BRCD-8K EPR - FY14Q1

EX-99.2 3 brcd-8keprxfy14q1xex992.htm SLIDES WITH ACCOMPANYING PREPARED REMARKS OF BROCADE COMMUNICATIONS SYSTEMS, INC BRCD-8K EPR - FY14Q1 - Ex 99.2

Q1 FY 2014 Earnings

Prepared Comments and Slides

February 13, 2014

Ben Jones

Senior Director, Investor Relations

Phone: 408-333-6601

bjones@brocade.com

John Noh

Senior Director, Public Relations

Phone: 408-333-5108

jnoh@brocade.com

NASDAQ: BRCD

Brocade Q1 FY 2014 Earnings 2/13/2014

Prepared comments provided by Ben Jones, Investor Relations

Thank you for your interest in Brocade's Q1 Fiscal 2014 earnings presentation, which includes prepared remarks, safe harbor, slides, and a press release detailing fiscal first quarter 2014 results. The press release, along with these prepared comments and slides, has been furnished to the SEC on Form 8-K and has been made available on the Brocade Investor Relations website at www.brcd.com. The press release will be issued subsequently via Marketwired.

Brocade Q1 FY 2014 Earnings 2/13/2014

Brocade Q1 FY 2014 Earnings 2/13/2014

Today’s prepared comments include remarks by Lloyd Carney, 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 February 13 at www.brcd.com and will be archived on the Brocade Investor Relations website.

Brocade Q1 FY 2014 Earnings 2/13/2014

Prepared comments provided by Lloyd Carney, CEO

Brocade Q1 FY 2014 Earnings 2/13/2014

This was a solid quarter for Brocade in which we achieved revenue of $565M and non-GAAP EPS of $0.24, exceeding our expectations in both areas. Non-GAAP gross margin and non-GAAP operating margin were both company records. With strong cash flow in the quarter, we repurchased $140M of our common stock at an average price of $8.42, executing to the plan we outlined at our Analyst and Technology Day last September of returning a minimum of 60% of free cash flow to shareholders.

We saw healthy demand for our Storage Area Networking (SAN) products in the quarter, underscoring the business recovery in the storage market. IP Networking revenue was lower year-over-year but within the range of our outlook. We continued to see growth in our Ethernet fabric sales, where customer interest and sales activity remain high. Brocade VDX sales were up 61% Yr./Yr. as both enterprise and service provider customers implement next-generation networks to support their increasingly virtualized data centers.

During the quarter we announced the sale of our network adapter business to QLogic, reinforcing our strategy to focus on our core businesses and to be the network provider of choice to the world’s data centers.

From the day I started at Brocade, my top priority has been customer satisfaction. An integral part of this is providing world-class customer support. I am very pleased that we received the award for Certified Technology Service and Support (CTSS) from J.D. Power and Associates during the quarter. To achieve certification, an organization must attain customer satisfaction scores among the top 20 percent of companies nationwide that offer technology support. This is based on J.D. Power's extensive technology industry benchmark customer satisfaction research. The organization must also pass a detailed audit of its support practices, policies, and procedures. This recognition, combined with the TSIA certifications we received in 2013, underscores and validates our commitment to providing an outstanding customer experience.

I’ll now cover the quarterly highlights in greater detail, starting with a recap of our SAN business.

Brocade Q1 FY 2014 Earnings 2/13/2014

During the first quarter, we saw strong performance in our SAN business with sequential growth of 10%, exceeding our expectations. Recent storage product launches that leverage our Gen 5 Fibre channel technologies, drove improved revenue performance in the quarter. In addition, we continue to see solid demand from emerging markets, such as Russia and China, where SAN is increasingly viewed as a key technology for new data center build-outs.

We are also seeing Fibre Channel momentum in high-growth storage technology markets, namely solid state disks, or SSDs. Some of our OEMs, as well as other storage vendors, have released SSD-based storage arrays that include Fibre Channel connectivity. Fibre Channel uniquely delivers high-bandwidth capability, rapid data accessibility, and superior reliability, which are all critical requirements to optimize the use of SSDs. This was validated by a recently published report by the Evaluator Group, in which testing found that heavily-utilized SSD storage environments function to their highest levels with Fibre Channel connectivity. Additionally, Fibre Channel delivered superior availability, while reducing cabling, complexity, and other management costs compared to FCoE.

