BRCD-8K EPR - FY12Q3

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Pursuant to Section 13 or 15(d) of the

Securities Exchange Act of 1934

Date of report (Date of earliest event reported): August 16, 2012

BROCADE COMMUNICATIONS SYSTEMS, INC.

(Exact name of registrant as specified in its charter)



Delaware	000-25601	77-0409517
(State or other jurisdiction of incorporation)	(Commission File Number)	(I.R.S. Employer Identification Number)

(Address, including zip code, of principal executive offices)

(Registrant’s telephone number, including area code)

(Former name or former address, if changed since last report)

Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions (see General Instruction A.2. below):



¨	Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425)



¨	Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12)



¨	Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b))



¨	Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c))

Item 2.02 Results of Operations and Financial Condition.

On August 16, 2012, Brocade Communications Systems, Inc. (the “Company”) issued a press release regarding financial results for the third quarter ended July 28, 2012. The Company also posted on its website (www.BRCD.com) slides with accompanying prepared remarks regarding such financial results and forward-looking statements, including statements relating to the Company’s estimated financial results of the fourth quarter of fiscal year 2012. Copies of the press release and slides with accompanying prepared remarks by the Company are attached as Exhibits 99.1 and 99.2, respectively, and the information in Exhibits 99.1 and 99.2 is incorporated herein by reference.

The information in Item 2.02 and Item 9.01 in this Current Report on Form 8-K and the exhibits attached hereto shall not be deemed “filed” for the purposes of Section 18 of the Securities Exchange Act of 1934, as amended, or otherwise subject to the liabilities of that Section, nor shall it be deemed incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended.

Item 9.01 Financial Statements and Exhibits.

Description of Document

Press release, dated August 16, 2012, regarding financial results of Brocade Communications Systems, Inc. for the third quarter ended July 28, 2012.

Slides with accompanying prepared remarks of Brocade Communications Systems, Inc., dated August 16, 2012, regarding financial results of the third quarter ended July 28, 2012 and forward-looking statements, including statements relating to the Company’s estimated financial results of the fourth quarter of fiscal year 2012.

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.



		BROCADE COMMUNICATIONS SYSTEMS, INC.

Date:	August 16, 2012	By:	/s/ Daniel W. Fairfax
			Daniel W. Fairfax
			Chief Financial Officer and Vice President, Finance



BROCADE CONTACTS
Public Relations John Noh Tel: 408-333-5108 jnoh@brocade.com	Investor Relations Robert Eggers Tel: 408-333-8797 reggers@brocade.com

Brocade Reports Fiscal Q3 2012 Results

Revenue Growth of 10% and Improved Margins Drove Higher EPS Yr./Yr.

SAN JOSE, Calif., August 16, 2012 — Brocade^® (NASDAQ: BRCD) today reported financial results for its third fiscal quarter ended July 28, 2012. Brocade reported third quarter revenue of $555.3 million, representing an increase of 10% year-over-year and 2% quarter-over-quarter. The resulting GAAP diluted earnings per share of $0.09, was up from break-even EPS in Q3 2011, and non-GAAP diluted EPS of $0.14, was up 59% year-over-year.

“Fiscal Q3 was a great quarter for Brocade. With continued differentiation in our products and focused execution across our organization, we were able to overcome many issues in the current challenging macroeconomic environment. As a result, our financial performance in the quarter exceeded our expectations for revenue, operating margin and earnings per share,” said Michael Klayko, CEO of Brocade.

Summary of Q3 2012 results:

Storage business revenue, including products and services, was $377.6 million, up 13% year-over-year and down 6% sequentially. Storage product revenue increased 17% year-over-year and decreased 6% sequentially, in a seasonally soft quarter for the company. Brocade's industry-leading 16 Gbps Fibre Channel products represented nearly 30% of director and switch revenue in the quarter.

Ethernet business revenue, including products and services, was $177.8 million, up 5% year-over-year and up 24% quarter-over-quarter. Revenue growth for the Ethernet business was driven by an increase in Federal sales, which were up 40% year-over-year and 108% quarter-over-quarter. Enterprise business revenue was up 2% year-over-year and up 21% quarter-over-quarter as the Brocade ICX products continue to ramp. Service provider business revenue was up slightly quarter-over-quarter and down 5% year-over-year.

GAAP gross margin was 61.3% and non-GAAP gross margin was 63.7% in Q3 2012, compared to 61.0% and 61.8% in Q3 2011, respectively. The year-over-year improvement in gross margin was due to higher revenue, favorable product mix and lower fixed costs. Gross margin declined sequentially, as expected, driven by a greater mix of lower margin Ethernet revenue in Q3 2012.

GAAP operating margin was 12.6% and non-GAAP operating margin was 19.5% in Q3 2012, compared to 6.8% and 14.0% in Q3 2011, respectively. The year-over-year improvement in operating margin was due to higher revenue and expanded gross margin in Q3 2012. Operating margin improved quarter-over-quarter on higher revenue and lower operating expenses.

Operating cash flow was $113.1 million in Q3 2012. During the quarter, the Company reduced its term loan by $40.0 million. The remaining term loan balance was $30.0 million exiting the quarter.

GAAP EPS was $0.09 in Q3 2012, and non-GAAP EPS of $0.14 was up 59% year-over-year, which marks the fourth consecutive quarter of non-GAAP EPS year-over-year growth of nearly 20% or more.

Average diluted shares outstanding for Q3 2012 were lower by 40.0 million shares from Q3 2011, principally from share repurchases during the past year including 8.7 million shares ($45 million) repurchased during Q3 2012.

