Executives
Shirley Stacy - Director of IR
Michael Klayko - CEO
Richard Deranleau - CFO
Tom Buiocchi - VP of Marketing
Analysts
Harry Blount - Lehman Brothers
Brent Bracelin - Pacific Crest Securities
Samuel Wilson - JMP Securities
Mark Moskowitz - J.P. Morgan
Mark Kelleher - Canaccord Adams
Shebly Seyrafi - Caris
Chris Werner - Citigroup
Glenn Hanus - Needham
Aaron Rakers - A.G. Edwards
Dan Renouard - R.W. Baird
Brocade Communications Systems, Inc. (BRCD) F4Q06 Earnings Call November 21, 2006 5:00 PM ET
Operator
Good afternoon. My name is Bliss and I will be your conference operator today. At this time, I would like to welcome everyone to the Brocade Communications Fourth Quarter Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. (Operator Instructions). Thank you. Ms. Stacy, you may begin your conference.
Shirley Stacy
Thank you. Good afternoon everyone, I am Shirley Stacy, Brocade's Director of Investor Relations. Joining me today are Michael Klayko, Brocade's CEO; Richard Deranleau, Brocade's CFO; and Tom Buiocchi, Vice President of Marketing.
Before we begin, let me cover some housekeeping items. Brocade issued a press release detailing its fourth quarter and fiscal year end financial results today via PR Newswire and FirstCall. The Q4 press release along with the slide presentation is available on our website at www.brocade.com. This conference call is being audio webcast and will be archived on our website for approximately 12 months. In addition, a telephone replay will be available; however, it will not be accessible until we have a filed a transcript of this conference call with the SEC. We expect the webcast and telephone replays to be available at approximately 8 p.m. Pacific Standard Time today. To access the telephone replay dial 800-642-1687 or 706-645-9291. The passcode is 1658228.
As a reminder, the information the presenters discuss today will include forward-looking statements, including without limitation, statements about Brocade's financial results, business outlook, and guidance. These forward-looking statements are only predictions and involve risks and uncertainties such that actual results may vary significantly. These and other risks are set forth in more detail in our Form 10-K for the fiscal year ended October 29, 2005, and our Form 10-Q for the quarter ended July 29, 2006.
These forward-looking statements reflect beliefs, estimates and predictions as of today, and Brocade expressly assumes no obligation to update any such forward-looking statements.
Certain financial information that we reveal on today's conference call is presented on a non-GAAP basis. The most directly comparable GAAP information and a reconciliation between non-GAAP and GAAP figures is provided in our Q4 '06 press release, which has been furnished to the SEC on Form 8K, and in the corresponding Q4 '06 slide presentation posted on our website at www.brocade.com/investors.
In addition, the presenters will discuss sell-through information which provides a measure of OEM and channel partners' sales to end users. Brocade does not record revenue based on OEM sell-through information, and this measure is not intended to be viewed as a substitute for reported GAAP revenue. Sell-through is a measure of demand, but it is not a GAAP measurement of revenue, and therefore is not subject to the same level of internal controls as reported GAAP revenue. Please note that certain reclassifications have been made to prior year balances in order to conform to the current year presentation.
And finally, this presentation includes forward-looking statements regarding the acquisition of McDATA, and the financial and strategic benefits of the acquisition. The acquisition remains subject to the approval by the stockholders of Brocade and McDATA, regulatory approval, as well as certain other closing conditions. We also face risks that could cause the combined company not to achieve the anticipated benefits of the acquisition. A registration statement on Form S-4 has been filed with the SEC in connection with the transaction, which contains important information about Brocade and McDATA and the transaction.
I will now turn the call over to Mike.
Michael Klayko
Thank you, Shirley. Good afternoon, everyone and thank you for joining us. I'm very pleased to be speaking to you today about our fourth quarter performance. Today I will briefly discuss our results for the fourth quarter, highlight our performance across our product lines and growth initiatives, and summarize our fiscal 2006 accomplishments.
Following my remarks Richard will provide more detail on our financial results as well as our outlook for the first quarter of fiscal 2007. Our results for the fourth quarter of fiscal 2006 were again outstanding, and represented the fourth consecutive quarter of record revenues, and the fifth consecutive quarter of increased profitability. Q4 revenue was a record $208.8 million, revenues increased 44% year-over-year and 11% sequentially from Q3.
Our product sell-through for the fourth quarter was also a record, at approximately $204.2 million representing an increase of 27% year-over-year and 7% sequentially. Q4 non-GAAP gross margin of 62.1% was strongly unexpected and higher than our long-term model due primarily to product mix and a better than historical pricing environment. As a result non-GAAP operating margin increased to 21.5%, once again reflecting the leverage in our financial model. Q4 non-GAAP diluted EPS was $0.14 as compared to $0.11 in Q3 '06 and $0.07 in Q4 '05.
