1
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
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 JUNE 28, 1998
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. 0-23298
QLOGIC CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 33-0537669
(State or other jurisdiction (I.R.S. Employer
of incorporation or 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 July 26, 1998, the registrant had 8,706,744 shares of common stock
outstanding.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
2
QLOGIC CORPORATION
INDEX
PAGE
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets -- June 28, 1998 and
March 29, 1998.............................................. 3
Condensed Consolidated Statements of Income -- three months
ended June 28, 1998 and June 29, 1997....................... 4
Condensed Consolidated Statements of Cash Flows -- three
months ended June 28, 1998 and June 29, 1997................ 5
Notes to Condensed Consolidated Financial Statements........ 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 7
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K............................ 17
2
3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
QLOGIC CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
ASSETS
JUNE 28, MARCH 29,
1998 1998
-------- ---------
Cash and cash equivalents................................... $ 51,550 $ 64,090
Short term investments...................................... 34,941 27,746
Accounts and notes receivable, net.......................... 5,869 7,836
Inventories................................................. 8,893 3,835
Deferred income taxes....................................... 4,217 4,353
Prepaid expenses and other current assets................... 482 475
-------- --------
Total current assets.............................. 105,952 108,335
Long term investments....................................... 28,188 20,934
Property and equipment, net................................. 8,340 6,372
Other assets................................................ 250 601
-------- --------
$142,730 $136,242
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable............................................ $ 4,302 $ 3,765
Accrued expenses............................................ 14,829 13,610
Current installments of capitalized lease obligations....... 212 211
-------- --------
Total current liabilities......................... 19,343 17,586
Capitalized lease obligations, excluding current
installments.............................................. 89 141
Other non-current liabilities............................... -- 466
-------- --------
Total liabilities................................. 19,432 18,193
Commitments and contingencies
Stockholders' equity:
Preferred stock, $.10 par value; 1,000,000 shares
authorized (200,000 shares designated as Series A
Junior Participating Preferred, $0.001 par value); none
issued and outstanding................................. -- --
Common stock $.10 par value; 12,500,000 shares authorized;
8,677,043 and 8,650,826 shares issued and outstanding
at June 28, 1998 and March 29, 1998 respectively....... 867 865
Additional paid-in capital................................ 99,480 99,008
Retained earnings......................................... 22,951 18,176
-------- --------
Total stockholders' equity........................ 123,298 118,049
-------- --------
$142,730 $136,242
======== ========
See accompanying notes to condensed consolidated financial statements.
3
4
QLOGIC CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED
-------------------
JUNE 28, JUNE 29,
1998 1997
-------- --------
Net revenues................................................ $24,115 $18,172
Cost of sales............................................... 9,703 7,840
------- -------
Gross profit.............................................. 14,412 10,332
------- -------
Operating expenses
Engineering and development............................... 4,941 3,528
Selling and marketing..................................... 2,375 2,082
General and administrative................................ 1,208 1,355
------- -------
Total operating expenses.......................... 8,524 6,965
------- -------
Operating income.................................. 5,888 3,367
Interest income, net........................................ 1,349 282
------- -------
Income before income taxes................................ 7,237 3,649
Income tax provision........................................ 2,462 1,405
------- -------
Net income.................................................. $ 4,775 $ 2,244
======= =======
Basic earnings per common share............................. $ 0.55 $ 0.38
======= =======
Diluted earnings per share.................................. $ 0.52 $ 0.35
======= =======
Common shares used in the calculations of basic
earnings per share........................................ 8,665 5,864
======= =======
Shares used in the calculations of diluted earnings
per share................................................. 9,168 6,333
======= =======
See accompanying notes to condensed consolidated financial statements.
