Current Report





UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 8-K
 
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
Date of report (Date of earliest event reported): May 22, 2014
 
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)
130 Holger Way
San Jose, CA 95134-1376
(Address, including zip code, of principal executive offices)
(408) 333-8000
(Registrant’s telephone number, including area code)
Not Applicable
(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 May 22, 2014 , Brocade Communications Systems, Inc. (the “Company”) issued a press release regarding financial results for the second quarter ended May 3, 2014 . 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 third quarter of fiscal year 2014 . 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.
(d) Exhibits.

Exhibit
Number
Description of Document
99.1
Press release, dated May 22, 2014 , regarding financial results of Brocade Communications Systems, Inc. for the second quarter ended May 3, 2014 .
99.2
Slides with accompanying prepared remarks of Brocade Communications Systems, Inc., dated May 22, 2014 , regarding financial results of the second quarter ended May 3, 2014 and forward-looking statements, including statements relating to the Company’s estimated financial results of the third quarter of fiscal year 2014 .






SIGNATURES
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:
May 22, 2014
 
 
 
By:
 
/s/ Daniel W. Fairfax
 
 
 
 
 
 
 
Daniel W. Fairfax
 
 
 
 
 
 
 
Chief Financial Officer and Vice President, Finance




Exhibit 99.1
BROCADE CONTACTS
 
 
Public Relations
John Noh
Tel: 408-333-5108
jnoh@brocade.com
Investor Relations
Ben Jones
Tel: 408-333-6601
bjones@brocade.com
Brocade Reports Fiscal Q2 2014 Results
Board of Directors Initiates Cash Dividend

SAN JOSE, Calif., May 22, 2014 — Brocade ® (NASDAQ: BRCD) today reported financial results for its second fiscal quarter ended May 3, 2014 . Brocade reported second quarter revenue of $537 million , flat year-over-year and down 5% quarter-over-quarter. The company reported a GAAP loss per share of $(0.03) , compared with a profit of $0.10 per share in Q2 2013 . The GAAP loss was due to an $83 million non-cash goodwill impairment charge associated with the strategic repositioning of the ADX product family. More information on this subject is provided in the highlights section below. Non-GAAP diluted EPS was $0.19 , up from $0.17 in Q2 2013 , principally due to higher gross margins and lower operating expenses.

“This was a solid quarter for Brocade in which our Storage Area Networking (SAN) revenue grew year-over-year and our refocused IP Networking business made good progress in the quarter,” said Lloyd Carney, CEO of Brocade.  “We see increasing customer interest in our software networking and Ethernet fabric technology as we drive innovation and disruption in data center networking. We are also pleased to report that our Board has approved the initiation of a quarterly cash dividend of $0.035 per share to be paid in Q3 2014."

Key Financial Metrics:
 
Q2 2014
 
Q1 2014
 
Q2 2013
Q2 2014 vs. Q1 2014
Q2 2014 vs. Q2 2013
Revenue
$
537
M
 
$
565
M
 
$
539
M
(5
%)
%
GAAP EPS—diluted
$
(0.03
)
 
$
0.18

 
$
0.10

(118
%)
(131
%)
Non-GAAP EPS—diluted
$
0.19

 
$
0.24

 
$
0.17

(19
%)
16
%
GAAP gross margin
66.0
%
 
66.0
%
 
62.0
%

4.0 pts

Non-GAAP gross margin
66.7
%
 
67.7
%
 
65.1
%
(1.0) pts

1.6 pts

GAAP operating margin
3.8
%
 
21.5
%
 
10.6
%
(17.7) pts

(6.8) pts

Non-GAAP operating margin
23.2
%
 
27.9
%
 
19.0
%
(4.7) pts

4.2 pts

Cash provided by operations
$
168
M
 
$
109
M
 
$
120
M
54
%
41
%
Share Repurchases
$
50
M
 
$
140
M
 
$
39
M
(64
%)
30
%

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

Highlights:
SAN business revenue, including products and services, was $379 million , up 1% year-over-year and down 8% sequentially. The year-over-year growth was primarily due to higher sales within the switch and embedded products as well as increased support revenue. The sequential decline was slightly better than expected in a seasonally soft quarter for many OEM partners of Brocade.
IP Networking business revenue, including products and services, was $157 million , down 4% year-over-year and up 3% sequentially. The year-over-year decline was due to lower sales to the U.S. Federal government, the divestiture of the network adapter business, and the change in the Company's wireless business strategy. The sequential increase was principally due to higher sales of Ethernet switching products as well as increased support revenue. During Q2 2014, an estimated 57% of IP Networking product revenue came from data center customers, up 7 pts year-over-year and down 2 pts sequentially. The estimated percentage of revenue coming from data center IP Networking customers may fluctuate quarter-to-quarter due to the timing of large data center customer transactions.

Page 1 of 11



As part of the Company's previously communicated strategy to focus on the data center and other key technology segments, the Company made a strategic shift during Q2 2014 to reduce investment in the hardware-based ADX products and to increase investment in the software-based ADX products for the Layer 4-7 market. As a result of this change in strategy, the Company expects hardware-based ADX and related support revenue to be negatively impacted by $20 million to $40 million on an annualized basis compared with fiscal 2013 results. The Company recognized a related $83 million non-cash goodwill impairment charge in Q2 2014.
The $83 million goodwill impairment charge is non-deductible for tax purposes resulting in the Company's effective GAAP tax provision rate being significantly higher in Q2 2014. In addition, the effective GAAP and non-GAAP tax provision rates for Q2 2014 were higher than Q2 2013 due to the R&D tax credit that expired on December 31, 2013 and has not been extended by Congress.
The Brocade Board of Directors has initiated a quarterly cash dividend of $0.035 per share of the Company's common stock. The first dividend payment will be made on July 2, 2014 to stockholders of record as of the close of market on June 10, 2014. Future dividend payments are subject to review and approval by the Board of Directors.
Brocade management will host a conference call to discuss the fiscal second quarter results and the fiscal third 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 Q2 2014 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

Page 2 of 11


Financial Highlights and Additional Financial Information
 
Q2 2014
 
Q1 2014
 
Q2 2013
Routes to market as a % of total net revenues:
 
 
 
 
 
OEM revenues
68
%
 
70
%
 
66
%
Channel/Direct revenues
32
%
 
30
%
 
34
%
10% or greater customer revenues
56
%
 
57
%
 
45
%
Geographic split as a % of total net revenues (1) :
 
