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EDITED TRANSCRIPTBRCD - Q3 2016 Brocade Communications Systems Inc Earnings Call

EVENT DATE/TIME: AUGUST 25, 2016 / 9:30PM GMT

OVERVIEW:

BRCD reported 3Q16 revenues of $591m. Expects 4Q16 non-GAAP EPS to be$0.21-0.23.

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C O R P O R A T E P A R T I C I P A N T S

Michael Iburg Brocade Communications Systems, Inc. - Senior Director of IR

Lloyd Carney Brocade Communications Systems, Inc. - CEO

Dan Fairfax Brocade Communications Systems, Inc. - CFO

Jack Rondoni Brocade Communications Systems, Inc. - VP of Storage Networking

Jason Nolet Brocade Communications Systems, Inc. - SVP of Switching, Routing, Analytics

Jeff Lindholm Brocade Communications Systems, Inc. - SVP of Worldwide Sales

C O N F E R E N C E C A L L P A R T I C I P A N T S

James Faucette Morgan Stanley - Analyst

Stanley Kovler Citigroup - Analyst

Simona Jankowski Goldman Sachs - Analyst

Vijay Bhagavath Deutsche Bank - Analyst

Jess Lubert Wells Fargo Securities, LLC - Analyst

Joe Quatrochi Stifel Nicolaus - Analyst

Tejas Venkatesh UBS - Analyst

Matt Robison Wunderlich Securities, Inc. - Analyst

Rod Hall JPMorgan - Analyst

Erik Suppiger JMP Securities - Analyst

Jayson Noland Robert W. Baird & Company, Inc. - Analyst

Chad Bennett Craig-Hallum Capital Group - Analyst

Dariush Ruch-Kamgar BofA Merrill Lynch - Analyst

P R E S E N T A T I O N

Operator

Good day, ladies and gentlemen. Thank you for standing by. Welcome to Brocade's third fiscal quarter 2016 earnings conference call.

(Operator Instructions)

As a reminder, this conference call is being recorded. And now, I would now like to turn the program over to our speaker, Michael Iburg, SeniorDirector of Investor Relations with Brocade. Sir, please go ahead.

Michael Iburg - Brocade Communications Systems, Inc. - Senior Director of IR

Thank you, Ronya. Good afternoon and welcome to Brocade's third-quarter FY16 earnings call. By now, you should have seen our press releaseand prepared comments, which are available on our website at BRCD.com. Those materials also were furnished to the SEC, and the press releasewill be distributed by Market Wired.

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AUGUST 25, 2016 / 9:30PM, BRCD - Q3 2016 Brocade Communications Systems Inc Earnings Call



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Before we begin, investors should note our comments today may include forward-looking statements, including but not limited to, statementsregarding Brocade's financial results, goals, plans, assumptions, strategy, business outlook, revenue, margin, expenses, tax rate, earnings, cash flow,capital expenditures, stock buyback, inventory, IT spending, and prospects. These forward-looking statements are based on current expectationsas of the date of this call and involve a number of risks and uncertainties and assumptions that may cause actual results to differ significantly.

These and other risks are set forth in more detail in our Form 10-K for the fiscal year ended October 31, 2015, and Form 10-Q for the quarter endedApril 30, 2016. Brocade expressly assumes no obligation to update any such forward-looking statements, whether as to the result of new developmentsor otherwise. In addition, this presentation involved various third-party estimates regarding market share and other measures which do notnecessarily reflect the views of Brocade. Further, Brocade does not guarantee the accuracy or reliability of any such information.

This presentation includes non-GAAP financial measures. For historical measures, the most directly comparable GAAP information, and a reconciliationbetween the GAAP and non-GAAP financial measures is provided in our Q3 2016 press release, which was furnished to the SEC on Form 8-K andposted on our website at BRCD.com.

After brief opening remarks, we will open the call to questions. Here to take your questions today are Lloyd Carney, CEO; Dan Fairfax, CFO; JeffLindholm, Senior VP Worldwide Sales; Ken Cheng, CTO and Senior VP of Corporate Development and Emerging Businesses; Jason Nolet, Senior VPof Switching, Routing, and Analytics; and Jack Rondoni, VP Storage Networking. With that I will now turn the call over to Lloyd Carney, our CEO.Lloyd?

Lloyd Carney - Brocade Communications Systems, Inc. - CEO

Good afternoon and thank you, everyone. Q3 was a productive quarter for Brocade. Against the backdrop of a mixed macro environment, weposted solid results with total revenue at the high end of our guidance range. In addition, we closed our acquisition of Ruckus Wireless and continueda strong year of new product [introductions] across our portfolio.

Beginning with SAN, our revenue was consistent with the Q3 outlook we provided on our last earnings call. Fixed-switch revenue was up by 3%year over year, largely driven by pull-through demand from all flash-array deployments. Over the same period we saw a decline in the directorsales, as sales cycles elongated, reflecting the sluggish storage environment reported by many of our partners. However, we were encouraged bythe early demand for Gen 6 directors from a number of leading-edge customers.

During the quarter, we achieved a significant milestone with the launch of the industry's first Gen 6 fibre channel director, the Brocade's X6, whichwe have already begun shipping for revenue. The Brocade X6 extends our technology leadership and expands upon our portfolio of Gen 6 solutions,including the Brocade G620 switch that we launched in March.

Widespread enthusiasm for Brocade fibre channel Gen 6 technology was echoed in our announcement by more than 20 partners and industryanalysts who affirmed the value of our portfolio and roadmap. Moreover, the Gen 6 ecosystem is developing faster than previous generations, astrong indication of the market readiness for this technology. Today, three of our OEM partners are shipping Gen 6 directors, with most othersexpected to launch within the next several months.

Further by early 2017, several of our largest OEM partners will have 32-gig storage arrays in the market, which will be ideally suited to connect withour Gen 6 directors and switches. Similarly, leading [AC] providers are already shipping Gen 6 solutions, a meaningful contrast to the launch of Gen5 technology several years ago.

