Executives
Rob Eggers - VP of IR
Mike Klayko - CEO
Richard Deranleau - CFO
John McHugh - CMO
Jason Nolet - VP, Data Center and Enterprise Networking Group
Ian Whiting - SVP of Worldwide Sales
Analysts
Ittia Kidron - Oppenheimer
Munjal Shah - Jefferies & Company
Mark Sue - RBC Capital Markets
Kaushik Roy - Wedbush Securities
Mark Moskowitz - JPMorgan
Simona Jankowski - Goldman Sachs
Glenn Hanus - Needham
Scott Smith - Morgan Stanley
Rajesh Ghai - ThinkEquity
Erik Suppiger - Signal Hill
Aaron Rakers - Stifel Nicolaus
Brian Marshall - Gleacher & Company
Jung Pak - BMO Capital Markets
John Slack - Citigroup
Brocade Communications Systems, Inc. (BRCD) F4Q2010 (Qtr End 10/30/2010) Earnings Call November 22, 2010 5:30 PM ET
Operator
Welcome to the Q4 2010 Brocade Communications Systems earnings question-and-answer 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 Q4 earnings and 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 July 31, 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 any such information or forecast.
This presentation includes non-GAAP financial measures, the 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, CMO; Jason Nolet, VP, Data Center and Enterprise Networking; and Ian Whiting, Senior Vice President of Worldwide Sales.
I will now turn the call over to CEO, Mike Klayko. Mike?
Mike Klayko
As Rob mentioned, please refer to the prepared comments and the slides for full details of our Q4 financial results. I did want to take a few minutes to summarize some of the key items and things that developed in the quarter.
I am extremely pleased with the record revenue performance of $550.4 million in Q4, which was an all-time high for our company in our 15-year history. The main driver was our outstanding performance of $171 million in the Ethernet business, representing 14% growth sequentially and 13% year-over-year. I believe that the strength of our Ethernet business in the latter part of this year indicates that the key growth initiatives we implemented earlier in the year are right on track.
Other company highlights in Q4 include 7% sequential revenue growth in our SAN business in what is a seasonally strong quarter. In terms of geographies, Americas and Asia Pacific led the way with sequential growth of 11% and 9% respectively. On a year-over-year basis, Asia Pacific ended 2010 with 22% growth, which is certainly noteworthy.
Innovation is a significant factor to the company's differentiation to the market and a foundation for future growth. In that regard, 2010 was a solid year for us with a number of highlights in this area.
These include the introduction of virtual cluster switching or VCS technology, which we believe is a game changer for the data center networking industry. VCS forms a basis of Ethernet fabric through cloud optimized networking, and we believe that it will advance the adoption of fully virtualized cloud-enabled data centers. Just last week, we helped deliver on the promise of VCS by introducing the Brocade VDX, which is the first product based on VCS technology.
Another highlight was the introduction of the Brocade MLXe Core Router and the two-port 100 gigabit Ethernet modules, which we believe helps Brocade offer our customers the world's most powerful 100 gig Ethernet router.
These products are designed to tackle the massive growth in both network traffic and digital data that our customers are dealing with today. It is little wonder that five of the world's largest internet exchange points or IXPs run on Brocade networks.
The final innovation or highlight I wanted to touch upon is our recently announced commitment to 16 gigabit Fibre Channel technology. Our commitment is not only important to our install base, but is critical to the Fibre Channel industry. It also reaffirms what our customers have been telling us. Fibre Channel continues to be a key technology now and will continue to be a critical technology for the future.
In FY '11, we will turn our innovation focus to other game changing areas namely virtualization, cloud computing and the continuing development of Ethernet fabrics. Please refer to my prepared comments for more details on the strategies to address these important opportunities.
With that, I'd like to open up the conference call for your questions.
Question-and-Answer Session
Operator
(Operator Instructions) We'll go first to Ittia Kidron with Oppenheimer.
Ittia Kidron - Oppenheimer
I'm trying to better understand the sequential trends over the Ethernet business line to the next quarter. In a way, I understand the federal point, but I'm trying to understand also how much of the expected weakness next quarter comes from the fact, they're introducing new solutions and could create somewhat of a freeze in the market before customers get their hands on it, and test it and trail out. So John, maybe you can kind of comment, how do you expect your portfolio to revolve through the market and adoption rates? And then I have a follow-up question?
Mike Klayko
Let me start with that. You're correct to assume that the federal business right now is, one of the reasons our growth as outlined in the prepared comments has muted in Q1. Last year we learned after experiencing Q4 to Q1, where our builds sit in various appropriations. And with Congress in a lame duck session right now and then coming back with a lot of change in January. There's just a lot of uncertainty there and we're very uncomfortable.
On the Ethernet business in our federal space pull that aside and you take a look at it, we're actually expecting our non-federal Ethernet business to grow 10% to 15%, so quite healthy. And we think our services business is relatively flat quarter-on-quarter. And then with regards to our product portfolio just on VDX, we just announced the product, and then as we mentioned in our earlier call, when we announced it, we said that that product will begin to ship in quantities in Q2 and have a small effect in Q1, but it is all planned in.
