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Brocade shares jump on strong earnings

Shares of the maker of network switches rise after it releases positive first-quarter earnings.

Shares of Brocade rose more than 13 percent today after the network switch maker released positive first-quarter earnings.

The San Jose, Calif.-based company earned 12 cents per share on net revenue of $42.7 million, compared with a loss of 4 cents a share on $8 million in revenue for the year-ago quarter. Analysts expected the company to make 7 cents a share.

At the 1 p.m. PST close of regular trading today the shares gained $32.25 to $275.88 on volume of 2.8 million shares. Yesterday, the company also set a 2-for-1 stock split for shareholders of record as of Feb. 28, 2000.

"We expected a very good quarter out of them and we were surprised," said associate analyst Glen Ingalls of SoundView in an interview. "They were far beyond what we expected in terms of revenue and operating margin. Their operating margin increased from 8.5 percent three months ago to 19 percent this last quarter. That's just unheard of."

Ingalls also mentioned the company's updated Silkworm product line contributed to strong earnings due to a lower selling price and higher profit margin.

The company's first-quarter revenues also increased 42 percent from the previous quarter. Chief executive Greg Reyes said in the report "growth reflects the market momentum and our continued investment in channel expansion. We signed two additional (original equipment manufacturers) in the first quarter, Amdahl and HP, which increased our OEM channel penetration to more than 90 percent."

Brocade develops and markets switches and network software that connects computers with storage devices such as disk and tape drives. Among the company's customers are IBM/Sequent, Compaq and Hewlett-Packard.

Morgan Stanley Dean Witter upgraded the stock to "strong buy" from "outperform" today and set a 12-month price target of $350.

"The company has a superior management team who has proven that it can deliver on aggressive strategic and operational goals," Morgan Stanley analysts George Kelly and Gillian Munson said in a research report.

Ashok Kumar of Piper Jaffray initiated coverage of Brocade yesterday with a "buy" rating. He raised his price target today to $300 from $275.

"Brocade is one of the best-positioned companies to emerge as a principal fiber-channel switch vendor," Kumar said in his report.

Kumar estimates the company will generate $227.7 million in revenue for fiscal year 2000 compared to last year's $68.7 million.

As Brocade's shares have risen, the shares of competitor Ancor have followed.

In heavy trading yesterday, Ancor stock rose $11.44 to $54.94. Today, however, the shares slipped $2.75 to $52.19.

"There is a wide divergence in the valuation of the two companies," Kumar said in an interview. "Brocade is valued at 49 times calendar 2001 sales while Ancor is about a tenth of that."

"The product lines of the two companies are identical," he said. Brocade was just earlier to the market."

Ingalls agrees but adds, "There's more to a switch than plugging a wire into a wall. Brocade has a robust operating system running on its network which is key to traffic management." He believes Brocade products are better designed partly because they use fewer chips.

Kumar also said there is a chance of a major change in the valuation difference between the two companies.

"Two things might happen" said Kumar. "Either Ancor shares rise to Brocade's valuation levels, or Brocade falls back to Ancor's."