The positive reception to our Gen 6 launch is consistent with recent industry reports from Gartner and others. In its June 2016 report on the futureof storage protocols, Gartner wrote, and I quote, storage performance bottlenecks are moving out of arrays and into storage networks. So fibrechannel will remain as the data center storage protocol of choice for the next decade, end of quote. Reports such as this confirm our long-timeexpectation regarding the longevity of fibre channel technology. Fibre channel is generally accepted as the lowest latency and most reliableprotocol in the market. And these attributes are more critical than ever as industry moves to adopt high-performance flash-based storage.

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During Q4, we expect additional opportunity from our announcement this week of new capabilities as Brocade analytics monitoring platform.Brocade AMP offers us an incremental revenue opportunity from our current install base and provides additional incentive for customers to moveto the latest generation of Brocade fibre channel technology.

Turning to IP networking, we exceeded our overall revenue outlook, largely due to the strong contribution from Ruckus Wireless, following thecompletion of our acquisition on May 27. We continue to see increasing demand for the Ruckus ZoneFlex axis points, in line with the ongoingindustry upgrade cycle to 802.11ac. With less than one-third of our axis points' install base running this latest generation today, we believe thiscycle and the growing demand for Wave 2 should continue to provide a long-term growth opportunity.

We're progressing well with integration of Ruckus, and our sales teams are already working collaboratively to optimize near-term opportunities.In fact, during the quarter, we had a number of joint wins, including success in education, communication, [toxicality] and consumer verticals. Weare excited to bring together the full benefits of our combined portfolios for the network edge, data center and service provider markets.

Underscoring our synergies early this week, Brocade was named a leader in the IHS wireless LAN scorecard, which cited the strategic benefits ofcombining Ruckus' high-performance wireless LAN offering and Brocade's extensive switching portfolio. As a networking pure-play Company,addressing the core of data center through network edge, we are well positioned to expand our market reach, diversify our revenue mix, and driveincremental opportunities for growth.

In terms of the wide IP networking business, sales into the enterprise and service provider markets came in largely within our expectations. However,weakness in the US federal markets in Q3 extended a disappointing year for this vertical. We're hopeful that an improved business environmentand our expanded portfolio that now includes wireless solutions will provide greater opportunity in the coming fiscal year. In addition, we saw adecrease in E-Rate deal flow, consistent with market commentary relating to funding, timing and administrative challenges.

From a portfolio innovation perspective, FY16 has been a significant year for IP networking business, demonstrating the strong execution of ourproduct and technology teams. Over the last several quarters, we have brought the market groundbreaking new products in strategic areas suchas IP fabrics, mobility, automation, and network visibility.

During Q3 we continued this momentum with an announcement of the Brocade Workflow Composer, a new server-based platform that providesend-to-end automation of cross-functional IT workflows furthering Brocade's long-standing heritage of network automation leadership. Thissolution enables greater business agility through a DevOp-style solution for IT operational improvement.

In addition, in keeping with Ruckus' stated 2016 growth initiatives, we are aggressively expanding our portfolio of indoor/outdoor wireless accesspoints. During the quarter, we announced two new solutions in the highly successful Ruckus ZoneFlex family. Expansion of this portfolio extendsour market reach, provides further opportunity to continue Ruckus' track record of outpacing market growth.

We also announced a general availability of Ruckus' cloud Wi-Fi, a wireless LAN management service offering stemming from the new Ruckuspublic cloud platform. Leveraging this platform, we expect to deliver integrated solutions that simplify the configurations, monitoring, andtroubleshooting of both wired and wireless networks.

In closing, we are laying the foundation for growth in the coming years. Industry commentary on fibre channel technology from Gartner and others,as well as indications of market readiness for our Gen 6 portfolio, demonstrate the value of our solutions in the market. We believe that our storagenetworking business will continue to provide long-term revenue opportunity and solid profit contribution.

IP networking, we continue to invest strategically with new IP innovations that are closely aligned with major industry trends. We expect to makeadditional announcements in our fiscal fourth quarter and believe that we are building a solid foundation for business growth and TAM expansionin the coming years.

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Finally, we have successful completion of our acquisition of Ruckus Wireless. We're pleased to welcome this talented and committed team to theBrocade family. Our combined strengths open up new opportunities and distinguish Brocade as a pure-play networking Company for the digitaltransformation [here].

At Investor Day events on September 21 in New York City, we will provide further details about our progress, take you through our marketopportunities and provide an updated financial model. I encourage you to attend in person or participate virtually and look forward to speakingwith you soon. Turn it over to Dan.

Dan Fairfax - Brocade Communications Systems, Inc. - CFO

Thanks, Lloyd. As you've heard from Lloyd, we've had a busy quarter. We closed the Ruckus transaction, announced the formation of a joint venturein China that will greatly expand the distribution of our IP products, and delivered a solid set of financial results. Against our quarterly outlook, SANrevenue met our expectations and the IP networking business overachieved. While Ruckus exceeded our guidance, unfortunately, US federal fellbelow our expectations. A number of factors contributed to our results in the quarter, but overall, we found the macro environment challengingin Q3 for both SAN and IP networking.

For fiscal Q3, Brocade reported revenue of $591 million, up 7% year over year and up 13% sequentially. This includes Ruckus product and servicerevenue of approximately $78 million. Q3 SAN product revenue of $282 million was slightly above the midpoint of our guidance range and down9% year over year, while IP networking product revenue, including Ruckus, was $209 million, up 35% year over year. IP networking revenue,excluding Ruckus, was $136 million and slightly below our guidance range, primarily due to US federal, which missed our expectations due to thetiming of large orders.

Ruckus revenue of $78 million was significantly above our guidance range, primarily due to better-than-anticipated linearity during June and Julyand a smaller-than-anticipated impact in the quarter from the purchase accounting adjustments to deferred revenue on Ruckus opening balancesheet. A schedule of the impact of the purchase price accounting on Q3 is included in today's earnings materials, including our forecast of adjustmentsin future periods. We have also provided GAAP and non-GAAP metrics, and a reconciliation in our filings today with the SEC and my followingcomments should be considered together with that information.

Our Q3 non-GAAP gross margin was 66.5%, down 210 basis points over the prior year due to lower SAN revenue, an unfavorable shift in bothproduct and customer mix, the impact of the purchase price adjustments, and an increase in inventory reserves related to new product transition.Q3 non-GAAP operating margin was 19.5%, down 740 basis points from the prior year, primarily due to lower gross margins and higher operatingexpenses. Q3 non-GAAP diluted earnings per share was $0.21, down from $0.27 in the year-ago quarter.

