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Brocade Communications Systems (NASDAQ:BRCD)

Q2 2012 Earnings Call

May 17, 2012 5:30 pm ET

Executives

Robert Eggers

Michael A. Klayko - Chief Executive Officer, Director And Chairman Of Corporate Development Committee

Daniel W. Fairfax - Chief Financial Officer, Principal Accounting Officer and Vice President of Finance

David B. Stevens - Former Chief Technology Officer

Ian Whiting - Senior Vice President of Worldwide Sales

Jason Nolet

Analysts

Jayson Noland - Robert W. Baird & Co. Incorporated, Research Division

Jess L. Lubert - Wells Fargo Securities, LLC, Research Division

Mark Sue - RBC Capital Markets, LLC, Research Division

Shebly Seyrafi - FBN Securities, Inc., Research Division

Aaron C. Rakers - Stifel, Nicolaus & Co., Inc., Research Division

Brian Marshall - ISI Group Inc., Research Division

Vijay Bhagavath - Deutsche Bank AG, Research Division

Keith F. Bachman - BMO Capital Markets U.S.

Andrew J. Nowinski - Piper Jaffray Companies, Research Division

Paul H. Mansky - Cantor Fitzgerald & Co., Research Division

Scott Schmitz - Morgan Stanley, Research Division

Rajesh Ghai - ThinkEquity LLC, Research Division

Glenn Hanus - Needham & Company, LLC, Research Division

Erik Suppiger - JMP Securities LLC, Research Division

Operator

Good day, ladies and gentlemen, thank you for standing by, and welcome to Brocade's Second Quarter 2012 Earnings Conference Call. As a reminder, this conference call is being recorded. And now, I would like to turn the program over to our speaker, Rob Eggers, Vice President of Investor Relations with Brocade. Sir, please go ahead.

Robert Eggers

Thank you. Good afternoon, and welcome to Brocade's Q2 earnings call. By now, you should have seen our press release and prepared comments, which are available on our website, brcd.com. The press release is also distributed by MarketWire and furnished to the SEC.

Before we take your questions, investors should note our comments today may include forward-looking statements regarding Brocade's financial results, 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 in our Form 10-K for the fiscal year ended October 29, 2011, and our Form 10-Q for the fiscal quarter ended January 28, 2012.

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 for SAN and Ethernet, as well as 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 Q2 2012 press release, which has been furnished to the SEC on Form 8-K and in our slide presentation and prepared comments on our website, brcd.com.

Here to take your questions are Mike Klayko, Brocade's CEO; Dan Fairfax, CFO; John McHugh, CMO;

Dave Stevens, CTO and VP of Corporate Development; Jason Nolet, VP Data Center Networking; and Ian Whiting, Senior Vice President, Worldwide Sales.

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

Michael A. Klayko

Thank you, Rob. Brocade exited Q2 with $543.4 million in revenue and $0.15 in EPS on a non-GAAP basis. We reported revenue at the high-end of our guidance, and we exceeded our expectation for EPS, which was up 24% year-over-year and marked the third consecutive quarter of non-GAAP EPS year-over-year growth of nearly 20% or more. And the solid year-over-year improvement in EPS was primarily driven by an expansion of both gross margin and operating margin, lower interest expense and a reduction in the company's share count.

Our Q2 revenue was slightly down year-over-year, primarily due to the divestiture of the SBS business unit in late 2011. However, the increased focus on our core businesses, as well as emerging target markets helped improve gross margins and profitability.

An important part of our growth strategy is to focus on investments in key target markets, selecting those areas where we can leverage our technology and market leadership. Over the past 2 years, we have made strategic investments that have reduced profitability. But we do believe that the aggregate return over time will be significant to our business. We're now at an inflection point where we expect to grow profits faster than revenue by driving efficiencies into our business.

To date, this strategy includes the introduction of new highly differentiated products with improved cost structures, the divestiture of a low-margin business unit, the development of our channels for efficient sales coverage and the prioritization of resources and investment dollars into high-growth markets.

We've been aggressively reducing our term loan and opportunistically repurchasing shares, which returns cash to our shareholders. The Board of Directors recently increased our authorization for stock repurchase plan, which was originally approved in 2004. To date, we repurchased more than $650 million or 108 million shares and had approximately $124 million remaining under the plan. The refreshed plan increases our authorization by another $500 million to approximately $624 million. To fund the updated program, we plan to utilize cash from operations, and we may consider monetizing our San Jose campus depending on the market conditions.

Now on to the quarter. One of the highlights in Q2 was the strength of our Storage business, which generated $400 million in total revenue, representing a 3% increase year-over-year in what is typically a seasonally soft quarter. A key driver was our 16-gig SAN portfolio, which accounted for 23% of Director and Switch Storage product sales in Q2 and helped us gain market share.

In our Ethernet business, we generated revenue of $143 million in Q2, down 10% year-over-year due in part to softness in Federal sales and lower average selling prices driven by product mix, competitive pricing pressures as well as a transition to a 2-tier distribution model. The transition in our go-to-market model has also impacted sales execution in the short term.

Our Ethernet business quarter-over-quarter benefited from 11% growth in the Enterprise business, but was offset by smaller router orders from our service provider customers after a record Q1. Despite the challenges that exist in our Ethernet business and the competitive environment in the market, we're seeing encouraging results and are taking active steps to position us well for near-term and longer-term success. These include: Accelerating customer adoption of our Ethernet fabrics, we exited Q2 with the global installed base of more than 550 VDX customers that have deployed more than 100,000 ports to date; we've also expanded in our 100-gig Ethernet offering routing business, the segment where we now hold the #2 market share position according to the Dell’Oro Group; strength in our Service Provider business, which is growing 18% year-over-year as we continue to expand and diversify our customer base; and execution of important initiatives in our channel, campus LAN and Ethernet fabric businesses, including 2 executive appointments, which I'll cover in greater detail later.

In addition, the feedback from recent meetings we've had with hundreds of partners and customers affirm that our business and innovation strategies for the Ethernet market are on the right track.

During the past few months, Brocade hosted several successful partner summits and customer forums in APAC, EMEA and the Americas, which helped us gauge the effectiveness of our go-to-market strategy. We are excited about the interest we have received and through this outreach, we are constantly hearing that our channel programs and our technology portfolio differentiates Brocade in a very positive manner.

In Q2, we also opened 2 new state-of-the-art regional briefing centers in Singapore and the United Kingdom to better serve our customers and partners and to help accelerate the sales cycle in those regions. These facilities complement the capabilities of our executive briefing center in San Jose, which has a track record of helping us win new accounts and close competitive bids. I expect the same level of success in these new regional briefing centers, and I'm pleased to be able to offer additional localized showcases for our innovation.

