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Brocade on target despite sinking sales

Brocade Communications met analysts' reduced estimates in its second-quarter earnings Tuesday even though total sales plunged 30 percent from the prior quarter.

In the quarter, Brocade pocketed $12 million, or 5 cents a share, on sales of $115.2 million, down from a profit of $32.5 million, or 13 cents a share, on sales of $165 million in the first quarter. In the year-ago quarter, Brocade pocketed $13.3 million, or 6 cents a share, on sales of $62.1 million.

The consensus earnings estimate, according to a survey of analysts by First Call, pegged the maker of fiber-channel switches and management software for storage area networks (SANs) for a profit of 5 cents a share in the quarter. SANs allow network users to share storage devices over the Internet.

Brocade shares rose $2.41 to $42.50 ahead of the earnings report before moving up to $43.10 in after-hours trading.

After the company's strong first-quarter earnings report, Brocade executives lowered their sales and earnings targets for the second quarter for the first time in the company's history, sparking a sell-off in its shares that culminated with the stock bottoming out at a 52-week low of $16.75 in April.

"We're now seeing signs that IT budgets are thawing," Chief Executive Greg Reyes said during a conference call with analysts. "Network storage products still continue to be a top priority for companies. The return on investment is incredibly compelling."

Gross profit margins in the quarter came in at 60 percent, and the company exited the quarter with more than $217 million in cash and short-term investments.

Ahead of the earnings report, SunTrust Equitable Securities analyst Joel Pitt expected the company would beat his profit estimate of 5 cents a share.

"On a certain level, Brocade was blindsided by the economy and the rapid deceleration in new orders," he said. "But we really like the company and its management even if the stock continues to trade at an unrealistic valuation."

Two weeks ago, Brocade executives told analysts attending the Merrill Lynch Hardware Technology Conference that it would at least meet or perhaps beat lowered estimates in the second quarter.

"They did lower the bar dramatically but it wasn't terribly unexpected," said Shebly Seyrafi, an analyst at A.G. Edwards. "March was clearly their worst month, and orders fell much faster than anyone could have predicted. But it appears there's been a rebound lately."

On Friday, CS First Boston analyst Amit Chopra weighed on the Brocade situation by initiating coverage of the stock with a "buy" rating and set a 12-month price target of $52 a share.

In the research note, Chopra justified the rating by saying the company "is now driving the evolution of the switch from its roots as a hardware-based packet passing interconnect to a launching pad for SAN management services."

"With these higher-level services, the company is laying the groundwork for the build-out of more scalable and distributed storage fabrics," Chopra said.

Chief Financial Officer Tony Canova told analysts to expect year-over-year sales growth of 58 percent in the fiscal year and gross profit margins of at least 60 percent for "the next several quarters."

"We feel the economic backdrop is much better today than it was back in February," he said.

Brocade shares rallied up to a 52-week high of $133.72 in October before crashing to a low of $16.75 in April.

Trading at roughly 80 times its projected fiscal 2002 earnings, Brocade is rated either "buy" or "strong buy" by 16 of the 20 analysts tracking the stock. >