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): February 13, 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
(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 February 13, 2014 , Brocade Communications Systems, Inc. (the “Company”) issued a press release regarding financial results for the first quarter ended January 25, 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 second 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 February 13, 2014 , regarding financial results of Brocade Communications Systems, Inc. for the first quarter ended January 25, 2014 .
99.2
Slides with accompanying prepared remarks of Brocade Communications Systems, Inc., dated February 13, 2014 , regarding financial results of the first quarter ended January 25, 2014 and forward-looking statements, including statements relating to the Company’s estimated financial results of the second 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:
February 13, 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 Q1 2014 Results
SAN JOSE, Calif., February 13, 2014 — Brocade ® (NASDAQ: BRCD) today reported financial results for its first fiscal quarter ended January 25, 2014 . Brocade reported first quarter revenue of $565 million , down 4% year-over-year and up 1% quarter-over-quarter. The company reported GAAP diluted earnings per share (EPS) of $0.18 , up from a loss of $0.05 per share in Q1 2013 . Non-GAAP diluted EPS was $0.24 , up from $0.21 in Q1 2013 .
“Brocade achieved solid results in Q1, exceeding our outlook for revenue and profitability,” said Lloyd Carney, CEO of Brocade. “Our performance was driven by the strength of our Storage Area Networking (SAN) business as customers continue to adopt Gen 5 Fibre Channel networks for their highly virtualized data centers and high-performance storage environments, including Solid State Disks (SSDs). While the overall IP Networking business declined year-over-year, we achieved our outlook for the quarter. This is a transformational year for Brocade and we remain committed to our mission to be the network provider of choice to the world’s data centers.”

Summary of Q1 2014 results:
SAN business revenue, including products and services, was $412 million , down 1% year-over-year and up 8% sequentially. SAN business revenue grew sequentially across all product segments and performed better than the company’s outlook for Q1 2014. Gen 5 Fibre Channel products represented approximately 71% of director and switch revenue in the quarter, higher than the 42% reported in Q1 2013 and 69% in Q4 2013 .
IP Networking business revenue, including products and services, was $153 million , down 11% year-over-year and 15% quarter-over-quarter. The year-over-year and sequential decline was principally due to lower sales into the U.S. Federal government as well as lower non-Federal sales in the Americas region. During Q1 2014, an estimated 59% of our IP Networking product revenue came from data center customers, a favorable shift in the mix of our IP business from an estimated 48% in Q1 2013 and 53% in Q4 2013.
GAAP gross margin was 66.0% , compared with 63.5% in Q1 2013 and 64.9% in Q4 2013. Non-GAAP gross margin was 67.7% , compared with 66.0% in Q1 2013 and 67.2% in Q4 2013. 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 due to a more favorable overall product mix shift to SAN product revenue.
GAAP operating margin was 21.5% , compared with 15.8% in Q1 2013 and 15.0% in Q4 2013. Non-GAAP operating margin was 27.9% , compared with 23.5% in Q1 2013 and 26.6% in Q4 2013. The year-over-year and sequential improvement in operating margin was due to higher gross margin and lower operating expenses. Non-GAAP operating expenses of $225 million were down 10% year-over-year and 1% quarter-over-quarter.
Operating cash flow was $109 million , up 85% year-over-year and down 36% quarter-over-quarter. The year-over-year increase in operating cash flow was primarily due to increased operating profits and the timing of payments for employee incentives. The quarter-over-quarter decrease in operating cash flow 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.
GAAP diluted EPS was $0.18 , up from a loss of $0.05 in Q1 2013 and up 29% from Q4 2013. The year-over-year increase in GAAP diluted EPS was primarily due to a $0.17 per share charge in Q1 2013 from the change in California tax law and the related reduction in the company’s deferred tax assets as well as higher operating income. The quarter-over-quarter increase in GAAP EPS was primarily due to higher net income resulting from lower restructuring costs.
Non-GAAP diluted EPS of $0.24 was up 13% from Q1 2013 and unchanged from Q4 2013. The year-over-year increase was primarily due to decreased spending and reduced diluted shares outstanding.



