Brocade Communications Systems (BRCD) CEO Lloyd Carney on Q2 2016 - Earnings Call Transcript

| About: Brocade Communications (BRCD)
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Brocade Communications Systems, Inc. (NASDAQ:BRCD) Q2 2016 Earnings Conference Call May 19, 2016 5:30 PM ET

Executives

Michael Iburg – Senior Director-Investor Relations

Lloyd Carney – Chief Executive Officer

Daniel Fairfax – Senior Vice President and Chief Financial Officer

Jeffrey Lindholm – Senior Vice President-Worldwide Sales

Ken Cheng – CTO and Senior VP of Corporate Development and Emerging Businesses

Jason Nolet – Senior VP of Switching, Routing and Analytics

Jack Rondoni – Vice President Storage Networking

Analysts

Chad Bennett – Craig Hallum

Mitch Steves – RBC Capital Markets

Balaji Krishnamurthy – Goldman Sachs

Alex Kurtz – Sterne Agee

John Roy – UBS

Matt Robison – Wunderlich

Jeff Luber – Wells Fargo

Jason Nolan – Baird

Stanley Kovler – Citi Research

Operator

Good day, ladies and gentlemen. Thank you for standing by and welcome to Brocade's Second Fiscal Quarter 2016 Earnings Conference Call. As a reminder, this conference is being recorded.

And now I would like to turn the program over to our speaker, Michael Iburg, Senior Director of Investor Relations with Brocade. Sir, please go ahead.

Michael Iburg

Thank you, operator. Good afternoon and welcome to Brocade's second quarter fiscal 2016 earnings call. By now, you should have seen our press release and prepared comments, which are available on our website at brcd.com. The press release was also furnished to the SEC and will be distributed by Marketwired.

Before we begin, investors should note our comments today may include forward-looking statements, including but not limited to statements regarding Brocade's financial results, goals, plans, assumptions, strategy, business outlook, revenue, margins, expenses, tax rate, earnings, cash flows, capital expenditures, stock buybacks, inventory, IT spending, and prospects.

Our comments also include forward-looking statements about the Ruckus acquisition. These forward-looking statements are based on current expectations as of the date of this call and involve a number of risks, uncertainties, and assumptions that may cause actual results to differ significantly. These risks, uncertainties, and assumptions include, but are not limited to the effect on Brocade of increasing market competition and changes in the industry; the impact on Brocade of conditions in the market for storage-area networking product; Brocade's ability to execute on a sales strategy and plans for future operations; the impact on Brocade of macroeconomic trends and events and changes in IT spending levels; Brocade's ability to introduce and achieve market acceptance of new products and support offerings on a timely basis; risks associated with Brocade international operations; and integration and other risks associated with acquisitions, divestitures, and strategic investments, including Brocade's recently announced proposed acquisition of Ruckus; the ability of Brocade and Ruckus to consummate the proposed transaction on a timely basis or at al; and the satisfaction of the conditions precedent to consummation of the proposed transaction, including the conditions that a majority of Ruckus shares be validly tendered into the exchange offer.

These and other risks are set forth in more detail in our Form 10-K for the fiscal year ended October 31, 2015 and Form 10-Q for the fiscal quarter ended January 30, 2016. These forward-looking statements reflect beliefs, assumptions, outlook, estimates, and forecasts as of today, and Brocade expressly assumes no obligation to update any such forward-looking statements, whether as the result of new developments or otherwise. In addition, this presentation includes various third-party estimates regarding market share and other measures, which do not necessarily reflect the views of Brocade. Further, Brocade does not guarantee the accuracy or reliability of any such information.

This presentation includes non-GAAP financial measures. The most directly comparable GAAP information and a reconciliation between GAAP and non-GAAP financial measures is provided in our Q2 2016 press release, which has been furnished to the SEC on Form 8-K and posted to our website to our website at brcd.com.

After brief opening remarks, we will open the call to questions. Here to take your questions today are Lloyd Carney, CEO; Dan Fairfax, CFO; Jeff Lindholm, Senior VP Worldwide Sales; Ken Cheng, CTO and Senior VP of Corporate Development and Emerging Businesses; Jason Nolet, Senior VP of Switching, Routing, and Analytics; and Jack Rondoni, Vice President Storage Networking.

I will now turn the call over to our CEO, Lloyd Carney. Lloyd?

Lloyd Carney

Thank you, and good afternoon, everyone. So while we saw many successes in fiscal Q2, including the announcement of our intention to acquire Ruckus Wireless, revenue for the quarter fell short of our expectations, consistent with the soft demand environment reported by many of our partner base and peers.

In SAN, revenue for both directors and switches was weaker than we anticipated. The weakness was broadly spread across our partner base and appears to indicate lower overall storage spending. However, a bright spot in our SAN business was China. Our SAN revenue through our Chinese partners grew for the eighth quarter in a row.

On the product front, we're excited to being shipping the industry's first Gen 6 Fibre Channel solution, Brocade G620 Switch, advancing our sustained leadership in fibre channel technology. This new purpose-built identity solution delivers a performance, reliability, and scalability to support exponential data growth and mission-critical workloads.

In addition, our Gen 6 Fabric Vision technology also includes Brocade's IO Insight to help organization achieve greater visibility into network performance. Over the course of fiscal 2016, we expect to further expand our Gen 6 portfolio of high-performance products with additional solutions, including director and embedded switches to support a variety of environments and customer needs.