In Q1, Gen 5 product sales represented 71% of director and switch product shipments, demonstrating the continued healthy adoption of this technology. Brocade’s Gen 5 solutions offer differentiated features and functionality that highlight our continuing leadership in this market. In fact, Brocade’s Fabric Vision technology, launched in FY13, has been nominated for Storage Magazine’s Product of the Year award, in the storage management category.

We continued to strengthen the SAN ecosystem by collaborating closely with industry associations and vendors within the industry. For example, this week the Fibre Channel Industry Association (FCIA) provided an update on the industry’s progress on Gen 6 Fibre Channel, referring to the technology as the next generation of Fibre Channel designed to address performance, reliability, and scalability requirements for hyper-scale virtualization, SSD storage technology, and new data center architectures. The FCIA also announced that solutions are expected to be broadly available in 2016.

Brocade Q1 FY 2014 Earnings 2/13/2014

IP Networking revenue was at the low end of the range we provided for the quarter. We continue to make progress towards our strategy to be the network provider of choice to the world's data centers. During Q1 14, an estimated 59% of our IP Networking revenue came from data center-related deployments, an increase in the mix of our IP business from an estimated 53% in Q4 13 and 48% in Q1 13.

We were pleased with our performance in Ethernet fabrics-related products, with Brocade VDX product revenue growth of 61% Yr./Yr. The continued growth is a good indicator that our customers are investing in Ethernet fabric technology as the platform to support existing and emerging requirements in their data centers including virtualization, network functions virtualization (NFV), and SDN. With our broad Ethernet fabric product portfolio, Brocade is in an excellent position to capitalize on these network-based transformations underway in the data center.

On the software networking product front, we moved to beta testing on our Brocade Vyatta 5600 vRouter during the quarter. This is the first virtualized router on the market for telco-class networks, and we believe that it is up to 40 times faster than competitive virtual routing products. Brocade’s virtual routing capabilities provide the required performance for NFV, enabling meaningful capital expenditures and operating expense savings as well as improvements in network service agility and time-to-service.

Brocade Q1 FY 2014 Earnings 2/13/2014

Data center networking is undergoing a technology transition that includes fabrics, SDN, and NFV. These technologies are playing an increasingly important role in the buying decisions of IP Networking customers and offer new selling opportunities for Brocade. Further, we are beginning to see increased customer engagement as a result of our open and differentiated capabilities in these areas.

For example, during Q1 we deployed an SDN solution within the University of Florida’s core network that connects the institution's supercomputer with external research networks, such as Internet2. The university's deployment of the OpenFlow-supported Brocade MLXe 100 GbE router provides it with the necessary performance to enable its research and a roadmap that supports SDN and Big Data. We expect that this is just one of many hybrid use cases where software and hardware networking function seamlessly together.

Similarly, NFV and SDN are becoming crucial vendor capabilities as Tier-1 service providers accelerate their move to these technologies, enabling the adoption of a more cloud-based architecture while reducing capital expenses. With our leadership in NFV, Brocade is being invited to respond to numerous RFIs, providing new inroads into large, prominent customers. In fact, we are currently working with five of the top ten service providers worldwide. Further, with an emphasis on disruptive technologies, these initiatives provide a more level playing field where incumbent strength is neutralized. The clearest evidence of this is AT&T’s announcement of the new Supplier Domain 2.0 last September, which highlights openness to new players and technologies.

With our continuing focus on SDN and NFV, we expect to expand our technology leadership. Currently, we are investing to increase our expertise in software networking by expanding our technology team and recruiting top engineering talent. We believe that these technologies will continue to rise to meet the evolving customer requirements and we are firmly committed to leading the market.

Brocade Q1 FY 2014 Earnings 2/13/2014

In summary, we continue to execute on our data center-focused strategy and build our expertise in emerging technologies. We believe in the longevity of our SAN business underscored by the continued customer adoption of our Gen 5 solutions and use of Fibre Channel technology in emerging storage technologies, such as SSD-based storage arrays.

We are a market leader in data center fabrics, software networking, and open architectures, and these technologies are beginning to play a more prominent role in purchasing decisions in IP Networking.

We have made great progress in driving efficiency and improved profitability in our business, which should continue to allow us to deploy our resources in the areas that will contribute to our growth and success.

