Brocade Communications Earnings Call Cheat Sheet: Ethernet Business, Pricing Strategy, Gross Margins

Brocade Communications Systems Inc (NASDAQ:BRCD) reported its first quarter earnings and discussed the following topics in its earnings conference call, Tuesday, January 31st. Take a look.

Ethernet Business

Jess Lubert – Wells Fargo Securities: I’ve got a couple of questions on the non-federal, non-service provider Ethernet business, which appears to have declined about 36% sequentially – according to my model, the lowest level since the foundry days – while most of your competitors reported much better sequential trends in their respective businesses. So, can you help us understand what gives you confidence this weakness is transitory and due to some delays in channel build and not a sign of material share loss in this area?

Ian Whiting – SVP, Worldwide Sales: This is Ian Whiting. So, a couple of things. First of all, I think it’s important to point out that as Dan said, we are expecting to grow faster than the market again this year. We grew the Ethernet revenue 13% last year, and we’re expecting to continue to outpace the market through this year as well. There are a few things that are affecting our revenue in that space. One is our continued move to more of a channel indirect model, which obviously takes time and there is an impact on revenue and gross margin when you transition from a more direct sales model to a channel model. That’s been a work in progress that’s going to continue through this year and that will undoubtedly result in more leverage and more growth for us in the long-term. The second thing that we will start feeling a little bit in Q1 was that product transition, as was alluded to earlier on, we are in the middle of a transition to a whole new very exciting range of campus line products and there may well have been some pause in the market as we transition to those products. Lastly, as part of our continued focus on winning larger accounts, some of the deals are longer sales cycles, and we are certainly in the middle of some very competitive deals right now that in some cases moved out and we’ll continue to see that as we focus more effort upscale and larger enterprise accounts. But overall, we’re feeling that we will continue on the same trajectory as we have through last year, which is to outpace the market in Ethernet across the board.

Jess Lubert – Wells Fargo Securities: Can you quantify the amount of Ethernet business that slipped from Q1 and your confidence in your ability to close that business and perhaps remind us of how fast do you think the Ethernet business is going to grow this year?

Ian Whiting – SVP, Worldwide Sales: Deals slip every quarter, and so, to some extent that’s a phenomenon we experience every quarter. We are very comfortable with the ranges that we’ve provided in terms of Ethernet growth this year. As I said, we fully expect to outpace the market in terms of year-over-year growth this year and we’re on that trajectory as we enter into Q2.

Jess Lubert – Wells Fargo Securities: Then my last question is also on the Ethernet side of the business. Can you talk directionally about the margins that you saw this quarter and to what degree the pricing environment changed over the last 90 days and how do you expect Ethernet pricing and gross margins to progress going forward?

Dan Fairfax – VP, Finance and CFO: Jess, this is Dan. In terms of the margins we saw, some pricing, as Ian talked about, the larger opportunities with Russia competing more often and tend to be aggressive in terms of initial wins. What we see is we win that business as longer term we are able to expand the margin in those customer accounts. As time progresses, we add additional products in there. So, we did see some impact in the quarter from pricing impacts. The other impact we saw in the quarter as the volumes dropped was the overhead load didn’t drop, and so, the overhead absorption was negative for us. Ian, maybe you want to add some comments on?

Ian Whiting – SVP, Worldwide Sales: Yeah, I would just say that it’s consistent with the strategy we laid out, which is for us, this is all about new account acquisition. We added 2,800 net new accounts over the last two years. We stayed on that trajectory in Q1 and we fully intend to continue to be aggressive. Obviously pricing and discounting is one element of that. The arrival of really exciting new products line and campus will help further accelerate growth there, but overall I would say pricing and discounting is consistent with our posture in the market rates and we will continue to be aggressive and win new business.

Pricing Strategy and Gross Margins

Mark Sue – RBC Capital Markets: What sort of a price performance magnitude should we consider on your new campus Ethernet products and should we think about impact to gross margins as you see the initial ramp-up of the new products?

Jason Nolet – VP, Data Center and Enterprise Networking: Mark, this is Jason Nolet. Let me try that one. So, we’re not quite ready to disclose the announcements that we’re going to make on March 6th. We encourage you to attend the virtual launch and hear that story first hand if you would. But we do expect that the new campus products will have improved margin relative to the existing portfolio, so that is an opportunity for us.

Mark Sue – RBC Capital Markets: Then on VDX recognizing its small in revenues, but what’s the indication as I know the growth is pretty healthy in terms of wins against competitors and also pull through of other Brocade switches and how big are some of the intended Ethernet fabrics that some of your customers are discussing?

Ian Whiting – SVP, Worldwide Sales: I’ll take a first short on that. This is Ian. So, we’ve continued very nicely with new account, I think you heard earlier on we’re now up to over 400 accounts that meet the Ethernet fabric classification and each one of those is now expanding, so that’s exactly in consistent with our strategy. The deal sizes haven’t changed significantly. I would say that its certain VDX and DCX is viewed as part of a larger Ethernet acquisition, obviously you will see more products other than just VDX and VCS in those deals, but what we’re really focusing on is expanding the Ethernet fabric footprint and I think probably when we get to Tech Day we will talk more about some of the applications specifically and where we’re starting to see some patterns emerge in terms of the use cases. But we’re very happy and I’m very pleased with the overall progress in Ethernet fabrics and it has continued momentum through Q1 coming out of a very strong first year for us.

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