Brocade Communications Systems Earnings Call Insights: Storage Market and Spend Reduction

Brocade Communications Systems Inc (NASDAQ:BRCD) recently reported its third quarter earnings and discussed the following topics in its earnings conference call.

Storage Market

Mark Sue – RBC Capital Markets: It’s good to see the strong financial metrics and the positive operating metrics as well. If I could ask just on end demand, what’s the main component of the better than expected revenues is related to the resumption of activity which did not occur in the second quarter or do you feel that this is actually an uptick in demand for 16 gig, perhaps some share gain with the (6529) and does the customer inclination to adopt 32 gig fiber channel imply actually a good and smooth settling run rate for maybe 16 gig fiber channel?

Lloyd Carney – CEO: As most of you on the call know, Mark, we tend to be a proxy for the overall storage market and there’s definitely indicators from the broader storage market that there is a rebound in sight. You heard from second quarter all our major OEM partners pretty much spoke about the second half. They saw a rebound. And what we’re seeing is that rebound occurring a little sooner than we thought. So, it’s a combination of overall strength in the storage market or increasing strength in storage markets there because you’re not truly out of the woods, until you’re out of the woods. And of course, we now have a full suite of 16 gig products out there, which is a great job of meshing around the 32 gig as you just pointed out. So, customers know that there is indeed future path along the 32 gig strength and as you know, 32 gig means that we have a 128 gig connectivity between our directors. So, we have a really solid roadmap going forward and that of course comforts our customers. So, I think what you’re seeing in the increase in the storage, SAN revenues is just a reflection of the broader market and the fact that people know that 16 gig is real and there’s 32 gig coming as you pointed out, and we’re seeing that, we’re benefitting from that.

Mark Sue – RBC Capital Markets: Then maybe a financial question. Dan if I look at your free cash flow on an annual basis, it looks like you will be generating quite a bit of cash and you’ve been committedly returning that to shareholders in the form of a buyback. What’s your thought of maintaining your debt at the current levels, any urgency to refinance or repay that debt? Also, how we should be thinking of the buyback? Is it 50% of your free cash flow, should that be a recurring program on an ongoing forward basis?

Dan Fairfax – VP, Finance and CFO: The current thinking around the debt is that it’s structured in two bonds, the first due in 2020 and the second in 2023. We recently refinanced those 2023s, change the structure to an unsecured structure there, so $300 million of the $600 million is secured, $300 million isn’t, and we have a call date in January of ’15 when it would be economic for us to look at potentially either refinancing or retiring those 2020 bonds. We haven’t made any decision on that at this point, but we assume that we are pleased to kind of catch the right interest rates of – when we whether the 2023 notes. In terms of as we look at return to capital shareholders, we have been focused on that consistently over a number of years now. The Board has quite in tune with and I think we’re always punctuated with if this is shareholder’s cash, we want to be good stewards of it, if we see good opportunities to invest that in the business, we will. When we don’t, we want to return that to shareholders and our thinking right now is along with the refresh of the financial model, we’ll give you some more guidance around a return of capital strategies as we look into 2014 and beyond, but at this – for this call, we don’t have anything really new to report there.

Mark Sue – RBC Capital Markets: Lastly, Dan, just the overhead expense reduction, was that just dimming the lights a little bit at Brocade or…?

Dan Fairfax – VP, Finance and CFO: I wasn’t dimming the lights that maybe overhead reduction. I think a lot of it really stems from our strategic focus, Mark. We have this – we embark on this process, where we team together, where it could be one, two or three, I told you about that last quarter. We actually brought the top 50 executives back again for the second time last month just to reaffirm the strategy we are on. I want you now to focus then it becomes easier to decide where to spend and whatnot to spend because if you have a broader product portfolio then you have to spend across much broader space. You are now in the product focus. They go-to-market focus to public sector, data centers and all of a sudden, it’s real clear where we should and shouldn’t spending. So, it is either result of the strategic effort that the team did and the Board endorsed and we have reaffirmed that we are able to reduce the cost so quickly and you’ll see us continue on that path of ensuring that we adhere to the strategy. And yeah, there’s some delta in that that occurs. I mean, we expect every (PO) now over $10,000 and we spend $1.2 billion and we’re looking at everything over $10,000. Hiring, my executive team, we decide on every hire that comes into this Company and it’s painful, but everybody gets in the side when we hire people or not hire people. There is no automatic refills and so on. So, there’s some basic housekeeping things we have done. But I think the most important thing in the reductions to-date, the $60 million reductions to-date is the strategic work the team did and it was a team effort and again, we have reaffirmed it again in the last month that we’re on the right path and that’s really the benefit.

Spend Reduction

Keith Bachman – BMO Capital Markets: I have a follow-up from this last question. If you’ve completed $60 million in annual run rate, your target is $100 million. I’m surprised you got to the $60 million so quickly, should be (indiscernible), but what’s the incremental areas of spend reduction, what are the focus areas to get there?

Lloyd Carney – CEO: So, we attained the $60 million and we have $40 million to go. We’ve made a commitment around September. So, we’ve made a commitment to give you further update in September for the Analyst Day and we’ll do that. The commitment we made is $100 million by February 1 of 2014. We made that $100 million commitment because we know we’ll make $100 million and we made in February because we knew we will get it done prior to that. The areas that we’re looking at is, again, there is fulfillment of strategic direction. They are – you can assume that there are things that we do today, marks that we play in today that a year from now, we may not be playing it. You can assume that the efficiencies that we have garnered so far that we continue to garner efficiency across the piece. We have brought in an executive Gale England whose job it is to ensure that we drive efficiency across the organization. Every organization is looking at, everything we do, how we do it and how we can ensure that a year from now we are more efficient in every department, in every organization. So, it is all the knobs are still accessible to us to turn to get the further $40 million and we will be letting you know more details around that in September at the Analyst Day.

Keith Bachman – BMO Capital Markets: Well let me ask my second question and then I will cede the floor. On the Ethernet side, when that (gets over) it looks like you will have lost share on the Ethernet side, is it your assumption because you are now trying to get more focused on specific markets like Fed and datacenter. Did that play a role in your revenues this quarter or is that still to come? If so, how long do you think it normalizes before you will be at some kind of market related growth for the Ethernet side of your business?

Jason Nolet – Vice President, Data Center Switching and Routing: Yes. This is Jason, Keith. So, you heard the commentary and you probably saw the prepared remarks around Federal, that was particularly soft this quarter and we expect that to see some rebound in the next quarter. But in general I think you are onto the theme here and the theme is that part of how we end up winning in Ethernet is to be appropriately focused and narrow and deep in the markets where we are going to play. Our Ethernet fabrics offering would be, the poster channel for that where we have decided that in datacenter Ethernet, there is a great opportunity to take share and we have been growing that business consistently quarter-over-quarter another 80% this quarter year-over-year. In fact that’s four to five times the TAM growth rate in that space. So, for us it’s about finding that focus, making sure we are credible and deep in the areas of the markets that we intend to play in and making sure that we are not too dilutive in being too broad in Ethernet because it is a big market overall and lots of different use cases and segments.

A Closer Look: Brocade Communications Systems Earnings Cheat Sheet>>

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