IP networking revenue in Q2 was also below our outlook range. The year-over-year decline was largely the result of lower router sales to service provider customers and slower US federal market spending within programs and projects where we were engaged.

From a product perspective, we achieve some encouraging results. We grew VDX sales by 11% sequentially and 36% year over year. This reflects demand from both traditional data center deployments, as well as increasing IP storage deployments, including sales EMC Connectrix VDX6740 IP storage switch. All geos were up in VDX sales except for the federal region.

We also announced a disruptive new mobility platform during Q2. This solution is a culmination of internal R&D coupled with the technology acquired through our strategic acquisition of Connectem, it expands our TAM into new markets, and is driving strong customer interest.

In fact, we achieved our first revenue-generating customer win, SmartSky in the quarter for its air-to-ground broadband network now deployed Brocade's Virtual Evolved Packet Core running on VMWare's vCloud NFV.

This solution enables SmartSky to take a software-defined approach to network infrastructure that is more agile, flexible, and cost-effective than a pure hardware-based approach.

On a strategic level during the quarter, we continued to execute on our vision to build a pure-play networking Company that supports the rapidly evolving requirements of the digital transformation era. In March, we acquired StackStorm, underscoring our commitment to open-store software, data center automation, and DevOps models.

We also announced our intent to acquire Ruckus Wireless, a pioneer in wireless infrastructure, and the transaction is expected to close in our fiscal Q3. This transaction enhances our scale, competitive positioning in both enterprise networking and service provider markets.

We also expect it to seamlessly complement our mobility strategy and enhance our ability to pursue emerging opportunities around 5G mobile services, Internet of Things, Smart Cities, in-building LTE, and wireless Wi-Fi coverage.

In closing, recent market softness impacted our Q2 revenue results and is expected to provide a headwind in Q3. As such, we are taking appropriate actions to control expenses and manage our investments in line with our stated priorities. Longer term, we continue to expand our capabilities, support mission-critical networking requirements from the core of data center to the wireless edge.

Through focused execution of our product and technology road map, we're beginning - we're bringing to market innovative solutions that are being recognized by both our industry and customers.

We expect to further road map this fiscal year with advancements across our portfolio that set the stage for expanded opportunities in the quarters to come.

I'll now turn the call over to Dan to provide the review of our financials.

Daniel Fairfax

Thank, Lloyd. As Lloyd has already noted, our fiscal second quarter of 2016 was challenging, similar to commentary provided by our partners and peers, we experienced slower storage spending, which impacted our SANs business.

Within our IP networking business, weakness in key vertical markets, primarily service provider and US federal, caused revenue to be below our outlook range.

For fiscal Q2, Brocade reported revenue of $523 million, down 4% year-over-year and down 9% sequentially. Q2 SAN product revenue of $297 million was down 5% year-over-year, while IP networking product revenue of $132 million was down 9% year-over-year.

We have provided GAAP and non-GAAP metrics and a reconciliation in our filings today with the SEC. My following comments should be considered together with that information.

Our Q2 non-GAAP gross margin was 68.2%, down 60 basis points over the prior year, primarily due to lower revenue. Q2 non-GAAP operating margin was 22.4%, down 220 basis points from the prior year, due to increased spending and lower revenue.

Q2 non-GAAP diluted earnings per share was $0.22, flat year-over-year. Our operating cash flow of $112 million was below our outlook, due primarily to higher Q2, '16 DSOs and lower revenue.

As I mentioned last quarter, we accelerated our 2016 share repurchase program in Q1, repurchasing $144 million in the first quarter. In Q2, we repurchased an additional $36 million of our shares.

In conjunction with the announcement of our intent to acquire Ruckus Wireless, Brocade's Board of Directors has increased our share repurchase authorization by $800 million. Since the date we initiated our exchange offer, Brocade has not been permitted to repurchase shares.

However, once the Ruckus exchange offers closes, we expect to resume our share repurchase program with the intent to repurchase all of the shares issued in conjunction with the Ruckus acquisition as quickly as possible, which, of course, is subject to market conditions and regulatory requirements.

As previously mentioned, our Q2 SAN product revenue was below our outlook range and declined 5% year-over-year. This is consistent with the commentary from our partners and peers regarding weakness in the overall storage markets. On a year-to-date basis, our SAN business revenue is down 2.6% as compared to our two-year SAN revenue guidance of flat to down 2%.

IP networking product revenue was also below our outlook range and declined 9% year-over-year. The decline was primarily driven by lower router sales to service providers and lower US federal revenue. Our global services revenue was slightly better than expected at $95 million.

Looking forward to Q3, '16, we considered a number of factors, including the following in setting our outlook. Many of our partners and peers have commented on the challenging macro environment that is negatively affecting the storage and IP networking markets.

The Dell and the MC merger may close during our fiscal Q3, and although we strongly believe this merger will be very positive for Brocade over the long-term, the potential for near-term disruption exists. We expect to close the Ruckus acquisition within our fiscal third quarter, and we are taking steps to ensure the successful integration of our businesses.

Given this framework for our outlook for fiscal Q3, excluding the impact of the Ruckus acquisition, is as follows. We expect SAN product revenue to be down 3.5% to 7% quarter-over-quarter, as we are cautious given the factors just discussed.

We expect our Q3 IP networking product revenue to increase between 7% and 14% quarter-over-quarter, primarily driven by improvement in US federal and Americas enterprise revenue. We expect global services revenue to be down 1% to 2% quarter-over-quarter.

