Brocade Eyes SEC Settlement

Brocade could be close to a settlement with the U.S. Securities and Exchange Commission (SEC) regarding its accounting problems. But that may not be the end of the company's legal troubles. (See Brocade Reports Earnings.)

During Brocade's earnings call Thursday night, CEO Mike Klayko said the company is discussing a settlement with the SEC regarding its restatements related to stock options accounting. The switch maker has set aside $5 million for a settlement expense. Klayko said the $5 million was Brocades “best estimate, and subject to change as discussions continue.”

If that’s all it costs, Brocade may not even break a sweat, considering it reported net income of $12.6 million for last quarter and has $512 million cash on its balance sheet. “This is far less than we expected for what seemed like a blatantaccounting infraction,” financial analyst Steve Berg of Punk, Ziegel & Co. wrote today in a note to clients.

However, the SEC inquiry is just part of the problem regarding Brocade’s accounting woes. The SEC and U.S. Department of Justice (DOJ) have been jointly investigating Brocade, and Klayko did not say whether the DOJ was involved in the settlement talks. Brocade also faces class action suits from investors who claim the company misled them during the periods for which it's restated earnings. (See Brocade Hit With Class Action Suit.)Even if Brocade gets off with a $5 million settlement, the investigation has taken its toll in the boardroom. Klayko’s predecessor Greg Reyes resigned when the stock options mess first came to light 13 months ago. CFO Tony Canova left in December after Brocade completed its earnings restatements. (See Brocade Switches CEOs, Restates and Another Brocade Exec Bolts.) Board members Christopher Paisley and Seth Neiman have told Brocade they will not seek re-election.

News reports earlier this month state the SEC is likely to bring civil charges against Reyes and the DOJ is investigating criminal charges. Brocade and Reyes are also considering litigation against each other as the company seeks to avoid paying Reyes $1.7 million in consulting services executives say the former CEO never completed. (See Options Preserved and Brocade Blasts 'Consultant' Reyes.)

All this means it won't be "end of story" even after Brocade settles with the SEC. In a note to clients today, financial analyst Shebly Seyrafi of Kaufman Bros. Equity Research said there was “continued uncertainty related to the SEC investigation. It is somewhat encouraging, however, that Brocade is beginning active discussions [with the SEC].”

There was less uncertainty about Brocade’s sales last quarter. Its revenue of $170 million far exceeded expectations and its previous forecast. Brocade attributed its performance to strong sales of 4-Gbit/s gear and director switches, and large deals with Porsche, IBM Global Services, and China Mobile.

Brocade’s lead over rivals McData and Cisco in 4-Gbit/s switches and directors seems to be paying off. (See Cisco 4-Gbit Director MIA.) Klayko says 72 percent of Brocade's revenues last quarter came from 4-Gbit/s equipment, up from 50 percent the previous quarter.Observers also have noted Brocade's apparent rise in the switch market. In the latest Byte and Switch poll, 83 percent of respondents think Brocade stands to lead the market if Cisco backs out.

— Dave Raffo, Senior Editor, Byte and Switch

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