Full Transcript of Brocade’s F4Q05 (Qtr Ending Oct 29, 2005) Conference Call — Q&A (BRCD)

Here’s the entire text of the Q&A from Brocade’s (ticker: BRCD) fiscal Q4 2005 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and we’ll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha.

Questions and Answers

Shirley Stacy

Operator, let's try and open Mike's line and see if we can get him to participate in Q&A please.

Operator

Okay. We sure will.

Operator Instructions

We are still having some difficulty with his line.

Shirley Stacy

That's okay. Let's go ahead and move to Q&A.

Operator

Question by Samuel Wilson, JMP Securities.

Q - Samuel Wilson

Everybody's having a rough morning this morning. Just a question on geography, really. I wanted to get a sense for if you are seeing most of the transition from 2 gig to 4 gig first in the United States and what activity you are seeing in the international markets?

A - Tony Canova

Sam, it's Tony Canova. I'll take this one. Actually we're seeing good transitions to 4 gig across all of our markets. From where I sit, I could not actually tell you, from where I sit, all markets are looking like they are full transition onto 4 gig and it's full steam ahead. There is not any significant difference from one market to the other.

Q - Samuel Wilson

As a follow-up to that, do you see that your OEMs are managing your inventory levels across all regions well?

A - Tony Canova

Yes, I think my comments with respect to inventory, our global supply chain commentary. I would not say that there is any distinction in any of the geos. They are all pretty much operating at the levels that we're talking about.

Q - Samuel Wilson

Perfect, thank you very much.

Operator

Question by Andy McCullough, CSFB.

Q - Andy McCullough

Tony, Mike talked about in the director business wins in the install base and some wins outside the install base. Can you elaborate a little bit on the latter, whose installed base these were in or were these more greenfield type of accounts that he's talking about?

A - Tony Canova

This is Tony again. We've seen some good wins across the director product line. We have seen wins obviously within our installed base where we feel most confident. But we have also had some good success competing against the installed base of a former and long-time incumbent competitor in the market. And the other, more recent entry into the market, we compete against day in and day out and we experience our share of wins with that competitor as well. So I would say across the board winning an incumbent's install base is always more challenging but we have been getting our fair share of those wins.

Q - Andy McCullough

Can you just elaborate on how you're doing that, how aggressive the pricing environment is when you are dislodging an incumbent?

A - Tony Canova

Well, as I mentioned, trying to dislodge an incumbent are always the more difficult and sometimes they can be more price sensitive. But as a whole I would not necessarily characterize any different environment for dislodging an incumbent versus not. When we find that we have an ability to dislodge the incumbent it's when we have a stronger product roadmap and today we gratefully fit in a position where the 48,000 is a very strong product and we have a very strong roadmap in front of us. So this is not a question of price. Price certainly is a factor, but I think we look at it more as a factor of the competitiveness of our product today, which is very, very strong.

Q - Andy McCullough

Thank you.

Operator

Question by Ted Chung, Bear Stearns.

Q - Andy Neff

Hi. It's Andy Neff. Three quick things. One, could you just talk about the relative pricing dynamics of 4 gig versus 2 gig? Do you get a pricing premium and how do customers look at that? The second question is could you just talk about, you sort of alluded to this but how much of your share gains reflect you think is just, one of your competitors and how are you going to retain that? Third thing, could you just restate that the executive who came over from Dell? You mentioned that at the end of I guess Mike's presentation.

A - Tony Canova

Sure. I will take the first two and then I'll have Tom Buiocchi talk about the third. Pricing dynamics of 2 to 4 gig, what we traditionally do when we enter new technologies is we generally will bring as we did bring 2 gig in at about the same price point as 1 gig was, we generally bring 4 gig on at the same price point as 2 gig. There is a difference in this case because in our new entry line of product we brought our overall cost of our entry line down to try to stimulate more growth, particularly in the SMB market. But as a whole, the fair way of understanding it is, we bring in new technologies at about the same price point as the ones that they are replacing. With respect to share gains, I think you were referring to the director space when you were asking the question, were you not, Andy?

Q - Andy Neff

Yes.

A - Tony Canova

Our share gains in the director really in our opinion are coming from the product position that we now and the strength of the director. It's 4 gig. It's 256 ports. It's FICON capable. It has got a roadmap of future blades that is very sound and it is interoperable backward and forward compatible with our installed base and across the entire product line, we are all in the same operating system. So you throw all of those things in one bucket and it really is a formidable product, not to mention the fact that it has substantially lower power requirements and cooling requirements. The environmentals are just substantially better on it than the competition. So you net that out and yes, we may be doing better against one competitor than the other in certain circumstances, but as a whole I think it is hard to articulate it that way. As a whole we just kind of articulate it as the product is doing well, so we're doing well competitively wherever we show up. Tom, do what talk about --?