Opening cash flow of $33 million was below our outlook, due primarily to payments made in Q3 related to the Ruckus acquisition and higher Q3DSOs. As you can see from the $661 million share repurchase in Q3, we have repurchased and retired the shares issued in conjunction with theRuckus acquisition.

Looking forward to Q4 2016, we considered a number of factors, including the following, in setting our outlook. Although we see signs of stabilization,the macro environment remains challenging in both storage and IP networking markets. The Dell/EMC merger is expected to close within our fiscalQ4, and although we believe this merger will be positive for Brocade over the long term, both EMC and Dell are important customers for Brocade,and we are cautious about the potential for a continued near-term disruption as they close their merger and begin to integrate the two businesses.

The storage market continues to move through a significant transition, and we have observed that many end customers have paused projects inthe short term, which we have factored into our guidance. As Lloyd has discussed, longer term, we were very encouraged by strong industry andanalyst support of fibre channel storage networks, which we expect will continue to be a dominant storage networking protocol in the future.

Given this framework, our outlook for fiscal Q4, including Ruckus, is as follows. We expect SAN product revenue to be up 1% to 4% quarter overquarter, slightly below normal seasonal patterns. We expect our Q3 IP networking product revenue to increase between 17% and 22% quarterover quarter, primarily driven by a full quarter of Ruckus revenue and an expected rebound in US federal.

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We expect global services revenue to be up 1% to 2% quarter over quarter, we expect our non-GAAP gross margins to be in the range of 66.5% to67.5% in Q4, as we anticipate an unfavorable mix shift in Q4 as IP networking revenue increases as a percentage of the total. We expect Q4 non-GAAPoperating margin to be between 19% and 20.5% due to the full quarter impact of the Ruckus business. We have assumed a structural non-GAAPtax rate of 22% to 24% for Q4 2016. We expect non-GAAP EPS of $0.21 to $0.23 for Q4. And finally, we expect Q4 FY16 operating cash flow to bewithin the range of $140 million to $160 million.

We will address our longer-term view of the business in a few weeks at our September 21 Investor Day in New York. We will therefore be somewhatlimited today in what we say about our longer-term model and targets for FY17 and beyond. With that overview of our outlook, I will turn the callback over to the operator to begin the question-and-answer session. Ronya, please open the line.

Q U E S T I O N S A N D A N S W E R S

Operator

(Operator Instructions)

James Faucette, Morgan Stanley.

James Faucette - Morgan Stanley - Analyst

Hello, can you hear me okay?


Yes.


Thanks. Sorry about that. If we look at our questions, is that you talked about a longer time to close large deals. Is that really due to the macro thatyou highlighted or the weakness with traditional storage? Or are we seeing potential customers evaluate their storage architects or decisions,especially around Gen 6? Just wondering how you would rank order some of those impacts.


I don't know that we could rank order it, but think we can say that all of those impacted it. You look and most of our customers, a lot of our customersare large financials, so you can imagine what the Brexit impact had on us in Europe there, as they all tapped on the brakes. And they're all comingback in from their vacations and so on, so we're getting a good sense of what's going on there.

There has been some Gen 6, but I'd say we're involved in all the major deals. I'm looking at Jack; he'll finish up here, but we're involved in most ofthe major deals, and we haven't seen a lot of Gen 6 pause. I think a lot of customers, especially when you see this article coming out from Gartnernow. Which, I mean if you had any doubt about the viability of fibre channel long term, this should put it to rest.

You should believe in all flash; you have to believe in fibre channel, and the guys at Gartner -- usually though -- as most of us technologists, wenever say anything longer than three years out, maybe five years out. But Gartner's going to go out there and stick their necks out to 10 years,there's going to be fibre channel; it's going to be the storage connection mechanism of choice. That's a long way to stick your neck out. So I thinkthere's a strong feeling out there amongst all of us who know the storage business really well that fibre channel's going to be there for a while.

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So I think we kind of see a pause this last quarter. We had more than one of our partners had a slow down. Usually one partner slows down; theother's trying to make up for it. Had multiple partners this time around slow down. You had a bit of an overhang from the Dell/EMC merger, whichDan talked about. There's definitely some -- they're not as efficient as they used to be and I think that will go away once the merger is done andpeople are in seats.

There's multiple things I think that impacted us, but the longer term I think we feel pretty good. The pipeline certainly is the strongest we've seenit in the last probably eight quarters. And so we feel pretty good about it, and especially around the growth on the switches. So, we feel prettygood.


Commenting on the increase in switch sales is that we saw a pretty large drop off in director sales that balanced that out. Do you think directorthen recovers with Gen 6 or is this the more normalized level that we should be looking at.

Jack Rondoni - Brocade Communications Systems, Inc. - VP of Storage Networking

I think there's a little bit of a tough compare in there too on directors, I would certainly expect you'll see some increased traction as Gen 6 gets outthere into the market to the points that Lloyd and Dan made around some of the macro, as well as the partner changes you'll start seeing that. SoI don't think it's necessary indicating a fundamental shift for years. As we certainly make switches that are more dense, more dense, we've seensome customers go to switches. But in very, very large-scale environment, the OpEx savings from a large-scale director is still very, very compelling.


That's great. Thank you.


Thanks, James.

Operator

Stanley Kovler, Citi Research.

Stanley Kovler - Citigroup - Analyst

Hi. Thanks very much. So I just wanted to follow-up in terms of the outlook and just get a sense of the linearity that you expect in Q4 given thecomments around Brexit and customers coming back from vacation. As you think about your IP networking business for next quarter, and also ifyou can comment this quarter, how much of the upside in the wireless LAN business was from being able to recognize revenue? If we can revisitthat with some of the deferred impact that you commented last quarter was going to be challenging to recognize versus upside from new deals.And then how you think about that into fiscal Q4. Thanks a lot.


I think on the wireless front, seasonally July is very strong for the wireless business because one of our strongest verticals is education; that's thetimeframe which they do all their new build outs. To some extent if you follow the Ruckus trend, that was a seasonably strong quarter. I think overallIP story, we had -- if you look [out over] IP, there's IP growth quarter over quarter.

