-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, LYE9nItDg+1T9eJyg8OTE6o18NTx+c6jYJ6tfDxp3GZ4GYucgycB07Ei+vzCMz+/ GK9sShOIREmiCJxLaD4ZMg== 0000892569-98-001815.txt : 19980619 0000892569-98-001815.hdr.sgml : 19980618 ACCESSION NUMBER: 0000892569-98-001815 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19980329 FILED AS OF DATE: 19980617 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: QLOGIC CORP CENTRAL INDEX KEY: 0000918386 STANDARD INDUSTRIAL CLASSIFICATION: SEMICONDUCTORS & RELATED DEVICES [3674] IRS NUMBER: 330537669 STATE OF INCORPORATION: DE FISCAL YEAR END: 0330 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-23298 FILM NUMBER: 98649750 BUSINESS ADDRESS: STREET 1: 3545 HARBOR BLVD CITY: COSTA MESA STATE: CA ZIP: 92626 BUSINESS PHONE: 7144382200 MAIL ADDRESS: STREET 1: 3545 HARBOR BOULEVARD CITY: COSTA MESA STATE: CA ZIP: 92626 FORMER COMPANY: FORMER CONFORMED NAME: Q LOGIC CORP DATE OF NAME CHANGE: 19940201 - -----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, P/YxJwbRWZcB7xYSrKOc2HEaUaeQDfZgP1yT+3uCOrC5hDJeETUPNlv5tkK6T9Jo lRPW+fcgPODpHCTCyf4/sw== 0000892569-98-001815.txt : 19980618 0000892569-98-001815.hdr.sgml : 19980618 ACCESSION NUMBER: 0000892569-98-001815 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19980329 FILED AS OF DATE: 19980617 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: QLOGIC CORP CENTRAL INDEX KEY: 0000918386 STANDARD INDUSTRIAL CLASSIFICATION: SEMICONDUCTORS & RELATED DEVICES [3674] IRS NUMBER: 330537669 STATE OF INCORPORATION: DE FISCAL YEAR END: 0330 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-23298 FILM NUMBER: 98649750 BUSINESS ADDRESS: STREET 1: 3545 HARBOR BLVD CITY: COSTA MESA STATE: CA ZIP: 92626 BUSINESS PHONE: 7144382200 MAIL ADDRESS: STREET 1: 3545 HARBOR BOULEVARD CITY: COSTA MESA STATE: CA ZIP: 92626 FORMER COMPANY: FORMER CONFORMED NAME: Q LOGIC CORP DATE OF NAME CHANGE: 19940201 10-K 1 FORM 10-K - FOR THE FISCAL YEAR ENDED 3-29-1998 1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-K (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED MARCH 29, 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 OF INCORPORATION) (I.R.S. EMPLOYER 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) SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, PAR VALUE $0.10 PER SHARE SERIES A JUNIOR PARTICIPATING PREFERRED STOCK, PAR VALUE $0.001 PER SHARE (TITLE OF CLASS) ------------------------ Indicate by check mark whether the registrant (a) 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 [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] As of May 24, 1998, the aggregate market value of the voting stock held by non-affiliates of the registrant was $378,842,992. As of May 24, 1998, the registrant had 8,667,294 shares of common stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE: Portions of the following documents are incorporated herein by reference in the Parts of this report indicated below: Part II, Items 10, 11, 12 and 13 -- Definitive proxy statement for the 1998 Annual Meeting of Stockholders which will be filed with the Securities and Exchange Commission within 120 days after the close of the 1998 year. ================================================================================ 2 PART I ITEM 1. BUSINESS INTRODUCTION QLogic Corporation ("QLogic") was organized as a Delaware corporation in 1992. Unless the context indicates otherwise, the "Company" and "QLogic" each refer to the Registrant and its subsidiary. All references to years refer to the Company's fiscal years ended March 29, 1998, March 30, 1997 and March 31, 1996, as applicable, unless the calendar years are specified. References to dollar amounts, except share and per share data, are in thousands, unless otherwise specified. OVERVIEW QLogic Corporation is a leading designer and supplier of semiconductor and board level input/output ("I/O") products. The Company's products provide a high performance interface between computer systems and their attached data storage peripherals, such as hard disk and tape drives, removable disk drives, CD-ROM drives and RAID subsystems. QLogic provides complete I/O technology solutions by designing and marketing single chip controller and adapter board products for both sides of the computer/peripheral device interlink, or "bus." Historically, the Company has targeted the high performance sector of the I/O market, focusing primarily on the SCSI industry standard. The Company is utilizing its I/O expertise to develop products for emerging I/O standards, such as Fibre Channel. Fibre Channel is experiencing early industry acceptance as a higher performance solution that maintains signal integrity while allowing for increased connectivity between a computer system and its data storage peripherals. QLogic's products utilize various I/O standards to service the needs of manufacturers and end users of various types of computer systems and components, such as workstations, servers and data storage peripherals. The Company provides high performance SCSI-based solutions and new I/O solutions based on the emerging Fibre Channel standard, and is leveraging its technological capabilities to provide solutions based on the IDE standard. The Company believes that its technological leadership, extensive involvement in its customers' product development process and the ease of migration of its SCSI-based products to its new I/O products position the Company to provide additional I/O solutions to its existing customer base. The Company believes that these attributes also provide it with competitive advantages in establishing new relationships with additional OEMs for both computer systems and data storage peripherals. QLogic markets and distributes its products through a direct sales organization supported by field application engineers, as well as through a network of independent manufacturers' representatives and regional and international distributors. The Company's primary OEM customers are major domestic and international suppliers and manufacturers of servers, workstations and data peripherals, such as Sun Microsystems, Inc., Fujitsu Limited and Digital Equipment Corporation. INDUSTRY BACKGROUND The increasing processing power of computers, the proliferation of networks, the rapid growth in the usage of the Internet and intranets, the wider application of computers in multimedia and telecommunications applications and the availability of higher performance data storage peripheral devices have driven the demand for increased data throughput among servers, workstations and data storage peripherals and, as a result, for increased I/O system performance. The I/O system is the electronic link between the host CPU and the computer's data storage peripheral devices, such as hard disk drives, tape drives, removable disk drives, CD-ROM drives and RAID subsystems. The I/O system must utilize industry standard hardware and software interfaces to manage and direct the flow of large volumes of data at high speeds between the CPU and multiple data storage peripherals, and, at the same time, minimize the consumption of CPU processing power and maintain peripheral data storage integrity. As microprocessors run at higher speeds and levels of performance, they require I/O systems which support faster and more autonomous data transmission and other advanced capabilities in order to function optimally. 2 3 IDE was an early standard for data interchange for personal computers. Historically, IDE-based I/O systems managed and directed the flow of data between personal computers and up to two hard disk drives. As PC-based servers became increasingly sophisticated, the relatively low data throughput and minimal connectivity of IDE became a limiting factor for system performance. As a result, high performance systems, such as servers and workstations, migrated to faster standards. Nevertheless, it is anticipated that IDE will remain an important and cost-effective solution to the I/O needs of the personal computer market due to the large installed base of personal computers and due to the increasing performance capabilities of new IDE standards, such as EIDE and Ultra IDE, which operate at higher data transfer rates and support up to four data storage peripherals. In response to the increased data throughput required by networks and workstations, SCSI was developed and adopted as the industry high performance I/O communications standard. The overall growth of the SCSI marketplace has been driven by rapid technological change and the evolving dynamics of high performance computer and computer data storage peripheral devices, including the following factors: the increased variety of higher performance peripheral devices and the continual shift toward higher capacity and higher data rate disk drives; the demand for I/O interfacing capabilities with greater numbers and types of attached peripherals; the movement toward more distributed network architectures across greater distances; the need for greater volumes of data transfer; and the demand for increased data throughput. Additionally, SCSI is also benefiting from the emerging "plug and play" standard, that is supported by Windows operating systems and Intel microprocessor-based systems, which simplifies the installation process, and from the growing usage of multi-tasking, multi-threading operating systems for which the prevailing IDE technology is less suited. The continuing evolution towards higher performance computer systems has led to the development of new connectivity solutions that provide even greater data interchange between computer systems and data storage peripherals. Fibre Channel is emerging as a new industry standard to meet the demand for increased connectivity and data transfer rates. Fibre Channel is an advanced I/O standard which provides data transmission speeds up to approximately two and one-half times the rate currently provided by the fastest SCSI-based solutions. In addition, Fibre Channel is designed to maintain signal integrity while allowing for data interchange between a computer system and up to eight times more peripherals than SCSI. Furthermore, Fibre Channel is designed to support the use of either a fibre optic connection or a more compact version of the copper cable traditionally used for SCSI solutions. Fibre optic connection allows the distance between a computer system and its data storage peripherals to extend up to 10 kilometers. The Company believes Fibre Channel will likely be the I/O technology of choice for larger, higher performance data and network applications while SCSI-based products will continue to be used in applications requiring less functionality and performance. See "Risk Factors -- Rapid Technological Change; Dependence on New Products; Industry Standards." Computer system and peripheral device manufacturers select I/O technologies for incorporation into their products primarily on the basis of application, performance and connectivity needs. The I/O products selected must be specifically tailored to the manufacturer's requirements, in order to be compatible with the manufacturer's system or peripherals either on a turn-key basis or with minimum developmental effort. In addition to being compatible with the present system or peripherals, I/O products ideally must be both "forward" and "backward" compatible with future and past computers and peripherals. That is, there must be a ready migration path between the I/O product and other products sold and under development by the manufacturer. Also, it is critical that the I/O product be available at a reasonable cost and in a timely manner, so as not to delay the manufacturer's time to market, which has become increasingly important in an era of short product life cycles. In order to achieve these goals, manufacturers increasingly seek to involve I/O product suppliers in their product validation and development cycles. By including the I/O system providers in their planning and development process, manufacturers not only ensure compatibility between product lines but also reduce the average time to market for their products. THE QLOGIC SOLUTION QLogic is a leading designer and supplier of semiconductor and board-level I/O products. The Company has been designing and marketing SCSI-based products for over 11 years and is a leading supplier of 3 4 connectivity solutions to this market sector. The Company is leveraging its technological expertise in SCSI into higher and lower end hardware and software solutions for its OEM customer base. In 1996, the Company introduced the industry's first fully integrated single chip PCI to Fibre Channel controller. During fiscal 1997 and 1998 the Company introduced products and intellectual property based on IDE standards to address additional I/O needs of its OEM customer base. The Company works closely with its customers in order to anticipate and help identify their needs. Even after a product is identified and validated, the Company continues to work with the customer in a joint product development process to ensure compatibility with the customer's future product designs. As a result of this partnership oriented approach, the Company believes that its customers benefit from significant time to market advantages. By gaining insight into the customers' system needs, the Company believes that it is in a better position to deliver I/O products with an easier migration path, thus reducing the customers' firmware and software development costs and associated implementation risks. In addition, by utilizing selected wafer fabrication suppliers, the Company seeks to ensure that it has ready access to the latest developments in wafer fabrication, in addition to avoiding the fixed costs associated with foundry ownership. The Company's products are designed to reduce board space requirements on plug-in cards, computer motherboards and peripheral controller boards by integrating multiple I/O controller functions on a single chip. The Company believes its products offer superior compatibility and ease of migration across multiple I/O standards due to their use of common software. The Company believes that its experience and focus on the SCSI market sector, the ease of migration of its products, its current development efforts into I/O standards such as IDE and Fibre Channel and its close customer relationships with leading server, workstation and peripheral manufacturers provide the Company with competitive advantages in the I/O product market. TECHNOLOGY The Company develops and markets I/O products for both the host and peripheral connections of the I/O bus. For the host interface, the Company's products include a variety of adapters, in both board and single chip integrated circuit form, which address the server and workstation segments of the computer market. For peripheral applications, the Company provides single chip controllers for data storage peripherals, including hard disk drives, tape drives, removable disk drives, CD-ROM drives and RAID subsystems. The Company's I/O products are currently based on the three most prevalent interface standards: IDE, SCSI and Fibre Channel. The Company has historically focused on the SCSI standard interface for its I/O product development. The Company's initial design wins for SCSI-based host products came from manufacturers of workstations and servers using Reduced Instruction Set Computer ("RISC") processors. The Company developed an embedded RISC-based controller, which is supplied with executable firmware capable of being custom tailored. The Company's leading peripheral technological developments include a broad range of Very Large Scale Integration ("VLSI") SCSI and IDE controllers, which incorporate intelligent I/O controllers with powerful data error correction capability, in order to ensure data integrity between the CPU and its peripherals. After accumulating significant architectural and systems expertise in designing SCSI devices over successive generations of the products, the Company expanded its SCSI-based host adapter board and peripheral controller product lines to address additional computer systems and data storage peripheral market segments, such as IDE and Fibre Channel. In 1996, the Company introduced the industry's first fully integrated single chip PCI to Fibre Channel controller. Fibre Channel is a scaleable data transfer interface technology (currently implemented at 100 megabytes per second) that maps multiple standard transport protocols, and utilizes compact copper cables, or fiber optics to transmit data over a distance of up to 10 kilometers, while supporting various topologies for data transfer. The Company's single chip design with an embedded transceiver provides certain advantages over existing multi-chip solutions, including a smaller footprint, increased reliability and a more cost-effective solution. The Company believes Fibre Channel will become an important I/O interface for high performance peripherals and networks over the next several years. See "Risk Factors -- Rapid Technological Change; Dependence on New Products; Industry Standards." 4 5 The Company's host adapter chip product line incorporates its Intelligent SCSI Processor ("ISP"), which integrates certain controller functions, such as proprietary RISC processor, host interface (PCI or SBus) and protocol processor (SCSI or Fibre Channel). By incorporating an I/O processor to control SCSI or Fibre Channel operations and by including a proprietary RISC processor to control and direct memory and software activities, the Company's ISP architecture facilitates faster throughput and is designed to minimize customer resource requirements as I/O standards evolve. Furthermore, the Company's product architecture is designed to facilitate both upward and downward compatibility. Customers' significant software investments can be preserved during transition from Fast SCSI to Ultra SCSI, with only minimal additional software design necessary to complete the upward migration to the Company's Fibre Channel solutions. For the peripherals market, the Company's triple embedded controller ("TEC") architecture integrates certain control functions such as buffer controller, powerful data error correction and disk formatting, microprocessor interface and I/O interface (SCSI, IDE or Fibre Channel). The Company's products are designed to facilitate backward migration from SCSI to IDE and forward migration from SCSI to Fibre Channel by ensuring that a substantial portion of a customer's firmware investments can be preserved during the transition. The Company's common architecture modules for ISP and TEC products are designed to benefit the Company's customers by providing faster time to market, reduced support costs, simplified technology transitions and increased performance. The markets in which the Company competes are characterized by rapidly changing technology, evolving industry standards and continuing improvements in products and services. There can be no assurance that the Company will respond effectively to technological changes or that the Company's products will conform to evolving industry standards and protocols. The Company has invested and will continue to invest significant resources in the development of its Fibre Channel based products; there can be no assurance that Fibre Channel will be adopted as a predominant industry standard, or that the Company's Fibre Channel products will conform to an industry standard which has yet to be uniformly adopted. The failure of the Company's products to gain acceptance within industry standards and protocols would adversely effect the Company's business, financial condition and results of operations. PRODUCTS QLogic designs and supplies semiconductor and board level I/O solutions for peripheral and computer systems products. The Company's products have traditionally been based on the SCSI standard, and the Company has expanded its product lines to include products based on the Fibre Channel and IDE standards.
PRODUCT DESCRIPTION ------- ----------- PERIPHERAL PRODUCTS SCSI Fast Architecture (FAS) - First introduced in 1991 - Single chip general purpose controllers - Integrated DMA controller and SCSI processor - Supports Fast and Ultra SCSI transfer rates (up to 40MB/sec) - Supports 8- or 16-bit data handling - May be used in host or peripheral applications SCSI Triple Embedded Controllers (TEC) - First introduced in 1991 - Single chip disk controllers - Integrated buffer controller, formatter and SCSI processor - Powerful on-chip data error correction - Supports Fast and Ultra SCSI transfer rates (up to 40MB/sec)
5 6
PRODUCT DESCRIPTION ------- ----------- Fibre Channel Triple Embedded Controller - First introduced in 1997 (FTEC) - Single chip disk controllers - Integrated buffer controller, formatter, fibre channel processor, and dual loop transceivers - Powerful on-chip data error correction - Supports FC-AL, 100MBytes/sec IDE Triple Embedded Controller (ATEC) - First introduced in 1997 - Single chip disk controllers - Integrated buffer controller, formatter, and IDE processor - Powerful on-chip data error correction - Supports ATA and Ultra/33 COMPUTER SYSTEMS PRODUCTS Intelligent SCSI Processor (ISP) - First introduced in 1992 Host Adapter Chips - Embedded RISC single chip solution - Supports latest SCSI standards - Supports transfer rates up to 40MB/sec - Supports 8- or 16-bit data handling - Supports direct PCI and SBus connection - Recently shipped Fibre Channel evaluation units which operate at transfer rates up to 100MB/sec. QLA Product Family - First introduced in 1993 Host Adapter Boards - Full line of host adapter cards with direct PCI and Sbus connection - Supports latest SCSI standards - Incorporates the Company's ISP host adapter chips - Provides a fully integrated, high performance board level I/O interface solution - Recently shipped Fibre Channel evaluation units which operate at transfer rates up to 100MB/sec.
