Brocade Dives; Peers Follow

The company's latest guidance and other surprises leave investors cold.
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Shares of

Brocade

(BRCD)

lost more than a quarter of their value Friday after the company dropped several bombs on investors in its

earnings report Thursday.

The stock was down $1.96, or nearly 27%, at $5.32 in midafternoon trading.

Other storage concerns suffered from Brocade's troubles as well, with rival

McData

(MCDT)

off 72 cents, or 8.1%, at $8.13.

QLogic

(QLGC)

was down $1.05, or 2.4%, at $43.45;

Emulex

(ELX)

was off $1.07, or 4.2%, at $24.34; and

EMC

(EMC)

was off 33 cents, or 4.8%, at $6.52.

Chief among Brocade's surprises was its downward guidance. The company said it expects sales in the January quarter to nosedive by 18% to 22%, far below analysts' expectations for a 3% gain. Management also said earnings will be at the break-even point, compared with Wall Street's estimates for a 7 cent profit.

Head-Scratching

In the wake of the company's conference call, analysts were left puzzled. "We were all sufficiently shocked" at the size of the downward guidance, said Brion Tanous, an analyst at RTX Securities. "I think there is definitely a credibility issue here. There's a lot of confusion about what's really going on at Brocade."

Brocade's forecast for a tumble in revenue flies in the face of guidance from its competitors, he said. "The networking storage universe in general has been guiding to between 2% and 6% sequential growth for the December quarter, with no mention of a steep decline starting in January."

At Lazard Freres, analyst Luke Fichthorn took issue with the company's rationale for the weak outlook. Brocade said it had been hurt by what it called "a contraction in the customer supply chain."

"We have no idea what management is talking about," said Fichthorn in a research note. "In fact, it sounds like Brocade stuffed the channel, but management strongly denies that channel inventories are up." Moreover, if Brocade's rivals achieve their guidance for sales growth in the fourth quarter, "Brocade will lose share by definition," concluded Fichthorn.

In the wake of the news, he cut his EPS estimate for calendar-year 2003 to 7 cents from 26 cents. The current consensus estimate is 23 cents. Fichthorn, whose firm hasn't done recent banking for Brocade, has a sell rating on the shares. He estimates Brocade should be valued around $4 to $5.

Others were more lenient toward Brocade. In a note, Thomas Weisel's Jason Ader said the dropoff is likely due to

Hewlett-Packard's

(HPQ) - Get Report

move to aggressively lower inventories across the board, with

Dell

(DELL) - Get Report

possibly following suit.

"The silver lining here is that the inventory correction should only be a one-quarter phenomenon as end-user demand remains healthy," he wrote in a research note. After a sharp dropoff in the quarter under way, he expects to see sequential growth of 12% in the April quarter.

He has a market perform rating on the stock; Thomas Weisel hasn't done recent banking for Brocade.

Aside from guidance, the most recent quarter held its share of unpleasantness, too. The company managed to meet analysts' estimates of 7 cents only by selling securities to create a $7 million gain on investments. Without the sale, EPS would have fallen short by 2 cents, a fact underscored by many analysts in critical notes Friday.

For the first time in eight quarters, gross margins fell below 60% to 58.5%, which management attributed to tougher pricing. Margins are expected to stage a further drop to the range of 53% to 55% in the quarter under way, also below expectations.

In another blow, Brocade's president and chief operating officer, Michael Byrd, said he'll be leaving at the end of the quarter under way, which follows the exit of the chief technology officer and two other top executives in recent layoffs. "The departure of Michael Byrd, such a high-profile executive suddenly leaving, makes you have to ask questions. You have to wonder whether there are execution issues," said Tanous.

If that weren't enough, the company also announced plans to reprice underwater options, a move sure to displease already-rattled investors. At the same time, in a cost-cutting measure, management said the company had cut 12% of its work force.