For ease of use - complete Brocade 8/12/99 conference call:
Greg Reyes- CEO and CFO on call
Reyes open:
-revenue and earnings acceleration due to OEM customers announced earlier in year exceeded earlier ramp up forecasts.
_ the mkt for f/c and f/c switching solutions in the mid range and work group segments is accelerating - these are high growth segs that brcd dominates.
-new major oem's this quarter oem's IBM and Bull -
-HP also announced SureStore "based on brcd's Silkworm technology"
-NEC announced in first 2 wks of new quarter
"Why has brcd been so successful in announcing this unprecedented string or OEM account wins?"
- When given a level playing field, our customers have told us that brcd has been successful in bringing them best in class switching technology, the broadest product line and that we're the only vendor who can provide the capability today to start with a single switch config and grow into a true fabric backbone of multiple switches.
-that we have the broadest suite of functionality in form of fabric services and that every facet of our line is standards based.
-that we provide the broadest and most flexible instrumentation for SAN manageability providing our customers with numerous options with managing this networking model for storage
- lastly, our decision to partner with Solectron as our mfg partner has proven instrumental in providing our customers the confidence that brcd will be able to effectively meet their increasing volume demands.
-The addition of Bull, IBM, HP and NEC has solidified HP as the clear market leader
- also announced the Silkworm 2000 family of switches that has received overwhelmingly positive response from the technical analysts and our customers who have indicated that they will migrate to new switches-
-Silkworm2100- industry's first to provide for arbitrated loop functionality
Silkworm2400 - 8 port switch with hardware zoning- first in category to have 2 hot swapable power supplies.
Silkworm2800 - 16 port switch -hot swapable power supplies and removable cooling
-all backward compatible
-with accelerating deployment of brcd based solutions in the market combined with our stunning string of oem wins and with the announcement of the new Silkworm products, brcd has consolidated its position as the clear technology and market leader in the mid range and work group segments of the market. Not only do we have the largest installed base but we have the broadest product line.
'-It is now clearer than ever that the development of the SAN market will have numerous parallels to the evolution of data communications
- backbone will enable a number of killer apps that are difficult to deploy with today's IT infrastructure such as:
off the lan backup and restore, disaster tolerance, storage consolidation and ?
-first phase of market evolution is well under way- this being the mass deployment of storage networks in the mid range and work group segments. brcd is uniquely positioned to take advantage of this....
- brcd will be investing heavily in r & d
BRCD Q & A
From: Alex. Brown:
Q) Where do you see challenges in the market and where are real opportunities coming forward?
A) 3 market segments-
1) arbitrated loop space which is predominately playing the role of taking place of historical or legacy scsi interconnect -
2)there's what we call the switch interconnect market
which are single switch configs replacing interconnecting multiple servers and storage sub systems
3)and the fabric market- which is implied by having multiple interconnect switches
larger number of servers and storage subsystems and in certain instances provide for heterogeneous connectivity for the Unix and NT environments. If you look into the mktplce you will see that we have a very very strong position in the work group and mid-range space. With the 2100 product , our goal is to drive switching functionality into the loop segment of the market place and weÕre going to continue to invest heavily into our fabric services to provide a feature rich and robust environment in which to build these backbones. So from a competitive standpoint, we see an open field running opportunity, and an opportunity to expand what weÕve started.
From Dain:
Q) Can you talk a little more about the roll out of the fabric 2000 with the oemÕs , which are shipping and which will be shipping over the next couple of quarters?
A) We try not to publicly pre- announce or disclose our oemÕs product introduction strategies, but suffice it to say that all of our historical oemÕs which are shipping the silkworm 1000 products have indicated their intention to qualify and migrate to the silkworm 2000. That transition is in process. WeÕve also announced a number of new oemÕs account wins that will be starting out with the 2000 product. So we donÕt see a big bang effect, if you will, in the transition but a very logical and orderly progression to the new architecture. The great news about out product family is that all our Silkworm 2000 products are backward compatible, so our customers have been delighted by the fact that we have a nice migration path to allow the sale of silkworm2000 products into their installed base.
