0 million, primarily due to higher engineering and development cost (up 8.4%) and sharp rise in sales & marketing expense (up 6.6%), which fully offset lower general & administrative expense (down 8.1%). Operating expense exceeded management’s expectation of $60.0 million, which hurt the company’s operating profit during the quarter.

Operating profit in the second quarter declined 57.0% year over year to $13.2 million. Operating margin decreased from 22.6% a year ago to 11.2% in the reported quarter.

Non-GAAP net income was $11.9 million compared with $26.7 million in the year-ago quarter.

As of September 30, 2012, QLogic had cash and short-term investments of $484.4 million versus $496.3 million in the previous quarter. At the end of the quarter, the company had no debt on its balance sheet.

Guidance

QLogic expects third quarter 2013 revenue in the range of $112.0 million to $118.0 million. Gross margin is expected to be approximately 57.0% to 58.0%, as QLogic expects to incur operating expenses of $60.0 million. Non-GAAP earnings are expected in the range of 14 cents to 19 cents for the third quarter.

Our Recommendation

We believe that QLogic will benefit from major OEM customer wins, innovative product pipeline, new technologies (Mt. Rainier) and increased focus on its key strategic initiatives over the long term.

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 Mellanox Technologies (MLNX - Snapshot Report) will hurt profitability going forward.

We continue to maintain a Neutral recommendation on a long-term basis (6–12 months). Currently, QLogic has a Zacks #4 Rank, which implies a Sell rating on a short-term basis.

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