UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended April 3, 2016

Commission File No. 0-23298

QLogic Corporation

(Exact name of registrant as specified in its charter)

 

 

(949) 389-6000

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

None

(Title of class)

 

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  R    No  £

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  £    No  R

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  R    No  £

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).    Yes  R    No  £

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 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.  £

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  £    No  R

The aggregate market value of the voting stock held by non-affiliates of the Registrant on September 25, 2015 was $831,623,000 (based on the closing price for shares of the Registrant’s common stock as reported by the NASDAQ Global Select Market on such date).

As of May 18, 2016, 83,186,000 shares of the Registrant’s common stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s Proxy Statement relating to the Registrant’s 2016 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K where indicated.

 

 

 

 

 

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QLOGIC CORPORATION

TABLE OF CONTENTS

 

 

 

 

 

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PART I

Introduction

QLogic Corporation was organized as a Delaware corporation in 1992. Our principal executive offices are located at 26650 Aliso Viejo Parkway, Aliso Viejo, California 92656, and our telephone number at that location is (949) 389-6000. Our website address is www.qlogic.com. The Company’s Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and any amendment to these reports, that we file with or furnish to the Securities and Exchange Commission (SEC) are available free of charge on our website as soon as reasonably practicable after those reports are filed with the SEC.

On January 17, 2014, we completed the acquisition from Brocade Communications Systems, Inc. of certain assets related to its Fibre Channel and converged network adapter business.  On March 13, 2014, we completed the acquisition from Broadcom Corporation of certain 10/25/40/50/100Gb Ethernet controller-related assets.

Unless the context indicates otherwise, “we,” “our,” “us,” “QLogic” and the “Company” each refer to QLogic Corporation and its subsidiaries.

All references to years refer to our fiscal years ended April 3, 2016, March 29, 2015 and March 30, 2014, as applicable, unless calendar years are specified.

Our Networking Products

We design and supply high performance server and storage networking connectivity products that provide, enhance and manage computer data communication. These products facilitate the rapid transfer of data and enable efficient resource sharing between servers, networks and storage. Our products are used in enterprise, managed service provider and cloud service provider data centers, along with other environments dependent on high performance, reliable data networking.

Our products are based primarily on Fibre Channel and Ethernet technologies and are used in connection with storage networks, data networks and converged networks. Storage networks are used to provide access to storage across enterprise environments. Fibre Channel is currently a dominant technology for enterprise storage networking.  Data networks are used to provide workstation-to-server, server-to-server, and server-to-storage connectivity using Ethernet.  Converged networks are designed to address the evolving data center by consolidating and unifying storage and data networks, using high-speed Ethernet.  Fibre Channel over Ethernet (FCoE) is a converged networking technology that uses high-speed Ethernet for both storage and data transmission.  Internet Small Computer System Interface (iSCSI) is an alternative to FCoE and provides storage over Ethernet capabilities.  Our converged network products can support storage networking and data networking capability covering a variety of protocols either individually or in combination.

Our products are sold worldwide, primarily to original equipment manufacturers (OEMs) and distributors.  Our customers rely on our various server and storage connectivity products to deliver solutions to information technology professionals in virtually every business sector. Our products are found primarily in server and storage subsystem solutions that are used by enterprises with critical business data requirements, as well as managed service and cloud service providers. The data center and business applications that drive requirements for our networking connectivity products include:

Our products consist primarily of connectivity products such as adapters and application-specific integrated circuits (ASICs). Adapters reside in server or storage systems and provide high performance connectivity for data and storage networks. The ASICs that we sell are used in servers, storage systems and switches.

We provide Fibre Channel, high-speed Ethernet and converged network adapters and ASICs for rack and tower servers, as well as custom adapters and ASICs for bladed servers.  Our adapters and ASICs are also used in a variety of storage systems.

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All of these adapters and ASICs provide single or multi-protocol network connectivity. We also sell switches that manage the transmission and routing of data between servers and storage, as well as servers to servers. However, in connection with our June 2013 restructuring plan, we announced that we were ceasing development of future switch ASICs. We continue to invest in the next generation of our current products, as well as investing in various new product initiatives that are in the early stages of development.

We classify our products into two categories – Advanced Connectivity Platforms and Legacy Connectivity Products.  Advanced Connectivity Platforms are comprised primarily of adapters and ASICs for server and storage connectivity applications. Legacy Connectivity Products are comprised primarily of Fibre Channel switch products.

Advanced Connectivity Platforms accounted for 91%, 89% and 84% of our net revenues for fiscal 2016, 2015 and 2014, respectively.  For a summary of our net revenues by product category, see Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in Part II, Item 7 of this report.

Customers

Our products are incorporated in solutions from a number of server and storage system OEM customers, including Cisco Systems, Inc., Dell Inc. (Dell), EMC Corporation, Fujitsu Ltd., Hewlett Packard Enterprise Company (HPE), Huawei Technologies Co. Ltd., Inspur Group Co., Ltd., International Business Machines Corporation (IBM), Lenovo Group Ltd., NetApp, Inc., Oracle Corporation and Pure Storage, Inc.  A small number of these customers account for a substantial portion of our net revenues, and we expect that a small number of customers will continue to represent a substantial portion of our net revenues for the foreseeable future. Our top ten customers accounted for 80%, 81% and 83% of net revenues during fiscal 2016, 2015 and 2014, respectively.

A summary of our customers, including their manufacturing subcontractors, that represent 10% or more of our net revenues is as follows:

 

 

 

We believe that we have good relationships with our customers. However, we believe our major customers continually evaluate whether or not to purchase products from alternative or additional sources. Accordingly, there can be no assurance that a major customer will not reduce, delay or eliminate its purchases from us. Any such reduction, delay or loss of purchases could have a material adverse effect on our business, financial condition or results of operations.

Some of our OEM customers experience seasonality and uneven sales patterns in their businesses.  As a result, we experience similar seasonality and uneven sales patterns.  This variability in sales patterns is the result of various factors and makes it extremely difficult to predict demand and buying patterns of our customers.  Although we do not consider our business to be highly seasonal, we believe that seasonality and uneven sales patterns have impacted and may impact our business. To the extent that we experience seasonality or uneven sales patterns in our business, it would most likely have a negative impact on the sequential growth rate of our net revenues during the fourth quarter of our fiscal year.

International revenues accounted for 67%, 63% and 58% of our net revenues for fiscal 2016, 2015 and 2014, respectively.  For additional information on our international sales and operations, see Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in Part II, Item 7 of this report.  For a discussion of risks related to our foreign operations, see Risk Factors, included in Part I, Item 1A of this report.

Sales and Marketing

Our products are marketed and sold primarily to OEMs by our internal sales team supported by field sales and systems engineering personnel. In addition, we sell our products through a network of domestic and international distributors.  We also sell our products to original design manufacturers (ODMs) both as an extension of our OEM design organizations and as direct sales transactions.

In domestic and in certain international markets, we maintain both a sales force to serve our OEM customers and distributors that are focused on medium-sized and emerging accounts. We maintain a business development and marketing

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organization to assist, train and equip the sales organizations of our OEM customers and their respective reseller organizations and partners. We maintain sales offices in the United States and various international locations. For information regarding revenue by geographic area, see Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in Part II, Item 7 of this report.

We work with our server and storage system OEM customers during their design cycles. We provide these customers with pre-sales system design support and services, as well as training classes and seminars conducted both in the field and from our worldwide offices.

Our sales and marketing efforts are focused on establishing and developing long-term relationships with our OEM customers, ODM customers and distribution partners, as well as brand preference activities. The sales cycle for OEMs typically begins with the identification of a requirement that could be potentially fulfilled with an existing QLogic product or a product based on a new technology.  The cycle continues with technical and sales collaboration with the OEM and, if successful, leads to one of our product designs being selected as a component in a customer’s server or storage system. We then work closely with the customer to integrate our products with the customer’s current and future generations of products or platforms. This cycle, from opportunity identification to initial production shipment, typically ranges from six to 36 months.  Following initial production shipment, our sales efforts are focused on educating the OEM’s sales and marketing teams on the applications and benefits of our products to drive brand preference.  The brand preference phase of the sales activities can last for the duration of the OEM program.

In addition to sales and marketing efforts, we actively participate with industry organizations relating to the development and acceptance of industry standards. We collaborate with peer companies through open standards bodies, cooperative testing and certifications. To ensure and promote multi-vendor heterogeneous operation, we maintain interoperability certification programs and testing laboratories.

Engineering and Development

Our industry is subject to rapid, regular and sometimes unpredictable technological change. Our ability to compete depends upon our ability to continually design, develop and introduce new products that take advantage of market opportunities and address emerging standards. Our strategy is to leverage our substantial base of architectural, systems and engineering expertise to address a broad range of server and storage networking solutions.

We are engaged in the design and development of ASICs and adapters that are primarily based on one or more of Fibre Channel, iSCSI, FCoE and Ethernet technologies.

We continue to invest in engineering and development to expand our capabilities to address the emerging technologies in the rapid evolution of storage, data and converged networks. During fiscal 2016, 2015 and 2014, we incurred engineering and development expenses of $128.8 million, $144.3 million and $147.0 million, respectively.

Backlog

A large portion of our sales to OEM customers are transacted through hub arrangements whereby our products are purchased on a just-in-time basis and fulfilled from warehouse facilities, or hubs, in proximity to the facilities of our customers or their contract manufacturers. Our sales are made primarily pursuant to purchase orders, including blanket purchase orders for hub arrangements.  Because the hub arrangements with our customers and industry practice allow customers to cancel or change orders with limited advance notice, we believe that backlog at any particular date is not a reliable indicator of our future revenue levels and is not material to understanding our business.

Competition

The markets for networking connectivity products are highly competitive and characterized by short product life cycles, price erosion, rapidly changing technology, frequent product performance improvements and evolving industry standards. We believe the principal competitive factors in our industry include:

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Due to the diversity of products required in storage, data and converged networking, we compete with many companies.  In the traditional enterprise storage Fibre Channel adapter and ASIC markets, our primary competitor is Broadcom Limited (formerly known as Avago Technologies Limited), who acquired our former long-time competitor Emulex Corporation in May 2015.  In the high-speed Ethernet adapter and ASIC markets, which include converged networking products such as FCoE and iSCSI, we compete primarily with Broadcom Limited, Mellanox Technologies, Ltd. and Intel Corporation.  We may also compete with some of our server and storage systems customers, some of which have the capability to develop products comparable to those we offer.

Manufacturing

We use ASIC industry suppliers to access foundries for the manufacture of ASICs, which we sell as standalone products or integrate into our adapter and switch products.  This approach allows us to avoid the high costs of owning, operating, maintaining and upgrading wafer fabrication and assembly facilities. As a result, we focus our resources on product design and development, quality assurance, sales and marketing, and supply chain management. Prior to the sale of our adapter and ASIC products, final tests are performed to ensure quality.  Product test, customer-specific configuration and product localization are completed by third-party service providers or by us.  We also provide fabrication process reliability tests, as required, and conduct failure analysis to confirm the integrity of our quality assurance procedures. These reliability and failure analysis tests may be completed by third-party providers or by us.

Most of the ASICs used in our products are manufactured using 90, 65, 40 or 28 nanometer process technology.  In addition, we continually evaluate smaller geometries. In the past, we have experienced some difficulties in shifting to smaller geometry process technologies or new manufacturing processes, which resulted in reduced manufacturing yields, delays in product deliveries and increased expenses.  We may face similar difficulties, delays and expenses as we continue to transition our products to smaller geometry processes.

We depend on our ASIC suppliers to work with wafer foundries to allocate a portion of their capacity sufficient to meet our 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, in certain cases, manufacture products of their own design. We do not have long-term supply agreements directly with any of these foundries; we purchase both wafers and finished chips from our ASIC suppliers on a discrete purchase order basis. Therefore, in the event of foundry capacity constraints, our ASIC suppliers may not be able to satisfy our demand for products.  

We currently purchase our semiconductor products through our ASIC suppliers either in finished or wafer form. We use subcontractors to assemble our semiconductor products purchased in wafer form. In the assembly process for our semiconductor products, the silicon wafers are separated into individual die, which are then assembled into packaged ASICs and tested by our ASIC suppliers, third-party ASIC test partners or by us.

For our adapter and switch products, we use third-party contract manufacturers for material procurement, assembly, test and inspection in a turnkey model, prior to shipment to our customers.  These contract manufacturers are primarily located outside the United States.  To the extent that we rely on these contract manufacturers, we are not able to directly control product delivery schedules and quality assurance.  The loss of our largest contract manufacturer could significantly impact our ability to produce products for an indefinite period of time.  Qualifying a new contract manufacturer and commencing volume production is a lengthy and expensive process.

While we believe that we have good relationships with our contract manufacturers, if a contract manufacturer moves the production lines for our products to new locations, or otherwise experiences delays, disruptions, capacity constraints, component part shortages or quality control problems in its manufacturing operations, shipment of our products to our customers could be delayed, resulting in the loss or postponement of revenue and potential harm to our competitive position and relationships with customers.

Certain key components used in the manufacture of our products are purchased from single or limited sources.  ASICs are purchased from single sources. For example, in connection with our acquisition of certain 10/25/40/50/100Gb Ethernet

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controller-related assets, we entered into a development and supply agreement which requires us to purchase certain ASICs used in the related products exclusively from Broadcom Corporation, which was recently acquired by Avago Technologies Limited and renamed Broadcom Limited.  Other key components such as microprocessors, logic chips, power supplies and programmable logic devices are purchased from limited sources.  If one of these suppliers experiences an interruption in its ability to supply our needs, or chooses to sever or significantly change its relationship with us, we may be unable to produce certain of our products until alternative suppliers are identified and qualified.

Many of the component parts used in our adapter, switch and other products are standard off-the-shelf items, which are, or can be, obtained from more than one source. We select suppliers on the basis of technology, manufacturing capacity, financial viability, quality and cost. Our reliance on third-party manufacturers involves risks, including possible limitations on availability of products due to market abnormalities, geopolitical instability, natural disasters, labor shortages and labor strikes, 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 our suppliers to deliver products of acceptable quality and in a timely manner or our inability to procure adequate supplies of our products could have a material adverse effect on our business, financial condition or results of operations.

Intellectual Property

While we have a number of patents issued and additional patent applications pending in the United States, Canada, Europe and Asia, we rely primarily on our trade secrets, trademarks, copyrights and contractual provisions to protect our intellectual property. We attempt to protect our proprietary information through confidentiality agreements and contractual provisions with our customers, suppliers, employees and consultants, and through other security measures. However, the laws of certain countries in which our products are or may be developed, manufactured or sold, including various countries in Asia, may not protect our products and intellectual property rights to the same extent as the laws of the United States, or at all.

Our ability to compete may be affected by our ability to protect our intellectual property.  We protect our rights vigorously; however there can be no assurance that these measures will be successful.  We may be required to assert claims of infringement of intellectual property rights against others.  In the event of such a dispute, we may be required to expend significant resources and there can be no assurance that we would be successful.  If the dispute led to litigation, it could result in significant expense to us, and divert the efforts of our technical and management personnel, whether or not such litigation is determined in our favor.

We have in the past received notices of claimed infringement of intellectual property rights and been involved in intellectual property litigation. There can be no assurance that third parties will not assert additional claims of infringement of intellectual property rights against us, or against customers or others whom we are contractually obligated to indemnify, with respect to existing and future products. In the event of a patent or other intellectual property dispute, we may be required to expend significant resources to defend such claims, develop non-infringing technology or obtain licenses to the technology that is the subject of the claim. There can be no assurance that we 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 us, and divert the efforts of our technical and management personnel, whether or not such litigation is determined in our favor.

Some of our products are designed to include software or other intellectual property licensed from third parties. None of these licenses relate to core QLogic-developed technology, are material to our business, or require payment of amounts that are material.

Environment

Our operations are subject to regulation under various federal, state, local and foreign laws concerning the environment, including laws addressing the discharge of pollutants into the environment, the management and disposal of hazardous substances and wastes, and the cleanup of contaminated sites. We could incur substantial costs, including cleanup costs, fines and civil or criminal sanctions, and third-party damage or personal injury claims, if we violate or become liable under environmental laws.

Most of our products are also subject to various laws governing chemical substances in products, including those regulating the manufacture and distribution of chemical substances and those restricting the presence of certain substances in electronic products.  We could incur substantial costs, or our products could be restricted from entering certain countries, if our products become non-compliant with environmental laws. We also face increasing complexity in our product design and procurement operations as we adjust to new and future requirements relating to the materials composition of our products. For example, the European Union adopted the Waste Electrical and Electronic Equipment (WEEE) Directive, pursuant to which European

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Union countries have enacted legislation making producers of electrical goods financially responsible for specified collection, recycling, treatment and disposal of past and future covered products. These and similar laws adopted in other countries could impose a significant cost of doing business in those countries.

Environmental costs are presently not material to our results of operations or financial position, and we do not currently anticipate material capital expenditures for environmental control facilities.

Working Capital

Our working capital was $402.3 million as of April 3, 2016, which includes $354.8 million of cash, cash equivalents and marketable securities.  For additional information, see Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources, included in Part II, Item 7 of this report.

Employees

We had 782 employees as of May 18, 2016. We believe our future prospects will depend, in part, on our ability to continue to attract, train, motivate, retain and manage skilled engineering, sales, marketing and executive personnel. Our employees are not represented by a labor union. We believe that our relations with our employees are good.

 

 

Set forth below and elsewhere in this report and in other documents we file with the Securities and Exchange Commission (SEC) are risks and uncertainties that could cause our actual results of operations to differ materially from the results contemplated by the forward-looking statements contained in this report or otherwise publicly disclosed by the Company.

Our operating results may fluctuate in future periods, which could cause our stock price to decline.

We have experienced, are currently experiencing, and expect to experience in future periods, fluctuations in sales and operating results from quarter to quarter. For example, the market for our Fibre Channel products is mature and has declined during recent periods. The lack of growth in the Fibre Channel market may be the result of a shift in the information technology (IT) data center deployment model, as more enterprise workloads are moving to cloud data centers, which primarily use Ethernet solutions as their connectivity protocol.  To the extent the Fibre Channel market declines, our quarterly operating results would be negatively impacted.