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One place we've really been short is on the federal space. We have new leader as of the beginning of the quarter in the federal space. We usuallyget about two-thirds of our federal revenue in the last six months of the year. We are behind that trend right now, but we expect to see a good Q4because we have good deals in the pipeline, any one of which could really make a big difference. So I think we should be back on track with theFed this quarter and the pipeline looks good.

I think there's been strong execution in the sales side. Ruckus team and the Brocade team, remember, we were selling together before we acquiredRuckus. So there's good familiarity with the team and there are some opportunities that we were brought into because Ruckus is there and viceversa, where they brought us in because we were now a part of the organization. So there was some of that efficiency and I would expect to seemore of that efficiency play out over the next year or so.


Stan, maybe to address your question on what revenue was deferred, so we did provide a table in the appendix materials or our prepublishedinformation. And we had a $6-million revenue impact for deferred revenue in Q3. We anticipate that will drop down quite a bit, down to about a$2 million impact. And that's coming from two places one is deferred sport arrangements and the other was inventory that had been shipped intodistributors, but deferred because it wasn't sold through. And we saw as we acquired the business that level of inventory at the distributors havecome down much greater that we'd expected prior to our taking active control of the business.

Operator

Simona Jankowski, Goldman Sachs.

Simona Jankowski - Goldman Sachs - Analyst

Hi, thanks. If we strip out the impact you talked about in federal, did your ethernet switching business grow? And also can you just expand a biton the cross-selling opportunities that you're seeing with Ruckus, whether in terms of the incremental revenues or bookings or pipeline, justanything you can share with us would be terrific.

Jason Nolet - Brocade Communications Systems, Inc. - SVP of Switching, Routing, Analytics

Hi, Simona, this is Jason. Let me start with the ethernet question. So on federal side, that was the most pronounced weakness in the switching partof the business, and if we had a stronger outlook there, or I should say stronger actuals there, we certainly would have done better.

The only other place I'd call out where we saw just a little bit of softness was in the routing space where we're busy briefing all of our top customerson a new product line that we're going to announce mid-September, and that caused a little bit of stall in the routing part of that portfolio. That'sone issue.

I'm sorry, what was the second part of your question? Oh, cross-selling, yes, yes, cross-selling. So, great question. So the teams are actively workingon a number of cross-selling initiatives, things that we identified going into the acquisition itself. Two examples there, one would be in hospitalitywhere Ruckus is particularly strong. And circumstantially, Brocade didn't really have a presence there with our wired switches, and so there's agreat opportunity to cross-sell into hospitality; that's work underway.

There's a sales leader assigned to that. His team is now folding in both the wired switches into the Wi-Fi play that they're running. And the otherone is -- and part of the reason that we see optimism in fed going forward is the federal space where, conversely, Brocade has had a very strongpoint of strength in federal, but Ruckus had not really made a play there. Getting the certifications as quickly as we can for those parts of the federalspace that require them and begin selling the combined wireless and Wi-Fi offering into the parts of federal that don't require certifications isanother major point of synergy that we're running right now.

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Jeff Lindholm - Brocade Communications Systems, Inc. - SVP of Worldwide Sales

I would add, this is Jeff, that we're also making specific investments in the fed team to fast start in taking in the wireless opportunity there.

Simona Jankowski - Goldman Sachs - Analyst

Great. Thank you. Thanks.


Next question.

Operator

Vijah Bhagavath, Deutsche Bank.

Vijay Bhagavath - Deutsche Bank - Analyst

Hi, good afternoon. Question is as follows; like to better understand which of these end markets and use cases that you are seeing the strength inIP networking. Is it primarily in a public sector, government, higher education? Are there any new incremental end markets or product segmentsthat you saw strength in IP networking and likely would continue to see the next few quarters will be truly helpful. And I have a follow-up.


BJ, this is Jason. Let me touch on a couple. The first would be with respect to the partnerships that we have on the VDX product line with our OEMsin particular, HDS and EMC, who use that product either in their hyper-converged offering, in the case of HDS, is their UCP offering. In the case ofEMC is their VxRail offering. Or is just part of a storage networking play that they're running.

And in particular with EMC, where I think you should probably know, they've taken our VDX switch OEM that rebranded it an EMC IP storage switchand are seeing terrific uptake there. For example, with all of our OEMs and the VDX switch portfolio, we were up 28% year over year. And with VDXand EMC in particular, we were up 47% quarter over quarter. With that hyper-converged play in the partner arena, as well as with the dedicated IPstorage play, we're seeing good growth on the VDX side.


From a wireless IP standpoint the top places we play, service provider, hospitality, and education, in that order, we continue to see great strengthselling IP products into those verticals.


Perfect. And then quickly, a follow-up. In terms of Ruckus, help us better understand the OpEx synergy story. Would you anticipate any bill ofmaterial, like BOM cost efficiencies post folding into Brocade, any OpEx efficiencies to be had on the sales and marketing line? Thanks.

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Sure, so this is Dan. We see a number of areas of synergy, the ones you'd expect we would've taken off the table fairly quickly. Some of the corporateof expense to location around Board of Directors and legal cost accounting, et cetera. We'll have further expense savings as we do a full integrationof our back-office systems.

The Ruckus business operated on an SAP-based system or an Oracle shop, and so we're working on that. So we believe we'll see real synergiescoming out of more efficient back-office and merging sales, CRMs, et cetera. So that work is coming and I think we will be able to talk more aboutthat at Investor Day in a few weeks.

Clearly, on the sales side, I think already we pointed out some of where we see the synergies in the market, but there will be model synergies thatI think we have touched on already. The Ruckus team pre-merger into Brocade, their focused on trying to move up into larger accounts where theydidn't have coverage, but we already have coverage in the market. Clearly, we think we can extend the blend there to make our sales dollars gomuch further and scale that up.

And then, where Ruckus had been strong with a lower touch channel operations, it was highly efficient. We will be able to extend there our productswhere we hadn't made those investments. So to just to give you an idea of some of the places beyond taking those Ruckus products into federal,where again, we have strong sales presence, a lot of marketing support. There's many places that we'll be able to scale out the business.