 
 
 
 
Domestic revenues
59
%
 
57
%
 
58
%
International revenues
41
%
 
43
%
 
42
%
Segment split as a % of total net revenues:
 
 
 
 
 
SAN product revenues
60
%
 
63
%
 
59
%
IP Networking product revenues
22
%
 
21
%
 
25
%
Global Services revenues
18
%
 
16
%
 
16
%
SAN business revenues (2)
71
%
 
73
%
 
69
%
IP Networking business revenues (2)
29
%
 
27
%
 
31
%
IP Networking Business Revenue by Use Category (3) :
 
 
 
 
 
Data Center (4)
57
%
 
59
%
 
50
%
Enterprise Campus
37
%
 
34
%
 
36
%
Carrier Network (MAN/WAN)
6
%
 
7
%
 
14
%
Additional information:
Q2 2014
 
Q1 2014
 
Q2 2013
GAAP net income (loss)
$
(14
)M
 
$
81
M
 
$
47
M
Non-GAAP net income
$
87
M
 
$
109
M
 
$
78
M
GAAP operating income
$
20
M
 
$
121
M
 
$
57
M
Non-GAAP operating income
$
124
M
 
$
158
M
 
$
103
M
Adjusted EBITDA (5)
$
146
M
 
$
184
M
 
$
120
M
Effective GAAP tax provision (benefit) rate
225.1
%
 
27.1
%
 
(0.4
%)
Effective Non-GAAP tax provision rate
24.6
%
 
26.1
%
 
15.9
%
Cash and cash equivalents
$
1,138
M
 
$
999
M
 
$
764
M
Deferred revenues
$
304
M
 
$
298
M
 
$
302
M
Capital expenditures
$
14
M
 
$
13
M
 
$
13
M
Total debt, net of discount
$
598
M
 
$
599
M
 
$
599
M
Cash, net of senior debt and capitalized leases
$
535
M
 
$
395
M
 
$
159
M
Days sales outstanding
35 days
 
35 days
 
40 days
Employees at end of period
4,061
 
4,077
 
4,648
SAN port shipments
1.1
M
 
1.2
M
 
1.0
M
Please see important note of explanation on non-GAAP financial measures below, including a detailed reconciliation between GAAP and non-GAAP information in the tables included herein.
1)  
Revenues are attributed to geographic areas based on product delivery location. Since some OEM partners take delivery of Brocade products domestically and then ship internationally to their end-users, the percentage of international revenues based on end-user location would likely be higher.
2)  
SAN and IP Networking business revenues include product, support, and services revenues.
3)  
Business revenue by use category split is estimated based on the analysis of the information the Company collects in its sales management system.
4)  
Data Center includes enterprise, service provider, and government data center revenues.
5)  
Adjusted EBITDA is as defined in the Company's Credit Agreement.


Page 3 of 11


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, but are not limited to: (i) legal provision or recovery associated with certain pre-acquisition litigation, (ii) call premium cost and write-off of original issue discount and debt issuance costs related to lenders that did not participate in refinancing, (iii) settlement gain associated with certain pre-acquisition-related litigation, (iv) restructuring, goodwill impairment, and other related costs, net, (v) gain on sale of network adapter business and (vi) specific non-cash and non-recurring tax benefits or detriments.
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 also believes that the exclusion of expense associated with the amortization of acquisition-related intangible assets is appropriate 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.

Page 4 of 11


Cautionary Statement
This press release contains statements that are forward-looking in nature, including statements regarding Brocade’s strategy, operational performance and capital allocation. 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, Brocade’s ability to execute on its sale strategy, 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 “Item 1A. Risk Factors” in Brocade’s Annual Report on Form 10-K for the fiscal year ended October 26, 2013 . 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 (NASDAQ: BRCD) networking solutions help the world’s leading organizations transition smoothly to a world where applications and information reside anywhere. (www.brocade.com)
ADX, Brocade, Brocade Assurance, the B-wing symbol, DCX, Fabric OS, ICX, MLX, MyBrocade, OpenScript, VCS, VDX, and Vyatta are registered trademarks, and HyperEdge, The Effortless Network, and The On-Demand Data Center are trademarks of Brocade Communications Systems, Inc., in the United States and/or in other countries. Other brands, products, or service names mentioned may be trademarks of their respective owners.

© 2014 Brocade Communications Systems, Inc. All Rights Reserved.


Page 5 of 11


BROCADE COMMUNICATIONS SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
 
Three Months Ended
 
Six Months Ended
 
May 3,
2014
 
April 27,
2013
 
May 3,
2014
 
April 27,
2013
 
(In thousands, except per-share amounts)
Net revenues
 
 
 
 
 
 
 
Product
$
442,280

 
$
451,746

 
$
917,485

 
$
953,993

Service
94,630

 
87,038

 
183,960

 
173,520

Total net revenues
536,910

 
538,784

 
1,101,445

 
1,127,513

Cost of revenues
 
 
 
 
 
 
 
Product
142,271

 
164,599

 
295,898

 
338,974

Service
40,347

 
40,073

 
78,585

 
80,502

Total cost of revenues
182,618

 
204,672

 
374,483

 
419,476

Gross margin
354,292

 
334,112

 
726,962

 
708,037

Operating expenses:
 
 
 
 
 
 
 
Research and development
90,554

 
98,429

 
177,710

 
196,119

Sales and marketing
139,597

 
145,316

 
272,262

 
294,327

General and administrative
21,112

 
20,037

 
41,255

 
39,114

Amortization of intangible assets
131

 
13,151

 
10,014

 
28,007

Restructuring, goodwill impairment, and other related costs
82,703

 

 
88,920

 

Gain on sale of network adapter business

 

 
(4,884
)
 

Total operating expenses
334,097

 
276,933

 
585,277

 
557,567

Income from operations
20,195

 
57,179

 
141,685

 
150,470

Interest expense
(9,234
)
 
(10,432
)
 
(18,430
)
 
(36,800
)
Interest and other income (loss), net
(20
)
 
31

 
(1,356
)
 
97

Income before income tax
10,941

 
46,778

 
121,899

 
113,767

Income tax expense (benefit)
24,625

 
(171
)
 
54,699

 
88,073

Net income (loss)
$
(13,684
)
 