Now just look at some detail about Q4 performance. Our director business remained solid with 2% sequential revenue growth in a market that we believe was flat to slightly down sequentially. The so called 48K remains performance leader in this category. In our September announcement of our 384 port model of the 48K emblems that our high performance ISCSI capabilities to the 48K barely expand the value proposition to enterprises. Year-on-year, our director revenue grew 25%.
Our switch business was again very strong and we delivered our third consecutive record revenue quarter in switch products. Our new SilkWorm 4900 which is a 64-port switch began shipping in Q3 and continues to gain outstanding customer acceptance and delivered 19% sequential growth in the switch category. Year-on-year we grew 53% in switches. Our embedded SAN switches had an outstanding quarter and we believed that the market for server blade and embedded SAN switches its strong and gaining momentum. We grew our embedded switch business a phenomenal 38% sequentially and 90% year on year.
4Gig products represented well over 90% of our product revenue for the third consecutive quarter. Although we had substantially completed our transition to 4Gig, I want to point out that the end-to-end 4Gig solutions including HBA and storage arrays will continue to be delivered through the market throughout the next several quarters, and we expect 4Gig SAN solutions to represent most of the market demand throughout all of 2007. We believe our time-to-market and product advantages should fit us well as this market continues its transition to 4Gig solutions.
In Q4 our services initiative continued to build momentum, growing 18% sequentially and over 78% year-on-year in terms of revenue. Most importantly in our first full year in the services business, we completed over 450 service engagements, and received outstanding feedback on the quality of our service bill rates. The percentage of repeat customers is very high and customers now look at Brocade as a trusted services provider in the Data center.
The File Area Network or FAN market continues to be an opportunity we are excited about in the market that is developing at a rapid pace. To get some perspective, the FAN concept was first introduced by us to the market around April of this year, was first covered by press and analyst this July and has quickly spread through the industry and end-user community which trend over 2000 customers through foreign educational of seminars on how to properly architect and deploy SAN. And recently participated in an industry consortium to develop standards and set direction in this market.
Our product offerings in the SAN space include our wap solutions, and biomanagement software from our NuView acquisition. The combination of our solutions along with partnerships with network appliance and Microsoft are allowing us to take an early leadership position in this emerging market. In Q4 our ramp business grew over 50% sequentially and the pipeline for our third portfolio of tapestry software doubled.
At the beginning of the year, we established a goal to have 10% of our revenue through software and services. In Q4, we are pleased to have achieved this goal, particularly in light of the higher total revenues that we achieved. And we had indicated in past earning calls the mixes of this 10% is currently weighted more towards services. I will now turn the call over to Richard, to provide more detail on our results.
Richard Deranleau
Thank you, Mike. I'll now turn to a review of our Q4 results, beginning with our income statement. Q4 revenues were $208.8 million. This represented an increase of 11% sequentially from $188.9 million in Q3 '06, and 44% year-over-year from $145.5 million reported in Q4 '05. Our sell-through in Q4 was approximately $204.2 million, an increase of 7% sequentially from sell-through of approximately $190.6 million in Q3 '06 and an increase of 27% year-over-year from sell-through of approximately $160.2 million in Q4 '05.
As a percent of sales in Q4, OEM revenue was 91% of total, this compares to 92% in Q3 and 91% in Q4 '05. From a customer perspective our top three OEM partners, EMC, HP, and IBM, did well and represented approximately 74% of Q4 revenues, unchanged from Q3.
On a geographic basis, all major regions showed good growth, recovering nicely from a seasonally slower summer. As a percent of sales, domestic was 63%, and international was 37% of revenue. This compares to 65% and 35% respectively in Q3 '06 and 62% and 38% respectively in Q4 '05.
Cumulative port shipped were approximately 8.2 million, an increase of approximately 9% from Q3.
Non-GAAP diluted EPS was $0.14. This compares to non-GAAP diluted EPS of $0.11 in Q3 '06 and non-GAAP diluted EPS of $0.07 in Q4 '05. Reporting on a GAAP basis, Q4 '06 EPS was $0.07. This compares to GAAP EPS of $0.09 in Q3'06 and breakeven in Q4 '05.
Non GAAP net income for Q4 excludes charges of approximately $9.1 million in expenses associated with the acquisition and integration planning activities with McDATA, $3.5 million in expenses related to the SEC investigation and other related costs, of which $2.9 million represents legal expenses associated with our indemnification obligation related to various ongoing legal proceedings against 30 former employees, $7 million for stock-based compensation, and $0.9 million for amortization of acquired intangibles and related income tax effect.
Our effective non-GAAP tax rate in Q4 was 23%, well within our expected tax rate of 24% reflecting year-end true-up to the annualized rate of 24%.
In Q4 '06, the impact of FAS 123R was $4.6 million and it included in the $7 million in net stock-based compensation expense, which we had excluded from our non-GAAP results. The difference between the FAS 123R chart and the $7 million in net stock-based compensation expense is a charge of $2 million in stock-based expenses for certain stock awards accounted for on a variable accounting basis and 0.3 million of deferred stock compensation related to acquisition.
