Brocade Reports Third Quarter Fiscal Year 2007 Results

Monitor this Company

Margin Expansion Drives Improved Profitability

    SAN JOSE, Calif., Aug. 23 /-/ -- Brocade(R) (Nasdaq: BRCD), the leader in networked storage solutions that help enterprises connect and manage their information, today reported financial results for its third quarter of fiscal year 2007 (Q3 07), which ended July 28, 2007. Revenues for Q3 07 were $327.5 million, slightly above the Company's preliminary results reported on August 8, 2007. Revenues for the quarter decreased 5% from $345.3 million reported in the second quarter of fiscal year 2007 (Q2 07) and increased 73% from $188.9 million reported in the third quarter of fiscal year 2006 (Q3 06). Results for Q3 07 and Q2 07 reflect the acquisition of McDATA, which closed on January 29, 2007. The Company's third fiscal quarter is typically one of two seasonally weaker periods.

    Commenting on the Company's third quarter results, CEO Michael Klayko said, "Overall, we are very pleased with both our results and execution in our third fiscal quarter. In just two quarters, we have met or exceeded the vast majority of our target business metrics related to the acquisition of McDATA, and have strengthened our combined profitability and business fundamentals. We believe we are well positioned competitively and our leadership position is unchanged."

    Reporting on a GAAP basis, net income for Q3 07 was $10.7 million, or $0.03 per share basic and diluted. This reflects an increase from GAAP net income of $0.8 million, or $0.00 per share basic and diluted in Q2 07, and a decrease of 56% from GAAP net income of $24.5 million, or $0.09 per share basic and diluted in Q3 06, which was prior to the McDATA acquisition. The increase from Q2 07 to Q3 07 primarily reflects higher gross margin, lower operating expenses and a lower provision for income taxes on a GAAP basis.

    Non-GAAP net income for Q3 07 was $49.5 million, or $0.13 per share basic and $0.12 per share diluted. This reflects an increase of 6% from non-GAAP net income of $46.6 million, or $0.12 per share basic and $0.11 per share diluted in Q2 07, and an increase of 60% from non-GAAP net income of $31.0 million, or $0.11 per share basic and diluted in Q3 06. Non-GAAP financial measures should be considered in addition to results prepared in accordance with GAAP, but should not be considered a substitute for, or superior to, GAAP results. A detailed reconciliation between GAAP and non-GAAP information is contained in the tables included herein.

    Q3 07 Financial Highlights and Additional Financial Information

    Note: Q3 07 and Q2 07 figures include McDATA results. Other periods shown do not include McDATA results.

    -- In Q3 07, as a percent of total, OEM revenues were 84% and

     Channel/Direct were 16%. This compares to 85% and 15%, respectively in

     Q2 07 and 92% and 8%, respectively in Q3 06. Three OEM customers, EMC,

     HP, and IBM, each accounted for 10% or more of total revenues and

     together represented approximately 64% of total revenues in Q3 07. The

     same three customers each accounted for 10% or more of total revenues

     and together represented approximately 67% of total revenues in Q2 07

     and 74% in Q3 06.

    -- In Q3 07, as a percent of total, domestic revenue was 58% and

     international was 42%. This compares to 65% and 35%, respectively in

     Q2 07 and 65% and 35%, respectively, in Q3 06.

    -- Service revenue accounted for 14% of total revenue in Q3 07, compared

     with 13% of total revenue in Q2 07 and 8% of total revenue in Q3 06.

    -- Q3 07 non-GAAP gross margin was 55.0%, compared to non-GAAP gross

     margin of 53.4% in Q2 07 and 60.2% in Q3 06.

    -- The Company's total installed base of SAN ports is approximately 14.1

     million.

    -- Sequential Average Selling Price (ASP) declines were in the low single

     digits in Q3 07.

    -- In Q3 07 net stock-based compensation expense was $9.7 million and has

     been excluded from the Company's non-GAAP results.

    -- Q3 07 non-GAAP operating margin was 19.2%, compared to non-GAAP

     operating margin of 16.8% in Q2 07 and non-GAAP operating margin of

     17.4% in Q3 06.