$
46,949

 
$
67,200

 
$
25,694

Net income (loss) per share—basic
$
(0.03
)
 
$
0.10

 
$
0.15

 
$
0.06

Net income (loss) per share—diluted
$
(0.03
)
 
$
0.10

 
$
0.15

 
$
0.06

Shares used in per-share calculation—basic
436,167

 
453,133

 
438,370

 
453,988

Shares used in per-share calculation—diluted
436,167

 
466,919

 
451,999

 
466,620


Page 6 of 11


BROCADE COMMUNICATIONS SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
 
Three Months Ended
 
Six Months Ended
 
May 3,
2014
 
April 27,
2013
 
May 3,
2014
 
April 27,
2013
 
(In thousands)
Net income (loss)
$
(13,684
)
 
$
46,949

 
$
67,200

 
$
25,694

Other comprehensive income and loss, net of tax:
 
 
 
 
 
 
 
Unrealized gains (losses) on cash flow hedges:
 
 
 
 
 
 
 
Change in unrealized gains and losses
1,094

 
(1,915
)
 
170

 
(1,992
)
Net gains and losses reclassified into earnings
32

 
(32
)
 
1

 
(210
)
Net unrealized gains (losses) on cash flow hedges
1,126

 
(1,947
)
 
171

 
(2,202
)
Foreign currency translation adjustments
1,298

 
(1,762
)
 
475

 
(2,142
)
Total other comprehensive income (loss)
$
2,424

 
$
(3,709
)
 
646

 
(4,344
)
Total comprehensive income (loss)
$
(11,260
)
 
$
43,240

 
$
67,846

 
$
21,350


Page 7 of 11


BROCADE COMMUNICATIONS SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
May 3,
2014
 
October 26,
2013
 
(In thousands, except par value)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
1,137,613

 
$
986,997

Accounts receivable, net of allowances for doubtful accounts of $531 and $575 at May 3, 2014, and October 26, 2013, respectively
193,804

 
249,598

Inventories
40,773

 
45,344

Deferred tax assets
116,557

 
98,018

Prepaid expenses and other current assets
47,687

 
42,846

Total current assets
1,536,434

 
1,422,803

Property and equipment, net
452,722

 
472,940

Goodwill
1,556,733

 
1,645,437

Intangible assets, net
23,386

 
40,258

Non-current deferred tax assets
788

 
1,585

Other assets
38,846

 
38,368

Total assets
$
3,608,909

 
$
3,621,391

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
79,952

 
$
88,218

Accrued employee compensation
141,482

 
145,996

Deferred revenue
230,704

 
226,696

Current restructuring liabilities
2,876

 
16,418

Current portion of long-term debt
2,277

 
2,996

Other accrued liabilities
64,898

 
80,339

Total current liabilities
522,189

 
560,663

Long-term debt, net of current portion
595,452

 
596,208

Non-current restructuring liabilities
3,587

 
1,008

Non-current deferred revenue
72,956

 
76,426

Non-current income tax liability
46,271

 
38,680

Non-current deferred tax liabilities
31,124

 

Other non-current liabilities
1,583

 
1,593

Total liabilities
1,273,162

 
1,274,578

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: 435,452 and 445,285 shares at May 3, 2014, and October 26, 2013, respectively
436

 
445

Additional paid-in capital
1,836,249

 
1,915,152

Accumulated other comprehensive loss
(12,798
)
 
(13,444
)
Retained earnings
511,860

 
444,660

Total stockholders’ equity
2,335,747

 
2,346,813

Total liabilities and stockholders’ equity
$
3,608,909

 
$
3,621,391


Page 8 of 11


BROCADE COMMUNICATIONS SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
Three Months Ended
 
May 3,
2014
 
April 27,
2013
 
(In thousands)
Cash flows from operating activities:
 
 
 
Net income (loss)
$
(13,684
)
 
$
46,949

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Excess tax benefits from stock-based compensation
(13,080
)
 
(3,248
)
Depreciation and amortization
21,173

 
43,964

Loss on disposal of property and equipment
830

 
1,057

Amortization of debt issuance costs and original issue discount
285

 
268

Call premium cost related to lenders that did not participate in refinancing

 
(9,939
)
Provision for doubtful accounts receivable and sales allowances
1,961

 
2,206

Non-cash compensation expense
21,052

 
19,172

Goodwill impairment charge
83,382

 

Changes in assets and liabilities:
 
 
 
Restricted cash

 
11,926

Accounts receivable
22,495

 
(24,811
)
Inventories
2,473

 
6,980

Prepaid expenses and other assets
(11,857
)
 
(12
)
Deferred tax assets
(38
)
 
157

Accounts payable
951

 
268

Accrued employee compensation
27,470

 
18,407

Deferred revenue
5,987

 
6,405

Other accrued liabilities
22,869

 
93

Restructuring liabilities
(4,025
)
 
(227
)
Net cash provided by operating activities
168,244

 
119,615

Cash flows from investing activities:
 
 
 
Purchases of non-marketable minority equity investments
(223
)
 

Purchases of property and equipment
(14,429
)
 
(13,082
)
Net cash used in investing activities
(14,652
)
 
(13,082
)
Cash flows from financing activities:
 
 
 
Payment of principal related to senior secured notes

 
(300,000
)
Payment of debt issuance costs related to senior unsecured notes

 
(549
)
Payment of principal related to capital leases
(1,141
)
 
(491
)
Common stock repurchases
(50,052
)
 
(38,649
)
Proceeds from issuance of common stock
22,120

 
12,087

Excess tax benefits from stock-based compensation
13,080

 
3,248

Decrease in restricted cash

 
300,000

Net cash used in financing activities
(15,993
)
 
(24,354
)
Effect of exchange rate fluctuations on cash and cash equivalents
1,327

 
(1,497
)
Net increase in cash and cash equivalents
138,926

 
80,682

Cash and cash equivalents, beginning of period
998,687

 
683,616

Cash and cash equivalents, end of period
$
1,137,613

 
$
764,298



Page 9 of 11


BROCADE COMMUNICATIONS SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
Six Months Ended
 
May 3,
2014
 
April 27,
2013
 
(In thousands)
Cash flows from operating activities:
 
 
 
Net income
$
67,200

 
$
25,694

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Excess tax benefits from stock-based compensation
(27,415
)
 