We expect our non-GAAP gross margins to be in the range of 66.5% to 67% in Q3, as we anticipate an unfavorable segment mix shift as SAN revenue declines seasonally and IP revenue increases sequentially. We expect Q3 non-GAAP operating margin to be between 20.5% and 22%.

We have assumed a structural non-GAAP tax rate of 22% to 23% for Q3 2016. And we expect non-GAAP EPS of $0.19 to $0.21 for Q3, 2016. Finally, we expect Q3, 2016 operating cash flow to be within the range of $45 million to $55 million.

In addition to our normal quarterly outlook just provided, I would like to take a moment and provide some comments on the full-year of 2061 for Brocade excluding the impact of the Ruckus acquisition.

As reflected in our Q3 SAN outlook, we expect macro uncertainty to continue to challenge our near-term results. We do expect, however, to see a typical seasonal uplift in SAN revenue in our fiscal Q4.

In addition, although macro headwinds continue to weigh on our IP networking revenue in certain geographies, we expect a rebound US federal sales to provide an uplift in both Q3 and Q4 of fiscal 2016.

However, we now expect both our SAN and IP networking revenues to be below the growth rate targets we provided in Investor Day in September 2015 for fiscal year 2016. We will provide revised revenue growth rates to you at our Investor Day in September of 2016.

With regards to our operating model, historically, we have been below our operating margin target model range in fiscal Q3 and within or above the range in fiscal Q4. We expect this year to follow a similar pattern. As always, we continue to take appropriate actions to control expenses and manage our investments in line with our priorities.

Finally, in addition to our quarterly outlook and full-year commentary just provided for Brocade, excluding the impact of the Ruckus acquisition, I would like to take a moment and provide a few modeling guideposts relative to the Ruckus acquisition.

Assuming for modeling purposes the Ruckus acquisition closes at the end of May, we would be incorporating two calendar months of Ruckus revenue and expenses into our fiscal Q3 financial results.

Acquisition accounting rules will reduce Ruckus's deferred revenue and require a revaluation of all of Ruckus's assets including inventory. We currently estimate the revenue impact of these adjustments to be in the range of $15 million to $20 million for our fiscal Q3.

Although we expect to aggressively buy back stock after the Ruckus acquisition closes, we expect the fully diluted weighted average outstanding share count for our fiscal Q3 to be between 450 million to 460 million shares compared to the 409 million share count we have in fiscal Q2. This increase in fully diluted shares outstanding will negatively impact our Q3 non-GAAP EPS by approximately $0.02.

Looking forward, we expect the impact of this acquisition in our fiscal Q4, the first full fiscal quarter of combined operations, to be neutral to non-GAAP diluted EPS. Looking further out into fiscal year 2017, we are preliminarily estimating that the Ruckus acquisition will be $0.02 to $0.03 accretive to non-GAAP diluted earnings per share in each fiscal quarter. We plan to provide a consolidated outlook for fiscal Q4 on our next earnings call in August and an updated two year model at our Investor Day in September.

With that summary of our outlook, I will turn the call back to the operator to begin the question-and-answer session. Operator, please open the line.

Question-and-Answer Session

Operator

Yes, sir. [Operator Instructions] Our first question comes from the line of Chad Bennett of Craig-Hallum. Your question please?

Chad Bennett

Great, guys. Think for taking my question. So maybe Dan, can you talk about, obviously I don't know how much you want to disclose, but on the Ruckus expectations going forward, you know I think we talked about that being accretive the first quarter out of the gate, you know are we going to change our Ruckus expectations or Brocade expectations relative to what we are thinking a month or two ago when we pre-announced?

And then as you look at the $0.02 to $0.03 accretion per quarter for next year, can you give us an indication of kind of a run rate you're expecting for Ruckus and if you're thinking that business is on it normal growth path that it has been next year or are you just assuming its current run rate is it's run rate? Thanks

Lloyd Carney

Look, Chad. We always describe the acquisition being accretive the first quarter of our new fiscal year. So FY '16 – SMT [ph] Q1 been accretive then and so that's…

Daniel Fairfax

There is no - I think essentially what we certainly – very good integration funding period with the Ruckus team has been a shot, but we haven't seen anything to change our expectations from when we announced the transaction.

Lloyd Carney

Yes, we expect that they be on at a minimum their existing growth rate.

Chad Bennett

Okay, existing growth rate, okay, all right. And then second maybe per Lloyd, are we still thinking along the same lines on the software piece of the business on kind of exiting run rates this year and next year, I think those were kind of $60 million exiting this year and looking towards $100 million exiting next are we still comfortable with those targets?

Lloyd Carney

Chad, probably - now thought we're quarter ago, yes we absolutely bingo go hit the $60 million exit rate for this year and $100 million for next year, all the deals we talked about on my - precursor there was a VPC deal, software deal for SmartSky which you know, quite frankly we didn't expect this start filling up part of yet, so we feel pretty good about the momentum we haven't software space.

Chad Bennett

Okay and last one for me if I may, Gen 6 update - uptake I know it's really early, but what's your sense of the uptake on Gen 6 versus Gen 5 and then I'll come out - leave my questions for later? Thanks.

Lloyd Carney

Chad, we only shipped one line item so far good, we've got interest and we've got good revenue so far, the other products come online in the August timeframe and the uptake is as we expected right now, but we see good interest on it, product being well accepted and we're pretty excited about it.

Chad Bennett

Okay, thanks.

Lloyd Carney

Thanks, Chad. Next question?