Q) Do you think the fabric 2000 offerings will be 50% of companyÕs products by the end of the year, 70% of the companyÕs products shipped by the end of the year or is it going to take longer to transition to the new offerings and is there a margin difference between the old and the new.
A) We expect the transition to be occurring over Q4 and Q1, largely done by the end of Q1 and yes there is a margin expansion in the new product.
From Morgan Stanley
Q)What are your expectations for deferred revenue for the next quarter - will it go up or down? and re: your spending levels- should we expect that the spending as a % of revenues should be about the same or up/down?
A) In terms of spending levels, we expect to spend heavily in our product road map and expanding our channels. We did on our road show put out a financial model showed us reaching 12-15% operating income by our Q3-Q4 time frame. WeÕre on track to meet that. Deferred revenues are a function of timing. I would guess down slightly in Q4 and then go away in Q1 and the next time we have a product transition you will see them rise. We want to see customers successfully launch their programs before we recognize revenues.
Q) Should we view deferred revenues as a sign of new product launches in the future?
A) ItÕs a by-product of new product launches, that is as product does reach the market place, we will continue to defer those revenues until our customers successfully launch their programs.
Q) Also from Morgan Stanley
In terms of factors outside of Brocade that will really need to enable your revenue growth going forward, can you walk us through how you look at the actual market that you sit (?)in over the next 6 months and what needs to happen with players outside yourselves that need to happen to keep the kind of momentum you have going?
A) Great question. If you look back to last calendar year, the key enabling event is that there are a number of companies introduced host bus adapter technology that supported full fabric technology. That is the last building block that enabled our customers to begin to deploy what IÕll call phase 1 SANs. Phase 1 SANs being either arbitrated loop, single switch or fabric backbones. ThereÕs a lot of infrastructure being deployed that solves a number of very real tactical problems, if you will, such as the I/O bottleneck, such as the ability to see and have access to all my servers and storage sub-systems on a single backbone. That I think positions us for what we call the phase 2 development of the market . That is as this backbone infrastructure is deployed we think it will provide a platform if you will for layering on top robust SAN applications such as off the LAN back up and restore, such as disaster tolerance, such as dynamic fail over. There are companies out there that provide key enabling software such as Veritas, Legato and others.Almost all our oem customers have applications of some type serving some market that theyÕre going after. I think as we see more ÒSAN enabled applicationsÓ become available, it will take a fantastic ROI and performance benefit that you get from the SAN and layer on top of it really compelling applications that fundamentally canÕt be implemented today in todayÕs IT infrastructure. In terms of the timing for that a number of storage utility software companies have announced products. We think that there is a cycle that starts in the second half of this year and carries through to first half of next year and then I think weÕll see the knee of the curve.
From Deutsche Bank
Q) Is there any critical component or anything in your infrastructure that will gate the ability to grow at these kind of rates over the next 3 quarters, anything that youÕre kind of losing sleep over internally besides revenue line and do you look through your oemÕs are you seeing any vertical markets or applications that are kind of leading the way in the SAN market or any specific industries that are really getting this faster than others.
A) (CFO) IÕm not losing sleep over any of the lines. Having said that we have Solectron as a world class manufacturer that is important to us. Today our agreement with them is we place an order , they ship a switch. They have an infinite ability to expand within our horizon and so weÕre very pleased with that relationship and it continues to be a fundamental core competency of the company. (my question- how can out sourcing be a fundamental core competency?)
A) Reyes - What is stunning to me is that we have met with in excess 100-200 end users in conjunction with our OEM customers and speaking from my own personal experience when IÕve sat with CIOÕs or IT directors and we talk about SANs and the types of applications that can be enabled IÕll always ask which of these is most important to you and literally, to a customer, they respond ÒI need to implement them allÓ. Which is really interesting in that it implies that multiple applications have exponential ROI potential for the end user. In terms of the oems almost each of them has their particular segment that they want to focus on, whether itÕs off the lan backup, disaster tolerance or storage consolidation. I would say that the first wave is very much oriented to off the lan backup, thatÕs very acute ping point (?) almost across all industries. There are certain industries that are very focused on high availability and disaster tolerance like the financial community. But weÕve talked to companies in the banking sector, the industrial sector, aerospace companies , consumer goods companies and from what we can tell weÕll see all of them implement varying versions of multiple applications. WeÕve seen the film, video and broadcast market place emerge as a clear vertical. As we look out , what will be interesting is new companies take these islands of data and build them into true enterprise backbones where data can in fact can become a virtual resource and time will tell.