At the heart of our strategy is a commitment to innovation, which is key for any technology leader. By leveraging our previous product and technology investment, Brocade is now positioned favorably to compete in both established markets, such as campus LAN and storage networking, as well as emerging high-growth markets such as Ethernet fabrics, 100-gig Ethernet routing and software-defined networking. We are now shipping many innovative, highly differentiated products to customers worldwide in each of these technology markets. And we expect these products to help drive revenue growth and margin expansion going forward.

Customers are deploying our networking solutions into production environments to address important IT imperatives, including cloud computing, highly scalable server virtualization, consumerization of IT through bring-your-own devices, Big Data and business class video communications.

I'll now cover the Q2 highlights by segment in greater detail. An important part of our Ethernet growth strategy is the $13 billion campus LAN market. To be successful in this highly competitive market over the long term, Brocade needs a simple, highly available cost-effective and complete product portfolio as well as a strong channel presence with focused go-to market plans to deliver these solutions to customers.

Over the past 24 months, we've been building both a compelling product portfolio for the campus LAN and a robust 2-tier distribution channel to extend our reach into the enterprise. The road has not been without its bumps. And in Q2, we made significant strides and announcements to position us for growth in this market going forward.

First, with the launch of The Effortless Network portfolio in Q2. Brocade has strengthened its ability to compete in the campus LAN market with differentiated products and technology. The foundation of The Effortless Network is a complete access layer campus portfolio, which now includes the Brocade ICX 6430 and 6450 switches. These switches fill a gap in Brocade's campus product portfolio and are designed for the entry-level switch market.

Brocade's refreshed campus switch portfolio is purpose-built to be delivered through the channel and will help expand margins for Brocade while giving customers a cost-effective solution. But the true differentiator of The Effortless Network is Brocade's HyperEdge technology, which is designed to deliver new levels of automation and simplification that offers significant cost savings and investment production.

We announced The Effortless Network as part of a global virtual launch that exceeded our target goals for audience participation and has generated strong customer demand for new Brocade ICX portfolio.

Second, we executed a number of strategic initiatives in our Channel business to better align our sales and marketing efforts. The key change that we made was the appointment of Regan McGrath as VP of Global Channel Sales and Marketing. Regan brings more than 25 years of IT industry experience, most recently as that VP of America's Sales at Brocade, where he led the largest regional channel sales team for the company. In his new role, Regan will both have channel sales and marketing on a global basis to drive increased level of integration between the 2 disciplines in order to address the unique needs of the channel.

In addition to Regan's appointment, we introduced a number of enhancements in Q2 to our Alliance Partner Network, which is designed specifically to generate new campus LAN business. We believe that these enhancements will allow us to further develop our presence in the market and fully leverage the competitive benefits of our differentiated technology.

As Brocade remains committed to innovation, we continue to invest in key campus LAN solutions with partners. In Q2, we unveiled an architectural framework with Microsoft to deliver the network foundation for easy-to-manage and scalable Microsoft Lync deployments for both data center and campus environments. This architectural framework includes Brocade ICX and VDX switches as part of the overall solution.

Another important part of our long-term strategy in the Ethernet market is growing our presence in the data center. Data center LAN is a $6 billion market and is undergoing a significant evolution as companies accelerate their virtualization deployments to accommodate the expected massive increase in east-west data traffic by 2014. Ethernet fabrics are the optimal platform for high-growth virtualization and cloud businesses. And we are progressing well in our goal to maintain thought leadership with our game-changing technology.

A year ago, in the category Brocade helped launch, we had an install base of just over 100 Ethernet fabric customers. Today, Brocade has deployed Ethernet fabric-enabled products in more than 550 customers worldwide and has shipped more than 100,000 VDX ports, many in high-performance, mission-critical environments. As the competition is now reaching to catch up with their own fabric solutions, they are validating the market and technology direction that Brocade has established.

In the Ethernet fabric category, I want to highlight 2 customer wins that Brocade announced in Q2, namely the deployments at United Broadcast Facilities and Rushes, both players in the high-end video production and broadcast industries. Each of these customers required a network infrastructure capable of moving large amounts of data with very low latency, and Brocade Ethernet fabrics delivered on both critical requirements.

Ethernet fabrics are also engineered to support a large-scale server virtualization, deployments at Watson, Farley and Williams, SunPower, and Government Employees Health Association, are all recent examples of organizations that are implementing Brocade's innovative Ethernet fabrics as the foundation for the virtualized data center strategies.

In Q2, Brocade also generated tremendous momentum among key strategic partners, indicating that Ethernet fabrics provide an essential core technology in private cloud, data center hosting solutions. For example, Brocade and EMC announced the inclusion of Brocade VDX switches and VCS software, along with other Brocade networking solutions as part of the EMC VSPEX reference architectures. These architectures are optimized for EMC's global reseller network and then targeted at small and medium-sized businesses that are looking to leverage private cloud.

Other key partner wins in Q2 include: NetApp becoming the first OEM the VDX switches as part of its unified storage architecture; the launch of the new Ethernet fabric embedded switch, the VDX 6746 or Hitachi blade servers, first of its kind; and then Fujitsu making the VDX switches available as part of its cloud and analytics solutions bundle.

We continue to make strategic investments to press our time-to-market advantage and industry leadership in the Ethernet fabric business. A key part of this strategy is the appointment of Phil O’Reilly as VP of Sales, Ethernet Fabrics. Phil has more than 20 years of experience in senior sales and marketing positions across the networking industry and has been instrumental in building businesses in the past. Phil will lead a dedicated team to grow our presence in this exciting market. Our objective for this team is to have a focused effort to win sales opportunities that are becoming more available as customers migrate from traditional data center networks to Ethernet fabrics. Along with Phil's dedicated team, we are in good position for continued growth with our industry-leading portfolio of Ethernet fabrics solutions. Later this year, we look forward to bringing significant advancements to the portfolio that will offer new features, functionality and greater scale for virtualized data centers.

The third area of focus of our Ethernet strategy is on the $14 billion service provider market. We have been successful in growing our revenue in this customer segment over the past 2 years by offering high-performance and high-density routing platforms.

The enormous growth of network traffic requires customers to continually adopt higher-performance technologies. Brocade was the first in the networking industry to introduce a high-density, 100-gigabit Ethernet module in a routing platform, which has been well received by customers who require the massive scalability that it enables.

The Brocade 100-gig Ethernet deployment at Indiana University as part of its Monon100 network project, is a great example of the benefits of this technology. We're extremely pleased to help Indiana become the first state in the country to launch 100-gigabit Ethernet network dedicated to research and education. With this high-performance network, Indiana University scientists, medical researchers and students can now rapidly share and expedite the processing of massive amounts of data created by modern digital instruments such as revolutionary DNA sequencers, advanced electron microscopes, large particle accelerators, such as the Large Hadron Collider at CERN.

