Brocade Beats; Target for HP, IBM?

On May 21, Brocade Communications Systems, Inc. (NASDAQ:BRCD), a leading supplier of data center networking solutions with annual revenue of $1.5 billion, reported second quarter results that beat earnings estimates for the fifteenth straight quarter. This was the first full quarter since the $3 billion acquisition of Foundry in December. With the rapid and successful integration of the Foundry acquisition, Brocade has increased its IP Ethernet market share. In addition, it has also increased share in its core SAN market. Let’s take a closer look.

Q2 revenue was up 43% y-o-y and 17% q-o-q to $506.3 million, driven by stronger-than-expected demand for its IP Ethernet products and continued growth in Global Services. GAAP net loss was $63.1 million or $0.16 per share. Excluding acquisition and stock-compensation costs and a $53.3 million goodwill write-down, net income was $47.1 million or $0.11 per share. Analysts expected earnings of $0.09 on revenue of $476 million.

Non-GAAP gross margin was 56.2%, down from 59.7% last quarter. Cash flow from operations was about $107 million, more than two times that of Q1. The outstanding acquisition term debt balance was $1.025 billion, before a debt discount of $41 million. Brocade ended the quarter with $236 million in cash and cash equivalents.

A major highlight of the earnings call was the discussion of the company’s recently concluded worldwide road show, the Extraordinary Networks Tour, which covered 40 cities in the US, EMEA, and Asia Pacific. During the tour, the company shared its strategy, technology, and product directions to customers, partners, and investors. Insights gained from the tour included the importance of the cost factor, the need to handle the massive growth in network traffic and data, and support for fiber channel and IP Ethernet technologies as customers adopt the latest FCOE and CEE technologies at their own pace.

Brocade expects the current IT spending environment to prevail through fiscal 2009 and expects IT spending to improve during 2010. It expects Q3 revenues to be flat to down 2%, displaying normal seasonal patterns.

With Cisco introducing a unified computing system, data centers and consequently Brocade have gained more attention. Brocade, after the Foundry acquisition, is a strong competitor to Cisco in end-to-end data center solutions. In my last post, I had speculated about HP and Brocade joining hands. IBM and HP are key customers of Brocade and it has formed a new OEM partnership with IBM and is a virtual connect partner for HP’s new C-class blade system solutions. Both IBM and HP are potential acquirers for the company.

Brocade is currently trading around $7.5 with a market cap of about $3 billion. The stock recovered from its 52-week low of $2.05 on March 6 and hit a 52-week high of $7.92 on June 12.