SALES AND MARKETING QLogic markets and distributes its products through a direct sales organization supported by field application engineers, as well as through a network of independent manufacturers' representatives and regional and international distributors. In North America, the Company uses a tiered sales and marketing approach, with a direct sales force to serve large and strategic OEM accounts, OEM representatives that are focused on specific medium sized accounts, and regional distributors and resellers that serve smaller accounts. Throughout the Pacific Rim, the Company sells directly as well as through a master distributor. In Europe, the Company sells its products through distributors and through a representative. The Company believes that it is important to work closely with its large peripheral and computer system manufacturer OEMs during their design cycles. The Company supports these customers with extensive applications and system design support, as well as training classes and seminars both in the field and from its offices in Costa Mesa, California. The Company also maintains a high level of customer support through technical hotlines and Internet communications. The Company's manufacturers' representatives and distributors are not subject to minimum purchase requirements and can discontinue marketing any of the Company's products at any time. The Company's distributors are permitted to return to the Company a portion of the products purchased by them. In addition, 6 7 the Company provides its distributors with price protection in the event that the Company reduces the prices of its products. The loss of one or more manufacturers' representatives or distributors could have an adverse effect on the Company's business, financial condition and results of operations. The Company's sales efforts are focused on establishing and developing long term relationships with OEMs and other potential customers. The sales cycle typically begins with a design win, which entails a product of the Company being selected to be incorporated into a potential customer's computer system or data storage peripherals. Once the Company secures a design win with a given customer, the time to production shipment can range between six and 18 months. After winning a design with a potential customer, QLogic works closely with the customer to integrate its product with the customer's current and next generation products. Due to the extensive amounts of resources required for each customer design, typically only one I/O solution is designed into any given customer product. After being designed into a customer's product, sales are typically made through purchase orders, which are subject to cancellation, postponement or other types of delays. International sales (primarily to the Pacific Rim countries) of the Company's products accounted for approximately 42%, 45%, and 55% and $34,558, $31,301 and $29,800 of net revenues for fiscal years 1998, 1997 and 1996, respectively. International sales are denominated in U.S. dollars. The Company does not expect the uncertainty in the Southeast Asia foreign currency markets to have a material adverse effect on the results of the Company's operations. Due to its international sales, the Company is subject to a number of risks, including restrictions related to export regulations as well as those related to political upheaval and economic downturns in foreign nations. ENGINEERING AND DEVELOPMENT In order to compete successfully, the Company believes that it must continually design, develop and introduce new products that take advantage of market opportunities and address emerging standards. The Company's strategy is to leverage its substantial base of architectural and systems expertise and product innovation capabilities to address a broad range of I/O solutions as well as to develop products for its core SCSI business. The Company is currently engaged in the development of integrated circuit I/O controllers for additional I/O standards and enabling technologies, such as Fibre Channel, Ultra SCSI, Low Voltage Differential (LVD), Ultra IDE. The Company intends to broaden its product lines while continuing to allow its customers to transition rapidly to Fibre Channel and other emerging I/O standards. At March 29, 1998, the Company employed approximately 122 engineers, including technicians and support personnel engaged in the development of new products and the improvement of existing products. There can be no assurance that the Company will continue to be successful in attracting and retaining key personnel with the skills and expertise necessary to develop new products in the future. Engineering and development expenses were approximately $15.6 million, $10.4 million, and $7.2 million for fiscal 1998, 1997 and 1996, respectively. The markets for the Company's products are characterized by rapid technological change, evolving industry standards and product obsolescence. The Company's success is highly dependent upon the timely completion and introduction of new products at competitive prices and performance levels. There can be no assurance that the Company will be able to identify new product opportunities successfully and develop and bring to market new products in a timely manner, or that the Company will be able to respond effectively to technological advancements or new product announcements. BACKLOG The Company's backlog of orders was approximately $22.1 million at March 29, 1998, compared to approximately $20.6 million at March 30, 1997. These backlog figures include only orders scheduled for shipment within six months, of which the majority are scheduled for delivery within 90 days. Most orders are subject to rescheduling and/or cancellation with little or no penalty. Purchase order release lead times depend upon the scheduling practices of the individual customer, and the rate of booking new orders fluctuates from month to month. The Company's customers have in the past encountered uncertain and changing demand for their products. Orders are typically placed based on customer forecasts. If demand falls below customers' forecasts, or if customers do not control their inventories effectively, they may cancel or reschedule shipments 7 8 previously ordered from the Company. In the past, the Company has experienced, and may at any time and with minimal notice in the future experience, cancellations and postponements of orders. Therefore, the level of backlog at any particular date is not necessarily indicative of sales for any future period. 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 whom have research and development, long term guaranteed supply capacity, marketing and financial resources, manufacturing capability and customer support organizations that are substantially greater 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 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 adversely effected. 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., Hewlett-Packard Company and Emulex Corporation. In the IDE sector, the Company expects to compete with Adaptec 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 has decided to vertically integrate and has therefore ceased purchases from the Company. The Company believes that one of its principal competitive strengths in the integrated circuit I/O controller market is its ability to obtain major design wins as the result of its systems level expertise, integrated circuit design capability and substantial experience in I/O applications, particularly SCSI and Fibre Channel. The Company believes competitive factors in design wins are time to market, performance, product features, price, quality, technical support and ease of migration path to other I/O standards. The Company will have 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 against its existing competitors or potential competitors. MANUFACTURING The Company subcontracts the manufacturing of its semiconductor chips and its host adapter boards to independent foundries and subcontractors, which allows the Company to avoid the high costs of owning, operating and constantly upgrading a wafer fabrication facility and a host adapter board assembly factory. As a result, the Company focuses its resources on product design and development, quality assurance, sales and marketing and customer support. The Company designs both its semiconductor and host adapter board products, and performs final tests on products, including tests required under the Company's ISO9001/TickIT 8 9 Certification. The Company also provides fab process reliability tests, conducts failure analysis and audits its finished goods inventory to confirm the integrity of its quality assurance procedures. The Company's semiconductor products are ASICs, currently manufactured for the Company by a number of domestic and offshore foundries. The Company's major semiconductor suppliers are Toshiba, NEC Electronics, LSI Logic and Samsung Semiconductor, Inc. Most of the Company's products are manufactured using 0.8, 0.6 or 0.5 micron process technology. The Company is dependent on its foundries to allocate to the Company a portion of their foundry capacity sufficient to meet the Company's needs and to produce products of acceptable quality and with satisfactory manufacturing yields in a timely manner. These foundries fabricate products for other companies and manufacture products of their own design. The Company does not have long-term agreements with any of its foundries, and purchases both wafers and finished chips on a purchase order basis. Therefore, the foundries generally are not obligated to supply products to the Company for any specific period, in any specific quantity or at any specific price, except as may be provided in a particular purchase order. The Company works with its existing foundries, and intends to qualify new foundries, as needed, to obtain additional manufacturing capacity. There can be no assurance, however, that the Company will be able to obtain additional capacity. The Company currently purchases its semiconductor products from its foundries either in finished form or wafer form. The Company uses subcontractors for die assembly of its semiconductor products purchased in wafer form, and for assembly of its host adapter board products. In the assembly process for the Company's semiconductor products, the silicon wafers are separated into individual die, which are then assembled into packages and tested. Following assembly, the packaged devices are further tested and inspected by the Company prior to shipment to customers. For its host adapter board products, the Company purchases components in kit form, and printed circuit boards. The Company provides these items to contract manufacturing companies that work together with the Company's component suppliers to assemble the boards to the Company's specifications. The Company believes most component parts used in its host adapter boards are standard off-the-shelf items which are, or can be, purchased from two or more sources. The Company selects suppliers on the basis of technology, manufacturing capacity, quality and cost. Whenever possible and practicable, the Company strives to have at least two manufacturing locations for each host adapter board and chip product. Nevertheless, the Company's reliance on third-party manufacturers involves risks, including possible limitations on availability of products due to market abnormalities, unavailability of, or delays in obtaining access to, certain product technologies and the absence of complete control over delivery schedules, manufacturing yields, and total production costs. The inability of the Company's suppliers to deliver products of acceptable quality and in a timely manner or the inability of the Company to procure adequate supplies of its products could have a material adverse effect on the Company's business, financial condition and results of operations. INTELLECTUAL PROPERTY Although the Company has eight patents issued and three additional patent applications pending in the United States, the Company relies primarily on its trade secrets, trademarks and copyrights to protect its intellectual property. The Company attempts to protect its proprietary information through agreements with its customers, suppliers, employees and consultants, and through other security measures. Although the Company intends to protect its rights vigorously, there can be no assurance that these measures will be successful. 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. While the Company's ability to compete may be effected by its ability to protect its intellectual property, the Company believes that, because of the rapid pace of technological change in the I/O solutions markets, its technical expertise and ability to introduce new products on a timely basis will be more important in maintaining its competitive position than protection of its intellectual property. Although the Company continues to implement protective measures and intends to defend vigorously its intellectual property rights, there can be no assurance that these measures will be successful. 9 10 The Company has received notices of claimed infringement of trademark rights in the past, and there can be no assurance that third parties will not assert claims of infringement of trademarks or any other intellectual property rights against the Company with respect to existing and future products. The Company has received a notice of claimed infringement of patent rights. In the event of a patent or other intellectual property dispute, the Company may be required to expend significant resources to develop non-infringing technology or to obtain licenses to the technology which is the subject of the claim. There can be no assurance that the Company would be successful in such development or that any such license would be available on commercially reasonable terms, if at all. In the event of litigation to determine the validity of any third party's claims, such litigation could result in significant expense to the Company, and divert the efforts of the Company's technical and management personnel, whether or not such litigation is determined in favor of the Company. EMPLOYEES The Company had 225 employees as of March 29, 1998. The Company believes that its future prospects will depend, in part, on its ability to continue to attract, train, motivate, retain and manage skilled engineering, sales, marketing and executive personnel. None of QLogic's employees is represented by a labor union. The Company believes that its relations with its employees are good. ITEM 2. PROPERTIES The Company's corporate offices and principal product development, sales and operational facilities are currently located in two adjacent facilities comprised of approximately 83,000 square foot building in Costa Mesa, California. The Company occupies the facility pursuant to leases that expires in October 1999. While the Company believes that its current facilities are adequate through fiscal 1999, it is presently evaluating its needs for the period beyond the expiration of its current leases. ITEM 3. LEGAL PROCEEDINGS From time to time, the Company is a party to ordinary disputes arising in the normal course of business. The Company does not believe that the outcome of these matters will have a material adverse effect on the Company's business, financial condition or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted during the fourth quarter of fiscal 1998 to a vote of security holders. EXECUTIVE OFFICERS OF THE REGISTRANT The executive and certain other officers of the Company are as follows:
NAME AGE POSITION ---- --- -------- H.K. Desai................ 52 President, Chief Executive Officer and Director Thomas R. Anderson........ 53 Vice President and Chief Financial Officer Michael R. Manning........ 43 Secretary and Treasurer David Tovey............... 53 Vice President and General Manager, Peripheral Products Lawrence Fortmuller....... 49 Vice President and General Manager, Computer Products Mark Edwards.............. 39 Vice President, Sales and Corporate Marketing
Officers of the Company are elected annually by the Board of Directors for each year period, or portion thereof, and serve at the discretion of the Board of Directors of the Company. Mr. Desai joined the Company in August 1995 as President and Chief Technical Officer of QLogic and President of QLogic Foreign Sales Corporation. He was subsequently promoted to President and Chief Executive Officer and became a Director in January 1996. From May 1995 to August 1995, he was Vice 10 11 President, Engineering (Systems Products) at Western Digital Corporation, a manufacturer of disk drives. From July 1990 until May 1995, he served as Director of Engineering, and subsequently Vice President of Engineering at QLogic. From 1980 until joining the Company in 1990, Mr. Desai was an Engineering Section Manager at Unisys Corporation, a computer system manufacturer. Mr. Anderson joined the Company in July 1993 as Chief Financial Officer. Prior to joining the Company, Mr. Anderson was Executive Vice President, Chief Operating Officer and Chief Financial Officer of HIARC, Inc., a software startup company. From October 1990 to December 1992, he was corporate Senior Vice President and Chief Financial Officer at Distributed Logic Corporation, a manufacturer of tape and disk controllers and subsystems. From June 1982 to April 1990, he held various positions, the latest of which was corporate Vice President and Chief Financial Officer with Cipher Data Products, Inc., a supplier of tape and optical disk drives to the computer industry. Mr. Manning joined Emulex, a network product manufacturer (QLogic's former parent company), in July 1983 as Director of Tax. He was named Senior Director and Treasurer of Emulex in April 1991 and Secretary in August 1992. Mr. Manning joined the Company in June 1993. Prior to joining Emulex, Mr. Manning was a Tax Manager at KPMG Peat Marwick LLP, independent certified public accountants. Mr. Tovey joined the Company in April 1994 as Vice President Marketing. From March 1985 to April 1994, he held various positions with Toshiba America Information Systems, a computer system manufacturer, including director of technology planning and Vice President of OEM marketing. Prior to Toshiba, Mr. Tovey held various marketing and sales management positions with Unisys Corporation. Mr. Fortmuller joined the Company in October 1996 as Vice President and General Manager, Computer Products. Prior to joining the Company, Mr. Fortmuller held various management positions at AST Research, Inc., a computer manufacturer. Mr. Edwards joined the Company in September 1996 as Vice President of Sales and Corporate Marketing. Prior to joining the Company, Mr. Edwards worked at Unisys from August 1993 to September 1996 where he was most recently Vice President Sales & Marketing for the Storage Systems Division. Mr. Edwards has held a number of sales and marketing positions in the U.S. and Europe with Unisys, Digital Equipment Corporation and Zitel. None of the executive officers of the Company has any family relationship with any other executive officer of the Company or director of the Company. 11 12 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS PRINCIPAL MARKET AND PRICES Shares of common stock of the Company are traded and quoted in the NASDAQ National Market System under the symbol QLGC. The following table sets forth the range of high and low sales prices per share of common stock of the Company for each quarterly period of the three most recent years as reported on NASDAQ.
SALES PRICES ------------------ FISCAL 1998 HIGH LOW ----------- ------- ------- First Quarter............................................... $26.500 $18.750 Second Quarter.............................................. 45.375 24.750 Third Quarter............................................... 45.375 24.500 Fourth Quarter.............................................. 42.000 24.000
FISCAL 1997 HIGH LOW ----------- ------- ------- First Quarter............................................... 12.000 8.500 Second Quarter.............................................. 13.000 9.000 Third Quarter............................................... 28.380 12.500 Fourth Quarter.............................................. 30.130 18.500
NUMBER OF COMMON STOCKHOLDERS The approximate number of record holders of common stock of the Company as of May 20, 1998 was 416. DIVIDENDS The Company has never paid cash dividends on its common stock and has no current intention to do so. 12 13 ITEM 6. SELECTED FINANCIAL DATA The following table of certain selected data regarding the Company should be read in conjunction with the consolidated financial statements and notes thereto.