Operator

Our next question comes from the line of Mitch Steves of RBC Capital Markets. Your line is open.

Mitch Steves

Hey, guys. Thanks for taking my questions. So I wanted to start first on the SAN business, it looks like the implied message is that the SAN business to be down by 9% year-over-year, is that because people are going and shifty more to flash storage systems, that is probably a pause or sort of lumpiness in the business or how do we think about that product going forward?

Lloyd Carney

This is Lloyd. So we are not imply 9% down, similar across the wires here. We are down exactly 2.6% year-to-date right now on the SAN business. We expected to be down 2% for the year, we're exactly at 2.6% right now. We expect to see an uptick in Q4 and a lot of really big deals pipeline [indiscernible] we full visibility to and feel good about it.

There is some headwinds in the space right now and as a matter fact we go back those of you who are following us back in 2013 when it first arrived exactly this quarter exactly the same thing happened where all of the dollar storage went soft third quarter and we guided flat for Q2 to Q3 and then Q4 we took off again.

So it looks exactly like where we were then, there seems to be a pause in the buying pattern, there is some larger macro headwinds, I mean, if you think about couple years ago largest deals were in Brazil and China. Brazil and Russia all those markets have gone soft for all kinds of political reasons.

But we think there is a pause this time around the pause probably has to do as we alluded to the old flash raise. Jack and I were just in the call this morning on launched customers about to make a transition upgrading and he was asking us about which all flash ray we should purchase in making the transition.

So there's definitely is a bit of customers who are transitional and now all our partners out aggressive offerings, very well-placed offerings in all flash phase and so its causing some of these customer to have to take a look at their architecture, see how these build outs have been going forward and it is some bit of a pause here.

So but clearly all flash array issue which you raised Mitch and overall geopolitical issues that we see we're been cautious and reflecting back but we saw back in Q2 of 2013 and the smart thing to do is to be cautious Q2 to Q3 and expect to see it come back in Q4 as it did three years ago.

Daniel Fairfax

And just to anchor Lloyd's point, so he is referring to is we saw a similar dynamics we came into Q2 of 2013, sequential revenue dropped 12% in that second quarter, down 2% in the third quarter before starting recovery our seasonally strong Q4 and Q1 and this year we saw something very similar. So our Q2 is down quarter over quarter by 15%, the dynamic's kind of disability we had going down both of these quarters very similar.

Lloyd Carney

So we're not going to - short answers were not expecting 9% down from current space, we're expecting to see a it bounce back in Q4 and as you saw in Dan's remarks we fully expect to be back within their up warding margin range he talked about in the Q4 timeframe. Next question?

Operator

Our next question comes from Simona Jankowski of Goldman Sachs. Your question please?

Balaji Krishnamurthy

Hi. This is Balaji on behalf of Simona. I have to maybe allows the first one on Ruckus, so the accretion targets they are slightly lower than what we would've expected, but could you detailed the revenues synergy dis-synergy in OpEx synergy assumptions you're baking in here and maybe what the exposure to Juniper was?

Lloyd Carney

Exposure to Juniper, how much pull through to Juniper

Daniel Fairfax

I'll say minimal exposure to Juniper acquisition they really had started selling in earnest and the accretion numbers that were outlining were pretty similar to what we talked about when we outline the deal I don't think were off in any significant way from that we expect to see the overall revenue numbers and growth rate be maintained about improve somewhat there was some additional spending on some joint projects we need to work on them one of them is the cloud provisioning tool that enabled ship this summer to campus products in the partner we are going to launch in order to better provide a high-value solution that the equation numbers that we lay out we think are pretty prudent.

Balaji Krishnamurthy

Fair enough. And another question on IP storage networking so the competition profile is very different from your traditional business maybe if you could just provide some color on what you're seeing out in the field there I know have been talking about it a little bit as well. And what's on impact does it have on your margin profile? Thanks.

Jack Rondoni

This is Jack, let me – start with the market dynamics and market profile, but certainly from - we are seeing strength in IP storage solution that we're putting forward to our partners, I think you see that reflected as a component of the DBX successfully been seen here in the and basically were seen is less customers consider new work around virtualization IP storage has to be an important option for them.

And with our storage heritage and storage expertise and some of the capabilities frankly we built into the product as well as the go to market synergies we have in us E&P for example brands our product and connect and provides a single source for the customer were seen some wins and strengthen that part of the business, as well as it expands into software defined stores limitation such as E&C, DX12 solution that leverages VMware [ph] So we're seeing good strength there with our technology that has a storage centric storage first kind of aspect to it as well as go to market partnership.

Jason Nolet

This is Jason just to add to that from a larger part of the margin on the IP storage deals is not really any different than the margin that were seeing on the VDX product line overall so it's quite healthy much for us and just read to the comment Jack made with respect to the two leading partners that we have with respect to using the VDX and storage use cases EMC and HDS we grew 28% year-over-year with those OEMs so we're feeling pretty good about the momentum that were starting to see as VDX is positioned with their solution as an IP storage switch so good momentum.

Balaji Krishnamurthy

Thank you.

Lloyd Carney

Operator, next question?

Operator

Thank you. Our next question comes from the line of Alex Kurtz from Sterne Agee. Your line is open.

Alex Kurtz

Yes. Thanks, guys for taking the question. Lloyd just back on the storage demand functions in the market, now that we've had some time with hyper converge products in the market and all flash raise of been out for a couple years now. Could there be another deflationary impact year around the porch shipments and maybe the ASP's or just some kind of mix around what you're seeing in the storage market as these more efficient technologies take root with larger customers and larger orders?