Non-GAAP gross margin for Q4 '06 was 62.1% above our guidance of 58% to 59% and above the high end of our target model of 55% to 58%.
This reflected a favorable product mix and better than historical pricing environment, which we have seen for all of fiscal 2006. This compares to non-GAAP gross margins of 60.2% in Q3 '06 and 55.3% in Q4 '05. Q4 ASP declines were again in the low single-digits reflecting a better than historical pricing environment for the quarter, as well as for the full year.
Q4 '06 non-GAAP operating expenses, excluding the items referred to previously, were $84.9 million. This reflects an increase of approximately $4 million from $80.8 million in Q3 '06 and compared with operating expenses of $67.1 million in Q4 '05.
Non-GAAP operating margin for Q4 '06 was 21.5% above our long-term model of 15% to 20% of sales. This compares to Q3 '06 non-GAAP operating margin of 17.4% and Q4 '05 non-GAAP operating margins of 9.2%. The strong increase demonstrates the leverage of our financial model.
Now let's turn to our balance sheet. Our cash and investment balance at the end of Q4 '06 was $582.6 million. This compares to our cash and investment balance including restricted short-term investments net of the company's convertible debt at the end of Q3 '06 of $518.6 million and $485.5 million as of the end of in Q3 likely due to timing of employee compensation program.
Days sales outstanding in Q4 '06 was 43 days and is at the lower end of our target range of 40 to 50 days. This compares to 38 days in Q3 '06 and 44 days in Q4 '05.
Our on-hand inventory in Q4 was $9 million and in line with our range of $8 million to $10 million as projected last quarter. This compares to $9.2 million in Q3 and $11 million in Q4 '05.
Capital expenditures in Q4 were $7.5 million and is consistent with our target range of $6 million to $8 million per quarter. This compares to $7.5 million in Q3 and $8 million in Q4 '05. And finally, our deferred revenue increased to $60.9 million in Q4 '06, compared to $57.3 million in Q3 '06 and $45.5 million in Q4 '05.
Now for our outlook, and as you compile your models and estimates, there are some factors to consider. Our outlook assumes the economy and demand for storage solutions will continue to be healthy. The market remains extremely competitive and we are expecting competitors to bring several new products to market. Brocade and McDATA will continue to compete in the market place as independent companies until the acquisition is closed. The pending transaction may increase uncertainty in the market place. We believe that our competitive position is strong and we will continue to execute on our strategy and business plan.
For the pricing environment throughout all of fiscal 2006, has been more favorable than historical levels. The continued plan for ASP declined to return to mid single-digits for quarter as our competitors bring new products to market.
In fiscal 2006, we believe that we benefited from 4-gig technology cycle, which may have disrupted historical seasonal patterns in revenue. This combined with the uncertainty related to the pending acquisition of McDATA has rendered seasonal pattern less meaningful.
When we take all of these factors into consideration, our outlook for Q1 is as follows. We expect our reported revenue in Q1 to be in a range of $210 million to $215 million, representing a 23% to 26% year-over-year growth rate from a strong Q1 '06. We expect non-GAAP Q1 gross margin to be in a 60% to 61% range, which is above our long-term model. For Q1, we expect total non-GAAP operating expenses to be in a range of $85 million to $87 million. We expect other income, other expenses net, to be approximately $6 million in Q1.
We expect our Q1 non-GAAP effective tax rate to be approximately 26% to 27%. As we have disclosed in the past our, tax rate is expected to increase and return to historical tax rate, which have been in the high 20. This is primarily due to the company's alternative minimum tax position.
We expect diluted share outstanding to be in a range of $275 million to $280 million shares. We expect Q1 '07 GAAP EPS of $0.08 to $0.10. We expect Q1 '07 non-GAAP EPS of $0.12 to $0.14. We expect Q1 '07 non-GAAP operating margin range of 20% to 22%. We expect capital investments to be in the $6 million to $8 million range.
We expect DSOs to be in a range of 40 to 50 days. We expect on-hand inventory to be in a range of $9 million to $12 million. We expect to remain cash flow positive, and expect to generate cash from operations of approximately $20 million to $30 million in Q1' 07.
Due to the pending McDATA transaction, we do not expect to be active purchasers of the company's stock in Q1. As a reminder, the company has approximately $52.7 million remaining under the prior announced $100 million stock repurchase program.
Non-GAAP results for Q1 are expected to exclude the same categories of items that we excluded in Q4. I want to reiterate our commitment to our long-term financial model target, which include a gross margin range of 55% to 58%, non-GAAP operating expense range of 38% to 40%, and non-GAAP operating margin range of 15% to 20%. We outperformed solidly within or above our model in every quarter this year and as you have seen from our guidance, we expect to continue to be within our model target in Q1.