FISCAL YEAR ENDED ------------------------------------------------------- MARCH 29, MARCH 30, MARCH 31, APRIL 2, APRIL 3, 1998 1997 1996 1995 1994 --------- --------- --------- -------- -------- (IN THOUSANDS, EXCEPT PER SHARE DATA) SELECTED STATEMENTS OF OPERATIONS DATA Net revenues................................... $ 81,393 $68,927 $53,779 $57,675 $44,902 Cost of sales.................................. 34,049 38,151 34,413 34,285 28,148 -------- ------- ------- ------- ------- Gross profit......................... 47,344 30,776 19,366 23,390 16,754 -------- ------- ------- ------- ------- Operating expenses: Engineering and development.................. 15,601 10,422 7,191 7,598 8,603 Selling and marketing........................ 8,707 6,372 6,490 7,541 6,178 General and administrative................... 4,550 4,628 4,501 4,872 4,356 Impairment of goodwill....................... -- -- -- -- 542 Amortization of goodwill..................... -- -- -- -- 99 Consolidation charges........................ -- -- -- -- 507 -------- ------- ------- ------- ------- Total operating expenses............. 28,858 21,422 18,182 20,011 20,285 -------- ------- ------- ------- ------- Operating income (loss).............. 18,486 9,354 1,184 3,379 (3,531) Transaction costs.............................. -- -- -- -- 1,142 Interest expense............................... 109 125 153 146 107 Interest and other income...................... 3,453 602 172 93 3 -------- ------- ------- ------- ------- Income (loss) before income taxes............ 21,830 9,831 1,203 3,326 (4,777) Income tax provision (benefit)................. 8,422 3,983 537 1,361 (28) -------- ------- ------- ------- ------- Net income (loss).............................. $ 13,408 $ 5,848 $ 666 $ 1,965 $(4,749) ======== ======= ======= ======= ======= Basic earnings per share....................... 1.77 1.02 0.12 0.35 ======== ======= ======= ======= Diluted earnings per share(1).................. $ 1.66 $ 0.96 $ 0.12 $ 0.35 ======== ======= ======= ======= SELECTED BALANCE SHEET DATA Working capital................................ $ 90,749 $19,811 $13,334 $10,564 $ 6,424 Total assets................................... $136,242 $36,963 $28,539 $24,592 $22,613 Long-term capitalized lease obligations, excluding current installments............... $ 141 $ 352 $ 576 $ 853 $ 1,156 Other non-current liabilities.................. $ 466 $ 924 $ 2,016 $ 1,381 $ -- Total stockholders' equity..................... $118,049 $24,353 $16,277 $15,581 $13,615
- - --------------- (1) Per share data has not been presented for periods prior to fiscal 1995 as the Company operated as a wholly owned subsidiary of Emulex Corporation. Per share data for 1998 has been calculated in accordance with SFAS No. 128, which was effective December 15, 1997, and all prior periods have been restated to conform to this presentation. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis contains forward-looking statements that involve risks 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" or "Item 1," as well as those discussed elsewhere in this report. OVERVIEW QLogic Corporation is a leading designer and supplier of semiconductor and board level I/O products. The Company's products provide a high performance interface between computer systems and their attached data storage peripherals, such as hard disk and tape drives, removable disk drives, CD-ROM drives and RAID subsystems. QLogic provides complete I/O technology solutions by designing and marketing single chip 13 14 controller and adapter board products for both sides of the computer/peripheral device interlink, or "bus." Historically, the Company has targeted the high performance sector of the I/O market, focusing primarily on the SCSI industry standard. The Company is utilizing its I/O expertise to develop products for emerging I/O standards, such as Fibre Channel. Fibre Channel is experiencing early industry acceptance as a higher performance solution that maintains signal integrity while allowing for increased connectivity between a computer system and its data storage peripherals. The Company's products include semiconductors for computer peripheral devices and semiconductors and adapter boards for computer systems. The Company's peripheral products are comprised of the FAS and TEC product lines, and its computer systems products are comprised of the ISP and Host Board product lines. The Company's products have traditionally been based on the SCSI standard, but during fiscal 1997 and 1998 the Company introduced products for the Fibre Channel and IDE I/O standards. Net revenues from the Company's computer systems products are relatively less subject to fluctuations than those from the Company's peripheral device products due to generally longer product life cycles. In addition, the Company's computer systems products are manufactured to meet the specific solution needs of its OEM customers and, as a result, tend to carry higher gross margins. The Company is attempting to increase its proportionate sales of computer systems products. The Company is also identifying new sectors of the peripheral device market with the goal of expanding its business. For example, the Company is leveraging its I/O technological expertise to develop high performance IDE-based peripheral controllers. The Company recognizes revenue from the sale of products at the time of shipment. The Company currently sells a majority of its products directly to OEMs such as Sun Microsystems, Inc., Fujitsu Limited, Digital Equipment Corporation, and Hitachi America, Ltd. The Company also sells its products through a network of independent manufacturers' representatives and regional and international distributors. The Company believes that by establishing and developing direct relationships with leading OEMs within the computer industry, the Company will have greater opportunities to expand its SCSI-based sales and to leverage these relationships into design wins for its IDE and Fibre Channel products. The Company believes that sales to OEMs result in lower product return rates and require a smaller customer support infrastructure. However, there is a limited number of potential OEM customers. As a result, the loss of a large OEM customer would have a material adverse effect on the Company's business, results of operations and financial condition. Also, the Company has historically experienced seasonality resulting in somewhat lower net revenues in its first fiscal quarter as compared to the previous quarter, which the Company believes is due to reduced spending by its OEM customers in advance of scheduled production slowdowns in the forthcoming summer months. The Company also generates revenues by licensing certain of its technology. License revenues are recognized when earned and receipt is assured. 14 15 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. The purpose of the Distribution was to enable the Company to gain independent access to equity markets so that it may use its capital stock as a source of funding. 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.
FISCAL YEAR ENDED ----------------------------------------------------- MARCH 29, 1998 MARCH 30, 1997 MARCH 31, 1996 --------------- --------------- --------------- Net revenues............................... $81,393 100.0% $68,927 100.0% $53,779 100.0% Cost of sales.............................. 34,049 41.8 38,151 55.3 34,413 64.0 ------- ----- ------- ----- ------- ----- Gross profit............................. 47,344 58.2 30,776 44.7 19,366 36.0 Operating expenses: Engineering and development.............. 15,601 19.2 10,422 15.1 7,191 13.4 Selling and marketing.................... 8,707 10.7 6,372 9.3 6,490 12.1 General and administrative............... 4,550 5.6 4,628 6.7 4,501 8.3 ------- ----- ------- ----- ------- ----- Total operating expenses......... 28,858 35.5 21,422 31.1 18,182 33.8 ------- ----- ------- ----- ------- ----- Operating income......................... $18,486 22.7% $ 9,354 13.6% $ 1,184 2.2% ======= ===== ======= ===== ======= =====
NET REVENUES The Company's net revenues are derived primarily from the sale of SCSI-based I/O products. License fees also contribute to the Company's net revenues. Net revenues for fiscal 1998 increased $12.5 million or 18% from fiscal 1997 to $81.4 million. The increase was the result of an $8.7 million increase in sales of the Host Board product line, combined with a $4.4 million increase in sales in the FAS product line. A partially offsetting decline of $0.6 million occurred in license fees. Net revenues for fiscal 1997 increased $15.1 million or 28% from fiscal 1996 to $68.9 million. The increase was primarily the result of an increase in sales of the TEC, Host Board and ISP product lines and increased license fees. A partially offsetting decline in sales of $4.4 million occurred in the FAS product line. Export revenues for fiscal 1998 increased $3.3 million or 10.4% from fiscal 1997, to approximately $34.6 million, primarily due to increased sales to customers in Europe, along with smaller increases from Southeast Asia. Export revenues for fiscal 1997 increased $1.5 million or 5% from fiscal 1996, to approximately $31.3 million, primarily due to increased sales to customers in Japan. 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. International sales (primarily to the Pacific Rim countries) of the Company's products accounted for approximately 42%, 45%, and 55% and $34,558, $31,301 and $29,800 of net revenues for fiscal years 1998, 1997 and 1996, respectively. International sales are denominated in U.S. dollars. The Company does not expect the uncertainty in the Southeast Asia foreign currency markets to have a material adverse effect on the results of the Company's operations. 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 Company's six largest customers in each respective period accounted for approximately 71%, 71% and 81% of the Company's net revenues for fiscal 1998, 1997 15 16 and 1996, respectively. For fiscal 1998, Fujitsu Limited, Sun Microsystems, Inc. and Digital Equipment Corporation accounted for approximately 23%, 20% and 8% of the Company's net revenues, respectively. For fiscal 1997, Sun Microsystems, Inc., Tokyo Electron Limited, and Fujitsu Limited accounted for approximately 20%, 19%, and 16% of the Company's net revenues, respectively. For fiscal 1996, Tokyo Electron Limited, Sun Microsystems, Inc. and Avex Electronics, Inc. accounted for approximately 42%, 13% and 11% of the Company's net revenues, respectively. 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 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 fiscal 1998 was 42%, a decrease of 13% from the prior fiscal year. The percentage decrease was due to a shift in product mix to products with lower unit costs, as well as increased production volumes. Additionally, multiple disciplines within the Company worked together to improve inventory management. The cost of sales percentage for fiscal 1997 was 55%, a decrease of 9% from the prior fiscal year. The percentage decrease was due to increased revenue from products that contain higher levels of integration and functionality and are generally associated with higher average selling prices and gross margins. The Company continued to focus on reducing component costs as well as implementing design efficiencies during fiscal 1997. The cost of sales percentage for fiscal 1996 was 64%, an increase of 5% over fiscal 1995. The increase in the cost of sales percentage was primarily due to inventory write-down charges being higher in fiscal 1996 compared to the prior year. 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. In addition, the Company believes the cost of sales percentage will be adversely impacted by sales of IDE-based products, which carry lower margins. As a result, the Company does not anticipate percentage cost of sales to decrease at a rate consistent with historic trends. OPERATING EXPENSES Engineering and Development. Engineering and development expenses consist primarily of salaries and other personnel related expenses, development related material, occupancy costs and depreciation. For fiscal 1998 engineering and development expenditures increased by $5.2 million from fiscal 1997, primarily due to salary and occupancy expenses related to increased headcount. The Company expects that engineering and development expenses will increase in absolute dollars in fiscal 1999. In fiscal 1997, engineering and development expenditures increased by $3.2 million from the prior fiscal year, primarily due to increased salary and occupancy expenses related to increased headcount. In particular, the Company significantly expanded its engineering staff in fiscal 1997 in connection with its development of Fibre Channel products. In fiscal 1996, engineering and development expenditures decreased by $0.4 million from fiscal 1995 expenditures. 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 fiscal 1998, selling and marketing expenses increased by $2.3 million compared to fiscal 1997, primarily as a result of increased sales, as well as increases in advertising and trade show expenses. The Company expects that selling and marketing expenses will increase in absolute dollars in fiscal 1999. During fiscal 1997, selling and marketing expenses decreased by $0.1 million compared to fiscal 1996, primarily as a result of reduced advertising and trade show expenses, due to the Company's shift away from 16 17 selling to resellers, which typically requires more advertising and other promotions. The decrease in advertising cost was partially offset by an increase in marketing salaries. In fiscal 1996, selling and marketing expenses decreased by $1.1 million compared to fiscal 1995, primarily due to a reduction in advertising. General and Administrative. General and administrative expenses consist primarily of salaries and other expenses for corporate management, finance, accounting and human resources. For fiscal 1998, general and administrative expenses decreased by $0.1 million due to reduced corporate administrative expenses. For fiscal 1997, general and administrative expenses increased $0.1 million from the prior year, primarily due to expenses related to implementing a new computer system and salaries. For fiscal year 1996, general and administrative expenses decreased $0.4 million compared to fiscal 1995, primarily due to decreased bad debt expense. INTEREST INCOME (EXPENSE) Interest income, net of expense, increased $2.9 million during fiscal 1998 from fiscal 1997, due to larger balances of cash, cash equivalents, and investments. In addition, the Company continued to make payments to reduce its capital lease liabilities. Interest income, net of expense, for fiscal 1997 increased $0.5 million from fiscal 1996, due to larger balances of cash and cash equivalents and due to lower capital lease commitments outstanding. Interest income, net of expense, increased in fiscal 1996 to $19 from a net expense of $53 in fiscal 1995. INCOME TAX PROVISION The Company's effective tax rates were approximately 39%, 41%, and 45%, for fiscal years 1998, 1997, and 1996, respectively. 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 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 will not have a significant impact on the consolidated financial statements. LIQUIDITY AND CAPITAL RESOURCES For fiscal years 1998, 1997 and 1996 the Company's cash flow from operations have exceeded capital expenditures. Capital expenditures on property and equipment were $3.9 million, $3.9 million, and $1.2 million for fiscal years 1998, 1997 and 1996, respectively. Cash provided by operations was approximately $19.0 million, $12.6 million, and $8.8 million for fiscal years 1998, 1997, and 1996, respectively. The growth in cash provided by operations is primarily attributable to improved profitability, accounts receivable collection, inventory management, cash management and cost reductions in operations. Cash used in investing activities was approximately $52.6 million, $3.9 million, and $1.2 million, in fiscal 1998, 1997, and 1996 respectively, primarily reflecting investment of the proceeds of the secondary offering in fiscal 1998 and expenditures for property and equipment during fiscal 1998, 1997 and 1996. Cash provided by financing activities was approximately $78.6 million for fiscal 1998, which reflected the sale of 2,645,000 shares of common stock from which the Company received net proceeds of $77.5 million and exercise of stock options, offset in part by principal payments under capital leases. Cash used in financing activities, reflecting primarily principal payments under capital leases, was approximately $0.2 million, $0.3 million and $0.3 million in fiscal 1998, 1997 and 1996, respectively. 17 18 Working capital at March 29, 1998 was $90.7 million, as compared to $19.8 million at March 30, 1997. At March 29, 1998, the Company's principal sources of liquidity included cash and cash equivalents of $64.1 million, and investments of $48.7 million. In addition, the Company has an unsecured 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 March 29, 1998. The line of credit with Silicon Valley Bank expires 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 investment balances, facilities and equipment leases, cash flow 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. 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. 18 19 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. 19 20 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 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 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 effected. 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. and Hewlett-Packard Company. In the IDE sector, the Company expects to compete with Adaptec, Inc. and Cirrus Logic, Inc.. Adaptec 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 20 21 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. 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. 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 21 22 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 22 23 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 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 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. 23 24 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, could lead 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 24 25 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. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Not applicable. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements of the Company are referenced in Item 14(a). 25 26 INDEPENDENT AUDITORS' REPORT The Board of Directors QLogic Corporation: We have audited the consolidated financial statements of QLogic Corporation and subsidiary as listed in Item 14(a). In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedule as listed in Item 14(a). These consolidated financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and the financial statement schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of QLogic Corporation and subsidiary as of March 29, 1998 and March 30, 1997 and the results of their operations and their cash flows for each of the years in the three-year period ended March 29, 1998, in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. KPMG PEAT MARWICK LLP Orange County, California May 12, 1998 26 27 QLOGIC CORPORATION CONSOLIDATED BALANCE SHEETS MARCH 29, 1998 AND MARCH 30, 1997 (IN THOUSANDS, EXCEPT SHARE DATA) ASSETS
1998 1997 -------- ------- Cash and cash equivalents................................... $ 64,090 $19,091 Short term investments...................................... 27,746 -- Accounts and notes receivable, less allowance for doubtful accounts of $746 and $636 as of March 29, 1998 and March 30, 1997, respectively.................................... 7,836 5,720 Inventories................................................. 3,835 4,794 Deferred income taxes....................................... 4,353 1,149 Prepaid expenses and other current assets................... 475 391 -------- ------- Total current assets.............................. 108,335 31,145 Long term investments....................................... 20,934 -- Property and equipment, net................................. 6,372 5,043 Other assets................................................ 601 775 -------- ------- $136,242 $36,963 ======== ======= LIABILITIES AND STOCKHOLDERS' EQUITY Accounts payable............................................ $ 3,765 $ 3,994 Accrued expenses............................................ 13,610 7,115 Current installments of capitalized lease obligations....... 211 225 -------- ------- Total current liabilities......................... 17,586 11,334 Capitalized lease obligations, excluding current installments.............................................. 141 352 Other non-current liabilities............................... 466 924 -------- ------- Total liabilities................................. 18,193 12,610 -------- ------- Commitments and contingencies Stockholders' equity: Preferred stock, $0.10 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, $0.10 par value; 12,500,000 shares authorized; 8,650,826 and 5,840,701 shares issued and outstanding at March 29, 1998, and March 30, 1997, respectively........................................... 865 584 Additional paid-in capital................................ 99,008 19,001 Retained earnings......................................... 18,176 4,768 -------- ------- Total stockholders' equity........................ 118,049 24,353 -------- ------- $136,242 $36,963 ======== =======
See accompanying notes to consolidated financial statements. 27 28 QLOGIC CORPORATION CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED MARCH 29, 1998, MARCH 30, 1997, AND MARCH 31, 1996 (IN THOUSANDS, EXCEPT PER SHARE DATA)
1998 1997 1996 ------- ------- ------- Net revenues................................................ $81,393 $68,927 $53,779 Cost of sales............................................... 34,049 38,151 34,413 ------- ------- ------- Gross profit.............................................. 47,344 30,776 19,366 ------- ------- ------- Operating expenses Engineering and development............................... 15,601 10,422 7,191 Selling and marketing..................................... 8,707 6,372 6,490 General and administrative................................ 4,550 4,628 4,501 ------- ------- ------- Total operating expenses.......................... 28,858 21,422 18,182 ------- ------- ------- Operating income.................................. 18,486 9,354 1,184 Interest expense............................................ 109 125 153 Interest and other income................................... 3,453 602 172 ------- ------- ------- Income before income taxes................................ 21,830 9,831 1,203 Income tax provision........................................ 8,422 3,983 537 ------- ------- ------- Net income.................................................. $13,408 $ 5,848 $ 666 ======= ======= ======= Basic earnings per common share............................. $ 1.77 $ 1.02 $ 0.12 ======= ======= ======= Diluted earnings per share.................................. $ 1.66 $ 0.96 $ 0.12 ======= ======= ======= Common shares used in the calculation of basic earnings per share..................................................... 7,592 5,722 5,554 ======= ======= ======= Shares used in the calculation of diluted earnings per share..................................................... 8,099 6,115 5,612 ======= ======= =======