Brocade management will host a conference call to discuss fiscal third quarter results and fiscal fourth quarter outlook today at 2:30 p.m. PT (5:30 p.m. ET). To access the webcast please go to www.brcd.com/events.cfm. A replay of the conference call, prepared comments and slides as well as a written transcript, will be available at www.brcd.com.

Other Q3 2012 product, customer and partner announcements are available at http://newsroom.brocade.com/.

Brocade (www.brocade.com)

130 Holger Way, San Jose, CA. 95134

T. 408.333.8000 F. 408.333.8101

Financial Highlights and Additional Financial Information



	Q3 2012			Q2 2012			Q3 2011
Revenue	$	555	M	$	543	M	$	503	M
GAAP net income	$	43	M	$	39	M	$	2	M
Non-GAAP net income	$	67	M	$	72	M	$	46	M
GAAP EPS — diluted	$	0.09		$	0.08		$	0.00
Non-GAAP EPS — diluted	$	0.14		$	0.15		$	0.09
GAAP gross margin	61.3		%	62.0		%	61.0		%
Non-GAAP gross margin	63.7		%	64.8		%	61.8		%
GAAP operating income	$	70	M	$	52	M	$	34	M
Non-GAAP operating income	$	108	M	$	101	M	$	70	M
GAAP operating margin	12.6		%	9.5		%	6.8		%
Non-GAAP operating margin	19.5		%	18.6		%	14.0		%
Adjusted EBITDA (1)	$	131	M	$	123	M	$	91	M
Cash provided by operations	$	113	M	$	140	M	$	11	M

•Q3 2012 effective GAAP tax rate was 25.7% and effective non-GAAP effective tax rate was 30.1%.

•Q3 2012 total Storage Area Networking (SAN) port shipments were approximately 1.1 million.

Please see important note of explanation on Non-GAAP measures below, including a detailed reconciliation between GAAP and Non-GAAP information in the tables included herein.



	Q3 2012		Q2 2012		Q3 2011
As a % of total revenues
OEM revenues	67	%	70	%	61	%
Channel/Direct revenues	33	%	30	%	39	%
10% or greater customer revenues	55	%	58	%	43	%
Domestic revenues	64	%	65	%	61	%
International revenues	36	%	35	%	39	%
Data Storage Products Revenues	58	%	63	%	55	%
Ethernet Products Revenues	26	%	21	%	28	%
Global Services Revenue	16	%	16	%	18	%
Ethernet Business Revenues (2)	32	%	26	%	34	%
As a % of Ethernet Business Revenues:
Enterprise, excluding Federal	52	%	54	%	54	%
Federal	19	%	11	%	15	%
Service Provider	29	%	35	%	32	%



	Q3 2012			Q2 2012			Q3 2011
Cash, cash equivalents and short-term investments	$	581	M	$	545	M	$	473	M
Deferred revenues	$	280	M	$	278	M	$	264	M
Capital expenditures	$	18	M	$	21	M	$	26	M
Total debt, net of discount	$	630	M	$	670	M	$	839	M
Days sales outstanding	38 days			36 days			54 days
Employees at end of period	4,597			4,600			4,772

Adjusted EBITDA is as defined in the Term Debt Credit Agreement.

Ethernet Business revenues include product and global services revenues.

Non-GAAP Financial Measures

This press release contains non-GAAP financial measures. In evaluating Brocade's performance, management uses certain non-GAAP financial measures to supplement consolidated financial statements prepared under GAAP.

Management believes that non-GAAP financial measures used in this press release allow management to gain a better understanding of Brocade's comparative operating performance both from period to period, and to its competitors' operating results. Management also believes these non-GAAP financial measures help indicate Brocade's baseline performance before gains, losses or charges that are considered by management to be outside ongoing operating results. Accordingly, management uses these non-GAAP financial 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 financial measures, when read in conjunction with Brocade's GAAP financials, provide useful information to investors by offering:

the ability to make more meaningful period-to-period comparisons of Brocade's ongoing operating results;

the ability to make more meaningful comparisons of Brocade's operating performance against industry and competitor companies;

the ability to better identify trends in Brocade's underlying business and to perform related trend analysis;

a better understanding of how management plans and measures Brocade's underlying business; and

an easier way to compare Brocade'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 Brocade's continuing operations. Management believes that it is appropriate to evaluate Brocade's operating performance by excluding those items that are not indicative of ongoing operating results or limit comparability. Such items include: (i) provision or benefit from certain pre-acquisition litigation (ii) legal fees associated with certain pre-acquisition litigation, (iii) legal fees associated with indemnification obligations and other related costs, net, (iv) acquisition and integration costs, (v) loss on sale of property, (vi) interest expense related to the adoption of new standards relating to convertible debt instruments, (vii) original issue discount and debt issuance costs of debt related to lenders that did not participate in refinancing, and (viii) loss on sale of a subsidiary.

Management also excludes the following non-cash charges in determining non-GAAP net income (i) stock-based compensation expense 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. 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 Brocade'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 of non-GAAP net income.

Limitations These non-GAAP financial 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 Brocade's GAAP results. The non-GAAP financial measures that Brocade 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 net income per share, and should not be considered measurements of Brocade'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 measurements reported by other companies.