    -- Q3 07 cash flow from operations was $36.3 million, compared to $46.2

     million in Q2 07 and $26.3 million in Q3 06.

    -- Cash and cash equivalents and investments at the end of Q3 07, net of

     the Company's convertible debt, were $639.2 million, compared to $674.5

     million at the end of Q2 07 and $518.6 million at the end of Q3 06.

    -- In Q3 07, the Company repurchased $81.0 million of its common stock,

     representing 9.4 million shares, compared with $59.9 million spent in

     Q2 07 to repurchase 6.3 million shares. The Company has $132.7 million

     remaining under its $300 million stock buyback authorizations.

    -- Day sales outstanding in accounts receivable for Q3 07 were 45 days,

     compared to 40 days in Q2 07 and 38 days in Q3 06.

    -- Q3 07 capital expenditures were $14.0 million. This compares to $14.2

     million in Q2 07 and $7.5 million in Q3 06.

    -- As of July 28, 2007, the Company had 2,376 employees, compared with

     2,440 employees as of April 28, 2007 and 1,399 employees as of July 29,

     2006. The higher number of employees at the end of Q2 07 and Q3 07

     compared to the end of Q3 06 reflects the acquisition of McDATA

     Corporation, which closed during Q2 07.

    Q3 07 Business Highlights:

    -- During the quarter, news announcements from Brocade, its business

     partners, and customers highlighted continued progress in global

     markets, professional services, and technology leadership.

    -- Brocade's global momentum continued to expand with the news that it has

     opened a world-class research and development facility in Bangalore,

     India. This opening will expand the Company's presence in India and

     accelerate development of enhancements to its data center networking

     and management solutions for global markets.

    -- The Company announced that it has bolstered its Storage Area Network

     (SAN) management solutions with greater analytic and reporting

     capabilities in the Brocade SAN Health(TM) family of proactive

     diagnostic utilities, including full support for mainframe FICON(R) and

     McDATA SAN environments.

    -- Further extending Brocade's position as an industry-leading SAN

     technology provider, the Brocade 5000 Switch was added to the HP

     B-Series portfolio of networked storage solutions.

    -- During the quarter, Brocade Access Gateway became generally available

     for IBM BladeCenter solutions. The new feature enables interoperability

     between Brocade blade SAN switches and products from other SAN switch

     and director manufacturers, while also simplifying SAN management and

     reducing costs.

    -- Brocade was recognized among the top finalists for the 2007 Microsoft

     Partner of the Year Award in the Advanced Infrastructure Solutions,

     Storage Solutions categories. The 2007 Microsoft Partner Program

     Awards recognizes top Microsoft Partners delivering market-leading,

     Microsoft-based solutions.

    -- Brocade unveiled new capabilities that dramatically improve the backup

     and recovery of critical data in IBM and Sun Microsystems mainframe

     environments. These industry-first capabilities improve disaster

     recovery and business continuity operations by enabling faster backup

     of data to remote locations.

    -- Brocade StorageX(R) was named as a finalist in eWeek's 7th Annual

     Excellence Awards. Brocade StorageX is a Microsoft Windows-based FAN

     solution, which was recognized for its ability to improve

     enterprise-wide file data management

    Non-GAAP Financial Measures

    This press release and the related conference call contain non-GAAP financial measures. In evaluating the Company's performance, management uses certain non-GAAP financial measures to supplement consolidated financial statements prepared under GAAP.

    Management believes that non-GAAP net income and other non-GAAP measures used in this press release allows management to gain a better understanding of the Company's comparative operating performance from period-to-period and to its competitors' operating results. Management also believes these non-GAAP measures help indicate the Company baseline performance before gains, losses or charges that are considered by management to be outside on-going operating results. Accordingly, management uses these non-GAAP measures for planning and forecasting of future periods and in making decisions regarding operations performance and the allocation of resources. Management believes these non-GAAP earnings measures, when read in conjunction with the Company's GAAP financials, provide useful information to investors by offering:

    -- the ability to make more meaningful period-to-period comparisons of the

     Company's on-going operating results;

    -- the ability to better identify trends in the Company's underlying

     business and perform related trend analysis;

    -- a better understanding of how management plans and measures the

     Company's underlying business; and

    -- an easier way to compare the Company's most recent results of

     operations against investor and analyst financial models.