See accompanying notes to consolidated financial statements. 28 29 QLOGIC CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED MARCH 29, 1998, MARCH 30, 1997, AND MARCH 31, 1996 (IN THOUSANDS)
RETAINED COMMON STOCK ADDITIONAL EARNINGS TOTAL --------------- PAID-IN (ACCUMULATED STOCKHOLDERS' SHARES AMOUNT CAPITAL DEFICIT) EQUITY ------ ------ ---------- ------------ ------------- Balance as of April 2, 1995................... 5,552 $555 $16,772 $ (1,746) $ 15,581 Net income.................................. -- -- -- 666 666 Issuance of common stock.................... 6 1 29 -- 30 ----- ---- ------- -------- -------- Balance as of March 31, 1996.................. 5,558 556 16,801 (1,080) 16,277 Net income.................................. -- -- -- 5,848 5,848 Issuance of common stock.................... 283 28 2,200 -- 2,228 ----- ---- ------- -------- -------- Balance as of March 30, 1997.................. 5,841 584 19,001 4,768 24,353 Net income.................................. -- -- -- 13,408 13,408 Issuance of common stock (net of tax benefit of $1,494)............................... 165 16 2,736 -- 2,752 Stock offering.............................. 2,645 265 77,271 -- 77,536 ----- ---- ------- -------- -------- Balance as of March 29, 1998.................. 8,651 $865 $99,008 $ 18,176 $118,049 ===== ==== ======= ======== ========
See accompanying notes to consolidated financial statements. 29 30 QLOGIC CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED MARCH 29, 1998, MARCH 30, 1997, AND MARCH 31, 1996 (IN THOUSANDS)
1998 1997 1996 ------- ------- ------- Cash flows from operating activities: Net income................................................ $13,408 $ 5,848 $ 666 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization.......................... 2,434 3,023 2,452 Provision for doubtful accounts........................ 200 129 23 Loss on disposal of property and equipment............. 161 1,338 11 Benefit from deferred income taxes..................... (3,204) (1,273) (561) Changes in assets and liabilities: Accounts and notes receivable............................. (2,316) 1,184 2,302 Inventories............................................... 959 1,876 (123) Prepaid expenses and other current assets................. (84) (152) (39) Other assets.............................................. 174 (6) 463 Accounts payable.......................................... (229) (2,183) 1,240 Accrued expenses.......................................... 7,989 3,897 1,681 Other non-current liabilities............................. (458) (1,092) 635 ------- ------- ------- Net cash provided by operating activities......... 19,034 12,589 8,750 ------- ------- ------- Cash flows from investing activities: Additions to property and equipment....................... (3,924) (3,866) (1,210) Purchases of investments.................................. (53,059) -- -- Maturities and sales of investments....................... 4,379 -- -- ------- ------- ------- Net cash used in investing activities............. (52,604) (3,866) (1,210) ------- ------- ------- Cash flows from financing activities: Principal payments under capital leases................... (225) (274) (305) Proceeds from exercise of stock options................... 1,258 2,228 30 Proceeds from sale of common stock........................ 77,536 -- -- ------- ------- ------- Net cash provided by (used in) financing activities...................................... 78,569 1,954 (275) ------- ------- ------- Net increase in cash and cash equivalents................... 44,999 10,677 7,265 Cash and cash equivalents at beginning of year.............. 19,091 8,414 1,149 ------- ------- ------- Cash and cash equivalents at end of year.................... $64,090 $19,091 $ 8,414 ======= ======= ======= Supplemental disclosure of cash flow information: Cash paid during the year for: Interest.................................................. $ 90 $ 133 $ 101 ======= ======= ======= Income taxes.............................................. $ 6,275 $ 3,881 $ 404 ======= ======= =======
Non-cash financing activities: During fiscal year 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 $1,494 related to the tax benefit of exercises of stock options under the Company's various stock option plans. See accompanying notes to consolidated financial statements. 30 31 QLOGIC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 29, 1998, MARCH 30, 1997, AND MARCH 31, 1996 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) NOTE (1) DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES GENERAL BUSINESS INFORMATION QLogic Corporation ("QLogic" or the "Company") designs and supplies semiconductor and board level I/O products. The Company's products provide a high performance interface between computer systems and their attached data storage peripherals, such as hard disk drives, tape drives, removable disk drives, CD-ROM drives and RAID subsystems. QLogic provides complete input/output ("I/O") technology solutions by designing and marketing single chip controller and adapter board products for both sides of the computer/peripheral device interlink or "bus." The Company has targeted the high performance sector of the I/O market, focusing primarily on the SCSI industry standard. The Company is utilizing its I/O expertise to develop products for emerging I/O standards, such as Fibre Channel. QLogic's products utilize various I/O standards to service the needs of manufacturers and end users of various types of computer systems and components, such as workstations, servers and data storage peripherals. The Company provides high performance SCSI-based solutions and new I/O solutions based on the emerging Fibre Channel standard, and is leveraging its technological capabilities to provide solutions based on the IDE standard. QLogic markets and distributes its products through a direct sales organization supported by field application engineers, as well as through a network of independent manufacturers' representatives and regional and international distributors. The Company's primary OEM customers are major domestic and international suppliers and manufacturers of servers, workstations and data storage peripherals. The Company is the successor to the Emulex Micro Devices division of Emulex Corporation ("Emulex"). The Company was incorporated in Delaware in 1992 as Emulex Micro Devices Corporation, a wholly owned subsidiary of Emulex. In 1993, substantially all of the assets of the Emulex Micro Devices division were transferred to the Company. On February 24, 1994, Emulex declared a special dividend consisting of the distribution to its stockholders of all outstanding shares of common stock of QLogic (the "Distribution"), pursuant to which the Company became a separate publicly held corporation. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation The consolidated financial statements include the financial statements of QLogic Corporation and its wholly owned subsidiary. All significant intercompany balances and transactions have been eliminated in consolidation. Fiscal Year QLogic's fiscal year ends on the Sunday nearest March 31. The fiscal years ended March 29, 1998 ("fiscal 1998"), March 30, 1997 ("fiscal 1997") and March 31, 1996 ("fiscal 1996") each comprised 52 weeks. Cash and Cash Equivalents For purposes of the consolidated statements of cash flows, the Company considers all highly liquid investments purchased with original maturities of three months or less on their acquisition date to be cash equivalents. Investments The Company determines the appropriate balance sheet classification of its investments in debt securities based on the maturity date at the time of purchase and reevaluates such determinations of long-term or short-term at each balance sheet date. Debt securities are classified as held to maturity as the Company has the 31 32 QLOGIC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 29, 1998, MARCH 30, 1997 AND MARCH 31, 1996 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) positive intent and ability to hold the securities to maturity. Held to maturity securities are stated at amortized cost. The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization and interest are included in interest income. Realized gains and losses are included in interest and other in the consolidated statements of income. The cost of securities sold is based on the specific identification method. The Company's investment in debt securities is diversified among high credit quality securities in accordance with the Company's investment policy. Inventories Inventories are stated at the lower of cost (first-in, first-out) or net realizable value. Property and Equipment Property and equipment are stated at cost. Property and equipment held under capital leases are stated at the present value of minimum lease payments. Depreciation is calculated using the straight-line method over estimated useful lives of two to seven years. Property and equipment held under capital leases and leasehold improvements are amortized on a straight-line basis over the shorter of the lease term or the estimated useful life of the related asset. Stock Offering In the second quarter of fiscal 1998, the Company completed a secondary offering of 2,645,000 shares of the Company's common stock at a price of $31.25 per share. The Company received proceeds of $77.5 million net of underwriters discount and expenses. Stock Option Plan Prior to April 1, 1996, the Company accounted for its stock option plan in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations. As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. On April 1, 1996, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation," which permits entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively, SFAS No. 123 also allows entities to continue to apply the provisions of APB Opinion No. 25 and provide pro forma net income and pro forma net income per share disclosures for employee stock option grants made in fiscal 1996 and future years as if the fair-value-based method defined in SFAS No. 123 had been applied. The Company has elected to continue to apply the provisions of APB Opinion No. 25 and provide the pro forma disclosure provisions of SFAS No. 123. Use of Estimates Company management has made a number of estimates and assumptions relating to the reporting of assets and liabilities in conformity with generally accepted accounting principles. Actual results could differ from these estimates. 32 33 QLOGIC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 29, 1998, MARCH 30, 1997 AND MARCH 31, 1996 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) Revenue Recognition Revenue is recognized upon product shipment. Royalty revenue is recognized when earned and receipt is assured. The customer's obligation to pay the Company, and the payment terms, are set at the time of shipment and are not dependent on subsequent resale of the Company's product. However, certain of the Company's sales are made to distributors under agreements allowing limited right of return and/or price protection. The Company warrants its products, on a limited basis, to be free from defects for periods of one to five years from date of shipment. The Company estimates and establishes allowances and reserves, by a current charge to income, for product returns, warranty obligations, doubtful accounts, and price adjustments. Research and Development Research and development costs, including costs related to the development of new products and process technology, are expensed as incurred. Capitalized Software Costs SFAS No. 86, "Accounting for the Costs of Computer Software to be Sold, Leased or Otherwise Marketed," provides for the capitalization of certain software development costs once technological feasibility is established. The cost so capitalized is then amortized on a straight-line basis over the estimated product life, or the ratio of current revenues to total projected product revenues, whichever is greater. No internal costs have been capitalized as the impact on the consolidated financial statements for all periods presented is immaterial. Income Taxes Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Net Income per Share During the third quarter of 1998, the Company adopted 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 periods ended March 29, 1998, March 30, 1997 and March 31, 1996 were 7,592, 5,722 and 5,554, 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 periods ended March 29, 1998, March 30, 1997 and March 31, 1996 were 8,099, 6,115 and 5,612, respectively. The Adoption of SFAS No. 128 did not have a material impact on the Company's financial statements. 33 34 QLOGIC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 29, 1998, MARCH 30, 1997 AND MARCH 31, 1996 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) Options to purchase 14,273, 18,133 and 560,494 shares of common stock with exercise prices which exceed the average market prices of $31.96, $15.69 and $6.29 during fiscal years 1998, 1997 and 1996, respectively, were excluded from the calculation of diluted EPS because their inclusion would have been anti- dilutive. Fair Value of Financial Instruments In December 1991, the FASB issued SFAS No. 107, "Disclosures about Fair Value of Financial Instruments." SFAS No. 107 requires all entities to disclose the fair value of financial instruments, both assets and liabilities recognized and not recognized on the balance sheet, for which it is practicable to estimate fair value. SFAS No. 107 defines fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties. As of March 29, 1998 and March 30, 1997, the fair value of all financial instruments approximated carrying value. (See note 11). Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of Long-lived assets and certain identifiable intangibles are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceed the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. NOTE (2) INVENTORIES Components of inventories are as follows:
1998 1997 ------ ------ Raw materials............................................... $2,720 $2,931 Work in progress............................................ 585 1,117 Finished goods.............................................. 530 746 ------ ------ $3,835 $4,794 ====== ======
NOTE (3) PROPERTY AND EQUIPMENT Components of property and equipment are as follows:
1998 1997 ------- ------- Product and test equipment.................................. $13,855 $10,970 Furniture and fixtures...................................... 1,543 1,219 Semiconductor designs....................................... 1,957 1,802 Leasehold improvements...................................... 575 447 Land and buildings.......................................... 358 358 ------- ------- 18,288 14,796 Less accumulated depreciation and amortization.............. 11,916 9,753 ------- ------- $ 6,372 $ 5,043 ======= =======
34 35 QLOGIC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 29, 1998, MARCH 30, 1997 AND MARCH 31, 1996 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) NOTE (4) INCOME TAXES The components of the income tax provision are as follows:
1998 1997 1996 ------- ------- ------ Federal: Current............................................ $ 9,888 $ 4,479 $ 872 Deferred........................................... (2,264) (1,059) (453) State: Current............................................ 1,564 777 226 Deferred........................................... (766) (214) (108) ------- ------- ------ $ 8,422 $ 3,983 $ 537 ======= ======= ======
A reconciliation of the income tax provision with the amounts computed by applying the federal statutory tax rate to income before income taxes is as follows:
1998 1997 1996 ------- ------- ------ Expected income tax provision at the statutory rate............................................... $ 7,641 $ 3,343 $ 409 State income tax, net of Federal tax benefit......... 1,991 370 74 Tax benefit of net operating loss.................... (13) (13) (26) Tax benefit of research and development and other credits............................................ -- -- (391) Increase (decrease) in valuation allowance........... (1,904) (14) 312 Nondeductible permanent differences.................. 26 20 39 Other, net........................................... 681 277 120 ------- ------- ------ $ 8,422 $ 3,983 $ 537 ======= ======= ======
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities are as follows:
1998 1997 1996 ------ ------ ------ Deferred tax assets: Alternative minimum tax credit......................... $ 19 $ 92 $ 92 Reserves not currently deductible...................... 4,569 2,504 1,555 Property and equipment................................. 836 980 940 Research and development credit........................ 238 1,085 1,085 Other.................................................. 87 85 101 ------ ------ ------ Total gross deferred tax assets...................... 5,749 4,746 3,773 Less valuation allowance............................... -- 1,904 1,918 ------ ------ ------ 5,749 2,842 1,855 ------ ------ ------ Deferred tax liabilities: Research and development expenditures.................. 404 516 875 State tax expense...................................... 394 405 332 ------ ------ ------ Total gross deferred tax liabilities................. 798 921 1,207 ------ ------ ------ Net deferred tax assets................................ $4,951 $1,921 $ 648 ====== ====== ======
The net change in the valuation allowance for the deferred tax assets was a decrease of approximately $1,904 and $14 in 1998 and 1997, respectively, and an increase of approximately $312 in 1996. Based upon the 35 36 QLOGIC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 29, 1998, MARCH 30, 1997 AND MARCH 31, 1996 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) Company's current and historical pre-tax earnings, management believes it is more likely than not that the Company will realize the benefit of the existing net deferred tax assets as of March 29, 1998. Management believes the existing net deductible temporary differences will reverse during periods in which the Company generates net taxable income; however, there can be no assurance that the Company will generate any earnings or any specific level of continuing earnings in future years. For Federal purposes, QLogic has approximately $70 of net operating loss carryovers as of March 29, 1998. Utilization of the carryover will be limited to approximately $35 a year over the next two fiscal years, as a result of the Company filing short period tax returns in 1994. Any unused carryover at the end of this period will be fully utilizable in any future year until 2009, after which any unused carryover will expire. For state purposes, QLogic has approximately $238 of research and development credit and $19 of alternative minimum tax credit carryovers as of March 29, 1998. These credits may be carried over indefinitely. The tax benefit associated with the exercise of employee stock options reduced taxes currently payable by $1,494 for the year ended March 29, 1998. The Company's U.S. income tax returns for the 1995 through 1997 fiscal years and certain tax attributes carried over from earlier years, are presently under examination by the Internal Revenue Service. Management does not expect a material impact on the consolidated financial statements from the examination. During fiscal year 1994, QLogic and Emulex entered into a Tax Sharing Agreement for the purposes of allocating pre-Distribution tax liabilities between QLogic and Emulex. Under the Tax Sharing Agreement, Emulex generally will be liable for and will indemnify QLogic against (a) pre-Distribution Federal, state and local tax liabilities of Emulex and its subsidiaries (including QLogic), (b) taxes or liabilities resulting from a breach of any covenant or representation by Emulex contained in the Tax Sharing Agreement, (c) taxes imposed on QLogic or its stockholders in the event that the Distribution is taxable due to any reason other than a breach of certain covenants or representations by QLogic and (d) taxes relating to the recapture or restoration of certain pre-Distribution tax items (such as depreciation recapture) of Emulex or its subsidiaries. QLogic will be liable for and will indemnify Emulex and its subsidiaries against (i) post-Distribution Federal, state and local tax liabilities of QLogic, (ii) taxes or liabilities resulting from a breach of any covenant or representation by QLogic contained in the Tax Sharing Agreement, and (iii) taxes imposed on Emulex in the event that the Distribution is taxable due to a breach of certain covenants and representations by QLogic in the Tax Sharing Agreement unless, prior to the breach, there is obtained, on the basis of valid representations, (1) a ruling from the Internal Revenue Service reasonably satisfactory to Emulex, or (2) an opinion acceptable to Emulex from counsel (such acceptance not to be unreasonably withheld, provided that, if counsel for Emulex does not concur with such opinion, Emulex's refusal to accept such opinion will not be considered unreasonable), in each case to the effect that the breach will not cause the Distribution to become subject to Federal income tax. In any event, if QLogic becomes liable to indemnify Emulex pursuant to these provisions, it is likely that the liability will be material to QLogic. The Tax Sharing Agreement provides that the party having responsibility for a tax liability under the Tax Sharing Agreement generally will be primarily responsible for, and bear the fees, costs and expenses (including attorneys' and accountants' fees) of, the defense of an audit or other proceeding arising out of or related to that tax liability. The Tax Sharing Agreement also generally provides that, subject to certain limitations, Emulex will pay to QLogic the net benefit realized by Emulex from the carryback to tax years before the Distribution of certain tax attributes of QLogic arising in tax years after the Distribution and QLogic will pay Emulex the net benefit realized by QLogic from the use after the Distribution Date of certain tax attributes of Emulex arising in pre- 36 37 QLOGIC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 29, 1998, MARCH 30, 1997 AND MARCH 31, 1996 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) Distribution tax years. Accordingly, QLogic has recognized no deferred tax assets with respect to such tax attributes. The total amount due Emulex pursuant to the Tax Sharing Agreement at March 29, 1998, and March 30, 1997 totaled $0 and $458, respectively, and is included in other non-current liabilities. NOTE (5) EXPORT REVENUES AND SIGNIFICANT CUSTOMERS QLogic's export shipments (primarily to Pacific Rim countries) were approximately $34,558, $31,301, and $29,800, representing 42, 45, and 55 percent of net revenues for 1998, 1997, and 1996, respectively. The following table represents sales to customers accounting for greater than 10% of Company net revenues, or customer accounts receivable accounting for greater than 10% of Company accounts receivable.