Cautionary Statement

This press release contains statements that are forward-looking in nature, including statements regarding Brocade’s strategy and its routes to market. 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, changes in IT spending levels in one or more of our target markets including the government sector, Brocade’s ability to capitalize on new Brocade sales and marketing initiatives, including expanded go-to-market activities in our Ethernet business, customer acceptance of Brocade’s Ethernet fabric solutions, Brocade’s ability to continue to successfully innovate new products and services on a timely basis and achieve widespread market acceptance, and the effect of increasing market competition and changes in the industry. Certain of these and other risks are set forth in more detail in our Form 10-Q for the fiscal quarter ended April 28, 2012 and in “Item 1A. Risk Factors” in Brocade’s Annual Report on Form 10-K for the fiscal year ended October 29, 2011. Brocade does not assume any obligation to update or revise any such forward-looking statements, whether as the result of new developments or otherwise.

Brocade (NASDAQ: BRCD) networking solutions help the world’s leading organizations transition smoothly to a world where applications and information reside anywhere. (www.brocade.com)

Brocade, the B-wing symbol, DCX, Fabric OS, and SAN Health are registered trademarks, and Brocade Assurance, Brocade NET Health, Brocade One, CloudPlex, MLX, VCS, VDX, and When the Mission Is Critical, the Network Is Brocade are trademarks of Brocade Communications Systems, Inc., in the United States and/or in other countries. Other brands, products, or service names mentioned are or may be trademarks or service marks of their respective owners.

BROCADE COMMUNICATIONS SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME



	Three Months Ended						Nine Months Ended
	July 28, 2012			July 30, 2011			July 28, 2012			July 30, 2011
	(In thousands, except per share amounts)
Net revenues
Product	$	467,281		$	414,298		$	1,399,687		$	1,328,822
Service	88,051			88,552			259,726			268,148
Total net revenues	555,332			502,850			1,659,413			1,596,970
Cost of revenues
Product	173,637			149,321			513,221			498,012
Service	41,217			47,002			123,863			142,939
Total cost of revenues	214,854			196,323			637,084			640,951
Gross margin	340,478			306,527			1,022,329			956,019
Operating expenses:
Research and development	90,530			87,320			272,780			270,669
Sales and marketing	146,378			153,345			457,921			462,991
General and administrative	18,612			16,617			55,752			53,176
Legal fees associated with indemnification obligations and other related costs, net	—			—			—			124
Amortization of intangible assets	14,737			15,023			44,467			46,236
Total operating expenses	270,257			272,305			830,920			833,196
Income from operations	70,221			34,222			191,409			122,823
Interest expense	(12,029		)	(42,066		)	(37,804		)	(84,357		)
Interest and other income (loss), net	103			(519		)	(1,345		)	(160		)
Income (loss) before income tax	58,295			(8,363		)	152,260			38,306
Income tax expense (benefit)	14,995			(10,300		)	11,080			(16,628		)
Net income	$	43,300		$	1,937		$	141,180		$	54,934
Net income per share — basic	$	0.09		$	0.00		$	0.31		$	0.12
Net income per share — diluted	$	0.09		$	0.00		$	0.30		$	0.11
Shares used in per share calculation — basic	457,147			483,744			455,727			474,020
Shares used in per share calculation — diluted	469,571			509,548			471,719			500,741

BROCADE COMMUNICATIONS SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS



	July 28, 2012			October 29, 2011
	(In thousands, except par value)
Assets
Current assets:
Cash and cash equivalents	$	580,626		$	414,202
Short-term investments	808			774
Total cash, cash equivalents and short-term investments	581,434			414,976
Accounts receivable, net of allowances for doubtful accounts of $2,184 and $1,388 at July 28, 2012 and October 29, 2011, respectively	231,155			249,141
Inventories	74,200			74,172
Deferred tax assets	55,400			53,604
Prepaid expenses and other current assets	49,176			52,308
Total current assets	991,365			844,201
Property and equipment, net	523,405			532,384
Goodwill	1,626,754			1,630,967
Intangible assets, net	134,715			214,697
Non-current deferred tax assets	182,381			210,028
Other assets	38,904			42,031
Total assets	$	3,497,524		$	3,474,308
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	116,469		$	109,471
Accrued employee compensation	137,942			118,298
Deferred revenue	208,263			201,421
Current liabilities associated with facilities lease losses	868			1,456
Current portion of long-term debt	8,515			40,539
Other accrued liabilities	83,311			94,802
Total current liabilities	555,368			565,987
Long-term debt, net of current portion	621,206			748,904
Non-current liabilities associated with facilities lease losses	1,942			2,496
Non-current deferred revenue	71,560			69,024
Non-current income tax liability	46,366			63,593
Other non-current liabilities	9,481			10,166
Total liabilities	1,305,923			1,460,170
Commitments and contingencies
Stockholders’ equity:
Preferred stock, $0.001 par value, 5,000 shares authorized, no shares issued and outstanding	—			—
Common stock, $0.001 par value, 800,000 shares authorized:
Issued and outstanding: 460,903 and 448,022 shares at July 28, 2012 and October 29, 2011, respectively	461			448
Additional paid-in capital	2,028,305			1,984,830
Accumulated other comprehensive loss	(19,204		)	(11,996		)
Retained earnings	182,039			40,856
Total stockholders’ equity	2,191,601			2,014,138
Total liabilities and stockholders’ equity	$	3,497,524		$	3,474,308