We have made, and continue to make, significant investments in the development and sale of our Ethernet products. The market for our Ethernet products is highly competitive. Some of our competitors are large, well-established companies that have significant competitive advantages over us. To the extent that we are unable to effectively compete in this market, our quarterly operating results would be negatively impacted.

A significant portion of our net revenues in each fiscal quarter results from orders booked in that quarter. Orders placed by major customers are typically based on their forecasted sales and inventory levels for our products. Accordingly, it is extremely difficult for us to forecast future sales levels and historical information may not be indicative of future trends. In addition, there can be no assurance that we will maintain our current gross margins or profitability in the future.

Fluctuations in our quarterly operating results may also be the result of:

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In addition, our quarterly results of operations are influenced by competitive factors, including the pricing and availability of our products and our competitors’ products. Furthermore, communications regarding new products and technologies could cause our customers to defer or cancel purchases of our products. Order deferrals by our customers, delays in our introduction of new products, and longer than anticipated design-in cycles for our products have in the past adversely affected our quarterly results of operations. Due to these factors, as well as other unanticipated factors, it is likely that in some future quarter or quarters our operating results will be below the expectations of public market analysts or investors, and as a result, the price of our common stock could significantly decrease.

Competition within the markets for products such as ours is intense and includes various established competitors.

The markets for networking connectivity products are highly competitive and characterized by short product life cycles, price erosion, rapidly changing technology, frequent product performance improvements and evolving industry standards. Due to the diversity of products required in storage, data and converged networking, we compete with many companies. In the traditional enterprise storage Fibre Channel adapter and ASIC markets, our primary competitor is Broadcom Limited (formerly known as Avago Technologies Limited), who acquired our former long-time competitor Emulex Corporation (Emulex) in May 2015. In the high-speed Ethernet adapter and ASIC markets, which include converged networking products such as Fibre Channel over Ethernet (FCoE) and Internet Small Computer Systems Interface (iSCSI), we compete primarily with Broadcom Limited, Mellanox Technologies, Ltd. and Intel Corporation (Intel). We may also compete with some of our server and storage systems customers, some of which have the capability to develop products comparable to those we offer.

Some of our competitors, including Broadcom Limited and Intel, have significantly more engineering, sales and marketing resources than us to dedicate to developing and penetrating markets, offer a much broader portfolio of products to customers, and have cost advantages over us due to their vertical integration and greater scale of operations. Should these companies successfully leverage these competitive advantages, our business could significantly deteriorate and our results of operations would be materially and adversely affected.

As noted above, Broadcom Limited acquired Emulex in May 2015 and, as a result, Broadcom Limited is a competitor in both the Fibre Channel and Ethernet markets. In February 2016, Avago Technologies Limited (now known as Broadcom Limited) acquired Broadcom Corporation, which was our primary supplier of Ethernet ASICs. Broadcom Limited is our primary Fibre Channel ASIC supplier and is now our primary Ethernet ASIC supplier. We have long-term supply contracts in place that we believe safeguard our supply of Fibre Channel and Ethernet ASICs. Should this supplier fail to adhere to the terms of our supply contracts and if the remedies in the contracts fail to adequately protect us, our supply of Fibre Channel and Ethernet ASICs could be at risk or more costly, and our business and results of operations could be materially and adversely affected.

We need to continue to develop products appropriate to our markets to remain competitive as our competitors continue to introduce products with improved features. While we continue to devote significant resources to engineering and development, these efforts may not be successful or competitive products may not be developed and introduced in a timely manner. If we are unable to design, develop or introduce competitive new products on a timely basis, or if our competitors introduce new products that are more successful than ours in the marketplace, our future operating results may be materially and adversely affected.

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Our operating results have been, are being, and may in the future be, adversely affected by unfavorable economic conditions.

Certain countries around the world, including but not limited to China, have experienced and are continuing to experience economic weakness and uncertainty. Political instability in certain regions of the world is significantly contributing to this economic uncertainty. Economic uncertainty is adversely affecting, and in the future may continue to adversely affect, IT spending rates. For example, certain of our large OEM customers are reporting significant weakness in particular markets and geographies. Reductions in IT spending rates have resulted in reduced sales volumes, and could result in lower prices for our products, longer sales cycles, increased inventory provisions and increased production costs, all of which could negatively impact our results of operations.

As a result of worldwide economic weakness and uncertainty, it is extremely difficult for us and our customers to forecast future revenue levels based on historical information and trends. To the extent that we do not achieve our anticipated level of revenue, our operating results could be adversely affected.

If we are unable to attract and retain key personnel, we may not be able to sustain or grow our business.

Our future success largely depends on our key engineering, sales, marketing and executive personnel, including highly skilled ASIC design personnel and software developers. Our Chief Executive Officer resigned in August 2015 and we appointed Jean Hu as Acting Chief Executive Officer and Christine King as Executive Chairman. It is important that we retain key personnel. If we lose the services of key personnel, or do not hire or retain other personnel for key positions, our business could be adversely affected.

We believe that the market for key personnel in the industries in which we compete is highly competitive. In particular, we have periodically experienced difficulty in attracting and retaining qualified engineers and other technical personnel and anticipate that competition for such personnel will increase in the future. As a result, we may not be able to attract and retain key personnel with the skills and expertise necessary to develop new products in the future or to manage our business, both in the United States and abroad.

We have historically used equity awards and our employee stock purchase program as key components of our total employee compensation program in order to align employees’ interests with the interests of our stockholders, encourage retention of key personnel, and provide competitive compensation packages. However, the guidelines of proxy advisory firms relating to stockholder approval of shares available under equity compensation plans and share usage could make it more difficult for us to obtain such approval and therefore grant stock-based awards to employees in the future, which may result in changes in our stock-based compensation strategy. These and other developments relating to the provision of stock-based compensation to employees could make it more difficult to attract, retain and motivate key personnel.

We expect gross margin to vary over time primarily due to product mix.

Our gross margin is expected to vary over time primarily due to product mix, including the mix of Fibre Channel and Ethernet product sales. Our gross margins may also be adversely affected by numerous factors, including:

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A decrease in our gross margin could adversely affect the market price of our common stock.

Our stock price may be volatile.

The market price of our common stock has fluctuated substantially and there can be no assurance that such volatility will not continue. Several factors could impact our stock price, including:

In addition, stock markets have experienced extreme price and volume volatility in recent years and stock prices of technology companies have been especially volatile. This volatility has had a substantial effect on the market prices of securities of many public companies for reasons frequently unrelated to the operating performance of the specific companies. These broad market fluctuations could adversely affect the market price of our common stock, which could have a material adverse impact on investor confidence and employee retention.

Our business is dependent, in large part, on the continued growth of the networking markets that we serve and if these markets do not continue to develop, our business will suffer.

Our products are used in storage, data and converged networks, and therefore our business is dependent on these markets. Our success in generating revenue in these markets will depend on, among other things, our ability to:

If we are not successful in any or all of these items, our business and results of operations could be materially and adversely affected.

We depend on a small number of customers and any decrease in revenues from any one of our major customers could adversely affect our results of operations and cause our stock price to decline.

A small number of customers account for a substantial portion of our net revenues, and we expect that a small number of customers will continue to represent a substantial portion of our net revenues for the foreseeable future. Our top ten customers accounted for 80%, 81% and 83% of net revenues during fiscal 2016, 2015 and 2014, respectively. Total revenue from our three largest customers during fiscal 2016, Hewlett Packard Enterprise Company, Dell Inc. (Dell), and Lenovo Group Ltd. (Lenovo), collectively accounted for more than 50% of fiscal 2016 net revenues. Total revenue from our three largest customers during fiscal 2015 and 2014, Hewlett-Packard Company, Dell and International Business Machines Corporation (IBM), collectively accounted for more than 50% of net revenues for such periods. In November 2015, Hewlett-Packard Company separated itself into two new public companies, HP Inc. and Hewlett Packard Enterprise Company. In early 2015, Lenovo completed the closing of its acquisition of IBM’s x86 server business. 

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A significant portion of the products we sell are incorporated into servers manufactured by our major customers for use in enterprise environments. Certain of our large OEM customers are reporting weakness in this market. If server sales by our major customers continue to be adversely affected by the IT spending environment or server market factors (such as an acceleration in the shift from servers used in enterprise environments to servers used in cloud environments), demand for our products could decrease further, which could have a material adverse effect on our business, financial condition or results of operations.

Our customers generally order products through written purchase orders instead of long-term supply contracts and, therefore, are generally not obligated to purchase products from us for any extended period. Customers typically incorporate our products into complex devices and systems, which creates supply chain cross-dependencies. Accordingly, supply chain disruptions affecting components of our customers’ devices and/or systems could negatively impact the demand for our products, even if the supply of our products is not directly affected. Major customers also have significant leverage over us and may attempt to change the sales terms, including pricing, customer incentives and payment terms, or insist that we undertake or fund significant aspects of the design, qualification and testing that our customers have typically been responsible for, either of which could have a material adverse effect on our business, financial condition or results of operations. As our customers are pressured to reduce prices as a result of competitive factors, we may be required to contractually commit to price reductions for our products before we know how, or if, cost reductions can be achieved. If we are unable to achieve these cost reductions, our gross margins could decline and such a decline could have a material adverse effect on our business, financial condition or results of operations.

The ongoing consolidation in the technology industry could adversely impact our business. There is the potential for some of our customers to merge with or acquire one or more of our other customers. For example, Dell has announced its intention to acquire EMC Corporation. There is also a possibility that one of our large customers could acquire one of our current competitors. As a result of such transactions, demand for our products could decrease, which could have a material adverse effect on our business, financial condition or results of operations.

Our financial condition will be materially harmed if we do not maintain and gain market acceptance of our products.

The markets in which we compete involve rapidly changing technologies, evolving industry standards and continuing improvements in products and services. Examples of these changing technologies include system-on-chip products and both software-defined-networking and software-defined-storage products. Our future success depends, in part, on our ability to:

We believe that to remain competitive, we will need to continue to develop new products and enter new markets, which will require significant investment. Some new markets may require engagement with customers with whom we have limited or no prior experience. Our competitors may be developing alternative technologies, or entering into exclusive strategic alliances with our major customers, either of which may adversely affect the market acceptance of our products, our ability to enter new markets, or our ability to secure customer design wins. Although we continue to explore and develop products based on new technologies, a substantial portion of our revenues is generated today from Fibre Channel technology. If alternative technologies are adopted by the industry, we may not be able to develop products for these technologies in a timely manner. Further, even if alternative technologies do augment Fibre Channel revenues, our products may not be fully developed in time to be accepted by our customers. Even if our new products are developed in time, we may not be able to manufacture them at competitive prices or in sufficient volumes.

Some of our products are based on FCoE or high-speed Ethernet technologies. FCoE is a converged networking technology that provides a unified storage and data network over Enhanced Ethernet, while preserving the investment by end users in their existing Fibre Channel infrastructure and storage. High-speed Ethernet is a technology for use in enterprise, managed service provider and cloud service provider data centers. The market for high-speed Ethernet products includes well-established participants who have significantly more engineering, sales and marketing resources to dedicate to developing and penetrating the market than we do. An inability to maintain, or build on, our market share in the Fibre Channel, high-speed Ethernet or converged markets, or the failure of these markets to expand, could have a material adverse effect on our business or results of operations.

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We are dependent on sole source and limited source suppliers for certain key components.

Certain key components used in the manufacture of our products are purchased from single or limited sources. ASICs are purchased from single sources. For example, in connection with our acquisition of certain 10/25/40/50/100Gb Ethernet controller-related assets, we entered into a development and supply agreement which requires us to purchase certain ASICs used in the related products exclusively from Broadcom Corporation. Other key components such as microprocessors, logic chips, power supplies and programmable logic devices are purchased from limited sources. If one of these suppliers experiences an interruption in its ability to supply our needs, or chooses to sever or significantly change its relationship with us, we may be unable to produce certain of our products, which could result in the loss of customers and have a material adverse effect on our results of operations.

Broadcom Limited, our primary Fibre Channel ASIC supplier, acquired Emulex in May 2015. Emulex had historically been our principal competitor in the Fibre Channel market. In February 2016, Avago Technologies Limited (now known as Broadcom Limited) acquired Broadcom Corporation, which was our primary supplier of Ethernet ASICs. We have long-term supply contracts in place that we believe safeguard our supply of Fibre Channel and Ethernet ASICs. Should our suppliers fail to adhere to the terms of our supply contracts and if the remedies in the contracts fail to adequately protect us, our supply of Fibre Channel and Ethernet ASICs could be at risk or more costly, and our business and results of operations could be materially and adversely affected.

We are dependent on worldwide third-party subcontractors and contract manufacturers.

Third-party subcontractors located outside the United States assemble and test certain products for us. To the extent that we rely on third-party subcontractors to perform these functions, we will not be able to directly control product delivery schedules and quality assurance. This lack of control may result in product shortages or quality assurance problems that could delay shipments of products or increase manufacturing, assembly, testing or other costs. If a subcontractor experiences capacity constraints or financial difficulties, suffers damage to its facilities, experiences power outages, natural disasters, labor shortages or labor strikes, or any other disruption of assembly or testing capacity, we may not be able to obtain alternative assembly and testing services in a timely manner or on commercially acceptable terms.

In addition, the loss of our largest third-party contract manufacturer could significantly impact our ability to produce products for an indefinite period of time. Qualifying a new contract manufacturer and commencing volume production is a lengthy and expensive process. Some customers will not purchase any products, other than a limited number of evaluation units, until they qualify the manufacturing line for the product. If we are required to change a contract manufacturer or if a contract manufacturer moves the production lines for our products to new locations, or otherwise experiences delays, disruptions, capacity constraints, component part shortages or quality control problems in its manufacturing operations, shipment of our products to our customers could be delayed, resulting in loss or postponement of revenues and potential harm to our competitive position and relationships with customers.

We may engage in mergers, acquisitions, divestitures and strategic investments and these activities could adversely affect our results of operations and stock price.

Our future growth may depend in part on our ability to identify and acquire businesses, technologies or product lines. Mergers and acquisitions involve numerous risks, including:

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Further, we may never realize the perceived benefits of a business combination or divestiture. Acquisitions by us could negatively impact gross margins or dilute stockholders’ investment and cause us to incur debt, contingent liabilities and amortization/impairment charges related to intangible assets, all of which could materially and adversely affect our financial condition or results of operations. Divestitures involve risks, such as difficulty splitting up businesses, distracting employees, potential loss of revenue and negatively impacting margins, and potentially disrupting customer relationships. In addition, our effective tax rate for future periods could be negatively impacted by acquisitions or divestitures.

We have made, and could make in the future, investments in technology companies, including privately-held companies in a development stage. Many of these private equity investments are inherently risky because the companies’ businesses may never develop, and we may incur losses related to these investments. In addition, we may be required to write down the carrying value of these investments to reflect other-than-temporary declines in their value, which could have a material adverse effect on our financial condition and results of operations.

Our products are complex and may contain undetected software or hardware errors that could lead to an increase in our costs, reduce our net revenues or damage our reputation.

Our products are complex and may contain undetected software or hardware errors when first introduced or as newer versions are released. We are also exposed to risks associated with latent defects in existing products and to risks that components purchased from third-party subcontractors and incorporated into our products may not meet our specifications or may otherwise fail prematurely. From time to time, we have found errors in existing, new or enhanced products. In addition, our products are frequently combined with other products, including software, from other vendors, and these products often need to interface with existing networks, each of which have different specifications and utilize multiple protocol standards. As a result, when problems occur, it may be difficult to identify the source of the problems. The occurrence of hardware or software errors could adversely affect the sales of our products, cause us to incur significant warranty and repair costs, divert the attention of our engineering personnel from our product development efforts and cause significant customer relations problems, any of which could materially and adversely affect our operating results.

We expect the pricing of our products to continue to decline, which could reduce our revenues, gross margins and profitability.

We expect the average unit prices of our products (on a like-for-like product comparison basis) to decline in the future as a result of competitive pricing pressures, increased sales discounts and customer incentives, new product introductions by us or our competitors, or other factors. In addition, the market opportunities we are pursuing in managed service provider and cloud service provider data centers are more price competitive than other markets we serve. If we are unable to offset these factors by increasing sales volumes or reducing product manufacturing costs, our total revenues and gross margins may decline. Moreover, most of our expenses are fixed in the short-term or incurred in advance of receipt of corresponding revenues. As a result, we may not be able to decrease our spending to offset any unexpected shortfall in revenues. If this occurs, our revenues, gross margins and profitability could decline.

The migration of our customers toward new products could adversely affect our results of operations.

As new or enhanced products are introduced, we must successfully manage the transition from older products in order to minimize the effects of product inventories that may become excess and obsolete, as well as ensure that sufficient supplies of new products can be delivered to meet customer demand. Our failure to manage the transition to newer products in the future or to develop and successfully introduce new products and product enhancements could adversely affect our business or results of operations. In addition, our customers are demanding a higher level of customization for new products, which prevents us

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from fully leveraging our product design work and adds to our new product development costs. When we introduce new products and product enhancements, we face additional risks relating to product transitions, including risks relating to forecasting demand and longer lead times associated with smaller product geometries and more complex production operations. Any such adverse event or increased costs could have a material adverse effect on our business, financial condition or results of operations.

Historically, the technology industry has developed higher performance ASICs, which create chip-level solutions that replace selected board-level or box-level solutions at a significantly lower average selling price. We have previously offered ASICs to customers for certain applications that have effectively resulted in a lower-priced solution when compared to an adapter solution. This transition to ASICs may also occur with respect to other current and future products. The result of this transition may have an adverse effect on our business, financial condition or results of operations. In the future, a similar adverse effect to our business could occur if there were rapid shifts in customer purchases from our midrange networking connectivity products to lower-cost products.

Sales and purchasing patterns with our customers and suppliers are uneven and subject to seasonal fluctuations.