Ittia Kidron - Oppenheimer
And just a follow-up question, can you give us a little more detail on how many quota-based salespeople you have and how has that changed through the last couple of quarters? You've had a big increase in sales and marketing, a part of that is the accounting change, I understand. But it looks from your guidance, you're also implying to continue to increase in that number, unless I'm mismodelling. I was hoping to get a little bit more color on your OpEx ramp and what's the revenue generating element within that?
Ian Whiting
Let me cover first of all on the growth in headcount in sales. So we laid out a plan back in September, I must say, to indicate how we were looking to grow in coverage from both the customer facing and channel facing sales force. And I'm very pleased that we met or exceeded our hiring ramps in the second half of 2010.
And as you've seen in the outlook for this year, we are going to continue to grow field facing and customer facing sales resources, based on our strong belief that growth in the IP business is a lot about turning up and addressing customers directly with our value proposition, which has been enhanced significantly just recently with the whole Brocade One and VCS especially. So very pleased with the hiring ramp and we've certainly planned to continue to build out for it makes sense in global sales coverage in 2010.
Ittia Kidron - Oppenheimer
But is the productivity of those salespeople progressing also according to your plan?
Ian Whiting
Yes, I laid that out again in September. I showed you the ramp, the model we have. And I am very comfortable that we are on track to meet that ramp in sales productivity per head.
Richard Deranleau
There's a couple of more things to add on that. And as Ian was saying, if you look at our performance in Q4, I think, if you also look at our guidance with the non-federal business, it would indicate that we are making our productivity ramps higher that Ian has put in place. And from a overall expense point of view, as Ian said, we are going to invest in sales and demand generation. There'll be smaller investments in R&D as we make the push to get these new product innovations that make us talk about out.
But frankly, I just wanted to reiterate that for the support function at Brocade, those will be very, very low hiring or flat. And we are continue to be committed to the fewer model that we showed at Analyst Day.
Operator
We'll go next to Munjal Shah with Jefferies & Company.
Munjal Shah - Jefferies & Company
I had a follow-up on OpEx and another question. So the 41.9% OpEx today, it reflects all (inaudible). And the guidance for 46% to 47% is that all from new hires or is there any kind of a trickle effect from this quarter to next quarter?
Mike Klayko
The first comment is, yes, the (inaudible) now puts us on apples-to-apples basis with others in the industry. What you're seeing in our guidance for OpEx is a reflection of having the folks that Ian has hired, the new hires onboard for full quarter as well as the incremental hires that Ian had talked about.
Munjal Shah - Jefferies & Company
And then Richard, how should we look at beyond next quarter in terms of OpEx, because for full year you have mentioned 43% to 44%. For January you're guiding 46% to 47%, does it drop off at some point in the future due to revenue ramp or how do you see it beyond next quarter, OpEx specifically?
Richard Deranleau
I would reiterate what we said back in terms of our objectives from Analyst Day. And I think if you look at Analyst Day and what we said at our Analyst Day, we expect to, Ian model for FY '11 that would imply that we get more efficient from an asset perspective through the year as revenues increases.
Munjal Shah - Jefferies & Company
And then I had a question on service providers. Last quarter when you mentioned service provider was 16% and that came out to about $24 million, and today it's flat, I think its $31 million and I'm talking about last quarter. So did anything change in terms of how you characterize service provider customers?
Mike Klayko
If you look at the press release, the details out. The short story is that as we build more and more channel and we're more and more successful in the channel business, some of that service provider goes through and is not a direct sale. As a result to that to give a true vision we're showing our service provider now based on where the product was actually shipped to, not whether it went through a distribution. So that's just making things more clear and we've made that consistent to show that in the press release. And Ian may have some more color on service providers.
Ian Whiting
Yes, overall we're very pleased with the growth and service provider sales, which is up 32% in Q4. And it gets a function of a few things. One is, again, it's more coverage, where you have been building out significantly not only in the Americas, but internationally as well our service provider coverage. And we also had a number of significant design wins based on innovation that we brought from market with MLXe and our new high-density 10 GbE blade.
And last but not least is our roadmap around 100 Gig, which in terms of density and performance has certainly set a new bar in the industry. And that's getting us sort of traction with not any existing, but new service providers around the world. So very pleased with the service provider space overall.
Munjal Shah - Jefferies & Company
And you think it continues from this level going forward or do you think it will be lumpy where we had a strong quarter, because you started the 8x10 line cards were into buy now?
Mike Klayko
I think, we've certainly factored in a successful year-end service provider into the numbers that you've seen. And there's no reason for things that we can't take the success we've had particularly in the America's and explore that to the international markets, which have been historically under funded in terms of sales resource in the form of foundry days. And we've certainly addressed that with some critical hires from top talent from our competition just in the last six months. So we feel pretty good about that space.
Operator
We'll go next to Mark Sue with RBC Capital Markets.
Mark Sue - RBC Capital Markets
If we take all the moving dynamics, the SAN inventories, the infinite, the federal; and all the moving parts on the regions. Can you give us a sense of what the new seasonality is on a quarter-to-quarter basis for the rest of the year? How we should kind of thinking about it, so that we kind of have an outline for the next three-four quarters?
Mike Klayko
Where I'd start is the typical seasonality that we showed at Analyst Day as a historical look then what I would look at is, I think from a non-federal perspective Ethernet should be increasing throughout the year on a sequential basis. Federal is the one which really going to have the visibility to, Mike talked about federal in his opening remarks.