BROCADE COMMUNICATIONS SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS



	Three Months Ended
	July 28, 2012			July 30, 2011
	(In thousands)
Cash flows from operating activities:
Net income	$	43,300		$	1,937
Adjustments to reconcile net income to net cash provided by operating activities:
Excess tax benefits from stock-based compensation	(6		)	(796		)
Depreciation and amortization	47,159			51,220
Loss on disposal of property and equipment	108			136
Amortization of debt issuance costs and original issue discount	1,141			2,729
Write-off of debt issuance costs and original issue discount on debt extinguishment	—			25,465
Net gains on investments	(11		)	(338		)
Provision for doubtful accounts receivable and sales allowances	3,669			2,986
Non-cash compensation expense	13,069			20,969
Changes in assets and liabilities:
Accounts receivable	(16,986		)	(10,229		)
Inventories	5,280			14,733
Prepaid expenses and other assets	2,375			2,838
Deferred tax assets	(11		)	53
Accounts payable	15,165			(21,621		)
Accrued employee compensation	(3,089		)	(41,899		)
Deferred revenue	1,720			(7,870		)
Other accrued liabilities	363			(26,901		)
Liabilities associated with facilities lease losses	(187		)	(2,354		)
Net cash provided by operating activities	113,059			11,058
Cash flows from investing activities:
Proceeds from maturities and sale of short-term investments	—			1,584
Purchases of property and equipment	(17,736		)	(26,086		)
Net cash used in investing activities	(17,736		)	(24,502		)
Cash flows from financing activities:
Payment of principal related to the term loan	(40,000		)	(211,257		)
Payment of fees related to the term loan	—			(1,090		)
Proceeds from term loan	—			198,949
Payment of principal related to capital leases	(469		)	(443		)
Common stock repurchases	(45,087		)	(10,044		)
Proceeds from issuance of common stock	29,211			45,945
Excess tax benefits from stock-based compensation	6			796
Net cash provided (used) in financing activities	(56,339		)	22,856
Effect of exchange rate fluctuations on cash and cash equivalents	(2,697		)	(415		)
Net increase in cash and cash equivalents	36,287			8,997
Cash and cash equivalents, beginning of period	544,339			463,562
Cash and cash equivalents, end of period	$	580,626		$	472,559

BROCADE COMMUNICATIONS SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS



	Nine Months Ended
	July 28, 2012			July 30, 2011
	(In thousands)
Cash flows from operating activities:
Net income	$	141,180		$	54,934
Adjustments to reconcile net income to net cash provided by operating activities:
Excess tax (benefits) detriments from stock-based compensation	(1,338		)	81
Depreciation and amortization	144,683			155,453
Loss on disposal of property and equipment	404			2,046
Amortization of debt issuance costs and original issue discount	3,767			11,924
Write-off of debt issuance costs and original issue discount on debt extinguishment	—			25,465
Net gains on investments	(35		)	(348		)
Provision for doubtful accounts receivable and sales allowances	9,533			8,057
Non-cash compensation expense	58,746			63,405
Changes in assets and liabilities:
Accounts receivable	8,454			13,802
Inventories	(2,099		)	(2,931		)
Prepaid expenses and other assets	2,675			(4,069		)
Deferred tax assets	181			23
Accounts payable	8,476			(31,874		)
Accrued employee compensation	5,554			(22,184		)
Deferred revenue	9,377			13,299
Other accrued liabilities	(8,038		)	(38,877		)
Liabilities associated with facilities lease losses	(1,142		)	(5,207		)
Net cash provided by operating activities	380,378			242,999
Cash flows from investing activities:
Purchases of short-term investments	—			(38		)
Proceeds from maturities and sale of short-term investments	—			1,604
Proceeds from sale of subsidiary	35			—
Purchases of property and equipment	(56,005		)	(76,661		)
Net cash used in investing activities	(55,970		)	(75,095		)
Cash flows from financing activities:
Payment of principal related to the term loan	(160,000		)	(309,897		)
Payment of fees related to the term loan	—			(1,090		)
Proceeds from term loan	—			198,949
Payment of principal related to capital leases	(1,389		)	(1,311		)
Common stock repurchases	(70,153		)	(10,044		)
Proceeds from issuance of common stock	76,472			93,333
Excess tax benefits (detriments) from stock-based compensation	1,338			(81		)
Net cash used in financing activities	(153,732		)	(30,141		)
Effect of exchange rate fluctuations on cash and cash equivalents	(4,252		)	812
Net increase in cash and cash equivalents	166,424			138,575
Cash and cash equivalents, beginning of period	414,202			333,984
Cash and cash equivalents, end of period	$	580,626		$	472,559

BROCADE COMMUNICATIONS SYSTEMS, INC.

RECONCILIATION BETWEEN GAAP AND NON-GAAP NET INCOME



	Three Months Ended
	July 28, 2012			July 30, 2011
	(In thousands, except per share amounts)
Net income on a GAAP basis	$	43,300		$	1,937
Adjustments:
Stock-based compensation expense included in cost of revenues	3,074			4,235
Amortization of intangible assets expense included in cost of revenues	10,713			14,466
Benefit from certain pre-acquisition litigation	—			(14,334		)
Legal fees expense (recovery) associated with certain pre-acquisition litigation	(414		)	92
Total gross margin adjustments	13,373			4,459
Stock-based compensation expense included in research and development	3,110			5,581
Stock-based compensation expense included in sales and marketing	4,483			8,670
Stock-based compensation expense included in general and administrative	2,402			2,483
Amortization of intangible assets expense included in operating expenses	14,737			15,023
Total operating expense adjustments	24,732			31,757
Total operating income adjustments	38,105			36,216
Original issue discount and debt issuance costs of debt related to lenders that did not participate in refinancing	—			25,465
Income tax effect of adjustments	(14,012		)	(17,657		)
Non-GAAP net income	$	67,393		$	45,961
Non-GAAP net income per share — basic	$	0.15		$	0.10
Non-GAAP net income per share — diluted	$	0.14		$	0.09
Shares used in non-GAAP per share calculation — basic	457,147			483,744
Shares used in non-GAAP per share calculation — diluted	469,571			509,548

BROCADE COMMUNICATIONS SYSTEMS, INC.

