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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
------------------------
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED DECEMBER 28, 1997
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OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
-------------------- --------------------
COMMISSION FILE NO. 2-23298
QLOGIC CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 33-0537669
(STATE OR OTHER JURISDICTION OF INCORPORATION OR (I.R.S. EMPLOYER
ORGANIZATION) IDENTIFICATION NO.)
3545 HARBOR BOULEVARD, COSTA MESA, CALIFORNIA 92626
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
(714) 438-2200
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
------------------------
INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS
REQUIRED TO BE FILED BY SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 DURING THE PRECEDING 12 MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE
REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH
FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES X NO
--- ---
AS OF JANUARY 25, 1998, THE REGISTRANT HAD 8,593,774 SHARES OF COMMON STOCK
OUTSTANDING.
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QLOGIC CORPORATION
INDEX
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets
December 28, 1997 and March 30, 1997........................................... 3
Condensed Consolidated Statements of Income --
three months and nine months ended December 28, 1997 and December 29, 1996..... 4
Condensed Consolidated Statements of Cash Flows --
nine months ended December 28, 1997 and December 29, 1996...................... 5
Notes to Condensed Consolidated Financial Statements............................. 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations............................... 6
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K............................................. 17
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3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
QLOGIC CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE DATA)
DECEMBER 28, MARCH 30,
1997 1997
------------ ---------
ASSETS
Cash and cash equivalents.............................................. $ 54,731 $19,091
Short term investments................................................. 50,997 --
Accounts and notes receivable, net..................................... 6,698 5,720
Inventories............................................................ 4,006 4,794
Deferred income taxes.................................................. 2,188 1,149
Prepaid expenses and other current assets.............................. 670 391
-------- -------
Total current assets.............................................. 119,290 31,145
Property and equipment, net............................................ 5,963 5,043
Other assets........................................................... 1,108 775
-------- -------
$126,361 $36,963
======== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable....................................................... $ 2,549 $ 3,994
Accrued expenses....................................................... 10,876 7,115
Current installments of capitalized lease obligations.................. 204 225
-------- -------
Total current liabilities......................................... 13,629 11,334
Capitalized lease obligations, excluding current installments.......... 196 352
Other non-current liabilities.......................................... 654 924
Stockholders' equity:
Preferred stock, $.10 par value; 1,000,000 shares authorized,
(200,000 shares designated as Series A Junior participating
preferred, $.001 par value); none issued and outstanding......... -- --
Common stock, $.10 par value; 12,500,000 shares authorized;
8,589,624 and 5,840,701 shares issued and outstanding at December
28, 1997 and March 30, 1997, respectively........................ 859 584
Additional paid-in capital........................................ 97,024 19,001
Retained earnings................................................. 13,999 4,768
-------- -------
Total stockholders' equity................................... 111,882 24,353
-------- -------
$126,361 $36,963
======== =======
See accompanying notes to condensed consolidated financial statements.
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QLOGIC CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED NINE MONTHS ENDED
--------------------------- ---------------------------
DECEMBER 28, DECEMBER 29, DECEMBER 28, DECEMBER 29,
1997 1996 1997 1996
------------ ------------ ------------ ------------
Net revenues.................................. $ 20,856 $ 17,431 $ 58,653 $ 49,896
Cost of sales................................. 8,594 9,391 24,884 28,598
-------- -------- -------- --------
Gross profit................................ 12,262 8,040 33,769 21,298
Operating expenses:
Engineering and development................. 4,085 2,575 11,268 7,200
Selling and marketing....................... 2,041 1,742 6,299 4,565
General and administrative.................. 952 1,067 3,426 3,413
-------- -------- -------- --------
Total operating expenses................. 7,078 5,384 20,993 15,178
-------- -------- -------- --------
Operating income............................ 5,184 2,656 12,776 6,120
Interest income, net.......................... 1,261 138 2,263 289
-------- -------- -------- --------
Income before income taxes.................. 6,445 2,794 15,039 6,409
Income tax provision.......................... 2,499 1,117 5,808 2,587
-------- -------- -------- --------
Net income.................................... $ 3,946 $ 1,677 $ 9,231 $ 3,822
======== ======== ======== ========
Basic earnings per common share............... $ 0.46 $ 0.29 $ 1.28 $ 0.67
======== ======== ======== ========
Diluted earnings per share.................... $ 0.43 $ 0.27 $ 1.19 $ 0.64
======== ======== ======== ========
Common shares used in the calculations of
basic earnings per share.................... 8,590 5,777 7,238 5,682
======== ======== ======== ========
Shares used in the calculations of diluted
earnings per share.......................... 9,115 6,238 7,757 6,024
======== ======== ======== ========
See accompanying notes to condensed consolidated financial statements.