A large percentage of our products are sold to customers who experience seasonality and uneven sales patterns in their own businesses. As a result, we experience similar seasonality and uneven sales and purchasing patterns with our customers and suppliers. We believe the variability in sales and purchasing patterns results from many factors, including:

This variability makes it extremely difficult to predict the demand and buying patterns of our customers and, in turn, causes challenges for us in sourcing goods and services from our suppliers, adjusting manufacturing capacity, and forecasting cash flow and working capital needs. If we predict demand that is substantially greater than actual customer orders, we will have excess inventory. Alternatively, if customer orders substantially exceed predicted demand, the ability to assemble, test and ship orders received in the last weeks and days of each quarter may be limited, or be completed at an increased cost, which could have a material adverse effect on our business, financial condition or results of operations.

Unanticipated changes in our tax provisions or adverse outcomes resulting from examination of our income tax returns could adversely affect our results of operations.

We are subject to income taxes in the United States and various foreign jurisdictions. Our effective tax rate has been and could in the future be adversely affected by changes in tax laws or interpretations of those tax laws, by changes in the mix of earnings in countries with differing statutory tax rates, or by changes in the valuation of our deferred tax assets and liabilities. Our effective tax rate is also affected by intercompany transactions for licenses, services, funding and other items. Given the global scope of our operations, and the complexity of global tax and transfer pricing rules and regulations, it is difficult to estimate earnings within each tax jurisdiction. If actual earnings within a tax jurisdiction differ materially from our estimates, we may not achieve our expected effective tax rate.

Additionally, our effective tax rate may be impacted by the tax effects of acquisitions, dispositions, changes to tax laws or regulations, examinations by tax authorities, stock-based compensation, uncertain tax positions, and changes in our ability to realize deferred tax assets. Significant judgment and estimates are required in determining the impact on our effective tax rate related to these items, including whether it is more likely than not that some or all of our deferred tax assets will be realized. Such estimates are subject to uncertainty due to various factors, including the economic environment, industry and market conditions, and the length of time of the projections included in the analyses. If our actual results are less favorable than current estimates, or we revise our estimates downward in future analyses, a valuation allowance may be required related to our deferred tax assets with a corresponding adjustment to earnings in the period in which such determination is made, which could have a material effect on our results of operations. In addition, the Organisation for Economic Co-operation and Development (OECD), an international association of 34 countries including the United States, as well as other taxing authorities have made or are contemplating changes to numerous long-standing tax principles. In particular, due to inconsistencies in application of the arm’s length standard among tax authorities, as well as lack of adequate treaty-based protection, transfer pricing challenges by tax authorities could, if successful, result in adjustments for prior or future tax years.  Any enacted or contemplated changes may increase tax uncertainty and adversely affect our provision for income taxes.

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Finally, we are subject to examination of our income tax returns by the United States Internal Revenue Service and other tax authorities, which may result in the assessment of additional income taxes. We regularly assess the likelihood of adverse outcomes resulting from examinations to determine the adequacy of our provisions for income taxes. However, unanticipated outcomes from examinations could have a material adverse effect on our financial condition or results of operations.

Because we have operations in foreign countries and depend on foreign customers and suppliers, we are subject to international economic, currency, regulatory, political and other risks that could harm our business, financial condition and results of operations.

International revenues accounted for 67%, 63% and 58% of our net revenues for fiscal 2016, 2015 and 2014, respectively. We expect that international revenues will continue to account for a significant percentage of our net revenues for the foreseeable future. In addition, we maintain operations in foreign countries and a significant portion of our inventory purchases are from suppliers that are located outside the United States. As a result, we are subject to several risks, which include:

As of April 3, 2016, our international subsidiaries held $302.3 million of our total cash, cash equivalents and marketable securities. These holdings by our international subsidiaries consist primarily of debt securities due from U.S. issuers, including the U.S. government and related agencies, and U.S. dollar denominated cash and money market funds. Certain foreign regulations could impact our ability to transfer funds to the United States. Additionally, should we decide to repatriate cash held outside of the United States, we may incur a significant tax obligation.

Our international sales are invoiced in U.S. dollars and, accordingly, if the relative value of the U.S. dollar in comparison to the currency of our foreign customers should increase, the resulting effective price increase of our products to such foreign customers could result in decreased sales. In addition, a significant portion of our inventory is purchased from international suppliers, who invoice us in U.S. dollars. If the relative value of the U.S. dollar in comparison to the currency of our foreign suppliers should decrease, our suppliers may increase prices, which could result in a decline of our gross margin. Any of the foregoing factors could have a material adverse effect on our business, financial condition or results of operations.

Changes in and compliance with regulations could materially and adversely affect us.

Our business, results of operations or financial condition could be materially and adversely affected if new laws, regulations or standards relating to us or our products are implemented or existing ones are changed. In addition, our compliance with existing regulations may have a material adverse impact on us. For example, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act) was enacted in 2010. There are significant corporate governance and executive compensation related provisions in the Dodd-Frank Act that require the SEC to adopt additional rules and regulations in these areas. The SEC has also issued disclosure requirements relating to the sourcing of so-called conflict minerals from the Democratic Republic of Congo and certain other adjoining countries. Our disclosures have been and will be predicated upon the timely receipt of accurate information from suppliers, who may be unwilling or unable to provide us with the relevant information. As a result, these requirements could adversely affect our costs, the availability of minerals used in our products and our relationships with customers and suppliers. In addition, we are subject to laws, rules and regulations in the United States and other countries relating to the collection, use and security of personal information and data. We have incurred, and will continue to incur, expenses to comply with privacy and security standards, protocols and obligations imposed by applicable laws, regulations, industry standards and contracts. Any inability to comply with applicable privacy or data protection laws, regulations or other obligations, could result in significant cost and liability, damage our reputation, and adversely affect our business.

Under applicable federal securities laws, including the Sarbanes-Oxley Act of 2002, we are required to evaluate and determine the effectiveness of our internal control structure and procedures for financial reporting. Should we or our

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independent auditors determine that we have material weaknesses in our internal controls, our business, financial condition or results of operations may be materially and adversely affected and our stock price may decline.

We and our customers are subject to various import and export regulations of the United States government and other countries. Certain government export regulations apply to the encryption or other features contained in some of our products. Changes in or violations of any such import or export regulations could materially and adversely affect our business, financial condition or results of operations.

In many foreign countries, particularly in those with developing economies, it is common to engage in business practices that are prohibited by regulations applicable to us, such as the Foreign Corrupt Practices Act and other anti-bribery laws. Although we have policies and procedures designed to ensure compliance with these laws, our employees, contractors and agents, as well as those companies to which we outsource certain of our business operations, may take actions in violation of our policies. Any such violation, even if prohibited by our policies, could have a material adverse effect on our business, financial condition or results of operations.

We face increasing complexity in our product design and procurement operations as we adjust to new and future requirements relating to the chemical and material composition of our products, their safe use, the energy consumption associated with those products and product take-back legislation (i.e., legislation that makes producers of electrical goods financially responsible for specified collection, recycling, treatment and disposal of past and future covered products). We could incur substantial costs, our products could be restricted from entering certain jurisdictions, and we could face other sanctions, if we were to violate or become liable under environmental laws or if our products become non-compliant with environmental laws.

We continually seek ways to increase the energy efficiency of our products. Recent analyses have estimated the amount of global carbon emissions that are due to information technology products. As a result, governmental and non-governmental organizations have turned their attention to development of regulations and standards to drive technological improvements and reduce the amount of carbon emissions. There is a risk that these regulations or standards, once developed, will not fully address the complexity of the technology developed by the IT industry or will favor certain technological approaches that we do not currently utilize. Depending on the regulations or standards that are ultimately adopted, compliance could adversely affect our business, results of operations or financial condition.

System security risks, data protection breaches and cyber-attacks could disrupt our internal operations, and any such disruption could reduce our expected revenues, increase our expenses, damage our reputation and adversely affect our stock price.

Experienced computer programmers and hackers may be able to penetrate our network and misappropriate or compromise our confidential information or that of third parties, create system disruptions or cause shutdowns. Computer programmers and hackers also may be able to develop and deploy viruses, worms, and other malicious software programs that attack our products or otherwise exploit any security vulnerabilities of our products. In addition, sophisticated hardware and operating system software and applications that we produce or procure from third parties may contain defects in design or manufacture, including “bugs” and other problems that could unexpectedly interfere with the operation of the system. The costs to us to eliminate or alleviate cyber or other security problems, bugs, viruses, worms, malicious software programs and security vulnerabilities could be significant and, if our efforts to address these problems are not successful, this could result in interruptions, delays, cessation of service and loss of existing or potential customers that may impede our sales, manufacturing, distribution or other critical functions.

We manage and store various proprietary information and sensitive or confidential data relating to our business. We have also outsourced a number of our business functions to third party contractors. Breaches of our or our third party contractors’ security measures or the accidental loss, inadvertent disclosure or unapproved dissemination of proprietary information or sensitive or confidential data about us or our customers, including the potential loss or disclosure of such information or data as a result of fraud, trickery or other forms of deception, could expose us or our customers to a risk of loss or misuse of this information, result in litigation and potential liability for us, damage our brand and reputation or otherwise harm our business. In addition, the cost and operational consequences of implementing further data protection measures could be significant.

Our proprietary rights may be inadequately protected and difficult to enforce.

In some jurisdictions, we have patent protection on certain aspects of our technology. However, we rely primarily on trade secrets, trademarks, copyrights and contractual provisions to protect our proprietary rights. There can be no assurance that these protections will be adequate to protect our proprietary rights, that others will not independently develop or otherwise acquire equivalent or superior technology, or that we can maintain such technology as trade secrets. There also can be no

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assurance that any patents we possess will not be invalidated, circumvented or challenged. We have taken steps in several jurisdictions to enforce our trademarks against third parties. No assurances can be given that we will ultimately be successful in protecting our trademarks. The laws of certain countries in which our products are or may be developed, manufactured or sold, including various countries in Asia, may not protect our products and intellectual property rights to the same extent as the laws of the United States, or at all. If we fail to protect our intellectual property rights, our business could be negatively impacted.

Disputes relating to claimed infringement of intellectual property rights may adversely affect our business.

We have in the past received notices of claimed infringement of intellectual property rights and been involved in intellectual property litigation. There can be no assurance that third parties will not assert future claims of infringement of intellectual property rights against us, or against customers or others whom we are contractually obligated to indemnify, with respect to existing and future products. In addition, our supply of ASICs and other components can also be interrupted by intellectual property infringement claims against our suppliers.

Individuals and groups are purchasing intellectual property assets for the sole purpose of making claims of infringement and attempting to extract settlements from companies such as ours. Although patent and intellectual property disputes may be settled through licensing or similar arrangements, costs associated with these arrangements may be substantial and the necessary licenses or similar arrangements may not be available to us on satisfactory terms, or at all. As a result, we could be prevented from manufacturing and selling some of our products. In addition, if we litigate these kinds of claims, the litigation could be expensive, time consuming and could divert management’s attention from other matters and there is no guarantee we would prevail. Our business could suffer regardless of the outcome of the litigation.

Our facilities and the facilities of our suppliers and customers are located in regions that are subject to natural disasters.

Our California facilities, including our principal executive offices, our principal design facilities and our critical business operations, are located near major earthquake faults. We are not specifically insured for earthquakes or other natural disasters. Any personal injury at, or damages to, the facilities as a result of such occurrences could have a material adverse effect on our business, results of operations or financial condition. Additionally, we have operations, suppliers and customers in regions that have historically experienced natural disasters. Furthermore, as a result of a natural disaster, our major customers may face shortages of components that could negatively impact their ability to build the servers and data center devices into which our products are integrated, thereby negatively impacting the demand for our products even if the supply of our products is not directly affected by the natural disaster. Any earthquake or other natural disaster, including a hurricane, flood, volcanic eruption, tsunami or fire, affecting any of these regions could adversely affect our business, results of operations and financial condition.

Our portfolio of marketable securities could experience a decline in market value, which could materially and adversely affect our financial results.

As of April 3, 2016, we held short-term marketable securities totaling $229.4 million. We invest in debt securities, the majority of which are high investment grade, and we limit the exposure to credit risk through diversification and investment in highly-rated securities. However, investing in highly-rated securities does not entirely mitigate the risk of potential declines in market value. A deterioration in the economy, including tightening of credit markets or significant volatility in interest rates, could cause declines in value of our marketable securities or could impact the liquidity of the portfolio. If market conditions deteriorate significantly, our results of operations or financial condition could be materially and adversely affected.

We may experience difficulties in transitioning to smaller geometry process technologies.

We expect to continue to transition our ASICs to increasingly smaller line width geometries. This transition requires us to modify the manufacturing processes for our products and to redesign some products, as well as standard cells and other integrated circuit designs that we may use in multiple products. We periodically evaluate the benefits, on a product-by-product basis, of migrating to smaller geometry process technologies. In the past, we have experienced some difficulties in shifting to smaller geometry process technologies or new manufacturing processes, which resulted in reduced manufacturing yields, delays in product deliveries and increased expenses. We may face similar difficulties, delays and expenses as we continue to transition our products to smaller geometry processes.

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If we fail to carefully manage the use of “open source” software in our products, we may be required to license key portions of our products on a royalty-free basis or expose key parts of our source code.

Certain of our software may be derived from “open source” software that is generally made available to the public by its authors and/or other third parties. Such open source software is often made available to us under licenses, such as the GNU General Public License, that impose certain obligations on us in the event we were to distribute derivative works of the open source software. These obligations may require us to make source code for the derivative works available to the public and license such derivative works under a particular type of license, rather than the forms of licenses customarily used to protect our intellectual property. In the event the copyright holder of any open source software were to successfully establish in court that we had not complied with the terms of a license for a particular work, we could be required to release the source code of that work to the public or stop distributing that work.

Our ability to borrow and maintain outstanding borrowings under our credit agreement is subject to certain covenants.

We have a credit agreement that provides us with a $125 million unsecured revolving credit facility that matures in March 2018. Borrowings under the credit agreement may be used for general corporate purposes, including permitted share repurchases and acquisitions. Under the credit agreement, we may increase the revolving commitments or obtain incremental term loans in an aggregate amount up to $100 million, subject to certain conditions. Our ability to borrow under the credit agreement is subject to continued compliance with certain financial and non-financial covenants. In addition, a breach of any of the covenants or other provisions in the credit agreement could result in an event of default, which if not cured or waived, could result in outstanding borrowings becoming immediately due and payable. We may be unable to maintain compliance with these covenants and, if we fail to do so, we may be unable to obtain waivers or amend the covenants. In the event that some or all of our outstanding borrowings are accelerated and become immediately due and payable, we may not have the funds to repay, or the ability to refinance, our borrowings. There were no borrowings outstanding under the credit agreement as of April 3, 2016.

 

 

None.

Our principal product development, operations, sales and corporate offices are located in three buildings comprising approximately 161,000 square feet in Aliso Viejo, California.  We own each of these buildings. Additionally, we lease one building comprising approximately 100,000 square feet in Shakopee, Minnesota, that previously housed product development and operations teams for many of our Legacy Connectivity Products. Our lease for the Shakopee facility runs until 2018 and we are currently attempting to sublease that facility. We lease an operations, sales and fulfillment facility located in Dublin, Ireland.  In addition, we lease facilities in Irvine, San Jose, Mountain View and Roseville, California; Minnetonka, Minnesota; Pune, India; Ramat Gan, Israel; and Taipei City, Taiwan. These facilities are used primarily for product engineering, development and support services. We also maintain sales offices at various locations in the United States, Europe and Asia.  We believe that our existing properties, including both owned and leased sites, are in good condition and suitable for the conduct of our business.

On September 28, 2015, a purported class action was commenced in the U.S. District Court for the Central District of California asserting claims arising under federal securities laws against the Company and certain individual defendants.  The plaintiff, Phyllis Hull, purported to represent a class of persons who purchased the Company’s common stock between April 30, 2015 and July 30, 2015.  The plaintiff alleged that the defendants, including a former officer and a current officer, engaged in a scheme to inflate the Company’s stock price by making false and misleading statements regarding the Company’s operations, financial results and future business prospects in violation of federal securities laws.  The plaintiff sought compensatory damages, interest and an award of reasonable attorneys’ fees and costs.  On March 4, 2016, the parties filed a Joint Stipulation with the Court to voluntarily dismiss the case. On March 7, 2016, the Court dismissed the case with prejudice as to Phyllis Hull and her individual claims and without prejudice as to the unnamed class members.

On October 23, 2015, Stephen Kramer filed a shareholder derivative complaint in the California Superior Court in and for the County of Orange County purportedly on behalf of the Company against certain current and former officers and directors of the Company.  The plaintiff alleges breaches of fiduciary duty, unjust enrichment, corporate waste, aiding and abetting breaches of fiduciary duty, and improper insider sales of stock in violation of California law based on the allegation that, since October 17, 2014, the individual defendants engaged in a scheme to inflate the Company’s stock price by making false and

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misleading statements regarding the Company’s operations, financial results, internal controls and future business prospects.  The plaintiff seeks an award of damages and restitution to the Company from the individual defendants, disgorgement of the individual defendants’ profits and compensation, an order requiring the Company to reform and improve its corporate governance, and an award of costs and attorneys’ fees to the plaintiff and its counsel.  On March 14, 2016, a second shareholder derivative complaint was filed in the same Court. The plaintiff in the second suit, Indiana Laborers Pension and Welfare Funds, makes similar allegations against certain current and former officers and directors of the Company and seeks similar demands.  The defendants have not yet responded to the complaints in either of the shareholder derivative cases.

The Company currently believes the disposition of the matters described above will not have a material adverse effect on the Company’s financial condition or results of operations.

Various other lawsuits, claims and proceedings have been or may be instituted against the Company. The outcome of litigation cannot be predicted with certainty and some lawsuits, claims and proceedings may be disposed of unfavorably to the Company. Many intellectual property disputes have a risk of injunctive relief and there can be no assurance that a license will be granted. Injunctive relief could have a material adverse effect on the Company’s financial condition or results of operations.  Based on an evaluation of such other matters that are pending or asserted, management believes the disposition of such matters will not have a material adverse effect on the Company’s financial condition or results of operations.

Not applicable.

 

 

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PART II

Principal Market and Prices

Shares of our common stock are traded and quoted on the NASDAQ Global Select Market under the symbol QLGC. The following table sets forth the range of high and low sales prices per share of our common stock for each quarterly period of the two most recent fiscal years as reported on the NASDAQ Global Select Market.

 

 

Number of Common Stockholders

The number of record holders of our common stock was 367 as of May 18, 2016.

