CEOBeat: Brocade Communications
[BRIEFING.COM - Michael Ashbaugh] As part of our CEOBeat series in which we interview company executives and offer our observations, we spoke with Greg Reyes, Chairman and CEO of Brocade Communications (BRCD 30.34).
Company Background
Brocade makes Fibre Channel fabric switches and software for storage area networks (SANs). Brocade's Fibre Channel fabric switches interconnect servers and storage subsystems in a SAN creating a scalable environment for storage applications. Its products are available in multiple configurations to meet a range of SAN requirements from entry-level to high end/enterprise. The company plans to rollout SilkWorm 12000 in early 2002 which represents an upgrade in the high end market.
Where Does Brocade Fit in the Storage Space?
In simple terms, Brocade makes Fibre Channel fabric switches and software that network the storage of data. Put another way, storage is moved off traditional hardware devices to an environment where it can be separated from servers and accessed by multiple users. SANs are a strategic part of IT infrastructure which promote efficiency and cost savings. The capacity to store and access data from remote locations is among the more pronounced benefits. This eliminates the need to maintain hardware at a single location and enhances the physical flexibility of an organization. Competitor McDATA (MCDT) has targeted the high-end of the storage market (SANs) and is moving into the middle and lower end, whereas Network Appliance (NTAP) has staked out its territory with network attached storage. Brocade has a commanding lead in the Fiber Channel market laying claim to a "majority" market share. Brocade's primary customers are OEMs and systems integrators. Major OEM customers include Compaq, Dell, Hewlett Packard, IBM and Sun Microsystems. BRCD's major system integrators include Advanced Digital Information, Datalink, Hitachi Data Systems and StorageNetworks.
Competition
Brocade faces competition from other developers of Fibre Channel interconnection products including McDATA (MCDT), InRange (INRG) and Qlogic (QLGC). As the SAN market evolves, non-Fibre Channel interconnection products may also pose a threat, particularly Storage-over-IP (SoIP) leader Nishan Systems (private). Other non-Fibre Channel based emerging products include using Gigabit Ethernet, 10 Gigabit Ethernet, and Infiniband. More recently, talk has surfaced that Cisco Systems (CSCO) may prioritize storage area networking as a target market.
The Call
BRCD met the estimates for its July quarter. Third quarter diluted earnings per share came in at $0.05 which was in line with consensus expectations and flat relative to the year ago figure.
Revenues grew 26.3% annually to $116.3 million which was in line with the consensus estimate for $116 million.
Gross margins held steady at 60% while DSO's decreased to 57 days from 58 days in the prior quarter.
Forward guidance was modestly reduced. Management expects fourth quarter revenues of $120 mln vs the consensus estimate of $122 mln and sees earnings of $0.05 per share vs the consensus estimate of $0.06 per share.
Beyond the fourth quarter, the company refrained from providing firm guidance.
The Interview
With the financial outlook covered in the conference call, we chose to focus on strategic issues. Management had indicated on the conference call that Brocade retained its market leadership status with 90% of the fiber channel switch market and "the majority" of the market for SAN infrastructure. When asked how "retaining" the market lead translates into share expansion or contraction, Mr. Reyes indicated they had maintained market share. His preference was to focus on market position which he believes will grow much stronger with the release of SilkWorm 12000 early next year. With SilkWorm 12000 and "an aggressive" Fall calendar of new product releases, he believes the company is positioned to take incremental share going forward.
Taking the market position thought a step further, Mr. Reyes said the business is in the process of transitioning from a "product company" to a "platform company." As a platform company, Brocade makes a product around which more than 100 other companies are developing products themselves. Companies such as Veritas Software (VRTS), BMC Software (BMC) and EMC are each creating SAN solutions in an effort to capitalize on Brocade's large installed base.
In terms of forward guidance, Brocade officially opted not to provide firm numbers for fiscal 2002. Outside of firm numbers, Reyes said Brocade was very well positioned for sequential growth should the economy make a turn in the second half of the year. If the economy "drags along the bottom for a while" he believes they are still positioned for modest incremental gains due to the introduction of several new products this Fall and into next year.
Towards the end of the interview, Mr. Reyes made a number of relatively direct and well placed comments. He stated that despite the economic downturn management was not "starving the business" trying to hit analyst estimates. The company is working to "manage the business and invest in it" so that when the upturn in economy does materialize new market opportunities will be apparent.
As a final thought, Mr. Reyes asked a rhetorical question of sorts. He said, "As the economy does begin to recover and as IT spending picks up -- you have to ask yourself whether that spending is going to spring up in the same spots, or whether it will occur in new places, and create a new set of bellwethers."
Our Take on Brocade
As a business, BRCD continues to look very well positioned. The company's large installed base due to its first mover advantage is a compelling reason to believe in its market position. BRCD names Sun Microsystems, IBM, Compaq, Dell and Hewlett Packard among its OEM customers. Further, software vendors such as EMC, Veritas and BMC Software have bought into BRCD's technology in an effort to capitalize on BRCD's large customer base. These vendors enhance the capacity of Fiber Channel making it more attractive to customers on the high end. The SAN market is projected to be as large as $10 billion by 2004 and BRCD believes it can retain, if not grow, its market lead. The real question then becomes one of valuation. The shares currently trade at 65x forward estimates. With a market leading position in a rapidly growing market, it undoubtedly deserves a premium multiple. At current levels, BRCD may be suitable for longer-term investors willing to undertake the relative risk of this fluid technology. Nonetheless, Briefing.com would not be aggressive buyers at current prices. Though projections for the business may bottom in the aftermath of this report (and we see a very good chance of that), macroeconomic uncertainty and the fragility of the broader market make the risk/reward dynamics less than favorable for the time being. In the end, we believe Brocade has a great business model and will prove to be a longer-term success story. Yet as an investment, the urgency to stake out a new position today is mitigated by the macroeconomic climate. |
