Brocade Communications CEO Discusses F3Q10 Results - Earnings Call Transcript

Aug.19.10 | About: Brocade Communications (BRCD)

Brocade Communications Systems (NASDAQ:BRCD)

F3Q10 (Qtr End 07/31/2010) Earnings Call

August 18, 2010 5:30 pm ET

Executives

Rob Eggers - VP, IR

Mike Klayko - CEO

Richard Deranleau - CFO

John McHugh - VP and CMO

Dave Stevens - CTO

Ian Whiting - SVP of Worldwide Sales.

Analysts

Brian Marshall - Gleacher & Company

Nikos Theodosopoulos - UBS

Ryan Hutchinson - Lazard Capital Markets

Mark Sue - RBC Capital Markets

Aaron Rakers - Stifel Nicolaus

Erik Suppiger - Signal Hill

Munjal Shah - Jefferies & Company

Katie Huberty - Morgan Stanley

Min Park - Goldman Sachs

Kaushik Roy - Wedbush

Jayson Noland - Robert Baird

John Slack - Citigroup

Operator

Good day ladies and gentlemen, and thank you for standing by. Welcome to the Q3 2010 Brocade Communications Systems earnings and question-and-answer session conference call. (Operator Instructions) And now, I would like to turn the program over to our speaker Rob Eggers, Vice President of Investor Relations with Brocade.

Rob Eggers

Good afternoon, and welcome to Brocade's Q3 earnings question-and-answer conference call. By now you should have seen our press release and prepared comments, which are available on www.brcd.com. The press release was also distributed by First Call and Business Wire, and furnished to the SEC.

Before we take questions, investors should note our comments today may include forward-looking statements regarding Brocade's financial results, cash and debt positions, plans, market opportunities and business outlook, which 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 on our Form 10-Q for the fiscal quarter ended May 1, 2010, and our Form 10-K for the fiscal year ended October 31, 2009. These forward-looking statements reflect beliefs, assumptions, outlook, estimates and predictions as of today, and Brocade expressly assumes no obligation to update any such forward-looking statements.

In addition, this presentation may include various third-party estimates regarding the total available market and other measures, which do not necessarily reflect the view of Brocade. Further, Brocade does not guarantee the accuracy or reliability of such information or forecast.

This presentation includes non-GAAP financial measures and most directly comparable GAAP information, and a reconciliation between the non-GAAP and GAAP figures are provided in our Q3 2010 press release, which has been furnished to the SEC on Form 8-K and in our slide presentation and prepared comments on www.brcd.com.

Here to take your questions are Mike Klayko, Brocade's CEO; Richard Deranleau, CFO; John McHugh, VP and CMO; Dave Stevens, CTO; and Ian Whiting, Senior Vice President of Worldwide Sales.

I will now turn the call over to CEO, Mike Klayko. Mike?

Mike Klayko

Thank you, Rob. As Rob mentioned, please refer to the prepared comments and the slides for full details of our Q3 financial results. But I did want to take a few minutes to summarize some of the key themes that developed in the quarter. Overall, this is solid performance in what is seasonally a challenging quarter. We executed well in our SAN business, which was up 4% sequentially; again, what is normally our toughest quarter.

The SAN Switch business did very well, up 20% sequentially. All this supports something we've been saying that fiber channel is a technology that is vibrant and has a long productive future ahead of it. And the fact is, customers want a reliable datacenter networking technology to support IT initiatives such as virtualization and fiber channel continues to be a right answer for many of them.

Moving on to our Ethernet business, there are many indicators from Q3 that give us confidence that we are on the right track, and that our strategies and investments are working. For example, we're pleased with the fact that we have completed the bulk of our hiring goals in our sales organization, which is having a positive impact on our ability to win new customers.

In Q3 we won more net new Ethernet accounts which generated more revenue than any quarter since the Foundry acquisition. Our Ethernet innovation strategy is also on track. There is no better indication of this than the enthusiastic positive response we generated at Technology Day where we launched the Brocade One architecture and unveiled some compelling next generation Ethernet technologies, such as Brocade VCS, which is designed to make networks simpler to use, and highly tuned for virtualized datacenters.