Dividends

We have never paid cash dividends on our common stock. We currently anticipate that we will retain all of our future earnings for use in the development and expansion of our business and for general corporate purposes, including repurchases of our common stock. Any determination to pay dividends in the future will be at the discretion of our board of directors and will depend upon our operating results, financial condition and other factors as the board of directors deems relevant.

Recent Sales of Unregistered Securities

We did not issue any unregistered securities during fiscal 2016, 2015 or 2014.

Issuer Purchases of Equity Securities

During the fourth quarter of fiscal 2016, there were no purchases by the Company of its outstanding common stock.

In November 2015, our Board of Directors approved a new program authorizing the Company to purchase up to $125 million of its outstanding common stock over a period of up to two years from the date of the initial purchase under the new program. No shares have been purchased under this program as of April 3, 2016.

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Stockholder Return Performance

The performance graph below shall not be deemed filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (Exchange Act), or otherwise subject to the liabilities under that Section and shall not be deemed to be incorporated by reference into any of our filings under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent that we specifically incorporate this information by reference, and will not otherwise be deemed filed under the Securities Act of 1933, as amended, or the Exchange Act.

The following graph compares, for the five-year period ended April 3, 2016, the cumulative total stockholder return for our common stock, the Standard & Poor’s Midcap 400 Index (S&P Midcap 400 Index), the NASDAQ Composite Index and the NASDAQ Computer Index.  Measurement points are the last trading day of each of our fiscal years ended April 3, 2011, April 1, 2012, March 31, 2013, March 30, 2014, March 29, 2015 and April 3, 2016.  The graph assumes that $100 was invested on April 3, 2011 in our common stock, the S&P Midcap 400 Index, the NASDAQ Composite Index and the NASDAQ Computer Index and assumes reinvestment of dividends.  The stock price performance on the following graph is not necessarily indicative of future stock price performance.

 

 

 

 

 

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The following selected financial data should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the consolidated financial statements and notes thereto appearing elsewhere in this report. 

 

 

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This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our audited consolidated financial statements and related notes. In this discussion and elsewhere in this report, we make forward-looking statements. These forward-looking statements are made in reliance upon safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements include, without limitation, descriptions of our expectations regarding future trends affecting our business and other statements regarding future events or our objectives, goals, strategies, beliefs and underlying assumptions that are other than statements of historical fact. When used in this report, the words “anticipates,” “believes,” “can,” “continue,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “should,” “will” and similar expressions, or the negative of such expressions, are intended to identify these forward-looking statements. Statements concerning current conditions may also be forward-looking if they imply a continuation of current conditions. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of several factors, including, but not limited to those factors set forth and discussed in Part I, Item 1A “Risk Factors” and elsewhere in this report. In light of the significant uncertainties inherent in the forward-looking information included in this report, the inclusion of this information should not be regarded as a representation by us or any other person that our objectives or plans will be achieved. You are cautioned, therefore, not to place undue reliance on these forward-looking statements, which are made only as of the date of this report. We undertake no obligation to update or revise these forward-looking statements, whether as a result of new information, future events or otherwise.

Overview

We design and supply high performance server and storage networking connectivity products that provide, enhance and manage computer data communication. These products facilitate the rapid transfer of data and enable efficient resource sharing between servers, networks and storage. Our products are used in enterprise, managed service provider and cloud service provider data centers, along with other environments dependent on high performance, reliable data networking.

Our products are based primarily on Fibre Channel and Ethernet technologies and are used in connection with storage networks, data networks and converged networks. Storage networks are used to provide access to storage across enterprise environments. Fibre Channel is currently a dominant technology for enterprise storage networking.  Data networks are used to provide workstation-to-server, server-to-server, and server-to-storage connectivity using Ethernet.  Converged networks are designed to address the evolving data center by consolidating and unifying storage and data networks, using high-speed Ethernet.  Fibre Channel over Ethernet (FCoE) is a converged networking technology that uses high-speed Ethernet for both storage and data transmission.  Internet Small Computer System Interface (iSCSI) is an alternative to FCoE and provides storage over Ethernet capabilities.  Our converged network products can support storage networking and data networking capability covering a variety of protocols either individually or in combination.

We classify our products into two categories – Advanced Connectivity Platforms and Legacy Connectivity Products. Advanced Connectivity Platforms are comprised primarily of adapters and application-specific integrated circuits (ASICs) for server and storage connectivity applications. Legacy Connectivity Products are comprised primarily of Fibre Channel switch products.

Our products are sold worldwide, primarily to original equipment manufacturers (OEMs) and distributors. Our customers rely on our various server and storage connectivity products to deliver solutions to information technology professionals in virtually every business sector. Our products are found primarily in server and storage subsystem solutions that are used by enterprises with critical business data requirements, as well as managed service and cloud service providers.  These products are incorporated in solutions from a number of server and storage system OEM customers, including Cisco Systems, Inc., Dell Inc. (Dell), EMC Corporation, Fujitsu Ltd., Hewlett Packard Enterprise Company (HPE), Huawei Technologies Co. Ltd.,

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Inspur Group Co., Ltd., International Business Machines Corporation (IBM), Lenovo Group Ltd., NetApp, Inc., Oracle Corporation and Pure Storage, Inc.

We use a fifty-two/fifty-three week fiscal year ending on the Sunday nearest March 31.  Fiscal year 2016 comprised fifty-three weeks and ended on April 3, 2016.  Fiscal years 2015 and 2014 each comprised fifty-two weeks and ended on March 29, 2015 and March 30, 2014, respectively.

Business Acquisitions

In March 2014, we acquired certain 10/25/40/50/100Gb Ethernet controller-related assets from Broadcom Corporation and licensed certain related intellectual property under non-exclusive licenses for total cash consideration of $147.8 million and the assumption of certain liabilities. This business acquisition expanded our product portfolio and accelerated our time to market for next generation products in the server Ethernet connectivity market.

In January 2014, we acquired certain assets related to the Fibre Channel and converged network adapter business from Brocade Communications Systems, Inc. for cash consideration of $9.6 million and the assumption of certain liabilities. We completed this acquisition to expand our product portfolio and market position in the Fibre Channel and converged network adapter market.

Restructuring Plans

During fiscal 2016, 2015 and 2014, we implemented various restructuring plans primarily designed to reduce operating expenses and streamline business operations.  For additional information regarding the objectives and the charges associated with these plans, see Note 12 to the Consolidated Financial Statements, included in Part II, Item 8 of this report.

Fiscal Year and Fourth Quarter Financial Highlights and Other Information

Net revenues were $458.9 million for fiscal 2016 compared to $520.2 million in fiscal 2015.  Net income for fiscal 2016 was $46.5 million, or $0.54 per diluted share, compared to net income of $50.6 million, or $0.57 per diluted share, in fiscal 2015.  During fiscal 2016, cash generated from operations increased to $121.5 million from $82.5 million in fiscal 2015.

A summary of our financial performance during the fourth quarter of fiscal 2016 is as follows:

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Results of Operations

Net Revenues

A summary of our net revenues by product category is as follows:

 

 

Historically, the global marketplace for server and storage connectivity solutions has expanded in response to the information requirements of enterprise, managed service provider and cloud service provider data centers, along with other environments dependent on high performance, reliable data networking. The markets we serve have been characterized by rapid advances in technology and related product performance, which has generally resulted in declining average selling prices for existing products over time.

The market for our Fibre Channel products is mature and has declined during recent periods. The lack of growth in the Fibre Channel market may be the result of a shift in the information technology (IT) data center deployment model, as more enterprise workloads are moving to cloud data centers, which primarily use Ethernet solutions as their connectivity protocol. To the extent the Fibre Channel market declines, our quarterly operating results would be negatively impacted. In addition, some of our customers may purchase products strategically in advance of demand to take advantage of favorable pricing or to mitigate risks around product availability. As a result of these and other factors, it is extremely difficult for us to forecast future sales levels and historical information may not be indicative of future trends.

Net revenues of $458.9 million for fiscal 2016 decreased from $520.2 million in fiscal 2015.  The decrease in net revenues was the result of a $47.1 million, or 10%, decrease in revenue from Advanced Connectivity Platforms, and a $14.2 million, or 26%, decrease in revenue from Legacy Connectivity Products. The decrease in revenue from Advanced Connectivity Platforms was primarily due to a decrease in the units sold.  The decrease in revenue from Legacy Connectivity Products was also primarily due to a decrease in the units sold.  We expect net revenue from our Legacy Connectivity Products to continue to decline over time.  As part of the restructuring plan we implemented in June 2013, we ceased development of future ASICs for switch products; however, we will continue to sell and support products based on the current generation switch ASICs.

Net revenues of $520.2 million for fiscal 2015 increased 13% from $460.9 million in fiscal 2014.  The increase in net revenues was the result of a $78.3 million, or 20%, increase in revenue from Advanced Connectivity Platforms, partially offset by a $19.0 million, or 26%, decrease in revenue from Legacy Connectivity Products.  The increase in revenue from Advanced Connectivity Platforms was primarily driven by an increase in revenue from Ethernet products associated with an acquisition in the fourth quarter of fiscal 2014.  The decrease in revenue from Legacy Connectivity Products was primarily due to a 16% decrease in both the quantity of switches sold and the average selling price of these products.

A small number of our customers account for a substantial portion of our net revenues, and we expect that a small number of customers will continue to represent a substantial portion of our net revenues for the foreseeable future.  Our top ten customers accounted for 80%, 81% and 83% of net revenues during fiscal 2016, 2015 and 2014, respectively.

A summary of our customers, including their manufacturing subcontractors, that represent 10% or more of our net revenues is as follows:

 

 

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We believe our major customers continually evaluate whether or not to purchase products from alternative or additional sources. Accordingly, there can be no assurance that a major customer will not reduce, delay or eliminate its purchases from us. Any such reduction, delay or loss of purchases could have a material adverse effect on our business, financial condition or results of operations.

Net revenues by geographic area are as follows:

 

 

Revenues by geographic area are presented based upon the ship-to location of the customer, which is not necessarily indicative of the location of the ultimate end-user of our products.  The United States, China and Hong Kong are the only countries that represented 10% or more of net revenues for fiscal 2016.  Net revenues from customers in China and Hong Kong were $75.5 million and $60.1 million for 2016, respectively.  The United States and China are the only countries that represented 10% or more of net revenues for fiscal 2015 and 2014.  Net revenues from customers in China were $90.4 million and $56.0 million for fiscal 2015 and 2014, respectively.

Gross Profit

Gross profit represents net revenues less cost of revenues.  Cost of revenues consists primarily of the cost of purchased products, assembly and test services; costs associated with product procurement, inventory management, logistics and product quality; and the amortization of purchased intangible assets and other assets.  A summary of our gross profit and related percentage of net revenues is as follows:

 

 

Gross profit for fiscal 2016 decreased $34.6 million, or 11%, from gross profit for fiscal 2015.  The gross profit percentage for fiscal 2016 increased to 59.2% from 58.8% for fiscal 2015.  The decrease in gross profit was primarily due to a decrease in net revenues.  The increase in gross profit percentage was primarily due to a $3.0 million decrease in amortization of acquisition-related purchased intangible assets, partially offset by an unfavorable change in product mix.

Gross profit for fiscal 2015 decreased $4.0 million, or 1%, from gross profit for fiscal 2014.  The gross profit percentage for fiscal 2015 decreased to 58.8% from 67.3% for fiscal 2014.  The decrease in gross profit and gross profit percentage was primarily due to a combination of an unfavorable change in product mix, as lower margin Ethernet products increased as a percentage of total revenue, and incremental amortization of acquisition-related purchased intangible assets of $14.5 million.

Our ability to maintain our current gross profit percentage may be significantly affected by factors such as the mix of products shipped, manufacturing volumes over which fixed costs are absorbed, sales discounts and customer incentives, component costs, the transition to new products, competitive price pressures, the timeliness of volume shipments of new products, our ability to achieve manufacturing cost reductions, and amortization and impairments of purchased intangible assets and other assets. We anticipate that it will continue to be difficult to reduce manufacturing costs. As a result of these and other factors, our gross profit percentage may vary over time and could decline in future periods.

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Operating Expenses

Our operating expenses are summarized in the following table:

 

 

Engineering and Development.  Engineering and development expenses consist primarily of compensation and related employee benefit costs, outside service and material costs, occupancy and equipment costs and related computer support costs.  During fiscal 2016, engineering and development expenses decreased 11% to $128.8 million from $144.3 million in fiscal 2015.  The decrease was primarily due to an $8.2 million decrease in cash compensation and related employee benefit costs, principally due to cost savings achieved as a result of our restructuring plans, and a $4.0 million decrease in equipment depreciation and maintenance costs.

Engineering and development expenses decreased 2% to $144.3 million for fiscal 2015 from $147.0 million in fiscal 2014.  The decrease was primarily due to a $5.3 million decrease in cash compensation and related employee benefit costs, principally due to cost savings achieved as a result of our restructuring plans.  These decreases were partially offset by a $1.6 million increase in equipment depreciation and maintenance costs and a $1.4 million increase in outside service and material costs related to new product development.

We believe continued investments in engineering and development activities are critical to achieving future design wins, expansion of our customer base and revenue growth opportunities.

Sales and Marketing.  Sales and marketing expenses consist primarily of compensation and related employee benefit costs, sales commissions, promotional activities and travel for sales and marketing personnel.  Sales and marketing expenses decreased 12% to $56.6 million for fiscal 2016 from $64.3 million in fiscal 2015.  The decrease was primarily due to a decrease in cash compensation and related employee benefit costs, principally due to cost savings achieved as a result of our restructuring plans.

Sales and marketing expenses decreased 6% to $64.3 million for fiscal 2015 from $68.4 million in fiscal 2014.  The decrease was primarily due to a $2.8 million decrease in cash compensation and related employee benefit costs, principally due to a reduction in headcount resulting from our restructuring plans, and a $1.2 million decrease in promotional expenses.

General and Administrative.  General and administrative expenses consist primarily of compensation and related employee benefit costs for executive, finance, accounting, human resources, legal and information technology personnel. Non-compensation components of general and administrative expenses include accounting, legal and other professional fees, facilities expenses and other corporate expenses.  General and administrative expenses decreased 22% to $25.5 million for fiscal 2016 from $32.5 million for fiscal 2015.  The decrease was primarily due to a $3.2 million decrease in cash compensation and related employee benefit costs, a $2.0 million decrease in stock-based compensation and a $1.5 million decrease in consulting and outside services.  General and administrative expenses were $32.5 million for fiscal 2015 and $32.1 million for fiscal 2014.

Special Charges.  During fiscal 2016, we recorded special charges of $11.8 million consisting of $9.8 million of exit costs and $2.0 million of asset impairment charges related to property and equipment.  During fiscal 2015, we recorded special charges of $10.5 million consisting of $6.9 million of exit costs, $3.1 million of asset impairment charges related to abandoned property and equipment, and $0.5 million of other charges.  During fiscal 2014, we recorded special charges of $74.8 million, consisting of $41.0 million for the portion of a license payment attributed to the use of the related technology in periods prior

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to the date of the license agreement, $26.5 million of exit costs and $7.3 million of asset impairment charges primarily related to property and equipment.

Exit costs for all years include severance and related costs associated with involuntarily terminated employees and the estimated costs associated with facilities under non-cancelable leases that we ceased using. Certain employees that were notified of their termination are required to provide future services for varying periods in excess of statutory notice periods.  Severance costs related to these services are recognized ratably over the estimated requisite service period.  We expect to incur less than $1 million of additional severance costs for these employees over the remaining requisite service period.  Exit costs for fiscal 2014 also included the costs associated with the cancellation of certain contracts.

The total unpaid exit costs of $8.1 million as of April 3, 2016 are expected to be paid over the terms of the related agreements through fiscal 2018, including $3.6 million during the next twelve months.

Income Taxes

Our income tax expense was $4.3 million, $4.6 million and $9.3 million for fiscal 2016, 2015 and 2014, respectively. 

During fiscal 2016, the statute of limitations expired for certain tax years in various states.  As a result, we reduced the related income tax liabilities for such periods and recorded income tax benefits totaling $4.3 million.  Income tax expense was also impacted by the effect of a discrete tax-related expense associated with the difference between stock-based compensation expense and the deduction related to stock-based awards on income tax returns.

During fiscal 2015, we settled all open matters relating to the Internal Revenue Service (IRS) examination of our income tax returns for fiscal years 2010 through 2013 and are no longer subject to federal income tax examinations for years prior to fiscal 2014.  This settlement was for an amount less than we had previously accrued for this tax position and as a result, we recorded an income tax benefit of $2.5 million during fiscal 2015. Income tax expense for fiscal 2015 was also impacted by the effect of a discrete tax-related expense associated with the difference between stock-based compensation expense and the deduction related to stock-based awards on income tax returns.

Income tax expense for fiscal 2014 included $16.5 million of valuation allowances we recorded against deferred tax assets related to certain state tax credits and net operating loss carryforwards.  Based upon our projections of future taxable income in the respective states, we were no longer able to assert that it is more likely than not that we would realize the full benefit of these deferred tax assets.  The projections reflected changes in our forecasted taxable income, including the impact of acquisitions and restructuring activities. Income tax expense for fiscal 2014 was also impacted by the effect of a discrete tax-related expense associated with the difference between stock-based compensation expense and the deduction related to stock-based awards on income tax returns.

Considering the global scope of our operations and the complexity of global tax and transfer pricing rules and regulations, it is difficult to estimate earnings within each tax jurisdiction. If actual earnings within each tax jurisdiction differ materially from our estimates, we may not achieve our expected effective tax rate. Additionally, our effective tax rate may be impacted by other items, including the tax effects of acquisitions and dispositions, changes to tax laws or regulations, examinations by tax authorities, stock-based compensation, uncertain tax positions and changes in our ability to realize deferred tax assets.  While we believe that our provision for income taxes is appropriate, there can be no assurance that the effect of any of these or other items will not have a material impact on our consolidated financial statements.  In December 2015, a final decision was entered by the U.S. Tax Court in Altera Corp. v. Commissioner related to the treatment of stock-based compensation in intercompany cost-sharing agreements. The IRS notified the U.S. Court of Appeals for the Ninth Circuit in February 2016 of its intent to appeal the Tax Court's decision in the case. At this time the U.S. Department of the Treasury has not withdrawn the requirement from its regulations to include stock-based compensation in intercompany cost-sharing arrangements. Due to the uncertainty surrounding the status of the current regulations, questions related to the scope of potential benefits, and the risk of the Tax Court’s decision being overturned upon appeal, we have concluded that no adjustment to our consolidated financial statements is appropriate as of April 3, 2016. We will continue to monitor ongoing developments and potential impacts to our consolidated financial statements.