From SAN and from a demand perspective, we'll be very similar to what we showed at Analyst Day. As you remember Mark in Q2 of last year, the OEMs took down their inventories, and we're expecting them to do that a little bit earlier this time. Because they are no supply constraints perceived in the market. So that's really where I'd leave it.
Ian Whiting
I got a couple of other comments Mark. The interesting part is we get under these new businesses and we had a lot of predictability in just the SAN space as from years past. As we've expanded out into the Ethernet space, putting along with a lot of larger customers and a lot of larger transactions and build-outs, when we started to get into Ethernet fabric, that could have actually a major effect sometime in the future. I just look at some of the transactions and some of the deals that we're working on and some of the large build outs, they're material from quarter to next.
I mean, I'll look at talking about Q4 and on a go-forward basis into Q1. We had a couple of transactions that were earmarked to happen in December of this year that actually happened in October, because a customer wanted to begin to build out and get going now on this. Now this is good for us, it took the deal off the table. The customer began his build out earlier and that gives us an opportunity even to grow those build outs even more rapidly.
We're in some very large build outs now and some very large customers. And they have sometimes a little bit of lumpiness effect, as you could get large installations of the core infrastructure one quarter where you may have planned another. It's harder to predict now. We're engaged in more places as you've seen in some of the prepared comments, 1600 new accounts we've been installed in. Those new accounts give us an opportunity to go back and to sell additional footprint.
It's a little more lumpy. We're doing, I think the best we can on an ongoing basis. The federal piece is a little sketchy right now. We're just more unsure about the congressional area, then we are at the, are we going to win or lose type of business. But from an overall business right now, I actually think some of the large transactions that we are getting involved with, make it a little more challenging to forecast quarter-to-quarter.
Mark Sue - RBC Capital Markets
And then maybe just on, how we should think about variable and fixed OpEx as you ramp on the Ethernet side? And also are there channels you can leverage for Ethernet, so that it's not heavy incremental port has to come with incremental OpEx spending from Brocade. How should we think about the leverage longer term?
Richard Deranleau
I think one of the important things of our model it is highly leveraged, highly variable cost or cost to principally around employment people. And we can make decisions relative to adding cost as we look and have visibility into our revenue. So where we are going to invest though, is again going back to Analyst Day. We had set out 2011 as a year to drive topline growth, to drive at least as fast as industry or fast in Ethernet. I think we had a good start in Q4 and we're going to continue to invest in sales and demand gem.
Mike Klayko
If I could just add a little bit on channel, as you brought it up, that's been another corner stone of the strategy, which we outline there in year. And I'm pleased to say, we continue to see significant expansion, we've thought it was 5,500 channel partners are officially authorized now under our Brocade channel programs. And it's a testament I think to the program, the value proposition we've been bringing to the channel and innovation, and margin opportunities as well.
And with the VCS announced, and we've certainly seen and even more pronounced uptic in interest from the channel, because we now have real differentiate offerings, so they can build solutions and services around. But that's giving us another strong foundation for the growth in the IP business, which will certainly help us to withstand any of the ups and downs that you typically see in that lumpy business as Mike described it. And John's marketing team has been instrumental in helping us build out that channel infrastructure.
John McHugh
If I was to add, just a last bit of color from marketing perspective. In terms of efficiencies, our top imperative has been to a kind of extend the reach and visibility of the company. And especially as it applies to the IP channel, you just did this introduction of the VDX solution last week. And so about 150 unique articles in all regions of the world, interestingly about 80% to 90% positive, and we believe that kind of very positive up take of a message we delivered, and the ability for us to define this new Ethernet fabric category in the market.
It's kind of driven based on a very persistent set of communication tools that we've been using, since going back to June 9 on our technology day. The development of a much broader community as well as the channel investments that, Ian referred to. And I think just going forward foundationally it looks like, we have built a very strong engine to search scaling out that model.
Operator
We'll go next to (Jeff Rupert) with Wells Fargo Securities.
Unidentified Analyst
First on the revenue guidance, do you expect to recapture the federal dollars you suspect will be delayed? And then is it fair to assume that you're expecting a much stronger second half, as you capture some of these deals and some of the new products begin to achieve scale?
Mike Klayko
Last year, we had this phenomenon on Q1. And as we said, it got moved out, and if you look at our overall last year in terms of just year-to-year growth, we grew the federal business about 7%, I believe is the way it turned out. So those projects are funded. It's just a matter when the appropriations release the funding. So again, this is not a matter of wining or loosing, many of the projects that we're referencing right now we want, it's just a matter of deploying.
So unfortunately, the government doesn't really pay particular attention to when my quarters end and such, and they do roll out these projects, when they do have the funding and they're ready to absorb it in. So it's just a matter of the dates and the times, when they're ready to absorb the projects.
Unidentified Analyst
And then qualitatively within the Ethernet business, it seems like the data center remain strong. But can you discuss, what you're saying the campus LAN and enterprise market outside of the data center. And maybe provide an update on the competitive landscape and where, and from whom you believe you have the greatest opportunity to take share?
Ian Whiting
One of the leading indicators that have strength the growth for campus and enterprise market is somewhat of a shift in our product mix, where we've seen a marked increase in the percentage of our business is Classic Ethernet stackable switches, which is a leading indicator I think of the strength of couple of things.
