Brocade: Fiscal 3Q13 Financial Results

Brocade Communication Systems, Inc. reported financial results for its third fiscal quarter ended July 27, 2013.

It reported third quarter revenue of $536.6 million, down 3% year-over-year and down slightly quarter-over-quarter.

The company reported GAAP diluted earnings per share (EPS) of $0.26, which includes the A10 Networks litigation settlement, up from $0.09 per diluted share in Q3 2012. Non-GAAP diluted EPS was $0.19, up from $0.14 per diluted share in Q3 2012.

"In Q3, Brocade exceeded our guidance for revenue, non-GAAP operating margin, non-GAAP EPS, and cash flow," said Lloyd Carney, CEO of Brocade. "The storage market is recovering more quickly than we had anticipated entering our third quarter and, coupled with continued strong adoption of Gen 5 FC, contributed to good SANing revenue results. In IP networking, our federal sales were disappointing while Brocade VDX switch revenue showed continued strong growth in Q3, underscoring our leadership in Ethernet fabrics. We are making great progress toward our spending-reduction goal, and are already seeing the benefits in our financial results and cash flow."

 (2) SAN and IP Networking business revenues
 include product, support and services revenues.

Summary of Q3 2013 results:

• SAN business revenue, including products and services, was $369.2 million, down 2% year-over-year and 1% sequentially. In a continuing soft storage market that began in Q2 2013, end-user demand showed improvement in the third fiscal quarter. The quarter-over-quarter SAN revenue performance was better than expected. Gen 5 16Gb FC products represented approximately 64% of director and switch revenue in the quarter, higher than the 29% reported in Q3 2012 and 52% in Q2 2013.
• IP networking business revenue, including products and services, was $167.3 million, down 6% year-over-year and up 2% quarter-over-quarter. The year-over-year decline was due to lower sales into the U.S. federal government as some expected orders moved out of the third fiscal quarter in a challenging budget environment. Estimated Federal revenue was $19.9 million in the quarter, down 42% year-over-year and 5% quarter-over-quarter. Non-federal IP networking revenue, including data center, enterprise and service provider customers, was $147.4 million in the third quarter, up 3% year-over-year and 3% quarter-over-quarter.
• GAAP gross margin was 63.0% and non-GAAP gross margin was 65.6% in Q3 2013, compared with 61.3% and 63.7% respectively, in Q3 2012. The year-over-year improvement in gross margin was due in part to a more favorable product mix within the IP Networking segment and lower spending. Gross margin improved quarter-over-quarter, primarily due to lower spending.
• GAAP operating margin was 13.9% and non-GAAP operating margin was 21.6% in Q3 2013, compared with 12.6% and 19.5% respectively, in Q3 2012. The year-over-year improvement in operating margin was due to the higher gross margin noted above and lower operating expenses as the company made progress on reducing spending in non-strategic areas. Non-GAAP operating expenses of $235.8 million were down 4% year-over-year and 5% quarter-over-quarter. Using Q1 2013 as a baseline, the company has now reduced quarterly spending by more than $15 million, or more than $60 million on an annualized basis, and is on track to realize $100 million of annualized savings by February 2014. Operating margin also increased quarter-over-quarter due to higher gross margin and lower operating expenses.
• Operating cash flow was $102.2 million in Q3 2013, down 10% year-over-year and 15% quarter-over-quarter in a seasonally softer quarter for cash generation. The lower operating cash flow year-over-year and quarter-over-quarter, respectively, was due to the payment of employee incentive compensation earned through the first half of fiscal 2013 in Q3 2013, while no payment was made in Q3 2012 or Q2 2013.
• During Q3 2013, the company recognized a gain of $76.8 million in Other Income related to the litigation settlement with A10 Networks, which increased GAAP EPS by $0.13 in the quarter. The settlement includes a $5.0 million cash payment received during Q3 2013, $70.0 million in notes receivable that are payable on or before January 2014, and the value of licensing rights granted to Brocade.
• GAAP diluted EPS was $0.26 in Q3 2013, up 179% year-over-year, and non-GAAP diluted EPS of $0.19 was up 32% year-over-year. The company recorded a tax benefit of approximately $0.02 per share resulting from the final resolution of various tax audits and assessments during the quarter.
• Average diluted shares outstanding for Q3 2013 were 461.3 million shares, down 2% year-over-year and 1% quarter-over-quarter. The company repurchased 17.9 million shares for $101.2 million at an average price of $5.64 during Q3 2013. Subsequent to the end of Q3 2013, the company has repurchased an additional 7.8 million shares for $52.6 million and has approximately $308 million remaining in the board-authorized share repurchase program as of August 12, 2013.