Before turning the call back to Mike, I would like to update you on our acquisition of McDATA. As you know, we are in the midst of integration planning and to date we have made very good progress. We have a dedicated integration team and program management office in place with representatives from both companies in each major function. The team has kicked off immediately after we announced the acquisition and has very clear goals and principles to adhere to. We review the final decisions and priorities on a regular basis to ensure that there is alignment of activities and priorities. [Input] and analysis is a joint company effort, final decisions left with Brocade. Given the progress to date, I remain very comfortable with the expected 100 million of annualized deal synergies by the fourth quarter of combined operation as previously disclosed.
As it relates to the status of the FTC review, as we previously announced, the FTC issued a second request on September 25, 2006. We continue to cooperate with the FTC and are still providing the government with information. We continue to believe that the FTC will conclude that this transaction does not raise any competitive concern and will close its investigation. As soon as the investigation closes, we are expected to close the transaction as early as January 2007.
With that I will now turn the call back over to Mike.
Michael Klayko
Well, thank you Richard. All in all, it was another rewarding quarter and a very strong finish to fiscal 2006. On the call a year ago, we said that we were well positioned to grow and maintain our leadership position in core SAN switching and to innovate to help solve broader customer problems in the data center with our Tapestry and service solution offering. As you can see from our performance this past year we did just that and more.
To close let me reiterate the four key points of our ongoing strategy along with some of the accomplishments from 2006. First and foremost, throughout 2006, we have continued to execute very well in our Base SAN business, we had an outstanding year and I'm very proud of our team.
Overall, we gained share across our product family and solidified our leadership position with over 30 new product introductions, most of which were industry first. The success in our SAN business has helped us to drive returns this year while at the same time investing for future growth. Second, Brocade continues to drive our strategy for growth and diversification.
In terms of financial performance for fiscal 2006, revenues increased 31% to $750.6 million from $574.1 million in fiscal 2005. In addition, as a result of our strong revenue growth and expense management, we generated exceptional earnings power in fiscal 2006, which showcased the tremendous leverage in our financial model. On a non-GAAP basis, diluted EPS increased 73% to $0.45 in fiscal 2006 from $0.26 in fiscal 2005.
In 2006, we also announced two important and strategic acquisitions with NuView and our proposed acquisition of McDATA, both of which we believe will help to drive our long-term growth and diversification and help us to establish broader solution sets for next generation data centers.
Third, we have reminded you on the last several calls that our belief in strategy is that shared storage will have an increasingly important role in driving next generation efficiencies across the enterprise, and Brocade will be a leading supplier of these solutions. Our strategy is validated in the marketplace everyday. The data management challenges that our customers face are only getting larger and more complex. The need for a more comprehensive approach to [globify] our management has spawn the emerging FAN industry, and new solutions, partnerships, and opportunities are being developed.
With the expected unrelenting growth of data and the enterprise, we continue to see a myriad of opportunities to leverage our position in shared storage.
And finally our team is focused and committed to delivering exceptional results to customers, partners, and our shareholders. Ultimately it comes down to our people and their commitment to get the job done. The performance that we have achieved this past year is a direct result of outstanding teamwork from product development to operations to sales to marketing and finance and customer support, our employees have set high expectation, and overachieved in 2006. I'm extremely proud of the entire Brocade organization for their focus and achievement.
In 2007, we will continue to focus on these four points and look forward to updating you on our ongoing progress.
Question-and-Answer Session
Operator
(Operator Instructions). We will pause for just a moment to compile the Q&A roster. Our first question comes from the line of Harry Blount with Lehman Brothers.
Harry Blount - Lehman Brothers
Thanks guys, couple of questions if I might; first of all I was hoping that you guys might may be provide a comment on not only the overall demand environment but what you are seeing in the marketplace in terms of the tempo of sales cycles and closure rates, see if there has been any impact on the part of the end users because of the pending merger?
Michael Klayko
I will have Tom start with that one.
Tom Buiocchi
Hey, this is Tom. So, in terms of market demand and strength of the marketplace, the fundamentals are all there, right. The data growth, the enterprise is continuing to grow the data retention policies are very, very challenging and the complexity continues to grow. So, in terms of demand we see for the foreseeable future that's not going to be a problem. That presents obviously a lot of opportunities for our SAN business as well as our growing FAN and services opportunities.
Harry Blount - Lehman Brothers
And just in terms of the sale cycles and the success rates of closure against competition?
Tom Buiocchi
We've seen no fundamental change quarter-on-quarter in terms of that Harry.
Harry Blount - Lehman Brothers
Okay, and then Richard a question for you on the financial model; your comments are obviously that you expect to return to the target financial model in the next several quarters, but why are we likely to see that happen and if I did -- if I heard you correctly on the upcoming quarter it sounds like the gross margin is still above the long term target.
Richard Deranleau
Yes, thanks Harry, just a couple of quick things, just as a note. We have heard -- we got some feedback that the line was a little statically, so they switched this over, so the questions on the outlook you can always refer to the slides if you missed anything. But what I would say on your question is, we basically were at or above our model this year and some of that's included, some very good strength in the gross margin model. We definitely had a great gross margin quarter this quarter and so when you look at the guidance for Q1 we would expect again to be at or above our targeted financial model for the quarter.