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QLOGIC CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
NINE MONTHS ENDED
---------------------------
DECEMBER 28, DECEMBER 29,
1997 1996
------------ ------------
Cash flows from operating activities:
Net income......................................................... $ 9,231 $ 3,822
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization................................... 1,790 1,782
Provision for doubtful accounts................................. 161 157
Loss on disposal of property and equipment...................... 192 1,235
Benefit from deferred income taxes.............................. (1,039) (552)
Changes in assets and liabilities:
Accounts and notes receivables.................................. (1,139) 1,605
Inventories..................................................... 788 2,771
Prepaid expenses and other current assets....................... (279) (81)
Other assets.................................................... (333) (690)
Accounts payable................................................ (1,445) (2,410)
Accrued expenses................................................ 3,761 2,501
Other non-current liabilities................................... (270) (1,092)
-------- --------
Net cash provided by operating activities..................... 11,418 9,048
-------- --------
Cash flows from investing activities:
Additions to property and equipment............................. (2,902) (3,093)
Purchases of short term investments............................. (50,997) --
-------- --------
Net cash used in investing activities......................... (53,899) (3,093)
-------- --------
Cash flows from financing activities:
Principal payments under capital leases......................... (177) (219)
Proceeds from exercise of stock options......................... 191 1,730
Proceeds from sale of common stock, net......................... 78,107 --
-------- --------
Net cash provided by financing activities..................... 78,121 1,511
-------- --------
Net increase in cash................................................. 35,640 7,466
-------- --------
Cash at beginning of period.......................................... 19,091 8,414
-------- --------
Cash at end of period................................................ $ 54,731 $ 15,880
======== ========
Cash paid during the period for:
Interest........................................................ $ 66 $ 105
======== ========
Income taxes.................................................... $ 5,175 $ 3,131
======== ========
See accompanying notes to condensed consolidated financial statements.
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QLOGIC CORPORATION AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
NOTE (1) BASIS OF PRESENTATION
In the opinion of the Company, the accompanying unaudited condensed
consolidated financial statements contain all adjustments (which are normal
recurring accruals) necessary to present fairly the financial position as of
December 28, 1997 and March 30, 1997, the results of operations for the three
months and nine months ended December 28, 1997 and December 29, 1996 and the
statements of cash flows for the nine months ended December 28, 1997 and
December 29, 1996.
NOTE (2) INVENTORIES
Components of inventories are as follows:
DECEMBER 28, MARCH 30,
1997 1997
------------ ------------
Raw materials................................................ $2,630 $2,931
Work in progress............................................. 7 1,117
Finished goods............................................... 1,369 746
------ ------
$4,006 $4,794
====== ======
NOTE (3) EARNINGS PER SHARE
In the quarter ended December 28, 1997, the Company adopted Statement of
Financial Accounting Standards No. 128, "Earnings per Share." All prior periods
have been restated accordingly. Basic earnings per common share was computed
based on the weighted average number of common shares outstanding during the
periods presented. The weighted average number of common shares outstanding for
the three months ended December 28, 1997 and December 29, 1996, were 8,590 and
5,777, respectively. For the nine months ended December 28, 1997 and December
29, 1996, the weighted average number of common shares outstanding were 7,238
and 5,682 shares, respectively.
Diluted earnings per share was computed based on the weighted average number of
common and dilutive potential common shares outstanding during the periods
presented. The Company has granted certain stock options which have been treated
as dilutive potential common shares in computing diluted earnings per share. The
weighted average number of common and dilutive potential common shares for the
three months ended December 28, 1997 and December 29, 1996, were 9,115 and
6,238, respectively. For the nine months ended December 28, 1997 and December
29, 1996, the weighted average number of common and dilutive potential common
shares were 7,757 and 6,024, respectively.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis contains forward-looking statements
that involve risk and uncertainties. The Company's actual results could differ
materially from those discussed herein. Factors that could cause or contribute
to such differences include, but are not limited to, those discussed hereunder,
in "Risk Factors."
The Company is the successor to the Emulex Micro Devices division of Emulex
Corporation ("Emulex"). On February 24, 1994, Emulex declared a special dividend
consisting of the distribution (the "Distribution") to its stockholders of all
outstanding shares of common stock of QLogic, pursuant to which the Company
became a separate publicly held corporation.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain income
and expense items expressed in absolute terms and as a percentage of the
Company's net revenues.
THREE MONTHS ENDED NINE MONTHS ENDED
--------------------------------------- ----------------------------------------
(000'S) (000'S)
DECEMBER 28, 1997 DECEMBER 29, 1996 DECEMBER 28, 1997 DECEMBER 29, 1996
----------------- ----------------- ------------------ -----------------
Net revenues........................... $20,856 100.0% $17,431 100.0% $58,653 100.0% $49,896 100.0%
Cost of sales.......................... 8,594 41.2 9,391 53.9 24,884 42.4 28,598 57.3
------- ----- ------- ----- ------- ----- ------- -----
Gross profit....................... 12,262 58.8 8,040 46.1 33,769 57.6 21,298 42.7
Operating expenses:
Engineering and development........ 4,085 19.6 2,575 14.8 11,268 19.2 7,200 14.4
Selling and marketing.............. 2,041 9.8 1,742 10.0 6,299 10.7 4,565 9.2
General and administrative......... 952 4.5 1,067 6.1 3,426 5.9 3,413 6.8
------- ----- ------- ----- ------- ----- ------- -----
Total operating expenses........... 7,078 33.9 5,384 30.9 20,993 35.8 15,178 30.4
------- ----- ------- ----- ------- ----- ------- -----
Operating income................... $ 5,184 24.9% $ 2,656 15.2% $12,776 21.8% $ 6,120 12.3%
======= ===== ======= ===== ======= ===== ======= =====
NET REVENUES
The Company's net revenues are derived primarily from the sale of
SCSI-based I/O (Input/Output) products. License fees also contribute to the
Company's net revenues. Net revenues for the three months ended December 28,
1997 increased $3.4 million or 20% from the three months ended December 29, 1996
to $20.9 million. The increase was primarily the result of an increase in sales
of the Host Board and FAS product lines of $2.6 million and $1.4 million,
respectively. A partially offsetting decline in sales of $0.6 million occurred
in the ISP product line. The Company's principal markets are in Japan, the
United States, the United Kingdom and Malaysia. The Company's international
revenue during the three months ended December 28, 1997 was $9.4 million, or 45%
of net revenues. Most of this international revenue came from shipments to
Japan, where the Company's largest customers are Fujitsu Limited, Hitachi
Limited and Servants International. During the three months ended December 28,
1997, sales to Japan increased from the quarter ended September 28, 1997.