Brocade Q1 FY 2014 Earnings 2/13/2014

Prepared comments provided by Dan Fairfax, CFO

Brocade Q1 FY 2014 Earnings 2/13/2014

In Q1 14, revenue was $565M, a decrease of 4% Yr./Yr. and up 1% sequentially. SAN product revenue was $356M in the quarter, a decrease of 2% Yr./Yr. SAN product revenue continued to strengthen in Q1 14 and was up 10% sequentially. SAN product revenue represented 63% of total revenue, compared to 58% in Q4 13 and 61% in Q1 13.

Revenue from our IP Networking products in Q1 14 was $120M, down 15% Yr./Yr. and down 17% sequentially. The year-over-year decline was due to lower revenues from our U.S. Federal government, U.S. enterprise, and Japan customers, and was partially offset by growth in the APAC and EMEA regions. IP Networking product revenue represented 21% of total revenue in Q1, decreasing from 26% in Q4 13 and 24% in Q1 13.

Q1 14 Global Services revenue was $89M, up 3% Yr./Yr. and down 1% sequentially. Our Global Services revenue represented 16% of total Q1 revenue, relatively unchanged quarter-over-quarter and year-over-year.

Non-GAAP gross margin was a record 67.7% in Q1 14, up 170 basis points from Q1 13 and up 50 basis points from Q4 13. The year-over-year improvement in gross margin was due to a favorable revenue mix shift to more SAN products, a favorable product and customer mix within the IP Networking business, and lower manufacturing and overhead costs. The sequential improvement in gross margin was primarily due to a more favorable mix to SAN products. Non-GAAP operating margin was 27.9% in Q1, also a record, up 440 basis points from Q1 13 and up 130 basis points Qtr./Qtr. due to improved gross margins and lower spending.

Q1 14 GAAP diluted EPS was $0.18, up from a loss of $0.05 in Q1 13 and up from $0.14 in Q4 13. Non-GAAP diluted EPS was $0.24 in the quarter, up from $0.21 in Q1 13 and flat with Q4 13. In Q1 14 the effective GAAP tax rate was 27.1% and the effective non-GAAP tax rate was 26.1%.

In Q1 14 we generated $109M in operating cash flow, up 85% Yr./Yr. and down 36% Qtr./Qtr. The year-to-year increase in operating cash flow was primarily due to increased operating profits and the timing of payments for employee incentives. The reduction in operating cash flow from Q4 13 was due to the payment in Q1 2014 of employee incentive compensation earned during fiscal 2013 as well as an increase in the amount of the excess tax benefit from stock-based compensation.⁽²⁾ Non-GAAP average diluted shares outstanding for Q1 2014 were 454 million shares, down 3% year-over-year and down 1% quarter-over-quarter.

(2) Prior to fiscal 2014, available non-stock-based compensation net operating losses (NOLs) and credits were first applied to reduce our tax liability. During Q1 14, we utilized all available non-stock-based compensation NOLs that are not subject to limitation, resulting in increased utilization of excess tax benefits from stock-based compensation, which increased the amount reclassified to cash flows from financing activities.

Brocade Q1 FY 2014 Earnings 2/13/2014

For our total SAN business, including hardware products and SAN-based support and services, Q1 14 revenue was $412M, down 1% from Q1 13 and up 8% sequentially.

We saw strength in our SAN product revenue in the quarter from recent storage array product launches from our OEM partners. Our Gen 5 products represented 71% of director and switch revenue during the quarter compared with 69% in Q4 13 and 42% in Q1 13.

SAN product revenue was $356M in the quarter, down 2% Yr./Yr. and up 10% sequentially. In

looking at the SAN product families, director revenue was down 4% Yr./Yr. and up 14% sequentially and switch revenue was down 3% Yr./Yr. and up 8% Qtr./Qtr. Our Server product group, including embedded switches and server adapter products, achieved revenue of $49M, up 8% Yr./Yr. and up 4% Qtr./Qtr.

SAN-based support and services revenue was $56M in the quarter, up 2% Yr./Yr. and flat

Qtr./Qtr.

Brocade Q1 FY 2014 Earnings 2/13/2014

For our total IP Networking business, including hardware and IP-based support and services, Q1 14 revenue was $153M, down 11% Yr./Yr. and down 15% sequentially. Our first quarter is a seasonally down quarter due to the fact that our U.S. Federal customers place more orders during our fiscal third and fourth quarters. Our Federal revenue was approximately $13M in the quarter, down 44% Qtr./Qtr. and 49% Yr./Yr.