(5,440
)
Non-cash tax charges

 
78,206

Depreciation and amortization
59,927

 
93,358

Loss on disposal of property and equipment
3,178

 
3,046

Gain on sale of network adapter business
(4,884
)
 

Amortization of debt issuance costs and original issue discount
566

 
665

Call premium cost and write-off of original issue discount and debt issuance costs related to lenders that did not participate in refinancing

 
5,360

Provision for doubtful accounts receivable and sales allowances
3,528

 
4,560

Non-cash compensation expense
39,640

 
38,322

Goodwill impairment charge
83,382

 

Changes in assets and liabilities:
 
 
 
Accounts receivable
52,266

 
(10,561
)
Inventories
4,570

 
16,605

Prepaid expenses and other assets
(8,371
)
 
(1,714
)
Deferred tax assets
57

 
322

Accounts payable
(7,126
)
 
(14,692
)
Accrued employee compensation
(11,738
)
 
(54,163
)
Deferred revenue
573

 
7,924

Other accrued liabilities
33,324

 
(7,969
)
Restructuring liabilities
(10,964
)
 
(418
)
Net cash provided by operating activities
277,713

 
179,105

Cash flows from investing activities:
 
 
 
Purchases of non-marketable minority equity investments
(223
)
 

Purchases of property and equipment
(27,395
)
 
(31,568
)
Net cash paid in connection with acquisition

 
(44,629
)
Proceeds from collection of note receivable
250

 

Proceeds from sale of network adapter business
9,995

 

Net cash used in investing activities
(17,373
)
 
(76,197
)
Cash flows from financing activities:
 
 
 
Proceeds from senior unsecured notes

 
296,250

Payment of principal related to senior secured notes

 
(300,000
)
Payment of debt issuance costs related to senior unsecured notes

 
(549
)
Payment of principal related to capital leases
(1,749
)
 
(975
)
Common stock repurchases
(190,432
)
 
(86,179
)
Proceeds from issuance of common stock
54,530

 
35,899

Excess tax benefits from stock-based compensation
27,415

 
5,440

Net cash used in financing activities
(110,236
)
 
(50,114
)
Effect of exchange rate fluctuations on cash and cash equivalents
512

 
(1,722
)
Net increase in cash and cash equivalents
150,616

 
51,072

Cash and cash equivalents, beginning of period
986,997

 
713,226

Cash and cash equivalents, end of period
$
1,137,613

 
$
764,298


Page 10 of 11


BROCADE COMMUNICATIONS SYSTEMS, INC.
RECONCILIATION BETWEEN GAAP AND NON-GAAP FINANCIAL MEASURES
(Unaudited)
 
Three Months Ended
 
May 3,
2014
 
January 25,
2014
 
April 27,
2013
 
(In thousands, except per share amounts)
Non-GAAP adjustments
 
 
 
 
 
Stock-based compensation expense included in cost of revenues
$
3,474

 
$
3,142

 
$
3,541

Amortization of intangible assets expense included in cost of revenues
396

 
6,462

 
9,651

Provision associated with certain pre-acquisition litigation

 

 
3,460

Total gross margin impact from non-GAAP adjustments
3,870

 
9,604

 
16,652

 
 
 
 
 
 
Stock-based compensation expense included in research and development
4,422

 
4,336

 
4,500

Stock-based compensation expense included in sales and marketing
8,462

 
6,765

 
8,012

Stock-based compensation expense included in general and administrative
4,694

 
4,345

 
3,119

Amortization of intangible assets expense included in operating expenses
131

 
9,883

 
13,151

Restructuring, goodwill impairment, and other related costs
82,703

 
6,217

 

Gain on sale of network adapter business

 
(4,884
)
 

Total operating income impact from non-GAAP adjustments
104,282

 
36,266

 
45,434

 
 
 
 
 
 
Income tax effect of non-tax adjustments
(3,685
)
 
(8,366
)
 
(14,814
)
Total net income impact from non-GAAP adjustments
$
100,597

 
$
27,900

 
$
30,620

 
 
 
 
 
 
Gross margin reconciliation
 
 
 
 
 
GAAP gross margin
$
354,292

 
$
372,670

 
$
334,112

Total gross margin impact from non-GAAP adjustments
3,870

 
9,604

 
16,652

Non-GAAP gross margin
$
358,162

 
$
382,274


$
350,764

GAAP gross margin, as a percent of Net revenues
66.0
%
 
66.0
%
 
62.0
%
Non-GAAP gross margin, as a percent of Net revenues
66.7
%
 
67.7
%
 
65.1
%
 
 
 
 
 
 
Operating income reconciliation
 
 
 
 
 
GAAP operating income
$
20,195

 
$
121,490

 
$
57,179

Total operating income impact from non-GAAP adjustments
104,282

 
36,266

 
45,434

Non-GAAP operating income
$
124,477

 
$
157,756

 
$
102,613

GAAP operating income, as a percent of Net revenues
3.8
%
 
21.5
%
 
10.6
%
Non-GAAP operating income, as a percent of Net revenues
23.2
%
 
27.9
%
 
19.0
%
 
 
 
 
 
 
Net income (loss) and net income (loss) per share reconciliation
 
 
 
 
 
Net income (loss) on a GAAP basis
$
(13,684
)
 
$
80,884

 
$
46,949

Total net income impact from non-GAAP adjustments
100,597

 
27,900

 
30,620

Non-GAAP net income
$
86,913

 
$
108,784

 
$
77,569

Non-GAAP net income per share — basic
$
0.20

 
$
0.25

 
$
0.17

Non-GAAP net income per share — diluted
$
0.19

 
$
0.24

 
$
0.17

Shares used in non-GAAP per share calculation — basic
436,167

 
440,573

 
453,133

Shares used in non-GAAP per share calculation — diluted
450,449

 
453,549

 
466,919



Page 11 of 11










Q2 FY 2014 Earnings




Prepared Comments and Slides

May 22, 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 Q2 FY 2014 Earnings    5/22/2014



Prepared comments provided by Ben Jones, Investor Relations

Thank you for your interest in Brocade's Q2 Fiscal 2014 earnings presentation, which includes prepared remarks, safe harbor, slides, and a press release detailing fiscal second 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.

© 2014 Brocade Communications Systems, Inc.     Page 2 of 27


Brocade Q2 FY 2014 Earnings    5/22/2014

 



© 2014 Brocade Communications Systems, Inc.     Page 3 of 27


Brocade Q2 FY 2014 Earnings    5/22/2014



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 May 22 at www.brcd.com and will be archived on the Brocade Investor Relations website.