Liquidity and Capital Resources

Our combined balances of cash, cash equivalents and marketable securities increased to $354.8 million as of April 3, 2016 from $316.4 million as of March 29, 2015.  As of April 3, 2016 and March 29, 2015, our international subsidiaries held $302.3 million and $248.0 million, respectively, of our total cash, cash equivalents and marketable securities.  These holdings by our international subsidiaries consisted primarily of debt securities due from U.S. issuers, including the U.S. government and related agencies, and U.S. dollar denominated cash and money market funds. Certain foreign regulations could impact our

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ability to transfer funds to the United States. We currently intend to invest the funds held outside of the United States in our international operations and, as a result, do not intend to repatriate these funds. Should we decide to repatriate funds held outside of the United States, we may incur a significant tax obligation.

We believe that existing cash, cash equivalents, marketable securities and expected cash flow from operations will provide sufficient funds to finance our operations for at least the next twelve months. However, it is possible that we may need to supplement our existing sources of liquidity to finance our activities beyond the next twelve months or for the future acquisition of businesses, products or technologies and there can be no assurance that sources of liquidity will be available to us at that time.

Revolving Credit Facility

We have a credit agreement that provides us with a $125 million unsecured revolving credit facility that matures in March 2018.  Borrowings under the credit agreement may be used for general corporate purposes, including permitted share repurchases and acquisitions.  Under the credit agreement, we may increase the revolving commitments or obtain incremental term loans in an aggregate amount up to $100 million, subject to certain conditions.  There were no borrowings outstanding under the credit agreement as of April 3, 2016.

Operating, Investing and Financing Activities

Cash provided by operating activities increased to $121.5 million for fiscal 2016 from $82.5 million for fiscal 2015. Operating cash flow for fiscal 2016 consisted of our net income of $46.5 million, net non-cash expenses of $66.8 million and net cash provided as a result of changes in operating assets and liabilities of $8.2 million. Net non-cash expenses consisted primarily of $39.5 million of depreciation and amortization and $16.6 million of stock-based compensation.  The changes in operating assets and liabilities consisted primarily of a $32.2 million decrease in accounts receivable, partially offset by a $12.0 million decrease in accrued taxes, net, and a $9.8 million increase in inventory.  The decrease in accounts receivable was primarily due to the timing of customer shipments and cash collections, as well as a decrease in net revenues.  The decrease in accrued taxes, net, was primarily due to lower taxable income and the recognition of tax benefits related to the expiration of the statute of limitations for certain tax years in various states.  The increase in inventory was primarily due to product purchases in support of anticipated future customer demand and changes in our product fulfillment model.

Cash provided by operating activities increased to $82.5 million for fiscal 2015 from $56.8 million for fiscal 2014.  Operating cash flow for fiscal 2015 consisted of our net income of $50.6 million and net non-cash expenses of $71.0 million, partially offset by net cash used as a result of changes in operating assets and liabilities of $39.1 million.  Net non-cash expenses included $47.1 million of depreciation and amortization, $20.5 million of stock-based compensation, and $3.7 million of asset impairments which were primarily related to our restructuring plans. The changes in operating assets and liabilities included a $22.3 million increase in accounts receivable, an $11.9 million increase in inventory and an $8.6 million decrease in other liabilities.  The increase in accounts receivable was primarily due to an increase in net revenues and the timing of cash collections.  The increase in inventory was primarily due to product purchases in support of anticipated future customer demand and advanced purchases of ASICs with long lead times. The decrease in other liabilities was primarily due to the payment of severance and related costs associated with our restructuring plans.

Operating cash flow for fiscal 2014 included the payment of $62.0 million related to a non-exclusive patent license agreement, of which $41.0 million was attributed to the use of the related technology in periods prior to the date of the license agreement and charged to operations in fiscal 2014 and $21.0 million was attributed to the future use of the related technology over the term of the agreement and recorded as a prepaid license.  Cash provided by operating activities for fiscal 2014 consisted of our net loss of $18.3 million, including the $41.0 million related to the license agreement, net non-cash expenses of $62.3 million and net cash provided as a result of changes in operating assets and liabilities of $12.8 million.  Net non-cash expenses included $32.5 million of depreciation and amortization, $22.6 million of stock-based compensation, and $8.0 million of asset impairments which were primarily related to our restructuring plans.  The changes in operating assets and liabilities included an $11.5 million increase in other liabilities, a $9.9 million increase in accrued taxes, net, and a $6.7 million decrease in inventory (excluding the impact of our acquisitions in fiscal 2014), partially offset by a $19.0 million increase in other assets.  The increase in other liabilities was primarily due to accrued exit costs associated with our restructuring plans. The increase in accrued taxes, net, was primarily due to lower tax payments remitted during fiscal 2014.  The decrease in inventory was primarily due to sales of products that included ASICs that were purchased in the prior year due to long lead times.  The increase in other assets was primarily related to the $21.0 million of the amount paid under the patent license agreement that we attributed to future periods.

Cash used in investing activities for fiscal 2016 was $48.9 million and consisted of $29.7 million of net purchases of available-for-sale securities and $26.8 million of purchases of property and equipment, partially offset by $7.6 million of

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proceeds from the disposition of assets held for sale.  Cash used in investing activities for fiscal 2015 was $42.4 million and consisted of $26.1 million of purchases of property and equipment and $16.3 million of net purchases of available-for-sale securities. Cash used in investing activities for fiscal 2014 was $17.0 million and consisted of $157.4 million for the acquisition of businesses and $27.5 million of purchases of property and equipment, partially offset by $167.9 million of net proceeds from sales and maturities of available-for-sale securities.

We expect capital expenditures to remain significant in the future as we continue to invest in more costly engineering and production tools for new technologies and machinery and equipment.

Cash used in financing activities for fiscal 2016 was $62.4 million and consisted primarily of $78.9 million of purchases of common stock under our stock purchase program and $6.2 million for minimum tax withholdings paid on behalf of employees for restricted stock units that vested during the year, partially offset by $21.6 million of proceeds from the issuance of common stock under stock-based awards.  Cash used in financing activities for fiscal 2015 was $16.1 million and consisted primarily of our purchase of $21.1 million of common stock under our stock repurchase program and $4.7 million for minimum tax withholdings paid on behalf of employees for restricted stock units that vested during the year, partially offset by $9.7 million of proceeds from the issuance of common stock under stock-based awards.  Cash used in financing activities for fiscal 2014 was $44.1 million and consisted primarily of our purchase of $47.8 million of common stock under our stock repurchase program and $4.7 million for minimum tax withholdings paid on behalf of employees for restricted stock units that vested during the year, partially offset by $8.7 million of proceeds from the issuance of common stock under stock-based awards.

Since fiscal 2003, our Board of Directors has authorized various programs to purchase shares of our outstanding common stock.  In November 2015, our Board of Directors approved a new program authorizing the purchase of up to $125 million of our outstanding common stock over a period of up to two years from the date of the initial purchase under the program.  No shares have been purchased under this program as of April 3, 2016.

Contractual Obligations and Commitments

We have certain contractual obligations and commitments to make future payments in the form of non-cancelable purchase orders to our suppliers and commitments under operating lease arrangements. A summary of our contractual obligations as of April 3, 2016, and their impact on our cash flows in future fiscal years, is as follows:

 

 

Our liability for unrecognized tax benefits, including related accrued interest and penalties, was $9.5 million as of April 3, 2016. We are not able to provide a reasonable estimate of the timing of future tax payments related to these obligations.

Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires us to make estimates and judgments that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of net revenues and expenses during the reporting period. We base our estimates on historical experience and on various other factors that we believe to be reasonable under the circumstances, including the current economic environment, in making judgments about the carrying values of assets and liabilities. We believe the accounting policies described below to be our most critical accounting policies. These accounting policies are affected significantly by judgments, assumptions and estimates used in the preparation of the financial statements and actual results could differ materially from the amounts reported based on these policies.

Revenue Recognition

We recognize revenue from product sales when all of the following fundamental criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the price to the customer is fixed or determinable and (iv) collection of the resulting accounts receivable is reasonably assured.

For all sales, we use a binding purchase order or a signed agreement as evidence of an arrangement.  Delivery occurs when goods are shipped and title and risk of loss transfer to the customer, in accordance with the terms specified in the arrangement with the customer.  The customer’s obligation to pay and the payment terms are set at the time of delivery and are not

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dependent on the subsequent resale of the product. However, certain of our sales are made to distributors under agreements that contain a limited right to return unsold product and price protection provisions.  These return rights and price protection provisions limit our ability to reasonably estimate product returns and the final price of the inventory sold to distributors. As a result, the price to the customer is not fixed or determinable at the time products are delivered to distributors. Accordingly, we recognize revenue from these distributors based on the sell-through method using inventory information provided by the distributor.  At times, we provide standard incentive programs to our customers. We account for our competitive pricing incentives and rebates as a reduction of revenue in the period the related revenue is recorded based on the specific program criteria and historical experience.  In addition, we record provisions against revenue and cost of revenue for estimated product returns in the same period that revenue is recognized.  These provisions are based on historical experience as well as specifically identified product returns.  Service and other revenue is recognized when earned and receipt is reasonably assured.

For those sales that include multiple deliverables, we allocate revenue based on the relative selling price of the individual components.  When more than one element, such as hardware and services, are contained in a single arrangement, we allocate revenue between the elements based on each element’s relative selling price, provided that each element meets the criteria for treatment as a separate unit of accounting. When applying the relative selling price method, we determine the selling price for each deliverable using vendor-specific objective evidence (VSOE) of the selling price, if it exists.  In order to establish VSOE of the selling price, we must regularly sell the product and/or service on a standalone basis with a substantial majority of the sales priced within a relatively narrow range. If VSOE of the selling price cannot be determined, we then consider third party evidence (TPE) of the selling price. Generally, we are not able to determine TPE due to the lack of similar products and services sold by other companies within the industry. If neither VSOE nor TPE exists, we determine the estimated selling price based on multiple factors including, but not limited to, cost, gross margin, market conditions and pricing practices. Revenue allocated to each element is then recognized when the basic revenue recognition criteria is met for each deliverable.

We sell certain software products and related post-contract customer support. We recognize revenue from software products when all of the following fundamental criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the price to the customer is fixed or determinable and (iv) collection of the resulting accounts receivable is probable.  Revenue is allocated to undelivered elements based upon VSOE of the fair value of the element.  VSOE of the fair value is based upon the price charged when the element is sold separately.  Revenue allocated to each element is then recognized when the basic revenue recognition criteria are met for each element.  If we are unable to determine VSOE of fair value for an undelivered element, the entire amount of revenue from the arrangement is deferred and recognized over the service period or when all elements have been delivered.

Income Taxes

We utilize the asset and liability method of accounting for income taxes.  Income tax positions taken or expected to be taken in a tax return are recognized in the first reporting period that it is more likely than not the tax position will be sustained upon examination.  A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon settlement with a taxing authority that has full knowledge of all relevant information.  Previously recognized income tax positions that fail to meet the recognition threshold in a subsequent period are derecognized in that period.  Differences between actual results and our assumptions, or changes in our assumptions in future periods, are recorded in the period they become known.  We record potential accrued interest and penalties related to unrecognized tax benefits in income tax expense.

Deferred income taxes are recognized for the future tax consequences of temporary differences using enacted statutory tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  Temporary differences include the difference between the financial statement carrying amounts and the tax bases of existing assets and liabilities and operating loss and tax credit carryforwards.  The effect on deferred taxes of a change in tax rates is recognized in earnings in the period that includes the enactment date.

A valuation allowance is recorded when it is more likely than not that some or all of a deferred tax asset will not be realized. Significant judgment and estimates are required in determining whether a valuation allowance is recorded.  In assessing the need for a valuation allowance, we consider all available evidence, including past operating results, estimates of future taxable income, and the feasibility of tax planning strategies.  Our estimates and projections require significant judgment and are subject to uncertainty due to various factors, including the economic environment, industry and market conditions, and the length of time of the projections included in the analyses.  If our actual results are less favorable than current estimates, or we revise our estimates downward in future analyses, a valuation allowance may be required with a corresponding adjustment to earnings in the period in which such determination is made.

As a multinational corporation, we are subject to complex tax laws and regulations in various jurisdictions.  The application of tax laws and regulations is subject to legal and factual interpretation, judgment and uncertainty.  Tax laws themselves are

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subject to change as a result of changes in fiscal policy, changes in legislation, evolution of regulations and court rulings.  Therefore, the actual liability for U.S. or foreign taxes may be materially different from our estimates, which could result in the need to record additional liabilities or potentially to reverse previously recorded tax liabilities.  Differences between actual results and our assumptions, or changes in our assumptions in future periods, are recorded in the period they become known.

Inventories

Inventories are stated at the lower of cost (first-in, first-out) or market. We write down the carrying value of our inventory to estimated net realizable value for estimated excess and obsolete inventory based upon assumptions about future demand and market conditions.  These assumptions are based on economic conditions and trends (both current and projected), anticipated customer demand and acceptance of our current products, expected future products and other assumptions. If actual market conditions are less favorable than those projected by management, additional write-downs may be required.  Once we write down the carrying value of inventory, a new cost basis is established.  Subsequent changes in facts and circumstances do not result in an increase in the newly established cost basis.

Inventories acquired through business combinations are recorded at their acquisition date fair value, which is generally estimated selling price less the costs of disposal and a normal profit allowance.

Goodwill and Indefinite-Lived Intangible Assets

Goodwill is recorded as the difference, if any, between the aggregate consideration paid for an acquisition and the fair value of the net tangible and intangible assets acquired.  The amount assigned to in-process research and development (IPR&D) is capitalized and accounted for as an indefinite-lived intangible asset until the underlying projects are completed or abandoned.

Goodwill is not amortized but instead is tested annually for impairment, or more frequently when events or changes in circumstances indicate that the asset might be impaired, by comparing the carrying value to the fair value of the reporting unit to which the goodwill is assigned.  A two-step test is used to identify the potential impairment and to measure the amount of impairment, if any. The first step is to compare the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit is less than its carrying amount, goodwill is considered impaired and the loss is measured by performing step two. Under step two, the impairment loss is measured by comparing the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill.  We perform the annual test for impairment as of the first day of our fourth fiscal quarter. During the annual goodwill impairment test in fiscal 2016, we completed step one and determined that there was no impairment of goodwill since the fair value (based on quoted market price in an active market) of our sole reporting unit exceeded its carrying value. Based on this impairment test, we believe that we have no at-risk goodwill.

IPR&D is not amortized but instead is tested annually for impairment, or more frequently when events or changes in circumstances indicate that the asset might be impaired.  We initially assess qualitative factors to determine whether it is more likely than not that the fair value of IPR&D is less than its carrying amount, and if so, we conduct a quantitative impairment test. The quantitative impairment test consists of a comparison of the fair value of IPR&D to its carrying amount. If the carrying value exceeds its fair value, an impairment loss is recognized in an amount equal to the difference.  When an IPR&D project is complete, the related intangible asset becomes subject to amortization and impairment analysis as a long-lived asset.

The initial recording and subsequent evaluation for impairment of goodwill and indefinite-lived intangible assets requires the use of significant management judgments, including the forecasts of future operating results.  It is possible that our business plans may change and our estimates used may prove to be inaccurate.  If our actual results or estimates used in future impairment analyses are lower than current estimates, we could incur impairment charges.

Long-Lived Assets

Long-lived assets, including property and equipment and purchased intangible assets subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. Significant judgment is required in determining whether a potential indicator of impairment of our long-lived assets exists.  Recoverability of assets to be held and used is measured by the comparison of the carrying amount of an asset or asset group to future undiscounted net cash flows expected to be generated by the asset or asset group. If such an asset or asset group is considered to be impaired, the impairment to be recognized is measured as the amount by which the carrying amount of the asset or asset group exceeds the fair value of the asset or asset group. Assets to be disposed of are reported at the lower of their carrying amount or fair value less costs to sell.  Estimating future net cash flows and determining proper asset groupings for the purpose of this impairment test requires the use of significant management judgment.  If our actual results or estimates used in future impairment analyses are lower than our current estimates, we could incur impairment charges.

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Recently Issued Accounting Standards Not Yet Effective

In May 2014, the Financial Accounting Standards Board (FASB) issued an accounting standard update that requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. This standard will replace most existing revenue recognition guidance when it becomes effective. In July 2015, the FASB amended this standard to defer the effective date by one year and permit early adoption as of the original effective date. This amended standard is effective for us in the first quarter of fiscal 2019. This standard permits the use of either the retrospective or cumulative effect transition method. We are currently evaluating the effect this new guidance will have on our consolidated financial statements and have not yet selected a transition method.

In February 2016, the FASB issued an accounting standard update that replaces existing lease guidance and requires, among other things, on-balance sheet recognition by lessees for operating leases greater than 12 months. It also changes the definition of a lease and expands the disclosure requirements of lease arrangements. This standard is effective for us in the first quarter of fiscal 2020, with early adoption permitted. The new lease standard requires adoption using a modified retrospective approach and provides for certain practical expedients. We are currently evaluating the effect this new guidance will have on our consolidated financial statements.

In March 2016, the FASB issued an accounting standard update that revises the accounting for share-based payment transactions, including the accounting for income taxes, forfeitures and statutory tax withholding requirements, as well as classification in the statement of cash flows. This standard is effective for us in the first quarter of fiscal 2018, with early adoption permitted.  We are currently evaluating the effect this new guidance will have on our consolidated financial statements.

Off-Balance Sheet Arrangements

During the years presented, we did not have any off-balance sheet arrangements other than operating leases.  Information related to our operating leases is included in Note 16 of the Notes to Consolidated Financial Statements in this Form 10-K.  Such information is hereby incorporated by reference.