In fact, we have already started to take early orders for Brocade VCS switches, a clear signal that there is a strong customer interest for this technology, and this is just the beginning of our Ethernet innovation cycle. Our partners are taking notice as well. The momentum behind our business is fueled in large part by Brocade One, and our Ethernet innovation is improving our ability to recruit and sign top-tier global distributors and resellers.

This is resulting in more of our Ethernet business going through this important channel, which is a critical success factor in our overall growth strategy. There's no question that all companies today face challenges, and we recognize the ones that lie ahead of us, some of which are out of our control. But we continue to focus on the ones within our control, and we continue to gain confidence from our customers and partners telling us that our innovation, sales and marketing strategies are tightly aligned with their imperatives, which bodes well for our long-term success.

With that, operator, I'd like to open up this conference call for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) And we'll take our first question from Brian Marshall with Gleacher & Company.

Brian Marshall - Gleacher & Company

A question on your core business relating to SAN networking. Brocade, as well as the other HP players etcetera are all down year-to-date in terms of stock performance. And clearly, a lot of the other enterprise infrastructure names have performed quite well. I know that there was an inventory build situation happening earlier this year.

I was just wondering, given the fact that you were up roughly 4% this last quarter in your core business, can you give us an update of where you think we are in terms of supply/demand equilibrium currently as well as in the back half of this year?

Richard Deranleau

This is Richard. I'll start the question. I think we are in pretty good shape. We are entering the strength of our year. Q4 and Q1 are strongest parts of the year on a go forward basis. Inventory at the OM is actually down. So I think it's hard to predict.

But I would think, heading into the strongest part of the year we're in pretty good shape.

Brian Marshall - Gleacher & Company

And Richard, do you think that that situation will continue into early next year, based upon order patterns etcetera and demand out there? And any potential impact that you've seen in the near term from fiber channel or Ethernet and how that's impacting the core business or perhaps 10 gigabit Ethernet switching?

Dave Stevens

So just a comment on FCoE, we're seeing really zero impact of FCoE in the fiber channel business. The people that buy fiber channel that build their infrastructure out of fiber channel networks are continuing to do so. They know that we're continuing to invest in that technology.

We've got a speed bump coming here over the next year or so that we've talked about before, and they're pleased that we'll go and do that and they are continuing to buy fiber channel. Where FCoE is having an impact is in the Ethernet business where people that are deploying Ethernet infrastructures are looking to deploy things that are future proof and that are capable of running all kinds of protocols including FCoE.

In terms of deployment, we're seeing some modest deployment only in top-of-rack situations where we're server I/O consolidation. And we're not really seeing any production multi-hop deployment of FCoE at all.

So the long answer is, it's not having any impact on the fiber channel business at all.

Brian Marshall - Gleacher & Company

And Dave, just a final question. The same thing with 10 gig E switching at this point?

Dave Stevens

I think we're seeing pretty rapid adaption. 10 gig Ethernet switching is more virtualization, you know, technology gets deployed.

Brian Marshall - Gleacher & Company

And no cannibalistic trends there? Can you talk about your positioning in that marketplace?

Dave Stevens

Well, I think our position there is great. As Mike pointed out I think in his opening remarks, the reaction to VCS and the platforms that support VCS that we launched at Technology Day has been, I'll have to describe it as almost overwhelming from customers and from our partners and from the analyst community.

I think there's a general recognition that that fundamentally will allow us to re-architect the datacenter, to very aggressively deploy 10 gig technology in a way that's simpler. It's capable of carrying all protocols including FCoE. And as Mike mentioned, it's tuned for virtualization, and it's designed specifically to make larger, flatter, faster networks that are designed to take operational expense out of the datacenter. And we're on track to ship that product set and the products that follow that over the coming years.

Operator

Our next question will come from Nikos Theodosopoulos with UBS.

Nikos Theodosopoulos - UBS

Can you go into a little bit into the gross margin? If I read the slides right, I think the impact of the inventory hit to the Ethernet business was about $10 million. So if I strip that out, the Ethernet business gross margin would have been flat sequentially.