From Morgan Keegan
Q)Great quarter. You talked about oem transition to new switch. Can you give us a sense of how many first tier customers have put a solution into the marketplace. Also, IÕd like to get a feel for the channel make-up for the revenue for the quarter and finally youÕve talked and positioned the transition to effect the revenue growth for the next couple of quarters sequentially in your expectations , do you still see that flattening or do you see growing right thru that given the stronger oem trends youÕre talking about?
A) At this point all of the oemÕs we announced in Q2 are shipping product and almost to an oem, itÕs the silkworm 1000 product line. All of them have mentioned to us their intention to migrate to the 2000 product line. The oemÕs weÕve announced this quarter are indicating plans to deploy in the 2nd half of the year and that will be almost exclusively the silkworm 2000 product so weÕre very very pleased with the aggressiveness our oemÕs are coming to market. In terms of the channel component of the business we donÕt break it out, but suffice it to say that itÕs today in the low single digits and is growing in a quarter to quarter basis at a triple digit rate, but itÕs something that for the next couple of quarters could be dwarfed by oem acceleration, but weÕre going to focus aggressively on building out our indirect channel business over the next couple of quarters.
CFO- As far as our guidance weÕve been trying to give out throughout the road show process and subsequent to that, weÕve been trying to be thoughtful about 2 things:
Our new products offering is priced about 20% less than our 1600 product offering and yet it has higher gross margins associated with it so there is a product transition we have to be thoughtful about and secondly the Y2K effect. We have not seen any at this time but we are somewhat at the mercy of our oemÕs and they have indicated that they have not seen any, but we still want to be thoughtful during the Q4-Q1 time frame and hence the nature of our guidance.
From BBRS:
Q) It feels like fc is ÒtornadoingÓ this year- why now and not before- whatÕs gone on in the last 6 -9 mos to set us up for this kind of acceleration?
A) There are a couple of factors. The first and overriding factor is that scsi technology has just not kept up with the demands of the IT infrastructure that sits on the other side of the server with the prorogation of the internet, with the prorogation of e-commerce with itÕs limited distance capabilities and fundamentally with its low node connectivity limitations, storage just has not scaled, it has just not scaled with performance. I think thatÕs the over-riding mega trend. I think the technical enablers have been that fc is complicated and if you look at the protocol itÕs very complicated and if youÕre looking at a SAN environment if youÕre trying to implement more than point to point connectivity itÕs increased the complexity. It was until the 4th quarter of this year that we saw all of the key network building blocks come into place , predominately the fabric aware HBAÕs and associated drivers. It seems like almost all our oem customers started to hit the market with a new cycle of fc ready products. I can tell you unequivocally that if those things hadnÕt fallen into place we wouldnÕt be having this cc today. That being said, it feels like we are seeing an acceleration into the marketplace fueled by a lot of pent up demand.
Q) You quoted an analogy up front in your comments to the networking industry. It appears that this has a lot of similarities but there are parts that are very dissimilar as well. In that business we started with shared and went to switch, in this business on a unit or dollar volume weÕre starting with switched and potentially can go over to shared for some applications. In that world they all went direct, you started oem and youÕre going to build a direct business over time. Draw out that analogy a little bit more, the good and the bad of whatÕs going on versus the networking industry.
