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QLogic Corporation (QLGC - Analyst Report) reported third quarter 2013 earnings of 15 cents, which beat the Zacks Consensus Estimate by 6 cents. The better-than-expected result was driven by much improved performance from the Network Products segment.

Revenues

Total revenue decreased 16.4% year over year but increased 1.3% sequentially to $119.4 million slightly better than the Zacks Consensus Estimate. Total revenue was slightly above management’s guided range of $112.0 million to $118.0 million. The year-over-year decline was primarily due to weak growth in the Host and Silicon products segment, partially offset by strong growth from Network products.

Host products revenue declined 19.7% year over year but remained flat on a sequential basis at $89.8 million. Silicon products revenue plunged 23.1% from the year-ago quarter and 10.8% from the previous quarter to $9.6 million. However, Network products jumped 8.4% year over year and 14.1% from the previous quarter to $20.1 million.

Margins

Gross profit fell 17.2% year over year but increased 1.8% quarter over quarter to $80.5 million in the reported quarter. Gross margin contracted 60 basis points (“bps”) to 67.5% year over year, primarily due to unfavorable product mix. However, on a sequential basis gross margin expanded 40 bps.

Total operating expense increased 4.7% year over year but remained flat on a sequential basis at $65.9 million. The year-over-year increase was primarily due to higher engineering and development cost (up 12.2%). 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 57.3% year over year but jumped 10.9% sequentially to $14.7 million. Operating margin decreased from 24.1% a year ago but increased from 11.2% in the previous quarter to 12.3%.

Net income declined 52.8% year over year but increased 16.0% from the previous quarter to $13.9 million. Earnings per share (“EPS”) plunged 48.7% year over year but increased 17.7% sequentially to 15 cents.

Balance Sheet and Cash Flow

As of Dec 30, 2012, QLogic had cash and short-term investments of $495.2 million versus $484.4 million in the previous quarter. At the end of the quarter, the company had no debt on its balance sheet.

Guidance

QLogic expects fourth quarter 2013 revenue in the range of $112.0 million to $118.0 million. Gross margin is expected to be approximately 67.0% to 68.0% as QLogic expects to incur operating expenses of $62.0 million. Earnings per share are expected to be in the range of 13 cents to 17 cents for the fourth 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 Broadcom Corp. (BRCM - Analyst Report), Cisco (CSCO - Analyst Report), Emulex (ELX - Snapshot Report) and MellanoxTechnologies (MLNX - Snapshot Report) will hurt profitability going forward.

Currently, QLogic has a Zacks #4 Rank (Sell).

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