McData Feels the Pinch

McData Corp. (Nasdaq: MCDT) has good news and bad: It has revised its third-quarter earnings forecast, while lowering its earnings per share (EPS) estimates (see McData Lowers EPS Outlook).

McData says it now expects revenues of $85 million to $87 million (up from $82 million to $86 million) when it reports its earnings October 17. But the company has lowered its EPS expectations to $0.01 - $0.03 (from $0.03 - $0.05). This is still in line with First Call estimates of $0.02 a share.

Buoyed by the news, brokerage firm Dain Rauscher Wessels upgraded its rating on the company from a buy” to a “strong buy."

However, despite the upbeat forecast from McData, management said it is seeing gross margin pressure from slowed sales of its director switches by OEM partners. (Director switches link together multiple distinct storage networks.)

McData generates the vast majority of its revenue through OEMs. EMC Corp. (NYSE: EMC)and IBM Corp. (NYSE: IBM) accounted for 68 percent and 16 percent of revenue, respectively, last quarter.McData could be facing other pressures, too. Brocade Communications Systems Inc. (Nasdaq: BRCD) intends to ship its Silkworm 12000 core switch towards the end of the fourth quarter (see Is Brocade's SilkWorm Losing the Thread?).

This product, Brocade's first pass at the director market, will compete head-to-head with McData’s switches, which have kept McData on top of this particular market segment for a couple of years.

Analysts say it's possible that the threat from Brocade, combined with a poor economy and weak demand, could increase the pressure on McData -- and on its margins.

By early afternoon Friday, both McData and Brocade were taking a hit in the public markets. McData was down 8.33 percent a share to $11.66, while Brocade was down 5.5 percent at $19.03.

— Jo Maitland, Senior Editor, Byte and Switch http://www.byteandswitch.com