RECONCILIATION BETWEEN GAAP AND NON-GAAP NET INCOME



	Nine Months Ended
	July 28, 2012			July 30, 2011
	(In thousands, except per share amounts)
Net income on a GAAP basis	$	141,180		$	54,934
Adjustments:
Stock-based compensation expense included in cost of revenues	12,045			11,262
Amortization of intangible assets expense included in cost of revenues	35,516			43,399
Benefit from certain pre-acquisition litigation	—			(14,334		)
Legal fees expense (recovery) associated with certain pre-acquisition litigation	(465		)	385
Total gross margin adjustments	47,096			40,712
Legal fees associated with indemnification obligations and other related costs, net	—			124
Stock-based compensation expense included in research and development	13,741			14,975
Stock-based compensation expense included in sales and marketing	24,946			27,081
Stock-based compensation expense included in general and administrative	8,014			10,087
Amortization of intangible assets expense included in operating expenses	44,467			46,236
Total operating expense adjustments	91,168			98,503
Total operating income adjustments	138,264			139,215
Original issue discount and debt issuance costs of debt related to lenders that did not participate in refinancing	—			25,465
Income tax effect of adjustments	(47,015		)	(51,906		)
Non-GAAP net income	$	232,429		$	167,708
Non-GAAP net income per share — basic	$	0.51		$	0.35
Non-GAAP net income per share — diluted	$	0.49		$	0.33
Shares used in non-GAAP per share calculation — basic	455,727			474,020
Shares used in non-GAAP per share calculation — diluted	471,719			500,741

Prepared Comments and Slides

Vice President, Investor Relations

Senior Director, Public Relations

Brocade Q3 FY 2012 Earnings 8/16/2012

Prepared comments provided by Rob Eggers, Investor Relations

Thank you for your interest in Brocade's Q3 Fiscal 2012 earnings presentation, which includes prepared remarks, slides, and a press release detailing fiscal third quarter 2012 results. The press release was issued shortly after 1:00 p.m. PT on August 16, 2012 via Marketwire. The press release, along with these prepared comments and slides, has been furnished to the SEC on Form 8-K and will be made available on the Brocade Investor Relations website at www.brcd.com.

Brocade Q3 FY 2012 Earnings 8/16/2012

Today’s prepared comments include remarks by Mike Klayko, Brocade CEO, regarding the company’s quarterly results, its strategy, and a review of operations, as well as industry trends and market/technology drivers related to its business; and by Dan Fairfax, Brocade CFO, who will provide a financial review.

A management discussion and live question and answer conference call will be webcast at 2:30 p.m. PT on August 16 at www.brcd.com and will be archived on the Brocade Investor Relations website.

Brocade Q3 FY 2012 Earnings 8/16/2012

Prepared comments provided by Mike Klayko, CEO

Brocade Q3 FY 2012 Earnings 8/16/2012

Fiscal Q3 was a great quarter for Brocade. With continued differentiation in our products and focused execution across our organization, we were able to overcome many issues in the current challenging macroeconomic environment. As a result, our financial performance in the quarter exceeded our expectations for revenue, non-GAAP operating margin and earnings per share.

Revenue in the third quarter 2012 increased by 10% from the prior year to $555.3M, driven by healthy growth in both our Storage and Ethernet businesses. Storage revenue grew 17% year-over-year, led by the strong ramp of 16 Gbps products, which now account for nearly 30% of our SAN Director and Switch revenue. Ethernet product revenue in Q3 was the second highest in the company's history, as a result of growth from our Enterprise customer segment, driven by our new Brocade ICX products, and higher Federal revenue.

We are very pleased to report non-GAAP EPS in the third quarter was $0.14, increasing 59% from the prior year and representing the fourth consecutive quarter of year-over-year EPS growth of nearly 20% or more.

On the balance sheet, our improvements were also substantial. With strong cash flows, we continued to pay down our term loan and now anticipate exiting the fiscal year in a net cash position, one year earlier than previously communicated. Further, leveraging our strong cash flow from operations, we repurchased $45M or 8.7M shares during the quarter. Over the past 12 months, we have bought back 60M shares, representing nearly 12% of the shares outstanding exiting Q3 2011.

Over the last several years, we have made significant R&D investments in our technology and product portfolio that have put the company in an industry-leading position. We are confident that these investments position us well as the networking industry continues to evolve with new technologies such as Ethernet fabrics, 16 Gbps SAN, Software-Defined Networking (SDN) and 100 Gigabit Ethernet.

Brocade Q3 FY 2012 Earnings 8/16/2012

A great example of innovation driving growth, is our investment and leadership in the emerging Ethernet fabric space, where our revenue in Q3 grew by more than 100% year-over-year. We continue to experience great customer interest with nearly 650 customers for the Brocade VDX product line, including many repeat buyers among the early adopters. In fact, one of these early adopters has now purchased well over $1 million to date of VDX products. As we announced last quarter, we now have a dedicated sales team in place to address this rapidly growing market. Our objective with this team is to have a focused effort to win emerging sales opportunities as customers migrate from traditional data center networks to Ethernet fabrics.

One of the important trends that we are beginning to see in the fabric space is customers scaling out their fabrics in order to support private cloud build-outs and server virtualization expansion. Especially when scaling to larger fabrics, customers require more sophisticated automation and management capabilities, which the combined Brocade VDX switch and VCS fabric technology solution delivers. Brocade will continue to innovate in this area and will be making specific announcements that will further differentiate Brocade from the competition at our Analyst and Technology Day event on September 12.

