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By Ronald Fink
Brocade Communications Systems may be facing a tougher third quarter than investors realize, according to research conducted earlier this month by CIOZone. And that calls into question the company's sale forecast for the full fiscal year.
The maker of switching gear for corporate data storage networks posted strong revenue results for the second quarter of the year, which ended on May 2. Revenues advanced 17% from the first quarter to $506.3 million, and 43% from a year earlier. Sales were helped by the acquisition late last year of Foundry Networks, whose products give Brocade's line of Ethernet switches more throughput.
The solid Q2 results led CEO Michael Klayko to offer a bullish view of the second half of the fiscal year. "We have definitely going into the second half a much higher run rate than we had thought about coming into the quarter," Klayko told analysts in a conference call to discuss the results Thursday morning.
Not surprisingly, the second quarter performance has boosted Brocade's stock price. The share price was up about 12% on Friday from the close of trading on Wednesday, the day before the results were announced.
But a survey of 72 Brocade customers by CIOZone finds that demand for Brocade products may be softer in the third quarter than investors expect. Only 3 of 31 customers with at least $1 billion in sales said they would increase their spending on Brocade products during the quarter, and only 1 said that its increase would exceed 10%.
Meanwhile, 9 of those customers said their outlays on Brocade products would decrease, with 7 of those saying their spending would fall by at least 11%.
Smaller customers are unlikely to pick up the slack. The CIOZone survey also found that of the 48 North American respondents of all sizes, only 11 indicated they would spend more on Brocade products during the current quarter than they had in the second quarter.
Of those, 7 said their spending would increase by no more than 10%. In addition, 9 of those customers said their spending would decrease, with 7 saying it would fall by at least 11%. More than two-thirds of Brocade's revenue comes from North America.
CIOZone could not get in touch with a Brocade spokesman to comment on the findings. But during the company's earlier conference call with analysts, management conceded that its third quarter normally suffers from seasonality, with sales usually flat or down 2% from the second quarter.
Klayko also acknowledged that even as many customers are wrestling with demands for their systems to handle more data and provide more networking capability, they also face "relatively flat to down budgets." He also said that cost would remain a major customer concern for at least the next two years.
But he also stood by Brocade's earlier forecast of $2 billion in revenue for the year, suggesting that revenue growth in the fourth quarter would make up for any shortfall in the current one.
The CIOZone research did support the view that spending on Brocade products will pick up somewhat in the fourth quarter of the year. Fifteen of 31 customers with at least $1 billion in revenue said their spending would increase for the full year, with 6 of those saying it would rise by at least 21%. Only five of those customers said their spending on Brocade would fall on a year-over-year basis.
Similarly, 23 of 48 North American customers of all sizes said they would increase their spending with Brocade this year, with 15 saying that increase would exceed 11%. And only 6 customers said their yearly expenditures would fall.
Yet there remains some question whether a bump-in in sales in the fourth quarter will be strong enough for Brocade to fulfill its sales forecast for the full year.
During the conference call, Aaron Rakers, an analyst at Stifel Nicolaus, pointed out that the company's sales in the fourth quarter would have to grow by 12% to reach $2 billion for the full year if Q3 sales followed their normal pattern. Typically, Brocade registers single-digit sales growth in the final quarter of a year.
But CEO Klayko claimed that the new products Brocade acquired from Foundry, along with a co-branding agreement signed in April with IBM, could help boost the company's revenues by double-digits in the fourth quarter. That, in turn, would help Brocade hit or exceed its full-year forecast. "Even in this tough macro environment, we still have [a] pretty good degree of confidence" in the forecast, Klayko said.
He explained that many existing customers have had the same systems in place since they replaced them because of the Y2K scare around the turn of the century, with new switching technology simply added on over the years. Klayko said that Brocade can help those customers in their efforts to boost network capacity. "We can come in and help eliminate layers, improve the performance and take radical cost out," he said.
But that pitch may be a tough sell. Fully 93% of the 72 Brocade customers surveyed by CIOZone said that acquisition of Foundry would have no effect on their spending going forward.
"No budget," an infrastructure planner for a Canadian utility with more than $40 billion in revenue told CIOZone. "Those types of expenditures are all on hold."
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