Q1 14 IP Networking product revenue was $120M, down 15% Yr./Yr. and down 17% Qtr./Qtr. As we look at the product splits for IP Networking in the quarter, our routing products generated $47M in revenue, down 11% Yr./Yr. and 14% Qtr./Qtr. Ethernet switch revenue, which includes products for the data center and campus LAN environments, generated revenue of $64M, down 21% Qtr./Qtr. and 7% Yr./Yr. Our switch revenue includes Brocade VDX products, which were up 21% Qtr./Qtr. and 61% Yr./Yr.

Other IP Networking revenue of $9M was down 53% Yr./Yr. and 11% Qtr./Qtr. on lower Brocade ADX sales and from the shift in our focus to the data center. IP Networking-based support and services revenue was $33M in the quarter, up 5% Yr./Yr. and down 3% sequentially.

Turning to data center networking, we are pleased with the progress we are making in realigning to our strategic focus of the business. Although it is difficult to identify all end users and use cases due to our two-tier distribution channel, we are providing estimates of our data center business which we update as we get better information. Our data center customers represented approximately 59% of IP Networking revenue in Q1 14, compared to 53% in Q4 13 and 48% in Q1 13. Other use cases, such as enterprise campus and carrier networks (MAN/WAN), represent the balance of the business.

Public sector revenue, including U.S. Federal, state, local, and other government entities including education, represented approximately 21% of our IP networking revenue in Q1 14, down from 32% in Q1 13. The year-over-year decline is principally due to lower orders received from our Federal customer base.

From a geographic viewpoint, the Americas (excluding Federal) was down approximately 6% Yr./Yr., the EMEA region grew 2% Yr./Yr., the APAC region grew 25% Yr./Yr., and the Japan region was down 28%. On a sequential basis, the Americas (excluding Federal) region was down 15%, EMEA was up 6%, APAC was down 19%, and Japan was up 20%.

Brocade Q1 FY 2014 Earnings 2/13/2014

In Q1 14, four of our customers (EMC, HDS, HP , and IBM) each contributed at least 10% of the total

company revenue. Our 10% customers collectively contributed 57% of revenue in Q1 14, up

11% from Q4 13 and Q1 13. All other OEMs represented 13% of revenue in Q1 14, down 6% from Q4 13 and down 8% from Q1 13 when HDS was not a 10% customer. Channel and direct routes to market contributed 30% of revenue in Q1 14, down 5% from Q4 13 and down 3% from Q1 13.

The mix of business based on ship-to location was 57% domestic and 43% international in the

quarter, a lower domestic share compared with 62% in Q4 13 and Q1 13. 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 Q1 FY 2014 Earnings 2/13/2014

Q1 14 non-GAAP company gross margin of 67.7% exceeded our original guidance range for the

quarter due in part to a more favorable SAN product mix and higher overall revenue.

Q1 14 non-GAAP product gross margin was 69.4%, above our FY14 target model range of 66.0% to 68.0%. This represents an increase of approximately 90 basis points from Q4 13 and 160 basis points from Q1 13 due to favorable segment mix, improving IP Networking margins, and lower manufacturing overhead spending. Q1 14 non-GAAP SAN product gross margin was in the mid-70's essentially flat quarter-over-quarter and year-over-year. Q1 14 non-GAAP IP Networking product gross margin was in the mid-50‘s, slightly down quarter-over-quarter but up year-over-year.

Non-GAAP Global Services gross margin was 58.9% in Q1 14, down 170 basis points quarter-over-quarter due to slightly higher spending and lower revenue. Non-GAAP Global Services gross margin was up approximately 340 basis points year-over-year based on lower spending.

Brocade Q1 FY 2014 Earnings 2/13/2014

Non-GAAP gross margin was 67.7% in Q1 14 which was higher than our FY14 target model of 65.0% to 66.0%. The increase in the mix of our total product revenue to SAN revenue and lower IP revenue was the principal reason we outperformed on non-GAAP gross margin.

On a non-GAAP basis, total operating expenses were $225M, or 39.8% of revenues in Q1 14,

which is slightly better than our FY14 target model range of 40.0% to 42.0%.

Ending headcount was 4,077 in Q1 14, down 92 from 4,169 in Q4 13, which excludes 224 employees that were notified of their termination during Q4, but were still on Brocade payroll as of the end of the fiscal year.

Non-GAAP operating margin was 27.9% in Q1 14, an increase of 440 basis points compared with Q1 13 and 130 basis points higher compared with Q4 13. This represents a company record and better than our FY14 target model of 23.0% to 25.0%.