Harry Blount - Lehman Brothers
Okay, and then the other thing is, you guys had a target of getting 10% of revenue from new initiatives; it looks like you are there. So, any update on that?
Richard Deranleau
Yes, we are actually very pleased with our progress in both service and tapestry. We were at -- did meet our goals although it was weighted little bit more towards services than we expected and what we would expect to see going forward is for these initiatives to continue to grow and as a percent of revenue, as their growth rates are higher than our base SAN business.
Harry Blount - Lehman Brothers
Great, thanks.
Michael Klayko
Thanks Harry.
Operator
Our next questions comes from the line of Brent Bracelin with Pacific Crest Securities
Brent Bracelin - Pacific Crest Securities
Thank you. I actually had a follow-on question on kind of the margins, obviously here you reported the best operating margin in what looks like 6 years at 21.5%, you are guiding next quarter to 20% to 22% op margin. As you look out beyond the first three, four quarters of the McDATA acquisition, do you think this is a business model that can support kind of north of 20% op margin or is there something that leads you to believe that pricing is going to be dramatically different year and a half, two years from now, and this will return to a 15% or 20% kind of operating margin business.
Richard Deranleau
Well, that’s a good question Brent; it’s a long time out. But when we gave our guidance regarding the acquisition, we did talk about operating within the model, within each quarter of the combined operations. So, I think we are comfortable that at a minimum we will be able to stay within our model and then we are going to have to wait and get more time as a combined company before we can look at changing the model.
Brent Bracelin - Pacific Crest Securities
Okay, fair enough. And then looking at kind of the FAN business or the NuView software, can you give us just an update on kind of the interest level in that from other kind of OEM’s and kind of momentum that you are seeing with that business.
Tom Buiocchi
Yes, Brent, this is Tom. It has been overwhelming in the last several months. As you know, the concept first came into market in April and we saw as recently as a couple weeks ago, an industry consortium at SNW; we have trained a couple of thousand people as Mike spoke about in our seminars and the pipeline we have is dramatically increased quarter-on-quarter. So, it's a real need out there, the solutions are coming together and we are getting more and more positive feedback from customers and partners everyday. There was even some interesting blogs on the web this week on FAN, so very, very positive response.
Brent Bracelin - Pacific Crest Securities
Okay, great. And then my last question really has to do with pricing; if you look at McDATA's pre announced numbers, it looked like they were a little more aggressive on price, you cited obviously very healthy gross margins in your quarter. You didn’t talk about kind of pricing having much change in the quarter. Was there any difference in pricing between kind of the product lines, core versus switching or was it stable across both segments for Brocade specifically?
Richard Deranleau
What we saw is that consistent really with the full year pricing was pretty stable and it was below our historical norms. So, until McDATA has a chance to really come out with their full release, it's premature for us to kind of guess what was going on behind the scene. But for us at Brocade, again the pricing was very stable this quarter.
Brent Bracelin - Pacific Crest Securities
Okay. Thank you.
Michael Klayko
Thanks, Brent.
Operator
Our next question comes from the line of Samuel Wilson with JMP Securities.
Samuel Wilson - JMP Securities
Good afternoon every one. Sorry Mike, but I am going to ask three financial questions today and [still be in] business for a second.
Michael Klayko
That’s okay, Sam.
Samuel Wilson - JMP Securities
First on and this is kind of popular gross margin question and pricing. But can you give us some sense as to why pricing hasn't been going down as you'd originally expected throughout the year? I mean, throughout the year you are coming in well above what you kind of forecast the gross margins every quarter. I am just going to throw the questions out, let you answer them all together. Second on operating margins, operating above the target clearly you controlled SG&A and R&D spending, are you thinking about kind of upping the investment here in the near-term as you are running above your model? And third, in G&A, how much accounting and legal expense is sort of in there given the pending SEC stock et cetera and McDATA that if those things go away or they are taken care of what would happen to the SG&A line? I mean, what is your leverage there?
Richard Deranleau
Yeah good question, if I remember all those. So, from a pricing perspective, I think that’s a good question I think there is always a little bit of uncertainty around, but what we look to in terms of the stable pricing is really our product cycle and the fact that we have been ahead of the game in introducing new products and 4-gig; so we are attributing that primarily to product cycle. When you go to the operating model, what we had talked about at our Analyst Day, was really about '06 being an investment year, and '07 really having try to complete that investment. So, we would not -- we do not talk about '07 being a significant investment year. Of course, we will continue to build on the progress that we have made, but that's how I would characterize it. From a G&A point-of-view, I guess, what I would ask you to look at is, if you go to the press release, I think it details out pretty closely and pretty transparently the cost that we consider to be associated with the transaction and I think that will answer your question.