Lloyd Carney

Again as I think about the headwinds I've seen in storage right now the biggest one been out for a while although Justin last year that the big has really turned on their all flash array's significant programs in place and six months all those all Blacks for a couple years growth rate has really been a small part of the overall storage marketplace now that's changing and again all the large players of all flash raise and a growing very fast's seen a lot of resources behind it for us the good news is most of them connect these in fiber channel now the more efficient as you move storage still growing kind of works hyper convert space we partner with some of the largest hyper converge out there in you want to connect hyper convert boxes together bested to do is fiber channel and so if you are buying individual hyper converge platforms you don't need us as part of the solution storage already in there you'll find for 60 boxes together all of a sudden networking doesn't matter how so by the us had when I think right now is does hold geopolitical been going on out there in Europe it's going for a while bounce off we see the growth in Asia still great wins in Asia US Canada not growing that well so my biggest issue I think from a headwind is the whole geopolitical and by people trying to make a decision why go all flash why keep using our existing IRAs

Alex Kurtz

Great. All right, thank you.

Lloyd Carney

Thank you.

Operator

Thank you. Our next question comes from John Roy of UBS. Your line is open.

John Roy

Thank you I've two quick questions one can you give us any color why there was a campus or data center switching where you saw the week is I think are. that would be helpful?

Jason Nolet

Yes, John, this is Jason. So what Dan had said in his comments and what as well it's around routing actually so if you think about the routings stage product that we still have to dynamics are during the quarter one is continued moderation of the install base upgrade we talked about that previously can of signal we thought we continue to moderate as we see the majority then to their upgrades and the other dynamic we had is one of our largest SP accounts had been on a multiyear build out very large build out actually of routing for 10 Gb and their essentially completing or nearing completion of that build out now and so the next way for them is going to be 100 gig held up but as you might imagine is that something they'll do overnight there to get build up so we saw some decline in that particular account which happens to be one of our largest SP accounts and those two factors together is what caused a weakness in routing.

John Roy

Right, thank you. And the second question is, if you could give us any more color on the kind of DMC property that disruptions you were talking about just what you see happier was kind of going on in market or what is the chatter?

Jason Nolet

Go really well as far as just been in the EMC user conference LCs was there working visually organizations there is joint planning going between the organization so from our sense of what everything looks right however never can't tell until it happens right until the deal is actually send people start trying to figure out who has what jobs and who wants what territory and wants what account and so we're being cautious in how we look at the impact what lot belongs in the short-term any long-term though everything looks as if it's going to be in for Brocade.

John Roy

Great, thank you.

Operator

Thank you. Our next question comes from Matt Robison of Wunderlich. Your line is open.

Matt Robison

Thanks for taking the question. A couple of things, so first on the gross margin looking at the numbers it seems kind of extreme to me because you've got your target of our revenue down six tents of a percent sequentially but cards actually up more than 3% sequentially can you give us a little back drop why the Cost of Goods Sold would actually go up?

Daniel Fairfax

Matt this is Dan the primary reason for that shift in gross margin is really related to the mix of the segments as set San comes on as percentage drives higher profitability IT portfolio and we also where we saw our services business contributed nicely in Q2 the revenue backs up a little bit there just based on timing of how support renewals are coming in. So that's the primary reason. We also go back look at where we think will land in terms of OpEx in the overhead pulls double the services business in manufacturing and is like you know reserves so we factored into the primary reason is really just a shift in the mix of segments quarter over quarter.

Matt Robison

So you think services cost of goods sold will actually go up in dollar terms?

Daniel Fairfax

Services cost of goods sold we are investing in as a Company we really shifted I think I made comments about this over several quarters to what were looking our customer person this is then the Company and so we have been having personal resources infrastructures down there.

Matt Robison

So you've got fairly declarative about your accretion after the deal, which are counter using?

Daniel Fairfax

Sorry say it again

Matt Robison

What share account are you using after the deal?

Daniel Fairfax

So right now we started 409 million shares outstanding as of the end of the second quarter and then we issue we end up issuing about 75 million shares when the transaction closes and then we don't know exactly when the deal closes figure out exactly the we provided 450 the fourth 60 million share count for that dilutive as a number for the quarter.

Lloyd Carney

We expect to be back at the four at the 4 to 9 at the 4 to 9,000,000 share count by the end of Q4. So when you do share

Matt Robison

So you're baking a buyback into your accretion calculation?

Lloyd Carney

Yes we are we are assuming it will take us again depending on volatility in the stock and we had the limitations of all we can repurchase planning four to six-month timeframe which will put us by the end of the fiscal year.

Matt Robison

Okay, thanks a lot.

Operator

Thank you. Our next question comes from Jeff Luber of Wells Fargo. Your line is open.

Jeff Luber

Hi, guys. Two questions first, can you touch on linearity and to what extent and market conditions and the storage or Ethernet markets strengthened or weakened through the course of the quarter you know just in general how you're feeling about visibility entering Q3?

Lloyd Carney

So I can't give you some overall view of our shipments brand through the second quarter so the portion of our business is most of the OEM so the low-end and San switches were impacted fairly consistently throughout the quarter we intended to be on the bigger box for the directors identify class San switches we saw that more backend loaded as we also saw with our bigger idea customer deals tended to be backend loaded and it was about 12% shift on it for over quarter basis Q1 had good fairly significantly in Q3 and you can see it by thread DSO number as well

Jeff Luber

And then the second question I was hoping you could help us understand how you get the routing segment moving back in the right direction when you think that's likely to occur and to some of your competitors introduced Jericho base which is with fairly powerful writing capabilities how big of a headwind you think that's likely to be because it seems like the MLX one of the see some incremental competition? Thanks.