Fujitsu Limited and Hitachi Limited, both with headquarters in Japan, are among
the Company's largest five customers. Servants International is an OEM
distributor of the Company's products. Recently, the Asian markets have suffered
property price deflation. This asset deflation has taken place especially in
countries that have had a collapse in both their currency and stock markets,
such as Japan. These deflationary pressures have reduced liquidity in the
banking systems of the affected countries and, when coupled with spare
industrial production capacity, could lead to widespread financial difficulty
among the companies in this region.
Net revenue for the nine months ended December 28, 1997 increased $8.8
million or 18% from the nine months ended December 29, 1996. The increase was
primarily the result of an increase in sales of the Host Board, ISP and FAS
product lines of $8.0 million, $2.4 million and $2.3 million, respectively. A
partially
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offsetting decline in sales of $3.3 million and $0.6 million occurred in the TEC
product line and in license fees, respectively.
COST OF SALES
Cost of sales consists primarily of raw materials (including wafers and
completed chips from third-party manufacturers), assembly and test labor,
overhead and warranty costs. The cost of sales percentage for the three months
ended December 28, 1997 was 41.2%, a decrease of 12.7% from the similar period
in the prior fiscal year. The percentage decrease was due to products containing
higher levels of integration and functionality, that are generally associated
with higher average selling prices and gross margins, accounting for a greater
percentage of net revenues. Additionally, the Company experienced manufacturing
efficiencies. The Company's ability to maintain its current gross margin can be
significantly affected by factors such as supply costs and, in particular, the
cost of silicon wafers, the mix of products shipped, competitive price
pressures, the timeliness of volume shipments of new products and the Company's
ability to achieve manufacturing cost reductions. The Company anticipates that
it will be increasingly difficult to reduce manufacturing costs. As the
Company's OEM customers are pressured to reduce prices as a result of
competitive factors, the Company may be required to contractually commit to
price reductions for its products before it knows how, or if, cost reductions
can be obtained. If the Company is unable to achieve such cost reductions, the
Company's gross margins could decline and such decline could have a material
adverse effect on the Company's business, financial condition and results of
operations (see Risk Factors -- DEPENDENCE ON A SMALL NUMBER OF CUSTOMERS). As a
result, the Company does not anticipate cost of sales as a percentage of sales
to decrease at a rate consistent with historic trends or at all.
The cost of sales percentage for the nine months ended December 28, 1997
was 42.4%, a decrease of 14.9% from the similar period in the prior fiscal year.
The percentage decrease was due to products containing higher levels of
integration and functionality, that are generally associated with higher average
selling prices and gross margins, accounting for a greater percentage of net
revenues. Additionally, the Company experienced manufacturing efficiencies. The
Company's ability to maintain its current gross margin can be significantly
affected by factors such as supply costs and, in particular, the cost of silicon
wafers, the mix of products shipped, competitive price pressures, the timeliness
of volume shipments of new products and the Company's ability to achieve
manufacturing cost reductions. The Company anticipates that it will be
increasingly more difficult to reduce manufacturing costs. As the Company's OEM
customers are pressured to reduce prices as a result of competitive factors, the
Company may be required to contractually commit to price reductions for its
products before it knows how, or if, cost reductions can be obtained. If the
Company is unable to achieve such cost reductions, the Company's gross margins
could decline and such decline could have a material adverse effect on the
Company's business, financial condition and results of operations (see Risk
Factors -- DEPENDENCE ON A SMALL NUMBER OF CUSTOMERS). As a result, the Company
does not anticipate cost of sales as a percentage of sales to decrease at a rate
consistent with historic trends or at all.
OPERATING EXPENSES
Engineering and Development. Engineering and development expenses consist
primarily of salaries and other personnel related expenses, development related
equipment, occupancy costs and depreciation. For the three months ended December
28, 1997, engineering and development expenditures increased by $1.5 million
from the similar period in fiscal 1996, primarily due to increased salary, new
product development, and depreciation expenses. In particular, the Company
significantly expanded its engineering staff in the three months ended December
28, 1997, from the similar period in the prior fiscal year. The Company expects
that engineering and development expenses will increase in absolute dollars
throughout the remainder of fiscal 1998.
For the nine months ended December 28, 1997, engineering and development
expenditures increased by $4.1 million from the similar period in fiscal 1996,
primarily due to increased salary, new product development and depreciation
expenses.
