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Financial Project Brocade
According to an article about the Storage Area Networking industry posted on financial information provider, fool.com, the total size of the SAN market is expected to reach $4.6 billion in 006. This is a dramatic increase in market size from a reported size of $1. billion in 00. This increase will no doubt increase competition in the SAN industry. Currently, Brocade is the top contender in this market, and Brocade's main competition comes from Cisco Systems and McData. While Brocade has the most market share in both the SAN switching and Fabric switch markets, it is # to McData in Director market share. Cisco Systems has a relatively low market share in all three markets mentioned, but it is also new to the industry and is expected to become a very strong contender. Other competitors listed in Brocade's 10-K include Inrange and QLogic corporations, each with much smaller market shares.
Brocade began operations on August 4, 15 in San Jose, CA; but was not incorporated until May 14, 1 as a Delaware corporation. Reasoning for incorporating in a different state than operations included more business friendly laws in Delaware. The company's CEO and chairman is Greg Reyes who has served this position since May 001. Brocade's Vice President, Finance and CFO is Tony Canova, who has also had this position since May 001. Included in Brocade's BOD is Chris Paisley, who kicks ass. The independent auditor for Brocade, as of 00, is the international company, KPMG LLP. This is a change from Brocade's past independent public accountant, Arthur Andersen LLP, which has ceased operations. Both Arthur Andersen LLP and KPMG LLP gave Brocade reports that express the opinion that Brocade's financial statements were presented fairly and were made in accordance with GAAP.
On November 5, 00, Brocade announced an agreement to acquire Rhapsody, a privately held technology company that provides an intelligent fabric application platform. Brocade's investment strategy is to make minority investments in companies that develop complementary goods and services or broaden the market. Other significant changes to the company include a recent announcement of a restructuring program in efforts to maintain profitability. This program includes an approximate 1 percent reduction of Brocade's current workforce, consolidation of facilities, and restructuring of business functions.
Horizontal and vertical analysis of Brocade's balance sheets from 1 to Q of 00 shows several trends in different assets and liabilities as a percent of total assets and total liabilities and shareholder's equity. First, current assets as a percentage of total assets have shrunk over time from 6% in 1 to 4% in Q of 00. There was a large decline from 6% in Brocade's first year of being incorporated to 6% in 000, and after that, the decline was more gradual. An increase in long-term assets such as Plant, Property, and Equipment; long-term investments; and other assets caused this decline. Another important percentage to decline over time is the percentage of acid test assets to total assets. This went from 1% in 1 to 46% in Q of 00, indicating that a lesser proportion of Brocade's total assets were in cash, marketable securities, and accounts receivable accounts. Like the others, the percentage of current liabilities to total liabilities and shareowner's equity also decreased over time. This percentage went from 8% in 1 to 10% in Q of 00. This means that less and less of the company was financed by short-term debt. Computing Brocade's acid test ratios from 1 to Q of 00 reveals not only that Brocade is a highly liquid company, but also that it has been gradually becoming more liquid as the years pass on. There is an exception to this; however, and that is the year 001. The acid ratio started at . in 1, went up to 4. in 000, dropped dramatically to .8 in 001, went back up to 4.1 in 00, and rose to 4.5 in Q of 00. Although the all acid ratios for Brocade were certainly high enough by lender's standards, it may be important to note that doubled current liabilities in 001 of $115 million up from $64 million in 000 caused the exceptional acid ratio in 001.
In examination of Brocade's statement of cash flows, the sources of cash generated each year can be seen. The following chart shows net cash provided by operating activities and net cash provided by financing activities as percentages of the net cash increases for each year. It is important to note that Q of 00 actually had a net cash decrease for the quarter.