Jason Nolet

This is Jason. Let me tackle that. So with respect to next-generation platform as you might imagine we have products in the pipeline now under development we're not quite ready to announce stem cell I'll ask for your patience and suggest to us a question that Q3 year's comp. But with respect to the MLX and leverage the growth that we have there's a couple of things one is as we talked about previously we are positioning and continuing to position that product for mobile operators as a network back of broker we formed a business unit around that rough and tough about a year ago we are now in 15 Tier one mobile operator PLCs and trials that one form or another so we feel good about that pipeline second lever for growth for us is around SDN and SDN combination with the MLX for things like to guys mitigation volumetric traffic management is proven to be very popular with research education customers and also large commercial enterprise customers. Served seeing good uptake there we've actually got 19 customers have deployed our C and control income niche with the MLX that use case and then we have the IP sec lately we introduced just at the beginning of last year continue to ramp. We're looking to federal and healthcare the financials we've got a good pipeline there as well so we believe that there some significant leverage for growth for the MLX I have anything we might introduce going forward.

Jeff Luber

Any sense what you'll start to see some of those Tier one packet broker trials convert to revenue and or some of these pipeline opportunities waiting for new cards or platforms?

Jason Nolet

No new hardware required to take advantage of the network TAC approved opportunity and we're actively working with all these providers to quickly get through PLCs field trials Lab trials etc. so I would expect that in the next couple quarters will start to see more material revenue but we're happy with the diversity of the pipeline in terms of customers are happy with the GS bread and GS sales team has a focused effort around this and is service provider sales force that starting to pay off.

Jeff Luber

And any comments on the competitive environment and what you're seeing from Jericho competition?

Jason Nolet

Well it's still pretty early even those products are brand-new many of them released perhaps with less mature functionality than you might see us go out with. But again I'd encourage you to read as the question into three.

Jeff Luber

Thanks, guys

Operator

Thank you. Our next question comes from Jason Nolan of Baird. Your line is open.

Jason Nolan

Thank you. There was a mention of ebb Q4 SAN uplift is that is that visibility that you have or just expecting normal seasonality based on past experience?

Lloyd Carney

A little both, we have visibility large director deals partners we see those deals in the pipeline and there's a bit of seasonality to look to the last however many years three or four years you'll see that Q4 has been a good uptake for us in the SAN space.

Jason Nolan

Typical seasonality would be three or 4% sequential?

Lloyd Carney

Were thinking more probably four to seven.

Jason Nolan

Okay. And then about question on Ruckus integration and the go to market opportunity I would assume there's some scale opportunity to drive more touch points with Ruckus but some risk also as we saw with sundry integration years ago Lloyd could you talk about that a little bit?

Lloyd Carney

Well thankfully I wasn't here. What were doing now the good news is integration is that there is no overlap there is no contention product and is integration that is born out of success in the field we jointly have sold as product we have joined pipelines developed before we came together this deal so our sales team new how to sell the Ruckus sales team some of their sales teams are proficient in selling switches and so we think will hit the ground running all the interaction timing is on so far we're focused on the impact on the customer decision we make how does all integration decisions we make enable us to sell more of the Ruckus more the Brocade product into the marketplace so obviously we probably made some mistakes in integration people here learn from that I've done myself and I think we're doing the necessary planning to ensure that this goes more smoothly so with the acquisitions look to see in the long too many people in the field there's no place in the field you look where you have to be sales anywhere you look there's salespeople Brocade sales combine them we don't have as many as HP or Cisco has their places where we have presence in the federal states have no presence in federal space uplift for them they have presence in Africa South Africa we have no presence there. There have a presence in South America we have no presence there with presence in Canada all these places where there's opportunity for us to get synergy immediately and just no opportunity for us to bicker over who's on what shaking up to be a really good integration process.

Jason Nolan

Okay, that makes sense. Thanks for the color.

Operator

Thank you. Our next question comes from Rod Hall of JPMorgan. Your line is open.

Unidentified Analyst

Hi, this is Kay, on behalf of Rod. Thanks for taking my question. Now, is an enterprise slot high-speed drive to flash does is generate a new sales for you or upgrade can you help us understand how those to think about that?

Jack Rondoni

Sure this is Jack the best way to think about it is all flash array provides all of unbelievable amounts of performance as well as efficiency to be environment and it's a great opportunity for us to upgrade the network you're not going to go and upgrade the device performance on the table you're going to go and upgrade the network as well there's actually a big opportunity which is why we're focused our go to market efforts with our partners that when they're selling flash we make it clear that customers the additional benefits if they upgrade the network so absolutely see it as an opportunity and we continue to work on that with our existing partners as well as new partners.

Unidentified Analyst

Okay, thanks. Now could you also comment on the status of your BCP deployment at a large US carrier and give us an update on the progress there and maybe even give us what kind of share you would expect in the best case scenario?