First is the channel build-out. We've already referred to just more sales coverage and I should also mention that a pretty significant ramp-up and build-out of an inside sales organization, which is giving us much more efficiency in terms of the volume of customers that we can reach in that space. And certainly that commercial enterprise or campus business has been beneficiary, if you like, from our perspective of the build-out in sales model.
But from a product perspective, I think we are well positioned competitively. And I think a lot of this is continued execution in channel build-out. And we'll see continued growth in that space.
Unidentified Analysts
So no unusual orders or recent weakness in the last couple of weeks?
Mike Klayko
No, I think in fact just to point out something Mike touched on one of the matrix that we set ourselves a goal we set ourselves was additional 1000 new IP customers in FY 10. We certainly hit that goal and a significant percentage of that is what you would classically refer to as the campus-land customer segment.
And we are on track we are going to set ourselves a task of doubling that number again this year. So that's really how we are growing in that space and we feel confident that we'll be able to reach those goals.
Operator
We'll go next to Kaushik Roy with Wedbush Securities.
Kaushik Roy - Wedbush Securities
Still on operating margins for Q1 you're guiding 15% to 16%. But at the Analyst Day, you had mentioned that for this year you could see 17% to 20% sale. Are you still sticking to the 17% to 20% for the full year?
Richard Deranleau
Yes, we are staying with the view we gave you at Analyst Day.
Kaushik Roy - Wedbush Securities
And on gross margins, you just reported 62.3% and you're guiding 62% so for Q1. Why cant gross margins be better considering that you are taking cost from the cogs and putting into OpEx and then on the Federal Ethernet it will be a sequentially down quarter.
Richard Deranleau
It's really around volume and a little a bit of product and customer mix. As you can see it is down by very much but based on when we gave you the guidance it would be volume and little bit of customer product mix.
Kaushik Roy - Wedbush Securities
Last question on the Ethernet type seems like Dell is helping you but are you seeing HP the [three common] ProCurve more and more as a competitor?
Mike Klayko
We have this is one of these classics where we cooperate in one part of business because they are very large organization and then in other areas we're going to go ahead and compete.
The Ethernet environment is a very large marketplace. And there is lots of opportunity for all of us. I just want more of my share of that opportunity going forward. The storage business we seem to actually do quite well together because we want to grow the portfolio there and we have a world class product that allows them to help a system to do that.
Operator
We'll go next to Mark Moskowitz with JPMorgan.
Mark Moskowitz - JPMorgan
Per your guidance in the prepared comments presentation you indicated there is no supply chain capacity concerned on the SAN side and you're expecting you've characterized this as a seasonal inventory just at the end of your fiscal first quarter. Can you give the full colors as to why your SAN guidance is below seasonality or just details around that inventory adjustment timing.
Mike Klayko
Sure, we started off with end of last year. In last year what you saw was that the OEM had about 2.5 weeks of inventories as they exited Q1. Right now there is about 2.5 weeks of inventory and then in our Q2 you saw you saw them adjust those inventories downward as we headed into our seasonally slow summer seasons Q2 and Q3. Those patterns are still there.
Last year there was a lot of concern in the industry as we are moving as the recession about the ability of the supply chain across the IT industry to keep up with demand. So OEM's as well as others tended to carry heavier commitments in their supply chain. Those concerns do not exist today and supply chains are fine what we would be anticipating the OEM's thin their inventories at the end of Q1 versus last year when they did in Q2 probably about the same given that the inventory levels are relatively the same. From a demand perspective we would expect to see end users buy at the typical seasonal as we shared with you at Analyst Day.
Mark Moskowitz - JPMorgan
How should we think about the cash flow from operations and free cash flow in the next three quarters beyond the first fiscal quarter guidance and then more probable working capital metrics in the guidance.
Mike Klayko
So, a positive story, we have completed the campus, which was a big capital investment over the last couple of years there's a few payments sitting in AP where we have some term that will small amount that will flow in the Q1 other than that it's just the $8 million payment that we shared with you at Analyst Day so our capital spend will come down materially we expect to generate up to $125 million of incremental cash.
We also as you saw in the press release that we took $10 million out of the inventory and our terms went up. We would like continue to focus on our inventory level.
The DSO was flat at 54 days might be a little bit of opportunity there but we need to prove some of our linearity in our shipments. So working capital I am not sure there's going to be a huge investment in that hope during a little bit out lots of cash coming through from lower capitals payment as the campus has done and then we would expect to be able to build cash, accelerate the repayment of our debt and then also be opportunistic from a stock buyback perspective.
Operator
We'll go next to Simona Jankowski with Goldman Sachs.
Simona Jankowski - Goldman Sachs
I think it's in the prepared remarks that the ASP's in your Ethernet business were a little bit better than expected and then it seems like you're guiding going forward for price declines there to accelerate, can you comment on what drove the better ASP's in the quarter and what drives your expectation for the out quarter?
Richard Deranleau
We had looked at ASP decline closer to the mid-single digit in our guidance through the quarter just ended, coming just in the low-single digit. So we did over-perform there. I think it helped certainly when we start having more exposure with customer, we have new products that we are selling those things tend to help us, as we look into Q1 we are looking to provide a guidance that allows us to be selectively more aggressive in pricing as we continue to penetrate new account.