ACCOUNTS NET REVENUES RECEIVABLE -------------------- ------------ 1998 1997 1996 1998 1997 ---- ---- ---- ---- ---- Customer 1................................... 23% 16% N/A 40% N/A Customer 2................................... 20% 20% 13% 22% 30% Customer 3................................... N/A N/A N/A 11% N/A Customer 4................................... N/A 10% 11% N/A 19% Customer 5................................... N/A 19% 42% N/A N/A
With the exception of these customers, management of QLogic believes that the loss of any one customer would not have a material adverse effect on its business. NOTE (6) COMMITMENTS AND CONTINGENCIES Line of Credit On July 6, 1997, the Company obtained an unsecured line of credit from a bank. Maximum borrowings under the line of credit are $7.5 million subject to a borrowing base based on accounts receivable, with a $3.0 million sub-limit for letters of credit. Interest on outstanding advances is payable monthly at the bank's prime rate. The line of credit expires on July 5, 1998. The line of credit contains certain restrictive covenants that, among other things, require the maintenance of certain financial ratios and restrict the Company's ability to incur additional indebtedness. The Company was in compliance with all such covenants as of March 29, 1998. There were no borrowings under the line of credit as of March 29, 1998. The Company expects to extend the line of credit through the end of fiscal 1999. Leases The Company leases certain equipment under long-term non-cancelable capital lease agreements which expire at various dates through the year 2000. The required lease payments and, accordingly, the capitalized lease obligation and related assets have been included in the accompanying financial statements. The cost of equipment held under capital leases was $1,993 at both March 29, 1998 and March 30, 1997. The related accumulated depreciation was $1,992 and $1,819, at March 29, 1998 and March 30, 1997, respectively. 37 38 QLOGIC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 29, 1998, MARCH 30, 1997 AND MARCH 31, 1996 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) Future minimum non-cancelable lease commitments are as follows:
CAPITAL OPERATING LEASES LEASES ------- --------- Fiscal year: 1999...................................................... $234 $ 869 2000...................................................... 145 507 ---- ------ Total minimum lease payments................................ 379 1,376 ====== Less amounts representing interest (at rates ranging from 4% to 9%).................................................... 27 ---- Present value of future minimum capitalized lease obligations............................................... 352 Less current installments under capitalized lease obligations............................................... 211 ---- Capitalized lease obligations, excluding current installments.............................................. $141 ====
Rent expense for fiscal 1998, 1997 and 1996 was $820, $712 and 653, respectively. Litigation QLogic is involved in various legal proceedings which have arisen in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company's financial position, results of operations or liquidity. NOTE (7) EMPLOYEE RETIREMENT SAVINGS PLAN QLogic has established a pretax savings and profit sharing plan under Section 401(k) of the Internal Revenue Code for substantially all domestic employees. Under the plan, eligible employees are able to contribute up to 15% of their compensation. QLogic contributions match up to 3% of a participant's compensation. QLogic's direct contributions on behalf of its employees were $349, $218, and $193, in fiscal 1998, 1997, and 1996, respectively. NOTE (8) INCENTIVE COMPENSATION PLANS On January 12, 1994, the Company's Board of Directors adopted the QLogic Corporation Stock Awards Plan (the "Stock Awards Plan") and the QLogic Corporation Non-Employee Director Stock Option Plan (the "Director Plan") (collectively the "Stock Option Plans"). Additionally, the Company issues options on an ad hoc basis from time to time. The Stock Awards Plan provides for the issuance of incentive and non-qualified stock options, restricted stock and other stock-based incentive awards for officers and key employees. The Stock Awards Plan permits the Compensation Committee of the Board of Directors to select eligible employees to receive awards and to determine the terms and conditions of awards. A total of 1,350,000 shares are reserved for issuance under the Stock Awards Plan. As of March 29, 1998, no shares of restricted stock were issued, options to purchase 726,328 shares of common stock were outstanding, and there were 219,551 shares available for future grants. Options granted under the Company's Stock Awards Plan provide that an employee holding a stock option may exchange stock which the employee already owns as payment against the exercise of an option. This provision applies to all options outstanding as of March 29, 1998. All stock options granted under the Company's Stock Awards Plan have ten year terms and vest ratably over four years from the date of grant. Under the terms of the Director Plan, new directors receive an option grant, at fair market value to purchase 8,000 shares of common stock of the Company upon election to the Board and provides for annual 38 39 QLOGIC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 29, 1998, MARCH 30, 1997 AND MARCH 31, 1996 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) grants to each non-employee director (other than the Chairman of the Board) of options to purchase 3,000 shares of common stock, and provides for annual grants to the Chairman of the Board of options to purchase 5,000 shares of common stock. A total of 200,000 shares have been reserved for issuance under the Director Plan. As of March 29, 1998, options for a total of 64,500 shares were outstanding, and the remaining 84,500 shares were available for grant. All stock options granted under the Director Plan have ten year terms and vest ratably over three years from the date of grant. As of March 29, 1998 ad hoc stock options have been issued and are outstanding representing options to purchase 10,000 shares. Stock option activity in fiscal 1998, 1997 and 1996 under the Company's Stock Option Plans was as follows:
AVERAGE OPTION SHARES PRICE PER SHARE -------- --------------- Options outstanding as of April 2, 1995..................... 871,001 $ 7.66 Granted..................................................... 395,983 5.66 Canceled.................................................... (407,346) 7.35 Exercised................................................... (5,140) 5.72 -------- ------ Options outstanding as of March 31, 1996.................... 854,498 6.89 Granted..................................................... 309,410 13.71 Canceled.................................................... (42,800) 8.00 Exercised................................................... (282,353) 7.88 -------- ------ Options outstanding as of March 30, 1997.................... 838,755 9.00 Granted..................................................... 152,750 29.47 Canceled.................................................... (25,552) 12.67 Exercised................................................... (165,125) 7.62 -------- ------ Options outstanding as of March 29, 1998.................... 800,828 $13.07 ======== ======
As of March 29, 1998, March 30, 1997 and March 31, 1996, the number of options exercisable was 338,780, 282,273 and 365,553, respectively, and the weighted average exercise price of those options was $7.92, $6.63 and $7.89, respectively.
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------------------------------------------ -------------------------------------- WEIGHTED REMAINING WEIGHTED OUTSTANDING AS OF AVERAGE EXERCISE CONTRACTUAL EXERCISABLE AS OF AVERAGE EXERCISE RANGE OF EXERCISE PRICES MARCH 29, 1998 PRICE PER OPTION LIFE (YEARS) MARCH 29, 1998 PRICE PER OPTION - - ------------------------ ------------------ ---------------- ------------ ------------------ ---------------- $4.500 to $5.875 232,036 $ 5.063 7.08 151,228 $ 5.021 $6.500 to $10.500 204,809 $ 8.324 6.57 123,895 $ 8.018 $10.580 to $24.375 215,733 $14.824 8.38 63,657 $14.601 $25.250 to $43.000 148,250 $29.593 9.37 -- $ -- ------- ------- ---- ------- ------- $4.500 to $43.000 800,828 $13.067 7.73 338,780 $ 7.917 ======= ======= ==== ======= =======
39 40 QLOGIC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 29, 1998, MARCH 30, 1997 AND MARCH 31, 1996 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) The Company applies APB Opinion No. 25 in accounting for its Stock Option Plans and, accordingly, no compensation cost has been recognized for its stock options in the financial statements. Had the Company determined compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123, the Company's net income would have been reduced to the pro forma amounts indicated below:
1998 1997 1996 ------- ------ ------ Net income as reported.................................. $13,408 $5,848 $ 666 Assumed stock compensation cost, net of tax effect...... 2,576 2,329 1,244 Pro forma net income.................................... $10,832 $3,519 $ (578) Diluted earnings per share as reported.................. $ 1.66 $ 0.96 $ 0.12 Pro forma diluted earnings per share.................... $ 1.34 $ 0.58 $(0.10)
Pro forma net income reflects only options granted in fiscal 1998, 1997 and 1996. Therefore, the full impact of calculating compensation cost for stock options under SFAS No. 123 is not reflected in the pro forma net income amounts presented above because compensation cost is reflected over the options' vesting period of four years and compensation cost for options granted prior to April 3, 1995 is not considered. The Company uses the Black-Scholes option-pricing model for estimating the fair value of its equity instruments. The following represents the weighted-average fair value of options granted and the assumptions used for the calculation:
1998 1997 1996 -------- -------- ------- Estimated fair value per option granted............. $16.8638 $ 7.6416 $3.1214 Average exercise price per option granted........... $29.4726 $13.7131 $5.6802 Stock volatility.................................... 0.6039 0.5644 0.5644 Risk-free interest rate............................. 6.00% 6.69% 6.11% Annual rate of forfeiture........................... 17.00% 20.00% 20.00% Expected life (years)............................... 5.00 5.00 5.00 Stock dividend yield................................ 0.00% 0.00% 0.00% -------- -------- -------
The fair value of each option grant, as defined by SFAS No. 123, is estimated on the date of grant using the Black-Scholes option-pricing model. The Black-Scholes model, as well as other currently accepted option valuation models, was developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Company's stock option awards. These models also require highly subjective assumptions, including future stock price volatility and expected time until exercise, which greatly effect the calculated fair value on the grant date. NOTE (9) ACCRUED EXPENSES Components of accrued expenses are as follows:
1998 1997 ------- ------ Compensation................................................ $ 4,975 $3,027 Income taxes................................................ 5,112 1,443 Deferred revenue............................................ 1,913 999 Other....................................................... 1,610 1,646 ------- ------ $13,610 $7,115 ======= ======
40 41 QLOGIC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 29, 1998, MARCH 30, 1997 AND MARCH 31, 1996 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) NOTE (10) SHAREHOLDER RIGHTS PLAN On June 4, 1996, the Board of Directors of the Company unanimously adopted a Shareholder Rights Plan (the "Rights Plan") pursuant to which it declared a dividend distribution of one preferred stock purchase right (a "Right") for each outstanding share of the common stock. The Rights dividend was paid on June 20, 1996 to the holders of record of shares of common stock on that date. Each Right entitled the registered holder to purchase from the Company 1/100th of a share of the Company's Series A Junior Participating Preferred Stock, par value $.001 per share (1,000,000 shares authorized and no shares issued or outstanding at June 4, 1996) (the "Series A Preferred Stock"), at a price of $45.00 per 1/100th of a share, subject to adjustment. On September 23, 1997, the Board of Directors adopted an amendment to the Rights Plan to increase the Purchase Price for each 1/100 of a share of Series A Preferred Stock pursuant to the exercise of a Right from $45.00 to $225.00. In addition, the Board further amended the Rights Plan 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. The Rights become exercisable (i) the 10th business day following the date of a public announcement that a person or a group of affiliated or associated persons (an "Acquiring Person") has acquired beneficial ownership of 15% or more of the outstanding shares of common stock, or (ii) the 10th business day following the commencement of, or announcement of an intention to make a tender offer or exchange offer the consummation of which would result in the person or group making the offer becoming an Acquiring Person (the earlier of the dates described in clauses (i) and (ii) being called the "Distribution Date"). The Rights held by an Acquiring Person or its affiliates are not exercisable. All shares of common stock that will be issued prior to the Distribution Date will include such Rights. The Rights will expire at the close of business on June 4, 2006 (the "Scheduled Expiration Date"), unless prior thereto the Distribution Date occurs, or unless the Scheduled Expiration Date is extended. In the event the Company's assets are liquidated, the holders of the shares of Series A Preferred Stock will be entitled to an aggregate payment of $1.00 per share or 100 times the payment to be distributed per share of common stock, whichever is greater. Each share of Series A Preferred Stock will have 100 votes, voting together with the shares of common stock. Finally, in the event of any merger, consolidation or other transaction in which shares of common stock are exchanged, each share of Series A Preferred Stock will entitle the holder to receive 100 times the amount received per share of common stock, subject to adjustment. Holders of Rights will be entitled to purchase shares or assets of the Company or an Acquiring Person with a value that is double the exercise price in the event of certain acquisitions involving the Acquiring Person, directly or indirectly. 41 42 QLOGIC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 29, 1998, MARCH 30, 1997 AND MARCH 31, 1996 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) NOTE (11) INVESTMENTS IN DEBT SECURITIES The following is a summary of the investments in debt securities classified in current and long-term assets as of March 29, 1998:
GROSS GROSS UNREALIZED UNREALIZED ESTIMATED COST GAINS LOSSES FAIR VALUE -------- ---------- ---------- ---------- U.S. Treasury and agency securities................ $ 10,474 $-- $ -- $ 10,474 Securities issued by states of the U.S. ........... 26,891 5 (6) 26,890 Corporate debt securities.......................... 21,625 -- -- 21,625 Other debt securities.............................. 32,064 -- -- 32,064 Less cash equivalents.............................. (63,308) -- -- (63,308) -------- --- ---- -------- Short-term investments........................ 27,746 5 (6) 27,745 -------- --- ---- -------- Securities issued by states of the U.S. ........... 20,934 26 (8) 20,952 -------- --- ---- -------- Long-term investments (with maturities from 1 to 2 years)................................. 20,934 26 (8) 20,952 -------- --- ---- -------- Total investments.................................. $ 48,680 $31 $(14) $ 48,697 ======== === ==== ========
42 43 QLOGIC CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) MARCH 29, 1998, MARCH 30, 1997 AND MARCH 31, 1996 (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) NOTE (12) CONDENSED QUARTERLY RESULTS (UNAUDITED) The following summarizes certain unaudited quarterly financial information for fiscal 1998, 1997, and 1996.
