Brocade Sends Strong Signals

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I understand if Brocade Communications Systems (Nasdaq: BRCD) shareholders are feeling a little nervous after the company's latest report. The storage-networking expert's free cash flow suddenly turned red after 11 straight quarters in the black.

Well, chill out, folks. There's a perfectly reasonable explanation for that harrowing turn of events: Brocade is growing.

After acquiring rival Foundry Networks for $3 billion, the company spent $80.2 million this quarter on the initial construction of a new campus, within walking distance from the old one in downtown San Jose, Calif. Foundry added another 950 employees or so to Brocade's headcount of around 2,400, so the old digs started to feel small. This is most likely a one-time project, budgeted at about $250 million in total, and should not be a permanent drain on Brocade's cash flows. Back that $80 million out, and the positive streak continues, with $57.6 million of incoming free cash.

Brocade is positioning itself for a bigger role in the storage market. It's taking on giants such as Cisco Systems (Nasdaq: CSCO) and EMC (NYSE: EMC) head-on. And investing in its own infrastructure is A-OK for a company with $704 million of cash equivalents and just $169 million of debt on its balance sheet.

Brocade is also buying back shares at a frantic pace. It has reduced its share count by about 5% in the past year and stepped up its research-and-development efforts to the tune of 21% above year-ago levels. That's quicker than the 12% sales growth to $366 million. Net income, meanwhile, grew 90% to $20.3 million. For a frame of reference, if you take out the approximately $80 million associated with the campus-expansion project, free cash flow grew 160% from $22.4 million a year ago to $57.6 million.

It's another show of strength in the corporate IT market, as Brocade pulled off the impressive performance despite this spring's doom and gloom and financing foibles. Interestingly, the markets didn't seem to respond to this report as a sectorwide omen -- Cisco and EMC drifted along with smaller Brocade competitors such as Dot Hill Systems (Nasdaq: HILL) and Adaptec (Nasdaq: ADPT), which seem to be flat after Brocade's announcement. But if a growing Brocade ain't your cup of tea, you might be able to catch an industrywide wave before the other guys show us what they have. I think we're in for a few nice surprises.

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