Jeffrey Lindholm

This is Jeff I'll take that one. There's been timing on the question like we just add concluded advisory Board meeting today providing number of Tier one carriers from all over the world and the conversation frankly center quite a bit around the VCE PE opportunity and overall I would suggest that that those customers that market segment is looking forward very much to leveraging the value proposition of virtual CPE mainly because it allows them to package a lot of the agility flexibility a lot of new services so the take away from the conversation over the last two days is that without exception these service providers are looking at virtualization in general and VCE as being important contributor to transforming their business starting this year and very much so getting going into 17 and a meaningful way.

Unidentified Analyst

Okay thanks. One final question if I may could you give us a little more color on the weakness in your sub business especially in contrast to the Cisco yesterday's back…

Jeffrey Lindholm

As we talked about before we play in three dimensions in federal civilian Intel and COD and then in fact last quarter we had actually had growth in the DoD and civilian business our challenge really came from Intel which is a big project but program oriented opportunities when we just we maintain our pipeline we are very significant pipeline in the Intel program balance but we have things seem things shipped out and that was really more that we does was around the Intel space and that really came about from some major reorganization in some of the agencies there and even changes in procurement technology so what not a weakness across the Board lose business in Intel just shifted out in time for some big program spends

Unidentified Analyst

Thank you.

Operator

Thank you. Our next comes from Stanley Kovler of Citi Research. Your line is open.

Stanley Kovler

Thanks. wanted to ask a clarification about Ruckus then another question so my clarification is just on the deferred revenue give us a sense of how long that deferred revenue spread out so we adjust back to what would be a normal quarterly run rate to get a sense of what the performance would've been on more of a reported basis and then for the top line going into your fiscal year for next year, essentially we did that 15 to 20,000,000 tests the entire amount then where do we fall in terms of top line is a closer to 450 million or so in terms of the fiscal 17 number to use for that accretion to get the $0.02-$0.03 a quarter? Thanks.

Daniel Fairfax

This is Dan I don't have the four I can give you pointers how to think about it so the purchase price accounting revenue most directly affects the services revenue for the business and probably think about the bulk of that revenue and I don't have the exact I know shared with me thinking about most of those contracts probably year in light so that deferred revenue.

On that service revenue will play over a year longer contracts tail is going longer than that but bulk will be passed in here in the other major adjustment comes from product that's been shipped into the Ruckus channel organization and then where the revenues been deferred and that it will turn on the cycle by which they turn their just inventories cycle pretty quick turnaround two different dynamics I think you should think about when we get to Q4 will be able to provide you a look at hey this is what system what we more or less couple months we've had the business say three quarters at the main what it would look like in Q4 and give you modeling guidance for the following year.

Stanley Kovler

Great that would be helpful. And my questions really around the OpEx planning a little bit longer term so it seems like you're treating what's going on with the essay in business right now with the customer integration issues the point of your customers cyclical nature coming back in Q4 and IP outside of routing also cyclical but when we think about the structure of the Company in this also relates to maybe post merger integration to some degree how much room do think there is for additional OpEx especially when you have a director GEN six product out we should start to think about ramp down in expenses related to specifically the San business effectively targeting more of a slowdown in two next year if the storage market is indeed slower or do you expect on a like for like basis adjusting for some of the issues that you talked about with the customer and the cyclicality that reference back it from 2013 how the business comes back if there's sort of an inflection point in the decline of the SAN business that would be very helpful? Thank you.

Daniel Fairfax

What I know saying full briefing Company looks like portfolio to actually about Q4 operative margins being back within the range of 24 to 27% your operating margin rains and so the last were pretty careful about managing the cash flow the Company operating margin Company and so we are where revenue trending down where even make investments and so you should expect to see that we're going to figure way to keep lugging ourselves along the term 24.77 operating margin kind of range

Lloyd Carney

Give you a little thinking around a bit of focus or question on the San engineering stand go to market for business on the engineering programs those systems are based off of custom ASIC we designed if they work is funded first prototype goes on we are now at the point of we're able to shift resources to the platform of deployment so we have a per switching market amount will have the rest of that fix which family and the directors coming up as we look at late summer and bit to the end of all partners will be deploying those following that then will be specialized form tractor switches using the same core technology in so the engineering for this grows at a pretty steady rate we don't suddenly spike up or engineering dramatically and see a drop-down so that operates very nicely and then we go to markets were going to continue to focus on all of our major San partners here partly with what we see is a terrific opportunity with the transition to flash will be working with them very strongly and then Lloyd made comments about the steady progress we made in China by both recruiting new partners taken additional products to those partners so we'll keep our attention focused on that and we know we are not planning thinking business from expense

Stanley Kovler

When I asked for clarification Mike Iburg our Dan are getting in here in the call, but I would ask it anyway so the clarification is this earlier in the Q&A you talked about sort of the pause as it release this new GEN six product and it was similar to 13 is that correct? Is that what you're seeing out there is that what you're trying to get at?