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Selling and Marketing. Selling and marketing expenses consist primarily of
sales commissions, salaries and other expenses for selling and marketing
personnel, travel expenses and trade shows. During the three months ended
December 28, 1997, selling and marketing expenses increased by $0.3 million from
the similar period in the prior fiscal year, primarily as a result of commission
expense increases, partially offset by reduced consulting expenses.
During the nine months ended December 28, 1997, selling and marketing
expenses increased by $1.7 million from the similar period in the prior fiscal
year, primarily as a result of increased sales commission and salary expense for
sales and marketing personnel.
General and Administrative. General and administrative expenses consist
primarily of salaries and other expenses for corporate management, finance,
accounting and human resources. For the three months ended December 28, 1997,
general and administrative expenses decreased $0.1 million from the similar
period in the prior year, primarily due to reduced salaries expense.
For the nine months ended December 28, 1997, general and administrative
expenses were comparable to the prior year period.
INTEREST INCOME
Interest income, net, increased $1.1 million during the three months ended
December 28, 1997 from the three months ended December 29, 1996, primarily due
to larger balances of cash, cash equivalents and short term investments.
Interest income, net, increased $2.0 million during the nine months ended
December 28, 1997 from the nine months ended December 29, 1996, primarily due to
larger balances of cash, cash equivalents and short term investments.
INCOME TAX PROVISION
The Company's effective tax rates were 39% and 40% for the three months
ended December 28, 1997 and December 29, 1996. The Company's effective tax rates
were 39% and 40% for the nine months ended December 28, 1997 and December 29,
1996.
NEW ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. (Statement) 130, "Reporting
Comprehensive Income". The new statement is effective for both interim and
annual periods for fiscal years beginning after December 15, 1997. The Company
has not yet determined the impact of adopting this new standard on the
consolidated financial statements.
In June 1997, the FASB issued Statement 131, "Disclosure about Segments of
an Enterprise and Related Information". The new statement is effective for
fiscal years beginning after December 15, 1997. The Company has not yet
determined the impact of adopting this new standard on the consolidated
financial statements.
LIQUIDITY AND CAPITAL RESOURCES
QLogic has financed its recent working capital needs and capital
expenditure requirements primarily from internally generated funds and
facilities and equipment leases. Cash provided by operations was approximately
$11.4 million for the nine months ended December 28, 1997. Cash provided by
operations was approximately $9.0 million for the nine months ended December 29,
1996. The growth in cash provided by operations is primarily attributable to
improved profitability and increased accrued expenses, partially offset by
increased accounts receivables, and smaller inventory reductions.
Cash used in investing activities was approximately $53.9 million for the
nine months ended December 28, 1997, reflecting the purchase of short term
investments and property and equipment using a portion of
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the proceeds received in August 1997 from the sale of 2,645,000 shares of common
stock from which the Company received net proceeds of $78.1 million.
Cash used in investing activities was approximately $3.1 million for the
nine months ended December 29, 1996, reflecting expenditures for property and
equipment. Cash provided by financing activities was approximately $78.1 for the
nine months ended December 28, 1997, which primarily reflects the net proceeds
from the sale of 2,645,000 common stock in the Company's second fiscal quarter.
Cash provided by financing activities was approximately $1.5 million for the
nine months ended December 29, 1996, which reflected proceeds from the exercise
of stock options, offset in part by principal payments under capital leases.
Working capital at December 28, 1997 was $105.7 million, as compared to
$19.8 million at March 30, 1997. At December 28, 1997, the Company's principal
sources of liquidity included cash and cash equivalents of $54.7 million and
short term investments of $51.0 million. In addition, the Company has a line of
credit of up to $7.5 million with Silicon Valley Bank. The line of credit allows
the Company to borrow at the bank's prime rate. There were no borrowings under
the line of credit as of December 28, 1997. The line of credit with Silicon
Valley Bank will expire July 5, 1998, and, although there can be no assurances,
the Company currently expects to renew this line of credit.
The Company believes that existing cash and short term investment balances,
facilities and equipment leases, cash flows from operating activities and its
available line of credit will provide the Company with sufficient funds to
finance its operations for at least the next 12 months.
RISK FACTORS
Except for the historical information contained herein, the discussion in
this Form 10-Q constitutes forward-looking statements. When used in this Form
10-Q the words "shall," "should," "forecast," "all of," "projected," "believes,"
"expects," and similar expressions are intended to identify forward looking
statements. In addition, the Company may from time to time make oral
forward-looking statements. The Company wishes to caution readers that a number
of important factors could cause results to differ materially from those in the
forward-looking statements. Factors that could cause or contribute to such
differences include those discussed below, as well as those discussed above or
elsewhere in this Form 10-Q.