© 2014 Brocade Communications Systems, Inc.     Page 4 of 27


Brocade Q2 FY 2014 Earnings    5/22/2014



Prepared comments provided by Lloyd Carney, CEO


© 2014 Brocade Communications Systems, Inc.     Page 5 of 27


Brocade Q2 FY 2014 Earnings    5/22/2014



This was another solid quarter for Brocade. Our SAN business grew year-over-year and we continued to execute against our strategic goals of focused innovation, increased efficiency, and profitability.

SAN product revenue grew 1% Yr./Yr. and business trends continue to improve. We saw healthy demand for our SAN products, coupled with strong shipment linearity throughout the quarter.

IP Networking product revenue was lower year-over-year, but within the range of the outlook for the quarter. We continue to focus on building on our #2 position in terms of revenue share within data center networking and disrupting the traditional hardware-oriented network with innovative software offerings and modern fabrics.

As an example of our increasing software focus, we have made a decision to shift a greater portion of our ADX product development resources to our virtual solution. Our decision to do this is an indicator of our growing expertise and commitment to software networking, increasing interest among our customers, and significantly higher growth rates for the software version of the Application Delivery Controller market. This decision resulted in a non-cash goodwill impairment charge during the quarter, which is covered in more detail in Dan's commentary that follows.

We repurchased $50M of common stock during Q2, reflecting our commitment of returning a minimum of 60% of adjusted free cash flow to our shareholders. Year to date, we have met this commitment solely through our share repurchase program. Today, we are pleased to announce that our Board has authorized a cash dividend, beginning in Q3 14. The addition of a quarterly dividend will give us another avenue to return cash to our shareholders in a consistent way that many of you have told us you wanted.


© 2014 Brocade Communications Systems, Inc.     Page 6 of 27


Brocade Q2 FY 2014 Earnings    5/22/2014



SAN revenues exceeded our expectations for Q2 and reflect the strength of our industry leadership and the compelling advantages of Brocade Gen 5 Fibre Channel and FabricVision technology.

SAN product revenue for Q2 14 increased 1% Yr./Yr. When adjusted for the sale of the network adapter business, SAN product revenue increased 2% Yr./Yr.

Storage capacity expansion is a major pain point for IT organizations as they manage the ever-increasing growth of data. IDC estimates demand for Fibre Channel storage capacity is expected to grow at a 34% CAGR through 2017. The growth of data is highly correlated to the growth in both physical and virtualized servers, all of which must be connected to the network.

The Fibre Channel adapter market has been negatively impacted by the increase in virtualized servers while the Fibre Channel switching market will continue to grow. This growth is partly driven by traditional Fibre Channel-connected storage capacity. Industry research shows that storage administrators prefer Fibre Channel connectivity over other technologies to support virtualized data centers because of significant performance, automation and reliability advantages.

Emerging storage technologies are creating market expansion opportunities for Fibre Channel switching. For these applications, Fibre Channel offers the high-bandwidth capability, fast data accessibility, and superior reliability that are critical requirements. Brocade research indicates that more than 90% of standalone enterprise flash array systems connect via Fibre Channel. The ecosystem of flash array vendors that now support Fibre Channel connectivity includes major storage array suppliers such as EMC, HDS, HP, IBM, and NetApp, as well as new entrants such as PureStorage and Violin, with others planning to launch products this calendar year.

The latest Dell’Oro report showed Brocade’s calendar year market share grew from 69% in 2012 to 71% in 2013. Since the launch of our Gen 5 products in 2011, we have increased our market share by 4%. We are on track with the Gen 6 technology and expect initial shipments in the first-half of calendar 2016 .

© 2014 Brocade Communications Systems, Inc.     Page 7 of 27


Brocade Q2 FY 2014 Earnings    5/22/2014



IP Networking revenue met our expectations for the quarter despite continued challenges within the U.S. Federal business. Data center networking revenue accounted for an estimated 57% of our total IP Networking revenues and represented growth of approximately 4% Yr./Yr. Brocade VDX product revenue grew 22% year-over-year and continues to be our fastest growing data center hardware product line.

We expanded our Ethernet fabric offerings with the availability of multitenant solutions, the VCS Virtual Fabric, and support for 100 Gigabit Ethernet connectivity.

Multitenancy is a critical capability for cloud service providers and enterprises that offer Infrastructure as a Service (IaaS). It ensures that each tenant's traffic remains private while sharing a common infrastructure. In addition, new line cards for the Brocade VDX 8770 Switch enable a wider range of network topologies and broaden our capability to provide the high performance and density required for cloud optimized data center deployments.

In Q2 14 we made a strategic shift within the Brocade ADX product family to reduce our investment in the hardware-based platform while increasing investment in the software-based products. The virtual ADX will become part of our NFV portfolio. In making this shift, our aim is to align with the growing market trend to unlock the dependency between proprietary hardware and performance, allowing our customers to utilize the server platforms of their choice while obtaining the throughput and services they require, all within a virtualized environment. According to Dell'Oro Group, the Application Delivery Controller market revenue is expected to grow approximately 30% for software-based products through 2017, while growth rates are in the low single digits for hardware-based products.

During the quarter we launched a formalized trial program for the Brocade Virtual ADX and the Brocade Vyatta 5400 vRouter. As a result of this program, we saw a significant increase in the number of downloads compared with Q1, further seeding the market with our technology.

The Brocade Vyatta 5600 vRouter, became generally available in Q2 and is the first 10 Gigabit virtual router for carrier-class networks.

Finally, Brocade Network Subscription secured wins at a major financial services company and a global systems integrator during the quarter.


© 2014 Brocade Communications Systems, Inc.     Page 8 of 27


Brocade Q2 FY 2014 Earnings    5/22/2014



We remain excited about disruptive technologies like NFV and SDN which create opportunities in the networking industry. These new architectures break the closed, proprietary model that has long favored incumbency.

Vertical architectures are giving way to open solutions that allow customers to select best-of-breed technologies that enable new services and networks optimized for their own specific requirements. I can say without hesitation that “openness” is an integral part of nearly every discussion I have with customers and I firmly believe it is creating meaningful business opportunities for Brocade. Disruption in the data center is real and it is happening today.