Can you clarify that? And do you expect any more of these charges in the next quarter or two? Then as a second part of that the trend on the SAN gross margin continues to be down. What's the outlook for that stabilizing going forward?

Richard Deranleau

Let's start with the SAN. From a SAN perspective, I would expect us to have a positive pressure on our gross margins or a benefit as we go into Q4 from mix perspective as we move more toward directors. That's traditionally one of our strongest director quarters. So from a gross margin perspective on SAN I would expect some improvement back to historical norms which were kind of mid-60s.

From an Ethernet perspective, I guess the way I would phrase it is, because of all of the new product introduction whether we've announced them or in the roadmap there's a lot of new product activity. That's all a good thing. However, it does impact our inventory positions.

On the Ethernet side, I would expect our Ethernet margins to return back to something closer to what they were in Q2, basically for two reasons; we would expect those period charges associated with the product launches to be significantly less, and then secondarily, as volume ramps we get a benefit from a volume perspective as well.

So those two issues should have a positive impact on our Ethernet margins in Q4.

Operator

And we'll go next to Ryan Hutchinson with Lazard Capital Markets.

Ryan Hutchinson - Lazard Capital Markets

My question's on the federal vertical. It looks like it was weak on the Ethernet side. So I want to get some clarity around that, and then in terms of the pipeline, as you look into the October quarter the comfort level with the Fed spend, actually both on the SAN and the LAN side and the expectations there as it coincides with the guidance you provided.

Ian Whiting

So the comparison on the Federal Business is a little bit off because had a stronger than normal Q2 in Federal. So sequentially, that was somewhat of an anomaly. I would say that the outlook in Federal Business has always been going into our Q4 is positive. We are seeing some positive trends that the Federal Government agencies that we're particularly strong in, will be spending in Q4. And so we remain optimistic for the Federal Q4 business we'll be strong. And as normal, will be in fact our strongest quarter of the year.

Ryan Hutchinson - Lazard Capital Markets

If we look historically on the Foundry business, is it fair to assume it will follow some historical trends witnessed over the last several years in terms of the percentage of total revenue?

Richard Deranleau

Just to add to Ian's comments, when you look at last year I think if my memory is correct, Q4 Federal was up 8% quarter-over-quarter from an Ethernet perspective. And I think this year we would expect something at least like that. In addition to that, we do have more resources in the field and we do have product cycle in our benefit.

Operator

We'll go now next to Mark Sue with RBC Capital Markets.

Mark Sue - RBC Capital Markets

There were a lot of positive assumptions made about three months ago when you were sticking to your full year outlook of $2.1 billion to $2.2 billion. Considering the reduction of the outlook, how much would you say is macro related? How much is related to market share loss in Ethernet? And if you could parse anything in further detail that would be helpful.

Mike Klayko

Mark, there's a lot of people who are larger, that's in the industry, are taking a more balanced view around the world. And they're calling on some of the macro trends that they're saying, we're just taking a more balanced view around some of the industry guidelines. And I'd say the last 60 days, and especially as we've heard some of our peer company's come forward. But from a spending standpoint, some of the customers we're dealing with at this point in time all the trends are in the right direction for us. But I would say some of our go forward is more macro based that execution on our part base.

Mark Sue - RBC Capital Markets

Mike, so the impact of the macro, is that more in your pipeline or are you assuming a more conservative closure rate? Is there some hesitation in your customers or is the orders actually starting to be impacted as well?

Mike Klayko

We haven't seen that at this point yet, Mark. In fact, we're actually starting to see because of this new technology actually a renewed interest. And so the pipeline is growing. And we're also adding the people into the field, it's more around how can we close the transaction given the products that we do have and our Q4 and then our Q1 quarter also. I wouldn't say that the closure or such, I think it's more of the fact that we're getting a lot of interest and our pipeline continues to grow.

Richard Deranleau

Just to put it in some perspective, the outlook for Q4 is still calling for revenue growth between 5% and 9%.

Mark Sue - RBC Capital Markets

And, Richard, separately last quarter I guess the goal was to price stimulate the Ethernet switch market, is that something that you and Mike continue considering the new products or do we start throttling that back?