    Management excludes certain gains or losses and benefits or costs in determining non-GAAP net income that are the result of infrequent events, or arise outside the ordinary course of our continuing operations. Management believes that it is appropriate to evaluate the Company's operating performance by excluding those items that are not indicative of ongoing operating results or limit comparability. Such items include: (i) legal fees associated with indemnification obligations to former employees and other related costs, (ii) SEC investigation and other related costs, (iii) acquisition and integration costs, (iv) gain on sale of investments and (v) gain on termination of an interest rate swap agreement.

    Management also excludes the following non-cash charges in determining non-GAAP net income: (i) stock-based compensation and (ii) amortization of purchased intangible assets. Because of varying available valuation methodologies, subjective assumptions and the variety of award types, management believes that the exclusion of stock-based compensation allows for more accurate comparisons of our operating results to our peer companies. Further, management believes that excluding stock-based compensation expense allows for a more accurate comparison of our financial results to previous periods during which our equity-based awards were not required to be reflected on our income statement. Management believes that the expense associated with the amortization of acquisition-related intangible assets is appropriate to be excluded because a significant portion of the purchase price for acquisitions may be allocated to intangible assets that have short lives and exclusion of the amortization expense allows comparisons of operating results that are consistent over time for both the Company's newly acquired and long-held businesses.

    Finally, management believes that it is appropriate to exclude the tax effects of the items noted above in order to present a more meaningful measure on non-GAAP net income.

    Limitations. These non-GAAP measures have limitations, however, because they do not include all items of income and expense that impact the Company. Management compensates for these limitations by also considering the Company's GAAP results. The non-GAAP financial measures the Company uses are not prepared in accordance with, and should not be considered an alternative to, measurements required by GAAP, such as operating income, net income and income per share, and should not be considered measures of the Company's liquidity. The presentation of this additional information is not meant to be considered in isolation or as a substitute for the most directly comparable GAAP measures. In addition, these non-GAAP financial measures may not be comparable to similar measures reported by other companies.

    Third Quarter Fiscal 2007 Conference Call and Web Cast Information

    Brocade management will host a conference call to discuss third quarter fiscal 2007 results on Thursday, August 23, 2007 at 1:30 p.m. Pacific Time. To access the live Web Cast, please visit Brocade's Website at http://www.brocade.com/investors at least 20 minutes prior to the call to download any necessary audio or plug-in software. A telephone replay will be available approximately two hours after the conference ends and will be available until 12:00 p.m. Pacific Time on August 30, 2007. A replay of the conference call will be available via the Web Cast at http://www.brocade.com/investors for approximately twelve months. To access the replay, please dial 888-286-8010 for domestic access and +617-801-6888 for international callers; the access code for the telephone replay is #44627068.

    Cautionary Statement

    This press release contains statements that are forward-looking in nature, including statements regarding the Company's competitive position and product and service offerings. These statements are based on current expectations on the date of this press release and involve a number of risks and uncertainties, which may cause actual results to differ significantly from such estimates. The risks include, but are not limited to, the degree of market adoption of the Company's new product and service offerings; market competition; the effect of changes in IT spending levels; the Company's ability to anticipate future OEM and end-user product needs or to accurately forecast end-user demand; dependence on strategic partners; expected synergies of the Company's acquisitions and anticipated cost savings; and the Company's ability to manage its business effectively in a rapidly evolving market. Certain of these and other risks are set forth in more detail in "Item 1A. Risk Factors" in Brocade's Quarterly report on Form 10-Q for the fiscal quarter ended April 28, 2007. Brocade does not assume any obligation to update or revise any such forward-looking statements, whether as the result of new developments or otherwise.

    About Brocade

    Brocade is the leading provider of networked storage solutions that help organizations connect, share, and manage their information. Organizations that use Brocade products and services are better able to optimize their IT infrastructures and ensure compliant data management. For more information, visit the Brocade Web site at http://www.brocade.com or contact the company at info@brocade.com.