For example, we are included in many RFIs from thought leaders in the service provider and enterprise space that we haven’t worked with previously, including a number of Tier-1 service providers around the world. We are excited to be one of a select number of companies in Telefonica’s NFV proof-of-concept project, in which we support the carrier-grade OpenStack virtualized infrastructure manager (VIM) and NFV infrastructure. And in April, Brocade was named the SDN Idol Winner at the Open Networking Summit where we demonstrated a real-time analytics solution for security mitigation.

Brocade remains committed to openness at the code, component, product, solution, and network levels. This is in stark contrast to our competitors and will differentiate us in the eyes of customers that seek to break free of vendor lock-in.

This commitment is demonstrated by our support of system architectures that include multi-vendor, best-of-breed components. We are actively involved in the foundational SDN and NFV-related initiatives and open source organizations, such as OpenDaylight, OpenStack, the Open Networking Foundation (ONF), the Internet Engineering Task Force (IETF), and the European Telecommunications Standards Institute (ETSI), providing technical and thought leadership to this rapidly evolving industry movement.

Last month we announced OpenFlow 1.3 support is planned to be available later this year across our entire IP routing and switching portfolio. Brocade technology allows service providers and enterprises to transition to SDN by enabling inter-working between SDN and non-SDN networks.

Brocade continues to expand its partner ecosystem. For example, earlier this month we announced a new solution with Ciena that provides dynamic resource provisioning for cloud networking. We are collaborating with Red Hat and Wind River on the development of carrier-class functionality for software-defined networking.

In total, emerging technologies such as fabrics, SDN, and NFV are playing an increasingly important role in customer discussions and buying decisions. Our commitment to open architectures and our differentiated capabilities are increasing customer engagements and creating new business opportunities. While this market is early in its formation, it is a key component of our growth strategy. 

© 2014 Brocade Communications Systems, Inc.     Page 9 of 27


Brocade Q2 FY 2014 Earnings    5/22/2014



In summary, this was another solid quarter for Brocade in which we executed against our strategic goals, met our financial objectives, and saw our SAN business grow year-over-year.

At the half-way mark of our fiscal 2014, Brocade is on track to meet the operating model we communicated at our September 2013 Analyst Day. In addition, we have already achieved more than 50% of the operating cash flow estimate for fiscal 2014. The continued strength of our operational performance and cash flow has enabled us to enhance our capital allocation program with the initiation of a cash dividend to be paid in Q3 14.

Our technology leadership and focus on the data center is continuing to drive new opportunities in our business. We will build on our #2 position in data center networking and focus on the world’s largest enterprise, telco and cloud service provider customers. We are confident that we have the right team, the right products, and the right strategy to take advantage of market trends that can drive our growth throughout this year and beyond.








© 2014 Brocade Communications Systems, Inc.     Page 10 of 27


Brocade Q2 FY 2014 Earnings    5/22/2014



Prepared comments provided by Dan Fairfax, CFO


© 2014 Brocade Communications Systems, Inc.     Page 11 of 27


Brocade Q2 FY 2014 Earnings    5/22/2014



In Q2 14, revenue was $537M , flat Yr./Yr. and down 5% sequentially. SAN product revenue was $321M in the quarter, an increase of 1% Yr./Yr. and down 10% sequentially in a seasonally soft quarter for some of our OEM partners. SAN product revenue represented 60% of total revenue, compared with 63% in Q1 14 and 59% in Q2 13.

Revenue from our IP Networking products in Q2 14 was $121M , down 9% Yr./Yr. and up 1% sequentially. The year-over-year decline was due to lower sales to the U.S. Federal government, the divestiture of the network adapter business, and the change in our wireless and Brocade ADX business strategies. The sequential increase was principally due to higher sales of Ethernet switching products. IP Networking product revenue represented 22% of total revenue in Q2, compared with 21% in Q1 14 and 25% in Q2 13.

Q2 14 Global Services revenue was $95M , up 9% Yr./Yr. and up 6% sequentially. The year-over-year and sequential increase was primarily due to Q2 14 being a 14-week quarter, which resulted in an extra week of amortized support revenue. Global Services revenue represented 18% of total Q2 revenue, compared with 16% in both Q1 14 and Q2 14.

Non-GAAP gross margin was 66.7% in Q2 14, up 160 basis points from Q2 13 and down 100 basis points from Q1 14. The year-over-year improvement in gross margin was due to lower manufacturing and overhead costs, a favorable revenue mix shift to more SAN products, and a favorable product and customer mix within the IP Networking business. The sequential decline was primarily due to seasonally lower volume, a less favorable revenue mix shift to less SAN products, and higher overhead costs due to the additional week of spending from the 14-week quarter. Non-GAAP operating margin was 23.2% in Q2, up 420 basis points from Q2 13 due to lower operating expenses and down 470 basis points from Q1 14 due to lower revenue and increased operating expense from the extra week in Q2 14.

As Lloyd mentioned, we have initiated a quarterly cash dividend of $0.035 per share of common stock to stockholders of record as of the close of market on June 10, 2014. Annualized, the dividend represents approximately 13% of our adjusted free cash flow target for FY14.


© 2014 Brocade Communications Systems, Inc.     Page 12 of 27


Brocade Q2 FY 2014 Earnings    5/22/2014




Q2 14 GAAP loss per share was $(0.03) , down from EPS of $0.10 in Q2 13 and $0.18 in Q1 14. Non-GAAP diluted EPS was $0.19 in the quarter, up from $0.17 in Q2 13 and down from $0.24 in Q1 14. The GAAP loss was due to an $83 million non-cash goodwill impairment charge associated with the Brocade ADX product family. During Q2 14, we made a strategic shift to reduce investment in the hardware-based ADX and to increase investment in the software-based ADX products for the Layer 4-7 market. As a result of this shift, we expect hardware-based ADX and related support revenue to be negatively impacted by $20 million to $40 million on an annualized basis.

In Q2 14 the effective GAAP tax rate was 225.1% and the effective non-GAAP tax rate was 24.6% . The $83 million goodwill impairment charge is non-deductible for tax purposes resulting in the Company's effective GAAP tax rate being significantly higher in Q2 14 than in Q1 14. In addition, the effective GAAP and non-GAAP tax rates for Q2 14 were higher than Q2 13 due to the R&D tax credit that expired on December 31, 2013 and has not been extended by Congress.