Ian Whiting
And let me just add one thing that we also made a couple of adjustments in our compensation plan which certainly encourages the field to be forceful about pricing and I think as Richard alluded to the fact that we saw significant traction and the take on the MRI which is a high value product and the 8x10 modules that go with that it's just a high value sale and with that (prospect) controls we've put in place.
Richard Deranleau
We've been able to keep a pretty tight reign on pricing.
Simona Jankowski - Goldman Sachs
Looks like your India and Japan businesses were down year-on-year. Can you give us an update what's happening there and what (might) change our trajectory?
Ian Whiting
So there's a combination of some macro and some company specific issues and challenges we've had in India and Japan. I think in both cases, the hiring ramp that we've been referring to was lagging in both regions. We actually chose specifically to ramp in the U.S. first and that's where we've also seen the commensurate increase in revenues as we pulled out, and APAC as well.
Also, we've introduced new leadership in both regions, and that's helped us to acquire some top talent from our competition. And we're starting to get some great wins. In both cases, we were up sequentially, but a year-over-year comparison is certainly not what we wanted to see. But overall, I think the business in both regions has certainly matured. We have right people in place now and the hiring ramp is certainly picking up.
So we're confident that we will be on the right track in both India and Japan, subject to obviously some economic challenges that those regions face but we have confidence overall in our ability to execute that in FY '11.
Operator
We'll go next to Glenn Hanus with Needham.
Glenn Hanus - Needham
Could we focus a minute on the Ethernet gross margins? If I looked at things correctly, you did 47.8%. And on the Analyst Day, I think you were looking for maybe something like 50%, 51%. And I realized that 57.8% was the progress. Could you talk about that a little bit?
Richard Deranleau
There is actually I think a slide that's fairly helpful in the prepared remarks that shows you the walk up from the 44.4% up to the 47.8%, our gross margins is going to be a journey for us. I was very pleased with the progress that we made the progress we made was really round our inventory management and in breaking up some of the new product cost savings and a little bit from volume as I said it's a nice move and over sequentially but we still are targeted to come into our target gross margin range that we shared with you at Analyst Day. And the comments that Ian made about changing some of our compensation metrics should help us along that journey.
Glenn Hanus - Needham
How we are doing at IBM with the Systemax and DCN and then I think you have an EMC win as well on the Ethernet site can you talk about that?
Ian Whiting
Let me just give you a little bit of color. We certainly view the IBM opportunity around IP as more opportunistic today than we did maybe a year ago and what I mean by that is we have some great opportunities in areas such as strategic outsourcing and managed services particularly as a matter of interest internationally we are seeing that opportunities sort of continue to grow. And so through the global services organization versus the traditional system group which provide the service and the storage is where we see that opportunity at IBM.
As we referenced earlier on Dell was certainly a positive story for us, we were up 52% in Q4 on our Dell IP business and as you had referred we also had a couple of design wins at EMC specifically in Q4 which is giving us an opportunity to bundle IP gear with some of their products as well and that really is the strategy going forward with our OEM's on IP's to find opportunities to create value around solutions which they are actively selling in the market by extending 10 gigabit Ethernet infrastructure and other pieces of the solution. And on that basis, I would say we're making good progress at IBM but also other OEM's as we look into the rest of the year.
Glenn Hanus - Needham
Maybe lastly on the major new switch launch could you talk through a little bit some of the steps you are taking in the field right now to really get things going, what are some of the key milestones you're measuring yourselves to and key steps you're taking to ensure a healthy ramp by Q2?
Ian Whiting
We outlined back at the Analyst Day in September some of the critical metrics that we put out there for our field. The key one I think is still the number of net new accounts that we are pursuing. We're very pleased with the results from FY '10. We have to do it all over again in FY '11, and as I said, we've set ourselves a goal of doubling the number of net new accounts.
One of the things we look at is the buying pattern of those new accounts. And in Q4, we saw more revenues from net new accounts than we've seen in any prior quarter. We also saw a very healthy repeat buying pattern emerge from new accounts that we had acquired earlier in the year.
So as we had somewhat predicted, our ability to build a broader base of IP customers will pay back in terms of not only initial impact to revenue growth, but the ongoing revenue as well.
Jason Nolet
The aggressiveness and the breadth of the launch and the insertion of the technology into the market, there is a number of new things to be done this time around. Let me just give you one example of a new eval program we are rolling out called Fibrocade, which is a very extensive program to get products into customers' hands very early on in the process for their evaluation, their trial, their testing with very few kind of obligations and strings attached.
So really trying to ease the process of which customers can get the technology in lab, because we're very confident that once they do that, a vast majority of them are going to say that that's a technology that they want to invest in and move forward with us more aggressively.
Operator
We'll go next to Scott Smith with Morgan Stanley.
Scott Smith - Morgan Stanley
I just had a quick question on the Ethernet revenue. The fall-off, is it just from the pull-ahead or is it just normal strength?
Mike Klayko
As I mentioned early on, there is no pull-ahead per se initiated by us. We had a couple of customers, one SAN customer, one IP customer, relatively modest in terms of transactions, but in two large enterprises that decided to begin their build-out in September-October instead of November-December. Other than that, it's just normal course of business.
