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Brocade Communications Systems, Inc. (NASDAQ: BRCD) sells hardware that lets data storage devices and computer servers communicate with each other and transmit hundreds of terabytes of data. Its customers are original equipment manufacturers, such as EMC, IBM and HP, that build Brocade's directors, switches and routers into their own data storage hardware.^[1] Therefore, the demand for Brocade's products is driven by the demand for data storage devices that use networks to connect computers that are far away. Corporations and government agencies are buying large data storage devices because of the increase in information stored electronically, from scientific advancements to population growth. In addition to high storage capacities, these institutions also demand products that keep their data safe, especially in a world where more and more confidential information is transferred through computer networks. Brocade's switches are used in hardware that protect sensitive data, and its software packages help companies minimize the cost of recovering from hardware theft or natural disasters.^[2] As an IT vendor, however, Brocade is especially susceptible to economic slumps, since many companies cut their IT budget during downturns. Its net income decreased by 38% for Q1 2008, because of a looming recession.^[3]

Contents 1 Business and Financials 1.1 Products 1.2 Revenues 1.2.1 Revenue Breakdown 2 Key Trends and Forces 2.1 Growth in the Amount of Data Stored Digitally Combined with Globalization mean Demand for Brocade's Hardware is Growing 2.2 Increased physical risks to devices storing confidential data lead to greater demand for data protection hardware 2.3 IT vendors such as Brocade are especially vulnerable to market conditions that affect their end users 3 Competitors 4 Market Share 5 References

[edit] Business and Financials

[edit] Products

Ninety-five percent of Brocade's net product revenue comes from selling pieces of hardware that let servers and data storage devices communicate with each other through networks. Examples include directors, switches and routers. While they do not hold data themselves, they control the flow of terrabytes of data that are transferred from computers to data storage devices and between storage devices. Additionally, stand-alone operating systems performing complex tasks, such as redirecting network traffic, are built into Brocade's hardware.^[4]

Brocade also sells software used for data management, accounting for 5% of net product revenue. Brocade's software centralizes stored data, which makes a company's data accessible around the world, and recovers damaged data, which reduces the amount of money a company spends to absorb the damage.^[5]

[edit] Revenues

Brocade's net revenues grew by 65% from 2006 to 2007, and 31% from 2005 to 2006. Added together, Brocade's hardware and security software & services comprised 87% of 2007 total revenues. The company's services, including hardware installation and maintenance and data management consulting, took up the remaining 13%. The increase in revenues from services is a result of increasing the number of companies Brocade sells to. From 2005 to 2007, net income has increased by 38% on average, while the cost of goods sold, as a percentage of net revenues, increased from 43.7% to 46.5%. While this increase mainly comes from the company's acquisition of McData, price competition and higher input costs also place pressure on margins.^[6]

Earnings Breakdown (in USD Millions)^[7]

Year	2007	2006	2005	2004	2003
Revenue	1,237	751	574	596	525
Gross margin	661	445	323	327	284
Net income	77	68	43	(24)	(147)

[edit] Revenue Breakdown

Within the four main products of Brocade, the respective revenue percentages are as follows:

Revenue Breakdown by Product ^[8]

Product Type	Storage Area Network (SANs)	File Area Network (FAN)	Sever Connectivity	Services
Percentage of Revenue	80%	5%	2%	13%

International revenues for Brocade represented 39.1%, 36.3% and 36.6% of net revenues in fiscal years 2007, 2006 and 2005, respectively. The year over year increase from 2006 to 2007 stems from absolute growth in international revenues.^[9]

Revenue Breakdown by Geography (USD Mil)^[10]

Year	2007	2006	2005
North America	753.4	478.1	373.7
Europe,Middle East, Africa	363.2	202.0	139.7
Asia Pacific	120.3	70.5	60.7

In 2007, 2006 and 2005, three original equipment manufacturers accounted for 68%, 73% and 71% of Brocade's total revenues, respectively. These three companies were EMC, HP and IBM. Original equipment manufacturers purchase Brocade's hardware parts, integrate them into their own hardware, and sell their products to end users.^[11]

[edit] Key Trends and Forces

[edit] Growth in the Amount of Data Stored Digitally Combined with Globalization mean Demand for Brocade's Hardware is Growing

The growth of information that is processed electronically creates high demand for high-end storage hardware and software: by some estimates, the growth rate of data needed to be stored has reached 100% a year.^[12] Sources of this growth include scientific advancements (such as genomic data in the field of bioengineering), higher standards for products/services (such as new categories of financial data kept by banks), and population growth (such as social security data).^[13] The challenge of managing large amounts of data is compounded by increased government regulations and more widespread regions where companies are conducting business. For example, in a survey of financial services companies, 88% of companies noted that data management for compliance and business growth as either "very important" or "important", and in this context, technological challenges are just as important as obtaining sufficient budget.^[14] To address these issues, Brocade sells hardware that interconnect servers and storage devices and route data between them, making networked storage (many computers having access to centralized data) possible. This is especially useful in an increasingly global economy. For example, an employee in New York can access changes to a document or project made by an employee in Hong Kong, bypassing geographic and bureaucratic barriers. Effective data management lets a company spend less time/money on information technology and increases the productivity of the company's employees, especially those that are separated by distance. As more companies realize this and implement hardware to enable global corporate interactions, Brocade's business will grow.^[15]

[edit] Increased physical risks to devices storing confidential data lead to greater demand for data protection hardware

