Qlogic Q1FY10 Earnings: Growth Engine Needed

Yesterday Qlogic announced first quarter revenues of $122.8 million for the period ended June 29, 2008. That's at the low-end of the previous guidance of $120-130 million and down 27% year-over-year.

Since peaking at $171.2 million in Q2FY09, Qlogic revenues have declined for the third consecutive quarter by a total of $48.4 million.   In my opinion the magnitude of the decline is an indicator that it's not all due to "the macro." I believe slowing Qlogic revenues also reflect the continuous decline of the Fibre Channel market thus the need for the company to build or buy an engine for growth.

The emphasis of the Qlogic conference call was continued profitability, the stabilization of orders and a bright future featuring contributions from FCoE products.

Qlogic deserves credit for delivering an astounding 56th consecutive quarter of profitability and another quarter of solid earnings per share. In addition, the company still has a strong cash position of almost $400 million and no debt.  With that much cash, the company can operate for years without any growth. However, it is worth noting that earnings per share have been achieved in large part with draconian cost-cutting and by retiring shares with approximately $1 billion in stock buy backs.  If the trend of declining revenue persists, it will seem obvious the company should have balanced EPS and growth in their investment strategy.  And right about then I expect QLogic will most appreciate how nice it would be to have $1 billion for technology and new sources of revenue.

During the call Qlogic management mentioned that orders were stabilizing and provided guidance for next quarter of flat-to-up 3%.  They also mentioned their market share lead in SAN adapters was the widest ever.  Reading between the lines, I see Qlogic's growth strategy focused on taking share from Emulex because inside of a shrinking global economy is a shrinking Fibre Channel market. Interestingly, the revamped Emulex management team including COO Jeff Benck was appointed specifically to turn this tide. And if Emulex doesn't make it harder for Qlogic to eek out some growth in Fibre Channel HBAs, Brocade will. After successfully qualifying their HBAs with several major OEMs, Brocade has turned on their huge sales force to convert those design wins into revenue.

Qlogic talked extensively about design wins for their Fibre Channel over Ethernet products, implying these products are their engine for growth. I admit it's possible the leader in the approximately 2 million ports a year Fibre Channel HBA market can overtake the incumbents in the over 100 million ports a year Ethernet LOM/NIC market, but it's an uphill climb of epic proportions.  As you can see by the sizes of the markets, FCoE will play a small role in unified networks based on CEE.  Getting traction with CNAs with early adopters for storage applications by no means guarantees success in the broader market for CEE NIC and LOM used for data networking.

I agree with Qlogic that early adopters of these first generation converged network adapters will buy CNAs for storage networking and will favor their existing Fibre Channel HBA vendors. Unfortunately I expect the Ethernet LOM/NIC leaders to unveil CNAs some time in the near future based on proven LOM/NIC designs for data networking.  This will be accompanied by collaboration between server, OS and NIC/LOM vendors to commoditize FCoE stacks by embedding them in the operating systems.  By the time CNAs achieve meaningful volume; OEMs and end users will be deploying CNAs primarily for data networking and most likely will favor their existing NIC vendors.

FCoE is an extension of the Ethernet market designed to assimilate connectivity to Fibre Channel storage.  It is not an extension of the Fibre Channel market.  QLogic should realize this and build or buy another engine for growth.