FLUCTUATIONS IN QUARTERLY OPERATING RESULTS
The Company has experienced, and expects to continue to experience,
fluctuations in sales and operating results from quarter to quarter. As a
result, the Company believes that period to period comparisons of its operating
results are not necessarily meaningful, and that such comparisons cannot be
relied upon as indicators of future performance. In addition, there can be no
assurance that the Company will maintain its current profitability in the
future. A significant portion of the Company's net revenues in each fiscal
quarter results from orders booked in that quarter. In the past, a significant
percentage of the Company's quarterly bookings and sales to major customers
occurred during the last month of the quarter, and there can be no assurance
that this trend will not return in the future. Orders placed by major customers
are typically based on their forecasted sales and inventory levels for the
Company's products. Changes in purchasing patterns by one or more of the
Company's major customers, customer order changes or rescheduling, gain or loss
of significant customers, customer policies pertaining to desired inventory
levels of the Company's products, negotiations of rebates and extended payment
terms, as well as changes in the ability of the Company to anticipate in advance
the mix of customer orders, could result in material fluctuations in quarterly
operating results. Certain large OEM customers may require the Company to
maintain higher levels of inventory as such customers attempt to minimize their
own inventories. In addition, the Company must order its products and build
inventory substantially in advance of product shipments, and because the markets
for the Company's products are subject to rapid technological and price changes,
there is a risk that the Company will forecast incorrectly and produce excess or
insufficient inventory of particular products. To the extent the Company
produces excess or insufficient inventory or is required to hold excess
inventory, the Company's operating results could be adversely affected.
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Other factors that could cause the Company's sales and operating results to
vary significantly from period to period include: the time, availability and
sale of new products; seasonal OEM customer demand, such as the decline
experienced in the fiscal quarter ended June 30, 1996; changes in the mix of
products having differing gross margins; variations in manufacturing capacities,
efficiencies and costs; the availability and cost of components, including
silicon wafers; warranty expenses; variations in product development and other
operating expenses; and general economic and other conditions affecting the
timing of customer orders and capital spending. The Company's quarterly results
of operations are also influenced by competitive factors, including pricing and
availability of the Company's and its competitors' products. Although the
Company does not maintain its own wafer manufacturing facility, a large portion
of the Company's expenses are fixed and difficult to reduce in a short period of
time. If net revenues do not meet the Company's expectations, the Company's
fixed expenses would exacerbate the effect on net income of such shortfall in
net revenues. Furthermore, announcements by the Company, its competitors or
others regarding new products and technologies could cause customers to defer or
cancel purchases of the Company's products. Order deferrals by the Company's
customers, delays in the Company's introduction of new products and longer than
anticipated design-in cycles for the Company's products have in the past
adversely affected the Company's quarterly results of operations. Due to all of
the foregoing factors, as well as other unanticipated factors, it is likely that
in some future quarter or quarters the Company's operating results will be below
the expectations of public market analysts or investors. In such event, the
price of the Company's common stock would likely be materially and adversely
affected.
DEPENDENCE ON SMALL NUMBER OF CUSTOMERS
A small number of customers account for a substantial portion of the
Company's net revenues, and the Company expects that a limited number of
customers will continue to represent a substantial portion of the Company's net
revenues for the foreseeable future. The loss of any of the Company's major
customers would have a material adverse effect on its business, financial
condition and results of operations. In addition, a majority of the Company's
customers order the Company's products through written purchase orders as
opposed to long term supply contracts and, therefore, such customers are
generally not obligated to purchase products from the Company for any specified
period. Major customers also have significant leverage over the Company and may
attempt to change the terms, including pricing, upon which the Company and such
customers do business, which could materially adversely affect the Company's
business, financial condition and results of operations. As the Company's OEM
customers are pressured to reduce prices as a result of competitive factors, the
Company may be required to contractually commit to price reductions for its
products before it knows how, or if, cost reductions can be obtained. If the
Company is unable to achieve such cost reductions, the Company's gross margins
could decline and such decline could have a material adverse effect on the
Company's business, financial condition and results of operations. In addition,
the Company provides its major distributors and certain volume purchasers with
price protection in the event that the Company reduces the prices of its
products. While the Company maintains reserves for such price protection, there
can be no assurance that the impact of future price reductions by the Company
will not exceed the Company's reserves in any specific fiscal period. Any price
protection in excess of recorded reserves could have a material adverse effect
on the Company's business, financial condition and results of operations.
COMPETITION
The markets for both peripheral and host computer products are highly
competitive and are characterized by short product life cycles, price erosion,
rapidly changing technology, frequent product performance improvements and
evolving industry standards. Competition typically occurs at the design stage,
where the customer evaluates alternative design approaches. Because of shortened
product life cycles and even shorter design-in cycles, the Company's competitors
have increasingly frequent opportunities to achieve design wins in next
generation systems. A design win usually ensures a customer will purchase the
product until a higher performance standard is available or a competitor can
demonstrate a significant price/performance advantage. All of the Company's
products compete with products available from several companies, many of which
have substantially greater research and development, long term guaranteed supply
capacity, marketing and financial resources, manufacturing capability and
customer support organizations than those of the Company. The Company believes
that its future operating results will depend, in part, upon its ability to
continue to improve
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product and process technologies and develop new technologies in order to
achieve or maintain the performance advantages of products and processes
relative to competitors, to adapt products and processes to technological
changes, and to identify and adopt emerging industry standards. Because of the
complexity of its products, the Company has experienced delays from time to time
in completing products on a timely basis. If the Company is unable to design,
develop and introduce competitive new products on a timely basis, its future
operating results would be materially and adversely affected.
The Company currently competes primarily with Adaptec, Inc. and Symbios
Logic, Inc. In the Fibre Channel sector of the I/O market, the Company expects
to compete primarily with Adaptec, Inc., Symbios Logic, Inc., Emulex and
Hewlett-Packard Company. In the IDE sector, the Company expects to compete with
Adaptec, Inc. and Cirrus Logic, Inc. The Company may compete with some of its
larger disk drive and computer systems customers, some of which have the
capability to develop I/O controller integrated circuits for use in their
products. At least one large OEM customer in the past decided to vertically
integrate and therefore ceased purchases from the Company.
