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BRCD > SEC Filings for BRCD > Form 10-K on 16-Dec-2016All Recent SEC Filings

Show all filings for BROCADE COMMUNICATIONS SYSTEMS INC

Form 10-K for BROCADE COMMUNICATIONS SYSTEMS INC


16-Dec-2016

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with the Company's Consolidated Financial Statements and the notes thereto included in Part II, Item 8 of this Annual Report on Form 10-K. This section and other parts of this Annual Report on Form 10-K contain forward-looking statements that involve risks and uncertainties. Forward-looking statements can also be identified by words such as "expects," "anticipates," "assumes," "targets," "projects," "intends," "plans," "believes," "seeks," "estimates," "continues," "may," "should," "could," "depend," "will," "contemplate," "predict," "potential," and variations of such words and similar expressions. Forward-looking statements are not guarantees of future performance and our actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in the subsection entitled "Item 1A. Risk Factors" above.

Overview
We are a leading supplier of networking hardware, software, and services for businesses and organizations of various types and sizes. Our end customers include global enterprises and other organizations that use our products and services as part of their communications infrastructure. In addition, service providers, such as telecommunication firms, cable operators, and mobile carriers, use our products and services as part of their commercial operations. Our business is focused on two key markets. One is Storage Area Networking ("SAN"), where we offer our SAN products, including modular directors, fixed-configuration and embedded switches, and network management and monitoring capabilities. The second is Internet Protocol ("IP") Networking, where we offer IP routers, Ethernet switches, wireless access points and controllers, network security, analytics, and monitoring, as well as products used to manage application delivery. Our IP Networking products are available in modular and fixed hardware-based form factors and can be deployed in both traditional network and next-generation fabric designs. Our IP Networking products also include a wide range of virtualized network software offerings, including a virtual routing software suite, application delivery controller and load balancer, and a cloud-based wireless controller offering. In addition, for mobile service providers, our products include a virtual Evolved Packet Core ("vEPC") solution and a software analytics probe and application monitoring application. We also provide product-related customer support and services across all our businesses.
Key customer information technology ("IT") initiatives, such as virtualization, enterprise mobility, data center consolidation, cloud computing, and migration to higher performance technologies, such as solid-state storage, continue to rely on our mission-critical SAN-based solutions. We are known as a storage networking innovator and have a leading SAN market share position. Our SAN business strategy is to continue to expand and diversify our partner base and introduce new, innovative solutions for both our large installed base and potential new customers. For example, we recently launched our Gen 6 Fibre Channel SAN platform. This next generation of switches and directors delivers superior performance and scalability designed to support demanding workloads from mission-critical applications. In addition, we continue to add new SAN partners, expand relationships with existing partners, and introduce new products, such as the Brocade Analytics Monitoring Platform. This new platform provides customers the ability to improve operational performance, stability, and security within their storage environments.
Our IP Networking business strategies are designed to support IP networking initiatives and intended to increase new customer accounts and expand our current market share through product innovations, acquisitions, and the development and expansion of our routes to market. Examples include the development of both IP and Ethernet fabric switches, next generation routers, virtualized software networking products, and the acquisition of Ruckus Wireless, Inc. ("Ruckus"), which was completed on May 27, 2016. The Ruckus acquisition, which provides us access to both the Ruckus product portfolio and Ruckus' channels to market, enhances our scale and competitive positioning in both the enterprise and service provider markets and compliments our mobility strategy that we announced in February 2016. Longer term, we expect the Ruckus acquisition to strengthen our ability to pursue emerging opportunities around 5G mobile services, the Internet of Things, Smart Cities, in-building LTE, and cellular/Wi-Fi convergence.