THREE MONTHS ENDED --------------------- JUNE SEPTEMBER DECEMBER MARCH ------- --------- -------- ------- FISCAL 1998: Net revenues....................................... $18,172 $19,625 $20,856 $22,740 Operating income................................... 3,367 4,225 5,184 5,710 Net income......................................... 2,244 3,041 3,946 4,177 Net income per basic share......................... 0.38 0.42 0.46 0.48 Net income per diluted share....................... 0.35 0.39 0.43 0.46 ======= ======= ======= ======= FISCAL 1997: Net revenues....................................... $15,740 $16,725 $17,431 $19,031 Operating income................................... 1,592 1,872 2,656 3,234 Net income......................................... 967 1,178 1,677 2,026 Net income per basic share......................... 0.17 0.21 0.29 0.35 Net income per diluted share....................... 0.16 0.20 0.27 0.32 ======= ======= ======= ======= FISCAL 1996: Net revenues....................................... $ 9,570 $13,105 $14,886 $16,218 Operating income (loss)............................ (1,162) 375 695 1,276 Net income (loss).................................. (724) 214 444 732 Net income (loss) per basic share.................. (0.13) 0.04 0.08 0.13 Net income (loss) per diluted share................ (0.13) 0.04 0.08 0.13 ======= ======= ======= =======
43 44 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Reference is made to the Company's Definitive Proxy Statement for its 1998 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days after the end of fiscal 1998, for information relating to the Company's Directors under the heading "Nomination and Election of Directors." Such information is incorporated herein by reference. See the information presented in Part I of this report under the heading "Executive Officers of the Registrant" for information relating to the Company's executive officers. ITEM 11. EXECUTIVE COMPENSATION Reference is made to the Company's Definitive Proxy Statement for its 1998 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days after the end of fiscal 1998, for information relating to executive compensation under the heading "Executive Compensation and Other Information" excluding the "Report of Executive Compensation Committee" and the "Stockholder Return Performance Presentation." Such information is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Reference is made to the Company's Definitive Proxy Statement for its 1998 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days after the end of fiscal 1998, for information relating to security ownership of certain beneficial owners and management under the heading "Principal Stockholders and Stock Ownership of Management." Such information is incorporated herein by reference. There are no arrangements, known to the Company, which might at a subsequent date result in a change in control of the Company. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Reference is made to the Company's Definitive Proxy Statement for its 1998 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days after the end of fiscal 1998, for information relating to certain relationships and related transactions, if any, under the headings "Compensation Committee Interlocks and Insider Participation" and "Certain Transactions." Such information is incorporated herein by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K (a) Financial Statements and Schedules (1) Consolidated Financial Statements 44 45 The following consolidated financial statements of the Company for the years ended March 29, 1998, March 30, 1997, and March 31, 1996 are filed as part of this report: FINANCIAL STATEMENT INDEX
STATEMENT PAGE NUMBER --------- ----------- QLogic Corporation: Independent Auditors' Report.............................. 26 Consolidated Balance Sheets as of March 29, 1998 and March 30, 1997............................................... 27 Consolidated Statements of Income for the years ended March 29, 1998, March 30, 1997 and March 31, 1996...... 28 Consolidated Statements of Stockholders' Equity for the years ended March 29, 1998, March 30, 1997 and March 31, 1996............................................... 29 Consolidated Statements of Cash Flows for the years ended March 29, 1998, March 30, 1997 and March 31, 1996...... 30 Notes to Consolidated Financial Statements................ 31
(2) Financial Statement Schedule The following consolidated financial statement schedule of the Company for the years ended March 28, 1998, March 30, 1997, and March 31, 1996 is filed as part of this report:
PAGE NUMBER OF THIS REPORT -------------------------- Schedule II -- Valuation and Qualifying Accounts............ 48
All other Schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are not applicable and, therefore, have been omitted. (3) Exhibits Index
EXHIBIT NO. ITEM CAPTION ----------- ------------ 2.1 Distribution Agreement dated as of January 24, 1994 among Emulex Corporation, A Delaware Corporation, Emulex Corporation, a California Corporation and QLogic Corporation.* 3.1 Certificate of Incorporation of Emulex Micro Devices Corporation, dated November 13, 1992.* 3.2 EMD Incorporation Agreement, dated as of January 1, 1993.* 3.3 Certificate of Amendment of Certificate of Incorporation, dated May 26, 1993.* 3.4 By-Laws of QLogic Corporation.* 3.5 Amendments to By-Laws of QLogic Corporation.*** 4.1 Rights Agreement, dated as of June 4, 1996, between the Company and Harris Trust Company of California, as Rights Agent, which includes as Exhibit A thereto a form of Certificate of Designation for the Preferred Stock, as Exhibit B thereto the form of Rights Certificate, and as Exhibit C thereto a Summary of the Terms of Shareholders Rights Plan.(2) 4.2 Amendment to Rights Agreement, date as of November 19, 1997, between the Company and Harris Trust Company of California, as Rights Agent.(3) 10.1 Form of QLogic Corporation Non-Employee Director Stock Option Plan.*(1) 10.2 Form of QLogic Corporation Stocks Awards Plan.*(1) 10.3 Form of Tax Sharing Agreement among Emulex Corporation, a Delaware corporation, Emulex Corporation, a California corporation, and QLogic Corporation.*
45 46
EXHIBIT NO. ITEM CAPTION ----------- ------------ 10.4 Administrative Services Agreement, dated as of February 21, 1993, among Emulex Corporation, a California corporation, Emulex Corporation, a Delaware corporation and QLogic Corporation.* 10.5 Employee Benefits Allocation Agreement, dated as of January 24, 1994, among Emulex Corporation, a Delaware corporation, Emulex Corporation, a California corporation, and QLogic Corporation.* 10.6 Form of Assignment, Assumption and Consent Re: Lease among Emulex Corporation, a California corporation, QLogic Corporation and C.J. Segerstrom & Sons, a general partnership.* 10.7 Intellectual Property Assignment and Licensing Agreement, dated as of January 24, 1994, between Emulex Corporation, a California Corporation, and QLogic Corporation.* 10.8 Form of QLogic Corporation Savings Plan.*(1) 10.9 Form of QLogic Corporation Savings Plan Trust.*(1) 10.10 Loan and Security Agreement with Silicon Valley Bank. 10.11 Form of Indemnification Agreement between QLogic Corporation and Directors.*.* 10.12 Supplement to Tax Sharing Agreement, dated June 2, 1995, between QLogic Corporation and Emulex Corporation.*.* 21.1 Subsidiary of the registrant. 23.1 Consent of Independent Auditors. 27 Financial Data Schedule.
- - --------------- * Previously filed as an exhibit to Registrant's Registration Statement on Form 10 filed January 28, 1994 and incorporated herein by reference. ** Previously filed as an exhibit to Registrant's annual Report on Form 10-K for the year ended April 3, 1994 and is incorporated herein by reference. *.* Previously filed as an exhibit to Registrant's Annual Report on Form 10-K for the year ended April 2, 1995. *** Previously filed as an exhibit to Registrant's annual Report on Form 10-K for the year ended March 31, 1996 and is incorporated herein by reference. (1) Management contract or compensation plan or arrangement. (2) Incorporated by reference to Exhibit 1 to the Company's Registration Statement on Form 8-A filed June 19, 1996. (3) Incorporated by reference to Exhibit 2 to the Company's Registration Statement on Form 8-A/A filed November 25, 1997. (b) Reports on Form 8-K. There were no reports on Form 8-K filed during the last quarter of the period covered by this report. 46 47 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. QLOGIC CORPORATION By: /s/ H.K. DESAI ------------------------------------ H.K. Desai President and Chief Executive Officer Date: June 12, 1998 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on.
SIGNATURE TITLE --------- ----- PRINCIPAL EXECUTIVE OFFICER: /s/ H.K. DESAI President and Chief Executive Officer - - -------------------------------------------------------- H.K. Desai PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER: /s/ THOMAS R. ANDERSON Vice President and Chief Financial Officer - - -------------------------------------------------------- Thomas R. Anderson /s/ GARY E. LIEBL Director and Chairman of the Board - - -------------------------------------------------------- Gary E. Liebl /s/ JAMES A. BIXBY Director - - -------------------------------------------------------- James A. Bixby /s/ CAROL L. MILTNER Director - - -------------------------------------------------------- Carol L. Miltner /s/ GEORGE D. WELLS Director - - -------------------------------------------------------- George D. Wells
47 48 QLOGIC CORPORATION SCHEDULE II VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED MARCH 29, 1998, MARCH 30, 1997 AND MARCH 31, 1996 (IN THOUSANDS)
ADDITIONS DEDUCTIONS - BALANCE AT CHARGED TO AMOUNTS BALANCE AT BEGINNING OF COSTS AND WRITTEN OFF/ END OF PERIOD EXPENSES RECOVERED PERIOD ------------ ---------- ------------- ---------- Classification: Year ended March 29, 1998 Allowance for doubtful accounts............ $ 636 $ 200 $ (90) $ 746 Inventory reserves......................... $2,322 $ 628 $ (376) $2,574 Year ended March 30, 1997 Allowance for doubtful accounts............ $ 506 $ 129 $ 1 $ 636 Inventory reserves......................... $1,841 $2,964 $(2,483) $2,322 Year ended March 31, 1996 Allowance for doubtful accounts............ $ 595 $ 23 $ (112) $ 506 Inventory reserves......................... $1,464 $2,914 $(2,537) $1,841
48 49 EXHIBIT INDEX
EXHIBIT NO. ITEM CAPTION - - ----------- ------------ 2.1 Distribution Agreement dated as of January 24, 1994 among Emulex Corporation, A Delaware Corporation, Emulex Corporation, a California Corporation and QLogic Corporation.* 3.1 Certificate of Incorporation of Emulex Micro Devices Corporation, dated November 13, 1992.* 3.2 EMD Incorporation Agreement, dated as of January 1, 1993.* 3.3 Certificate of Amendment of Certificate of Incorporation, dated May 26, 1993.* 3.4 By-Laws of QLogic Corporation.* 3.5 Amendments to By-Laws of QLogic Corporation.*** 4.1 Rights Agreement, dated as of June 4, 1996, between the Company and Harris Trust Company of California, as Rights Agent, which includes: as Exhibit A thereto a form of Certificate of Designation for the Preferred Stock, as Exhibit B thereto the form of Rights Certificate, and as Exhibit C thereto a Summary of the Terms of Shareholders Rights Plan.(2) 4.2 Amendment to Rights Agreement, dated as of November 19, 1997, between the Company and Harris Trust Company of California, as Rights Agent.(3) 10.1 Form of QLogic Corporation Non-Employee Director Stock Option Plan.*(1) 10.2 Form of QLogic Corporation Stocks Awards Plan.*(1) 10.3 Form of Tax Sharing Agreement among Emulex Corporation, a Delaware corporation, Emulex Corporation, a California corporation, and QLogic Corporation.* 10.4 Administrative Services Agreement, dated as of February 21, 1993, among Emulex Corporation, a California corporation, Emulex Corporation, a Delaware corporation and QLogic Corporation.* 10.5 Employee Benefits Allocation Agreement, dated as of January 24, 1994, among Emulex Corporation, a Delaware corporation, Emulex Corporation, a California corporation, and QLogic Corporation.* 10.6 Form of Assignment, Assumption and Consent Re: Lease among Emulex Corporation, a California corporation, QLogic Corporation and C.J. Segerstrom & Sons, a general partnership.* 10.7 Intellectual Property Assignment and Licensing Agreement, dated as of January 24, 1994, between Emulex Corporation, a California Corporation, and QLogic Corporation.* 10.8 Form of QLogic Corporation Savings Plan.*(1) 10.9 Form of QLogic Corporation Savings Plan Trust.*(1) 10.10 Loan and Security Agreement with Silicon Valley Bank. 10.11 Form of Indemnification Agreement between QLogic Corporation and Directors.*.* 10.12 Supplement to Tax Sharing Agreement, dated June 2, 1995, between QLogic Corporation and Emulex Corporation.*.* 21.1 Subsidiary of the registrant. 23.1 Consent of Independent Auditors. 27 Financial Data Schedule.
- - --------------- * Previously filed as an exhibit to Registrant's Registration Statement on Form 10 filed January 28, 1994 and incorporated herein by reference. ** Previously filed as an exhibit to Registrant's annual Report on Form 10-K for the year ended April 3, 1994 and is incorporated herein by reference. 49 50 *.* Previously filed as an exhibit to Registrant's Annual Report on Form 10-K for the year ended April 2, 1995. *** Previously filed as an exhibit to Registrant's annual Report on Form 10-K for the year ended March 31, 1996 and is incorporated herein by reference. (1) Management contract or compensation plan or arrangement. (2) Incorporated by reference to Exhibit 1 to the Company's Registration Statement on Form 8-A filed June 19, 1996. (3) Incorporated by reference to Exhibit 2 to the Company's Registration Statement on Form 8-A/A filed November 25, 1997. 50 EX-10.10 2 LOAN & SECURITY AGREEMENT WITH SILICON VALLEY BANK 1 EXHIBIT 10.10 SILICON VALLEY BANK AMENDMENT TO LOAN AND SECURITY AGREEMENT BORROWER: QLOGIC CORPORATION ADDRESS: 3545 HARBOR BOULEVARD, P.O. BOX 5001 COSTA MESA, CALIFORNIA 92628 DATED AS OF: JULY 6, 1997 THIS AMENDMENT TO LOAN AND SECURITY AGREEMENT is entered into between SILICON VALLEY BANK ("Silicon") and the borrower named above (the "Borrower"). The parties agree to amend the Loan and Security Agreement between them, dated March 31, 1994, as amended by that Amendment to Loan and Security Agreement dated July 10, 1995 and as amended by that Amendment to Loan and Security Agreement dated July 5, 1996 (as so amended and as otherwise amended from time to time, the "Loan Agreement"), as follows, effective as of the date hereof. (Capitalized terms used but not defined in this Amendment, shall have the meanings set forth in the Loan Agreement.) 1. AMENDED SCHEDULE. The Schedule to the Loan and Security Agreement is amended effective on the date hereof, to read as set forth on the Amended Schedule to Loan and Security Agreement attached hereto. 2. MODIFIED SECTION 2.2A. If Borrower consummates an Additional Equity Transaction (as defined below) on and after the date hereof, section 2.2A of the Loan Agreement shall be deemed deleted, and all references in the Loan Agreement to the Section 2.2A Condition shall be deemed of no force and effect. "Additional Equity Transaction" means an equity financing transaction by the Borrower from which it has received at least $20,000,000 in net proceeds. 3. SECURITY INTEREST REFERENCES IN LOAN AGREEMENT; ETC. Upon the consummation of the Additional Equity Transaction, and only upon the consummation of the Additional Equity Transaction, Borrower and Silicon hereby agree that all references to the security interest or lien of Silicon in the Collateral and related provisions are hereby deleted. Further, it is understood that Silicon shall not be required to be named as loss payee on the Borrower's insurance policies, nor are insurance payments relating to the Collateral required to be forwarded to Silicon for payment of the Obligations. Further, references in the Loan Agreement to remedies of Silicon on and after an Event of Default that depend upon the existence of a security interest in the Collateral in favor of Silicon at or prior to the occurrence of an Event of Default are considered deleted, provided, however, nothing herein affects or diminishes the rights of Silicon otherwise available as set forth in the Loan Agreement or as available under law. 4. FACILITY FEE. Borrower shall pay to Silicon concurrently herewith a facility fee of $37,500, which shall be in addition to all interest and all other fees payable to Silicon and shall be non-refundable. 5. REPRESENTATIONS TRUE. Borrower represents and warrants to Silicon that all representations and warranties set forth in the Loan Agreement, as amended hereby, are true and correct. 