The Company will need to continue to develop products appropriate to its
markets to remain competitive as its competitors continue to introduce products
with improved performance characteristics. While the Company continues to devote
significant resources to research and development, there can be no assurance
that such efforts will be successful or that the Company will develop and
introduce new technology and products in a timely manner. In addition, while
relatively few competitors offer a full range of SCSI and other I/O products,
additional domestic and foreign manufacturers may increase their presence in,
and resources devoted to, these markets. There can be no assurance that the
Company will compete successfully in the future.
DEPENDENCE ON WAFER SUPPLIERS AND OTHER SUBCONTRACTORS
The Company currently relies on several independent foundries to
manufacture its semiconductor products either in finished form or wafer form.
The Company conducts business with its foundries through written purchase orders
as opposed to long term supply contracts and, therefore, such foundries are
generally not obligated to supply products to the Company for any specific
period, in any specific quantity or at any specified price, except as may be
provided in a particular purchase order as may be accepted by a foundry. To the
extent a foundry terminates its relationship with the Company or should the
Company's supply from a foundry be interrupted or terminated for any other
reason, the Company may not have a sufficient amount of time to replace the
supply of products manufactured by that foundry. During several quarters in the
past there has been a worldwide shortage of advanced process technology foundry
capacity. The manufacture of semiconductor devices is subject to a wide variety
of factors, including the availability of raw materials, the level of
contaminants in the manufacturing environment, impurities in the materials used,
and the performance of personnel and equipment. The Company is continuously
evaluating potential new sources of supply. However, the qualification process
and the production ramp-up for additional foundries has in the past taken, and
could in the future take, longer than anticipated. There can be no assurance
that new supply sources will be able or willing to satisfy the Company's wafer
requirements on a timely basis or at acceptable quality or unit prices. While
the quality, yield and timeliness of wafer deliveries to date have been
acceptable, there can be no assurance that manufacturing yield problems will not
occur in the future.
The Company is using multiple sources of supply for certain of its
products, which may require the Company's customers to perform separate product
qualifications. The Company has not, however, developed alternate sources of
supply for certain other products and its newly introduced products are
typically produced initially by a single foundry until alternate sources can be
qualified. In particular, the Company's integrated single chip Fibre Channel
controller is manufactured by LSI Logic and integrates LSI Logic's transceiver
technology. In the event that LSI Logic is unable or unwilling to satisfy the
Company's requirements for this technology, the Company's attempt to market
Fibre Channel products would be delayed and, as such, its results of operations
could be materially and adversely affected. The requirement that a customer
perform separate product qualifications or a customer's inability to obtain a
sufficient supply of products from the Company may cause that customer to
satisfy its product requirements from the Company's competitors, which would
adversely affect the Company's results of operations.
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The Company's ability to obtain satisfactory wafer and other supplies is
subject to a number of other risks. These risks include, without limit, that the
Company's suppliers may be subject to injunctions arising from alleged
violations of third party intellectual property rights. The enforcement of such
an injunction could impede a supplier's ability to provide wafers, components or
packaging services to the Company. In addition, the Company's flexibility to
move production of any particular product from one foundry to another can be
limited in that such a move can require significant re-engineering, which may
take several quarters. These efforts also divert engineering resources which
otherwise could be dedicated to new product development which would adversely
affect new product development schedules. Accordingly, production may be
constrained even though capacity is available at one or more foundries. In
addition, the Company could encounter supply shortages if sales grow
substantially. The Company uses domestic and offshore subcontractors for die
assembly of its semiconductor products purchased in wafer form, and for assembly
of its host adapter board products. The Company's reliance on independent
subcontractors to provide these services involves a number of risks, including
the absence of guaranteed capacity and reduced control over delivery schedules,
quality assurance and costs. The Company is also subject to the risks of
shortages and increases in the cost of raw materials used in the manufacture or
assembly of the Company's products. In addition, the Company may receive orders
for large volumes of products to be shipped within short periods, and the
Company may not have sufficient testing capacity to fill such orders.
Constraints or delays in the supply of the Company's products, whether because
of capacity constraints, unexpected disruptions at the Company's foundries or
subcontractors, delays in obtaining additional production at the existing
foundries or in obtaining production from new foundries, shortages of raw
materials, or other reasons, could result in the loss of customers and other
material adverse effects on the Company's operating results, including those
that may result should the Company be forced to purchase products from higher
cost foundries or pay expediting charges to obtain additional supply.
TRANSACTIONS TO OBTAIN MANUFACTURING CAPACITY; FUTURE CAPITAL NEEDS
Although the Company is currently not experiencing any difficulties in
obtaining sufficient foundry capacity due to the current abundance of worldwide
semiconductor fabrication capacity, the Company and the semiconductor industry
have in the past experienced shortages of available foundry capacity.
Accordingly, in order to secure an adequate supply of wafers, especially wafers
manufactured using advanced process technologies, the Company may consider
various possible transactions, including the use of "take or pay" contracts that
commit the Company to purchase specified quantities of wafers over extended
periods, or equity investments in or advances to wafer manufacturing companies
in exchange for guaranteed production capacity, or the formation of joint
ventures to own and operate or construct foundries or to develop certain
products. Any of these transactions would involve financial risk to the Company
and could require the Company to commit substantial capital or provide
technology licenses in return for guaranteed production capacity.