 

 

Our cash and cash equivalents are not subject to significant interest rate risk due to the short maturities of these instruments.  As of April 3, 2016, the carrying value of our cash and cash equivalents approximates fair value.

We maintain a portfolio of marketable securities consisting primarily of U.S. government and agency securities, corporate debt obligations and mortgage-backed securities, the majority of which have remaining terms of three years or less. We are exposed to fluctuations in interest rates as movements in interest rates can result in changes in the market value of our investments in debt securities. However, due to the short-term expected duration of our portfolio of marketable securities, we do not believe that we are subject to material interest rate risk.

In accordance with our investment guidelines, we only invest in instruments with high credit quality ratings and we limit our exposure to any one issuer or type of investment. Our portfolio of marketable securities as of April 3, 2016 consists of $229.4 million of securities that are classified as available-for-sale. As of April 3, 2016, we had gross unrealized losses associated with our available-for-sale securities of $0.1 million that were determined by management to be temporary in nature.

We do not use derivative financial instruments.

 

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders

QLogic Corporation:

We have audited the accompanying consolidated balance sheets of QLogic Corporation and subsidiaries as of April 3, 2016 and March 29, 2015, and the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity and cash flows for each of the years in the three‑year period ended April 3, 2016. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedule of valuation and qualifying accounts as listed in the index under Item 15(a)(2). 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 the standards of the Public Company Accounting Oversight Board (United States). 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 subsidiaries as of April 3, 2016 and March 29, 2015, and the results of their operations and their cash flows for each of the years in the three‑year period ended April 3, 2016, in conformity with U.S. 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.

As discussed in note 1 to the consolidated financial statements, the Company has adopted, on a retrospective basis, FASB Accounting Standards Update No. 2015-17, Balance Sheet Classification of Deferred Taxes, and has classified all deferred tax assets, liabilities and associated allowances as non-current.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), QLogic Corporation’s internal control over financial reporting as of April 3, 2016, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated May 26, 2016, expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

 

/s/ KPMG LLP

 

Irvine, California

May 26, 2016

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders

QLogic Corporation:

We have audited QLogic Corporation’s internal control over financial reporting as of April 3, 2016, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). QLogic Corporation’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, QLogic Corporation maintained, in all material respects, effective internal control over financial reporting as of April 3, 2016, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of QLogic Corporation and subsidiaries as of April 3, 2016 and March 29, 2015, and the related consolidated statements of operations, comprehensive income (loss), stockholders’ equity and cash flows for each of the years in the three-year period ended April 3, 2016, and our report dated May 26, 2016, expressed an unqualified opinion on those consolidated financial statements.

 

/s/ KPMG LLP

 

Irvine, California

May 26, 2016

 

 

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QLOGIC CORPORATION

CONSOLIDATED BALANCE SHEETS

April 3, 2016 and March 29, 2015

 

 

See accompanying notes to consolidated financial statements.

 

 

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QLOGIC CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

Years Ended April 3, 2016, March 29, 2015 and March 30, 2014

 

 

See accompanying notes to consolidated financial statements.

 

 

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QLOGIC CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

Years Ended April 3, 2016, March 29, 2015 and March 30, 2014

 

 

See accompanying notes to consolidated financial statements.

 

 

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QLOGIC CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

Years Ended April 3, 2016, March 29, 2015 and March 30, 2014

 

 

See accompanying notes to consolidated financial statements.

 

 

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QLOGIC CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years Ended April 3, 2016, March 29, 2015 and March 30, 2014

 

 

See accompanying notes to consolidated financial statements.

 

 

 

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QLOGIC CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

Note 1. Description of Business and Summary of Significant Accounting Policies

General Business Information

QLogic Corporation (QLogic or the Company) designs and supplies high performance server and storage networking connectivity products that provide, enhance and manage computer data communication.  The Company’s products are used in enterprise, managed service provider and cloud service provider data centers, along with other environments dependent on high performance, reliable data networking.  The Company’s products are based primarily on Fibre Channel and Ethernet technologies and are used in connection with storage networks, data networks and converged networks.  The Company’s products consist primarily of connectivity products such as adapters and application-specific integrated circuits (ASICs) and are sold worldwide, primarily to original equipment manufacturers (OEMs) and distributors.

The Company classifies its products into two categories – Advanced Connectivity Platforms and Legacy Connectivity Products. Advanced Connectivity Platforms are comprised primarily of adapters and ASICs for server and storage connectivity applications. Legacy Connectivity Products are comprised primarily of Fibre Channel switch products.

Principles of Consolidation

The consolidated financial statements include the financial statements of QLogic Corporation and its wholly-owned subsidiaries. Intercompany balances and transactions have been eliminated in consolidation.

Financial Reporting Period

The Company uses a fifty-two/fifty-three week fiscal year ending on the Sunday nearest March 31.  Fiscal year 2016 comprised fifty-three weeks and ended on April 3, 2016.  Fiscal years 2015 and 2014 each comprised fifty-two weeks and ended on March 29, 2015 and March 30, 2014, respectively.

Use of Estimates

The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires management to make estimates and judgments that affect the amounts reported in the Company’s consolidated financial statements and accompanying notes.  Significant estimates and judgments affecting the consolidated financial statements are those related to revenue recognition, income taxes, inventories, goodwill and long-lived assets.

The Company evaluates its estimates on an ongoing basis using historical experience and other factors, including the current economic environment. Significant judgment is required in determining (i) the fair value of assets acquired and liabilities assumed in a business combination, including the fair value of identifiable intangible assets, (ii) the fair value of a patent license and the portion of the fair value attributable to past and future periods, (iii) the Company’s tax filing positions and the related assessment of recognition and measurement of uncertain tax positions, (iv) whether a valuation allowance related to a deferred tax asset should be recorded and (v) whether a potential indicator of impairment of the Company’s long-lived assets exists and in estimating future cash flows for the purpose of any necessary impairment tests. If management’s estimates differ materially from actual results, the Company’s future results of operations will be affected.

Revenue Recognition

The Company recognizes revenue from product sales when all of the following fundamental criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the price to the customer is fixed or determinable and (iv) collection of the resulting accounts receivable is reasonably assured.

For all sales, the Company uses a binding purchase order or a signed agreement as evidence of an arrangement.  Delivery occurs when goods are shipped and title and risk of loss transfer to the customer, in accordance with the terms specified in the arrangement with the customer.  The customer’s obligation to pay and the payment terms are set at the time of delivery and are not dependent on the subsequent resale of the product. However, certain of the Company’s sales are made to distributors under agreements that contain a limited right to return unsold product and price protection provisions.  These return rights and price protection provisions limit the Company’s ability to reasonably estimate product returns and the final price of the inventory sold to distributors. As a result, the price to the customer is not fixed or determinable at the time products are delivered to distributors. Accordingly, the Company recognizes revenue from these distributors based on the sell-through method using inventory information provided by the distributor.  At times, the Company provides standard incentive programs to its

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QLOGIC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

customers. The Company accounts for its competitive pricing incentives and rebates as a reduction of revenue in the period the related revenue is recorded based on the specific program criteria and historical experience.  In addition, the Company records provisions against revenue and cost of revenue for estimated product returns in the same period that revenue is recognized.  These provisions are based on historical experience as well as specifically identified product returns.  Service and other revenue is recognized when earned and receipt is reasonably assured.

For those sales that include multiple deliverables, the Company allocates revenue based on the relative selling price of the individual components.  When more than one element, such as hardware and services, are contained in a single arrangement, the Company allocates revenue between the elements based on each element’s relative selling price, provided that each element meets the criteria for treatment as a separate unit of accounting. When applying the relative selling price method, the Company determines the selling price for each deliverable using vendor-specific objective evidence (VSOE) of the selling price, if it exists.  In order to establish VSOE of the selling price, the Company must regularly sell the product and/or service on a standalone basis with a substantial majority of the sales priced within a relatively narrow range. If VSOE of the selling price cannot be determined, the Company then considers third party evidence (TPE) of the selling price. Generally, the Company is not able to determine TPE due to the lack of similar products and services sold by other companies within the industry. If neither VSOE nor TPE exists, the Company determines the estimated selling price based on multiple factors including, but not limited to, cost, gross margin, market conditions and pricing practices. Revenue allocated to each element is then recognized when the basic revenue recognition criteria is met for each deliverable.

The Company sells certain software products and related post-contract customer support. The Company recognizes revenue from software products when all of the following fundamental criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred, (iii) the price to the customer is fixed or determinable and (iv) collection of the resulting accounts receivable is probable.  Revenue is allocated to undelivered elements based upon VSOE of the fair value of the element.  VSOE of the fair value is based upon the price charged when the element is sold separately.  Revenue allocated to each element is then recognized when the basic revenue recognition criteria are met for each element.  If the Company is unable to determine VSOE of fair value for an undelivered element, the entire amount of revenue from the arrangement is deferred and recognized over the service period or when all elements have been delivered.

Stock-Based Compensation

The Company recognizes compensation expense for all stock-based awards made to employees and non-employee directors, including restricted stock units, stock options and stock purchases under its Employee Stock Purchase Plan (the ESPP), based on estimated fair values on the measurement date, which is generally the date of grant. Stock-based compensation is recognized for the portion of the award that is ultimately expected to vest.  Forfeitures are estimated at the time of grant based on historical trends and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.  The Company recognizes stock-based compensation expense for awards that are subject to only a service condition on a straight-line basis over the requisite service period for the entire award, which is the vesting period for restricted stock units and stock options, and the offering period for the ESPP.  For all other stock-based awards, stock-based compensation is recognized on a straight-line basis over the requisite service period for each separately vesting portion of the award.  The determination of fair value of stock-based awards on the date of grant using an option-pricing or other valuation model is affected by the Company’s stock price, as well as assumptions regarding a number of highly complex and subjective variables.  These variables may include, but are not limited to, the Company’s expected stock price volatility over the term of the awards and actual and projected employee stock option exercise behaviors.  In estimating expected stock price volatility, the Company uses a combination of (i) historical volatility, calculated based on the daily closing prices of its common stock over a period equal to the expected term of the option, and (ii) implied volatility, utilizing market data of actively traded options on its common stock.

Research and Development

Research and development costs, including costs related to the development of new products and process technologies, are expensed as incurred.

Advertising Costs

The Company expenses all advertising costs as incurred and such costs were not material to the consolidated statements of operations.

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QLOGIC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Income Taxes

The Company utilizes the asset and liability method of accounting for income taxes.  Income tax positions taken or expected to be taken in a tax return are recognized in the first reporting period that it is more likely than not the tax position will be sustained upon examination.  A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon settlement with a taxing authority that has full knowledge of all relevant information.  Previously recognized income tax positions that fail to meet the recognition threshold in a subsequent period are derecognized in that period.  Differences between actual results and the Company’s assumptions, or changes in its assumptions in future periods, are recorded in the period they become known. The Company records potential accrued interest and penalties related to unrecognized tax benefits in income tax expense.

Deferred income taxes are recognized for the future tax consequences of temporary differences using enacted statutory tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  Temporary differences include the difference between the financial statement carrying amounts and the tax bases of existing assets and liabilities and operating loss and tax credit carryforwards.  The effect on deferred taxes of a change in tax rates is recognized in earnings in the period that includes the enactment date.

A valuation allowance is recorded when it is more likely than not that some or all of a deferred tax asset will not be realized.  In assessing the need for a valuation allowance, the Company considers all available evidence, including past operating results, estimates of future taxable income, and the feasibility of tax planning strategies.  The Company’s estimates and projections require significant judgment and are subject to uncertainty due to various factors, including the economic environment, industry and market conditions, and the length of time of the projections included in the analyses.

Net Income per Share

The Company computes basic net income per share based on the weighted-average number of common shares outstanding during the periods presented. Diluted net income per share is computed based on the weighted-average number of common and any dilutive potential common shares outstanding using the treasury stock method. Restricted stock units, stock options and other stock-based awards granted by the Company have been treated as dilutive potential common shares in computing diluted net income per share.

Concentration of Credit Risk

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash equivalents, marketable securities and trade accounts receivable. Cash and cash equivalents are maintained with several financial institutions.  Deposits held with banks may exceed the amount of insurance provided on such deposits.

The Company invests primarily in debt securities, the majority of which are high investment grade. In accordance with the Company’s investment policy, exposure to credit risk is limited by the diversification and investment in highly-rated securities.

The Company’s products are sold worldwide, primarily to OEMs and distributors. As of April 3, 2016 and March 29, 2015, the Company had four customers that each individually accounted for 10% or more of the Company’s accounts receivable. These customers, all of which were OEMs or their manufacturing subcontractors, accounted for an aggregate of 75% and 63% of the Company’s total accounts receivable as of April 3, 2016 and March 29, 2015, respectively.  The Company performs ongoing credit evaluations of its customers’ financial condition and, generally, requires no collateral from its customers.  Sales to customers are denominated in U.S. dollars.  As a result, the Company believes its foreign currency risk related to trade accounts receivable is minimal.

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QLOGIC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Fair Value Measurements

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. The fair value hierarchy is based on three levels of inputs that may be used to measure fair value. The first two levels of inputs are considered observable and the last unobservable.  A description of the three levels of inputs is as follows:

Cash and Cash Equivalents

The Company considers all highly liquid investments purchased with original maturities of three months or less on their acquisition date to be cash equivalents. The carrying amounts of cash and cash equivalents approximate their fair values.

Marketable Securities

Marketable securities consist of available-for-sale securities and are classified in the consolidated balance sheets based on the nature of the security and the availability for use in current operations.  Available-for-sale securities are recorded at fair value based on quoted market prices or other observable inputs. Unrealized gains and losses, net of related income taxes, on available-for-sale securities are excluded from earnings and reported as a separate component of accumulated other comprehensive income until realized.

The Company recognizes an impairment charge on available-for-sale securities when the decline in the fair value of an investment below its cost basis is judged to be other-than-temporary.  If the Company intends to sell the security or it is more likely than not that it will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss, the Company would recognize the entire impairment in earnings.  If the Company does not intend to sell the security and it is not more likely than not that it will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss, the other-than-temporary impairment is separated into (a) the amount representing the credit loss and (b) the amount related to all other factors. The amount of the other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the other-than-temporary impairment related to other factors is recognized in other comprehensive income, net of applicable taxes. The Company considers various factors in determining whether to recognize an impairment charge, including the current financial and credit market environment, the financial condition and near-term prospects of the issuer of the security, the magnitude of the unrealized loss compared to the cost of the investment, the length of time the investment has been in a loss position and the Company’s intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery of market value.

Realized gains or losses are determined on a specific identification basis and reported in interest and other income, net, as incurred.  Realized gains and losses reclassified from accumulated other comprehensive income are included in interest and other income, net, in the consolidated statements of operations.

Allowance for Doubtful Accounts

An allowance for doubtful accounts is maintained for estimated losses resulting from the inability of the Company’s customers to make required payments.  This reserve is determined by analyzing specific customer accounts, applying estimated loss rates to the aging of remaining accounts receivable balances, and considering the impact of the current economic environment where appropriate.

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QLOGIC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Inventories

Inventories are stated at the lower of cost (first-in, first-out) or market. The Company writes down the carrying value of inventory to estimated net realizable value for estimated excess and obsolete inventory based upon assumptions about future demand and market conditions. These assumptions are based on economic conditions and trends (both current and projected), anticipated customer demand and acceptance of the Company’s current products, expected future products and other assumptions.  Once the Company writes down the carrying value of inventory, a new cost basis is established.  Subsequent changes in facts and circumstances do not result in an increase in the newly-established cost basis.

Inventories acquired through business combinations are recorded at their acquisition date fair value, which is generally estimated selling price less the costs of disposal and a normal profit allowance.

Property and Equipment

Property and equipment are stated at cost.  Property and equipment acquired through business combinations are recorded at their acquisition date fair value.  Depreciation is calculated using the straight-line method over estimated useful lives of 39.5 years for buildings, five to fifteen years for building and land improvements, and two to five years for other property and equipment.  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.

Goodwill and Indefinite-Lived Intangible Assets

Goodwill is recorded as the difference, if any, between the aggregate consideration paid for an acquisition and the fair value of the net tangible and intangible assets acquired.  The amount assigned to in-process research and development (IPR&D) is capitalized and accounted for as an indefinite-lived intangible asset until the underlying projects are completed or abandoned.

Goodwill is not amortized but instead is tested annually for impairment, or more frequently when events or changes in circumstances indicate that the asset might be impaired, by comparing the carrying value to the fair value of the reporting unit to which the goodwill is assigned.  A two-step test is used to identify the potential impairment and to measure the amount of impairment, if any. The first step is to compare the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit is less than its carrying amount, goodwill is considered impaired and the loss is measured by performing step two. Under step two, the impairment loss is measured by comparing the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill. Management determined that the Company has a single reporting unit for the purpose of testing goodwill for impairment.  The Company performs the annual test for impairment as of the first day of its fourth fiscal quarter. During the annual goodwill impairment test, the Company completed step one and determined that there was no impairment of goodwill since the fair value (based on quoted market price in an active market) of the reporting unit exceeded its carrying value.

IPR&D is not amortized but instead is tested annually for impairment, or more frequently when events or changes in circumstances indicate that the asset might be impaired.  The Company initially assesses qualitative factors to determine whether it is more likely than not that the fair value of IPR&D is less than its carrying amount, and if so, the Company conducts a quantitative impairment test. The quantitative impairment test consists of a comparison of the fair value of IPR&D to its carrying amount. If the carrying value exceeds its fair value, an impairment loss is recognized in an amount equal to the difference.  When an IPR&D project is complete, the related intangible asset becomes subject to amortization and impairment analysis as a long-lived asset. The Company performed a qualitative impairment test as of the first day of its fourth fiscal quarter and determined that there was no impairment of IPR&D.

Long-Lived Assets

Long-lived assets, including property and equipment and purchased intangible assets subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable. Recoverability of assets to be held and used is measured by the comparison of the carrying amount of an asset or asset group to future undiscounted net cash flows expected to be generated by the asset or asset group. If such an asset or asset group is considered to be impaired, the impairment to be recognized is measured as the amount by which the carrying amount of the asset or asset group exceeds the fair value of the asset or asset group. Assets to be disposed of are reported at the lower of their carrying amount or fair value less costs to sell.