Now turning to Storage. As I mentioned earlier, our Storage business performed well in Q2. The key driver for this was the strength in our 16-gig SAN sales, which accounted for 23% of Director and Switch revenue in the quarter. Our strategy has always been to be first to market with the fastest, most reliable, efficient and easiest to manage networks. The pace of the current transition to 16-gig SAN highlights the overall health of the Fibre Channel SAN market, which posted record results the last calendar quarter of 2011 according to the Dell’Oro Group.

In Q2, Brocade extended its leadership in the 16-gig market by adding the Brocade 6505 entry-level SAN switch to our portfolio. Brocade has the industry's most comprehensive 16-gig SAN portfolio that includes backbones, directors, switches and host bus adapters.

As of Q2, all our major OEMs have made our expanded 16-gig switch portfolio generally available to their customers. We are confident in the long-term opportunity in SAN and our ability to maintain our leadership position in this market.

In our annual customer survey published last fall, approximately 80% of our Brocade customers said they expect to maintain or increase Fibre Channel spending over the next 3 years, and we continue to be in the best position to meet that critical demand. As I mentioned, our goal is to focus our investments in high-growth target markets that result in revenue growth and increased profitability. An example of a new market that is just emerging is the software-defined networking or SDN market, which we believe has the potential to transform networking infrastructure into a platform for innovation. SDN will enable customers to more rapidly deliver new services and applications as well as scale their networks more efficiently.

Brocade is a pioneer and active participant in the SDN arena and has demonstrated its commitment to build SDN-ready solutions with its support for OpenFlow and OpenStack standards.

Recently, Brocade participated in a number of proof-of-concept interoperability tests at major industry forums, including the Open Networking Summit and Interop 2012. We are preparing to unveil our complete SDN strategy in the coming weeks, including an update on our SDN-ready product roadmap.

In summary, we are pleased with our Q2 performance that was at the high-end of our revenue guidance and exceeded our expectation for EPS. Our positive Q2 results were led by a strong performance in our Storage business that is indicative of good customer traction for Fibre Channel and our 16-gig portfolio. While the overall Ethernet business environment remains challenging, we delivered promising results in key product areas, including Ethernet fabric adoption, 100-gigabit Ethernet momentum and a customer demand for the new Brocade ICX campus LAN switches following the launch of our cutting-edge Effortless Network.

We have also taken important steps to grow the Ethernet business through focused initiatives in the channel and in our Ethernet fabric business. I believe we are executing well to our 2012 Playbook fundamentals. Our goal for the remainder of the year is to continue to grow revenue and to increase profits faster than revenue as part of our ongoing efforts to increase shareholder value.

With that, I will now turn the call over to Dan for a quick review and to add some color to our Q2 results and Q3 guidance. Dan?

Daniel W. Fairfax

Thanks, Mike. As you've already seen in our prepared remarks, our Storage product revenue was very strong in Q2, and we saw continued growth in our 16-gig product portfolio. The strength in Storage was offset, however, by lower revenue in our Ethernet business that Mike described.

Our overall non-GAAP gross margin was 64.8% in the quarter, and the resulting non-GAAP operating margin was 18.6%. We generated cash flow from operations of $140 million. We paid $50 million of our term loan and repurchased $25 million of stock during the quarter.

So far in Q3, we have incrementally repurchased more than $30 million of our shares. In addition, our Board of Directors has recently authorized an increase of $500 million for share repurchases. We provided Q3 guidance in our prepared remarks and I would like to take a minute now to give a little more color around our assumptions.

Looking forward to Q3, we contemplated the following in setting our outlook: The macro environment and economy continue to show uncertainty especially within the Eurozone countries. Overall IT spending is growing, but individual technology segments, such as networking may experience more uncertainty than others. In Q3, we are expecting total revenue between $525 million and $545 million, or growth of 4% to 8% year-over-year, and non-GAAP EPS of $0.11 to $0.13, or growth of 22% to 44% year-over-year.

Data center server virtualization continues to be a catalyst for the growth of our storage products. And we expect the market for the full year 2012 to grow approximately 5%. Based on the rate of adoption of our 16-gig products and share gains, we now expect our growth rate for fiscal year '12 to be higher than the industry growth rate.

We expect to see sequential growth in the Ethernet businesses in Q3. We also expect Federal revenue to grow sequentially, but be below the level of Q3 of '11. We expect to hold operating expense dollars relatively flat for the second half of the year, and we now anticipate that our operating cash flow will be in the range of $425 million to $450 million for fiscal year '12 as compared to the range of $400 million to $425 million we provided on our Q1 earnings call.

With that, I will now turn the call back to the operator to begin the question-and-answer session.

Question-and-Answer Session

Operator

[Operator Instructions] We will go first to Jayson Noland with Robert Baird.

Jayson Noland - Robert W. Baird & Co. Incorporated, Research Division

I wanted to dig into Ethernet a little bit. Gross margin was about flat sequentially in the mid-40s. Is that the expectation for F Q3 also?

Daniel W. Fairfax

Yes. And Jayson, this is Dan. So generally, we've been in that same range now for 2 quarters now. The step up in gross margin to our target of moving above 50% really will be dependent on volume. So I think you can model your number based on that, but you wouldn't expect a large change based on the guidance we've given you.

Jayson Noland - Robert W. Baird & Co. Incorporated, Research Division

Does it get incrementally difficult to get back to 50%-plus with the campus edge launch and others out there with fabric portfolios?

Daniel W. Fairfax

Yes. Let me just make a comment and I'll pass it to Dave. The new products that we've launched have been cost reduced and engineered to improve margins in the product set. And as the VDX product, which we report as part of our Ethernet, also has an attractive margin profile. So as the mix shifts to more 100-gig product, more VDX product and the new campus products, you should see the underlying strength in the product margins of the business. And Dave, maybe you have a comment to add to that?

David B. Stevens

Yes. I mean, I would just reiterate exactly what you said is that we did just launch a refreshed campus portfolio in Q2. We are seeing that ramp actually a little bit above our original expectations on some of those products, so the reception is really good on those. And as Dan said, we've engineered those to compete specifically in that environment, so I -- we expect the margin profile to be good on those. And then the VDX products and the data center tend to model at a higher level because of the ASIC content of those products. As those continue to ramp up, that should add some improvement as well, but it's really dependent on volume as well.

Jayson Noland - Robert W. Baird & Co. Incorporated, Research Division

I think VDX was $7 million in Q1. What was it roughly in Q2? And how would you expect to see that to play out in the second half?

Daniel W. Fairfax

Yes. So it was $8 million in Q2. We haven't specific guidance for VDX growth rates. But we have been saying consistently is the marketplace for these products is quite large, but we're still in an early adopter phase, and we would expect exiting 2012, and into '13, you'll start to see some significant growth rates there, but not likely you'll see a big change in the next quarter.