Brocade Q1 FY 2014 Earnings 2/13/2014

Operating cash flow was $109M in Q1 14, up 85% Yr./Yr. and down 36% sequentially.

The increase in cash flow from the prior year was primarily due to increased GAAP

net income for Q1 14 versus Q1 13. We typically see lower cash from operations in

our first fiscal quarter as compared with our fourth fiscal quarter due to timing of payments for employee incentives and the semi-annual payment of the interest on our outstanding notes.

In addition, we saw an increase in our excess tax benefit for stock-based compensation in Q1 14. The excess tax benefit resulted in a decrease of operating cash flow and an offsetting increase in cash flows from financing activities for Q1 14 of $14M as compared to an increase of $4M in Q4 13 and a decrease of $2M in Q1 13. We describe the tax impact of the excess tax benefit from stock-based compensation in the appendix.

Total capital expenditures in the quarter were $13M. Cash and cash equivalents were $999M, up $12M from Q4 13 and up $315M from Q1 13.

We repurchased $140M of common stock during Q1 14, and we have repurchased $31M of

common stock as of February 13, 2014 during Q2 14.

Brocade Q1 FY 2014 Earnings 2/13/2014

Looking forward to Q2 14, we considered a number of factors, including the following, in setting our outlook:

• As we modeled our business in Q2 14, we took into account the impact of the divestiture of the network adapter business, the discontinuation of the wireless business, as well as the de-emphasis of other product lines. The estimated total revenue impact of these actions was $15M compared with the historical quarterly run rate.

• FY14 is a 53-week year and Q2 14 is a 14-week quarter in which we expect to incur an extra week of spending.

• For Q2 14, we expect SAN revenue to be down 10% to 13% Qtr./Qtr. The strength in our Q1 14 SAN revenue coupled with the public commentary from the storage array vendors lead us to guide our Q2 SAN revenue lower than typical seasonality. The first half of fiscal 2014 SAN product revenue (Q1 14 actual plus Q2 14 outlook) is within the FY14 operating model presented at our September 25, 2013 Analyst Day.

• We expect our Q2 14 IP Networking revenue to be flat to up 7% Qtr./Qtr. as we expect a modest recovery in the Americas region including U.S. Federal.

• We expect non-GAAP operating expenses to be up 2% to 3% Qtr./Qtr. which is reflective of the impact of an extra week of expense for this 14-week quarter.

• At the end of Q1 14, OEM inventory was approximately 1.4 weeks of supply based on SAN business revenue. While we expect inventory to be between one to two weeks in Q2 14, 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 tax rate of 26% to 28% for Q2 14. Discrete events can impact our tax rate from time to time.

• We expect Q2 14 operating cash flow to be higher sequentially due to the timing of variable compensation payments and interest payments on the bonds.

• We expect Q2 14 non-GAAP gross margin to be 65.5% to 66.0%, within our two-year target model range, and non-GAAP operating margin to be at 21.5% to 23.0%, slightly lower than our two-year target model range.

• As we look at FY14, we continue to plan our business in accordance with the operating and cash flow model we presented at our September 25, 2013 Analyst Day.

Brocade Q1 FY 2014 Earnings 2/13/2014

Prepared comments provided by Ben Jones, Investor Relations

That concludes Brocade’s prepared comments. At 2:30 p.m. Pacific Time on February 13, Brocade will host a webcast conference call at www.brcd.com.

Thank you for your interest in Brocade.

Brocade Q1 FY 2014 Earnings 2/13/2014

Brocade Q1 FY 2014 Earnings 2/13/2014

Additional Financial Information:



	Q1 13		Q4 13		Q1 14
GAAP gross margin	63.5	%	64.9	%	66.0	%
Non-GAAP gross margin	66.0	%	67.2	%	67.7	%

GAAP product gross margin	65.3	%	66.1	%	67.7	%
Non-GAAP product gross margin	67.8	%	68.5	%	69.4	%

GAAP services gross margin	53.3	%	58.8	%	57.2	%
Non-GAAP services gross margin	55.5	%	60.6	%	58.9	%

GAAP operating margin	15.8	%	15.0	%	21.5	%
Non-GAAP operating margin	23.5	%	26.6	%	27.9	%

Brocade Q1 FY 2014 Earnings 2/13/2014

Brocade Q1 FY 2014 Earnings 2/13/2014

Brocade Q1 FY 2014 Earnings 2/13/2014