Jeff Lindholm - Brocade Communications Systems, Inc. - SVP of Worldwide Sales

I would even add maybe that there's just places where we both play that we can get that synergy going. So, for example, in service provider, Ruckushistorically, their play was more on managed services, an area that we think we can leverage to a great degree with our portfolio. While Brocadeis -- history there has been more infrastructure and sell-in where we can leverage that play too. So while we both play in service provider, we actuallyhave different sales motions that we can cross-poly, I think, and get more efficiency out of.


Thanks. That's a much longer answer than I was expecting, so thank you for the color.


Thanks, Vijay. Next question.

Operator

Jess Lubert, Wells Fargo Securities.

Jess Lubert - Wells Fargo Securities, LLC - Analyst

Hi guys, a couple questions. First, can you share with us how the VDX portfolio performed sequentially and year over year? I didn't hear thatmentioned or highlighted in the release.


Yes, Jess, it's Jason. So we were down just slightly, both quarter over quarter and year over year and it was really, for the reasons that Dan outlinedwith respect to US federal in particular, just a lot of weakness for us there based on what's happening in the business.

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The other point I'll make though on the VDX is that we actually saw an average deal size that decreased the little bit on us this quarter. A little bitunusual, but when you look behind that, you actually see that we sold to more customers in Q3 than we did in Q2 or Q3 of last year. So the abilityto attract new name customers and to win deals was still very robust. Just circumstantially, they happened to be smaller deals, many of them seeddeals that would grow over time, but in the quarter, started fairly modestly. So it was a combination of weakness in US federal and slightly smallerdeal sizes.


And then on routing side, it sounds like you've got some new products in the hopper that you're optimistic about. What gets that business movingback in the direction -- right direction? And how are you thinking about some of the new Jericho-based routing products coming from some ofyour peers? To what extent do they change the competitive dynamics you're seeing?


What gets that business moving for us is this new product. And we'll end up publicly announcing this a week before Investor Day, so I'll spend afair bit of time in my presentation at Investor Day sharing the details with you. But we've -- we held back in talking about this publicly, because wedidn't want to stall the existing business.

But we are very confident that we have a highly innovative Jericho-based product offering that's going to compete very effectively with a coupleof key points of differentiation. I don't want to preannounce and launch the thing on the phone here, but if you think about areas like visibility foranalytics, if you think about very dense 100-gig deployments for larger enterprises and service providers, and then you think about automationand the innovative position we've got in the market as a result of the StackStorm acquisition we did six months or so ago; these are the things thatwe think are really going to propel that new product offering in the marketplace. I will give you the full story at Investor Day.


And then last one for me. On the slide deck, you mentioned that your software revenue wasn't growing as fast as you anticipated. So I was justtrying to get a sense of in that software portfolio, what's going well, what's been a little bit weaker? And what gets you excited going forward thatmaybe things improve as we get into Fy17?


I think if you look at it from a booking standpoint, we're in pretty good shape. How revenue recognition is taking place it's a pretty wide varietyfrom site licenses for node licenses, all sorts of different methodologies we have to apply based on customer demand.

I think from a -- going through the carrier space, we're having good traction there with some of our OEM partners, the division that's run by HarryAult that takes care of the Hitachis of the world and the Dells of the world. We're finding those partners that have servers as part of their portfolio,there's a natural alignment with those partners around our load balancer on the virtual router. Some of those components offer a software packet.

So if I step back, I'd say we were seeing unexpectedly to a lot of us -- a year ago you'd asked me this, I'd say that probably isn't a hot spot for us. Butour OEM partners that have servers by their portfolio, good traction there, continue to have good traction with the large carriers. Our controller isgetting great deployment, as well as our traditional virtual platforms. So I think we're in pretty good shape. Again, not as fast as any of us initiallythought it would take off. Listen to all my peers, everybody is -- we're a little behind where we thought would be, but definitely not in doubt ofwhere the direction is.

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Thanks guys.


Thanks Jess. Next question.

Operator

Aaron Rakers, Stifel.

Joe Quatrochi - Stifel Nicolaus - Analyst

Great, this is Joe Quatrochi on for Aaron. I was wondering if you could go through the puts and takes on the guidance for the IP network. I understandUS federal, there's going to be a recovery there, and then also now it includes Ruckus. So maybe we can talk about those puts and takes therebetween Ruckus and the US federal.


So we normally aren't guiding specific product lines, and as we look at our IP business. But I know the street has models from tracking Ruckus. Ithink you can plan on us having baked in $100 million to $102 million worth of Ruckus revenue into that guide. And as Lloyd pointed out, we dohave normal seasonality where roughly two-thirds of our federal business post in the last two quarters of the year, the back half of the year. Wecame in short as we described and we are expecting to see some rebound in federal as we come through the fourth quarter.

Joe Quatrochi - Stifel Nicolaus - Analyst

That's helpful, and then just a quick follow-up if I could. How do we think about the attach rate of the directors versus switch for the all-flash arrays?I know you touched upon it earlier. Did you see a larger switch attach rate this quarter just in anticipation of the Gen 6 or just some color therewould be helpful? Thanks.


Yes, so this is Jack. Certainly, we did see some good, strong attach rate with our switches with our partners' flash array. So we have lots of jointgo-to-market motion, sales incentives that when that part of their portfolio, which is selling very, very well, we work with them to make sure ourswitches, as well as directors, connect to that as much as possible.

It's not necessarily an exclusive switch-only play. There's lots of other dynamics that go into the environment. A lot of it has to do with the size ofthe environment; if the environment is large, that's where the directors come into play, irrespective of what's happening with all-flash. Overall, aswe stated earlier, as we start ramping Gen6 and as we get through some of the other broader issues, we expect the director numbers to get backto what we would expect. But we're pleased with the switch results we're seeing, especially in the context of all-flash arrays.


Thank you. Operator, next question.

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Operator

Tejas Venkatesh, UBS.

Tejas Venkatesh - UBS - Analyst

Thanks for taking my question. I was curious how the campus portfolio did in the quarter.


Tejas, this is Jason. Campus did okay, again, just a little bit softer than we would have expected. And again, not to sound like a broken record, butUS federal was a contributor to that softness.

I would say that with respect to E-Rate though, especially in combination with Ruckus, I think we fared pretty well year to date, Ruckus in particular.And going forward, of course, we're going to combine the two portfolios to have a more complete play as we go after bids going forward. Aboutthe only weakness we saw was in the US fed space and we've talked about that and hopes of recovery here.