Brocade Q3 FY 2012 Earnings 8/16/2012

Turning to our Enterprise business, we experienced outstanding sequential growth in the third quarter with revenue increasing by 21% from the prior quarter and 2% year-over-year. This was largely driven by the strong ramp of the new Brocade ICX family of switches. Purpose-built for the channel, and launched in Q2 as part of our Effortless Network™ vision, this portfolio of products offers outstanding functionality and performance at an attractive price point. Another key differentiator is our Brocade HyperEdge™ technology, available next year, which is designed to deliver new levels of automation and simplification as well as significant cost savings and investment protection. Customer demand and feedback has been very encouraging as these products and technology fill a critical gap in the campus LAN market.

Another important driver of our third quarter growth in our Ethernet business was the Federal segment, which grew 108% sequentially and 40% year-over-year. We typically see higher revenue from our Federal customers in the second half of the fiscal year, but our Q3 performance was better than expected. We continue to be optimistic that we can grow our share in the large Federal IT market despite the challenges that exist in this segment.

We are also making progress with our two-tier channel strategy and are encouraged by both improved sales execution as well as the positive feedback we are receiving from our channel partners. Our Q3 performance gives us confidence that our strategy and plans are on the

Brocade Q3 FY 2012 Earnings 8/16/2012

Brocade continues to invest strategically in storage area networking where the ramp of our industry-leading 16 Gbps Fibre Channel technology has contributed to significant market share gains. Based on the Dell'Oro Group's most recent report for calendar Q1 2012, our market share has increased by six percentage points, resulting in 71% of the total market. 16 Gbps products now make up nearly 30% of our SAN Director and Switch revenue. With recent launches, such as IBM's Flex System x240 Compute Node and Dell's 6505 switch, we believe the adoption of this technology will continue to drive growth for the company.

The rapid qualification and deployment of our 16 Gbps Fibre Channel products indicate that our continued innovation not only improves network speed and performance but is also helping customers achieve their business goals. For example, these products help organizations to reduce complexity and costs, deploy new technologies and applications, support virtualization and cloud infrastructures, and build highly scalable storage networks that improve business agility and support growth. In total, this market continues to present great opportunities for us and we are committed to developing innovation that maintains our strong leadership.

Brocade Q3 FY 2012 Earnings 8/16/2012

Another area of investment and early leadership for Brocade is Software-Defined Networking. Like many of you, we have followed with interest the lively discussion regarding what SDN means for our industry. Brocade views SDN as a tremendous opportunity for growth. This emerging technology has the potential to transform networking infrastructure into a platform for innovation, enabling customers to deliver new services and applications faster and with much larger scale. Importantly, SDN requires and is optimized for fabrics, an area in which our highly differentiated product portfolio excels.

During the third quarter, we announced our comprehensive strategy for SDN and delivered our first SDN-ready products that include support for OpenFlow at 100 Gigabit Ethernet. We are already deploying solutions at customer locations, such as Indiana University and Internet2 (I2). We are also building our partner ecosystem and have established great relationships with OpenFlow partners, such as NEC, Big Switch, Nicira, and others. SDN will be a key theme at our upcoming Analyst and Technology Day and we look forward to showing you how our solutions will be an important enabler for this transformational emerging technology.

Brocade Q3 FY 2012 Earnings 8/16/2012

We will be hosting our Analyst and Technology Day event at our campus in San Jose, California on September 12. At that time, we will take you through our financial model, capital structure plans, and market opportunity assessment for the next several years. We will also be discussing our product and technology roadmap that will continue to drive our strategic direction. We encourage you to attend in person or participate virtually, as we will demonstrate our commitment to driving industry-leading innovations that set the stage for our continued growth and success. Please register for the event at www.brocade.com.

Brocade Q3 FY 2012 Earnings 8/16/2012

In closing, we are pleased with our ability to drive growth in revenue and profitability. As you know, last quarter we made a number of enhancements to our team and we are already seeing the benefit of these changes with continued progress in our channel, improvement in our ability to drive sales, and increased focus in markets that present exciting growth opportunities for Brocade. Further, the strength of our product portfolio has never been better and our third quarter results show that great products can help overcome a difficult macro environment. We will continue to make investments in strategic areas such as Ethernet fabrics, Storage Area Networking, Software-Defined Networking and 100 Gigabit Ethernet and look forward to showing you where our portfolio will go from here.

Brocade Q3 FY 2012 Earnings 8/16/2012

Prepared comments provided by Dan Fairfax, CFO

Brocade Q3 FY 2012 Earnings 8/16/2012

In Q3 12 Brocade generated revenue of $555.3M, up 10% compared to Q3 11 and up 2% Qtr./Qtr. Storage product revenue grew 17% Yr./Yr. driven by growth across all our SAN product segments and the continued ramp of our industry-leading 16 Gbps portfolio. Storage product revenue was down 6% Qtr./Qtr. in a seasonally soft quarter and represented approximately 58% of total revenue, down from 63% in Q2 and higher than the 55% reported in Q3 11.

Q3 Ethernet product revenue was up 29% Qtr./Qtr. and up 5% Yr./Yr. Sequentially, our Ethernet business improved significantly as we saw growth across all of our major customer segments, led by Enterprise and Federal. Ethernet product revenue in Q3 represented 26% of total revenue, up from 21% in Q2 and down from 28% in Q3 11.