Richard Deranleau

I think we've done a lot of simulation, Mark, that's how this pipeline has grown as well as demand. Now we're more into some the deployment. ECS has garnered a lot of interest for us. And so you'll see us putting a lot more investment around helping customers architect datacenters and that space. We had a maniacal focus on new footprints. We've actually exceeded our goal in what we wanted to get for new footprint, now we can actually go in and start driving these new footprints that we have for additional business in those accounts.

Operator

We'll go next to Aaron Rakers with Stifel Nicolaus.

Aaron Rakers - Stifel Nicolaus

I want to go back to the gross margin, and I apologize, I'm working some of the slide decks here and stuff. I think one of the comments that's in this is that the Ethernet gross margin you saw basically a 200 basis point effect sequentially, I believe from that inventory reserve, so that leaves us with about, let's call 600 basis points remaining on a sequential basis. I'm wondering if you could help us bridge that gap sequentially on what less than that, be it volume effect. And more importantly, what kind of pricing mix effect you're seeing on a sequential basis?

Richard Deranleau

Yes, Aaron, there are three components. There are period costs, which includes inventories which is on slide 27. Remember, 27 is a year-to-year comparison, not a sequential comparison. Overhead which is pure volume driven and there is everything else which is really pricing and mix. Which is what pricing and as well as product mix and to some extent channel and customer mix.

So the way I would look at it is from Ethernet perspective, Ethernet gross margins were unusually low in third quarter, Q3, driven by lower than normal absorption because of volume; also because our period costs were higher than normal including infrequent items. And then the price mix was less of an issue than maybe one would think because it was offset to a certain extent by some cost reductions.

So what you end up with is that normally low gross margin in Ethernet. And as you look into Q4, obviously the volume is a benefit, and that helps from a volume perspective. And the period costs we'd expect to normalize. When you get beyond that, the pricing, as we said in the prepared remarks is kind of low-to-mid, more like low single digits. And then you get some benefit from cost reductions, which mitigates that.

Aaron Rakers - Stifel Nicolaus

So if I look forward, and looking into next year, how should we think about the gross margin run on that business as we work past some of these issues? Are you expecting to see some stabilization on the pricing side? Where is the right level of gross margin in that business, looking out beyond the next couple of quarters?

Richard Deranleau

We'll talk a lot more about that at analyst day. But we have a model out there. I think what Mike would tell you is what I believe myself is that right now it's about footprint and gaining footprint. And there are some price implications from that.

However, as we've also talked that as we move to new platforms that are more Brocade-like and Foundry-like, in terms of their cost structure, you get benefits from that. The classic example to use is ASIC. Those will be impacting in '11. So from FY '11's perspective, we should have positive results in gross margins in FY '11. But keep in mind, our focus right now is on driving top-line.

Aaron Rakers - Stifel Nicolaus

The Dell relationship, I know its early stages with regards to that partnership on the Ethernet side, but any additional thoughts or color you can provide in terms of the ramp, or how we should think about that ramp going forward and any thoughts with regard to when that starts to really materialize from a revenue standpoint?

Ian Whiting

There are a couple of aspects to the Dell relationship. On the classic SAN side, we're very pleased with some of the recent announcements with Dell officially launching the Brocade HBAs and CNAs under their own brand. So that will be a positive benefit to the storage side of the house.

As importantly if not more importantly, we're seeing continued ramp and momentum on the IP networking side. One of the things that we measure very closely is the, as Richard alluded to, is the new IP footprint. And specifically with Dell, we're seeing a significant percentage of our overall IP business being generated through opportunities through us by Dell.

So collaboratively selling into their installed base and very strong field sales engagement. So I would characterize the Dell relationship as positive on all fronts with significant momentum going into Q4 which for both of us is obviously a very important quarter.

Aaron Rakers - Stifel Nicolaus

Can you say what the sell-through was relative to your 20% sequential growth on a sell-in basis for your storage business?

Ian Whiting

Could you repeat that?

Aaron Rakers - Stifel Nicolaus

What the sell-through number was on a sequential basis versus sell-in on your storage business?

Ian Whiting

I think the 20% you mentioned was specific to the switches. But I would say basically, the sell-in and sell-through were nearly the same; were effectively the same.