Got it, and I wanted to -- go ahead, sorry.


I'd say on the Ruckus front, as far as E-Rate, even though E-Rate spending was down, we're pretty sure we gained at least 2 points there becausewe saw pretty good traction on the Ruckus front in the E-Rate space.


Got it. I wanted to revisit federal. We didn't hear any of your competitors specifically call out federal weakness. I was curious how much of thesoftness that you saw there was because of the failed leadership transition versus spending.


To be honest, I think it's an execution problem and we have new leadership there and fully expect to see that get corrected.


That's helpful. Thanks.


Operator, next question.

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Operator

Mitch Steves, RBC.

Unidentified Participant - - Analyst

Hi, this is [Jerial] on behalf of Mitch. Just have a question on the SAN business; it was down high singles. When could -- should we expect a flatteningof the revenue line there?


I think we're going through our models, we're looking at the effects of some of the dynamics we talked about, and we're going to outline that inour Investor Day in September. We're going to go through that with you at that point.


The outlook for this quarter is 1 to 4 up. So, some moving parts, but again, you'll -- we expect to see it up this quarter. The pipeline is healthy; ashealthy as I've seen in the last eight quarters, and we'll have more at our analyst day in September.


If I could on a follow-up, the margins look a tad lighter. What was the negative margin impact from Ruckus for the quarter?


It's a longer conversation. The -- let's call it the legacy Ruckus gross margins, which were quite strong for business and very consistent, werenegatively impacted by purchase price adjustments, particularly the revenue adjustments that we have outlined in the package. Now we havetaken as a non-GAAP adjustment the inventory write-up amount, but there was also this -- a haircut, I can point out more specifically to give youa sense. On the services side all of the costs remain for the services business, but the revenue is down. So that caused the overall impact to benegative.


Thank you so much.

Operator

Matt Robinson, Wunderlich.

Matt Robison - Wunderlich Securities, Inc. - Analyst

Thanks, Dan. You mentioned of that sequential increase in margins, is that mostly from services absorption?

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Yes, so some of it's from services absorption. We'll have a mix shift when we have full quarter of Ruckus revenue in, and we're coming up, as Lloydjust mentioned, a bit light on what we'd normally see for our SAN seasonality. But largely it's better absorption.


Are you backing off your $60 million run rate for software this quarter?


We are seeing from a booking standpoint, we're looking pretty good there. And we're looking at the numbers every week right now. We'll have abetter update for you at the analyst day because we'll have another month behind us.


What's the -- with the channel inventory up another quarter, up sequentially for another quarter, what makes you so pleased with your pipeline?And is -- are you thinking that -- is that channel inventory up partly because it's Gen 6? I would think it's too early for Gen 6 to be that big of volume,but just give us a little color on what's got you so excited.


Well, so we normally see that in -- there I think that you're referring to the OEM storage. So with those inventories, it's not unusual for us to see andgoing into Q4 and Q1, those inventories to come up somewhat. So if you look at it a year ago, I think we're -- we exited Q3 a year ago with roughlyabout the same level of inventory in a dollarized amount, and usually it really depends on OEMs pulling inventory in anticipation of shipping theirlarger transactions where they configure and repackage before sending it out.


Yes, I hear that, but it's still the highest level it's been since the third quarter of 2013 in terms of weeks.


Seasonally it's not different though. If you do the compare rod it usually doesn't go up into this quarter because you expect to sell more throughthis quarter in Q4. And as I said, pipeline is pretty healthy. We have the healthiest pipeline now than probably the last eight quarters. So a prettyrobust measurement of deals in the pipeline and what we think we're going to be able to get done.


That's -- why don't you explain why you think it's healthy, just the [name] qualitatively or just volume over the next six months?


No, I think it really comes down to [map v]. So we have good visibility in our funnel to the larger transactions. This is what moves that number atthe end of the quarter is, not the run-rate business per se, which moves pretty steadily from our hubs through the OEMs. But it's really the staging

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of inventory in advance of larger customer shipments. And we made the comment there was a fair number of larger deals that we don't want tomake excuses about it, it's around execution; but that got left on the table at the end of the quarter.


Okay, now -- you mentioned some interesting things about VDX in the commentary, but there wasn't much in the prepared remarks that youprinted. How was the growth there?


Yes, so I spoke to that a little bit earlier, Matt. But just to summarize, the area that we see the most positive growth in the quarter was with respectto the design wins that we have through the OEMs. So HDS uses VDX and UCP, and EMC uses it in a variety of different use cases, including in their[VX rail]converged offering. So we were up double digits quarter over quarter, year over year there, feel very good about that. About the onlyweakness we had with respect to VDX was federal, and we've already talked through that.


So that -- was that weak enough to keep it from growing overall?


Yes.


Matt, we're going to need to move on to the next caller.


I appreciate you taking the time.

Operator

Rod Hall, JPMorgan.

Rod Hall - JPMorgan - Analyst

Hi guys, thanks for the question. I just had a couple, I wanted to come back and make sure I understood the revenue trajectory. So you guys areguiding a number that's a little bit weaker than we anticipated. But yet you're saying fed rebounds. And I think what I'm hearing you say is fedrebounds partially but not all the way. So the reason it would be a little bit weaker is you still don't have all that fed revenue back. So I just wantedto double check that and then I've got a follow-up.


That's correct. We didn't bake in a full recovery of what we fell short in Q3 into our Q4 numbers. So you're right.

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Okay, and then on fed, I just wanted to see, is this just a couple of deals, is it a handful of deals, is it a pretty finite number of things or is it a broaderpattern that you're observing?


It's both actually on both SAN and IP. So we've got some nice, healthy, big deals in the pipeline. Some of them different confidence levels, but theexistence of them is a positive movement, but we also have a good coverage of volume deals as well. So it's an increase across-the-board in bothSAN and IP and field of the opportunities.


The last thing I had for you guys is on flash, I'm going to ask a completely opposite question from probably what you're used to maybe. But do youthink that Gen 6 will actually drive acceleration of flash? In other words, as it becomes available, people might accelerate flash adoption? It seems-- what we find is consistent with what you guys are saying, that flash is generally being attached with SAN, so with fibre channel. But does Gen 6accelerate that?