Richard Deranleau
Scott, the growth that we're forecasting for the non-federal is to 10% to 15%, which I think is pretty good growth rate for Q1.
Scott Smith - Morgan Stanley
And then just on the server side, the revenue was up fairly strong as well. The CNA business is 10% of your revenue. I know at your Analyst Day, you talked about FCoE being a slower ramp. Is there any indication that FCoE is a leading indicator kind of to maybe better FCoE adoption or is that still kind of the assumption that we should go by that smaller ramp than expected?
Jason Nolet
So I think what we're seeing on FCoE is that the take-up is still fairly modest. Customers who are interested in conversions are largely looking at server I/O consolidation. But not ready to deploy and tend FCoE, just because there are compelling business drivers today to do that and there are also some missing components on the technology side.
So we expect the take-up to continue to be fairly modest, but despite that we remain committed to having a very robust product portfolio in that space. We've had at Brocade a thousand offering FCoE for sometime now. We've just, as Mike has mentioned, added the VDX products, which is to that family which are all conversions ready and fully support FCoE, as well as FCoE blades for the flagship VCX product line as well. So fully committed and we'll be there when customers are ready, but not expect in the near term for the take-up to continue to be slightly modest.
Operator
We'll go next to Rajesh Ghai with ThinkEquity.
Rajesh Ghai - ThinkEquity
Just to understand the net new accounts on the Ethernet side, you mentioned 300 new accounts this quarter and 1600 accounts during the fiscal year. How much business does an account have to do to qualify that number? In general, given that you're LAN revenue is still below the run rate that Foundry had before the acquisition, and you've had 1600 net new customers. What is the dynamic here, are the legacy Foundry customers not buying as much or have you lost some customers, is it fairly more than what you've added?
Ian Whiting
Let me just clarify a couple of things. First of all the 1600 net new accounts is a number since the acquisition of Foundry in FY '010, specifically it was just over a thousand. And we're looking to double that number in FY '11. In terms of revenue run rates as you saw in the announcement, in fact this was a record quarter for IP and that was a statement of the former Foundry acquisition. So we are certainly up above any revenue number that have been achieved in the past.
So for a number of reasons we think that it's a function of net new customers. The definition of net new customer is one that has not bought from either Brocade or Foundry in the past any IP gear. And the ASP should give you an indication of the size of those deals, when they range from pretty small to very big for the ASPs or what we reported in the average deal size, is what we reported in the prepared remarks.
So overall we certainly don't think there's any materially loss of business from the Foundry installed base. And more importantly we're gaining significant number of new customers and that's what's the forming the base of our growth going forward.
Rajesh Ghai - ThinkEquity
And can you dwell a little bit more on the Dell relationship, things have improved. Is Dell actively pointing you to new customers to gain share or is it only an account where Juniper and Cisco don't have relationship right now?
Ian Whiting
I think the Dell relationship is very positive on a number of fronts. Dell clearly have a tremendous sales force and reach into customers. And I think it's a combination of our legacy as its strong partner oriented technology provider and our ability to engage in the field, and drive aggressive sales and marketing campaigns.
Plus I think as a strategy in the corporate level, an increasing amount of alignment around what we need to do together in the data center to present a very credible and compelling set of alternatives to the kind of infrastructure that have been proposed today around cloud computing. And I think that's the space that you would want to watch over the coming months, because it certainly an area. But Dell and Brocade, and VMware and another's are looking to collaborate, to make sure we have a very strong alternative story there.
Rajesh Ghai - ThinkEquity
And last question perhaps with the SAN inventory collection happening earlier than what had occurred last year. Richard, do you expect Q2 this year to be seasonally stronger than SAN side compared to last year? And can you give any metrics on that?
Richard Deranleau
Yes, I guess what I would look at is the seasonality we've shared with you at Analyst Day, and so for Q2 if the OEMs chose to take their inventories down, they may or they may not, because that's their call. But if they do, again, it would make sense for them to do that in Q1. If they do that in Q1, then the normal seasonality for Q2 should be there.
Operator
We'll take our next question from Erik Suppiger with Signal Hill.
Erik Suppiger - Signal Hill
So first just on the OEM revenues, the revenues to your big three were up reasonably good sequentially, but outside of that the OEM's outside of your top three looks like it was down sequentially and your channel and direct revenue was up pretty good. Are you shifting a fair amount of that business away from those other OEM partners?
Unidentified company representative
No, I don't think that's the case at all I just think that's just natural market dynamics that work here and the fact that we're getting a larger percentage of our business through direct and channel it becomes a math equation based on just a law of large numbers so some of our OEMs or larger OEMs get larger as a lot of the other business from our direct and channel continues to grow. There is no conscious effort at all underway to make any shift that you may have though that is going on.
Erik Suppiger - Signal Hill
What kind of reciprocation are you getting from the channel at this point are you seeing the leverage from the channel partners or is it still a period of trying to recruit and attract more of channel partners and you are investing kind of ahead of revenues?
Unidentified company representative
I think you certainly can see that there is some leverage starting to develop there. You can't back away from the fact that we are in investment mode and building out the channel there we have I believe 8% to growth in the raw number of channel partners just from Q3 to Q4 alone.