Operator

And we'll take our next question from Erik Suppiger with Signal Hill.

Erik Suppiger - Signal Hill

On the Ethernet gross margins, what have the gross margin there been? Where have they been trending? It was 43.5 in Q2. Where was it before that? And where does this stabilize?

Richard Deranleau

I'd go back to my conversations that I've had, or the comments that I made earlier. As you look into FY '11 what you're going to see is, you're going to see changes in the cost structure of the product which are going to improve our gross margins. I think when you look at gross margins from an Ethernet perspective, Q3 was a pretty low number for the reasons that I talked about. I think when you look at a go-forward perspective, you're going to see gross margins on the Ethernet side continue to improve going forward.

From the SAN perspective, gross margins continue to be very healthy. They move around a little bit because of seasonal patterns in our product mix, sensory directors versus switches, but they've been pretty stable and pretty strong.

Erik Suppiger - Signal Hill

On the Ethernet side though, can you tell us what the trajectory was before going into Q2, how it's performed in the last few quarters?

Richard Deranleau

I would say that in our basis of measurement, they've been operating from the date of acquisition kind of in the 45ish range, and we'll spend more time in explaining how we look at gross margin versus let's say others in the industry on the Ethernet side specifically. But I would say, it's kind of operating around the mid-45-ish. So the 35, as you can see, I'd almost characterize as an anomaly and you should see improvements going forward.

Erik Suppiger - Signal Hill

And to be clear, you had suggested that the competitive pricing was not playing much of a role in the down take that you saw this quarter. Going forward, do you continue to think that competitive pressures are not changing or do you have sense as you look out into Q4 and beyond? Have the competitive dynamics changed at all?

Mike Klayko

I think they've actually swung our benefit, because with the new architectures that we've just announced we began shipping those at the end of the year, and so we became the new de facto design point that everybody else would have to go ahead and use a different offering than they had in the past. Because our future set is going to be the one that I think that many of the datacenters will measure other competitive products by.

Erik Suppiger - Signal Hill

And then lastly, the VCS product, did you say when will be shipping?

Dave Stevens

So we've talk about it; shipping by calendar Q4 this year. So by December this year.

Erik Suppiger - Signal Hill

Can you give us any update, will it be before Q4, is that the expected release date?

Dave Stevens

Now, I mean that's the expected release date that we talked about. We are on track to ship it in, and I don't expect we'll pull it in from there?

Operator

Now we go next to Munjal Shah with Jefferies & Company

Munjal Shah - Jefferies & Company

Could you talk about your service provider business, I mean where do have more concentration, is it Japan or primarily U.S.?

Ian Whiting

Service provider business has been historically very strong in the U.S. and also in Europe and some very specific, segments of the market. We are very pleased with the overall performance of the that business and it's a function of a couple of things. One is a product leadership position which we've attained now with our MLX platform and some of the recent enhancements to that product which have been exceptionally well received by those customers.

And secondly, it's function of the increase in sales coverage that we've had in that marketplace, which is ramping in Europe and in Asia-Pacific, and in Japan. But we had a much stronger base and history of customers and revenue in United States. So that's given us that much more of a lift as we've introduced these new platforms.

So definitely an area of growth, focus for us as we go forward. The focus for us more specific is to get the European and the Asia-Pacific and Japan regions operating at the same level of productivity and success that we're seen in the U.S.

Munjal Shah - Jefferies & Company

A couple of questions on the balance sheet. One was accrued employee compensation, that was down, Richard, I mean should we read into it for Q4 in terms of your OpEx or how should we think about it.

Richard Deranleau

It's typically more a pattern about some structural times in terms of when we pay the employees their profit sharing and when the ESPP program is executed. So it's really just a timing, if you look back over time you will see very consistent pattern, there's really not much to read into that.

Munjal Shah - Jefferies & Company

And then you took inventory reserve this quarter and your inventory was up. So I mean is inventory up in storage or is it up in Ethernet products?