Table of Contents

The success of our IP Networking business, in particular, will depend on customers recognizing the benefits of upgrading their data center networks to fabric-based networking architectures, upgrading their wireline and wireless infrastructure at the network edge, and adopting our virtualized software-based networking solutions as part of the overall digital transformation happening in the marketplace. In particular, our future success in this area would be negatively impacted if the technological transition to virtual software-based solutions does not occur at the anticipated rate or at all. While our software networking license revenues have not been material to date, there is customer interest in software networking products, and we believe that customers prefer to buy networking products from suppliers that offer a portfolio of solutions that address their current and future needs. We plan to continue to support our growth strategy with continuous innovation, leveraging the strategic investments we have made in our core businesses, developing emerging technologies such as software-defined networking ("SDN"), network functions virtualization ("NFV"), and network visibility and analytics ("NVA"), introducing new products, making strategic acquisitions, and enhancing our existing partnerships and forming new partnerships through our various distribution channels.
We continue to face multiple challenges as customers consider moving specific workloads to the cloud, evaluate hyper-converged architectures, and assess new architectures based on software, servers, and a mix of proprietary- and commodity-networking hardware. We also continue to be affected by worldwide macroeconomic conditions and face the possibility that these conditions could deteriorate and create a more cautious capital spending environment in the IT sector. In addition, U.S. federal customers are important to our business, and spending by the U.S. government can be variable and difficult to predict. We are also cautious about the stability and health of certain international markets and current global and country-specific dynamics, such as the drop in the value of the euro and the Chinese yuan versus the U.S. dollar in the past fiscal year, slowing economic growth in China, Russia-related geopolitical uncertainty, and the withdrawal of the United Kingdom from the European Union as voted by the British citizens during the June 23, 2016, referendum, also commonly known as Brexit. These factors may impact our business and those of our partners. Our diversified portfolio of products helps mitigate the effect of some of these challenges, and we expect IT spending levels to generally rise in the long term. However, it is difficult for us to offset the effects of short-term reductions in IT spending.
We expect our SAN and IP Networking revenues to fluctuate depending on the demand for our existing and future products and services, and the quality of the sales support for our products and services from our distribution and reseller partners, as well as the timing of product and business transitions by our original equipment manufacturer ("OEM") partners. The average selling prices per port for our SAN and IP Networking products have typically declined over time, unless impacted favorably by a new product introduction or product mix, and we expect this dynamic to continue.
Our plans for our operating cash flows are to provide liquidity for operations, capital investment, and other strategic initiatives, including investments and acquisitions to strengthen our networking portfolios, and to return capital to stockholders. In the fourth quarter of fiscal year 2016, our Board of Directors declared and paid a quarterly cash dividend of $0.055 per share of our common stock for a total of $22.1 million. In addition, on November 20, 2016, our Board of Directors declared a quarterly cash dividend of $0.055 per share of our common stock to be paid on January 4, 2017, to stockholders of record as of the close of market on December 12, 2016. Future dividend payments are subject to review and approval on a quarterly basis by our Board of Directors, and are limited under the terms of the Merger Agreement (as defined below). Pending Acquisition by Broadcom Limited
On November 2, 2016, we entered into a merger agreement (the "Merger Agreement") with Broadcom Limited ("Broadcom") under which Broadcom agreed to acquire us. Upon closing of the merger, our stockholders will receive $12.75 in cash, without interest, less any required tax withholding, for each share of Brocade common stock. Consummation of the merger is subject to certain customary closing conditions, including approval by our stockholders and the receipt of certain governmental and regulatory approvals in various jurisdictions. The transaction is not subject to a financing condition.
Assuming timely satisfaction of the necessary closing conditions, we anticipate that the merger will be completed in the second half of our fiscal year 2017. For additional information related to the Merger Agreement, please refer to our preliminary proxy statement on Schedule14A filed with the Securities and Exchange Commission on December 6, 2016, which includes the full text of the Merger Agreement attached as Annex A. In addition, see Part I, Item 1A. Risk Factors of this Form 10-K, which is incorporated herein by reference, for a discussion of certain risks due to the announcement and pendency of the proposed acquisition or the failure of the acquisition to be completed that could have a material adverse effect on our business and operating results. These risks include, but are not limited to, the diversion of management and employee attention, potential employee attrition, potential adverse reactions or changes to our business relationships with customers, partners, and suppliers and uncertainty surrounding our future plans and prospects.