Q00 00 001 000 1
operating cash/ net cash increase for each year -% 0% 1% 406% 10%
financing cash/ net cash increase for each year 7% 160% 66% 558% 45%
In 1, a much greater portion of net cash for the year was provided by financing activities. This does not necessarily have negative indications for Brocade's financial standings. The reason being is that this was Brocade's first year as a corporation, so it is logical that they would need to finance most of their cash. This changed in 000, when cash provided by operating activities nearly doubled that of cash provided by financial activities. In 001, operating activities still provided more cash than financing activities; however, this changed in 00, where financing activities provided $477.51 million more cash. This is important to note because it means that Brocade accumulated a very large debt in 00. The chart is not as clear for Q of 00 because both the cash provided by financing activities and the net cash increase for the quarter were negative values; however, cash from operations did provide $6.5 million. Because on average, Brocade gets more of its cash each year from operating activities, it is not likely that they will have problems with short-term solvency. However, the very large amount of convertible subordinated debt acquired in 00 may provide long-term solvency problems in the future.
In examining Brocade's long-term solvency, it is important to look at how its leverage ratios have changed over the years. The following is a chart displaying Brocade's debt/asset and debt/equity ratios from 1 to Q of 00. It also shows these ratios if Commitments (lease obligations) were included in the liabilities portion of the balance sheet for years 000-00
Debt/ Assets Ratio Q00
51% 00
5% 001
1% 000
14% 1
8%
Debt/ Equity Ratio 104% 107% 7% 16% %
Debt/ Assets ratio (w/ capitalized Commitments) 5% 4% 15%
Debt/ Equity Ratio (w/ capitalized Commitments) 110% 0% 17%
There are a few trends that can be seen in this chart. One is that since 00, debt has become a much larger portion of total assets. This can be attributed to the aforementioned sizable long-term debt that Brocade accrued in 00. Another change, also attributed to the large long-term debt, is that total liabilities have drastically become a greater source of assets than shareholder's equity. The jump of the debt/equity ratio between the years 001-00 went from 7% to 107%, respectively, signifies a dramatic increase in the use of borrowed funds. This could pose problems for Brocade's long-term solvency.
When lenders want to see if Brocade can make required interest payments from current earnings they will look at the times interest earned ratio. The following is the times interest earned ratio for the years 000, 00, and Q of 00. 1 and 001 have been omitted because the amount of these year's interest expenses was negligible.
Times interest earned ratio Q00
7.7571 00
.6771 000
1547.778
From these ratios, it is plain to see that Brocade easily covers its interest payments with current earnings. This means that a lender would be very confident that Brocade would be able to make interest payments owed to them, and therefore, be willing to lend money to Brocade. From a financial standpoint, Brocade seems to be a very stable business. The fact that Brocade looks so good to lenders helped them to accumulate the massive debt in 00, which would be the only source of doubt in analyzing Brocades financial security. The future of Brocade's good financial standings depends on the company's ability to pay off current portions of its long-term debt as they come due. This is dependent on Brocade's ability to generate much more cash from operations than from financing activities in the upcoming years.
Next is an examination of how management has conducted its investing activities. This examination is aided by the following table which shows the fixed asset turnover and asset turnover ratios from 1 to Q of 00.
Fixed asset turnover ratio(sales/long-term assets) Q00
1% 00
80% 001
165% 000
188% 1
186%
Asset turnover(Sales/ total assets) 10% 40% 75% 7% 5%
The trends in these two ratios are that over the years, sales are becoming a smaller portion of assets. An exception is the change of sales increasing as a portion of total assets between 1 and 001. This could be explained by the fact that Brocade was just starting as a corporation in 1, and as a result, had a relatively paltry amount of assets while also enjoying increasing amounts of sales relative to other years. The dramatic decrease in the asset turnover ratio between 001 and 00 can be explained by Brocade's more that doubling total assets while only increasing sales by $4.4 million. This doubling of total assets was caused by Brocade's purchasing of a $640.777 million long-term asset in 00. The value of this purchase will not be fully assessable until it either pays off or proves to be unnecessary in the future. The fixed asset turnover ratio also exhibits an exception in the year of 1, which can also be attributed to the fact that Brocade was new as a corporation. This extremely high ratio is because back in 1, Brocade hardly had any long-term assets to speak of, and even though sales were relatively small, they still dwarfed long-term assets. The fact that these asset turnover ratios are getting smaller over the years reflects the normal growth of a large corporation as it accumulates assets. The decreasing ratios do, however, have negative implications for Brocade. They indicate that it is taking more and more assets to generate each sale as time goes on. NEED INDUSTRY STANDARDS HERE!
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