Richard Deranleau

No, this is all around the Ethernet, our supply chain on the storage side is incredibly fine tuned. And I'll just go back to a comment I made earlier and reiterate, this is a double edged sword. The good news is that we've announced quite a bit of products, we have more products on way. And that puts us in a transition period. So we are definitely in a period where we are refreshing our product line and that has implications when you are in a product transition mode to your inventory.

Operator

We would go next to Katie Huberty with Morgan Stanley

Katie Huberty - Morgan Stanley

This is a follow up on some of the expense discussion. On the inventory accrual in the Ethernet business, Richard, is that a known amount of inventory that gets written off and can be used or is that an estimate that potentially reverses depending on what you sell through over the next couple of quarters?

Richard Deranleau

It's the latter, for example, when we had acquired McDATA we had reserved quite of bit of McDATA product. And over time we actually ended up selling through a great majority of that. So we recaptured some of those reserves that we had posted.

Katie Huberty - Morgan Stanley

Do you think you were especially conservative given the demand environment or pretty consistent behavior in estimating those accruals in the past?

Richard Deranleau

I'll go back to Mike's point I think we are trying to be balanced in the way that we were during our businesses.

Katie Huberty - Morgan Stanley

And then just quickly on OpEx. Did you do anything to hold back through the quarter just given some of the weakness in Federal and Europe and the overall back row headlines and then why are you expecting an uptick in OpEx percentage in the next quarter? In light of a decent revenue uptick?

Richard Deranleau

It's really pretty straight forward, what we are doing in this year is we are investing in sales. We're investing to drive the top-line, also investing in marketing which impacts at us namely from a demand stimulation point of view. So again, to drive top line revenue, we are actively recruiting, hiring, bringing on boarding sales and sales support people.

Once you go beyond that, we are also focused on making sure we have adequate engineering resources. And then after that, once you get below those two line items, we are very careful about each and every hire we make. If they're not contributing to revenue we're not contributing to products.

Katie Huberty - Morgan Stanley

So nothing this quarter to hold back on OpEx and fund some of those hires?

Richard Deranleau

Well, I can tell you that we encouraged Dan to hire aggressively. And I myself would have been very selective in terms of whether I really needed to hire a position, and I think that's the way sales and marketing support types of staff positions are being looked at with more scrutiny.

Operator

And we go next to Min Park with Goldman Sachs.

Min Park - Goldman Sachs

Can you just give us a bit more detail on your outlook for the October quarter? I guess specifically your expectations for the SAN and Ethernet segments as well as any thoughts you might be able to add on GL and a particular protocol?

Richard Deranleau

Well maybe I could at least start framework then Ian might want to jump in with some more color around your second part of your question. But when we look at it again from a balance perspective, we look at the data storage growing at the low end to the within I would say normal seasonal patterns. When we look at Ethernet, keeping in mind the Federal perspective. And at the low end you would expect typical seasonality, at the higher end you would expect higher than that driven by the incremental Ethernet sales resources in place and the product cycle.

Ian Whiting

I think from a geographic point of view it's a fairly balanced story. Overall on the IP side specifically we see continued strength in the America's where we've been particularly focused from a hiring perspective and the ramp in those resources are beginning to show up in terms of productivity and we expect that to continue into Q1 into next year.

Already commented a little bit on Federal business I think it's well documented that we were unhappy with the business in Japan for number of reasons. Some of them are macro, but that scenario that we have to certainly turn around and get back to growth. And overall in EMEA and Asia-Pacific we're pleased with the results; we saw growth sequentially in Asia-Pacific and in EMEA.

EMEA was slightly less than we had anticipated, but still good forward momentum. And laying the foundations for growth going forward as these resources that Richard referred to that we've been bringing on board start to deliver results and deliver on productivity. So a very balanced view of of the world with some specific areas where we clearly need to focus.

Min Park - Goldman Sachs

And you even though your pipeline was a relatively strong in the quarter, I was wondering if you could show what is the linearity of bookings as the quarter progressed, not necessarily your revenue, but how your orders came through, and what your book-to-bill may have been at the end of the quarter?

Ian Whiting

Pretty much in line in what we seen in prior quarter. There was no major anomalies or differences to what we've seen in prior quarter on the IT side. And on SAN side that tends to follow a fairly standard pattern as well.