Yes, absolutely right, because when a customer installs Gen 6, they put their flash in there; they're going to be getting the maximum performancepossible out of those devices. That's why we're so excited about that market, because it's synergies, it's good for -- if it's a legacy network, it drivesthe network refresh opportunity. And then when customers put flash in their environments and they see that success, they're going to buy moreflash and Gen 6 helps enable that.

The other thing to remember too is with our Gen 6, with the speed and latency improvements are there, but we've added a lot of instrumentationand analytics into those -- into that product portfolio, which is really going to become vitally important in the future. You're going to hear moreand more people in the sector talk about the importance of analytics, and we have it all over the Gen 6 portfolio. Dan and Lloyd mentioned ouranalytics monitoring platform, so that's going to become more and more important in the future as well.


Is Gen 6 fully available in volume now or is it -- I'm sorry I keep -- this is my last question for sure. But is it fully available in volume now or it won'tbe available for a few more months? Can you give us a timing idea?


It's generally available from Brocade. Three of our partners have announced that the larger Gen 6 portfolio, the directors. Already we expect therest of them or a number of them over the next couple of months. If you remember, we launched our Gen 6 switch which is available from all ofour partners back in March. So Gen 6 is definitely hitting the ground hard now.


Okay, thanks a lot, guys.

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If you haven't seen that Gartner report, take a look at it. They even refer to -- if you really want to get maximum efficiency out of your all-flash arrays,you should be at 32 gig. So they compare, it's 32-gig fibre channel at 40-gig ethernet, which costs a whole lot more, doesn't have the right latency.And so the obvious thing if you want to maximize your all-flash deployment is 32-gig fibre channel.


That's exactly what we're finding, Lloyd, so sounds right to me. Thanks a lot for all the questions.


Sure thing, Rod. Ronya, next question

Operator

Eric Suppiger, JMP.

Erik Suppiger - JMP Securities - Analyst

Yes, I was just wondering, have you seen any change in terms of IP SAN in terms of the competitive dynamic there?


Certainly. This is Jack. We have seen a number of, let's say networking vendors talk about the importance of the market, really validating the positionthat we had a year or so ago. You hear our partners also talking about the importance of the network and dedicated IP storage networks or evenin hyper-converged solutions. So certainly we do see that as validation of the market.

That said, we're very confident on our strategy relative to the offerings. The VDX, as Jason has already mentioned, is seeing good strength there.And with our partners in that particular use case. And also, we're very confident about those partnerships as well, where we have great infrastructurethat we can leverage from our existing storage business, go-to-market infrastructure, back-end infrastructure to really go and hit the market verywell. So we still believe IP storage networking is a very important growth market, and it will be -- continue to be a meaningful component of usgrowing our storage footprint overall.


Maybe just add to that briefly, and this is Jason. If you think about EMC OEM and the VDX as an IP storage switch, they obviously had their choiceof any network vendor out there that got partnerships with other people. But ultimately they concluded that we had the best technology for thatIP storage use case, and that's why they chose to exclusively offer the Brocade VDX switch as a Connectrix IP storage switch portfolio from EMC.So it's a good proof point, I think, as to the superiority we have in the product portfolio.


Real quick, can you give us a sense for how MLX did in the quarter?

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MLX, as I mentioned earlier, Erik, was just a little bit soft as well. Again, US federal is a contributor there, but also, as we've been briefing our existingaccounts and prospects on this new product line that we'll announce September 16th, as you might guess, many of them said, hey, that's a reallycool offering. We'll sit tight for now and wait for that product to become available. The good news is it will [FCS] in the next three weeks, and again,I will give you the full story at Investor Day.


Very good. Thank you.


Thanks, Erik. Next question.

Operator

Jayson Noland, Baird.

Jayson Noland - Robert W. Baird & Company, Inc. - Analyst

Thank you. Sorry if I missed this, but I wanted to ask about the impact of AFA on your SAN business, Lloyd. Can you talk to the math behind thistransition? Or is that -- is this more of an Investor Day topic?


Probably Investor Day topic. One of the good things and we've talked a lot about flash's impact. Flash is an impact because we knew from talkingto flash vendors that they were connecting to SAN infrastructure, but we didn't see the numbers coming through; now we see numbers comingthrough. I think you're going to see -- on some of these switches, by the way, the people rolling out these small all-flash arrays, as these arrays growin density, I think they're going to end up connecting them into directors instead, because you'll need more connection space. And there's a lot ofvalue above and beyond what you get in switches that Jack has delivered in the director. So I think come Investor Day, we're going to have a betterview of what the impact is of the all-flash arrays on our SAN business and what we project going forward based on it.


Okay. Thanks. Make sense, there's puts and takes. Dan, I wanted to ask on gross margin, it looks like SAN is still in the mid-70s and IP in the high50s. Is that roughly correct and should we expect those to hold steady?


I think that's directionally correct, yes, from a Brocade side. Now when see, let's call it normalized after we finished passing through the purchaseprice adjustments the Ruckus business with its higher growth rate should bring our portfolio up on the IP side.


Okay. Thanks, guys.

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Operator

Chad Bennett, Craig-Hallum.

Chad Bennett - Craig-Hallum Capital Group - Analyst

Great, thanks for taking my questions. Just a couple. So just an update on Ruckus expectations. I think on last call, Lloyd, you were comfortable, soto speak, with Ruckus grew in last year 14%, 15% and mid-teens growth was expected this year. Although, if I look at, and they did better in -- outof that gate than you guys thought. But if I look at your guide, relative guide for Ruckus in the current quarter of $100 million to $102 million, andyou got purchase accounting of another $200 million on top of that, it's not that type of growth rate. In a nutshell, have our Ruckus growth-rateexpectations changed?


I would say there's a range, and I think what we'll do is come Investor Day, I will be able to give you better granularity as to how we go about thatrange. Right now we are in the mode of learning the Ruckus system and their seasonalities. We had a really good two-month stub here, whichincluded one of their strongest quarters, strongest months. And so, we're making adjustments for that, coming into this period here.

We -- there is upside to Ruckus over the year. In the short term, we're being prudent and trying to figure out exactly what that window should be,and we will give you some more visibility to it come September -- ?


21st.


21st.