Operator

We will go next to Jess Lubert with Wells Fargo Securities.

Jess L. Lubert - Wells Fargo Securities, LLC, Research Division

I was hoping you could start off by discussing linearity in the quarter and how your visibility has trended relative to where it was 90 days ago.

Daniel W. Fairfax

Yes. Let me mention -- so for the second quarter, our linearity, well, it was about the same as the first quarter. Some of that is a little bit dependent on the mix. More of our revenue came out on the Storage side. A little easier for us to forecast there. And I'll let Ian talk about just generally what he's seeing in the marketplace in terms of the closing rate on the Ethernet products.

Ian Whiting

Yes, I think overall close rates haven't fluctuated that much. We model a close rate, which has remained fairly consistent. I think it's fair to say that we have seen extended sales cycles in certain parts of our business most notably in the Service Provider space, where it's traditionally quite a lumpy business for us with some very large customers, and we have seen some elongated sales cycles there. But overall, I would characterize Q2 as fairly consistent from a linearity and visibility point of view.

Jess L. Lubert - Wells Fargo Securities, LLC, Research Division

Can you maybe talk a bit more about what you're seeing in Europe and the Federal vertical specifically, and whether or not you're seeing activity there stabilize or deteriorate?

Ian Whiting

Well, Europe, I think the situation in Europe is well-documented. We have seen some weakness in parts of Europe, which are exposed more to the debt crisis. That's fairly consistent, and so that has had an impact on our European contribution to the revenue. In Federal, as Dan said, we are expecting, as we normally see, more of a second half back-end-loaded contribution from the Federal business. And as we've been saying consistently, our strategies have been around diversification. And we have made some announcements a while back around our investments in the civilian space through the addition of some top industry talent in that space. And we are seeing good growth in that area as we seek to diversify our revenue stream from a small number of large programs to a much broader base. And we're happy with the progress that we're seeing there, so that should bring more consistency and predictably to that business over the next few quarters.

Jess L. Lubert - Wells Fargo Securities, LLC, Research Division

And then just last one from me, you've announced a number of sales leadership changes and our contacts have noted some elevated turnover particularly in the Ethernet business. So I was hoping you could discuss how the discussed changes in sales leadership are proceeding, how you're feeling about turnover levels and the general stability of the organization at this point in time.

Ian Whiting

Yes. We did -- I mean, it's fair to say that in Q1, we did see some unexpected -- an unexpected spike in attrition, which we took measures to address. And saw that come down nicely in Q2 back to well within what we would consider normal levels. But that does have an impact obviously on the out quarter, which is something we were very conscious of. But we certainly feel that's under control now. I think in terms of the changes we've made, as Mike mentioned in his opening comments, they are very consistent with the execution of our long-term strategy. The addition of Regan McGrath to take overall control of the channel sales and marketing effort is really a statement of our commitment to the channel. He's a been a very strong leader for us for many years, and that will add additional emphasis I think, to our efforts to grow a channel that modeled particularly in the area of campus. And the addition of Phil O'Reilly really puts even more emphasis on our desire to expand the customer base through Ethernet fabrics. And with a particular eye to growing a reference customer base and some light house accounts. And that will be the primary focus for Phil going forward here. So very consistent with our strategy in terms of the sales coverage and focus. And we're expecting some positive results from those changes.

Operator

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

Mark Sue - RBC Capital Markets, LLC, Research Division

Maybe just some thoughts on your guidance, should we expect a sequential decrease in most of your regions, or is it just Europe in the near term? Are you seeing some spillover of caution into the U.S.? And OEM inventories declined a bit. Historically, how low can it get? I ask since I think in the past, when things do slow down, it can dip below 1 week. And if I'm just trying to get a sense of your working assumptions there.

Daniel W. Fairfax

Mark, this is Dan. Let me take the inventory question first, and then I'll let Ian talk about what his team is seeing out actually in the field from a sales activity basis. So what we've been guiding on the OEM inventories is that they seem to be running in a range of about 1 week to 2 weeks' worth of inventory across the whole base of the OEMs that we have, and each one individually depending on whether they are gearing up for installations, they're coming into fiscal year end, it'll move from OEM to OEM. What we saw in Q1, we saw the inventories come down a day or 2. In Q2, we saw the inventories go up a day or 2. Things will be trading -- trading that kind of less than 1.5 weeks right now for inventory. And we don't expect any major movement at this point, and to stay pretty tightly bounded there. Let Ian make comments.

Ian Whiting

Yes. And very briefly, I would not characterize the woes of certain parts of Europe leading into the Americas business in any meaningful way. I think our distribution of our revenue in the second half of the year is expected to be pretty consistent with what we've always seen, so the short answer would be no.

Mark Sue - RBC Capital Markets, LLC, Research Division

Ian, just on a larger issue and Mike, feel free to chime in, I mean, Europe is a massive kind of continue to be status quo for a while. As an organization, do you quickly -- can you quickly shift or reallocate resources out of Europe to gather gross margins? Or just kind of how we have to go to deal with things for the foreseeable future as a -- in terms of exposure to Europe?

Ian Whiting

Well, I think taking Europe as a whole is misleading. There are obviously, markets in Europe, which remains strong. And where our IT spending is strong, there are the markets where clearly it's collapsing. And we have, for several quarters now, been adjusting our allocation of resources in anticipation of some of these things that we all read about. But I would say that we have a fairly good balance of the resources in the regions now where we see continued growth and opportunity. And we've been rightsizing our coverage in areas where we know, the market will struggle for some time. But that's an ongoing effort to make sure that we stay on top of those things and make cost corrections as needed. But we're pretty comfortable with where we have the people deployed now and where we see the opportunity.

Michael A. Klayko

And Mark, this is Mike. I'll add one more piece of color to that. From a strategy standpoint, I think the models we put in place are right. From a tactical standpoint, I think we're a little slow to act when we've seen some trends. And we probably didn't pull the trigger fast enough in some areas of execution, which has come back and bit us a little bit, as you know. Especially in the Ethernet market, we were highly concentrated in some large accounts, didn't diversify fast enough into some other areas. And so now, what we're doing to do is we're not going to be slow to act. To your question, can we redeploy and can we rebalance? Yes, in fact it's on us now just to execute to do that?

Operator

We'll go next to Shebly Seyrafi with FBN Securities.

Shebly Seyrafi - FBN Securities, Inc., Research Division

Can you guide a little bit on the SAN side? A year ago your SAN business declined 14% sequentially. You said Ethernet would grow sequentially, but you didn't make any comments on SAN. I also noticed that your 16-gig is at 27% of Director and Switch, 23% of Director and Switches. A quarter ago, it was 27% of Directors. Can you talk about that ramp, the 16-gig ramp whether it's meeting your expectations? And when do you think it will hit say, 50%?