Table of Contents

Overview of Financial Results
The following table provides an overview of some of our financial results (in
thousands, except percentages):
                                                              Fiscal Year Ended
                                                 October 29,     October 31,     November 1,
                                                    2016            2015            2014
Total net revenues                              $ 2,345,610     $ 2,263,460     $ 2,211,267
Gross margin                                    $ 1,516,339     $ 1,528,073     $ 1,465,793
Gross margin, as a percentage of total net             64.6 %          67.5 %          66.3 %
revenues
Income from operations                          $   307,093     $   492,680     $   386,112
Operating income, as a percentage of total net         13.1 %          21.8 %          17.5 %
revenues
Net income attributable to Brocade              $   213,815     $   340,362     $   237,971
Communications Systems, Inc.

Results of Operations
We report our fiscal year on a 52- or 53-week period ending on the last Saturday in October or the first Saturday in November, respectively. As is customary for companies that use the 52/53-week convention, every fifth year is a 53-week year. Fiscal year 2016 is a 52-week fiscal year, fiscal year 2015 was a 52-week fiscal year, and fiscal year 2014 was a 53-week fiscal year. Our next 53-week fiscal year will be fiscal year 2019 and our next 14-week quarter will be the second quarter of fiscal year 2019.
Our results of operations for the fiscal years ended October 29, 2016, October 31, 2015, and November 1, 2014, are reported in this discussion and analysis as a percentage of total net revenues, except for gross margin with respect to each reportable segment, which is indicated as a percentage of the respective reportable segment net revenues.
Revenues. Our revenues are derived primarily from sales of our SAN and IP Networking products and support and services related to these products, which we call Global Services.
Our total net revenues are summarized as follows (in thousands, except percentages):

                                             Fiscal Year Ended
                             October 29, 2016                October 31, 2015
                                           % of Net                        % of Net                                 %
                         Net Revenues      Revenues      Net Revenues      Revenues     Increase/(Decrease)      Change
SAN Products           $    1,229,184         52.4 %   $    1,301,231         57.5 %   $           (72,047 )       (5.5 )%
IP Networking Products        730,412         31.1 %          601,170         26.5 %               129,242         21.5  %
Global Services               386,014         16.5 %          361,059         16.0 %                24,955          6.9  %
Total net revenues     $    2,345,610        100.0 %   $    2,263,460        100.0 %   $            82,150          3.6  %


                                             Fiscal Year Ended
                             October 31, 2015                November 1, 2014
                                           % of Net                        % of Net                                 %
                         Net Revenues      Revenues      Net Revenues      Revenues     Increase/(Decrease)      Change
SAN Products           $    1,301,231         57.5 %   $    1,326,950         60.0 %   $           (25,719 )       (1.9 )%
IP Networking Products        601,170         26.5 %          525,237         23.8 %                75,933         14.5  %
Global Services               361,059         16.0 %          359,080         16.2 %                 1,979          0.6  %
Total net revenues     $    2,263,460        100.0 %   $    2,211,267        100.0 %   $            52,193          2.4  %


The increase in total net revenues for the fiscal year ended October 29, 2016, compared with the fiscal year ended October 31, 2015, reflects higher sales for our IP Networking products and Global Services offerings, partially offset by lower sales for our SAN products, as further described below.
The decrease in SAN product revenues was caused by lower director, embedded, and fixed-configuration switch product revenues, primarily due to the weaker storage demand environment and operational issues and transitions at certain OEM partners. Consequently, the number of ports shipped decreased by 9.3% during the fiscal year ended October 29, 2016, the effect of which was partially offset by a 4.1% increase in the average selling price per port during the same period related to the Gen 6 product introduction in fiscal year 2016 and higher density product configurations;

The increase in IP Networking product revenues primarily reflects $169.4 million in revenue from our newly acquired wireless products due to the May 2016 acquisition of Ruckus. In addition, IP Networking product revenues are higher due to the change we made in the fourth quarter of fiscal year 2016 with respect to how we recognize revenue from sales to our distributor customers (see Note 2, "Summary of Significant Accounting Policies," of the Notes to Consolidated Financial Statements). These increases were partially offset by a decrease in revenue from data center routing products, primarily due to weaker demand from large network carrier, enterprise, and federal customers. There were also decreases due to the completion of the MLXe product refresh and completion of a large service provider customer MLXe project; and

The increase in Global Services revenues was primarily due to higher support revenue related to our vADC software product line acquired in the second quarter of fiscal year 2015, more renewal support contracts for our SAN and IP hardware products, growth in support revenue from our newly acquired wireless products, as well as an increase in support and services revenue from federal customers and professional services revenues.