6. GENERAL PROVISIONS. This Amendment, the Loan Agreement, any prior written amendments to the Loan Agreement signed by Silicon and the Borrower, and the other written documents and agreements between Silicon and the Borrower set forth in full all of the representations and agreements of the parties with respect to the subject matter hereof and supersede all prior discussions, representations, agreements and understandings between the parties with respect to the subject hereof. Except 2 2 as herein expressly amended, all of the terms and provisions of the Loan Agreement, and all other documents and agreements between Silicon and the Borrower shall continue in full force and effect and the same are hereby ratified and confirmed. BORROWER: SILICON: QLOGIC CORPORATION SILICON VALLEY BANK BY /s/ TOM ANDERSON BY /s/ MICHAEL QUAIN ---------------------------------- ------------------------------ PRESIDENT OR VICE PRESIDENT TITLE VICE PRESIDENT BY /s/ MICHAEL MANNING --------------------------------- SECRETARY OR ASS'T SECRETARY 3 3 SILICON LOAN DOCUMENTS SCHEDULE TO LOAN AND SECURITY AGREEMENT -.S. -1- 4 SILICON VALLEY BANK SCHEDULE TO LOAN AND SECURITY AGREEMENT BORROWER: QLOGIC CORPORATION ADDRESS: 3545 HARBOR BOULEVARD, P.O. BOX 5001 COSTA MESA, CALIFORNIA 92628 DATED AS OF: JULY 6, 1997 CREDIT LIMIT (Section 1.1): PRIOR TO THE CONSUMMATION OF THE ADDITIONAL EQUITY TRANSACTION (AS DEFINED IN PARAGRAPH 5 OF SECTION 4.1 BELOW): An amount not to exceed the lesser of: (i) $7,500,000 at any one time outstanding; OR (ii) 80% of the Net Amount of Borrower's accounts, which Silicon in its discretion deems eligible for borrowing; Provided, however, that the minimum amount of a Loan shall be $100,000; "Net Amount" of an account means the gross amount of the account, minus all applicable sales, use, excise and other similar taxes and minus all discounts, credits and allowances of any nature granted or claimed. Without limiting the fact that the determination of which accounts are eligible for borrowing is a matter of Silicon's discretion, the following will not be deemed eligible for borrowing: accounts outstanding for more than 90 days from the invoice date, accounts subject to any contingencies, accounts owing from one account debtor to the extent they exceed 25% of the total eligible accounts outstanding, accounts owing from an affiliate of Borrower, and accounts owing from an account debtor to whom Borrower is or may be liable for goods purchased from such account debtor or otherwise. In addition, if more than 50% of the accounts owing from an account debtor are outstanding more than 90 days from the invoice date or are otherwise not eligible accounts, then all accounts owing from that account debtor will be deemed ineligible for borrowing. ON AND AFTER THE CONSUMMATION OF THE ADDITIONAL EQUITY TRANSACTION: An amount not to exceed $7,500,000; Provided, however, that the minimum amount of a Loan shall be $100,000; LETTER OF CREDIT SUBLIMIT Silicon, in its reasonable discretion, will from time to time during the term of this Agreement issue letters of credit for the account of the Borrower ("Letters of Credit"), in an aggregate amount at any one time outstanding not to exceed $3,000,000, upon the request of the Borrower, provided that, on the date the Letters of Credit are to be issued, Borrower has available to it Loans in an amount equal to or greater than the face amount of the Letters of Credit to be issued. Prior to the issuance of any Letters of Credit, Borrower shall execute and deliver to Silicon Applications for Letters of Credit and such other documentation as Silicon shall specify (the "Letter of Credit Documentation"). Fees for the Letters of Credit shall be as provided in the Letter of Credit Documentation. The Credit Limit set forth above and the Loans available under this Agreement at any time shall be reduced by the face amount of Letters of Credit from time to time outstanding. INTEREST RATE (Section 1.2): A rate equal to the "Prime Rate" in effect from time to time. Interest shall be calculated on the basis of a 360-day year for the actual number of days elapsed. "Prime Rate" means the rate announced from time to time by Silicon as its "prime -1- 5 SILICON VALLEY BANK SCHEDULE TO LOAN AND SECURITY AGREEMENT rate;" it is a base rate upon which other rates charged by Silicon are based, and it is not necessarily the best rate available at Silicon. The interest rate applicable to the Obligations shall change on each date there is a change in the Prime Rate. LOAN ORIGINATION FEE (Section 1.3): See Amendment to Loan Agreement of even date herewith. MATURITY DATE (Section 5.1): JULY 5, 1998. PRIOR NAMES OF BORROWER (Section 3.2): EMULEX MICRO DEVICES (EMD) A DIVISION OF EMULEX CORPORATION TRADE NAMES OF BORROWER (Section 3.2): NONE OTHER LOCATIONS AND ADDRESSES (Section 3.3): 5589 WINFIELD BLVD., SUITE 204, SAN JOSE, CA 95123 150 INDUSTRIAL AVE. EAST, SUITE 39, LOWELL, MA 01852 MATERIAL ADVERSE LITIGATION (Section 3.10): NONE NEGATIVE COVENANTS-EXCEPTIONS (Section 4.6): Without Silicon's prior written consent, Borrower may do the following, provided that, after giving effect thereto, no Event of Default has occurred and no event has occurred which, with notice or passage of time or both, would constitute an Event of Default, and provided that the following are done in compliance with all applicable laws, rules and regulations: (i) repurchase shares of Borrower's stock pursuant to any employee stock purchase or benefit plan, provided that the total amount paid by Borrower for such stock does not exceed $1,000,000 in any fiscal year and (ii) make employee loans in an aggregate amount outstanding at any time not to exceed $50,000. FINANCIAL COVENANTS (Section 4.1): Borrower shall comply with all of the following covenants. Compliance shall be determined as of the end of each quarter, except as otherwise specifically provided below: QUICK ASSET RATIO: Borrower shall maintain a ratio of "Quick Assets" to current liabilities of not less than 1.50 to 1. TANGIBLE NET WORTH: Borrower shall maintain a tangible net worth of not less than $23,000,000. DEBT TO TANGIBLE NET WORTH RATIO: Borrower shall maintain a ratio of total liabilities to tangible net worth of not more than 1.00 to 1. PROFITABILITY Borrower shall not incur a loss (after taxes) for any fiscal quarter during the term hereof, other than for a loss (after taxes) in a single fiscal quarter which loss (after taxes) may not exceed $750,000; and Borrower shall not incur a loss (after taxes) for any fiscal year. DEFINITIONS: "Current assets," and "current liabilities" shall have the meanings ascribed to them in accordance with generally accepted accounting principles. "Tangible net worth" means the excess of total assets over total liabilities, determined in accordance with generally accepted accounting principles, excluding however all assets which would be classified as intangible assets under generally accepted accounting principles, including without limitation goodwill, licenses, patents, trademarks, trade names, copyrights, capitalized software and organizational costs, licenses and franchises. "Quick Assets" means cash on hand or on deposit in banks, readily marketable securities issued by the United States, readily marketable commercial paper rated "A-1" by Standard & Poor's Corporation (or a similar rating by a similar rating organization), certificates of deposit and banker's acceptances, and accounts receivable (net of allowance for doubtful accounts). -2- 6 SILICON VALLEY BANK SCHEDULE TO LOAN AND SECURITY AGREEMENT DEFERRED REVENUES: For purposes of the above quick asset ratio deferred revenues shall not be counted as current liabilities. For purposes of the above debt to tangible net worth ratio, deferred revenues shall not be counted in determining total liabilities but shall be counted in determining tangible net worth for purposes of such ratio. For all other purposes deferred revenues shall be counted as liabilities in accordance with generally accepted accounting principles. SUBORDINATED DEBT: "Liabilities" for purposes of the foregoing covenants do not include indebtedness which is subordinated to the indebtedness to Silicon under a subordination agreement in form specified by Silicon or by language in the instrument evidencing the indebtedness which is acceptable to Silicon. OTHER COVENANTS (Section 4.1): Borrower shall at all times comply with all of the following additional covenants: 1. BANKING RELATIONSHIP. Borrower shall at all times maintain its primary banking relationship with Silicon, provided that the foregoing shall not restrict the Borrower's establishment of investment accounts at other institutions. 2. MONTHLY BORROWING BASE CERTIFICATE AND LISTING. At all times that any Loans are outstanding, within 20 days after the end of each month, Borrower shall provide Silicon with a Borrowing Base Certificate in such form as Silicon shall specify, and an aged listing of Borrower's accounts receivable. At such times that Borrower is requesting a Loan when no Loans are then outstanding, Borrower shall provide to Silicon a Borrowing Base Certificate in such form as Silicon shall specify, and an aged listing of Borrower's accounts within five (5) days of Silicon's making of any such Loan. Notwithstanding the foregoing, on and after the consummation of the Additional Equity Transaction (as defined in paragraph 5 below), Borrower shall not be required to submit to Silicon any of the documentation referred to in this paragraph, regardless of the outstanding Loan status. 3. INDEBTEDNESS. Without limiting any of the foregoing terms or provisions of this Agreement, Borrower shall not in the future incur indebtedness for borrowed money, except for (i) indebtedness to Silicon, (ii) indebtedness incurred in the future for the purchase price of or lease of equipment in an aggregate amount not exceeding $3,500,000 on an annual basis, and (iii) the creation of trade payable obligations in the ordinary course of business. 4. SEC FILINGS AND COMMUNICATIONS. Without limitation of the provisions of Section 3.7 hereof, Borrower agrees to provide to Silicon all filings made with the Securities and Exchange Commission (the "SEC"), and copies of all notices or other communication from the SEC, within 5 days of such filing or receipt of such notice or other communication. 5. UCC-1 NOT TO BE FILED ABSENT DEFAULT. Silicon shall not file the UCC-1 Financing Statements provided to Silicon unless any Obligations are outstanding and an Event of Default has occurred, provided that upon the consummation of the Additional Equity Transaction (as defined below), Silicon agrees that such UCC-1 Financing Statements shall be returned to the Borrower and shall be deemed terminated. "Additional Equity Transaction" means an equity financing transaction by the Borrower from which it has received at least $20,000,000 in net proceeds. 6. COLLATERAL ASSIGNMENT REGARDING INTELLECTUAL PROPERTY COLLATERAL. Borrower has executed and delivered to Silicon three originals of Silicon's standard form of security agreement relating to Collateral consisting of intellectual property items, which form is entitled "Collateral Assignment, Patent Mortgage and Security Agreement" (the "Copyright Assignment"), provided that Silicon agrees not to record the Copyright Assignment with the United States Patent and Trademark office or with the United States Copyright office until an Event of Default has occurred and any Obligations are outstanding, provided, further, it is understood and agreed that the terms and provisions of the Copyright Assignment shall not be considered to be effective until the satisfaction of the Section 2.2A Condition. In connection therewith, at such time that Silicon seeks to so record such agreement, Borrower agrees to effect registration with the United States Copyright office of Collateral consisting of copyrightable subject matter in accordance with the provisions set forth in the Copyright Assignment, and, without limitation of the other obligations of Borrower herein and therein, to take all other actions in order to assist Silicon in the perfection of its security interest in such items of Collateral. Notwithstanding the foregoing, it is understood and agreed that upon the -3- 7 SILICON VALLEY BANK SCHEDULE TO LOAN AND SECURITY AGREEMENT consummation of an Additional Equity Transaction the Copyright Assignment shall be returned to the Borrower and shall be deemed terminated. 7. NEGATIVE PLEDGE. Except as otherwise permitted hereunder (including without limitation the incurrence of Permitted Liens as set forth in Section 3.4 of this Agreement), Borrower shall not hereafter grant a security interest in any of its present or future Collateral, other than for liens on capital equipment relating to obligations incurred pursuant to paragraph 3 above. BORROWER: QLOGIC CORPORATION BY: /s/ THOMAS R. ANDERSON --------------------------------- PRESIDENT OR VICE PRESIDENT BY: /s/ MICHAEL R. MANNING --------------------------------- SECRETARY OR ASS'T SECRETARY SILICON: SILICON VALLEY BANK BY: /s/ MICHAEL P. QUAIN --------------------------------- VICE PRESIDENT -4- 8 SILICON LOAN DOCUMENTS CERTIFIED RESOLUTION -.R -1- 9 SILICON VALLEY BANK CERTIFIED RESOLUTION BORROWER: QLOGIC CORPORATION, A CORPORATION ORGANIZED UNDER THE LAWS OF THE STATE OF DELAWARE ADDRESS: 3545 HARBOR BOULEVARD, P.O. BOX 5001 COSTA MESA, CALIFORNIA 92628 DATED AS OF: JULY 6, 1997 I, the undersigned, Secretary or Assistant Secretary of the above-named borrower, a corporation organized under the laws of the state set forth above, do hereby certify that the following is a full, true and correct copy of resolutions duly and regularly adopted by the Board of Directors of said corporation as required by law, and by the by-laws of said corporation, and that said resolutions are still in full force and effect and have not been in any way modified, repealed, rescinded, amended or revoked. RESOLVED, that this corporation borrow from Silicon Valley Bank ("Silicon"), from time to time, such sum or sums of money as, in the judgment of the officer or officers hereinafter authorized hereby, this corporation may require. RESOLVED FURTHER, that any officer of this corporation be, and he or she is hereby authorized, directed and empowered, in the name of this corporation, to execute and deliver to Silicon, and Silicon is requested to accept, the loan agreements, security agreements, notes, financing statements, and other documents and instruments providing for such loans and evidencing and/or securing such loans, with interest thereon, and said authorized officers are authorized from time to time to execute renewals, extensions and/or amendments of said loan agreements, security agreements, and other documents and instruments. RESOLVED FURTHER, that said authorized officers be and they are hereby authorized, directed and empowered, as security for any and all indebtedness of this corporation to Silicon, whether arising pursuant to this resolution or otherwise, to grant, transfer, pledge, mortgage, assign, or otherwise hypothecate to Silicon, or deed in trust for its benefit, any property of any and every kind, belonging to this corporation, including, but not limited to, any and all real property, accounts, inventory, equipment, general intangibles, instruments, documents, chattel paper, notes, money, deposit accounts, furniture, fixtures, goods, and other property of every kind, and to execute and deliver to Silicon any and all grants, transfers, trust receipts, loan or credit agreements, pledge agreements, mortgages, deeds of trust, financing statements, security agreements and other hypothecation agreements, which said instruments and the note or notes and other instruments referred to in the preceding paragraph may contain such provisions, covenants, recitals and agreements as Silicon may require and said authorized officers may approve, and the execution thereof by said authorized officers shall be conclusive evidence of such approval. RESOLVED FURTHER, that Silicon may conclusively rely upon a certified copy of these resolutions and a certificate of the Secretary or Ass't Secretary of this corporation as to the officers of this corporation and their offices and signatures, and continue to conclusively rely on such certified copy of these resolutions and said certificate for all past, present and future transactions until written notice of any change hereto or thereto is given to Silicon by this corporation by certified mail, return receipt requested. 10 SILICON VALLEY BANK LOAN AND SECURITY AGREEMENT The undersigned further hereby certifies that the following persons are the duly elected and acting officers of the corporation named above as borrower and that the following are their actual signatures:
NAMES OFFICE(S) ACTUAL SIGNATURES - - ----- --------- ----------------- ________________________ ______________________ X________________________ ________________________ ______________________ X________________________ ________________________ ______________________ X________________________ ________________________ ______________________ X________________________
IN WITNESS WHEREOF, I have hereunto set my hand as such Secretary or Assistant Secretary on the date set forth above. -------------------------------- Secretary or Assistant Secretary 3 11 2.7 GRANT DATE. "Grant Date" means the first day of each Offering Period (February 1, May 1, August 1 and November 1) under the Plan. However, for the first Offering Period, the Grant Date shall be the Effective Date. 2.8 OFFERING PERIOD. "Offering Period" means the three-month periods from February 1 through April 30, May 1 through July 31, August 1 through October 31, and November 1 through January 31 of each calendar year. The first Offering Period shall commence on the Effective Date and end October 31, 1998. 2.9 5% OWNER. "5% Owner" means an Employee who, immediately after the grant of any rights under the Plan, would own Company Stock or hold outstanding options to purchase Company Stock possessing 5% or more of the total combined voting power of all classes of stock of the Company. For purposes of this Section, the ownership attribution rules of Code Section 425(d) shall apply. 2.10 PARTICIPANT. "Participant" means an Employee who has satisfied the eligibility requirements of Section 3.1 and has become a participant in the Plan in accordance with Section 3.2. 2.11 PURCHASE DATE. "Purchase Date" means the last day of each Offering Period (April 30, July 31, October 31, or January 31). ARTICLE 3 ELIGIBILITY AND PARTICIPATION 3.1 ELIGIBILITY. Each Employee of the Company, or any Designated Subsidiary, who has attained age eighteen (18) on the Entry Date and who regularly works at least 30 hours per week for more than five months per year in the rendition of personal services to the Company may become a Participant in the Plan on the Entry Date coincident with or next following his satisfaction of such requirements of employment with the Company. 3.2 PARTICIPATION. An Employee who has satisfied the eligibility requirements of Section 3.1 may become a Participant in the Plan upon his completion and delivery to the Administrator of the Company of a stock purchase agreement provided by the Company (the "Stock Purchase Agreement") authorizing payroll deductions. Payroll deductions for a Participant shall commence on the Entry Date coincident with or next following the filing of the Participant's Stock Purchase Agreement and shall remain in effect until revoked by the Participant by the filing of a notice of withdrawal from the Plan under Article 8 or by the filing of a new Stock Purchase Agreement providing for a change in the Participant's payroll deduction rate under Section 5.2. 3.3 SPECIAL RULES. Under no circumstances shall: a. A 5% Owner be granted an option to purchase Company Stock under the Plan; b. A Participant be entitled to purchase Company Stock under the Plan which, when aggregated with all other employee stock purchase plans of the Company, exceed an amount equal to the Aggregate Maximum. "Aggregate Maximum" means an amount equal to $25,000 worth of Company Stock (determined using the fair market value of such Company Stock at each applicable Grant Date) during each calendar year; or c. The number of shares of Company Stock purchasable by a Participant in any calendar year shall not exceed 5,000 shares, subject to periodic adjustments under Section 10.4. 5 12 ARTICLE 4 OFFERING PERIODS 4.1 OFFERING PERIODS. The initial grant of the right to purchase Company Stock under the Plan shall occur on the Effective Date and terminate on October 31, 1998. Thereafter, the Plan shall provide for Offering Periods commencing on each Grant Date and terminating on the next following Purchase Date. ARTICLE 5 PAYROLL DEDUCTIONS 5.1 PARTICIPANT ELECTION. Upon completion of the Stock Purchase Agreement, each Participant shall designate the amount of payroll deductions to be made from his or her paycheck to purchase Company Stock under the Plan. The amount of payroll deductions shall be designated in whole percentages of Compensation, not to exceed 10%, which percentage may be increased or decreased from time to time in the discretion of the Administrator, but in no event shall the maximum amount be increased to an amount in excess of 15% of Compensation. The amount so designated upon the Stock Purchase Agreement shall be effective as of the next Grant Date and shall continue until terminated or altered in accordance with Section 5.2 below. 