    Brocade, Brocade B weave logo, Fabric OS, File Lifecycle Manager, McDATA, MyView, Secure Fabric OS, SilkWorm, and StorageX are registered trademarks and the Brocade B-wing logo and Tapestry are trademarks of Brocade Communications Systems, Inc., in the United States and/or in other countries. FICON is a registered trademark of IBM Corporation in the U.S. and other countries. All other brands, products, or service names are or may be trademarks or service marks of, and are used to identify, products or services of their respective owners.

     BROCADE COMMUNICATIONS SYSTEMS, INC.

     GAAP CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

     (in thousands, except per share data)

     (unaudited)

     Three Months Ended Nine Months Ended

     July 28, July 29, July 28, July 29,

     2007 2006 2007 2006

    Net revenues

     Product $282,855 $174,209 $790,509 $500,177

     Services 44,600 14,738 106,370 41,594

     Total net revenues 327,455 188,947 896,879 541,771

    Cost of revenues

     Product $131,862 $67,220 $345,153 $198,208

     Services 29,805 9,813 73,724 25,804

     Total cost of revenues 161,667 77,033 418,877 224,012

     Gross margin 165,788 111,914 478,002 317,759

    Operating expenses:

     Research and development 54,085 42,534 154,780 121,416

     Sales and marketing 57,200 35,501 155,150 100,682

     General and administrative 12,536 8,426 33,511 23,523

     Legal fees associated with

     indemnification obligations

     and other related costs 17,984 - 38,446 -

     Acquisition and integration

     costs 4,055 - 19,051 585

     SEC investigation and

     other related costs - 2,990 - 10,179

     Provision for SEC settlement - - - 7,000

     Amortization of intangible

     assets 7,924 888 16,810 1,406

     Facilities lease losses - - - 3,775

     Total operating expenses 153,784 90,339 417,748 268,566

    Income from operations 12,004 21,575 60,254 49,193

    Interest and other income, net 10,913 8,133 29,157 22,391

    Interest expense (2,683) (1,863) (4,741) (5,478)

    Gain on investments 1,240 2,685 1,240 2,663

    Income before provision for

     income taxes 21,474 30,530 85,910 68,769

    Income tax provision 10,784 6,032 41,058 21,098

    Net income $10,690 $24,498 $44,852 $47,671

    Net income per share - Basic $0.03 $0.09 $0.13 $0.18

    Net income per share - Diluted $0.03 $0.09 $0.12 $0.17

    Shares used in per share

     calculation - Basic 392,450 269,417 353,627 269,794

    Shares used in per share

     calculation - Diluted 407,113 273,959 368,080 273,484

     BROCADE COMMUNICATIONS SYSTEMS, INC.

     GAAP CONDENSED CONSOLIDATED BALANCE SHEETS

     (in thousands)

     (unaudited)

     July 28, October 28,

     2007 2006

    Assets

    Current assets:

     Cash and cash equivalents $374,408 $274,368

     Short-term investments 313,902 267,694

     Total cash, cash equivalents, and 688,310 542,062

     short-term investments

     Accounts receivable, net 162,524 98,394

     Inventories 21,770 8,968

     Prepaid expenses and other current assets 43,511 43,365

     Total current assets 916,115 692,789

    Long-term investments 117,865 40,492

    Property and equipment, net 200,978 104,299

    Goodwill 434,489 41,013

    Intangible assets, net 292,724 15,465

    Other assets 26,146 6,660

     Total assets $1,988,317 $900,718

    Liabilities and Stockholders' Equity

    Current liabilities:

     Accounts payable $131,250 $56,741

     Accrued employee compensation 76,456 62,842

     Deferred revenue 86,442 52,051

     Current liabilities associated with lease losses 15,629 4,931

     Purchase commitments 43,240 6,104

     Income tax payable 56,594 39,076

     Other accrued liabilities 59,485 42,811

     Total current liabilities 469,096 264,556

    Convertible subordinated debt 166,957 -

    Non-current liabilities associated with

     lease losses 21,802 11,105

    Non-current deferred revenue 42,374 8,827

    Other non-current liabilities 1,533 -

    Stockholders' equity

     Common stock 1,500,323 889,250

     Accumulated other comprehensive loss 13,583 (817)

     Accumulated deficit (227,351) (272,203)

     Total stockholders' equity 1,286,555 616,230

     Total liabilities and stockholders' equity $1,988,317 $900,718

     BROCADE COMMUNICATIONS SYSTEMS, INC.