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QLOGIC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Purchased intangible assets consist primarily of technology and customer relationships acquired in business acquisitions.  Purchased intangible assets that have definite lives are amortized using a method that reflects the pattern in which the economic benefits of the intangible assets are realized or, if that pattern cannot be reliably determined, using a straight-line method over the estimated useful lives of the related assets, generally ranging from three to eight years.

Warranty

The Company’s products generally carry a warranty for periods of up to three years. The Company records a liability for product warranty obligations in the period the related revenue is recorded based on historical warranty experience. Warranty expense and the corresponding liability were not material to the consolidated financial statements.

Comprehensive Income

Comprehensive income includes all changes in equity other than transactions with stockholders. The Company’s accumulated other comprehensive loss consists of unrealized gains and losses on available-for-sale securities, net of income taxes, and foreign currency translation adjustments.

Foreign Currency Translation

Certain of the Company’s foreign subsidiaries utilize a functional currency other than U.S. dollars.  Assets and liabilities of these subsidiaries are translated to U.S. dollars at exchange rates in effect at the balance sheet date, and income and expenses are translated at average exchange rates during the period.  The resulting translation adjustments are recorded as a component of accumulated other comprehensive income.  Gains and losses resulting from transactions denominated in currencies other than the functional currency are included in interest and other income, net, and were not material to the consolidated statements of operations.

Recently Adopted Accounting Standards

In November 2015, the Financial Accounting Standards Board (FASB) issued an accounting standard update to simplify the presentation of deferred income taxes.  Under this new standard, deferred tax assets and liabilities are required to be classified as noncurrent in a classified balance sheet.  The Company adopted this standard during fiscal 2016 on a retrospective basis resulting in the reclassification of $12.5 million of current deferred tax assets to noncurrent in the Company’s consolidated balance sheet as of March 29, 2015.

Recently Issued Accounting Standards Not Yet Effective

In May 2014, the FASB issued an accounting standard update that requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. This standard will replace most existing revenue recognition guidance when it becomes effective. In July 2015, the FASB amended this standard to defer the effective date by one year and permit early adoption as of the original effective date. This amended standard is effective for the Company in the first quarter of fiscal 2019. This standard permits the use of either the retrospective or cumulative effect transition method. The Company is currently evaluating the effect this new guidance will have on its consolidated financial statements and has not yet selected a transition method.

 

Note 2. Business Acquisitions and License Agreement

Broadcom Corporation

In March 2014, the Company acquired certain 10/25/40/50/100Gb Ethernet controller-related assets from Broadcom Corporation and licensed certain related intellectual property under non-exclusive licenses for total cash consideration of $147.8 million and the assumption of certain liabilities. This business acquisition expanded the Company’s product portfolio and accelerated its time to market for next generation products in the server Ethernet connectivity market.  In connection with this acquisition, the Company entered into a development and supply agreement under which the Company will purchase services and ASICs from Broadcom Corporation related to this business.

In connection with this transaction, the Company acquired one IPR&D project which was related to next generation Ethernet products and determined to have an estimated fair value of $21.2 million at the acquisition date.  During the first quarter of fiscal 2017, the Company completed this IPR&D project and reclassified the $21.2 million to a developed

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technology intangible asset.  This intangible asset will be amortized to cost of revenues over its estimated useful life of six years.

Supplemental Pro Forma Data (Unaudited)

The unaudited supplemental pro forma financial data presented below gives effect to this acquisition as if it had occurred at the beginning of fiscal 2013, the year prior to the acquisition date. The supplemental data includes amortization expense related to the acquired intangible assets of $12.0 million in fiscal 2014.  In addition, the supplemental data reflects adjustments related to stock-based compensation, the amortization of acquired inventory valuation step-up and transaction costs, such as legal fees, directly associated with the acquisition.  These additional adjustments are not material to the period presented.

This unaudited supplemental pro forma financial data is presented for informational purposes only and does not purport to be indicative of the results of future operations or the results that would have occurred had the Company completed the acquisition at the beginning of fiscal 2013.

 

 

The results of operations for this acquisition have been included in the consolidated financial statements from the date of acquisition and are immaterial to the consolidated financial results of the Company in fiscal 2014.

Patent License Agreement

In March 2014, the Company entered into a non-exclusive patent license agreement with Broadcom Corporation and paid a one-time fee of $62.0 million as specified in the agreement.  The license covers all of the Company’s Fibre Channel products.  The Company determined that the $62.0 million fee represented the estimated fair value of the license utilizing a market approach, as well as a relief-from-royalty income approach based on the applicable historical revenues and projected future revenues over the ten-year term of the license.  Based on the relief-from-royalty income approach, the Company attributed $41.0 million of the license fee to the use of the related technology in periods prior to the date of the license agreement and recorded this amount in special charges in fiscal 2014.  The portion of the fee attributed to the future use of the technology was $21.0 million and was recorded as a prepaid license in other assets.  The prepaid license is being amortized using a method that reflects the pattern in which the economic benefits of the prepaid license are consumed or otherwise used over the ten-year license term.

Brocade Communications Systems, Inc.

In January 2014, the Company acquired certain assets related to the Fibre Channel and converged network adapter business from Brocade Communications Systems, Inc. for cash consideration of $9.6 million and the assumption of certain liabilities.  The Company completed this acquisition to expand its product portfolio and market position in the Fibre Channel and converged network adapter market.  

The results of operations for this acquisition have been included in the consolidated financial statements from the date of acquisition and are immaterial to the consolidated financial results of the Company.  Pro forma results of operations have not been presented for this acquisition as the results of operations of the acquired business are not material to the consolidated financial statements of the Company.

 

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Note 3. Marketable Securities

The Company’s portfolio of available-for-sale marketable securities consists of the following:

 

 

The amortized cost and estimated fair value of debt securities as of April 3, 2016, by contractual maturity, are presented below.  Expected maturities will differ from contractual maturities because the issuers of securities may have the right to repay obligations without prepayment penalties. Certain debt instruments, although possessing a contractual maturity greater than one year, are classified as short-term marketable securities based on their ability to be traded on active markets and availability for current operations.

 

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The following table presents the Company’s marketable securities with unrealized losses by investment category and length of time that individual securities have been in a continuous unrealized loss position as of April 3, 2016 and March 29, 2015.

 

 

As of April 3, 2016 and March 29, 2015, the fair value of certain of the Company’s available-for-sale securities was less than their cost basis.  Management reviewed various factors in determining whether to recognize an impairment charge related to these unrealized losses, including the current financial and credit market environment, the financial condition and near-term prospects of the issuer of the security, the magnitude of the unrealized loss compared to the cost of the investment, the length of time the investment had been in a loss position and the Company’s intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery of market value.  As of April 3, 2016 and March 29, 2015, the Company determined that the unrealized losses were temporary in nature and recorded them as a component of accumulated other comprehensive income.

 

 

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Note 4. Fair Value of Financial Instruments

The Company’s financial instruments consist principally of cash and cash equivalents, marketable securities, accounts receivable and accounts payable. The carrying value of cash equivalents, accounts receivable and accounts payable approximates fair value because of the nature and short-term maturity of these financial instruments.

A summary of the assets measured at fair value on a recurring basis as of April 3, 2016 and March 29, 2015 is as follows:

 

 

The Company’s investments classified within Level 2 were primarily valued based on valuations obtained from a third-party pricing service. To estimate fair value, the pricing service utilizes industry-standard valuation models, including both income and market-based approaches for which all significant inputs are observable either directly or indirectly. The Company obtained documentation from the pricing service as to the methodology and summary of inputs used for the various types of securities. The pricing service maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs. These observable inputs include reported trades and broker/dealer quotes of the same or similar securities, issuer credit spreads, benchmark securities and other observable inputs. The Company compares valuation information from the pricing service with other pricing sources to validate the reasonableness of the valuations.

 

 

Note 5. Inventories

Components of inventories are as follows:

 

 

 

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Note 6. Property and Equipment

Components of property and equipment are as follows:

 

 

During fiscal 2015, the Company consolidated its facilities and decided to sell one of its buildings.  The related land and building were classified as held for sale and the Company ceased depreciation on the building upon this determination.  As of March 29, 2015, the carrying value of the land and building totaling $7.5 million were excluded from property and equipment and were included in other current assets in the consolidated balance sheet.  During fiscal 2016, the Company sold this building and received net proceeds of $7.6 million.

Depreciation and amortization expense related to property and equipment totaled $24.8 million, $29.6 million and $30.1 million for fiscal 2016, 2015 and 2014, respectively.  The Company excluded purchases of property and equipment totaling $2.7 million, $9.6 million and $2.8 million from its consolidated statements of cash flows for fiscal 2016, 2015 and 2014, respectively, which amounts were unpaid as of the end of the respective fiscal year.

 

 

Note 7. Purchased Intangible Assets

 

Purchased intangible assets consist of the following:

 

 

A summary of the amortization expense, by classification, included in the consolidated statements of operations is as follows:

 

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The following table presents the estimated future amortization expense of purchased intangible assets as of April 3, 2016:

 

 

 

Note 8. Revolving Credit Facility

In March 2013, the Company entered into a credit agreement (the Credit Agreement) which provides the Company with a $125 million unsecured revolving credit facility that matures in March 2018.  Borrowings under the Credit Agreement may be used for general corporate purposes, including permitted share repurchases and acquisitions. Under the Credit Agreement, the Company may increase the revolving commitments or obtain incremental term loans in an aggregate amount up to $100 million, subject to certain conditions.

Borrowings under the credit facility bear interest, at the Company’s option, at either a rate equal to (i) a base rate described in the Credit Agreement plus an applicable margin based on the Company’s leverage ratio (varying from 0.25% to 1.00%) or (ii) an adjusted LIBO rate described in the Credit Agreement plus an applicable margin based on the Company’s leverage ratio (varying from 1.25% to 2.00%).  The credit facility also carries a commitment fee equal to the available but unused borrowing multiplied by an applicable margin based on the Company’s leverage ratio and the average daily used amount of the commitments (varying from 0.20% to 0.35%).

The Credit Agreement includes financial covenants requiring a maximum leverage ratio, a minimum fixed charge coverage ratio and minimum liquidity.  The Credit Agreement also contains other customary affirmative and negative covenants and events of default.

There were no borrowings outstanding under the Credit Agreement as April 3, 2016.

 

 

Note 9. Stockholders’ Equity

Capital Stock

The Company’s authorized capital consists of 1 million shares of preferred stock, par value $0.001 per share, and 500 million shares of common stock, par value $0.001 per share.  As of April 3, 2016 and March 29, 2015, the Company had 218.2 million and 215.5 million shares of common stock issued, respectively.  As of April 3, 2016, 19.6 million shares of common stock were reserved for the exercise of issued and unissued stock-based awards and 4.9 million shares were reserved for issuance in connection with the Company’s Employee Stock Purchase Plan.

Treasury Stock

Since fiscal 2003, the Company has had various programs that authorized the purchase by the Company of its outstanding common stock, including a program approved in October 2014 of which the total authorized amount of $100 million had been fully utilized as of April 3, 2016.  Shares purchased under these programs have been recorded as treasury shares and will be held as such until the Company’s Board of Directors designates that these shares be retired or used for other purposes.

In November 2015, the Company’s Board of Directors approved a new program authorizing the purchase by the Company of up to $125 million of its outstanding common stock over a period of up to two years from the date of the initial purchase under the program.  No shares have been purchased under this program as of April 3, 2016.

The Company excluded purchases of common stock totaling $0.9 million from its consolidated statement of cash flows for fiscal 2015, which amount was unpaid as of the end of the fiscal year.

 

 

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Note 10. Stock-Based Compensation

Employee Stock Purchase Plan

The Company has an Employee Stock Purchase Plan (the ESPP) that operates in accordance with Section 423 of the Internal Revenue Code. The ESPP is administered by the Compensation Committee of the Board of Directors. Under the ESPP, employees of the Company who elect to participate are granted options to purchase common stock at 85% of the lower of the market value of the common stock on either the first day of that offering period or on the applicable purchase date, whichever is less. Each offering period is generally 12 months and includes up to four purchase periods of three months each. If the fair market value of the Company’s common stock on the first day of any purchase period is less than on the date of grant, employee participation in that offering period ends and participants are automatically re-enrolled in a new 12-month offering period.  The ESPP permits an enrolled employee to make contributions to purchase shares of common stock, in an amount between 1% and 10% of compensation, subject to limits specified in the Internal Revenue Code. The total number of shares issued under the ESPP was 816,000, 845,000 and 836,000 during fiscal 2016, 2015 and 2014, respectively.

Stock Incentive Compensation Plans

The Company may grant stock-based awards to employees and directors under the QLogic 2005 Performance Incentive Plan (the 2005 Plan).

Prior to the adoption of the 2005 Plan in August 2005, the Company granted options to purchase shares of the Company’s common stock to employees and directors under a predecessor stock plan. No further awards can be granted under this predecessor plan.

The 2005 Plan provides for the issuance of restricted stock units, incentive and non-qualified stock options, and other stock-based incentive awards for employees. The 2005 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.  Restricted stock units represent a right to receive a share of stock at a future vesting date with no cash payment from the holder.  Restricted stock units granted to employees subject to only a service condition generally vest over four years from the date of grant.  Restricted stock units granted to employees subject to a service and either a performance or market condition generally vest over three years.  Stock options granted to employees have ten-year terms and vest over four years from the date of grant.

Under the terms of the 2005 Plan, as amended, non-employee directors receive grants of stock-based awards upon initial election or appointment to the Board of Directors and upon annual reelection to the Board.  The target fair value of such grants is determined by reference to the equity compensation for non-employee directors of the Company’s peer group of companies. The target value is then allocated 50% to a restricted stock unit award and 50% to a non-qualified stock option grant in the case of the initial grant and allocated 100% to a restricted stock unit award in the case of the annual grant. Restricted stock unit awards granted to non-employee directors vest from one to three years from the date of grant.  Stock options granted to non-employee directors have ten-year terms and vest over three years from the date of grant.

As of April 3, 2016, shares available for future grant were 10.2 million under the 2005 Plan.  Shares for market-based restricted stock units reduce the shares available for future grant assuming the maximum number of shares subject to the award.  

The 2014 New-Hire Performance Incentive Plan (the 2014 Plan) was adopted in November 2014 and provided for the issuance of non-qualified stock options, restricted stock units and other stock-based incentive awards for newly-hired officers or employees, where the awards granted were an inducement material to the employee’s entering into employment with the Company or one of its subsidiaries. The Company’s authority to grant new awards under the 2014 Plan was terminated by the Board of Directors in November 2015.  As of April 3, 2016, there were no outstanding awards remaining under the 2014 Plan.

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   A summary of activity of restricted stock units subject to only a service condition is as follows:

 

 

The table above includes 408,000 and 477,000 restricted stock units granted during fiscal 2015 and 2014, respectively, to employees that joined the Company in connection with acquisitions.

A summary of activity of restricted stock units subject to a service condition and either a performance or market condition is as follows:

 

 

During fiscal 2016, 2015 and 2014, the Company issued 811,000, 688,000 and 717,000 shares of common stock, respectively, in connection with the vesting of restricted stock units.  The difference between the number of restricted stock units vested and the shares of common stock issued is the result of restricted stock units withheld in satisfaction of minimum tax withholding obligations associated with the vesting.

 

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A summary of stock option activity is as follows:

 

 

The intrinsic value of options exercised in the table above is calculated as the difference between the market price on the date of exercise and the exercise price multiplied by the number of options exercised.  During fiscal 2016, 2015 and 2014, the grant date fair value of options vested totaled $1.0 million, $2.6 million and $7.7 million, respectively.

Stock-Based Compensation Expense

A summary of stock-based compensation expense, by functional line item in the consolidated statements of operations, is as follows:

 

 

The fair value of stock options granted and shares to be purchased under the ESPP have been estimated at the date of grant using a Black-Scholes option-pricing model.  The weighted-average fair values and underlying assumptions are as follows:

 

 

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Restricted stock units granted subject to either (i) a service condition only, or (ii) service and performance conditions, are valued based on the closing market price on the date of grant.  Restricted stock units granted with service and market conditions are valued based on a Monte Carlo simulation model on the date of grant.

The Company recognized tax benefits related to stock-based compensation expense for fiscal 2016, 2015 and 2014 of $4.9 million, $7.2 million and $6.2 million, respectively. Stock-based compensation costs capitalized as part of the cost of assets were not material to the consolidated financial statements.

As of April 3, 2016, there was $33.0 million of total unrecognized compensation costs related to outstanding stock-based awards. These costs are expected to be recognized over a weighted-average period of 2.2 years.

The Company currently issues new shares to deliver common stock under its stock-based award plans.

 

 

Note 11. Employee Retirement Savings Plan

The Company has established a pretax savings plan under Section 401(k) of the Internal Revenue Code for substantially all U.S. employees.  Under the plan, eligible employees are able to contribute up to 50% of their compensation, subject to limits specified in the Internal Revenue Code.  The Company matches contributions up to 2% of a participant’s compensation.  The Company’s matching contributions on behalf of its employees totaled $1.5 million, $1.6 million and $1.8 million in fiscal 2016, 2015 and 2014, respectively.

The Company maintains retirement plans in certain non-U.S. locations.  The total expense and total obligation for these plans were not material to the consolidated financial statements.

The Company previously had a nonqualified deferred compensation plan available to certain members of the Company’s management.  This plan was terminated in fiscal 2016. The total expense and total obligation of the Company for this plan was not material to the consolidated financial statements.  

 

 

Note 12. Special Charges

A summary of the special charges recorded during fiscal 2016, 2015 and 2014 is as follows:

 

 

September 2015 Initiative

In September 2015, the Company commenced a restructuring plan (September 2015 Initiative) designed to align its future operating expenses with its revenue expectations.  The restructuring plan includes a workforce reduction and the consolidation and elimination of certain engineering activities.