Global Services revenue was $88M in Q3, up 1% Qtr./Qtr. and down slightly Yr./Yr. Excluding the impact of the sale of our SBS consulting business at the end of FY11, our Global Services revenue increased nearly 7% Yr./Yr. Our Global Services revenue represented approximately 16% of total Q3 revenue, no change from Q2 and down slightly from the previous year.

Non-GAAP gross margin was 63.7% in Q3, up 190 basis points from Q3 11 and lower compared with Q2, as expected, due to a higher mix of Ethernet revenue in the quarter. Non-GAAP operating margin was 19.5% in Q3, an improvement of 550 basis points Yr./Yr. and 90 basis points from Q2.

Q3 GAAP EPS on a diluted basis was $0.09, and non-GAAP EPS was $0.14 for the quarter, growing 59% Yr./Yr. The effective GAAP tax rate was 25.7% and the effective non-GAAP tax rate was 30.1% for the quarter. The non-GAAP tax rate was slightly higher than expected due to an increase in the mix of domestic revenue and profits in the quarter.

During Q3 we generated $113M in operating cash flow and paid down $40M on our term loan. Net debt was $54M exiting the quarter, down from $131M at the end of Q2. Weighted average diluted shares outstanding were 470M in Q3, lower than the 477M shares reported for Q2, and reflect 8.7M in share repurchases ($45M) during the quarter.

Brocade Q3 FY 2012 Earnings 8/16/2012

Turning to our Storage business, including hardware and Storage-based support and services, Q3 revenue was $377.6M, up 13% from Q3 11 and down 6% sequentially.

Strong demand for Storage products continues to be driven by the ramp of 16 Gbps products as well as industry trends, including data center virtualization and digital data growth. Storage product revenue was $321.5M in the quarter, up 17% Yr./Yr and down 6% sequentially. The Q3 sequential decline was at the high end of our historical seasonality due to softness in EMEA orders, attributable to the weak macroeconomic environment. Nevertheless, sales from our 16 Gbps products continue to ramp and represent nearly 30% of Director and Switch revenue in the quarter.

We experienced healthy demand for our Director products in Q3 with 17% Yr./Yr. revenue growth. Sequentially Director revenue was down 11%. Switch revenue was up 19% Yr./Yr. and down 5% Qtr./Qtr.

Our Server product group, including embedded switches and server adapter products (HBAs and Mezzanine Cards), posted revenue of $49.3M, up 12% Yr./Yr. and up 7% sequentially. Embedded switch revenue was up 13% Yr./Yr., while our server adapter product revenue was flat Yr./Yr. We launched the first of our 16 Gbps embedded switch products in the quarter, which will help to drive growth in this product group.

Storage-based support and services revenue was $56.1M in the quarter, down 5% Yr./Yr., driven primarily by the sale of our SBS services subsidiary in Q4 11, and down 2% Qtr./Qtr.

Brocade Q3 FY 2012 Earnings 8/16/2012

Moving on to our Ethernet business, including hardware and Ethernet-based support and services, Q3 revenue was $177.8M, up 5% Yr./Yr. and up 24% sequentially.

As we look at the Q3 Ethernet customer segment split, including products and services, our Federal business generated $34.1M in revenue, up 108% sequentially as we saw more business close than expected within the quarter, and up 40% compared with Q3 11. We saw continued improvement in our Enterprise business as revenue grew 21% Qtr./Qtr. on top of 11% sequential growth in Q2. We attribute much of this improvement to the launch of the new Brocade ICX products in Q2 and continued focus on our channel go-to-market strategy. Enterprise revenue was up 2% Yr./Yr., and our Service Provider customer segment generated $51.0M in revenue, down 4.5% Yr./Yr. and up 1.3% Qtr./Qtr.

From a geographic viewpoint, Q3 Ethernet revenue was up sequentially across all geographies, with the biggest improvements in the Americas and EMEA. Ethernet revenue was up year-over-year led by growth in EMEA and Japan, while revenue for Americas and APAC were lower.

We continued to see good progress with our award-winning Ethernet fabric-enabled products. In Q3 we saw revenue growth of over 100% Yr./Yr. for our Brocade VDX products, which also surpassed $10M in the quarter for the first time. Many of these customers are returning each quarter, purchasing additional products to build out their Ethernet fabrics, and taking advantage of the scalability of the Brocade VDX offering.

Brocade Q3 FY 2012 Earnings 8/16/2012

In Q3, four of our customers, EMC, HDS, HP , and IBM each contributed at least 10% of the total company revenue. These 10% customers collectively contributed 55% of revenue in Q3, down from 58% in Q2, and up from 43% in Q3 11, when HDS was not a 10% customer. Other OEMs as a group, represented 12% of revenue in Q3, unchanged from Q2 and down from 18% in Q3 11, when HDS was not a 10% customer. Channel and direct routes to market contributed 33% of revenue in Q3, an increase from 30% in Q2 and down from 39% in Q3 11. The sequential increase in the percentage of revenue going through channel and/or shipped direct was driven by the shift in revenue mix to more Ethernet revenue, which is predominately sold through channel partners.

The mix of business based on ship-to location was 64% domestic and 36% international in the quarter, reflecting a shift in mix to more domestic revenue from 61% in Q3 11. Since some of our OEMs take delivery of our products domestically and then ship internationally to their end-users, the percentage of international revenue based on end-user location would be higher.

Brocade Q3 FY 2012 Earnings 8/16/2012

Q3 non-GAAP Company gross margin of 63.7% was within our guidance range of 63.3% to 63.8% for the quarter. Gross margin improved 190 basis points year-over-year driven by higher volumes and better product gross margins. Gross margin was down as expected from Q2 due to

Q3 product non-GAAP gross margin was 65.5%, near the high end of our 63% to 66% target model, and down from 66.9% in Q2 primarily due to product mix. Q3 Storage non-GAAP gross margin percentage was in the mid-70's. Q3 Ethernet non-GAAP gross margin percentage was in the upper-40's, higher compared to Q2 and lower year-over-year due to the increase in sales through the channel.