The increase in total net revenues for the fiscal year ended October 31, 2015, compared with the fiscal year ended November 1, 2014, reflects higher sales for our IP Networking products and Global Services offerings, partially offset by lower sales for our SAN products, as further described below.
The decrease in SAN product revenues was caused by lower embedded and fixed-configuration switch product revenues, primarily due to the increased throughput and efficiency of our latest generation of products, which allow customers to transmit significantly more data through the same number of ports, and operational issues at certain OEM partners, partially offset by higher director product revenues. The number of ports shipped decreased by 8.8% during the fiscal year ended October 31, 2015, due to lower embedded and fixed-configuration switch sales, the effect of which was partially offset by a 7.5% increase in the average selling price per port during the same period due to a shift in product mix towards more feature-rich director products;

The increase in IP Networking product revenues primarily reflects higher revenues from our data center routing and switching products, campus products, and software networking products, partially offset by a decrease in revenues as a result of the previously announced changes in our Brocade ADX and wireless business strategies and the divestiture of our network adapter business (converged network adapters) in January 2014. Data center routing product revenues increased primarily due to strong demand for our newest MLXe modules that we began shipping in the fourth quarter of fiscal year 2014. Data center switching product revenues increased as a result of strong fixed and modular Brocade VDX sales into data center deployments. Campus product revenues increased due to strong U.S. federal sales and the government program for funding schools and libraries, commonly known as E-Rate, generating higher revenue. Software networking revenues increased due to the vADC software product line acquired in March 2015 and growth in usage of our virtual routers by cloud service providers. Data center revenues from IP Networking products accounted for an estimated 57.0% of total IP Networking product revenues for both the fiscal years ended October 31, 2015, and November 1, 2014; and

The increase in Global Services revenues was primarily due to more new and renewal support contracts for our IP Networking products, as well as higher support contracts related to our vADC software product line acquired in March 2015. This increase was partially offset by one less fiscal week of amortized support revenue in fiscal year 2015 compared with fiscal year 2014, which was a 53-week fiscal year, and a decrease in new and renewal support contracts with certain OEMs for our SAN products.


Our total net revenues by geographic area are summarized as follows (in thousands, except percentages):

                                             Fiscal Year Ended
                             October 29, 2016                October 31, 2015
                                           % of Net                        % of Net                                 %
                         Net Revenues      Revenues      Net Revenues      Revenues     Increase/(Decrease)      Change
United States          $    1,202,792         51.3 %   $    1,275,056         56.3 %   $           (72,264 )       (5.7 )%
Europe, the Middle
East and Africa (1)           676,685         28.8 %          610,133         27.0 %                66,552         10.9  %
Asia Pacific                  318,758         13.6 %          229,903         10.2 %                88,855         38.6  %
Japan                         100,034          4.3 %           93,470          4.1 %                 6,564          7.0  %
Canada, Central and
South America                  47,341          2.0 %           54,898          2.4 %                (7,557 )      (13.8 )%
Total net revenues     $    2,345,610        100.0 %   $    2,263,460        100.0 %   $            82,150          3.6  %

                                             Fiscal Year Ended
                             October 31, 2015                November 1, 2014
                                           % of Net                        % of Net                                 %
                         Net Revenues      Revenues      Net Revenues      Revenues     Increase/(Decrease)      Change
United States          $    1,275,056         56.3 %   $    1,286,650         58.2 %   $           (11,594 )       (0.9 )%
Europe, the Middle
East and Africa (1)           610,133         27.0 %          598,196         27.0 %                11,937          2.0  %
Asia Pacific                  229,903         10.2 %          183,035          8.3 %                46,868         25.6  %
Japan                          93,470          4.1 %           91,062          4.1 %                 2,408          2.6  %
Canada, Central and
South America                  54,898          2.4 %           52,324          2.4 %                 2,574          4.9  %
Total net revenues     $    2,263,460        100.0 %   $    2,211,267        100.0 %   $            52,193          2.4  %

(1) Includes net revenues of $336.1 million, $400.0 million, and $385.2 million for the fiscal years ended October 29, 2016, October 31, 2015, and November 1, 2014, respectively, relating to the Netherlands.