Page 1 of 10


Non-GAAP average diluted shares outstanding for Q1 2014 were 454 million shares, down 3% year-over-year and down 1% quarter-over-quarter. The company repurchased 16.7 million shares for $140 million at an average price of $ 8.42 during Q1 2014 . Subsequent to the end of Q1 2014 , the company has repurchased an additional 3.3 million shares for $31 million and has approximately $829 million remaining in the Board-authorized share repurchase program as of February 13, 2014 .
Brocade management will host a conference call to discuss fiscal first quarter results and fiscal second 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 Q1 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
Financial Highlights and Additional Financial Information
 
Q1 2014
 
Q4 2013
 
Q1 2013
Revenue
$
565
M
 
$
559
M
 
$
589
M
GAAP net income (loss)
$
81
M
 
$
64
M
 
$
(21
)M
Non-GAAP net income
$
109
M
 
$
109
M
 
$
99
M
GAAP EPS—diluted
$
0.18

 
$
0.14

 
$
(0.05
)
Non-GAAP EPS—diluted
$
0.24

 
$
0.24

 
$
0.21

GAAP gross margin
66.0
%
 
64.9
%
 
63.5
%
Non-GAAP gross margin
67.7
%
 
67.2
%
 
66.0
%
GAAP operating income
$
121
M
 
$
84
M
 
$
93
M
Non-GAAP operating income
$
158
M
 
$
148
M
 
$
138
M
GAAP operating margin
21.5
%
 
15.0
%
 
15.8
%
Non-GAAP operating margin
27.9
%
 
26.6
%
 
23.5
%
Adjusted EBITDA (1)
$
184
M
 
$
149
M
 
$
162
M
Effective GAAP tax provision rate
27.1
%
 
14.2
%
 
131.7
%
Effective Non-GAAP tax provision rate
26.1
%
 
21.6
%
 
22.3
%
Cash provided by operations
$
109
M
 
$
170
M
 
$
59
M
Storage Area Networking (SAN) port shipments
1.2
M
 
1.1
M
 
1.2
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)  
Adjusted EBITDA is as defined in the Term Debt Credit Agreement.

Page 2 of 10


Financial Highlights and Additional Financial Information (Continued)
 
Q1 2014
 
Q4 2013
 
Q1 2013
Routes to market as a % of total net revenues:
 
 
 
 
 
OEM revenues
70
%
 
65
%
 
67
%
Channel/Direct revenues
30
%
 
35
%
 
33
%
10% or greater customer revenues
57
%
 
46
%
 
46
%
Geographic split as a % of total net revenues:
 
 
 
 
 
Domestic revenues
57
%
 
62
%
 
62
%
International revenues
43
%
 
38
%
 
38
%
Segment split as a % of total net revenues:
 
 
 
 
 
SAN product revenues
63
%
 
58
%
 
61
%
IP Networking product revenues
21
%
 
26
%
 
24
%
Global Services revenues
16
%
 
16
%
 
15
%
SAN business revenues (2)
73
%
 
68
%
 
71
%
IP Networking business revenues (2)
27
%
 
32
%
 
29
%
Estimates as a % of IP Networking business revenues:
 
 
 
 
 
Data Center (3)
59
%
 
53
%
 
48
%
Enterprise Campus

34
%
 
38
%
 
39
%
Carrier Network (MAN/WAN)

7
%
 
9
%
 
13
%
Additional information:
Q1 2014
 
Q4 2013
 
Q1 2013
Cash and cash equivalents
$
999
M
 
$
987
M
 
$
684
M
Restricted cash (4)
$

 
$

 
$
312
M
Deferred revenues
$
298
M
 
$
303
M
 
$
296
M
Capital expenditures
$
13
M
 
$
10
M
 
$
18
M
Total debt, net of discount (4)
$
599
M
 
$
599
M
 
$
900
M
Cash, net of senior debt and capitalized leases
$
395
M
 
$
382
M
 
$
78
M
Days sales outstanding
35 days
 
41 days
 
34 days
Employees at end of period (5)
4,077
 
4,169
 
4,604
2)  
SAN and IP Networking business revenues include product, support and services revenues.
3)  
Data Center includes enterprise, service provider and government data center revenues.
4)  
Q1 2013 restricted cash was used to redeem $300M of 2018 notes on February 21, 2013.
5)  
Q4 2013 ending headcount excludes 224 employees that were notified of their termination during the quarter, but were still on Brocade payroll as of the end of the quarter.


Page 3 of 10


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 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 10


Cautionary Statement
This press release contains statements that are forward-looking in nature, including statements regarding Brocade’s strategy, business prospects, and organizational and business alignment. 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 10


BROCADE COMMUNICATIONS SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
 
Three Months Ended
 
January 25,
2014
 
January 26,
2013
 
(In thousands, except per-share amounts)
Net revenues
 
 
 
Product
$
475,205

 
$
502,247

Service
89,330

 
86,482

Total net revenues
564,535

 
588,729

Cost of revenues
 
 
 
Product
153,627

 
174,375

Service
38,238

 
40,429

Total cost of revenues
191,865

 
214,804

Gross margin
372,670

 
373,925

Operating expenses:
 
 
 
