Brocade (Nasdaq:BRCD) is not a turnaround situation from a financial standpoint, but the stock has not managed to break out above $10 (and hold it) in almost a decade. Investors once loved the stock, but worries about the company's ability to match yesterday's growth in storage networking and find an interesting path in Ethernet has capped their enthusiasm of late. Now, with fiscal second quarter earnings in hand, the picture is still murky as the company cannot seem to make progress in both businesses at the same time.
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Some Good, Some Not So Good in Fiscal Q2
Brocade made some progress in the second quarter, but not as much as investors might have hoped. Revenue rose 10% overall from last year, but was up less than 1% on a sequential basis. Growth was led by the SAN business, which grew 17% from last year, but contracted a bit on a sequential basis. Ethernet was up a bit sequentially, but basically flat on an annual basis.
While the SAN business was helped by good performance in backbones, switches and adapters, the Ethernet business was smacked by a big year-on-year decline in revenue from federal customers, as several deals got pushed out. That federal detail is curious, as the state of the public sector market really seems to be a company-by-company phenomenon; Cisco (Nasdaq:CSCO) is not doing well here either, but Aruba Networks (Nasdaq:ARUN) (not a competitor to Brocade) and Juniper (Nasdaq:JNPR) don't seem to be having the same sort of problems.
Revenue might have been so-so, but Brocade nevertheless delivered better profits with it. Gross margin (on a GAAP basis) ticked up almost a full point, and also improved on a sequential basis, due to better results from the SAN business. Operating income was likewise better; growing over 14% despite a 19% increase in sales and marketing expense. Non-cash compensation fell about 25% in the quarter and represented about 4% of revenue. Non-cash amortization charges continue to be a significant expense item; these charges come from past acquisitions (McDATA and Foundry), and will peak in 2012 before dropping off in 2014 and beyond.
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A Bright (if Cloudy) Future
The shortfall in Ethernet is going to be a source of frustration, and will probably help keep a lid on the shares until Brocade can prove that it's a momentary phenomenon. That said, there's still more than a little promise here. The company's relatively new virtual cluster switching products could give Brocade a stake in the future growth of cloud computing, and a chance of growing, despite competition from Cisco, Juniper, Oracle (Nasdaq:ORCL) and F5 (Nasdaq:FFIV), just to name a few.
The company is still a market leader in storage switches, and neither Cisco nor QLogic (Nasdaq:QLGC) is doing anything all that unexpected there. That said, the company still depends upon Hewlett-Packard (NYSE:HPQ), Dell (Nasdaq:DELL) and EMC (NYSE:EMC) for a large chunk of its business. Complicating matters, the company also competes with HP, and that adds a few wrinkles to that relationship.
The Bottom Line
Brocade is not expensive, relative to comparable companies, but Brocade's growth is not nearly so impressive as many of those same comparables. On the other hand, if the company can get SAN and Ethernet both firing at the same time, growth could improve more than estimates currently suggest. For patient investors, especially those who believe in the potential of products like the virtual cluster switching lines, Brocade is worth a look. That said, EMC (NYSE:EMC) is quite cheap as well, at today's prices, and is a far stronger business than Brocade at present.
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