We have certified a 100 brokerage certified network engineers in the last 6 weeks alone based on some new classes and new programs we've developed. Our strategic objective in the channel is to build that base but we're also building a very high quality partners so that they are real value-add. So it's built around services, it's built around solution deployment. And it's a real, if you will, kind of top-down strategy. So I think the economics, the mix Ian talked about is showing that we are seeing attraction there but I also suspect we'll be in kind of development and scale up mode for certainly for the next 12 to 18 months.
Erik Suppiger - Signal Hill
And then lastly in terms of normal seasonality, given some of the fluctuation on the government side is it reasonable to expect normal seasonality in Q2? After Q1 there is the typical step down or is the thought process that government business might start rebounding at that point?
Richard Deranleau
I think you have to segregate just a little bit. So what we had said earlier on the call was we would expect the SAN business which is as Mike indicated principally an OEM business to represent typical seasonality. We would expect our non-Federal IP business to grow sequentially for the reasons that we talked about on the call today increased resources, increased demand generation, better channels.
And of the question we don't know and what were then we don't really have the visibility into is in the federal space. Will federal come back in Q2 as appropriations over the past or there will be some other element coming out the budget negotiations that forestall that? That's the area we don't have visibility to.
Operator
We'll go next to Aaron Rakers with Stifel Nicolaus.
Aaron Rakers - Stifel Nicolaus
Couple question guys. You had reference at couple different times the fact you have implemented some new compensation plans can you give us a little bit more detail on what that was and in particular whether or not those plans were already in place at the September Analyst Day or that was something incrementally changed post the Analyst Day.
Ian Whiting
These changes were implemented after Analyst Day. We followed to the few things towards the end of the year and we've rolled out a new compensation plan obviously in time for the beginning of this fiscal year and the major leverage point here is around the way we just manage discounting and therefore gross margin in the field. We put in some without going to the gory details we've put in some checks and balance and control to ensure we maximize in the values that we can drive out of our particularly at the high-end flagship products that we've alluded to. And we are seeing a change in behavior and we expect that to result in good strong controls and margin management in the field.
Aaron Rakers - Stifel Nicolaus
And with that said, it looks like relative to the targets you guys had laid out at the Analyst Day for Ethernet gross margin you've got about 8.5 to 9 percentage point to really get into the mid-point of that targeted range.
Can you help us understand how we should think about that when we should anticipate that Ethernet gross margin kind of getting into that targeted range and what aside from just volume what in particular leverage you are going for and then when I have one final question?
Mike Klayko
There's a couple of elements I will talk about from an innovation cycle standpoint. Obviously the VDX product that we just announce in VCS is a brand new product it'll be hitting the market I'll call it latter of part of this quarter it begins to shift and it has a heavy software component to it also. You could buy the VDX and then you buy the software license on the VCS, which is not something we have done in the past. So there's a heavy component of software licensing available.
So as Ethernet fabrics begin to scale over time and we bring out more and more products in the Ethernet Fabrics space that's going to have a dramatic effect I believe on the margin aspect because of this offer component. When you think about it in 2010 we announced 18 major software releases last year across our whole portfolio of products and stabilized that 26 different hardware platforms and those platforms now as we go forward and we start getting ramp on those will give us an opportunity to again having more margin impact going forward. So we have yet to get all the benefit of that.
Aaron Rakers - Stifel Nicolaus
And then the final question from me is that can you give us an idea of how and to what extent IBM's acquisition of our blade network technology can compete with what you are doing either with IBM or (our) side of IBM?
Mike Klayko
I have one comment and Jason can come on top of it. I believe that 65% of their business already for the acquisition was IBM from BladeLogic. And so from that standpoint, it's a supply chain consolidation. And so there is a big difference from our standpoint and we haven't seen a lot of difference. I don't if you have, Jason, from a product standpoint.
Jason Nolet
As Mike said, the focus of their product line is really around the embedded switches and largely for the IBM Chassis product line. So they're focused on Ethernet and net blade switch and that's a little exposure for us. We're going to continue to do business with them on the Fibre Channel side, both the embedded switches as well as the adapters and of course the Director and standalone SAN switch product technology. So I don't think there's a lot of exposure there for us on the VNT story with IBM.
Operator
Over next to Brian Marshall with Gleacher & Company.
Brian Marshall - Gleacher & Company
If we look at whether the revenue trends, the margins, the verticals, et cetera, there has been a fair amount of volatility at Brocade for the last couple of quarters. I was wondering if there is any sort of main reasons there underlying themes that are really driving this volatility and if so what can you do to kind of tamper this and how long will you take to get back on track so to speak?
Richard Darenleau
I think it's a fairly straightforward answer from my perspective. We acquired ourselves into a new market. For us, it's a related market, because it's all networking. But it's a different market. We were in there with the thesis around the OEMs. Getting close to a year now, we have changed and started building a separate go-to-market. We have built a lot of products along the way. So I think when you look back at buying yourself into a much larger much bigger much more competitive market. there's a few slips and starts along the way. But I think what we announced over three years ago is really still intact.
Brian Marshall - Gleacher & Company
If you look at your 10-gig product, can you talk about the potential for this over the next couple of quarters? And really relative to some of the MLX products that you've had, how much larger do you think this opportunity can be relative to some of those products that you have currently?