4
5
QLOGIC CORPORATION AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
-------------------
JUNE 28, JUNE 29,
1998 1997
-------- --------
Cash flows from operating activities:
Net income................................................ $ 4,775 $ 2,244
Adjustments to reconcile net income to net cash provided
by
operating activities:
Depreciation and amortization.......................... 679 595
Provision for doubtful accounts........................ -- 196
Loss on disposal of property and equipment............. 29 127
Provision for (benefit from) deferred income taxes..... 136 (685)
Changes in assets and liabilities:
Accounts and notes receivables............................ 1,967 1,122
Inventories............................................... (5,058) (1,066)
Prepaid expenses and other current assets................. (7) (76)
Other assets.............................................. 351 (514)
Accounts payable.......................................... 538 (28)
Accrued expenses.......................................... 1,435 2,515
Other non-current liabilities............................. (466) --
-------- -------
Net cash provided by operating activities......... 4,379 4,430
-------- -------
Cash flows from investing activities:
Additions to property and equipment....................... (2,676) (490)
Purchases of investments.................................. (23,883) --
Maturities and sales of investments....................... 9,434 --
-------- -------
Net cash used in investing activities.................. (17,125) (490)
-------- -------
Cash flows from financing activities:
Principal payments under capital leases................... (51) (58)
Proceeds from exercise of stock options................... 257 162
-------- -------
Net cash provided by financing activities.............. 206 104
-------- -------
Net increase (decrease) in cash and cash equivalents........ (12,540) 4,044
Cash and cash equivalents at beginning of period............ 64,090 19,091
-------- -------
Cash and cash equivalents at end of period.................. $ 51,550 $23,135
======== =======
Cash paid during the period for:
Interest.................................................. $ 13 $ 25
======== =======
Income taxes.............................................. $ 191 $ --
======== =======
Non-cash financing activities:
During the quarter ended June 28, 1998, pursuant
to Statement of Financial Accounting Standards No.
109 "Accounting For Income Taxes", the Company
recorded a credit to paid-in-capital and a debit to
accrued taxes payable of $217 related to the tax
benefit of exercises of stock options under the
Company's various stock option plans.
See accompanying notes to condensed consolidated financial statements.
5
6
QLOGIC CORPORATION AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS)
NOTE (1) BASIS OF PRESENTATION
In the opinion of QLogic Corporation ("QLogic" or 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 June 28, 1998 the results of operations for the
three months ended June 28, 1998 and June 29, 1997 and the statements of cash
flows for the three months ended June 28, 1998 and June 29, 1997. The results of
operations for the three month period ended June 28, 1998 are not necessarily
indicative of the results to be expected for the entire fiscal year. Certain
items previously reported in specific financial statement captions have been
reclassified to conform with the current presentation.
NOTE (2) INVENTORIES
Components of inventories are as follows:
JUNE 28, MARCH 29,
1998 1998
-------- ---------
Raw materials............................................... $6,667 $2,720
Work in process............................................. 2,132 585
Finished goods.............................................. 94 530
------ ------
$8,893 $3,835
====== ======
NOTE (3) NET INCOME PER SHARE
In the quarter ended December 28, 1997, the Company adopted Statement of
Financial Accounting Standards (SFAS) 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 June 28, 1998 and June 29, 1997, were
8,665 and 5,864, 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 June 28, 1998 and June 29, 1997 were 9,168 and
6,333, respectively.
The Adoption of SFAS No. 128 did not have a material impact on the
Company's financial statements.
Options to purchase 29,469 and 35,739 shares of common stock with exercise
prices that exceed the average market price of $41.55 and $23.37 during the
three months ended June 28, 1998 and June 29, 1997, respectively, were excluded
from the calculation of diluted EPS because their inclusion would have been
anti-dilutive.
6
7
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," as well as those discussed elsewhere in this report. All
figures are in thousands except as otherwise noted.
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
-------------------------------------
JUNE 28, 1998 JUNE 29, 1997
---------------- -----------------
Net revenue....................................... $24,115 100.0% $18,172 100.0%
Cost of sales..................................... 9,703 40.2 7,840 43.1
------- ------ ------- -------
Gross profit.................................... 14,412 59.8 10,332 56.9
------- ------ ------- -------
Operating expenses:
Engineering and development..................... 4,941 20.5 3,528 19.4
Selling and marketing........................... 2,375 9.9 2,082 11.5
General and administrative...................... 1,208 5.0 1,355 7.4
------- ------ ------- -------
Total operating expenses................ 8,524 35.4 6,965 38.3
------- ------ ------- -------
Operating income................................ $ 5,888 24.4% $ 3,367 18.6%
======= ====== ======= =======
NET REVENUES
The Company's net revenues are derived from the sale of fibre channel and
SCSI-based I/O products. License fees also contribute to the Company's net
revenues. Net revenues for three months ended June 28, 1998 increased $5.9
million or 33% from the three months ended June 29, 1997 to $24.1 million. The
increase was primarily the result of an increase in sales of the TEC, Host Board
product lines, and Other revenue of $4.2 million, $3.1 million and $0.5 million,
respectively. A partially offsetting decline in sales of $1.5 million, $0.3
million and $0.1 million occurred in the ISP product line, the FAS product line
and in license fees, respectively.