Jason Nolet

Shebly, this is Jason. So the ramp to 16-gig is absolutely meeting our expectations. I guess, as you pointed, out 23% of Director and Switch sales from that technology product -- sales from that technology. And we're seeing a transition from 8 to 16, that is at par or even slightly faster than what we saw with previous generations where we went from 2-gig to 4-gig and 4-gig to 8-gig. So I think we're pretty happy there. I'll point out that in this quarter with the introduction of 6505 entry-level switch, we've now rounded up the entire portfolio. And all of our major OEMs are through their qual release and are now fully into their sales cycle there. So I think we're very happy with the momentum. And I'll point out that -- and we tried to clarify this a few times, the speed increase to 16-gig is important, but what's more important is some of the value that we've built into the products, and notably, the ability to consolidate existing SANs into simpler fabrics with fewer devices. Just by way of an example, we have a major project going on with a bank right now, where we're helping them consolidate down from 52 chassis or directors down to 34 as a result of the new ICL capability in the 8510. So a lot of strong demand on the basis of the value, not just in the performance. But in the fabric simplification automation that we're delivering in the product as well.

Shebly Seyrafi - FBN Securities, Inc., Research Division

Great. On the SAN side?

Daniel W. Fairfax

Shebly, on the guidance. I think the way we're thinking about it, what we said in the published remarks is that we expect the growth of the SAN market, the Fibre Channel SAN market to be at the 5% level. Last quarter, we said we thought we're pushing the high end of the range that we'd originally projected for the year, 2% to 5%. On top of that, if we -- if you look at the compare a year ago, in our third quarter, we saw a significant amount of inventory come out of the OEM channel. And so the compares is much easier this Q3 than it was a year ago. On top of that, with our 16-gig product portfolio, as Jason said, being nearly complete, there's still some embedded devices that we'll continue to roll out to our customers. With that, transition well under way, we have seen that we're taking share in this marketplace. So if you add in the share gains, the underlying market growth rate of 5% plus the compare against light Q3 of revenues you'll come up with the number you need.

Jason Nolet

This is Jason. Just to add to that, I should point out example I gave you was actually a competitive take out. So we're able to go in and displace the existing fabrics from competitive environments in these large financial institutions, by way of example.

Daniel W. Fairfax

Then maybe -- then let me -- I just want to add this one final piece, just on the seasonality. So we're seeing what we would expect a normal kind of flat to 2% down seasonality quarter-over-quarter going into Q3 on the storage side.

Shebly Seyrafi - FBN Securities, Inc., Research Division

Slightly down 2%, sequentially, okay.

Daniel W. Fairfax

Yes.

Operator

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

Aaron C. Rakers - Stifel, Nicolaus & Co., Inc., Research Division

I guess I want to go back to Jayson's earlier question on the Ethernet gross margin. Back in September of last year, you guys gave an outline kind of progression of how we should think about the gross margin trend. I guess my question is you highlighted a 54% to 59% level as being your target and even went as far as saying that, that would happen just in fiscal '12. When do you think that can happen? Or do you think that can still happen? And if so, when? And I do have a follow-up.

Daniel W. Fairfax

Yes, I think we were getting 52% to 57%. We clearly wanted to be in the 50% range for gross margins. That remains a key target for us. But as I made a comment just a few minutes ago, the volumes that we're shipping right now with overhead absorption laying on top of that just don't allow us to get to that range. So volume fixes most of this gap to move over 50%. And the new products with the more attractive mix, gross margin mix gets us to the difference. So our goal is still to be in that range with these new products as they mature and we get volumes.

Aaron C. Rakers - Stifel, Nicolaus & Co., Inc., Research Division

So. So relative to what was said a year ago, you've sustained that level of gross margin on your new products, is that fair?

Daniel W. Fairfax

That's correct. You actually can think of, as an example, the VDX switches modeling from a gross margin standpoint, very similar to the Fibre Channel SAN products. We've got a lot more IP in that box, and as a result, we have a more attractive gross margin.

Aaron C. Rakers - Stifel, Nicolaus & Co., Inc., Research Division

Okay, that's helpful. And then the other thing I want to touch on is, I know you gave an updated cash flow from operations number. Can you tell us what free cash flow is because clearly, that's running well above what you thought this year? And on top of that, you threw in a comment about monetizing the San Jose facility. Can you help me understand what that is, what that means?

Daniel W. Fairfax

Yes, so let me take the second part, this is Dan again. The second part of that first, and a little bit of this is a history lesson. When we went about thinking about where we would locate our business back in the 2006 time frame, we had a number of leases expiring within the San Jose community. And ultimately, we ended up consolidating 5 different locations into the site we're at right now. Our goal was not to become landlord through that process. Our goal was to most efficiently acquire the space that would work for us. It just happens that if we stepped into the role of the developer, we could do that. And as we now look at where we are as a business, having very high utilization of the space, we're looking at do we want to remain a landlord or is there a higher use of cash that's effectively locked into those buildings?

Aaron C. Rakers - Stifel, Nicolaus & Co., Inc., Research Division

And then on the free cash flow target for this year, how maybe we should think about modeling that going forward?

Daniel W. Fairfax

Well, we haven't -- so we haven't given specific new guidance, but it's in the $345 million to $370 million range.

Aaron C. Rakers - Stifel, Nicolaus & Co., Inc., Research Division

$345 million to $370 million, okay.

Operator

We'll go next to Brian Marshall with ISI.

Brian Marshall - ISI Group Inc., Research Division

Question on VDX. If you have over 500 customers today and you shipped roughly 100,000 ports. Since inception that obviously averages out to less

than 200 ports per average customer. I guess the question is, is this still test and development phase? Or can you talk a little bit about where we are in sort of the development cycle of this product line? And when we do ramp to sort of production migration, I mean, could the volume scale 10x, 20x? Could you give us a sense there? And I do have a follow-up.

Jason Nolet

Brian, this is Jason. And I think -- and we may have mentioned this in the last call. We see a lot of deployments of VDX in Ethernet fabrics in new applications and new architectures and deployments like private cloud architectures where an enterprise is putting their toe into the water there. And so it's not unusual for us to sell 4, 5, 6, 7, 8 switches to a customer, have them go prototype or pilot that deployment and then decide to move it into production maybe 6, or 9 or so months later. So we're kind of -- we're seeing what we expected to see in the terms of seed units going out to lots of different customers, and as we pointed out over 550 cumulative now. I would expect to see those customers come back and do repeat buying because they build out their infrastructures once they've grown comfortable with the technology and ready to scale out. We actually do have a number of customers today who have scaled fully to the capacity of the technology as it exists. So 24 switches with 60 ports each. And they're looking forward to the next wave of release from us, which will come in just a few months actually, where we will increase the scalability both in terms of existing product as well as a new product. So we will see that scale out over time. But I think we fully expected see lots of customers, put the architecture into a pilot, into a prototype for the applications that I mentioned, and then once they're comfortable, scale out from there.