During fiscal 2016, the Company recorded special charges of $10.6 million related to the September 2015 Initiative.  Special charges for fiscal 2016 consisted of $8.6 million of exit costs and $2.0 million of asset impairment charges related to property and equipment.  Exit costs included severance and related costs associated with involuntarily terminated employees, as well as costs related to a leased facility that the Company ceased using during fiscal 2016.  The exit costs related to the leased facility include a non-cash adjustment of $0.5 million related to the reversal of a deferred rent liability associated with this facility.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

As of April 3, 2016, the Company had substantially completed the restructuring activities related to the September 2015 Initiative.  Activity and liability balances for exit costs related to this initiative are as follows:

 

 

The unpaid exit costs related to the September 2015 Initiative are expected to be paid over the term of the related agreement through fiscal 2019.

 

May 2015 Initiative

In May 2015, the Company commenced a restructuring plan designed to streamline business operations and recorded special charges of $0.7 million during fiscal 2016. The special charges consisted entirely of exit costs associated with severance benefits for the involuntarily terminated employees. The Company completed these restructuring activities and all amounts were paid as of September 27, 2015.

March 2015 Initiative

In March 2015, the Company implemented a restructuring plan consisting of a workforce reduction primarily designed to further streamline its business operations. In connection with this action, the Company recorded special charges of $1.2 million consisting of exit costs associated with severance benefits for involuntarily terminated employees.  The Company completed these restructuring activities and all amounts were paid as of June 28, 2015.

March 2014 Initiative

In March 2014, the Company commenced a restructuring plan (March 2014 Initiative) primarily designed to consolidate its Ethernet product roadmap following the acquisition of the Ethernet controller-related assets.  This restructuring plan primarily included a workforce reduction and the consolidation and elimination of certain engineering activities.  The Company completed these restructuring activities and all amounts were paid as of March 29, 2015.

In connection with the March 2014 Initiative, the Company recorded special charges of $3.6 million and $14.0 million during fiscal 2015 and fiscal 2014, respectively.  Special charges during fiscal 2015 included $2.6 million of exit costs and $1.0 million of asset impairment charges primarily related to abandoned property and equipment.  Special charges during fiscal 2014 included $9.1 million of exit costs and $4.9 million of asset impairment charges primarily related to abandoned property and equipment.  The exit costs included severance and related costs associated with involuntarily terminated employees. Exit costs for fiscal 2014 also included the costs associated with the cancellation of certain contracts.

Activity and liability balances for exit costs related to the March 2014 Initiative are as follows:

 

 

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June 2013 Initiative

In June 2013, the Company commenced a restructuring plan (June 2013 Initiative) designed to enhance product focus and streamline business operations.  The restructuring plan includes a workforce reduction and the consolidation and elimination of certain engineering activities.  In connection with this plan, the Company ceased development of future ASICs for switch products.

In connection with the June 2013 Initiative, the Company recorded special charges of $0.6 million, $5.2 million and $19.8 million during fiscal 2016, 2015 and 2014, respectively.  Special charges during fiscal 2016 consisted entirely of exit costs.  Special charges during fiscal 2015 consisted of $3.1 million of exit costs and $2.1 million of asset impairment charges primarily related to abandoned property.  During the fourth quarter of fiscal 2015, the Company vacated the remaining space in a facility that it had ceased using and recorded exit costs of $2.4 million.  In addition, the Company recorded a non-cash adjustment of $1.7 million primarily related to the reversal of a deferred rent liability associated with this facility.  Special charges for fiscal 2014 consisted of $17.4 million of exit costs and $2.4 million of asset impairment charges primarily related to abandoned property and equipment.  The exit costs included severance and related costs associated with involuntarily terminated employees.  Certain employees that were notified of their termination are required to provide future services for varying periods in excess of statutory notice periods.  Severance costs related to these services are recognized ratably over the estimated requisite service period.  The Company expects to incur less than $1 million of additional severance costs for these employees over the remaining requisite service period.  Exit costs also included the estimated costs associated with a facility under a non-cancelable lease that the Company ceased using.

Activity and liability balances for exit costs related to the June 2013 Initiative, including a liability associated with exit costs related to a portion of the facility the Company ceased using prior to fiscal 2013, are as follows:

 

 

The unpaid exit costs related to the June 2013 Initiative are expected to be paid over the terms of the related agreements through fiscal 2018.

A summary of the total unpaid exit costs for all restructuring plans, by classification, included in the consolidated balance sheets is as follows:

 

 

 

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Note 13. Interest and Other Income, net

Components of interest and other income, net, are as follows:

 

 

 

Note 14. Income Taxes

Income (loss) before income taxes consists of the following components:

 

 

The components of income tax expense are as follows:

 

The effect of deferred taxes associated with the change in unrealized gains and losses on the Company’s available-for-sale securities was immaterial and was recorded in accumulated other comprehensive income.

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A reconciliation of the income tax expense (benefit) with the amount computed by applying the federal statutory tax rate to income (loss) before income taxes is as follows:

 

 

The components of the deferred tax assets and liabilities are as follows:

 

 

The Company’s deferred tax assets related to research credits consist primarily of state and federal research credit carryforwards.  These state tax credits have no expiration date and may be carried forward indefinitely.  However, these credits may be utilized only to the extent that the Company realizes taxable income in the related state.  Based upon the Company’s current projections of future taxable income in the respective states, the Company is unable to assert that it is more likely than not that it will realize the full benefit of these deferred tax assets.  Accordingly, the Company has recorded valuation allowances against these deferred tax assets.  The balance of this valuation allowance was $19.8 million and $17.5 million as of April 3, 2016 and March 29, 2015, respectively.

The Company’s deferred tax assets related to net operating loss carryforwards include both federal and state net operating loss carryforwards.  The state net operating loss carryforwards are specific to the states in which the net operating losses were generated and certain of these carryforwards relate to previous acquisitions, which are subject to limitations on the timing of utilization.  Based upon the Company’s current projections of future taxable income in the respective states, the Company is unable to assert that it is more likely than not that it will realize the full benefit of these deferred tax assets.  Accordingly, the Company has recorded a valuation allowance against these deferred tax assets.  The balance of this valuation allowance was $1.8 million and $1.7 million as of April 3, 2016 and March 29, 2015, respectively.

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The Company’s deferred tax assets related to investment securities and capital loss carryovers consist primarily of temporary differences related to other-than-temporary impairments on the Company’s investment securities and realized losses on dispositions of investment securities that are subject to limitations on deductibility.  As a result of limitations on the deductibility of capital losses and other factors, management is unable to assert that it is more likely than not that the Company will realize the full benefit of these deferred tax assets.  Accordingly, the Company previously recorded a valuation allowance against these deferred tax assets. The balance of this valuation allowance was $1.1 million as of April 3, 2016 and March 29, 2015.

Based upon the Company’s current and historical pre-tax earnings, management believes it is more likely than not that the Company will realize the full benefit of the existing deferred tax assets as of April 3, 2016, except for the deferred tax assets discussed above.  Management believes the existing net deductible temporary differences will reverse during periods in which the Company generates net taxable income or that there would be sufficient tax carrybacks available; however, there can be no assurance that the Company will generate any earnings or any specific level of continuing earnings in future years.

As of April 3, 2016, the Company has federal net operating loss carryforwards of $13.0 million, which will expire between fiscal 2027 and 2029, if not utilized, and state net operating loss carryforwards of $67.5 million, which will expire between fiscal 2017 and 2036, if not utilized.  The net operating loss carryforwards relating to acquired companies are subject to limitations on the timing of utilization. The Company also has state capital loss carryovers of $54.5 million, which will expire between fiscal 2017 and 2031, if not utilized.

As of April 3, 2016, the Company has federal research tax credit carryforwards of $9.8 million, which will expire between fiscal 2034 and 2036, if not utilized. The Company also has state research tax credit carryforwards of $31.9 million and state alternative minimum tax credits of $0.6 million, both of which have no expiration date.

The Company has made no provision for U.S. income taxes or foreign withholding taxes on the earnings of its foreign subsidiaries, as these amounts are intended to be indefinitely reinvested in operations outside the United States.  As of April 3, 2016, the cumulative amount of undistributed earnings of the Company’s foreign subsidiaries was $438.1 million.  Because of the availability of U.S. foreign tax credits, it is not practicable to determine the U.S. federal income tax liability that would be payable if such earnings were not reinvested indefinitely.

During fiscal 2016, the statute of limitations expired for certain tax years in various states.  As a result, the Company reduced the related income tax liabilities for such periods and recorded income tax benefits totaling $4.3 million.  

During fiscal 2015, the Company settled all open matters relating to an Internal Revenue Service examination of the Company’s income tax returns for fiscal years 2010 through 2013. This settlement was for an amount less than the Company had previously accrued for this tax position.  As a result, the Company recorded an income tax benefit of $2.5 million.  In connection with this settlement, the Company paid federal and state income taxes totaling $2.1 million in fiscal 2016.

The Company is no longer subject to federal income tax examinations for years prior to fiscal 2014.  With limited exceptions, the Company is no longer subject to state and foreign income tax examinations by taxing authorities for years prior to fiscal 2009. Management does not believe that the results of tax examinations will have a material impact on the Company’s financial condition or results of operations.

A rollforward of the activity in the gross unrecognized tax benefits is as follows:

 

 

If the unrecognized tax benefits as of April 3, 2016 were recognized, $8.1 million, net of $1.1 million of tax benefits from state income taxes, would favorably affect the Company’s effective income tax rate.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

In addition to the unrecognized tax benefits noted above, the Company had accrued $2.6 million and $3.5 million of interest expense and penalties as of April 3, 2016 and March 29, 2015, respectively.  The Company recognized interest expense, net of the related tax effect, and penalties aggregating $(0.6) million, $0.1 million and $2.1 million during fiscal 2016, 2015 and 2014, respectively.

It is reasonably possible that the Company’s liability for uncertain tax positions may be reduced by as much as $1.0 million as a result of either the settlement of tax positions with various tax authorities or by virtue of the statute of limitations expiring through the end of fiscal 2017.

 

 

Note 15. Net Income Per Share

The following table sets forth the computation of basic and diluted net income (loss) per share:

 

 

Stock-based awards, including stock options and restricted stock units, representing 6.3 million, 9.7 million and 15.2 million shares of common stock have been excluded from the diluted per share calculations for fiscal 2016, 2015 and 2014, respectively. These stock-based awards have been excluded from the diluted per share calculations because their effect would have been antidilutive.

 

 

Note 16. Commitments and Contingencies

Leases

The Company leases certain facilities, software and equipment under operating lease agreements. A summary of the future minimum lease commitments under non-cancelable operating leases as of April 3, 2016 is as follows:

 

 

Rent expense for fiscal 2016, 2015 and 2014 was $11.7 million, $12.0 million and $10.4 million, respectively.

Contingencies

The Company indemnifies certain of its customers and others against claims that the Company’s products infringe upon a patent, copyright, trademark or trade secret of a third party.  In the event of such a claim, the Company agrees to pay all litigation costs, including attorney fees, and any settlement payments or damages awarded directly related to the infringement.

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QLOGIC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Management believes that any monetary liability or financial impact to the Company from these matters, individually and in the aggregate, would not be material to the Company’s financial condition or results of operations.  However, there can be no assurance with respect to such result, and the monetary liability or financial impact to the Company from these matters could differ materially from those projected.

Legal Proceedings

On September 28, 2015, a purported class action was commenced in the U.S. District Court for the Central District of California asserting claims arising under federal securities laws against the Company and certain individual defendants.  The plaintiff, Phyllis Hull, purported to represent a class of persons who purchased the Company’s common stock between April 30, 2015 and July 30, 2015.  The plaintiff alleged that the defendants, including a former officer and a current officer, engaged in a scheme to inflate the Company’s stock price by making false and misleading statements regarding the Company’s operations, financial results and future business prospects in violation of federal securities laws.  The plaintiff sought compensatory damages, interest and an award of reasonable attorneys’ fees and costs.  On March 4, 2016, the parties filed a Joint Stipulation with the Court to voluntarily dismiss the case. On March 7, 2016, the Court dismissed the case with prejudice as to Phyllis Hull and her individual claims and without prejudice as to the unnamed class members.

On October 23, 2015, Stephen Kramer filed a shareholder derivative complaint in the California Superior Court in and for the County of Orange County purportedly on behalf of the Company against certain current and former officers and directors of the Company.  The plaintiff alleges breaches of fiduciary duty, unjust enrichment, corporate waste, aiding and abetting breaches of fiduciary duty, and improper insider sales of stock in violation of California law based on the allegation that, since October 17, 2014, the individual defendants engaged in a scheme to inflate the Company’s stock price by making false and misleading statements regarding the Company’s operations, financial results, internal controls and future business prospects.  The plaintiff seeks an award of damages and restitution to the Company from the individual defendants, disgorgement of the individual defendants’ profits and compensation, an order requiring the Company to reform and improve its corporate governance, and an award of costs and attorneys’ fees to the plaintiff and its counsel.  On March 14, 2016, a second shareholder derivative complaint was filed in the same Court. The plaintiff in the second suit, Indiana Laborers Pension and Welfare Funds, makes similar allegations against certain current and former officers and directors of the Company, and seeks similar demands.  The defendants have not yet responded to the complaints in either of the shareholder derivative cases.

The Company currently believes the disposition of these matters will not have a material adverse effect on the Company’s financial condition or results of operations.

Various other lawsuits, claims and proceedings have been or may be instituted against the Company. The outcome of litigation cannot be predicted with certainty and some lawsuits, claims and proceedings may be disposed of unfavorably to the Company. Many intellectual property disputes have a risk of injunctive relief and there can be no assurance that a license will be granted. Injunctive relief could have a material adverse effect on the Company’s financial condition or results of operations.  Based on an evaluation of such other matters that are pending or asserted, management believes the disposition of such matters will not have a material adverse effect on the Company’s financial condition or results of operations.

 

 

Note 17. Revenue Components, Geographic Revenues and Significant Customers

Operating segments are components of an enterprise for which separate financial information is available and is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance.  The Company operates in one operating segment.

Revenue Components

A summary of net revenues by product category is as follows:

 

 

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QLOGIC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Geographic Revenues

Revenues by geographic area are presented based upon the ship-to location of the customer. Net revenues by geographic area are as follows:

 

 

The United States, China and Hong Kong are the only countries that represented 10% or more of net revenues for fiscal 2016.  Net revenues from customers in China and Hong Kong were $75.5 million and $60.1 million for fiscal 2016, respectively.  The United States and China are the only countries that represented 10% or more of net revenues for fiscal 2015 and 2014.  Net revenues from customers in China were $90.4 million and $56.0 million for fiscal 2015 and 2014, respectively.

Significant Customers

A summary of the Company’s customers, including their manufacturing subcontractors, that represent 10% or more of the Company’s net revenues is as follows:

 

 

 

 

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QLOGIC CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Note 18. Condensed Quarterly Results (Unaudited)

The following table summarizes certain unaudited quarterly financial information for fiscal 2016 and 2015:

 

 

 

 

 

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None.

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

We maintain disclosure controls and procedures to ensure that information we are required to disclose in reports that we file or submit under the Exchange Act (i) is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and (ii) is accumulated and communicated to our management, including our principal executive officer and principal financial officer, to allow timely decisions regarding required disclosure.  Our management evaluated, with the participation of our principal executive officer and principal financial officer, the effectiveness of our disclosure controls and procedures, as such term is defined under Rules 13a-15(e) and 15d-15(e) promulgated under the Exchange Act.  Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective at a reasonable assurance level as of April 3, 2016.

Management’s Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) promulgated under the Exchange Act.  Internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.  Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.  Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Our management evaluated the effectiveness of our internal control over financial reporting using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control – Integrated Framework (2013).  Based on this evaluation, our principal executive officer and principal financial officer concluded that the Company’s internal control over financial reporting was effective at a reasonable assurance level as of April 3, 2016.

The independent registered public accounting firm that audited the consolidated financial statements included in this annual report has issued an audit report on the effectiveness of the Company’s internal control over financial reporting. See page 34 herein.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting, as defined in Rule 13a-15(f) promulgated under the Exchange Act that occurred during the fourth quarter of fiscal 2016 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

None.

 

 

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PART III

Reference is made to the Company’s Definitive Proxy Statement for its 2016 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days after the end of fiscal 2016, for information required under this Item 10. Such information is incorporated herein by reference.

The Company has adopted and implemented a Business Ethics Policy (the Code of Ethics) that applies to the Company’s officers, employees and directors.  The Code of Ethics is available on our website at www.qlogic.com.

Reference is made to the Company’s Definitive Proxy Statement for its 2016 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days after the end of fiscal 2016, for information required under this Item 11.  Such information is incorporated herein by reference.

Reference is made to the Company’s Definitive Proxy Statement for its 2016 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days after the end of fiscal 2016, for information required under this Item 12.  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.

Reference is made to the Company’s Definitive Proxy Statement for its 2016 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days after the end of fiscal 2016, for information required under this Item 13.  Such information is incorporated herein by reference.

Reference is made to the Company’s Definitive Proxy Statement for its 2016 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission within 120 days after the end of fiscal 2016, for information required under this Item 14.  Such information is incorporated herein by reference.

 

 

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PART IV

(a) (1) Consolidated Financial Statements

The following consolidated financial statements of the Company for the years ended April 3, 2016, March 29, 2015 and March 30, 2014 are filed as part of this report:

 

 

FINANCIAL STATEMENT INDEX

 

 

(a) (2) Financial Statement Schedule

The following consolidated financial statement schedule of the Company for the years ended April 3, 2016, March 29, 2015 and March 30, 2014 is filed as part of this report and is incorporated herein by reference:

Schedule II - Valuation and Qualifying Accounts

All other schedules have been omitted because the required information is presented in the financial statements or notes thereto, the amounts involved are not significant or the schedules are not applicable.

(a) (3) Exhibits

An exhibit index has been filed as part of this report and is incorporated herein by reference.

 

 

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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.

 

Date: May 26, 2016

POWER OF ATTORNEY

Each person whose signature appears below hereby authorizes Jean Hu, as attorney-in-fact, to sign on his or her behalf and in each capacity stated below, and to file all amendments and/or supplements to this Annual Report on Form 10-K.

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 and on the dates indicated.

 

 

 

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SCHEDULE II

QLOGIC CORPORATION

VALUATION AND QUALIFYING ACCOUNTS

 

 

 

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EXHIBIT INDEX

 

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71