Samuel Wilson - JMP Securities
Right, but this is a follow-up on that. I understand the money associated with the McDATA stuff, but you've got ongoing SEC investigations all sorts of things. I am wondering, I mean, is there a leverage on the G&A line because of some of those kind of non-reoccurring or business related spending?
Richard Deranleau
Yeah that’s in there as well. So, what I would say is there is opportunity on a GAAP basis there. But if you look at it on a non-GAAP basis then I think we have been pretty transparent.
Samuel Wilson - JMP Securities
Okay. Thank you very much.
Richard Deranleau
Thank you.
Michael Klayko
You are welcome.
Operator
Our next question comes from the line of Mark Moskowitz with J.P. Morgan.
Mark Moskowitz - J.P. Morgan
Yes, thank you. A few questions if I may. I want to talk of the pricing issue from a different angle, obviously, we have been debating this since early April as far as why pricing is not coming down and you suggested to have relativity of the product cycle as well as some of your competitor woes or delays, but as you lookout and you are trying to assert the pricing will come down back to normal declines historically. We presume that McDATA goes away and it's just you and Cisco. Cisco does want to be a price leader as we know given what they do in the markets once they collapse number of participants. So, I am just trying to get a sense of what other forces out there are driving that will still be cautious on the pricing front?
Richard Deranleau
So, I guess what I would say and you bring up good points, but at the end of the day, we had a product advantage in '06. In '07, we are looking at competitors brining new product out to the market. So, when we have to make an assumption about when we give you our forecast, and our assumption is that based on those factors pricing is going to return to historical norms.
Mark Moskowitz - J.P. Morgan
Okay. And then, if I can move to the services piece, obviously you are getting some momentum there we've been looking for and maybe, give us a little more detail as far as the revenue stream in terms of recurring base, how that kind of boils down in terms of the initial part of the contract? What is the kind of the recurring revenue stream that are out there?
Michael Klayko
Mark, we really haven't broken that out. I mean, it's a lot of -- it's kind of all of the above. There are contracts that are multiple quarters or full year contracts. There are professional services, which are delivered right in the current period. So, it's kind of all the above, but we haven't broken those out.
Mark Moskowitz - J.P. Morgan
Okay. And then, should we assume, as far as these services contract is it such that the gross margin profile is somewhat not that exciting in the early part but you do get a margin benefit as you tail-out that contract?
Michael Klayko
I guess, I'd represent a little bit different in that as we build out, as the revenue stream from services increases we get economies of scales. So gross margins will improve in our service business as we continue to build revenue.
Mark Moskowitz - J.P. Morgan
Okay. And then just lastly, in terms of the services piece, can you give us a sense in terms of what the customer profile is right now those that are really coming to you for these services? Are the folks with new SANs or SMB, is it -- are they in the process of adding on to existing SAN installations in terms of trying to really better utilize or optimize their existing investments?
Tom Buiocchi
Mark, this is Tom. It's all of the above, but I would say it's very heavily weighted in the larger enterprises, who have SANs that have grown to enormous sizes from where they began and the migrations they have to do between 2 and 4-gig or from one vendor to another vendor or the architectures they want to deploy to optimize their standards that continues to grow, build multiple SANs, provide routing between and among them. These are capabilities where we are very deep and we'll provide a lot of assistance in implementation to help this. It's mostly larger enterprises with medium-to-large deployments.
Michael Klayko
And is more than just 2 gig to 4 gig transitions, that this will be an ongoing.
Tom Buiocchi
Yes, it's architecture in itself, and it's also onsite services and preventive maintenance and so forth.
Mark Moskowitz - J.P. Morgan
Okay, I appreciate that. Thank you.
Operator
Our next question comes from the line of Mark Kelleher with Canaccord Adams.
Mark Kelleher - Canaccord Adams
Thanks. Congratulations on a good quarter.
Michael Klayko
Thanks Mark.
Mark Kelleher - Canaccord Adams
Mike, could you talk a bit about the market share dynamics you are seeing with the McDATA acquisition closing, specifically could we be seeing a market share shift from McDATA to Brocade, which might be a factor in your overproduction and McDATA's underperformance?
Tom Buiocchi
This is Tom, Mark. I don’t think anything -- it's tough to tell, right? We had competitive takeouts of competition for quarters and quarters and quarters, but I am not sure that this made a tremendous difference there. We always factor in some competitive takeouts during the quarter, but I don’t think there is any dramatic dynamics happening right now.
Mark Kelleher - Canaccord Adams
You haven't seen any increase in those takeouts as the quarter went on?
Michael Klayko
No, it's just normal business as usual at this point in time.
Tom Buiocchi
Which is very, very healthy competition out there.
Mark Kelleher - Canaccord Adams
Okay. And switching topics entirely, the 10-gig market, do you see that as still something out there that even though you may not have McDATA and Cisco as price pushers, you have to keep an eye on what's coming down the line for 10-gig and iSCSI and Ethernet-based SAN, is that a factor?
Tom Buiocchi
Mark, just to clarify, you mean 10-gig Fibre Channel or 10-gig Ethernet?