Brian Marshall - ISI Group Inc., Research Division

That's helpful. Then I guess kind of a bigger question for Mike. When you think about it, you have a very high share count, 75% of a couple billion dollar TAM and SAN. But you have low single-digit share of a very large Ethernet space. And I think that's where the real opportunity lies going forward from a revenue growth standpoint. But when the number -- we look at the numbers, obviously, SAN was a little bit of, but Ethernet was down 10% year-over-year. So I guess the question is when do you think we should expect to start seeing some traction on the Ethernet side and really start gaining a percent of that TAM and whether that TAM is up or down, you guys should still be able to grow because you're going to be in a share gain perspective. I guess the question is when do you think we can start to see some of that sort of fruits of the labor of the investment over the last couple of years?

Michael A. Klayko

Okay, you're right. It should growing. And as we stated before, we do believe we can grow faster than the market, regardless of the market, we should be able to grow that just based on the competitive nature of the products that we've built and the differentiation. A lot of it is spent [ph] on the previous question you just asked of Jason on VDX. There is significant differentiation. We actually will go in with an Ethernet fabric, and then, oh, by the way, sell our routers technology and the other campus technologies with that. So we had some execution issues, I will tell you that we're taking full ownership. We're making all the adjustments and changes now. And that echoes back from all different facets of the organization because the market's there, the products are there. What we have to do now is just execute to those markets and that opportunity. But yes, there's a tremendous amount of opportunity yet in front of this. We just have to do a better job of executing to grab that share.

Operator

We'll go next to Brian Modoff with Deutsche Bank.

Vijay Bhagavath - Deutsche Bank AG, Research Division

Vijay Bhagavath on behalf of Brian Modoff. So 2 questions, I mean, first is help us understand the 16-gig Fibre Channel product cycle. How many more quarters do you think before the product cycles start kind of moderating? And the second question is around campus switching. I mean we know the near-term Enterprise IT spending weakness from chambers, et cetera. So what are your thoughts there, campus switching versus data center switching as we head into the second half.

Jason Nolet

Vijay this is Jason. Let me take the SAN part of your question first. So we don't expect market and the demand for that product to moderate any time soon. As you probably know, it's only been out for 9 or so months, and we're starting to ramp. What we're seeing despite all of the noise around competing storage networking technologies is that Fibre Channel continues to be extremely loyal in the customer base. And we're seeing continued investments, right? So whether you attribute that to the fact that SSD storage arrays are now coming online, and they really demand high-performance networking, introduction of new applications like VDI that require even more demands on the storage area network and subsystems or just virtualization, which is driving the need for pooled storage and Fibre Channel is the incumbent there. So very bullish on Fibre Channel going forward. And don't expect the take up on the 16-gig technology to moderate anytime soon.

David B. Stevens

Yes. And I would just complement -- this is Dave, on some of the switching product categories, i.e. in the data center sort of on the other side of the server from the storage networks, there still continues to be a very clear migration over the fabric architectures. We're well positioned there with the VDX product. As you noted, we had modest market share there. But we're up over 550 production customers in there, we're continuing to add resources there, continuing to make progress and win customers. In the service provider space, we're continuing to improve the density of the MLXe routers and win customers there. We're I think the #2 player in the marketplace today in 100-gig deployments. And we continue to see great demand on that. And then on the campus side, we've just rolled out a complete refresh product line last quarter. We're seeing great ramp on that product. It's differentiated from other people in the marketplace. It's got a very good cost of margin profile. And we're busy ramping up the channel to help sell that product and take it into the marketplace. So I think as Mike kind of made the comment, we're continuing to execute in the Ethernet space around all these different areas and we're continuing to push forward on those.

Vijay Bhagavath - Deutsche Bank AG, Research Division

Yes. My question was really in terms of demand trends, what are you seeing out there in the field in campus and fixed port campus switching, 10-gig data center switching given some macro-related near-term spending weakness that could play out potentially?

Michael A. Klayko

Yes. Well, I think there's a very clear migration from 1-gig to10-gig in the data center driven by virtualization and things like Romley base server refreshes that we're very well-positioned in there. In the campus space, there's some great new applications, BYOD, voice-over-IP implementations, virtual desktop, which are driving people to upgrade their campus infrastructures. And all that gets run over the service provider network so we're continuing to see big bandwidth demands in the service provider side. So I think we're seeing reasonable demand and upgrades really across all 3 of those segments.

Operator

We'll go next to Keith Bachman with Bank of Montréal.

Keith F. Bachman - BMO Capital Markets U.S.

I have a clarification question, please. On the 16-gig, when you talk about the 23%, is that 16-gig capable or 16-gig enabled? In other words, does it have the optics contained in it or are people buying it without the optics in it?

David B. Stevens

Yes, that is 16-gig enabled.

Keith F. Bachman - BMO Capital Markets U.S.

Okay. So that has all the capabilities in it, great. I want to go back to the sales model, if I could. As you're trying to migrate more to the indirect channels, just want to hear a little bit more about why you're trying to do it -- particularly on the Ethernet side, when a lot of your competitors are still focused on the direct model. Why do it -- how -- what were the execution issues that you experienced this quarter? And how long would you expect the implementation phase of this transition to last?

Ian Whiting

This is Ian. I think it's important to distinguish between data center Ethernet and campus Ethernet. So the execution issues that we've had frankly have been consistent with just the time it takes to ramp up the indirect channels, the distribution channels. This is a well-known model for driving volume in campus LAN products. And frankly, we started down this path a year or so ago. We have a clear strategy to move to a 2-tiered distribution model that involves investment in our partners, investment in the program. We call it the Alliance Partner Network program, and we just need to go faster, frankly. And we have the right distribution partners. We now have certainly a great product lineup. And there's some additional resources that we've put into this space, most recently obviously, the announcement of Regan McGrath to run both Worldwide Sales and Marketing. We're confident that we are on the right path, but we need to go faster. And that's a function of having the right product, better field sales execution. And we've already started to see a pretty healthy ramp, I mean, the ICX launch that we've been talking about, we consider that a success. We actually stockpiled that product in Q2 due to demand from distribution. But obviously the focus is on demand from the customer and sell-through. And we're pretty confident that we're going to continue to see that product ramp. And we'll see the benefits of these investments we've been making now for over a year in building out the 2-tiered distribution model, which is the only affordable effective model for growing the volume campus LAN business.