Research and development
87,156

 
97,690

Sales and marketing
132,665

 
149,011

General and administrative
20,143

 
19,077

Amortization of intangible assets
9,883

 
14,856

Restructuring and other costs
6,217

 

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

Total operating expenses
251,180

 
280,634

Income from operations
121,490

 
93,291

Interest expense
(9,196
)
 
(26,368
)
Interest and other income (loss), net
(1,336
)
 
66

Income before income tax
110,958

 
66,989

Income tax expense
30,074

 
88,244

Net income (loss)
$
80,884

 
$
(21,255
)
Net income (loss) per-share—basic
$
0.18

 
$
(0.05
)
Net income (loss) per-share—diluted
$
0.18

 
$
(0.05
)
Shares used in per-share calculation—basic
440,573

 
454,843

Shares used in per-share calculation—diluted
453,549

 
454,843


Page 6 of 10


BROCADE COMMUNICATIONS SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
 
Three Months Ended
 
January 25,
2014
 
January 26,
2013
 
(In thousands)
Net income (loss)
$
80,884

 
$
(21,255
)
Other comprehensive income and loss, net of tax:
 
 
 
Unrealized gains (losses) on cash flow hedges:
 
 
 
Change in unrealized gains and losses
(924
)
 
(76
)
Net gains and losses reclassified into earnings
(31
)
 
(179
)
Net unrealized gains (losses) on cash flow hedges
(955
)
 
(255
)
Foreign currency translation adjustments
(823
)
 
(380
)
Total other comprehensive loss
(1,778
)
 
(635
)
Total comprehensive income (loss)
$
79,106

 
$
(21,890
)

Page 7 of 10


BROCADE COMMUNICATIONS SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
January 25,
2014
 
October 26,
2013
 
(In thousands, except par value)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
998,687

 
$
986,997

Accounts receivable, net of allowances for doubtful accounts of $590 and $575 at January 25, 2014, and October 26, 2013, respectively
218,260

 
249,598

Inventories
43,247

 
45,344

Deferred tax assets
114,772

 
98,018

Prepaid expenses and other current assets
41,166

 
42,846

Total current assets
1,416,132

 
1,422,803

Property and equipment, net
459,367

 
472,940

Goodwill
1,640,629

 
1,645,437

Intangible assets, net
23,913

 
40,258

Non-current deferred tax assets
771

 
1,585

Other assets
37,025

 
38,368

Total assets
$
3,577,837

 
$
3,621,391

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
78,638

 
$
88,218

Accrued employee compensation
112,377

 
145,996

Deferred revenue
223,344

 
226,696

Current restructuring liabilities
5,768

 
16,418

Current portion of long-term debt
3,039

 
2,996

Other accrued liabilities
67,575

 
80,339

Total current liabilities
490,741

 
560,663

Long-term debt, net of current portion
595,694

 
596,208

Non-current restructuring liabilities
4,719

 
1,008

Non-current deferred revenue
74,329

 
76,426

Non-current income tax liability
42,850

 
38,680

Non-current deferred tax liabilities
23,607

 

Other non-current liabilities
1,568

 
1,593

Total liabilities
1,233,508

 
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: 436,955 and 445,285 shares at January 25, 2014, and October 26, 2013, respectively
437

 
445

Additional paid-in capital
1,833,570

 
1,915,152

Accumulated other comprehensive loss
(15,222
)
 
(13,444
)
Retained earnings
525,544

 
444,660

Total stockholders’ equity
2,344,329

 
2,346,813

Total liabilities and stockholders’ equity
$
3,577,837

 
$
3,621,391


Page 8 of 10


BROCADE COMMUNICATIONS SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
Three Months Ended
 
January 25,
2014
 
January 26,
2013
 
(In thousands)
Cash flows from operating activities:
 
 
 
Net income (loss)
$
80,884

 
$
(21,255
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Excess tax benefits from stock-based compensation
(14,335
)
 
(2,192
)
Non-cash tax charges

 
78,206

Depreciation and amortization
38,754

 
49,394

Loss on disposal of property and equipment
2,348

 
1,989

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

Amortization of debt issuance costs and original issue discount
281

 
397

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

 
15,299

Provision for doubtful accounts receivable and sales allowances
1,567

 
2,354

Non-cash compensation expense
18,588

 
19,150

Changes in assets and liabilities:
 
 
 
Restricted cash

 
(11,926
)
Accounts receivable
29,771

 
14,250

Inventories
2,097

 
9,625

Prepaid expenses and other assets
3,486

 
(1,952
)
Deferred tax assets
95

 
165

Accounts payable
(8,077
)
 
(14,960
)
Accrued employee compensation
(39,208
)
 
(72,570
)
Deferred revenue
(5,414
)
 