     GAAP CONDENSED CONSOLIDATED STATEMENT OF CASH FLOW

     For the Three Months Ended JULY 28, 2007 and JULY 29, 2006

     (in thousands)

     (unaudited)

     Three Months Ended

     July 28, July 29,

     2007 2006

    Cash flows from operating activities:

     Net income $10,690 $24,498

     Adjustments to reconcile net income to

     net cash provided by operating activities:

     Excess tax benefit from employee stock plans (8,959) (2,223)

     Depreciation and amortization 28,758 8,522

     Loss on disposal of property and equipment 609 108

     Amortization of debt issuance costs - 446

     Net (gains) losses on investments and - (2,685)

     marketable equity securities

     Non-cash compensation expense 9,714 8,468

     Provision for doubtful accounts 1,453 814

     receivable and sales returns

     Changes in operating assets and liabilities:

     Accounts receivable (12,381) (3,865)

     Inventories 4,636 (936)

     Prepaid expenses and other assets 6,920 (10,371)

     Accounts payable 53,453 1,661

     Accrued employee compensation (15,429) (2,617)

     Deferred revenue 2,828 1,635

     Other accrued liabilities (43,137) 4,047

     Liabilities associated with lease losses (2,866) (1,178)

     Net cash provided by operating activities 36,289 26,324

    Cash flows from investing activities:

     Purchases of property and equipment (13,939) (7,477)

     Purchases of short-term investments (106,973) (121,079)

     Proceeds from sales of property and equipment 1,336 -

     Proceeds from sale of marketable equity

     securities and equity investments - 10,185

     Purchases of restricted short-term investments - (50)

     Proceeds from maturities and sale of

     short-term investments 210,326 109,971

     Purchases of long-term investments (60,801) (684)

     Proceeds from maturities and sale of

     long-term investments 5,015 -

     Proceeds from the maturities of

     restricted short-term investments - 1,093

     Purchases of non-marketable minority

     equity investments (5,000) -

     Decrease in restricted cash 6,583 -

     Net cash provided (used)

     in investing activities 36,547 (8,041)

    Cash flows from financing activities:

     Payments on capital lease obligations (5) -

     Termination of interest rate swap (4,989) -

     Common stock repurchases (81,009) (25,276)

     Excess tax benefit from employees stock plans 8,959 2,223

     Proceeds from issuance of common stock, net 14,970 8,166

     Net cash provided (used) by financing

     activities (62,074) (14,887)

    Effect of exchange rate fluctuations on

     cash and cash equivalents (192) 79

    Net increase (decrease) in cash and cash equivalents 10,570 3,475

    Cash and cash equivalents, beginning of period 363,838 181,009

    Cash and cash equivalents, end of period $374,408 $184,484

     BROCADE COMMUNICATIONS SYSTEMS, INC.

     GAAP CONDENSED CONSOLIDATED STATEMENT OF CASH FLOW

     For the Nine Months Ended JULY 28, 2007 and JULY 29, 2006

     (in thousands)

     (unaudited)

     Nine Months Ended

     July 28, July 29,

     2007 2006

    Cash flows from operating activities:

     Net income $44,852 $47,671

     Adjustments to reconcile net income to net cash

     provided by operating activities:

     Excess tax benefit from employee stock plans (9,120) (8,810)

     Depreciation and amortization 69,560 27,073

     Loss on disposal of property and equipment 812 308

     Amortization of debt issuance costs - 1,297

     Net (gains) losses on investments and - (2,663)

     marketable equity securities

     Non-cash compensation expense 24,443 23,366

     Provision for doubtful accounts 3,115 1,558

     receivable and sales returns

     Provision for SEC settlement - 7,000

     Non-cash facilities lease loss expense - 3,775

     Changes in operating assets and liabilities:

     Accounts receivable 41,354 (10,045)

     Inventories 51 1,871

     Prepaid expenses and other assets (2,077) (13,308)

     Accounts payable 32,515 12,124

     Accrued employee compensation (37,701) 8,396

     Deferred revenue 15,101 11,798

     Other accrued liabilities (61,522) 6,193

     Liabilities associated with lease losses (5,519) (3,586)

     Net cash provided by operating activities 115,864 114,018

    Cash flows from investing activities:

     Purchases of property and equipment (41,526) (22,950)

     Purchases of short-term investments (397,863) (259,263)

     Proceeds of sales of property and equipment 1,336 -

     Proceeds from sale of marketable equity

     securities and equity investments - 10,185

     Purchases of restricted short-term investments - (2,216)

     Proceeds from maturities and sale of 588,159 245,455

     short-term investments

     Purchases of long-term investments (152,602) (13,252)

     Proceeds from maturities and sale of 10,862 -

     long-term investments

     Proceeds from the maturities of - 2,859

     restricted short-term investments

     Purchases of non-marketable minority (5,000) (4,575)

     equity investments

     Cash paid in connection with

     acquisitions, net of cash acquired (7,704) (59,887)

     Decrease in restricted cash 12,422 -

     Cash acquired on merger with McDATA 147,407 -

     Net cash provided (used) in investing

     activities 155,491 (103,644)

     Cash flows from financing activities:

     Payments on capital lease obligations (712) -

     Common stock repurchases (140,883) (40,206)

     Termination of interest swap (4,989) -

     Redemption of outstanding convertible debt (124,185) -

     Excess tax benefit from employees stock plans 9,120 8,810

     Proceeds from issuance of common stock, net 90,670 23,328

     Net cash provided (used) by

     financing activities (170,979) (8,068)

    Effect of exchange rate fluctuations on

     cash and cash equivalents (336) 177

    Net increase (decrease) in cash and cash equivalents 100,040 2,483

    Cash and cash equivalents, beginning of period 274,368 182,001

    Cash and cash equivalents, end of period $374,408 $184,484

     BROCADE COMMUNICATIONS SYSTEMS, INC.

     RECONCILIATION BETWEEN GAAP AND NON-GAAP NET INCOME

     (in thousands, except per share data)

     (unaudited)

     Q3 07 Q2 07 Q3 06

    Net income on a GAAP basis $10,690 $843 $24,498

    Adjustments:

     Stock-based compensation expense

     included in cost of revenues 3,128 2,236 1,738

     Amortization of intangible assets

     expense included in cost of revenues 11,328 11,328 -

     Total gross margin adjustments 14,456 13,564 1,738

     Legal fees associated with

     indemnification obligations and

     other related costs 17,984 15,234 -

     SEC investigation and other

     related costs - - 2,990

     Stock-based compensation expense

     included in research and development 2,992 2,056 3,052

     Stock-based compensation expense

     included in sales and marketing 2,453 1,682 1,771

     Stock-based compensation expense

     included in general and

     administrative 1,139 944 876

     Amortization of intangible assets

     expense included in operating expenses 7,924 7,977 888

     Acquisition and integration costs 4,055 7,564 -

     Total operating expense adjustments 36,547 35,457 9,577

     Total operating income adjustments 51,003 49,021 11,315

     Gain on termination of swap (367) - -

     Gain on investments (895) - (2,685)

     Income tax effect of adjustments (10,937) (3,250) (2,152)

    Non-GAAP net income $49,494 $46,614 $30,976

    Non-GAAP net income per share - Basic $0.13 $0.12 $0.11

    Non-GAAP net income per share - Diluted $0.12 $0.11 $0.11

    Shares used in non-GAAP per share

     calculation - Basic 392,450 395,574 269,417

    Shares used in non-GAAP per share

     calculation - Diluted 407,113 411,989 273,959

    See explanation of non-GAAP information included herein.
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