Global Services non-GAAP gross margin was 54.5% in Q3, up significantly compared with the 49.5% reported in Q3 11, primarily due to the sale of SBS. Global Services gross margin was up slightly quarter-over-quarter, due to lower spending, and was above the high end of our target model of 51% to 54%.

Brocade Q3 FY 2012 Earnings 8/16/2012

Q3 Non-GAAP gross margins were 63.7% and continued to be above the high end of our target model range of 61% to 63% for FY12.

On a non-GAAP basis, total operating expenses were 44.2% of revenues in Q3, near the low end of our target model of 44% to 46% for FY12 and lower compared with 46.2% reported in Q2. Operating expenses on a dollar basis decreased from Q2, driven by lower sales expenses as well as normal seasonal spending decreases in Q3. Ending headcount was 4,597 in Q3, essentially unchanged from the prior quarter.

Non-GAAP operating margin was 19.5% in Q3, an increase of 550 basis points compared with Q3 11. The operating margin was above the target model range of 16% to 18% and benefited from improved gross margin and lower operating expenses.

Brocade Q3 FY 2012 Earnings 8/16/2012

Cash generated from operations was $113M in Q3, up 922% Yr./Yr. and down 19% sequentially. We continued to see favorable shipment linearity in the quarter, which resulted in DSOs of 38 days, the third quarter in a row our DSOs were less than 40 days. Total capital expenditures in the quarter were $18M.

Cash, equivalents, and short-term investments were $581M, up $36M from Q2 and up $108M from Q3 11. With the $40M principal reduction of our term loan in Q3, our remaining principal is $30M exiting the quarter and we expect to pay off the remaining balance during Q4. We also expect to be net-cash positive as we exit Q4 12. As I mentioned earlier, we repurchased $45M of common stock during Q3 and had $608M remaining in the Board authorized share repurchase program exiting the quarter. In addition, since the beginning of Q4 12, we have repurchased $30M of common stock or 5.9M shares.

Since Q3 11, we have repurchased a total of 60M shares and have reduced our interest expense by nearly 30%.

Adjusted EBITDA in the quarter was $131M, which was up 43% compared to Q3 11 and up 6% Qtr/Qtr. The Senior Secured Leverage Ratio was 1.20x and the Fixed Charge Coverage Ratio was 4.83x. Both ratios have improved significantly over the past year and have comfortable headroom to the covenant requirements of our term credit agreement.

Brocade Q3 FY 2012 Earnings 8/16/2012

Looking forward to Q4 12, we considered a number of factors, including the following, in setting our outlook:

The current macro environment and economy continue to show uncertainty, especially within the Eurozone countries.

The overall IT spending is growing but individual customer segments, such as Federal and Service Provider, may experience more uncertainty than others.

We continue to see encouraging demand trends for our Storage products and expect Q4 Storage revenue to grow sequentially and be up approximately 7% to 10% year-over-year.

We expect our Q4 Ethernet revenue to be flat to slightly higher Qtr./Qtr.

We expect non-GAAP operating expenses to be approximately $250M in Q4.

At the end of Q3, OEM inventory was a little more than one and one-half weeks based on Storage business revenue and we expect OEMs to hold between one week and two weeks of inventory going forward. OEM inventory levels may fluctuate due to both seasonality and large end-user order patterns at the OEMs.

From a tax rate perspective, we assume a structural non-GAAP rate of 29% to 31% for Q4. Discrete events can impact our tax rate from time to time. However we do not provide guidance on such events due to the inherent uncertainty of their realization and timing.

Our guidance reflects the share repurchases already completed in Q4.

Finally, based on our Q4 outlook, we expect to grow overall revenue in FY12 by 3% to 4% Yr./Yr. and non-GAAP EPS by 26% to 28% Yr./Yr.

Brocade Q3 FY 2012 Earnings 8/16/2012

Prepared comments provided by Rob Eggers, Investor Relations

That concludes Brocade’s prepared comments. At 2:30 p.m. Pacific Time on August 16 Brocade will host a webcast conference call at www.brcd.com.

Thank you for your interest in Brocade.

Brocade Q3 FY 2012 Earnings 8/16/2012

Additional Financial Information:



	Q3 11		Q2 12		Q3 12
GAAP gross margin	61.0	%	62.0	%	61.3	%
Non-GAAP gross margin	61.8	%	64.8	%	63.7	%

GAAP product gross margin	64.0	%	64.0	%	62.8	%
Non-GAAP product gross margin	64.5	%	66.9	%	65.5	%

GAAP services gross margin	46.9	%	51.7	%	53.2	%
Non-GAAP services gross margin	49.5	%	54.3	%	54.5	%

GAAP operating margin	6.8	%	9.5	%	12.6	%
Non-GAAP operating margin	14.0	%	18.6	%	19.5	%

Brocade Q3 FY 2012 Earnings 8/16/2012


99.1	Press release, dated August 16, 2012, regarding financial results of Brocade Communications Systems, Inc. for the third quarter ended July 28, 2012.


99.2	Slides with accompanying prepared remarks of Brocade Communications Systems, Inc., dated August 16, 2012, regarding financial results of the third quarter ended July 28, 2012 and forward-looking statements, including statements relating to the Company’s estimated financial results of the fourth quarter of fiscal year 2012.