Min Park - Goldman Sachs

You know that your sell-in and sell-through on the SAN side was roughly even this quarter. So in your conversation with your OEM partners, do you get a sense that the inventory levels will actually come back or do you think two weeks of two and a half weeks is the new baseline, is that what you're expecting going forward?

Mike Klayko

It's hard to predict, Min. I think that as we get into their year ends and their quarters and so forth it's more of an indication of what they need from us. And so we try to be responsive. But I think we're kind of set into a seasonal pattern right now that we're going to live with for a long period of time.

Operator

The next question from Kaushik Roy with Wedbush

Kaushik Roy - Wedbush

So EMC storage products were up 27% year-over-year, NetApp's products up 51% year-over-year, your SAN revenue is up 2% year-over-year. So, the question is, is the SAN market shrinking, looking beyond this fiscal year what could be the growth rate of the company? Is it low single digits, mid single digits any kind of color would be helpful?

Mike Klayko

I think what you're asking is on a go forward basis, we have a variety of pieces of data we're going to share with you on, we think from 11, 12 or, 13 around the storage business and our analyst day coming up in September. And you'll get more detail on that broken out. That question as you ask it is storage is one thing but how it breaks down from a connectivity standpoint how it's used, where it's used, and where we can participate is another; because you're trying to connect the dots here. I think we're going to put in a bunch of color on that to help you connect the dots. But the fiber channel business has a lot of legs and it is going to be around for a long period of time.

Kaushik Roy - Wedbush

And then your services business, specially the SBS or the consulting, doesn't seem like it's growing, so why do you want to keep it, or what do you do to grow that business?

Mike Klayko

Yes, the services business is there to help our customers install the products that they bought from us, and we could help them implement it in a faster fashion so that they could buy additional product. And it was basically to fill a skill set that was needed in the marketplace.

We constantly look at all the different businesses that we have and we evaluate them on their own merits. And right now, it is a necessary business for us to go ahead and be in, but if it does change we'll let you know.

Operator

(Operator Instructions) and we'll go next to Jayson Noland with Robert Baird.

Jayson Noland - Robert Baird

A question on Ethernet pricing, I guess how much of the change there is more aggressive HP relative to historic norms?

Ian Whiting

I think HP is one of many competitors that we confront in the industry, and then we look at it by different segments. We really don't see HP in the datacenter, we see them primarily in the campus LAN space, nor do we see them in the service provider. So if you look at them from a campus LAN perspective, where there is the most players, the most competitions, certainly HP is an aggressive competitor.

Our strategy for combating that is the breadth and depth of our product line and the quality of our product. So we certainly see HP. HP are a factor as they were prior to their recent acquisition. I would not characterize then as being more aggressive or less aggressive than any of the other players in the marketplace right now.

Jayson Noland - Robert Baird

And then just a follow-up there, maybe an update on sales force restructuring as it relates to Ethernet? Are you finding the people you want in various geographies around the world?

Ian Whiting

Yes, this has been actually a highlight I think of the last quarter where we're extremely pleased with our ability to have attracted and recruited to the goals that we have set ourselves. I think it's a function of the interest in Brocade. Some of the announcements we've made recently, we've been very pleased with some of the additions in Europe where are able to attract a new sales leader from HP.

In the United States, we've attracted some senior sales executives from some of our other major competitors. And I think that's a good indication of the interest in Brocade and what we represent. But overall, the ramp has been pretty significant, in line with our goals. And we do expect the impact and the productivity from that to bear fruit in Q4, but also as we enter FY'11.

Jayson Noland - Robert Baird

Last question from me Richard. As it relates to CapEx, it sounds like the new campus is complete at this point.

Richard Deranleau

There's some information in the slides, Jason, but the campus itself is complete. We have final payments that we make during the quarter Q4. Going into next year, there are two specific payments. The total of both of those payments together are $11 million.

So obviously the cash flow generating capabilities of the company will be significantly improved next year versus this year for no other reason than the campus has been complete, other than that small $11 million payment in the first half of 2011.

Operator

And the last question comes from John Slack with Citigroup.

