McData Struggles to Keep Pace

Unlike its major switch rivals, McData Corp. (Nasdaq: MCDTA) had mixed results when it announced its quarterly earnings today. Its revenues and earnings rose, but so did its expenses, and guidance failed to suggest much growth next quarter.

McData reported income of $3.3 million, or $0.03 per share, beating the First Call estimate by $0.02 per share. That was up from $2.1 million, or $0.02 per share, in the previous quarter, but down from $10.6 million, or $0.09 per share, from the same quarter last year. McData's $114 million in revenue for the January quarter was up 20 percent sequentially and eight percent year-over-year (see McData Nudges Up Q4 Earnings).

For the fiscal year that ended in January 2004, McDatas income of $24.3 million or $0.21 EPS was up from $5.9 million or $0.05 EPS last year. Revenues for the year grew 28 percent to $418.9 million.

"Our product revenue was up on all fronts," CEO John Kelley said in a call with analysts. "We held serve in directors and switches, with more to come there." [Ed. note: That's not a typo. "Held serve" is a tennis term.]

McData was the last of the three major switch vendors to report earnings, following positive reports by Cisco Systems Inc. (Nasdaq: CSCO) and Brocade Communications Systems Inc. (Nasdaq: BRCD) (see Brocade Battles Back and Cisco Storage Growing Up).Taken overall, the quarter was a big change from the previous one for switch makers, when McData got hurt by pricing pressures from EMC Corp. (NYSE: EMC), Cisco had production problems, and Brocade failed to capitalize on its rivals' woes. (See McData Maudlin Over Price Pressure, Cisco Still a Kid in Storage, and Did Brocade Blow an Opportunity?).

McData's guidance for next quarter is lukewarm, however: The forecast is for $108 million to $115 million in revenue, from breakeven to $0.02 EPS. Splitting the difference in those ranges would represent sequential drops in both revenues and earnings.

Brocade’s guidance also called for a slight drop in earnings next quarter, but Brocade is expected to get a boost in the second half of the year from an extensive product rollout.

Since McData has the lion's share of the enterprise market, some observers felt Cisco's jump from barely any revenue to $40 million in its latest report could reflect poorly on McData, since Cisco too sells into the enterprise. (Brocade dominates the entry-level and midrange markets.) However, it's unclear how much of an effect Cisco had on McData specifically. McData reported a 12 percent sequential increase in ports, the same as Brocade.

McData’s operating expenses of $59.9 million last quarter were up 14 percent sequentially, due primarily to the full quarter impact of the recently completed acquisitions of Nishan and Sanera Systems (see McData Sweeps Up Nishan, Sanera). McData also took a charge on deferred compensation related to the layoff of 92 employees – roughly 9 percent of its workforce – on January 30. The company said it reduced staff to keep 2004 expenses flat (see McData McDownsized). Kelley did say he expects to increase headcount by about 25 to 1,050 this quarter with most of the additions coming in sales and marekting.While expenses rose, McData’s gross margin dropped sequentially from 58.2 percent to 57.3 percent. Guidance called for a continued rise in operating expenses to between $59 million and $62 million and a decline in margins to the mid-50s.

Some good news surfaced in McData's report of reduced dependence on its largest customer, EMC. EMC represented 47 percent of McData’s revenue for last quarter, down from 54 percent in the previous quarter. At the same time, McData’s revenue from IBM increased: It accounted for 29 percent, up from 21 percent.

— Dave Raffo, Senior Editor, Byte and Switch