RELIANCE ON HIGH PERFORMANCE COMPUTER AND COMPUTER PERIPHERAL MARKET
A significant portion of the Company's host adapter board products are
currently used in high-performance file servers, workstations and other office
automation products. The Company's growth has been supported by increasing
demand for sophisticated I/O solutions which support database systems, servers,
workstations, Internet/intranet applications, multimedia and telecommunications.
Should there be a slowing in the growth of demand for such systems, the
Company's business, financial condition and results of operations could be
materially and adversely affected.
As a supplier of controller products to manufacturers of computer
peripherals such as disk drives and other data storage devices, a portion of the
Company's business is dependent on the overall market for computer peripherals.
This market, which itself is dependent on the market for computers, has
historically been characterized by periods of rapid growth followed by periods
of oversupply and contraction. As a result, suppliers to the computer
peripherals industry from time to time experience large and sudden fluctuations
in demand for their products as their customers adjust to changing conditions in
their markets. If these fluctuations are not accurately anticipated, such
suppliers, including the Company, could produce excessive or
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insufficient inventories of various components which could have a material
adverse effect on the Company's business, financial condition and results of
operations.
RAPID TECHNOLOGICAL CHANGE; DEPENDENCE ON NEW PRODUCTS; INDUSTRY STANDARDS
The markets in which the Company and its competitors compete are
characterized by rapidly changing technology, evolving industry standards and
continuing improvements in products and services. The Company's future success
depends on its ability to enhance its current products and to develop and
introduce in a timely manner new products that keep pace with technological
developments and industry standards, compete effectively on the basis of price
and performance, adequately address OEM customer and end-user customer
requirements and achieve market acceptance. The Company believes that to remain
competitive in the future it will need to continue to develop new products,
which will require the investment of significant financial resources in new
product development. In anticipation of the implementation of Fibre Channel data
transfer interface technologies, the Company has invested and will continue to
invest significant resources in developing its integrated circuit single chip
PCI to Fibre Channel controllers. There can be no assurance that Fibre Channel
will be adopted as a predominant industry standard. The Company is aware of
products for alternative I/O standards and enabling technologies being developed
by its competitors. The Company believes that certain competitors, including
Symbios Logic, Inc., have extensive development efforts related to products
based on the Low Voltage Differential ("LVD") technology. There can be no
assurance that such technology will not be adopted as an industry standard and
if an alternative standard is adopted, there can be no assurance the Company
will timely develop products for such standard. Further, even if Fibre Channel
is adopted, there can be no assurance that the Company's integrated PCI to Fibre
Channel controller will be fully developed in time to be accepted for use in
Fibre Channel technology or that, if developed, it will achieve market
acceptance, or be capable of being manufactured at competitive prices in
sufficient volumes. In the event that Fibre Channel is not adopted as an
industry standard, or that the Company's integrated circuit PCI to Fibre Channel
controllers are not timely developed or do not gain market acceptance, the
Company's business, financial condition and results of operations could be
materially and adversely affected.
The computer industry is characterized by various standards and protocols
that evolve with time. The Company's current products are designed to conform to
certain industry standards and protocols such as IDE, SCSI, Ultra SCSI and PCI.
In addition, the Company's Fibre Channel products have been designed to conform
with a standard that has yet to be uniformly adopted. The Company's products
must be designed to operate effectively with a variety of hardware and software
products supplied by other manufacturers, including microprocessors, operating
system software and peripherals. The Company depends on significant cooperation
with these manufacturers in order to achieve its design objectives and produce
products that interoperate successfully. While the Company believes that it
generally has good relationships with leading microprocessor, systems and
peripheral suppliers, there can be no assurance that such suppliers will not
from time to time make it more difficult for the Company to design its products
for successful interoperability. If industry acceptance of these standards was
to decline or if they were replaced with new standards, and if the Company did
not anticipate these changes and develop new products, the Company's business,
financial condition and results of operations could be materially and adversely
affected.
The Company could experience delays in product development that are common
in the computer and semiconductor industry. Significant delays in product
development and release would adversely affect the Company's business, financial
condition and results of operations. There can be no assurance that the Company
will respond effectively to technological changes or new product announcements
by other companies or that the Company's research and development efforts will
be successful. Furthermore, introduction of new products and moving production
of existing products to different suppliers involves substantial business risks
because of the possibility of product "bugs" or performance problems, in which
event the Company could experience significant product returns, warranty
expenses and expedite charges, in addition to lower sales and lower profits.
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IDENTIFICATION AND INTEGRATION OF ACQUISITIONS
The Company anticipates that its future growth may depend in part on its
ability to identify and acquire complementary businesses, technologies or
product lines that are compatible to those of the Company. Acquisitions involve
numerous risks, including identifying and pursuing acquisitions, difficulties in
the assimilation of the operations, technologies and products of the acquired
companies, the diversion of management's attention from other business concerns,
risks associated with entering markets or conducting operations with which the
Company has no or limited direct prior experience, and the potential loss of key
employees of the acquired company. Moreover, there can be no assurance that the
anticipated benefits of an acquisition will be realized. There can be no
assurance that the Company will be effective in identifying and effecting
attractive acquisitions, assimilating acquisitions or managing future growth.