5.2 CHANGES IN ELECTION. Any Participant may change any election (increase or decrease the rate of payroll deductions) under this Section one time during any Offering Period by completing and delivering to the Administrator a new Stock Purchase Agreement setting forth the desired change at least 15 days prior to the end of the Offering Period. A Participant may terminate participation in the Plan at any time prior to the close of an Offering Period as provided in Article 8. A Participant may also terminate payroll deductions and have accumulated deductions for the Offering Period applied to the purchase of Company Stock as of the next Purchase Date by completing and delivering to the Administrator a new Stock Purchase Agreement setting forth the desired change. Any change under this Section shall become effective on the next payroll period (to the extent practical under the Company's payroll practices) following the delivery of the new Stock Purchase Agreement. 5.3 PARTICIPANT ACCOUNTS. The Company shall establish and maintain a separate account ("Account") for each Participant. The amount of each Participant's payroll deductions shall be credited to his Account. Subject to Section 11.2, no interest will be paid or allowed on amounts credited to a Participant's Account. All payroll deductions received by the Company under the Plan are general corporate assets of the Company and may be used by the Company for any corporate purpose. The Company is not obligated to segregate such payroll deductions. ARTICLE 6 GRANT OF OPTION 6.1 OPTION TO PURCHASE SHARES. On each Grant Date, each Participant shall be granted an option to purchase at the price determined under Section 6.2 that number of shares and partial shares of Company Stock that can be purchased or issued by the Company based upon that price with the amounts held in his Account, subject to the limits set forth in Section 3.3. In the event that there are amounts held in a Participant's Account that are not used to purchase Company Stock, such amounts shall remain in the Participant's Account and shall be eligible to purchase Company Stock in any subsequent Offering Period. 6.2 PURCHASE PRICE. The purchase price for any Offering Period shall be the lesser of: 6 13 a. 85% of the Fair Market Value of Company Stock on the Grant Date; or b. 85% of the Fair Market Value of Company Stock on the Purchase Date. 6.3 FAIR MARKET VALUE. "Fair Market Value" shall mean the value of one share of Company Stock, determined as follows: a. If the Company Stock is then listed or admitted to trading on the Nasdaq National Market System or a stock exchange which reports closing sale prices, the Fair Market Value shall be the closing sale price on the date of valuation on the Nasdaq National Market System or principal stock exchange on which the Company Stock is then listed or admitted to trading, or, if no closing sale price is quoted or no sale takes place on such day, then the Fair Market Value shall be the closing sale price of the Company Stock on the Nasdaq National Market System or such exchange on the next preceding day on which a sale occurred. b. If the Company Stock is not then listed or admitted to trading on the Nasdaq National Market System or a stock exchange which reports closing sale prices, the Fair Market Value shall be the average of the closing bid and asked prices of the Company Stock in the over-the-counter market on the date of valuation. c. If neither (a) nor (b) is applicable as of the date of valuation, then the Fair Market Value shall be determined by the Administrator in good faith using any reasonable method of valuation, which determination shall be conclusive and binding on all interested parties. ARTICLE 7 PURCHASE OF STOCK 7.1 EXERCISE OF OPTION. a. On each Purchase Date, the Participant will be deemed to exercise the option expiring on that Purchase Date. Notwithstanding the above, a Participant may exercise any option granted to him or her under the Plan on any Purchase Date during the Offering Period by executing and delivering the appropriate form to the Administrator. In addition, a Participant may direct the Company not to purchase Company Stock on the last Purchase Date in the Offering Period, but to continue to hold and accumulate the amounts in the Participant's account until the next Offering Period. b. Upon exercise of an option, the Plan shall purchase on behalf of each Participant the maximum number of full shares of Company Stock subject to such option at the option price determined under Section 6.2 above as can be purchased with the amounts held in each Participant's Account. Any amounts remaining in a Participant's Account shall be held in the Participant's Account and carried forward for the rest of the Offering Period or to the next Offering Period. 7 14 7.2 DELIVERY OF COMPANY STOCK. The time of issuance and delivery of the shares may be postponed for such period as may be necessary to comply with the registration requirements under the Securities Act of 1933, as amended, the listing requirements of any securities exchange on which the Company Stock may then be listed, or the requirements under other laws or regulations applicable to the issuance or sale of such shares. ARTICLE 8 WITHDRAWAL 8.1 IN SERVICE WITHDRAWALS. At any time prior to the Purchase Date of an Offering Period, any Participant may withdraw the amounts held in his Account by executing and delivering to the Administrator a written notice of withdrawal on the form provided by the Company. In such a case, the entire balance of the Participant's Account shall be paid to the Participant, without interest, as soon as is practicable. Upon such notification, the Participant shall cease to participate in the Plan for the remainder of the Offering Period in which the notice is given. A reduction in contributions to zero during any Offering Period with an instruction to hold the funds in a Participant's Account to purchase shares as of the Close of the Offering Period shall not be deemed a withdrawal. Any Employee who has withdrawn under this Section shall be excluded from participation in the Plan for the remainder of the Offering Period in which the withdrawal occurred and the next succeeding Offering Period, but may then be reinstated as a Participant thereafter by executing and delivering a new Stock Purchase Agreement to the Administrator. 8.2 TERMINATION OF EMPLOYMENT. a. In the event that a Participant's employment with the Company terminates for any reason, the Participant shall cease to participate in the Plan on the date of termination. As soon as is practical following the date of termination, the entire balance of the Participant's Account shall be paid to the Participant or his beneficiary in cash, without interest. b. A Participant may file a written designation of a beneficiary who is to receive any shares of Company Stock purchased under the Plan or any cash from the Participant's Account in the event of his or her death subsequent to a Purchase Date, but prior to delivery of such shares and cash. In addition, a Participant may file a written designation of a beneficiary who is to receive any cash from the Participant's Account under the Plan in the event of his death prior to a Purchase Date under paragraph (a) above. c. Any beneficiary designation under paragraph (b) above may be changed by the Participant at any time by written notice. In the event of the death of a Participant, the Administrator may rely upon the most recent beneficiary designation it has on file as being the appropriate beneficiary. In the event of the death of a Participant where no valid beneficiary designation exists or the beneficiary has predeceased the Participant, the Administrator shall deliver any cash or shares of Company Stock to the executor or administrator of the estate of the Participant, or if no such executor or administrator has been appointed to the knowledge of the Administrator, the Administrator, in its sole discretion, may deliver such shares of Company Stock or cash to the spouse or any one or more dependents or relatives of the Participant, or if no spouse, dependent or relative is known to the Administrator, then to such other person as the Administrator may designate. 8 15 ARTICLE 9 PLAN ADMINISTRATION 9.1 PLAN ADMINISTRATION. a. Authority to control and manage the operation and administration of the Plan shall be vested in the Board of Directors (the "Board") for the Company, or a committee ("Committee") thereof. Members of the Committee may be appointed from time to time by, and shall serve at the pleasure of, the Board. As used herein, the term "Administrator" shall mean the Board or, with respect to any matter as to which responsibility has been delegated to the Committee, the term Administrator shall mean the Committee. The initial Administrator of the Plan shall be the Compensation Committee of the Board of Directors. The Administrator shall have all powers necessary to supervise the administration of the Plan and control its operations. b. In addition to any powers and authority conferred on the Administrator elsewhere in the Plan or by law, the Administrator shall have the following powers and authority: (i) To designate agents to carry out responsibilities relating to the Plan; (ii) To administer, interpret, construe and apply this Plan and to answer all questions which may arise or which may be raised under this Plan by a Participant, his beneficiary or any other person whatsoever; (iii) To establish rules and procedures from time to time for the conduct of its business and for the administration and effectuation of its responsibilities under the Plan; and (iv) To perform or cause to be performed such further acts as it may deem to be necessary, appropriate, or convenient for the operation of the Plan. c. Any action taken in good faith by the Administrator in the exercise of authority conferred upon it by this Plan shall be conclusive and binding upon a Participant and his beneficiaries. All discretionary powers conferred upon the Administrator shall be absolute. 9.2 LIMITATION ON LIABILITY. No Employee of the Company nor member of the Board or Committee shall be subject to any liability with respect to his duties under the Plan unless the person acts fraudulently or in bad faith. To the extent permitted by law, the Company shall indemnify each member of the Board or Committee, and any other Employee of the Company with duties under the Plan who was or is a party, or is threatened to be made a party, to any threatened, pending or completed proceeding, whether civil, criminal, administrative, or investigative, by reason of the person's conduct in the performance of his duties under the Plan. ARTICLE 10 COMPANY STOCK 10.1 LIMITATIONS ON PURCHASE OF SHARES. The maximum number of shares of Company Stock that shall be made available for sale under the Plan shall be 300,000 shares, subject to adjustment under Section 10.4 below. The shares of Company Stock to be sold to Participants under the Plan will be issued by the Company. If the total number of shares of Company Stock that would otherwise be issuable pursuant to rights granted pursuant to Section 6.1 of the Plan at the Purchase Date exceeds the number of shares then available under the Plan, the Administrator shall make a pro rata allocation of the shares remaining available in as uniform and equitable manner as is practicable. In such event, the Administrator shall give written notice of such reduction of the 9 16 number of shares to each Participant affected thereby and any unused payroll deductions shall be returned to such Participant if necessary. 10.2 VOTING COMPANY STOCK. The Participant will have no interest or voting right in shares to be purchased under Section 6.1 of the Plan until such shares have been purchased. 10.3 REGISTRATION OF COMPANY STOCK. Shares to be delivered to a Participant under the Plan will be registered in the name of the Participant unless designated otherwise by the Participant. 10.4 CHANGES IN CAPITALIZATION OF THE COMPANY. Subject to any required action by the stockholders of the Company, the number of shares of Company Stock covered by each right under the Plan which has not yet been exercised and the number of shares of Company Stock which have been authorized for issuance under the Plan but have not yet been placed under rights or which have been returned to the Plan upon the cancellation of a right, as well as the purchase price per share of Company Stock covered by each right under the Plan which has not yet been exercised, shall be proportionately adjusted for any increase or decrease in the number of issued shares of Company Stock resulting from a stock split, stock dividend, spin-off, reorganization, recapitalization, merger, consolidation, exchange of shares or the like. Such adjustment shall be made by the Administrator, whose determination in that respect shall be final, binding and conclusive. Except as expressly provided herein, no issue by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall affect, and no adjustment by reason thereof shall be made with respect to, the number or price of shares of Company Stock subject to any option granted hereunder. 10.5 MERGER OF COMPANY. In the event that the Company at any time proposes to merge into, consolidate with or enter into any other reorganization pursuant to which the Company is not the surviving entity (including the sale of substantially all of its assets or a "reverse" merger in which the Company is the surviving entity), the Plan shall terminate, unless provision is made in writing in connection with such transaction for the continuance of the Plan and for the assumption of options theretofore granted, or the substitution for such options of new options covering the shares of a successor corporation, with appropriate adjustments as to number and kind of shares and prices, in which event the Plan and the options theretofore granted or the new options substituted therefor, shall continue in the manner and under the terms so provided. If such provision is not made in such transaction for the continuance of the Plan and the assumption of options theretofore granted or the substitution for such options of new options covering the shares of a successor corporation, then the Administrator shall cause written notice of the proposed transaction to be given to the persons holding options not less than 10 days prior to the anticipated effective date of the proposed transaction, and, concurrent with the effective date of the proposed transaction, such options shall be exercised automatically in accordance with Section 7.1 as if such effective date were a Purchase Date of the applicable Offering Period unless a Participant withdraws from the Plan as provided in Section 8.1. ARTICLE 11 MISCELLANEOUS MATTERS 11.1 AMENDMENT AND TERMINATION. The Plan shall terminate on December 31, 2008. Since future conditions affecting the Company cannot be anticipated or foreseen, the Company reserves the right to amend, modify, or terminate the Plan at any time. Upon termination of the Plan, all benefits shall become payable immediately. Notwithstanding the foregoing, no such amendment or termination shall affect rights previously granted, nor may an amendment make any change in any right previously granted which adversely affects the rights of any Participant. In addition, no amendment may be made without prior approval of the stockholders of the Company if such amendment would: 10 17 a. Increase the number of shares of Company Stock that may be issued under the Plan; b. Materially modify the requirements as to eligibility for participation in the Plan; or c. Materially increase the benefits which accrue to Participants under the Plan. 11.2 STOCKHOLDER APPROVAL. Continuance of the Plan and the effectiveness of any right granted hereunder shall be subject to approval by the stockholders of the Company, within six (6) months before or after the date the Plan is adopted by the Board. In the event the stockholders of the Company do not approve the Plan, the Company shall return to each Participant the funds paid by such Participant to purchase options, with interest at a rate of five percent (5%). 11.3 BENEFITS NOT ALIENABLE. Benefits under the Plan may not be assigned or alienated, whether voluntarily or involuntarily. Any attempt at assignment, transfer, pledge or other disposition shall be without effect, except that the Company may treat such act as an election to withdraw funds in accordance with Article 8. 11.4 NO ENLARGEMENT OF EMPLOYEE RIGHTS. This Plan is strictly a voluntary undertaking on the part of the Company and shall not be deemed to constitute a contract between the Company and any Employee or to be consideration for, or an inducement to, or a condition of, the employment of any Employee. Nothing contained in the Plan shall be deemed to give the right to any Employee to be retained in the employ of the Company or to interfere with the right of the Company to discharge any Employee at any time. 11.5 GOVERNING LAW. To the extent not preempted by Federal law, all legal questions pertaining to the Plan shall be determined in accordance with the laws of the State of California. 11.6 NON-BUSINESS DAYS. When any act under the Plan is required to be performed on a day that falls on a Saturday, Sunday or legal holiday, that act shall be performed on the next succeeding day which is not a Saturday, Sunday or legal holiday. Notwithstanding the above, Fair Market Value shall be determined in accordance with Section 6.3. 11.7 COMPLIANCE WITH SECURITIES LAWS. Notwithstanding any provision of the Plan, the Administrator shall administer the Plan in such a way to ensure that the Plan at all times complies with any requirements of Federal Securities Laws. For example, affiliates may be required to make irrevocable elections in accordance with the rules set forth under Section 16b-3 of the Securities Exchange Act of 1934. 11 EX-21.1 3 SUBSIDIARY OF THE REGISTRANT 1 EXHIBIT 21.1 QLOGIC CORPORATION SUBSIDIARY OF REGISTRANT QLogic Foreign Sales Corporation, A U.S. Virgin Islands Corporation EX-23.1 4 CONSENT OF INDEPENDENT AUDITORS 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT AUDITORS The Board of Directors QLogic Corporation: We consent to incorporation by reference in the registration statements on Form S-8 (Nos. 33-75814 and 333-13137) of QLogic Corporation of our report dated May 12, 1998, relating to the consolidated balance sheets of QLogic Corporation as of March 29, 1998 and March 30, 1997, and the related consolidated statements of income, stockholders' equity and cash flows for each of the years in the three-year period ended March 29, 1998 and the related financial statement schedule, which report appears in the March 29, 1998, annual report on Form 10-K of QLogic Corporation. KPMG PEAT MARWICK LLP Orange County, California June 16, 1998 EX-27 5 FINANCIAL DATA SCHEDULE
5 1,000 YEAR MAR-29-1998 MAR-31-1997 MAR-29-1998 64,090 48,680 8,582 746 3,835 108,335 18,288 11,916 136,242 17,586 0 0 0 865 117,184 136,242 81,393 81,393 34,049 34,049 28,858 110 (3,344) 21,830 8,422 13,408 0 0 0 13,408 1.77 1.66
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