Export revenues for three months ended June 28, 1998 increased $7.6 million
or 143% from the three months ended June 29, 1997. The increase was primarily
the result of a $5.1 million increase in sales to Japanese customers, and a $2.3
million increase in sales to Europe. The Company's principal markets are in
Japan, the United States, the United Kingdom and Malaysia. The Company's export
revenue during the three months ended June 28, 1998 was $12.8 million, or 53% of
net revenues. Export shipments to Japan amounted to approximately 84% of total
exports. The Company's largest Japanese customers are Fujitsu Limited, Hitachi
Limited and Servants International. During the three months ended June 28, 1998,
sales to Japan decreased 5.2 percent from the quarter ended March 29, 1998.
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.
The Company believes that its major customers continually evaluate whether
or not to purchase products from alternate or additional sources. Additionally,
customers' economic and market conditions frequently
7
8
change. Accordingly, there can be no assurance that a major customer will not
reduce, delay or eliminate its purchases from the Company. Any such reduction,
delay or loss of purchases could have a material adverse effect on the Company's
business, financial condition and results of operations.
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 June 28, 1998 was 40.2 percent, a decrease of 2.9 percent from the similar
period in the prior fiscal year. The percentage decrease was due to a
combination of increased production volumes, manufacturing efficiencies, and a
shift in product mix to products with lower unit costs. 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 further reduce manufacturing costs. 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 the
cost of sales percentage to decrease at a rate consistent with historic trends
and there can be no assurance that the Company will be able to maintain or
improve its gross margin in subsequent quarters.
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 June 28,
1998, engineering and development expenditures increased by $1.4 million from
the same period in fiscal 1998, primarily due to increased salary, new equipment
depreciation and new product development expenses. In particular, the Company
significantly expanded its engineering staff in the three months ended June 28,
1998, from the similar period in the prior fiscal year. The Company expects that
engineering and development expenses will increase in absolute dollars in fiscal
1999.
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 June
28, 1998, selling and marketing expenses increased by $0.3 million from the
similar period in the prior fiscal year, primarily as a result of salary and
advertising expenses.
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 June 28, 1998,
general and administrative expenses decreased $0.1 million from the similar
period in the prior fiscal year.
INTEREST INCOME (EXPENSE)
Net interest income increased $1.1 million during the three months ended
June 28, 1998 from the three months ended June 29, 1997, primarily due to larger
balances of cash, cash equivalents, and investments.
INCOME TAX PROVISION
The Company's effective tax rates were 34% and 39% for the three months
ended June 28, 1998 and June 29, 1997, respectively. The tax rate was reduced
primarily because of higher research and experimentation expenditures resulting
in a higher research and experimentation credit and a portion of the Company's
short term and long term investments were made in tax-exempt securities.
8
9
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. Adoption of
this new standard in fiscal 1999 will not have a significant impact 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. Adoption of this new standard in
fiscal 1999 will not have a significant impact on the consolidated financial
statements.
LIQUIDITY AND CAPITAL RESOURCES
QLogic has financed its working capital needs and capital expenditure
requirements from internally generated funds, facilities and equipment leases
and financing activities. Cash provided by operations was $4.4 million for the
three months ended June 28, 1998, and for the three months ended June 29, 1997.
Cash used in investing activities was $17.1 million for the three months
ended June 28, 1998, reflecting expenditures for property, equipment and
investments, partially offset by maturities and sales of investments.
Cash provided by financing activities was $0.2 million for the three months
ended June 28, 1998, which reflected proceeds from the exercise of stock
options, offset in part by principal payments under capital lease liabilities.
Working capital at June 28, 1998 was $86.6 million, as compared to $90.7
million at March 29, 1998. At June 28, 1998, the Company's principal sources of
liquidity included cash and cash equivalents of $51.6 million and short term
investments of $34.9 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
Company's line of credit as of June 28, 1998. The line of credit with Silicon
Valley Bank expires July 5, 1999, and, although there can be no assurance, the
Company currently expects to renew this line of credit.
The Company believes that existing cash and cash equivalent balances, short
term investments, facilities and equipment leases, and cash flows from operating
activities will provide the Company with sufficient funds to finance its
operations for at least the next 12 months.
YEAR 2000
Many existing computer systems and applications, and other control devices,
use only two digits to identify a year in the date field, without considering
the impact of the upcoming change in the century. As a result, such systems and
applications could fail or create erroneous results unless corrected so that
they can process data related to the year 2000. The Company relies on its
systems, applications and devices in operating and monitoring all major aspects
of its business, including financial systems (such as general ledger, accounts
payable, and payroll modules), customer services, infrastructure, embedded
computer chips, networks and telecommunications equipment and end products.
