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QLogic Plunges 23%: Bulls Stunned by Server Shortfall; Cisco, HP at Risk?
By Tiernan Ray
Shares of storage system connector maker QLogic (QLGC) are down $3.21, or 23%, at $10.77, after the stock was halted this morning before the company announced it was slashing its outlook for the June-ending fiscal Q1, citing “lower than expected demand due to general weakness in the Company’s traditional enterprise server and storage markets, and a build-up of inventory at certain of its OEM customers due to a slower next-generation server transition in enterprise environments.”
The company is a supplier to numerous firms, including Hewlett-Packard (HPQ) and Cisco Systems (CSCO). The news is not affecting them, however, this morning, with HP up fractionally at $30.56, and Cisco up 0.7% at $27.17.
The company now sees revenue of about $113 million, below its previously forecast range of $124 million to $132 million, and below consensus for $128 million. EPS is seen in a range of 16 cents to 17 cents, below the prior view of 23 cents to 27 cents, and below consensus of 25 cents.
QLogic’s CEO, Prasad Rampalli, remarked that the company was “disappointed with the level of business activity during the quarter,” adding,
We will work through these headwinds, leveraging our technologies and solutions to expand our addressable market opportunities. We believe QLogic is well positioned to capitalize on these opportunities in the data center.
The company plans to discuss the quarter in greater depth on July 30th.
Bulls on the Street are a little stunned by all this, it would seem, and not entirely clear what is going on.
BMO Capital’s Keith Bachman, who has an Outperform rating on the shares, and a $15.50 price target, writes that weakness in servers is a shocker:
Unlike hard drives, in which we think most investors expect very weak results, we think most data points around servers have been ok while storage data points have been mixed, and thus we think investors were generally expecting an in-line type of June quarter from QLGC, or at least within the range.
Bachman is perplexed by the issue of inventory, and the steep, steep drop in sales:
The issue we are not clear about is the role inventory at OEMs played in the negative pre-announcement. Based on expected revenues of $113 million for the June Q, this would suggest a q/q revenue decline of 15%. While QLGC results tend to have volatile quarterly patterns, including the run off of legacy businesses, over the past four years June revenues have averaged a 1% q/q decline. Hence, our first take is that inventory reductions must have had a meaningful impact.
Raymond James analysts Mitch Steves, who has an Outperform rating on the stock, and a $17 price target, thinks this is about a breakdown in fiber channel networking
We have seen negative data points in the overall server market and think the miss is likely attributable to Fibre Channel demand. With this dynamic in mind, Ethernet revenue could increase as a percentage of total Advanced Connectivity revenue. With lower gross margins in the 40% range, we think it is prudent to anticipate EPS of $0.16 at the lower end of the recent pre-announcement.
He notes how many enterprise vendors are potentially affected:
QLGC’s top 3 customers include: HPQ 27% revenue exposure, Dell at 17% and IBM at 11% as of FY15. In addition, the Company provides solutions to Cisco, EMC, Fujitsu, Huawei, Inspur, Lenovo, NetApp and Oracle. QLGC’s top 10 customers represent 81% of total revenue and we believe this is a slight negative for companies exposure to traditional enterprise server and storage markets. Finally, Emulex is QLGC’s nearest competitor and who was recently acquired by AVGO.
Srini Nandury with Summit Research, who has a Buy rating on Logic, writes that he thinks things likely got worse in June, and that the customer that’s clearing inventory is probably Lenovo (0992HK), which has “issues in China and general weakness in Europe.” Things will get worse before they get better, he writes:
We believe the inventory build up will take at least a quarter or two to wind down and Qlogic will likely lower next quarter’s estimates well below consensus. Therefore, we expect a steep sell off of the stock and the stock could be down to $10 levels presenting an attractive buying opportunity for investors with a stomach to hang in here.
Richard Kugele of Needham & Co., who doesn’t follow QLogic, but who follows shares of customers such as Hewlett, writes that it’s not clear if this is just individual customer issues, or signs of a broader IT slowdown:
While some level of company-specific factors can’t be discounted in the pre, we believe the perception will be that this miss is a negative for x86 server players (which would include HPQ and SMCI) within our universe. In terms of HPQ, the company is the largest x86 server player in the world with over 25% market share. If the transition to Grantley is suddenly slower mid-year than some companies expected, that would be interpreted as negative for HP’s server line. Similarly, for SMCI, Grantley represented roughly 50% of shipments in the March ending quarter. A gradual increase in that percentage was expected over time (cycle typically lasts 12-18 months), particularly around the expiration of Windows 2003 Server this month. Alternate View: We note that at SNX’s recent analyst day last week, servers were cited as an opportunity given the refresh and no weakness in the business was noted. Additionally, using QLGC as a proxy for SMCI performance in recent years would have been consistently inaccurate. So data points are not all pointing in the same direction as QLGC. Is this weakness part of a broader slowdown in enterprise IT spending? Are macro concerns leading to an incremental pause as buyers wait to see if the US is impacted more directly by the mess in Europe or China? Earnings season will have to sort out these questions.
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