Mark Kelleher - Canaccord Adams
10-Gig Ethernet.
Tom Buiocchi
So, yeah, obviously, Mark we look at all the different marketplaces out there and there is logical progression technology. And, 10-Gig obviously is something that we're looking at because when you look at some of the other technologies that we just recently announced, such as the high performance iSCSI Blade in the Director space in the marketplace, we approached the market with that. And as the technologies mature, as some of the -- as we overcome some of the physical -- physics characteristics and as applications become aware, obviously we'll be well-positioned with technology to meet those.
Mark Kelleher - Canaccord Adams
Okay, great. Thanks.
Operator
Our next question comes from the line of Shebly Seyrafi with Caris.
Shebly Seyrafi - Caris
Thank you very much. So, congratulations on excellent quarter.
Michael Klayko
Thank you.
Shebly Seyrafi - Caris
I guess one of the things I'd be concerned about over the next few quarters is the April quarter. Not only it will be a normal seasonality, but also because that will be -- supposing that you close the McDATA acquisition in the January quarter, the first full quarter where you'll have the two companies together. So, are you doing anything to mitigate risk in that April quarter right now? And, how concerned are you about it?
Michael Klayko
Well, so from a risk point of view, it blows down to the integration. And, what we have done is we have done an excellent job and done a tremendous amount of work in planning for the integration on day one. We have teams that are engaged, we're proactively doing a lot of work both from a cost structure point of view and a gross margin point of view. I think we are doing a lot of good work to make sure we do reduce the risk.
From a revenue point of view, there we would expect to see some seasonality because there has (inaudible) in '06, and there will be a combined company. And, we'll have to wait until then in terms of whether that creates any different dynamic?
Shebly Seyrafi - Caris
Okay, also your sell-through growth and your deferred revenue growth under grew your corporate revenue growth, and you are also guiding for I would argue less than normal seasonal growth in your top-line. I am wondering if that's spells that you may have front-end loaded some business from January to October, or if not, why are those visibility metrics lower than might be expected to be the case?
Richard Deranleau
Well, I guess, part of it is that we had such an outstanding Q4 and I wouldn't want to take away from that. The second thing is, the guidance we have given you is that $210 million to $215 million in a quarter, we have only been over $200 million in any quarter one. So, based on the dynamics and the assumption that I laid out for you, that's the guidance that we are providing.
Shebly Seyrafi - Caris
And, also you talked about better mix of the gross margin driver, yet your fabric switch growth was higher than the direct growth and I would think the direct higher gross margin, maybe you can talk about specifically what you mean by mix as a driver of gross margin?
Richard Deranleau
So just on a relative basis, the gross margins across our product line are pretty consistent. The blades actually do have our highest gross margins for, I think, obvious reasons, you don't have a box around it. But when I talk about the product mix being favorable, a lot of that had to do with the new products. We had our 4900 switch coming out and doing very well during the quarter. And, Tom did you--
Tom Buiocchi
No. it's coming out is the 4900 as well, which is the newest product in the product line.
Shirley Stacy
Thank you Shebly.
Shebly Seyrafi - Caris
Thank you.
Operator
Our next question comes from the line of Paul Mansky with Citigroup.
Chris Werner - Citigroup
Hi, this is [Chris Werner] sitting in for Paul. A quick question on the FAN piece of the business and specifically the WAFS and what you are seeing in that market? And specifically to competitive environment, I know that (inaudible) mentioned entering in that space and they have had success and just what kind of growth profile you are seeing there?
Tom Buiocchi
Yeah, this is Tom, Chris. Our WAFS business is up significantly quarter-on-quarter and what's driving it is, we have a unique solution out there that really looks at file consolidation and storage consolidation as the problem we are trying to solve, not bandwidth optimization. So, the fact that we are on the Windows platform and the fact that our WAFS platform works with respect to file management and optimizing global file management along with our StorageX product, give us a very unique position there. So, we're doing very well in that space. It’s a slightly different solution than our competitors offer and it’s the only one that really captivates the Windows technology. So, we're doing, we are very optimistic there.
Chris Werner - Citigroup
Great, and then it is one more for Richard. Regards to the legal fees, how we should think about that for next quarter? Are those going to continue to increase? I saw it bumped up a little bit this quarter or are we going to see that kind of start to tail off here?
Richard Deranleau
That’s a really hard one because it's not totally under our control. I would look for it to be probably somewhat consistent.
Chris Werner - Citigroup
Okay. Great, thank you.
Shirley Stacy
Thanks Chris. Next question.
Operator
Our next question comes from line of Glenn Hanus with Needham.
Glenn Hanus - Needham
Good afternoon. On the financial guidance for -- on a consolidated basis, just want to confirm or see if there is any update you have to provide there. You've talked in the past about no more than 30%, I guess, it was if, I have the number right, sort of, McDATA attrition and when you might be EPS accretive, any update on that or restatement there?