The Company is in the process of upgrading its software to address the year
2000 issue. Because a large portion of the Company's software is obtained from
its vendors on a non-custom basis, the Company believes that upgrades for its
commercial programs are currently available. The Company currently estimates
that the costs associated with the year 2000 issue, and the consequences of
incomplete or untimely resolution of the year 2000 issue, will not have a
material adverse effect on the results of operations or financial position of
the Company in any given year. The Company also relies, directly and indirectly,
on external systems of business enterprises such as customers, suppliers,
creditors, financial organizations, and of governmental entities, both domestic
and international, for accurate exchange of data. Even if the internal systems
of the Company are not materially affected by the year 2000 issue, the Company
could be affected through disruptions in the operation of the enterprises with
which the Company interacts. Despite the Company's efforts to address the year
2000 impact on its internal systems and business operations, there can be no
assurance that such impact will not result in material disruption of its
business or have a material adverse effect on the Company's business, financial
condition or results of operations. The Company is in the process of
establishing a year 2000 contingency plan to be completed by March 28, 1999.
9
10
RISK FACTORS
Except for the historical information contained herein, the information in
this report constitutes forward-looking statements. When used in this report 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 report.
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 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 effected.
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 effecting 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 effected 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
effected.
10
11
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 extended
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 effect 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 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 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, it would have material adverse effect on future operating results.
The Company currently competes primarily with Adaptec, Inc. and Symbios
Logic, Inc. in the SCSI sector of the I/O market. In the Fibre Channel sector of
the I/O market, the Company expects to compete primarily with Adaptec, Inc.,
Symbios Logic, Inc., Emulex Corporation and Hewlett-Packard Company. LSI Logic,
Corporation recently made a bid to acquire Symbios. 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
11
12
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. Until recently, 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. LSI Logic recently made a bid to acquire Symbios. In the event that
LSI Logic is unable or unwilling to satisfy the Company's requirements for this
technology, the Company's marketing efforts related to Fibre Channel products
would be delayed and, as such, its results of operations could be materially and
adversely effected. 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 effect the
Company's results of operations.
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
effect 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
12
13
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 effected.
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 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
13
14
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, 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 effected.
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
to 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
effected.
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 effect 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.
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 with 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 issuance's 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 effect the Company's
business, financial condition, results of operations or stock price. With
respect to the possible amortization of goodwill, the Financial Accounting
Standards Board ("FASB") is considering making pooling of interests accounting
treatment for merger transactions more difficult to attain, or may abolish such
treatment altogether. If the FASB does limit or eliminate pooling of interests
accounting treatment, the Company's ability to consummate merger transactions
without incurring goodwill would be materially and adversely effected.
14
15
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. 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, have led to widespread financial difficulty among the
companies in this region. 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 or the currency and economic disruptions in the Asian
markets 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 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.
The Company has experienced intellectual property claims being made against
it in the past. 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
15
16
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.
YEAR 2000
Many existing computer systems and applications, and other control devices,
use only two digits to identify a year in the date field, without considering
the impact of the upcoming change in the century. As a result, such systems and
applications could fail or create erroneous results unless corrected so that
they can process data related to the year 2000. The Company relies on its
systems, applications and devices in operating and monitoring all major aspects
of its business, including financial systems (such as general ledger, accounts
payable and payroll modules), customer services, infrastructure, embedded
computer chips, networks and telecommunications equipment and end products.
The Company is in the process of upgrading its software to address the year
2000 issue. Because a large portion of the Company's software is obtained from
its vendors on a non-custom basis, the Company believes that upgrades for its
commercial programs are currently available. The Company currently estimates
that the costs associated with the year 2000 issue, and the consequences of
incomplete or untimely resolution of the year 2000 issue, will not have a
material adverse effect on the results of operations or financial position of
the Company in any given year. The Company also relies, directly and indirectly,
on external systems of business enterprises such as customers, suppliers,
creditors, financial organizations, and of governmental entities, both domestic
and international, for accurate exchange of data. Even if the internal systems
of the Company are not materially affected by the year 2000 issue, the Company
could be affected through disruptions in the operation of the enterprises with
which the Company interacts. Despite the Company's efforts to address the year
2000 impact on its internal systems and business operations, there can be no
assurance that such impact will not result in a material disruption of its
business or have a material adverse effect on the Company's business, financial
condition or results of operations. The Company is in the process of
establishing a year 2000 contingency plan to be completed by March 28, 1999.
16
17
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.10 Loan and Security Agreement with Silicon Valley Bank
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.
17
18
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: August 10, 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)
18
19
EXHIBIT INDEX
EXHIBIT
NO. DESCRIPTION
- ------- -----------
10.10 Loan and Security Agreement with Silicon Valley Bank
27 Financial Data Schedule