Brocade Communications Systems (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 Presentation Operator
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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. Read the rest of this transcript for free on seekingalpha.com