Mike Klayko
I look at DVX and that's the product, but if you look at the category around Ethernet fabrics, I believe that we're just at the beginning of the build out of the Ethernet fabric. As we talk to customers around the world all of them want to build highly virtualized data center one of the foundational aspects of building a virtualized data center is they described to us is all the attributes that exist in the Ethernet fabric.
We happened to be delivering a product now in an architecture that I believe for the next decade people will be (fielding) out Ethernet fabric. Similar to what happened within a decade ago is people bought up built out storage area networking, they started small and they continued to grow I believe the same thing will happen in this base.
It's going to be not replacing. It will be an addition to the current Ethernet business, because the Ethernet business, that's just the sheer volume of data growing on digital networking and storage traffic, just the sheer volume of moving that much information and storing that much information is causing tremendous pressure on a lot of the organizations we deal with they have to design new architectures into their work environment and Ethernet fabric that we've been talking about is a perfect foundation.
So I think it's got a lot of legs as we talk about it we think it's foundational for at least another decade for all the networking industry we just happen to be out first.
Brian Marshall - Gleacher & Company
And in terms of ramping up to serve a material chunk of your revenue I mean are we talking 6 months or 12 months can you help clarify that situation a little bit?
Mike Klayko
I'd like to talk about it I think it's going to be in 2011. I don't want to pin it down to a quarter but I do believe that the early indications right now and the people we've talked to do believe and the feedback we've received so far is been very positive so I think 2011 could be a good year for us.
Jason Nolet
And the other thing I might add to that is that it's important to recognize that these new VDX switches introduced this new Ethernet fabric technology Mike talked about and a new way to think about how you build the data center network that's optimized for mobility, much simpler to deploy and manage. But these switches in a non-VCS mode are also very, very compelling as kind of classic Ethernet top of rank, if you will, very, very broad, port density is very low, very aggressive pricing.
So we think we have both opportunities, both in that classic Ethernet architecture data center network, but also introducing this Ethernet fabric and virtual cluster switching technology as well.
Operator
We'll take our next question from Jung Pak with BMO Capital Markets.
Jung Pak - BMO Capital Markets
Director was up 14% in the quarter sequentially. Can you help us understand what showed the better seasonal growth and is that driving the lower growth in SAN for Q1?
Ian Whiting
I think what we've seen consistent now for a few quarters is some loosening of the purse strings in large accounts. We're seeing some significant data center refreshes and build-out. And I think a combination of our current DCX product and the roadmap that we've laid out now for 16 gig next year has put significant daylight between us and our competitor in that space once again.
In all of the opportunities we're engaged in competitively we've started to see return to certainly winning ways there. And you are seeing the growth in terms of the quarter-on-quarter and year-on-year growth. And we are very optimistic with the product lead that we have in the core SAN space. That's an area that we will continue to see success in FY '11.
Richard Deranleau
It might be worth noting too that we expect to gain market share in the SAN market in Q4.
Operator
We'll take our final question from John Slack with Citigroup.
John Slack - Citigroup
Maybe I could start with asking about the service provider business. Pretty strong in the quarter both sequentially and year-over-year basis. Any kind of clarity on what's going on there? Is it one or two customers coming back to the pool with the MLXC or is this the beginning of some new longer tail business as customers are doing wide deployments, or is there a new customer on the service provider side?
Ian Whiting
I think we're seeing a couple of things. There is some trends happening in that space all around the rich digital media that's being used across the Internet. Now, it's driving the need for high-performance network. That's certainly helping fuel the market. Again, going back to some comments earlier on, we are in a very strong position from a product prospective with the MLXC, some of the high-density blades.
And the commitment that we've made is to be first to market with 100-gig with the highest density blade and at a price point which we think is going to be extremely competitive in the marketplace, that's enabling us to win footprint in SPs not only in Americas, but also internationally.
Also, within some of our existing very large tier-1 service providers, new applications, new cloud infrastructure that's being built is also fueling that growth.
So it's a combination of a technology cycle that we're in and some strong tailwinds from the market trend prospective. And once again, I will come to the sales coverage. We just have more people out there now looking to more tier-1, tier-2 and indeed tier-3 service providers giving us more opportunity to go after.
Jason Nolet
I am sure you know that service provider market sub-segments into lots of different kinds of providers. And what's really exciting for us is that both the MLXC and the 8x10 GigE high-density line Ian mentioned has seen terrific demand from content delivery providers, large tier-1 ISPs, transit operators, exchange points, a whole variety of different sub-segments within service providers. So broad demand and that I think bodes very well for that technology as well as the forthcoming dual-port 100 GigE module that he also mentioned.
John Slack - Citigroup
When should we think sales and marketing as a percent of revenue is going to peak? When are we really going to start to see the leverage really flowing through on the marketing line down only cash OpEx perspective?
Richard Deranleau
It is from high level modeling based on what we said at Analyst Day. Again, we are not moving away from any of that. That would imply that sales and marketing as a percent of revenue probably peaks in Q2 and then you get efficiencies in the second half of the year. The absolute dollars we would hope and expect to continue to invest from a percent of revenue, you see the efficiencies in the second half of the year and the pay-off of all the sales productivity and other revenue driving items that Ian and John are putting in place.
Mike Klayko
Thank you all for joining us for our Q4 conference call. We will conclude the call and I look forward to speaking to many of you over the coming quarters. Take care.
Operator
That does conclude today's call. We do appreciate everyone's participation.
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