Keith F. Bachman - BMO Capital Markets U.S.

What were the execution issue in the quarter? Was that just the churn, so to speak, on headcount you experienced last quarter or was there something else?

Ian Whiting

It's a combination of factors, which is within our control and within our visibility and we're dealing with all of those.

Michael A. Klayko

Keith, one of the things we also did is -- we always want to balance how much change you can absorb. And I think we got over our skis, and we put too much change into the system. So now it's -- now when you see some of these appointments focusing on VDX, focusing on very specific channel programs, focusing on different areas, we're tightening down the number of changes and focusing on things that can really truly make a difference, grow the top line and so forth. So we tried to do a few too many things, and it came back where we couldn't absorb it at the rate we needed to make the change. So now we're doing is -- we're focusing on the ones that we have to and executing on those.

Operator

We'll go next to Andrew Nowinski with Piper Jaffray.

Andrew J. Nowinski - Piper Jaffray Companies, Research Division

So I just wanted to go back onto the Storage revenue. So given your kind of prior comments that SAN line will increase going forward, shouldn't we expect margins to remain at this level versus revert back down to the 69% to 71% range?

Daniel W. Fairfax

Yes. This is Dan. I think, certainly, while we're in the market with these advanced products and none of our competitors offer this, you would expect that we would have a margin advantage there, particularly you can think of it as -- we're still seeing maybe low to single digit price erosion on the older products. But the new products shift that mix and we would expect by 18 months, there will be a market that will be halfway converted into the 16-gig products. So from a modeling standpoint, that should help.

Andrew J. Nowinski - Piper Jaffray Companies, Research Division

Okay. So mid-70s is the new norm until Cisco comes into market with their own 16-gig?

Daniel W. Fairfax

Yes. We don't have any visibility to anything else that would give us disruption to that kind of model right now.

Andrew J. Nowinski - Piper Jaffray Companies, Research Division

Okay, fair enough. And then I just want a clarification on the Ethernet margins again. So I know there's a shift to a more of a 2-tiered model obviously, will improve your volumes doesn't that also lower your gross margins, since you have to pay more points to the channel?

Daniel W. Fairfax

Yes, it's clear. We made some comments to the effect that we do pass margin to the partners in the channel. As we make the transition for the campus selling activities away from the direct touch model to pull through from the channel, we should save money in terms of the sales line, where we no longer touch on those accounts direct. So you can think of, as Mike talked about, the execution issues we're not completely converted over because we have to make that transition and the disruption came in the handoffs.

Andrew J. Nowinski - Piper Jaffray Companies, Research Division

Right. I guess I'm talking about on the gross margin side. So as volume, you're saying -- as volume increases, you'll have -- you'll offset that absorption cost enabling you to get back to the 50% range. But I guess if you're shifting to this 2-tiered model, how would volume increases continue to drive up margin if you're paying more to the channel?

Daniel W. Fairfax

Let me take a shot at it. I think volume and distribution go hand-in-hand. The reason we're moving to the 2-tiered distribution model is to accelerate the volume of those products. So the absorption rate kicks in sooner. There is an offset in gross margin in ASPs when you go through the 2-tiered distribution model. But the ramp that we're on right now I think is consistent with what we've modeled for the rest of the year. And it will, the volume will offset the margin erosion. That's the assumption.

Operator

We'll go next to Paul Mansky with Cantor Fitzgerald.

Paul H. Mansky - Cantor Fitzgerald & Co., Research Division

A couple of questions, if I may. First a clarification. I think you said inventory is 1.5 weeks this quarter. A year ago, it was 2.5 weeks. I remember that you transitioned from that inventory metric being the function of both storage and Ethernet products to just Storage. Can you remind me, is that 2.5 week to 1.5 week? Is that an apples to apples? Or when did you move to just storage product as a contributor to that -- with the reported OEM inventory figure?

Daniel W. Fairfax

Yes, we changed -- we changed the metric in Q1 -- was when we changed it to strip out and that was really recognizing that there wouldn't be volume Ethernet products moving to the OEMs anytime soon. The metric had been made, a combined metric based on the model that said we'd have more there. So I don't know off of the top of my head what a year ago would have been. We can certainly try to get that out to you.

Paul H. Mansky - Cantor Fitzgerald & Co., Research Division

I appreciate it. And what I was ultimately getting to and there's no gentle way of asking this. But obviously, we see Hitachi popped up as a 10% customer again this quarter. Last time they did that was that Q2 of last year. And we had a bit of a problem in Storage the subsequent quarter, maybe if you can kind of help walk us through. Clearly, you have a 16-gig product cycle that's giving you some tailwind. Offsetting that, we've heard some fairly public commentary about deceleration at the high end of the storage market this year. Can you walk through some of the things that you're looking at, that you really drive that confidence around the storage portfolio Q3 and apparently into Q4 as well?

Michael A. Klayko

Yes, I think we're winning more, Paul. This is Mike. And yes, there is a significant product -- there's significant product differentiation right now and customers are actually falling [ph] out the demand of our product from our various partners. If you look at the various partners right now, trying to predict inventory is very challenging. Making sure that we have it available for them when they want to buy it, to put it in their locations as they source out installations I think is critical. But for us, it's been -- I think the new norm, is what Dan was talking about, that 1 to 2 weeks range, I think that's the new norm going forward at any point in time. There was an earlier comment, would it ever get below a week? I think that will be really challenging. Does it get above 2 weeks? I think that's going to be challenging too. So it's kind of in that bandwidth right now. And it's really being driven by I think, the quality of the product as well as the demand for it. And we're winning in the marketplace.

Paul H. Mansky - Cantor Fitzgerald & Co., Research Division

Perfect. Actually I have one last follow-up, if I may sneak it in there. The server group revenue down 4% or 5% year-on-year, a bit more than that sequentially. Can you talk about some of the underlying dynamics there? Maybe split that between clearly some of the mezzanine products, some of the bladed products --excuse me and then maybe HBA specifically at the 16-gig level?

David B. Stevens

Paul, the commentary I'll make -- this is Dave -- the embedded product into obviously, be attached into blade server systems. And so that tends to run up and down a little bit with blade server shipments, there's been a little bit of a pause I think industry-wide with blade server shipments in anticipation of some of the Romley updates. But that product tends to follow the server trends pretty closely. In terms of embedded systems, we're continuing to do -- we've done on the past. We've had embedded wins with a major server manufacturers. I think Jason talked a little better. We talked about in the prepared comments some of those wins and some of the bundling opportunities that are there. But I don't think anything is really changed there.

Operator

We'll go next to Scott Schmitz with Morgan Stanley.