A - Tom Buiocchi

Andy, this is Tom Buiocchi. The gentlemen who joined us about six weeks ago is named Ray Wolf. Ray managed both professional and managed service business at Dell for the last five years and has actually built services business across a couple of different industries at a number of different companies. So we look forward to Ray helping us structure our service offerings going forward.

Q - Andy Neff

Thank you.

Operator

We do have Mr. Klayko's line open. Question by Paul Mansky, Citigroup.

Q - Paul Mansky

Actually building on a couple of the prior questions, can you talk a little bit about your success in FICON attach environments? Then I want to come back with a couple more.

A - Tom Buiocchi

Paul, this is Tom again. As you know, December is FICON month, right? So a lot of the deals in the FICON space are driven by a combination of very high-performance, very high port density and a very solid FICON implementation. And fortunately we have a great position there now. We have the highest performance director, the only 4 gig director out there. We have the highest density director, 256 ports and we have got a very, very strong FICON implementation that's been qualified by IBM. So we're in a great position there. We have won a number of FICON deals already this month and as you would expect we're looking forward to winning a number more before the year closes out. The last thing I would say about that is that the ability to have a strong FICON offering opens the doors for us in those customers who want a common platform across both our mainframe environments and their open systems environments, and that's kind of a new door opened for us with this capability.

Q - Paul Mansky

So as we look at those comments taken in the context of obviously a very strong director quarter for you, when we look at your mid single digits ASP declines sequential and expected going into January, is that inclusive of mix considerations?

A - Tony Canova

Paul, it is inclusive of mix.

Q - Paul Mansky

As we look into next year and I know you're going to grind your teeth around this one, but can you talk to me a little bit about what you're expected tax rate is going to be for fiscal '06?

A - Tony Canova

Sure. I think we mentioned on the call but it is 20 to 25%. That should be our run rate for '06 and from a long-term modeling standpoint, I have talked about that a right way of looking at our longer-term tax rate when everything starts to settle out is probably in the high 20s, low 30%.

Q - Paul Mansky

Finally from me just quickly, as it relates to the upper end of that OpEx, quarterly OpEx guidance of 75 to 80 million, what type of headcount growth is inclusive in that assumption?

A - Tony Canova

I appreciate the question, Paul, but we don't provide the headcount expectations during the course of the quarter. So it will almost all be headcount related as opposed to external costs if that's what you're looking at.

Q - Paul Mansky

Great, thank you very much.

Operator

Question by Henry Naah, Lehman Brothers.

Q - Henry Naah

A couple questions if I may. Switching back on Paul's question there, could you give us some sort of sense as to how large the services organization is right now?

A - Tony Canova

I will take a cut on that. Our service organization is still not a material portion of our business, but we are growing from a service bookings standpoint, as you see in our deferred revenue. But it is not yet at a point where we are breaking our service business. I think in order of magnitude what you're looking at is you're looking at us growing from a headcount standpoint somewhere in the range of from about 30 people today to about something like about 100 people during the course of the year, delivering professional services which include assessments, implementations, architecture as well as on-site support. And we are looking to also expand that with partnerships with other vendors in the marketplace. Tom, I don't know if you want to add?

A - Tom Buiocchi

Just to add just a note to that, the numbers we're talking about are a very detailed, deep expertise in SAN connectivity and SAN architectures and so forth. So we're not looking for thousands of people in this organization. We are looking for the best bench strength if you will in a very narrow area of SAN and SAN connectivity expertise.

A - Tony Canova

Henry, the other way to think about it is we've talked about this before but our goal is to have services, pure services, professional services represent about 5% of our total revenue by the fourth quarter of next year.

Q - Henry Naah

Okay, great. Maybe one question for Tom here. Looking into your crystal ball, any kind of thoughts on what port count growth for the industry would look like in 2006?

A - Tony Canova

I can take that one. I think we have looked, we have seen port count growth of kind of 20 to 30% up to 40% depending upon the category of the products. But it is an industry that certainly has healthy demand from a port perspective and so now it is a question of matching that demand against the right product set the right price point and augmenting that with additional services that we're bringing to market.

A - Tom Buiocchi

It depends a lot on the data you look at but anywhere from 35 to 45% I think is a relevant range of what we expect to see next year.

Q - Henry Naah

Thanks, guys.

Operator

Question by Tom Curlin, RBC Capital Markets.

Q - Tom Curlin

Can you talk about your thoughts on the rate of adoption of 4 gig? There's some commentary in the market over the last few weeks about an expectation that 4 gig versus 2 gig will see adoption even faster than 2 gig versus 1 gig. And I am just wondering if you agree with that and if you do, what are the factors that you think are driving that proposed faster rate of adoption including any supply chain or regulatory drivers.