John Slack - Citigroup

Maybe you can flesh out a little more color around what's going on in the service provider side on the IP business. Up big last quarter and down big this quarter; I know it is a lumpy business, but maybe you can flesh a little color around that. And then maybe talk about your plans for 100 gig, and how that affects that business going forward?

Ian Whiting

Yes, this is Ian, let me start with that. So I think it is a lumpy business, and as I said earlier on, we've seen strength in the U.S., we've seen strength in our core business and core customers outside of the U.S. We've been very focused on expanding the base of customers and the service provider segment. That's part of that new customer acquisition trend that Mike and Richard had referred to earlier on.

I think that we have some very specific product advantages today, but we'll certainly pay dividends for customers who are looking for extremely high performance, low latency in the most critical service provider applications. We have started to certainly generate a lot of interest in 100 gigs in our customers; strong interest at seminars and events that we've been holding around the world. We have taken our first conditional orders for 100 gig from some customers as well.

So there's a strong interest in that part of the technology as well. But overall, I would characterize the service provider business as an area of growth for us going forward based on a combination of focus and execution, and also our product roadmap.

Dave Stevens

One thing I would add to it is the response to the MLX platform and the service provider space has been extremely good in places like high performance backbones, internet exchange points where traffic is really growing dramatically. The 10 gig density in that platform, today we can support 256 line rate 10 gig ports in that platform. That density and the ability to lag those ports together gets very, very good response out of those customers.

And as Ian said, that platform is also 100 gig capable. We are going to have a very exciting announcement late this year with response to the 100 gig. But I would just say that we are going to set a new benchmark in terms of throughput and port density at 100 gig that other people in the industry are going to have a tough time matching, both from a performance standpoint, a density standpoint and also the price levels that we're able to achieve with the MLX platform.

So stand by on that.

John Slack - Citigroup

And then maybe a follow-up for Ian on the OEM side. The slide that talked a lot about HBA traction and continued traction in Fibre Channel, any update on the Ethernet side? I didn't really hear much about that.

Ian Whiting

Let me kind of break it down. We've talked at length in the couple of calls around IBM, and that relationship remains intact and there are positive signs that that business is moving in the right direction. But it's still below our expectations that we had going into the year.

One of the positive signs is that the Ethernet products have now been launched as part of the server group within IBM, the System x group, which is a new market opportunity for us which is not directly related to the storage group where the products had resided up until now.

So that's a very different business and value proposition; it's a server attach rate business versus a storage attach rate business. So we are very excited about that opportunity with IBM.

The Dell relationship I have already characterized I think as an area of significant growth. And certainly a lot of excitement, both on the Dell side and on our side. And we also, as you will recall, back in May announced a relationship with EMC to help EMC flush out and expand the value of some of their storage related iSCSI solutions where they require 10 gig connectivity. So that relationship is also off to a good start.

In Q3 we saw our first significant orders from EMC. So that's a nascent but an interesting opportunity for us going forward as well.

So all of the OEM partnerships we have are in growth mode. They are still early with the exception of IBM, where there is a new opportunity that's emerged. I would characterize it as a positive momentum.

John Slack - Citigroup

Maybe as just a final closing one, Mike, I'd love to hear your impressions of Chamber's comments last week about mixed signals interquarter and kind of going forward, and what Brocade's take on that is?

Mike Klayko

Actually that comes back to this balancing act that we all talk about. They obviously have a much broader market that they reach in terms of their product sectors; they are in more segments. But they have a lot of people looking at a lot of different markets. Where we compete, we compete very, very well. But I don't discount peers in the marketplace that have done well, and so we look at those and we have to balance what we see and what others are seeing in the market and then we have to factor that into our guidance going forward. And that's what we've done at this point in time.

I don't discount a large competitor; it's just that we continue to do well against them. But I still don't discount some of the things they're seeing. And we just factor that into our thinking.

John Slack - Citigroup

Good luck, guys.

Mike Klayko

I want to thank everybody for joining us for our Q3 earnings call today. I hope many or all of you can join us on September 15 at our analyst day here in San Jose.

With that, I'd ask the operator to close the call.

Operator

That does conclude today's conference. We appreciate your participation.

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