Richard Deranleau
No. It's -- we are not making any change to the guidance that we gave and the model that we shared with you folks at our Analyst Day. We continue to do -- I'd mentioned, we've been doing a lot of planning and a lot of work and that just continues to increase our confidence in the model that we put out.
Glenn Hanus - Needham
So EPS accretion in fiscal '07, anything on kind of at what point in the year?
Richard Deranleau
Not really. I think what we did say was we planned to be in model for the entire year.
Glenn Hanus - Needham
Okay, thank you.
Michael Klayko
You're welcome.
Shirley Stacy
Our next question.
Operator
Our next question comes from the line of Aaron Rakers with A.G. Edwards.
Aaron Rakers - A.G. Edwards
Yeah. Thanks a lot and congratulations as well.
Michael Klayko
Thank you.
Aaron Rakers - A.G. Edwards
I guess my first question is regards to your WAFS or your FAN business. I think last time Mike, you and I had talked, you talked about a little bit of a different business model in that segment of your business, i.e., a little bit more specifically a direct model. I'd like to just get an update where you are at today in terms of building out a direct sales force for that and when you expect that to materially kick in?
Michael Klayko
Yeah, Aaron, actually we have done that and what we are finding is that the go-to-market model in that space is, just for easy math right now, is being split about a third, a third and a third through -- a third through our current channels and partners, OEM partners. Third through a brand new VAR channel that we've been building over the last year, and in the third direct with customers as either part of a service offering or part of a larger solution. So we have been building that out, and it is balanced because it matches how the customer wants to purchase the product as well as what relationship they currently have in place.
Aaron Rakers - A.G. Edwards
And then if I could follow up, if I look at the SAN switching market, let's call it year-to-date, it looks like the growth in the market overall for the industry is possibly even in excess of 20% so far this year? I'd like to get your guys take on are we -- what's the true growth dynamic looking out over the next few years for the overall SAN switching market? And are we merely just seeing just a refresh cycle play out of 4-gig and 2007 looks to be closer to that mid single digit type growth for the industry overall?
Tom Buiocchi
Yeah, this is Tom. That’s a tough crystal ball to kind of discern, but we haven’t seen numbers that show in the 20s yet from any of the industry analysts. We’re looking more in the mid-teens this year so far. And they may change, obviously, with the recent quarters. But we've looked at the mid-teens for most of this year. Going forward, it's tough to tell. It's not clear that 4-gig or a technology cycle accelerates purchases; customers typically buy when they need capacity. And so they happen to buy 4-gig when it's available. But I'm not sure 4-gig stimulated demand. I think it caused for choice points and trade offs in a customer's mind, and we gained share doing that, but I'm not sure it creates fundamental industry demand. That comes from data growth in the enterprise, and a lot of the stringent criteria on data retention and data protection, which has, quite frankly, no end in sight in the foreseeable future.
Aaron Rakers - A.G. Edwards
Thank you.
Shirley Stacy
Thanks Aaron. Operator, we'll take one last question please.
Operator
Our final question comes from the line of Dan Renouard with R.W. Baird.
Dan Renouard - R.W. Baird
Thank you. My question -- I have two questions if I might, first is on the buyback, are there limitations around putting your cash to work in terms of buying your stock back, i.e., do you have to wait for the deal to close? Can you be in the market before, during, after, etcetera? And then my second question is, can you give us some perspective on deal sizes in terms of have you seen an increase in large deals in the last year or two, and particularly greater than $1 million deals, thanks.
Michael Klayko
Richard, you do to the buyback.
Richard Deranleau
Yes, on the buyback, until the transaction closes we believe it's inappropriate for us to be out into the market, so.
Dan Renouard - R.W. Baird
Inappropriate?
Richard Deranleau
Inappropriate.
Dan Renouard - R.W. Baird
Okay.
Richard Deranleau
So, we would -- we do have $52.7 million remaining under our originally announced buyback program which was 100 million. So, after the transaction closes we would look forward to getting back into the market and continuing the program.
Michael Klayko
In terms of deal size, Dan, I would say that the advent of the 48-K, the introduction of the 48-K, five, six quarters ago really put us into deal category that we had not been in historically, because it was really the first time we leapfrogged the market in terms of price performance on the directors side. Over the last four or five, six quarters there has been no significant change, but we are in fundamentally every big deal out there right now.
Dan Renouard - R.W. Baird
Thank you.
Michael Klayko
Okay.
Shirley Stacy
Thank you, Dan. And thank you everyone for joining us. This concludes our fourth quarter and fiscal 2006 year-end conference call. We look forward to seeing you at upcoming conferences including the Lehman Brothers' Conference on December 6th, in San Francisco and the Needham Conference on January 11th, in New York. As always, our presentation and breakout are webcast on our website. And finally with respect to the quality of conference call today if you have any questions I would encourage you to see the webcast slides posted on our website at www.brocade.com. Thanks for calling.
Operator
That does conclude today's teleconference. You may now disconnect.
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