A - Tom Buiocchi

Tom, this is Tom. That's a great question and in fact I couldn't agree more. The adoption of 4 gate is going fairly quickly. As I think Tony or Mike mentioned in their remarks, quicker than we expected with the high end of our range now representing about 50% of our sellthrough this quarter. We would expect in the next couple of quarters it is the large, dominant majority of all of our sellthrough going forward. Two things are driving it. One is that the entire 4 gig infrastructure from HBAs to switching technology to 4 gig arrays are either here or right around the corner and customers are very aware of that technology cycle. So when they have the opportunity to buy 4 gig instead of 2 gig at approximately the same price point, there's just not a lot of reason and compelling value proposition to buy 2 gig. So it's a combination of technology cycle the customers are very well aware of. And price points, to be honest with you. I don't think its driven so much by regulatory or other considerations. It's really about investment protection and value for the buck.

Q - Tom Curlin

What I'm speaking to specifically is these OEMs it seems have to be compliant with certain environmental standards by some point next year at least in Europe. And I know that they are requiring the latest products that qualify to all be compliant with those standards and so is there some push related to that? Does that somehow factor into the adoption pieces in terms of driving 4 gig faster because that is the product that has been qualified as lead-free and so forth?

A - Tony Canova

Tom, this is Tony. You're referring to RoHS. We are way, we are all over RoHS. We have been all over RoHS for several quarters now and I think find ourselves in a position where we consider us to be a leader in the charge here. Our 4 gig product family is all going to be RoHS compliant but that is not the dynamic that is causing it. We are 50% of our business today is four gig. I would say by the time RoHS is required which is in the middle of next year, we're probably going to be pretty close to 100% and RoHS is only required for Europe. So the rest of the markets are adopting 4 gig irrespective of what the environmental requirements are in Europe. So I would say it's really what Tom characterized but just to put an advertisement in for our operations team, we are all over the RoHS side of it and are completely under control there.

Q - Tom Curlin

Does that include 2 gig big? Are you RoHS compliant on all 2 gig products?

A - Tony Canova

I am not sure on the 2 gig side. I know that it is somewhat academic for us because by then we are all going to be 4 gig.

Q - Tom Curlin

All right, thank you very much.

Operator

Question by Laura Conigliaro, Goldman Sachs.

Q - Nick Flair

It's Nick Flair (ph) on behalf of Laura. First, for the director strength during the quarter, obviously McDATA has had issues at EMC. How much do you think you guys benefited in director sales at EMC this quarter? And how much of that benefit do you think is going to carry forward and be more of a longer-term benefit from whether it account takeaways or how much of it is really one time in nature?

A - Tony Canova

Nick, this is Tony Canova. I've thought about that a lot and I'm not sure that we benefited at all because of the problem with one of our competition getting their product qualified. I kind of look at the reason for our strength standing on the soles of the strength of the product and whether they were qualified or not, I think the 48,000 is a great product at the right time and is doing really well. Tom, do you want to add?

A - Tom Buiocchi

Just to the point to the extent that we did benefit at all, the director dynamic is not, the customer won't flip-flop back and forth between two vendors in the same fabric, right? So once a footprint is taken, you pretty much have that footprint to build out for a product cycle, a two- or three-year period and to the extent we did gain new footprint that represents a fertile ground for us.

Q - Nick Flair

I guess turning towards the inventory issue, I'm just trying to make sure we have it right. It sounds like you guys took out more inventory than anticipated out in the channel. You're now at about 2.5 weeks relative to the three-week target. So then does your go-forward targets include an assumption that you're going to have an additional channel fill back to three weeks or is it assuming that they are going to keep it at about the 2.5 weeks?

A - Tony Canova

I will take it. It's Tony. I have got to tell you that I'm out of the business of predicting inventory levels because you can see that I thought we would be at three weeks, which was in my opinion a pretty realistic goal and they came in less than that. Going forward we would love to have a situation where sellthrough and sell-in or sellthrough and rev rec were the same number. That would certainly be our goal but it is almost impossible to have them precisely the same number. So we're just going to report going forward what our inventory levels are, but we're not going to try to predict any more what they're going to be.

Q - Nick Flair

Okay, then just one last question. Looking at this quarter, sellthrough revenue was 160.2 million I think you said and now we are guiding for 156 to 161. So it seems like you could almost see sequential declines on a sellthrough basis, assuming that sell-in and sellthrough are about on par now that the inventory issue while it won't be perfect is roughly in line. Am I reading that correctly?