Scott Schmitz - Morgan Stanley, Research Division

I just have a follow-up on some of the guidance questions or comments. If I assume your prior comment that the SAN business is flat to down 2%, it seems to imply that the Ethernet business is flat kind of as well. Maybe a small amount of growth. So I'm just trying to reconcile that with your comment that you expect sequential growth on the Ethernet business with growth on the Federal side. So what does that imply for the Enterprise business and the Service Provider business?

Daniel W. Fairfax

Yes. So we haven't broken out a separate guidance there. What we have seen is -- and you can talk maybe a little bit about the color around them. But on the Service Provider business, that business has been growing very nicely. But it doesn't grow consistently quarter-over-quarter. So if you look at Q1, we had some larger deals that came into the quarter. And Q2, we didn't see that same deal flow. But there's nothing fundamentally different other than the buying patterns of who we're selling to there. On the Enterprise side, it's really dependent on the conversation that Mike and Ian have discussed today around execution through the channel because we're committed to moving that way. And so we're not seeing we're out of the woods there. That's still going to be a journey on the campus products.

Scott Schmitz - Morgan Stanley, Research Division

Okay, great. And then just on the slowing close rates that you mentioned how much do you really attribute that to the transition to channel versus maybe some of the broader macro trends in competition?

Michael A. Klayko

I'm not going to put anything on the macro right now, a lot of people do. I think we can control a lot of the execution issues that we need to address. And so if the macro gets better, that's just better for us.

Operator

We'll go next to Rajesh Ghai with ThinkEquity.

Rajesh Ghai - ThinkEquity LLC, Research Division

I'm wondering if you could dig a little bit deeper into your comments regarding competitive pricing pressure. Is that specific to any special vertical, product segment or is it coming from a sourcing competitor and also have you guys seen any impact due to the entry of Huawei?

Ian Whiting

I think the -- where we see -- this is Ian. I think the pricing pressure we've seen has probably is more pronounced in the campus LAN space. It's a crowded marketplace in that area. And it's only really I think since we've introduced the new ICX platform and our announcements around HyperEdge, where have been and we are now in a position to have both a price and value conversation with customers who are discerning in terms of the level of technology and the brand that they put in. So I would say that's where we've seen the pricing pressure, but we're well equipped to compete there, I think, on a go-forward basis.

Rajesh Ghai - ThinkEquity LLC, Research Division

And the impact of Huawei? With the entry of Huawei in the U.S.?

Ian Whiting

I would not characterize Huawei as being specifically more competitive than anyone else there or a factor in the industry. It's a crowded marketplace right now.

Rajesh Ghai - ThinkEquity LLC, Research Division

Okay. And also can you provide some more color on your visibility in the Federal vertical in the second half of the year in the light of upcoming election and also visibility in the Service Provider vertical in light of the continuing weakness in that vertical?

Michael A. Klayko

Federal is a hard one as you know, because of -- you just mentioned it -- the upcoming elections. To put it in perspective, the demand is there. It's a matter of the spending and when the dollars get released and so forth. But that's a general statement for all people selling to the government right now and eventually, I think that will sort itself out. Once either the elections or there's more clarity in terms of the budget process. So and then the other segments right now, I think every other segment goes through whether they're going to be spending money, whether it's Service Provider or Enterprises and so forth. And it's not -- there's not an event that's going to ahead and happen. It's just normal business cycles at this point in time and a lot of folks are refreshing the edges. Some people are looking at the cores. There's a lot of different investments being made just because of the bandwidth requirements that people are seeing on the Internet and so forth. So I think you just have to find a good focus and a good niche and then go and execute against that. Because again, you can't be everywhere, and so what you have to do is find out where you can compete, make sure you have competitive products set and then go address that.

Operator

We'll go next to Glenn Hanus with Needham.

Glenn Hanus - Needham & Company, LLC, Research Division

Just following up on the Romley-related question. The server pause that people have talked about, did you see that impact your business overall in the quarter on either side? And as these platforms get released, are you sort of incorporating that, thinking of that as a tailwind now in the next quarter or so?

Michael A. Klayko

Yes, I can't point to something that said it caused it to pause. There was no event there from that stand point. I don't think it affected us directly. And then as a go forward, I think that is more of just wind in the sails more than anything else. It's difficult to predict when but we just view that as upside then.

Glenn Hanus - Needham & Company, LLC, Research Division

And lastly, could you comment on your VDX go-to-market strategy? I thought there was a lot of sort of direct activity and then I noticed NetApp and some other OEMs were named. Can you just kind of sort out the go-to-markets and how to think about that going forward?

Ian Whiting

Yes. This is Ian. I mean, like any new technology or any new category, it's characterized by primarily direct selling activity in the early stages, and that remains a focus for us. I will say that we are also seeing good traction in some of our bigger, or what we call Global Service integrators, people building large public and private cloud infrastructures to deliver cloud services. Some of the announcements you've seen most recently, as Jason referred to earlier on, I think these specs with EMC is a good example of how some of our -- some of the bigger systems and storage companies are viewing Ethernet fabric as a very key component and valuable component of an integrated computer network and storage solution. So you can anticipate I think more activity there. But that is not our primary go-to-market, our primary go to market of direct and through some GSIs. And I think that to the extent that EMC and others see the value of VCS within their stack, that again will be [indiscernible] upside for us.

Operator

We'll take our last question from Erik Suppiger with JMP Securities.

Erik Suppiger - JMP Securities LLC, Research Division

You talked about a little -- some of the turnover on the Ethernet sales side back in Q1. What kind of candidates have you been hiring to replace some of the turnover? Are you looking for seasoned sales veterans? Or are you looking to train younger salespeople? And if you're looking for seasoned sales veterans, where are you attracting them from?

Ian Whiting

Yes, so first off, the attrition challenge we saw in Q1, I mean, Q1 is always the quarter when you are exposed to that. It's the beginning of the new fiscal year. And we did see a bit of a spike. We took some immediate action, and we've got that back under control now. So we are well within what I would consider normal run rate in terms of sales turnover. And to answer your question on the backfilling, we were certainly are looking for experienced professionals, whether it's in customer-facing sales roles or systems engineers or -- and indeed channel roles. I think the value proposition around Brocade is all about being a challenger brand in Ethernet, having some great innovative technology in the form of VCS and just a great track record and brand in the storage area networking space, which has carried us for many years. So we're certainly attracting good talent. But we're being very thoughtful about where we've put people based on some of the earlier comments around about where the opportunity is.

Erik Suppiger - JMP Securities LLC, Research Division

And any particular vendors where you've been able to attract seasoned people from?

Ian Whiting

It's very, very broad. It's a big marketplace. There's a lot of companies that we pull from, not just networking companies because sales skills are transportable across different industries. So I will not point to any specific companies, no.

Robert Eggers

And this concludes our call for Brocade's Fiscal Q2 2012 Conference Call. Thank you for participating.

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