Limiting the risk of compromising confidential information is the number one reason corporations are investing in data management hardware and software, with 84% of corporations emphasizing its importance (see section above).^[16] More and more pieces of sensitive information, ranging from social security numbers to numbers of credit cards, are being stored electronically. In light of this trend, geopolitical events such as terrorism, natural disasters such as hurricane season (both of which threaten to damage servers where data is physically stored), and laptop theft pose a challenge to the security of sensitive data. For example, from 2005 to 2006 there was an 81% increase in the number of companies reporting stolen laptops containing sensitive information.^[17] While Brocade sells data protection software, it is the company's hardware, accounting for most of its revenues, that enables vendors further down the supply change to develop features such as centrally administered encryption and data back-up bandwidth speed.^[18] These features minimize the cost of recovering from calamities, and as the value of a customer's data increases, so does the customer's demand for data protection products.^[19]

[edit] IT vendors such as Brocade are especially vulnerable to market conditions that affect their end users

While high-end data storage hardware and software improve the handling of a company's data, they are not an essential component of the company's business. Many companies see no need to purchase expensive, high-end data storage devices or spend money upgrading their preexisting data management systems. This rings especially true during times of recession, since IT is an easy place for companies to save money.^[20] In comparison to 2007, the demand for technology goods is projected to decrease by 3% to 6% by the end of 2008.^[21] For example, as a result of the credit crunch that began in summer 2007, banks that have suffered write downs, such as France's Société Générale, are opting out of inessential IT upgrades. Likewise, Brocade is also vulnerable to slow-downs in consumer confidence in the media & entertainment and telecommunications industries. While Brocade's revenues in the first quarter of fiscal year 2008 increased by 55% from the same quarter last year, the revenue increase is partly explained by a new contract with Hitachi Data Systems and Fujitsu-Siemens (original equipment manufacturers). Comparatively, the company's revenues grew by 63% over the previous year in 4Q FY2007, and 73% in 3Q FY2007. Furthermore, the company's net income decreased by 38% for 1Q FY2008 compared to the previous quarter, because of a single digit percentage decline in the average selling price of its products and an increased tax rate^[22][23]

[edit] Competitors

Brocade's two main competitors are Cisco Systems and QLogic, which also manufacture switches and directors. Original equipment manufacturers use hardware components from multiple sellers, so competition is high. Brocade also makes products, such as its Tapestry software package, that compete with many IT vendors like NetApp and EMC, but it generally partners with these vendors since they are the company's hardware customers.

Competitors Comparison^{[24][25][26][27]}

Year	Brocade	Cisco	QLogic	Emulex
Net revenues (thousands) (2007)	$1,237	$34,922	$587	$470
Operating margin (2007)	8%	25%	21%	9%

Cisco - Cisco sells switches and routers (accounting for 65.8% of net revenues) that compete directly with Brocade's products. Its main advantage is its size, with total revenues at $34.922B. Given its size, the company also has a stronger global presence, with international revenues accounting for 47.5% of net revenues.^[28]

Qlogic - Qlogic also sells switches and routers, but its FY2008 revenues were only $597.866M, making it a less serious player. Its biggest customers are HP, IBM, and Sun Microsystems. These three customers only accounted for 47% of net revenues in FY2008, which makes Qlogic's customer base more diversified than Brocade's.^[29]

Emulex - Emulex only had $470.19M in net revenues in FY2007. The company sells adapters and routers.^[30]

[edit] Market Share

Brocade and Cisco are the only two significant players left in the storage-area network switches market. Brocade has the upper hand with 51.2% of the market, based on total factory revenue, while Cisco holds 48.3% of the market.^[31][32]

[edit] References

1. ↑ BRCD 2007 10K, Item 1
2. ↑ BRCD 2007 10K, Item 1
3. ↑ BRCD 2007 10K, Item 6
4. ↑ BRCD 2007 10K, Item 1
5. ↑ BRCD 2007 10K, Item 1
6. ↑ BRCD 2007 10K, Item 6
7. ↑ Brocade Communications Systems, Inc., “Investors Annual Report, 2007,” 7/10/08, Item 6
8. ↑ BRCD 2007 10K, Item 6
9. ↑ BRCD 2007 10K, Item 6
10. ↑ BRCD 2007 10K, Item 6
11. ↑ BRCD 2007 10K, Item 6
12. ↑ NTAP 10-K 2007, Item 1
13. ↑ Network Computing "Low-Cost Network Area Storage Devices" April 23 2004
14. ↑ "Enterprise Data Management Market Intelligence" Golden Source December, 2006
15. ↑ BRCD 2007 10K, Item 1
16. ↑ "Enterprise Data Management Market Intelligence" Golden Source December, 2006
17. ↑ Absolute Software "Computer Theft and Recovery Statistics"
18. ↑ "Brocade, EMC simplify enterprise data security" EE Times Asia May 26 2008
19. ↑ BRCD 2007 10K, Item 1
20. ↑ "NetApp blames tightwad bankers for lower forecast" The Register February 14th 2008
21. ↑ "Recession To Slow Down US Tech Sector" BizTech2 April 3 2008
22. ↑ BRCD 2007 10K, Item 6
23. ↑ BRCD Earnings Release February 14 2008
24. ↑ BRCD 2007 10K, Item 6
25. ↑ ELX 2007 10K, Item 6
26. ↑ QLGC 2008 10K, Item 6
27. ↑ CSCO 2007 10K, Item 6
28. ↑ CSCO 2007 10K, Item 6
29. ↑ QLGC 2008 10K, Item 6
30. ↑ ELX 2007 10K, Item 6
31. ↑ "Cisco stamps on Brocade in Q4, Dell'Oro says" Storage Network News March 19 2007
32. ↑ "Cisco vs. Brocade: Brocade winning storage switch market share" NetworkWorld December 17 2007

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