A - Tony Canova

You're reading it correctly but you may not have picked up on a piece that we talked about on the call, and that is that if you remember when we had a fairly weak quarter in Q3, we talked about some of the demand that had existed stalling because of the 48,000. Well what we actually saw in Q4 is we quantified between 5 and $7 million of our sellthrough in the quarter really pertaining to demand from Q3 that fell into Q4. So we're normalizing what we think the real picture is for Q4 and feeling like the real revenue picture for Q4 on a sellthrough basis is closer to about 153 to $155 million, still healthy growth. Then off of that baseline number, you are looking at a 2 to 5% guidance that we have going forward. Does that clarify it for you?

Q - Nick Flair

All right. Thanks, guys.

Operator

Question by Kaushik Roy, Susquenhanna.

Q - Kaushik Roy

Congratulations for the nice quarter and nice guidance. Can you comment on how much of total rev are the directors, switches, bladed, and software? Then where in those segments are you seeing the most pricing pressure?

A - Tony Canova

What was the first part of your question?

Q - Kaushik Roy

Can you give any color on how much of the directors and switches and the bladed and software is as a percent of total rev?

A - Tony Canova

Sure, I will take that. You know, we don't provide that kind of data, but I will tell you a good place to go look to get a decent sense of course is Deloro when they are published. We just don't provide it on the calls. We try to provide color on what's going on with each of the product segments ups and downs.

Q - Kaushik Roy

And in which segment are you seeing the most pricing pressure?

A - Tony Canova

I would say that there really is about the same level of pricing pressure across the board. Now I thought about that quite a bit over the last couple of days just to try to understand, you would think that the entry and midrange might exhibit the greatest pricing pressures, but the numbers don't indicate that. The numbers indicate that it's about the same across the board.

Q - Kaushik Roy

Then can you comment on your SEC and DOJ investigation, where it stands?

A - Tony Canova

Sure, I can comment on it. There is no update on it. We continue to cooperate and do everything that is necessary. From a timetable standpoint, I've said recently that this one could take a while to sort out based upon the history of other companies. It is not going to be something that we give a month-to-month update on. So there really is no update at this point on the SEC or DOJ.

Q - Kaushik Roy

Then your customer concentration for the top three increased from 67 to 71%. So you are not focusing on the channel anymore or can you explain the dynamics there?

A - Tony Canova

Yes. Of course we are focusing on the channel. I think what you're finding is that we had a strong director quarter and directors generally don't get sold through the channel. They get sold through the OEMs and if you were watching of our OEMs, if you were watching their own results, we had one particular OEM that had just really a really strong storage quarter that we benefited handsomely from.

Q - Kaushik Roy

Okay, great. Thanks.

Shirley Stacy

Operator, we will take one more question please.

Operator

Question by Frank Timmons, Robert W. Baird.

Q - Frank Timmons

Thanks for taking my question. Just really quickly, you talked a little bit about services being a growth area for you and I'm just wondering if at a high level can you comment on, it seems there must be a balance you must walk with not competing with your partners and etc. Could you walk me through what you think or how you think about that?

A - Tom Buiocchi

Sure Frank. This is Tom. It turns out actually there's quite a value proposition for our partners and I'll just kind of outline a couple of things we hear in terms of feedback from them. It might be a little bit surprising, but they see the value in us going to that business as well because number one, we've got some pretty deep expertise in a pretty narrow area that is very, very mission critical for a lot of their customers. So we can provide a valuable skill set of scarce resources. Number two, they can use those scarce resources on a variable cost model. They don't have to hire 1000 SAN specialists. They can use us on a project by project basis as part of an overall solution to the customers. Number three, as more and more SAN deployments get larger and more complex, our added expertise to the mix can help them reduce operational implementation risks so they actually can achieve better customer satisfaction. Number four, maybe the most important criteria is, we are packaging our service offerings much like our product offerings to be resold by our partners as well. So they can provide our services as a component to a broader SLA or a broader customer service and augment their team, if you will. So they have an economic positive as well from reselling those services as part of a larger package.

Q - Frank Timmons

Thank you very much, very helpful.

Shirley Stacy, Investor Relations

Thank you. And thank you, everyone, for joining us today. This concludes our fourth-quarter conference call. We look forward to speaking to you again at the upcoming Lehman Brothers conference on December 8th in San Francisco and the Needham growth conference January 12th in New York City. As always, our presentations and breakouts are webcast via our website and if you have further questions or follow-ups, please contact Brocade Investor Relations. Thank you.

Related:

• The prepared remarks from this call are here.
• A list of full conference call transcripts available on the Seeking Alpha Network.
• The complete list of hardware stocks (and links to articles about them) covered by The Hardware Stock Blog.

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