1,519

Other accrued liabilities
10,455

 
(8,062
)
Restructuring liabilities
(6,939
)
 
(191
)
Net cash provided by operating activities
109,469

 
59,240

Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(12,966
)
 
(18,486
)
Net cash paid in connection with acquisition

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

 
250

Proceeds from sale of network adapter business
9,995

 

Net cash used in investing activities
(2,721
)
 
(62,865
)
Cash flows from financing activities:
 
 
 
Proceeds from senior unsecured notes

 
296,250

Payment of principal related to capital leases
(608
)
 
(484
)
Common stock repurchases
(140,380
)
 
(47,530
)
Proceeds from issuance of common stock
32,410

 
23,812

Excess tax benefits from stock-based compensation
14,335

 
2,192

Increase in restricted cash

 
(300,000
)
Net cash used in financing activities
(94,243
)
 
(25,760
)
Effect of exchange rate fluctuations on cash and cash equivalents
(815
)
 
(225
)
Net increase (decrease) in cash and cash equivalents
11,690

 
(29,610
)
Cash and cash equivalents, beginning of period
986,997

 
713,226

Cash and cash equivalents, end of period
$
998,687

 
$
683,616




Page 9 of 10


BROCADE COMMUNICATIONS SYSTEMS, INC.
RECONCILIATION BETWEEN GAAP AND NON-GAAP NET INCOME
(Unaudited)
 
Three Months Ended
 
January 25,
2014
 
January 26,
2013
 
(In thousands, except per-share amounts)
Net income (loss) on a GAAP basis
$
80,884

 
$
(21,255
)
Adjustments:
 
 
 
Stock-based compensation expense included in cost of revenues
3,142

 
3,946

Amortization of intangible assets expense included in cost of revenues
6,462

 
10,780

Total gross margin adjustments
9,604

 
14,726

Stock-based compensation expense included in research and development
4,336

 
4,685

Stock-based compensation expense included in sales and marketing
6,765

 
8,145

Stock-based compensation expense included in general and administrative
4,345

 
2,374

Amortization of intangible assets expense included in operating expenses
9,883

 
14,856

Restructuring and other related costs, net
6,217

 

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

Total operating expense adjustments
26,662

 
30,060

Total operating income adjustments
36,266

 
44,786

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

 
15,299

Tax provision impact from passage of California Proposition 39 - Single Sales Factor apportionment

 
78,206

Income tax effect of non-tax adjustments
(8,366
)
 
(18,287
)
Non-GAAP net income
$
108,784

 
$
98,749

Non-GAAP net income per-share—basic
$
0.25

 
$
0.22

Non-GAAP net income per-share—diluted
$
0.24

 
$
0.21

Shares used in non-GAAP per-share calculation—basic
440,573

 
454,843

Shares used in non-GAAP per-share calculation—diluted
453,549

 
466,321




Page 10 of 10











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.

© 2014 Brocade Communications Systems, Inc.     Page 2 of 25


Brocade Q1 FY 2014 Earnings    2/13/2014

 



© 2014 Brocade Communications Systems, Inc.     Page 3 of 25


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.


© 2014 Brocade Communications Systems, Inc.     Page 4 of 25


Brocade Q1 FY 2014 Earnings    2/13/2014



Prepared comments provided by Lloyd Carney, CEO


© 2014 Brocade Communications Systems, Inc.     Page 5 of 25


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.


© 2014 Brocade Communications Systems, Inc.     Page 6 of 25


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.




© 2014 Brocade Communications Systems, Inc.     Page 7 of 25


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.




© 2014 Brocade Communications Systems, Inc.     Page 8 of 25


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.
 

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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.





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Brocade Q1 FY 2014 Earnings    2/13/2014



Prepared comments provided by Dan Fairfax, CFO


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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.


© 2014 Brocade Communications Systems, Inc.     Page 12 of 25


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.



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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% .


© 2014 Brocade Communications Systems, Inc.     Page 14 of 25


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.


© 2014 Brocade Communications Systems, Inc.     Page 15 of 25


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.



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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%.


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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.




© 2014 Brocade Communications Systems, Inc.     Page 18 of 25


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.

© 2014 Brocade Communications Systems, Inc.     Page 19 of 25


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.

© 2014 Brocade Communications Systems, Inc.     Page 20 of 25


Brocade Q1 FY 2014 Earnings    2/13/2014





© 2014 Brocade Communications Systems, Inc.     Page 21 of 25


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
%


© 2014 Brocade Communications Systems, Inc.     Page 22 of 25


Brocade Q1 FY 2014 Earnings    2/13/2014


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Brocade Q1 FY 2014 Earnings    2/13/2014




© 2014 Brocade Communications Systems, Inc.     Page 25 of 25