In Q2 14 we generated $168M in operating cash flow, up 41% Yr./Yr. and 54% Qtr./Qtr. The year-to-year increase in operating cash flow was primarily due to lower days sales outstanding (DSOs) as well as increased operating profits. The increase in operating cash flow from Q1 14 was due to the timing of payment for employee incentives, which are made semi-annually. Non-GAAP average diluted shares outstanding for Q2 14 was 450 million shares, down 4% Yr./Yr. and down 1% Qtr./Qtr.







© 2014 Brocade Communications Systems, Inc.     Page 13 of 27


Brocade Q2 FY 2014 Earnings    5/22/2014

    

For our total SAN business, including hardware products and SAN-based support and services, Q2 14 revenue was $379M , up 1% from Q2 13 and down 8% sequentially.

Our SAN product revenue in the quarter saw strong performance in our switch and embedded product families. SAN product revenue was $321M in the quarter, up 1% Yr./Yr. and down 10% sequentially. When adjusted for the sale of the network adapter business that occurred in Q1 14, SAN product revenue was up 2% Yr./Yr. and down 9% sequentially. The sequential decline in SAN product revenue was due to a seasonally soft quarter for some of our OEM partners as well as certain partner specific sales disruption. The healthy demand for our SAN products, coupled with strong shipment linearity, resulted in Brocade ending the quarter with 1.2 weeks of OEM inventory; a decrease both year-over-year and sequentially.

In looking at the SAN product families, director revenue was down 8% Yr./Yr. and down 10% sequentially. SAN switch revenue was up 9% Yr./Yr. and down 6% Qtr./Qtr. Our Server product group, including embedded switches and server adapter products, was up 2% Yr./Yr. and down 20% Qtr./Qtr. When adjusted for the sale of the network adapter business, Server product group product revenue was up 13% Yr./Yr. and down 14% sequentially.

SAN-based support and services revenue was $58M in the quarter, up 5% Yr./Yr. and up 4% sequentially due to the benefit of an additional week of amortized support revenue from the 14-week quarter in Q2 14.


© 2014 Brocade Communications Systems, Inc.     Page 14 of 27


Brocade Q2 FY 2014 Earnings    5/22/2014



For our total IP Networking business, including hardware and IP-based support and services, Q2 14 revenue was $157M , down 4% Yr./Yr. and up 3% sequentially. The year-over-year decline was due to lower revenue from our U.S. Federal government customers, the impact of the divestiture of the network adapter business, and the shift in strategies in the Brocade ADX product line and wireless business . These reductions were partially offset by increased IP Networking based support revenue driven by an additional week of amortized support revenue from the 14-week quarter in Q2 14. The sequential increase in IP Networking business revenue was principally due to higher IP Networking based support revenue. Our Federal revenue was approximately $13M in the quarter, down 36% Yr./Yr. and essentially flat Qtr./Qtr.

Q2 14 IP Networking product revenue was $121M , down 9% Yr./Yr. and up 1% sequentially. The Q2 14 IP Networking product revenue was lower by $4M Yr./Yr. due to the impacts from the divestiture of the network adapter business and the changes in the wireless and Brocade ADX business strategies. The sequential increase was due to higher sales of Ethernet switching products.

As we look at the product splits for IP Networking in the quarter, our Ethernet switch revenue, which includes products for the data center and campus LAN environments, generated revenue of $72M , up 11% Yr./Yr. and 12% Qtr./Qtr. Our switch revenue includes Brocade VDX products, which were up 22% Yr./Yr. and down 4% Qtr./Qtr. Our routing products generated $43M in revenue, down 25% Yr./Yr. and 8% Qtr./Qtr.

Other IP Networking revenue of $6M was down 40% Yr./Yr. and 30% Qtr./Qtr. The year-over-year decrease was due to the divestiture of the network adapter business as well as lower Brocade ADX sales. The sequential decrease was due to the divestiture of the network adapter business. IP Networking-based support and services revenue was $36M in the quarter, up 14% Yr./Yr. and 10% sequentially.

Turning to the split of our IP Networking business based on customer use cases, we are pleased with the continued progress within our areas of strategic focus. Although it is difficult to identify all end users and their specific network deployments due to our two-tier distribution channel, we are providing estimates of the split of our IP Networking business. Our data center customers represented approximately 57% of IP Networking revenue in Q2 14, compared with 59% in Q1 14 and 50% in Q2 13. The estimated percentage of revenue coming from data center IP Networking customers may fluctuate quarter-to-quarter due to the timing of large data center transactions. Other use cases, such as enterprise campus and carrier networks (MAN/WAN) represent the balance of the business.

From a geographic viewpoint, the Americas region (excluding Federal) was up approximately 4% Yr./Yr., the EMEA region was down 3% Yr./Yr., the APAC region was down 3% Yr./Yr., and the Japan region was down 15% . On a sequential basis, the Americas (excluding Federal) region was up 6% , EMEA was down 6% , APAC was down 1% , and Japan was up 30% .

© 2014 Brocade Communications Systems, Inc.     Page 15 of 27


Brocade Q2 FY 2014 Earnings    5/22/2014



In Q2 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 56% of revenue in Q2 14, down
1% from Q1 14 and up 11% from Q2 13. All other OEMs represented 12% of revenue in Q2 14, down 1% from Q1 14 and down 10% from Q2 13 when HDS was not a 10% customer. Channel and direct routes to market contributed 32% of revenue in Q2 14, up 2% from Q1 14 and down 2% from Q2 13.

The mix of business based on ship-to location was 59% domestic and 41% international in the
quarter, a higher domestic share compared with 57% in Q1 14 and 58% in Q2 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.



© 2014 Brocade Communications Systems, Inc.     Page 16 of 27


Brocade Q2 FY 2014 Earnings    5/22/2014



Q2 14 non-GAAP company gross margin of 66.7% exceeded our original guidance range for the
quarter primarily due to a more favorable SAN share of the product mix than we estimated at the start of the quarter.

Q2 14 non-GAAP product gross margin was 68.3% , slightly above our FY14 target model range of 66.0% to 68.0%. This represents a decrease of approximately 110 basis points from Q1 14 and an increase of approximately 140 basis points from Q2 13. The quarter-over-quarter decline was primarily due to seasonally lower volume, a less favorable revenue mix shift to more IP Networking products, and higher overhead costs due to the additional week of spending from the 14-week quarter. The year-over-year increase 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.