A) In the networking industry we saw islands of automation, if you will. It was primarily driven by file and print sharing. Over time there was a screening requirement to interconnect these islands of automation and there was the build out of the IP plant. What Ôs different here is when youÕre sitting between the server and the storage subsystem, itÕs a very very intimate relationship and for any company to think that they can show up and drop in between that intimate relationship, which is not just device drivers and hbaÕs, itÕs also the willingness of the oem to integrate you into their solution, that was the predominant reason to come to market thru the oem channel. But I think the network corollary is interesting in that whenever you are interconnecting multiple target devices,be they servers or storage subsystems, and youÕre interconnecting multiple switches together, you have all the same kind of complexities that you would in an IP environment: youÕve got addressing complexity, management complexity, router complexity - thatÕs what Brocade has focused on. The other change here is that, letÕs make no mistake, our arbitrated loop technology is not a network, itÕs kind of like token ring without the token. All the devices on the network are managed by each of the discreet devices, they have to announce their addition or removal from the network. We can think of the early days of datacom and you turn the p.c. off and you blow up someoneÕs print shop, that would not be acceptable. Our customers are finding they need the resiliency of an any to any switch to provide that mission critical robustness. I think the other factor is it took approx. 6 to 8 years to migrate from sub based implementations to switching architectures. Brocade invested many, many millions of dollars in terms of compressing that time because we had an inkling that you couldnÕt get there from here with arbitrated loop so we went directly to switches and I think thatÕs one of the reasons that weÕve been able to get to the market first and had kind of the first mover advantage that weÕve enjoyed.
Q) That is a great segue into my final question which is : you are building a networking technology, it happens to be a storage related, at least initially and you have what appears to be dominant market share in that space if the market share data is real from what we have seen so far and it seems to me that there is a very large networking company out there that wants to claim 100% of the dollars spent on networking in enterprises and itÕs kind of too late for them to develop it on their own, so do you just co-exist with Cisco, do they become friend or foe over time, what happens?
A) We like to be everyoneÕs friend Paul to the extent that we can. I know the Cisco guys pretty well and as you are aware there is a $300 billion converged networking opportunity out there. ThatÕs enormous. The stakes are high and from what our sources indicate this is still a relatively small market and itÕs running fc and not IP. ThatÕs not to say that at some point Cisco or others might not get into the space, but right now it looks like weÕve got some open field running opportunity.
From Alex Brown:
Q) Nice quarter. Quick question for you. YouÕve made your observations regarding likely increased r&d spending. Can you give us some more perspective on what you see are some of the gateing or throttling issues as far as your abilities to advance technology and storage systems and servers ability to accept that new technology and secondly, if you can give us a little bit of color as to whether that increased r&d spend is sort of your move to proactively exploits some opportunities or whether itÕs perhaps in response to some of the strong oem demand youÕve had?
A) Let me try to decompose the question. In terms of the oemÕs ability to take advantage of the technology, as I indicated earlier, weÕve seen an initial wave of fc enabled solutions. I think that itÕs clear that when youÕre interconnecting servers and external storage or tape subsystems, fc is going to be the transport and we think that weÕll enjoy additional opportunities in the form of other products that have yet to be announced or other programs that have yet to be announced by our customers, so we see a continues assimilation of the technology almost across the entire oem front.
On the r&d side, what we are attempting to do is to provide a broader family of products. Our vision is to provide best in class switching platforms across all of the key market segments and we have started out by focusing on the mid range and the work group. The sense that we get is that the biggest barrier to market expansion is that switches historically have been expensive . I think that now we are getting at the point through silicon integration and volumes that we are going to see other segments of the market become available to us where they werenÕt necessarily available to us with the silkworm 1000 product.
From Needham:
Q) Can you tell us a little bit about what sort of pricing youÕre seeing on a per port basis here over the last quarter, what you perceive on hubs vs switch re: pricing.
A) We donÕt really get into discussing pricing
Q) industry related?
A) Industry related we are not really seeing any deterioration relative in our pricing other than our planned pricing move to the new product line and that as you see from our 2100 offering the price of our product line is getting closer to hub pricing.
From Schroeder:
Q) Could you clarify your relationship with McData. In talking to EMC they seem to be indicating that theyÕre not buying your switches anymore, so whatÕs your relationship there and what if any is the long term competition with EMC?