Lloyd Carney

We didn't connect those two events. I do want to correct that what we see happening is given we put our guidance together for our second-quarter fiscal 16 we have as Lloyd mentioned into the larger deals our partners we have a obviously work closely with them so we don't that visibility look pretty good of course we use judgment to that we saw was really an overall slowdown of the storage market you know across every one of our major OEMs with the one exception being the Chinese our Chinese OEMs didn't really expect that but everywhere else everyone missed the expectation we work with them on secular and wasn't we believe tied to a pause or because the Gen 6 products are coming

Daniel Fairfax

Read my mind that was a good question. I was trying to make sure that if you knew that shouldn't it have been factored in the other part of that is shouldn't Del EMC been factored in as not new and then when you reported in February, people that are Artie said there is a slowdown it just really trying to get at the sense of what really changed from February 17 two now because I think people already said things were slow in January and it was slow and the early part of February there was no see our path for the federal government things were already kind of slow but then yet we got and I was getting at trying to say why wasn't that factored in

Lloyd Carney

Probably in every Company it's all different you recall our Q1 we did over performer essay and expectations in Q1 and maybe we didn't read the messaging just singled quite right but may been some polling miss from partners into the quarter we got that benefit we have a number of when we look at year-to-date numbers versus second half some partners really aren't off six-month number like they could event -- some clearly are

Stanley Kovler

I appreciate that. Let me just asked this question and things were not giving me a hard time when the question. But on spec will give you a hard time later on the after calls back I know you give me a hard time later on the after call but here's a real question so you guys admitted an effort over the last lesser Scott Peters 2% of the data center into the higher-end so when you're acquiring Ruckus as a whole bunch of lower in products in some Soho product you have to trim that product line to sort of a line in more with the overall strategy of staying a little bit higher end back? What Ruckus does look at overall margins is pretty healthy pretty well overall margins give a mix of products but they have software-based products and Cloud-based products coming out at high-end access points the full range of products allows them to deliver a margin 60+ percent range realize perfectly with us we feel good about the rage that products they have been look to maintain that range of products and deliver some products as well to help enhance their end to end story.

Daniel Fairfax

Okay Lloyd things were not scaring me thanks Stan

Operator

Thank you. Our next question comes from James Faucette of Morgan Stanley. Your line is open.

Unidentified Analyst

Hi, this is Marshall for James Faucette, just a quick update on some of the partnerships you're looking to form with the hyper convert guys an update particular as kind of your traditional OEM partners software's record results vertically if some of these partnerships between Cisco and other partners were to go through how would that affect some of your partnerships with newer kind of hyper conversion players?

Jason Nolet

Yes this is Jason so the one we've I think publicly mentioned is new tannic's -- and I would report that I think these are going pretty well there's joint marketing activities joint selling activities there was a I think like a 50 or 70 city workshop that we did joint with them in only networking partner that participated in that so we feel good about that but also our hyper conversion general relationship we got with EMC and HDS is quite good in that regard right so the HDS UCP offering AUC VX rail you we are full guns going with those partners and making sure that we take advantage of those opportunities as well.

Unidentified Analyst

Great thank you

Operator

Thank you. Our next question comes from [indiscernible] Bank of America. Your line is open.

Unidentified Analyst

Hey guys thanks for taking the question. If I look at your guidance of the past two quarters of the essay and business guidance for fiscal 1Q as well as revenues behind guidance and you guided strongly in the expectations as quarter what your visibility like for this quarter and also given that you expect some large deals for taking the cute for Q3 Q is that delay result testing new Gen 6 products or just seasonality in the quarter

Jason Nolet

This quarter is seasonally slow for us. I guess look back to that 2013 period where you had that slow Q2, Q3 followed just about at the same level and then we had Q4 and taken a bit of a lead from this history and visibility we have is on the larger deals we feel good about Q4 uptick being pretty cautious about Q3 be driven mostly by back on economic things over here from our partners to caution there showing we kind of reflecting that.

Unidentified Analyst

Got it thanks and along with all flash array's in all flash array adoption understand that it's helps drive director sales helps drive adoption of Gen 6 hopefully later this year, but how much you see use in the Cloud flash using the private Cloud and how does that adoption a private Cloud impact the opportunity that you might see in IP storage area networking

Jack Rondoni

This is Jack,. so certainly flash is part of the solution it's a part of converge solutions all partners download different there's some mix of splash and they're even the hyper convert solutions you'll see more and more one of the drives actually been SSD type of device so we see it contributing and as we stated before it's an opportunity for our fiber channel business as well as our IP storage business with our partners some SSD will continue to a flash will continue to be a material part of system and convert or confident with SC 90 portfolios to help enable that to its full potential.

Lloyd Carney

In the good news is Jack with storage here in the actually started to like the storage initiative here and we're seeing storage experts and like the call we had earlier customers looking to what to say can you tell is what I should use in all flash array versus a standard way can you tell us our amp tool which is perform better and Jack of related story today we have all flash array's losing our tools to improve the performance and we are pretty good position as far as the all flash array market goes in helping help transition with that helping traditional partners transition to that in now developing in aggressively All Flash Array we consider that Spanish

Unidentified Analyst

That's helpful MS question is seen any movement from Cisco and rolling out line cards?.

Jeffrey Lindholm

This is Jeff, we've not seen a 32 gig line card off the market yet for Cisco where the only first with a 20 market with a 32 gig main switch when we lost the G6 20 in March we are very happy about that and we expect to build upon as Lloyd mentioned earlier this summer

Unidentified Analyst

Thanks, guys.

Operator

At this time I like to turn the call back over to Mr. Iburg for any closing remarks.

Michael Iburg

Thank you operator. Thank you for joining us today as we reviewed our Q2 results. Before we close the call, I would like to mention that with the likely closure of the Ruckus acquisition in our fiscal Q3, we expect our third-quarter to be the first quarter of where we will report consolidated results. As a result we have decided to push out our Q3 earnings announcement one week from our normal reporting pattern as resolved we now anticipate reporting Q3 earnings on or around Thursday on or around Thursday, August 27. With that, that concludes today's call. Thank you.

Operator

Thank you certain thank you ladies and gentlemen, for your participation. That does conclude your program you may disconnect your lines at this time. Have a wonderful day.

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