Q2 14 non-GAAP SAN product gross margin percentage was in the mid-70's essentially flat quarter-over-quarter and year-over-year. Q2 14 non-GAAP IP Networking product gross margin percentage was in the mid-50‘s, slightly down quarter-over-quarter but up slightly year-over-year.

Non-GAAP Global Services gross margin was 59.2% in Q2 14, up 30 basis points quarter-over-quarter primarily due to higher revenue and offset slightly by increased spending. Non-GAAP Global Services gross margin was up approximately 320 basis points year-over-year based on higher revenue.


© 2014 Brocade Communications Systems, Inc.     Page 17 of 27


Brocade Q2 FY 2014 Earnings    5/22/2014



Non-GAAP gross margin was 66.7% in Q2 14, which was higher than our FY14 target model of 65.0% to 66.0%. The increase in SAN share of the total product revenue mix was the principal reason we outperformed the non-GAAP gross margin target.

On a non-GAAP basis, total operating expenses were $234M , or 43.5% of revenues in Q2 14,
which is slightly higher than our FY14 target model range of 40.0% to 42.0%. The impact of the additional week of spending from the 14-week quarter was the primary reason we were above our FY14 target model range in Q2 14.

Ending headcount was 4,061 in Q2 14, down 16 from 4,077 in Q1 14, and down 587 from 4,648 in Q2 13.

Non-GAAP operating margin was 23.2% in Q2 14, an increase of 420 basis points compared with Q2 13 and 470 basis points lower compared with Q1 14. The increase from Q2 13 was primarily due to decreased overall spending as well as a favorable shift to more SAN share of the total revenue mix. The decrease from Q1 14 was due to lower gross margin from an unfavorable revenue mix shift to more IP Networking and Global Services revenue as well as the impact of the additional week of spending from the 14-week quarter.



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Operating cash flow was $168M in Q2 14, up 41% Yr./Yr. and 54% sequentially. The increase in cash flow from the prior year was primarily due to lower DSOs as well as increased non-GAAP net income. We typically see a sequential increase in cash from operations in our fiscal second quarter as Q1 includes the payment of employee incentives earned in the prior year as well as the semi-annual payment of the interest on our outstanding notes. We saw strong shipment linearity in Q2 14, which resulted in DSOs of 35.4 days, a slight increase from 35.2 days in Q1 14 and an improvement from 40.4 days in Q2 13.

The excess tax benefit from stock-based compensation resulted in a decrease of operating cash flow and an offsetting increase in cash flows from financing activities for Q2 14 of $13M as compared with a decrease of $14M in Q1 14 and a decrease of $3M in Q2 13. We describe the free cash flow impact of the excess tax benefit from stock-based compensation in the appendix.

Total capital expenditures in the quarter were $14M . Cash and cash equivalents were $1,138M in Q2 14, up $139M from Q1 14 and up $373M from Q2 13. The U.S. cash balance was $440M at the end of Q2 14.

We repurchased $50M of common stock at an average purchase price of $9.53 during Q2 14. Year to date, we have repurchased $190M of common stock as of the end of Q2 14. This represents a return of approximately 69% to our shareholders of adjusted free cash flow over the first six months of FY14. Subsequent to the end of our Q2 14, we have repurchased an additional $51M of common stock as of May 21, 2014.


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Looking forward to Q3 14, we considered a number of factors, including the following, in setting our outlook:

As we modeled our business in Q3 14, we took into account the impact of the divestiture of the network adapter business and the shift in strategies in the Brocade ADX product line and wireless business. The estimated total revenue impact of these actions is $15M compared with the historical quarterly run rate.
  
For Q3 14, we expect SAN revenue to be down 2% to 5% Qtr./Qtr. due to the seasonal buying patterns of our OEMs. In addition, we considered potential disruption from ongoing business transitions within certain of our OEM partners. When adjusted for the sale of the network adapter business, we expect our SAN product revenue to be down 2% to up 1% Yr./Yr.

We expect our Q3 14 IP Networking revenue to be up 9% to 16% Qtr./Qtr., principally driven by a seasonally stronger quarter for our U.S. Federal customers and growth in our enterprise customers. When adjusted for the sale of the network adapter business, we expect our IP Networking product revenue to be up 2% to 8% Yr./Yr.

We expect our Global Services revenue to be down 6% to 7% Qtr./Qtr. due to the impact of one less week of revenue as compared with the 14-week quarter that occurred in Q2 14.

We expect non-GAAP operating expenses to be down 2% to 3% Qtr./Qtr. which is reflective of the impact of one less week of expense as compared with the 14-week quarter that occurred in Q2 14 and the impact of summer holidays.

At the end of Q2 14, OEM inventory was approximately 1.2 weeks of supply based on SAN business revenue. While we expect inventory to be between one to two weeks in Q3 14, OEM inventory levels may fluctuate due to both seasonality and large end-user order patterns at the OEMs.

We have assumed a structural non-GAAP tax rate of 25% to 27% for Q3 14.

We expect Q3 14 operating cash flow to be lower sequentially due higher working capital, and the timing of variable compensation and bond interest payments. We estimate that DSOs will be within our target range of 40 to 45 days.

We expect Q3 14 non-GAAP gross margin to be 65.5% to 66.5%, within or slightly better than our two-year target model range, and non-GAAP operating margin to be at 22.5% to 24.5%, within or slightly lower than our two-year target model range.

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

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Brocade Q2 FY 2014 Earnings    5/22/2014



Prepared comments provided by Ben Jones, Investor Relations

That concludes Brocade’s prepared comments. At 2:30 p.m. Pacific Time on May 22, Brocade will host a webcast conference call at www.brcd.com .

Thank you for your interest in Brocade.

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Additional Financial Information:
 
Q2 13

Q1 14

Q2 14

GAAP gross margin
62.0
%
66.0
%
66.0
%
Non-GAAP gross margin
65.1
%
67.7
%
66.7
%
 
 
 
 
GAAP product gross margin
63.6
%
67.7
%
67.8
%
Non-GAAP product gross margin
66.9
%
69.4
%
68.3
%
 
 
 
 
GAAP services gross margin
54.0
%
57.2
%
57.4
%
Non-GAAP services gross margin
56.0
%
58.9
%
59.2
%
 
 
 
 
GAAP operating margin
10.6
%
21.5
%
3.8
%
Non-GAAP operating margin
19.0
%
27.9
%
23.2
%


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