A)Um, thatÕs a good question. McData has been an oem customer of ours, the bulk of their sales have not gone to EMC and EMC has been focused on, rightfully so, an excellent strategy for the high end data center and thatÕs a segment we donÕt participate in today and I think with EMCÕs announced acquisition of Data General, it feels like theyÕre going to be moving to a more segmented strategy and to the extent that we can participate there weÕd love to but itÕs unclear how things will unfold there. I think that you can argue that there are going to be multiple segments of the market and weÕve chosen to start with the mid range and work group because thatÕs where we think the volume is and we think thatÕs where the initial opportunity for seeding will come from.
From BBRS:
Q) YouÕve said that the phase 1 of SAN build out is under way, How crucial will the Brocade fabric services be to phase 2 when we see more value added applications layered on top of theSAN?
A) ThatÕs a great question. We think that it is virtually impossible, certainly highly difficult to interconnect multiple switches if you donÕt have fabric services. One of the things that has been a hallmark of our products is that you can interconnect multiple switches, have them dynamically discover each other and update their respective databases with regard to the attached target devices. It makes it very very simple to outgrow a single switch configuration and add additional switches enabling additional ports and we think thatÕs going to be very important. The fact that itÕs dynamic, the fact that the running algorithms are compatible, the fact that there is a common mechanism for managing all these switches, the fact that weÕre the only company that can zone across multiple switches creating logical dynamic pools of resources over a time will become increasingly more important . No customer whether itÕs an oem or a systems integrator end user is going to want to go out and have to manually update these switches, weÕve lived thru that in the early days of p.c. networking and Brocade has anticipated that and we want to make our products simple to deploy, easy to scale and easy to administer.
Q) How dependent do you think the oemÕs are on fabric services today?
A) It varies. If the oem is deploying a single switch, itÕs not very important, but suffice it to say we think our customers value that capability and we think our customers are becoming increasingly sensitized to the fact that as you scale the backbone they donÕt want to have to be encumbered with that complexity.
From Morgan Keegan:
Q) Can you comment on 3 things:
1) were there any 10% customers in the quarter
2)product role out in NT vs. UNIX
3) Maybe some more clarity on how youÕre selling against the high end director products.
A) As far as our specific customers, weÕre not going to disclose our greater than10% customers for proprietary reasons. I can tell you this: If you look back a year ago, or even all in 1998, we had 2 customers that comprised 80% of our revenue, today we have 6 customers that comprise 80% of our revenue and the smallest one is about 3 and the next one is about 7% so these are all significant customers so we are very pleased about the diversification of our customer base.
On the NT front, IÕd have to say that Brocade is the switch of choice between IBM, Compaq and Dell we have a very strong position in that space. In terms of the breakdown between NT and Unix we are very strong in the Unix space with Sequent, Data General and others. Up to this point the bulk of the revenue has been in the Unix environment and we are just starting to kick into the NT growth stage.
With respect to the director question, we donÕt hear that our customers are competing with that class of product on a regular basis, which really indicates to us that there are market segments here, that itÕs not one size fits all, winner take all and I think thatÕs good for the industry.
From Winrock (?)
Q) What are typical oem agreements in terms of length and IÕm a little confused on the IDC estimates.
A) YouÕd have to ask IDC about their numbers and in terms of oem agreements, it has nothing to do with the length of the contracts, weÕre not selling widgets here. Rather it has to do with the life of the program and one of the things that weÕve found with the silkworm 2000 product is the fact that it is backward compatible with the silkworm 1000, the fact that new device drivers do not need to be written, the fact that the system qualification is much easier , the fact that the software fundamentally doesnÕt change, we think bodes very well for our ability to participate in incremental programs, but at the end of the day, as we know in the technology business you have to be best in class
and we have been and we will be.
Next question was Arthur Friedman, a consultant.
Q) In the SAN area do you see any possible technological breakthroughs that will either positively complement your products or negatively impact them?
A) The fundamental drivers of this market are going to be based on the success of these early deployments and their expansion which is well under way and the next primary driver is going to be the deployment of SAN enabled applications. We donÕt see the gigabit ethernet question anymore, we think that issue is in the rear view mirror and as we go forward I think we are in the execution phase.
Next question was about his business and was quickly dispensed with.
Final question: Bennett Lawrence management
Q) Can you tell me how many ports or number of switches were shipped last quarter?
A) We do not disclose that for obvious competitive reasons.
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