Okay, and then one follow-up for me. So I hate to harp on the same subject, but the router -- the IP networking router business has beenunderperforming, I'd argue for this -- this is the third straight quarter. Is it really a -- we're waiting for the product upgrade issue or is there somethingmore secular, so to speak, happening in the overall router space that we're not factoring in?


No, I wouldn't think about it as an overall market condition necessarily. I think last quarter, we explained the weakness in the MLX product family,in particular, on one of our largest [SPA] accounts who completed their 10 GigE build out and decided to take a pause before they moved forwardwith 100 gig. And so, that was the situation last quarter.

This quarter because we're now right on the cusp of releasing this new product line, we've been actively briefing literally hundreds of our accountson the new product line. So it was pretty natural to see some stall there. We knew it was going to happen. We waited for as long as we could, butthat's definitely a key contributor this time around.

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So you'll hear me talk about the new product and why it's so compelling, and why we think the uptake will be quite quick, both within the installedbase as well as new named accounts going forward based on the competitiveness of the new offering.


Chad, just a little straight talk here. You're absolutely right; it's been off for a couple of quarters now and I've told the team here that it was my callbut we probably should have refreshed this box a year ago. In this platform, it was basically, what, seven to eight years old? The base platform,that's a long time to have a platform out there.

Looking at our product roadmaps, I made the call to wait longer, milk the platform a little bit longer; we shouldn't have done that. We should -- wewouldn't have this problem if we had accelerated the deployment that we have right now. So you're right, you've seen it. You're close to it. Youknow what we're doing, and the problem gets solved this quarter.


Great. I appreciate you taking my questions. Thanks.


Ronya, we will take our last question.

Operator

Dariush Ruch-Kamgar, Bank of America.

Dariush Ruch-Kamgar - BofA Merrill Lynch - Analyst

Hi guys. Thanks for taking my question. A couple. One is what would wireless sales have been for the entire quarter?


What would wireless -- We're not ready to tell you -- go back on the call here and give you the purchase price adjustments and refigure the calendarquarter to the fiscal quarter. If you'll just give us a pass on that one.


Absolutely. I will follow-up offline. Wanted to -- you guys sound like you're pretty bullish on SAN, I just want to go back to it. You have a productcycle coming up as well with Gen6. But the guide is actually somewhat negative and somewhat below the historical seasonality. So wonderingwhat's driving this dispersion between the two.


For the first time, we had, as I said, I've had people ask me before for in the last almost four years, people say, how come this storage vendor isdown and you guys still manage to make your numbers? How can you do that?

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Well, this past quarter, we had a couple of our partners be off, not just one partner be off. We -- Dan, talked about what's going on with EMC andwhat we expect to see when EMC/Dell merger finally gets completed and we actually see some traction there.

We had the IBM guys get out of the server business; that transitioned to Lenovo and some other Chinese players. It's going well, but it's not whereit has completely been supplanted as yet.

And so, there are a lot of moving parts; usually, we don't usually see all these moving pieces. We saw the Brexit thing with the guys in New Yorkwhere all the major banks had big transactions. They said, let's wait and see what happens.

There's a lot of variables in this, so we are being prudent, I think, based on the pipeline. The pipeline alone would lead you to a different discussion,would be a bigger number, but you'd dial-in some of the factors we see swirling around, the biggest one being to me actually is EMC/Dell. IfEMC/Dell performed close to where we'd expect them, we wouldn't be having this discussion. One partner makes a huge difference.

And so we expect to see them rebound. There are a lot of really smart, motivated people in the EMC sales force. They have a new series of productsthey just launched about six months ago. So we expect to see them get going and be back where they should be.


Thanks a lot for the color. You mentioned Brexit; I just wanted to touch on that little bit as well. EMEA's been a fairly strong growth driver for youguys now for the past few years, and just wanted to get a little more color around it if you could, just in terms of early signs you're seeing and anypotential fallout as well.


I think we have a great leader over there, Mark, that's navigating the storms there. [We don't a] significant deal in Turkey (inaudible) deal in Turkey,that would have made a big difference this quarter. That is of course on the sidelines right now with what has happened there.

Then the overall -- the banking sector, the major impact is financial, see how these guys are figuring out where they should invest, where theyshould put data centers. They have people who are -- my plan about data centers here to leverage Europe and all of a sudden I move my datacenter from where I thought was the right place to put it.

So there are all kinds of different transitional things going on that impact us. I think for the longer term, we could see it stabilizing already. I thinklonger term, we'll be fine.


Sounds good, and one last one if I could sneak it in. You have a couple of product cycles going on in switching. Just wanted to get a sense of howthe IP fabric product cycle is ramping and the momentum behind it as well as the ICX fabric as well.


I'm glad you asked. The IP fabric is going well. We have about 30 customers that are either design wins that we've now got in -- on the docket or[PFCs] that are ongoing. These are with larger accounts. Right? IP fabric by definition is going after larger networks and bigger accounts, so thecycle time is a little bit longer than we have seen historically with VCS fabric, which is a slightly easier sale, I suppose. But we're happy with whatwe are seeing so far.

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The story I'll tell you at Investor Day, if you come, is that the IP fabric combined with this new routing product line combined with the WorkflowComposer technology as a result of the StackStorm acquisition, we think is a very compelling combination of technologies to go after that datacenter design win.

On the ICX side, we've done a ton of refresh on that product line over the last year and half. We feel very good about where that portfolio is. We'rebusy adding a new low-end switch that we think meshes well with the hospitality play that Ruckus has been so successful in.

But by and large, other than that new low-end switch for hospitality and integrating into the Ruckus Wi-Fi cloud play with ICX, it's largely aboutgetting the sales synergies that we talked about earlier in hospitality, in federal, and in service provider, as Jeff outlined. So there's no product gapsfor us there; that's really getting the sales synergies and the go-to-market synergies that we've been planning on.


Great. Thanks so much for the color guys.

Operator

That does conclude our Q&A session. I would now like to turn the call back to Mr. Michael Iburg for any further remarks.


Thank you, operator. Thank you for joining us today as we reviewed our Q3 results. We look forward to reviewing our Q4 results with you in lateNovember. Operator, this concludes today's call.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does concludes today's program. You may all disconnect. Everyonehave a wonderful day.

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