Future acquisitions by the Company could result in potentially dilutive
issuances of equity securities, the incurrence of debt and contingent
liabilities and amortization expenses related to goodwill and other intangible
assets, all of which could materially adversely affect the Company's business,
financial condition, results of operations or stock price.
DEPENDENCE ON KEY PERSONNEL
The Company's future success is highly dependent on the continued services
of its key engineering, sales, marketing and executive personnel, including
highly skilled semiconductor design personnel and software developers, and its
ability to identify and hire additional personnel. The loss of the services of
key personnel could have a material adverse effect on the Company's business,
financial condition and results of operations. The Company believes that the
market for key personnel in the industries in which it competes is highly
competitive. In particular, the Company has experienced difficulty in attracting
and retaining qualified engineers and other technical personnel and anticipates
that competition for such personnel will increase in the future. There can be no
assurance that the Company will be able to attract and retain key personnel with
the skills and expertise necessary to develop new products in the future, or to
manage the Company's business, both in the United States and abroad.
RISKS OF DOING BUSINESS IN INTERNATIONAL MARKETS
The Company expects that export revenues will continue to account for a
significant percentage of the Company's net revenues for the foreseeable future.
As a result, the Company is subject to various risks, which include: a greater
difficulty of administering its business globally; compliance with multiple and
potentially conflicting regulatory requirements such as export requirements,
tariffs and other barriers; differences in intellectual property protections;
difficulties in staffing and managing foreign operations; potentially longer
accounts receivable cycles; currency fluctuations; export control restrictions;
overlapping or differing tax structures; political and economic instability; and
general trade restrictions. The Company's export sales are invoiced in U.S.
dollars and, accordingly, if the relative value of the U.S. dollar in comparison
to the currency of the Company's foreign customers should increase, the
resulting effective price increase of the Company's products to such foreign
customers could result in decreased sales. There can be no assurance that any of
the foregoing factors will not have a material adverse effect on the Company's
business, financial condition and results of operations.
LACK OF SIGNIFICANT PATENT PROTECTION; INFRINGEMENT RISKS
Although the Company has patent protection on certain aspects of its
technology in certain jurisdictions, it relies primarily on trade secrets,
copyrights and contractual provisions to protect its proprietary rights. There
can be no assurance that these protections will be adequate to protect its
proprietary rights, that others will not independently develop or otherwise
acquire equivalent or superior technology or that the Company can maintain such
technology as trade secrets. There also can be no assurance that any patents the
Company possesses will not be invalidated, circumvented or challenged. In
addition, the laws of certain countries in which the Company's products are or
may be developed, manufactured or sold, including various countries in Asia, may
not protect the Company's products and intellectual property rights to the same
extent as the laws
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of the United States or at all. The failure of the Company to protect its
intellectual property rights could have a material adverse effect on the
Company's business, financial condition and results of operations.
There can be no assurance that patent or other intellectual property
infringement claims will not be asserted against the Company in the future.
Although patent and intellectual property disputes may be settled through
licensing or similar arrangements, costs associated with such arrangements may
be substantial and there can be no assurance that necessary licenses or similar
arrangements would be available to the Company on satisfactory terms or at all.
Accordingly, an adverse determination in a judicial or administrative proceeding
or failure to obtain necessary licenses could prevent the Company from
manufacturing and selling certain of its products, which would have a material
adverse effect on the Company's business, financial condition and results of
operations. In addition, should the Company decide to, or be forced to, litigate
such claims, such litigation could be expensive and time consuming, could divert
management's attention from other matters or could otherwise have a material
adverse effect on the Company's business, financial condition and results of
operations, regardless of the outcome of the litigation. The Company's supply of
wafers and other components can also be interrupted by intellectual property
infringement claims against its suppliers.
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PART II. OTHER INFORMATION
On September 23, 1997, the Board of Directors adopted an amendment to the
Rights Agreement dated June 4, 1996 under the Company's Shareholder Rights Plan
to increase the Purchase Price for each one-one hundredth of a share of
preferred stock pursuant to the exercise of a Right from $45.00 to $225.00. The
Board of Directors had determined that, due to increases in the trading prices
of the Company's Common Stock and other factors that it deemed relevant, the
$45.00 Purchase Price would no longer serve as an adequate deterrent to the
abusive takeover practices the Shareholder Rights Plan is intended to deter. In
addition, the Board further amended the Rights Agreement to provide that any
future amendment would only be effective if approved by continuing members of
the Company's Board of Directors, or their designees. This provision is intended
to prevent an unfriendly acquirer of the Company from seizing control of the
Board of Directors and them amending the Rights Agreement for its own benefit.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27 Financial Data Schedule
(b) Reports on Form 8-K
The registrant has not filed any reports on Form 8-K during the
quarter for which this report is filed.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Date: February 9, 1998
QLOGIC CORPORATION
By: /s/ H.K. DESAI
------------------------------------
H.K. Desai
President and Chief Executive
Officer
By: /s/ THOMAS R. ANDERSON
------------------------------------
Thomas R. Anderson
Vice President and Chief Financial
Officer (Principal Financial and
Accounting Officer)
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EXHIBIT INDEX
EXHIBIT
NO.
- -------
27 Financial Data Schedule