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By | Chris Mellor 20th February 2009 11:26

Brocade turns red in first quarter

Legal and acquisition costs unstitch record revs

Brocade slipped into the red in its first fiscal quarter despite jacking up revenues by almost a quarter year on year.

For its first fiscal 2009 quarter (Q1 fy2009), Brocade reported record revenues up 24 per cent year-on-year at $431.6m, but nevertheless incurred a GAAP loss of $26m, contrasting with a $19.8m profit in Q1 fy2008. How come Brocade's revenue blue ink turned into net loss red ink?

Q1 fy2009's revenues were even up eight per cent sequentially, although the quarter included the tail end of 2008 when demand went down the plughole for many companies. Prices didn't go down much, Brocade saying that in Q1 fy2009, average selling price declines were in the low single digits compared to Q4 fy2008. Where was the damage done? We turned to the earnings call transcript for enlightenment.

For starters, it wasn't in Foundry. Dan Fairfax, VP business operations, said of the Foundry part of the business: "We saw good fourth quarter numbers."

CFO Richard Deranleau said: "Data storage revenues were down seven per cent quarter over quarter but up five per cent year-over-year," showing the recession biting. Yet: "DCX backbone revenue increased to approximately 57 per cent of overall Director sales in Q1... embedded switch revenues were up 1 per cent sequentially, 20 per cent y-on-y... (and) HBA revenues ramped up nicely in Q1."

It looks as if it was the switches and directors area where the storage revenues went south. But this wasn't the reason for the loss.

It was down to one-time charges. Deranleau said: "On an earnings per share basis, Q1 non-GAAP diluted EPS was $0.15. Reporting on a GAAP diluted basis, Q1 EPS was a loss of $0.07, reflecting significant non-cash charges related to the acquisition of Foundry."

There were legal fees of $19m relating to stock option backdating when Greg Reyes was the CEO, plus some stock compensation changes. The Foundry acquisition also involved $4.4m financing charges. Taking these into account the adjusted earnings per share (EPS) beat Wall Street estimates by $0.02.

In other words, Brocade is doing very well indeed despite these one-time expenses. That contrasts with Cisco reporting a 20 per cent or so sales drop. Brocade's two cents meant the results were actually terrific.

But its shares are slightly down, starting February 19 at $3.60 and ending it at $3.38.

Foundry integration

There is now one sales organisation, headed by Ian Whiting, SVP worldwide sales. Foundry and Brocade offices and back office operations are being rationalised. The two operations reseller programmes are being combined. No headcount cuts are being considered.

The company has been reorganised to sell products into three market sectors:

- Enterprise data centres, which includes directors, switches, HBAs, top-of-rack switches, end-of-row and backbones, file management solutions, application delivery, converged network products and virtualization solutions
- Enterprise LAN campuses, which means stackable 1GigE and 10GigE products, enhanced Power over Ethernet+ 1GigE and 10GigE density, as well as security and wireless products
- Service providers, with metro Edge and Aggregation products, Ethernet Backbone, MPLS, and 10GigE density products

Brocade reckons that fewer than five per cent of the combined Brocade and Foundry accounts overlap giving cross-selling opportunities. It claims that, in its storage accounts, Ethernet operations which it can now address can be quite inefficient with the prospect of a Foundry kit implant offering a 30 per cent or more cost improvement. That gives its sales force good reasons to knock on customers' doors.

Concerning Cisco competition, Paul Phillips, Brocade's UK country manager, reckons that Cisco has let MDS switch and director development languish. He's aware of Cisco's California project to combine servers and networking in one chassis and says it's helped Brocade relationships with server manufacturers greatly.

He says Brocade has absolutely no intentions at all to compete with its server-manufacturing OEMs - meaning no Brocade-built server blades in the DCX. He also expects that the Foundry and Brocade product technologies will converge at the high-end. We could well expect a combined DCX-ServerIron product in the future.

Brocade's outlook

CFO Richard Deranleau was pretty bullish about Brocade's ability to withstand the recession, which he reckons will start ending in Q4 this year: "Our planning assumption is that the current IT spending environment will remain adversely impacted by the current macroeconomic environment. We expect IT spending to begin to improve in Q4 2009 and throughout fiscal 2010. We expect our markets to return to normal historical growth rates in 2010."

He went on, "We expect to see normal to greater than normal seasonal declines in Q2 2009. While our core markets remain competitive, we believe the product advantages and momentum and our installed base advantage keeps us in a uniquely strong competitive position.

"We believe we will maintain market share in our core SAN market, grow market share in the LAN markets and we expect to be a leading supplier of HBAs... We believe HBA products will significantly ramp with qualifications of the 8 gig HBAs at our OEM partners in the second half of fiscal 2009."

The fy2009 outlook is for annual revenue to be in a range of $1.9bn - $2.0bn and $2.1bn - $2.2bn in fy2010. If hoped for synergies are realised from the Foundry part of the business this could rise to $2.2bn - $2.6bn. Brocade is finding customers are focussing more on cost-saving activities and projects than trialling new technology such as FCoE. Instead they may consolidate several small switches into a single big one.

It confirmed that IBM has certified its new HBAs and that it expects to get more tier 1 OEMs certifying them. There is an undercurrent here that Brocade expects all its tier 1 OEMs to certify its HBAs. This is bad news for Emulex and QLogic and other HBA suppliers. With virtualised servers requiring fewer HBAs than the same number of VMs running as separate physical servers, HBA unit volume growth is lower than it would otherwise have been and Brocade has entered the market.

It wants to lead it too and hopes to be doing so or be well on its way exiting 2010. The first goal is a ten per cent market share exiting 2009. It's conceivable we might just see supplier mergers or an exit here next year. ®

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