Revenues are generally attributed to geographic areas based on where our products are shipped. However, certain OEM partners take possession of our products domestically and then distribute these products to their international customers. We cannot be certain of the extent to which our domestic and international revenue mix is impacted by the logistics practices of our OEM partners. Unless we receive discrete shipment information from our OEM partners, we account for all domestically delivered OEM shipments as domestic revenues. Therefore international revenues may comprise a larger percentage of our total net revenues than the attributed revenues above indicate.
International revenues for the fiscal year ended October 29, 2016, increased to 48.7% as a percentage of total net revenues compared with the 43.7% for the prior year, primarily due to a shift in customer mix for our SAN and IP Networking products. In addition, one of our OEM customers, who individually accounted for 10% or more of our total net revenues in fiscal year 2016, attributed a higher percentage of their orders to end customers outside of the United States in fiscal year 2016 as compared with fiscal year 2015. International revenues for the fiscal year ended October 31, 2015, increased to 43.7% as a percentage of total net revenues compared with the 41.8% for the prior year, primarily due to a shift in customer mix for our SAN and IP Networking products.
A significant portion of our revenues are concentrated among a relatively small number of OEM customers. For the fiscal years ended October 29, 2016, October 31, 2015, and November 1, 2014, the following three customers individually accounted for 10% or more of our total net revenues:
39% of total net revenues for the fiscal year ended October 29, 2016, comprised of 19% from EMC Corporation ("EMC"), which was acquired by Dell, Inc. on September 7, 2016, combined with direct sales to Dell, Inc. (together "Dell EMC"), 10% from Hewlett Packard Enterprise Company ("HPE"), and 10% from International Business Machines Corporation ("IBM");

41% of total net revenues for the fiscal year ended October 31, 2015, comprised of 17% from EMC, 12% from HPE, and 12% from IBM; and

46% of total net revenues for the fiscal year ended November 1, 2014, comprised of 18% from EMC, 12% from HPE, and 16% from IBM.


We expect that a significant portion of our future revenues will continue to come from sales of products to a relatively small number of OEM partners and to the U.S. federal government and its individual agencies through our distributors and resellers. Therefore, the loss of, or significant decrease in the level of sales to, or a change in the ordering pattern of any one of these customers could seriously harm our financial condition and results of operations. Gross margin. Gross margin as stated below is indicated as a percentage of the respective reportable segment net revenues, except for total gross margin, which is stated as a percentage of total net revenues.
Gross margin is summarized as follows (in thousands, except percentages):

                                             Fiscal Year Ended
                             October 29, 2016                October 31, 2015
                                           % of Net                        % of Net                             % Points
                         Gross Margin      Revenues      Gross Margin      Revenues     Increase/(Decrease)      Change
SAN Products           $      934,084         76.0 %   $      989,350         76.0 %   $           (55,266 )          -  %
IP Networking Products        368,351         50.4 %          325,536         54.2 %                42,815         (3.8 )%
Global Services               213,904         55.4 %          213,187         59.0 %                   717         (3.6 )%
Total gross margin     $    1,516,339         64.6 %   $    1,528,073         67.5 %   $           (11,734 )       (2.9 )%


                                             Fiscal Year Ended
                             October 31, 2015                November 1, 2014
                                           % of Net                        % of Net                    % Points
                         Gross Margin      Revenues      Gross Margin      Revenues      Increase       Change
SAN Products           $      989,350         76.0 %   $      982,484         74.0 %   $    6,866          2.0 %
IP Networking Products        325,536         54.2 %          277,262         52.8 %       48,274          1.4 %
Global Services               213,187         59.0 %          206,047         57.4 %        7,140          1.6 %
Total gross margin     $    1,528,073         67.5 %   $    1,465,793         66.3 %   $   62,280          1.2 %

The changes in gross margin percentage for each reportable segment for the fiscal year ended October 29, 2016, compared with the fiscal year ended October 31, 2015, were primarily due to the following factors:
SAN gross margins relative to net revenues were flat on a percentage basis and decreased in absolute dollars primarily due to the decline in SAN net revenues, related to the weaker storage demand environment and operational issues and transitions at certain OEM partners, offset by a modest increase in the average selling price per port;

. . .

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