10-Q 1 brcd-10qxfy13q2.htm 10-Q BRCD-10Q - FY13Q2
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended April 27, 2013
OR 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the transition period from             to             
Commission file number: 000-25601
 
Brocade Communications Systems, Inc.
(Exact name of registrant as specified in its charter)
 
Delaware
 
77-0409517
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
130 Holger Way
San Jose, CA 95134
(408) 333-8000
(Address, including zip code, of principal
executive offices and registrant’s telephone
number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. 
Large accelerated filer
 
ý
 
Accelerated filer
 
¨
Non-accelerated filer
 
¨  (Do not check if a smaller reporting company)
 
Smaller reporting company
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý
The number of shares outstanding of the registrant’s common stock as of May 24, 2013, was 443,780,216 shares.



BROCADE COMMUNICATIONS SYSTEMS, INC.
FORM 10-Q
QUARTER ENDED APRIL 27, 2013
TABLE OF CONTENTS
 
 
Page
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 6.
 
 

2


Forward-Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements regarding future events and future results. All statements other than statements of historical fact are statements that could be deemed forward-looking statements, including, but not limited to: statements regarding future revenue, margins, expenses, tax provisions, earnings, cash flows, benefit obligations, expense savings or targets, debt repayments, share repurchases or other financial items; any statements of the plans, strategies and objectives of management for future operations; any statements concerning expected development, performance or market share relating to products or services; any statements regarding future economic conditions or performance; any statements regarding pending litigation, including claims or disputes; any statements of expectation or belief; and any statements of assumptions underlying any of the foregoing. Words such as “expects,” “anticipates,” “assumes,” “targets,” “goals,” “projects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “continues,” “may,” variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are based on current expectations, estimates, forecasts and projections about the industries in which Brocade operates, and the beliefs and assumptions of management. Readers are cautioned that these forward-looking statements are only predictions and are subject to risks, uncertainties and assumptions that are difficult to predict, including those identified below under “Part II - Other Information, Item 1A. Risk Factors” and elsewhere herein. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. Further, Brocade undertakes no obligation to revise or update any forward-looking statements for any reason.

3


PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

BROCADE COMMUNICATIONS SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited) 
 
Three Months Ended
 
Six Months Ended
 
April 27,
2013
 
April 28,
2012
 
April 27,
2013
 
April 28,
2012
 
(In thousands, except per share amounts)
Net revenues
 
 
 
 
 
 
 
Product
$
451,746

 
$
456,104

 
$
953,993

 
$
932,406

Service
87,038

 
87,335

 
173,520

 
171,675

Total net revenues
538,784

 
543,439

 
1,127,513

 
1,104,081

Cost of revenues
 
 
 
 
 
 
 
Product
164,599

 
164,177

 
338,974

 
339,584

Service
40,073

 
42,180

 
80,502

 
82,646

Total cost of revenues
204,672

 
206,357

 
419,476

 
422,230

Gross margin
334,112

 
337,082

 
708,037

 
681,851

Operating expenses:
 
 
 
 
 
 
 
Research and development
98,429

 
92,931

 
196,119

 
182,250

Sales and marketing
145,316

 
158,855

 
294,327

 
311,543

General and administrative
20,037

 
18,790

 
39,114

 
37,140

Amortization of intangible assets
13,151

 
14,737

 
28,007

 
29,730

Total operating expenses
276,933

 
285,313

 
557,567

 
560,663

Income from operations
57,179

 
51,769

 
150,470

 
121,188

Interest expense
(10,432
)
 
(12,729
)
 
(36,800
)
 
(25,775
)
Interest and other income (loss), net
31

 
(452
)
 
97

 
(1,448
)
Income before income tax
46,778

 
38,588

 
113,767

 
93,965

Income tax expense (benefit)
(171
)
 
(708
)
 
88,073

 
(3,915
)
Net income
$
46,949

 
$
39,296

 
$
25,694

 
$
97,880

Net income per share — basic
$
0.10

 
$
0.09

 
$
0.06

 
$
0.22

Net income per share — diluted
$
0.10

 
$
0.08

 
$
0.06

 
$
0.21

Shares used in per share calculation — basic
453,133

 
457,541

 
453,988

 
455,017

Shares used in per share calculation — diluted
466,919

 
476,848

 
466,620

 
472,793


See accompanying notes to condensed consolidated financial statements.

4



BROCADE COMMUNICATIONS SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
 
Three Months Ended
 
Six Months Ended
 
April 27,
2013
 
April 28,
2012
 
April 27,
2013
 
April 28,
2012
 
(In thousands)
Net income
$
46,949

 
$
39,296

 
$
25,694

 
$
97,880

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Unrealized gains (losses) on cash flow hedges:
 
 
 
 
 
 
 
Change in unrealized gains and losses
(1,915
)
 
(113
)
 
(1,992
)
 
(4,282
)
Net (gains) losses reclassified into earnings
(32
)
 
1,599

 
(210
)
 
2,923

Net unrealized gains (losses) on cash flow hedges
(1,947
)
 
1,486

 
(2,202
)
 
(1,359
)
Foreign currency translation adjustments
(1,762
)
 
84

 
(2,142
)
 
(1,476
)
Total other comprehensive income (loss)
(3,709
)
 
1,570

 
(4,344
)
 
(2,835
)
Total comprehensive income
$
43,240

 
$
40,866

 
$
21,350

 
$
95,045

 
See accompanying notes to condensed consolidated financial statements.


5


BROCADE COMMUNICATIONS SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
April 27,
2013
 
October 27,
2012
 
(In thousands, except par value)
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
764,298

 
$
713,226

Accounts receivable, net of allowances for doubtful accounts of $831 and $833 at April 27, 2013, and October 27, 2012, respectively
239,311

 
233,139

Inventories
52,911

 
68,179

Deferred tax assets
54,710

 
91,539

Prepaid expenses and other current assets
53,265

 
49,496

Total current assets
1,164,495

 
1,155,579

Property and equipment, net
499,968

 
518,940

Goodwill
1,647,767

 
1,624,089

Intangible assets, net
85,807

 
109,265

Non-current deferred tax assets
80,824

 
136,175

Other assets
31,962

 
37,213

Total assets
$
3,510,823

 
$
3,581,261

Liabilities and Stockholders’ Equity

 
 
Current liabilities:
 
 
 
Accounts payable
$
101,266

 
$
117,350

Accrued employee compensation
133,788

 
182,597

Deferred revenue
226,228

 
216,283

Current portion of long-term debt
2,306

 
1,977

Other accrued liabilities
85,634

 
92,261

Total current liabilities
549,222

 
610,468

Long-term debt, net of current portion
596,971

 
599,203

Non-current deferred revenue
76,218

 
76,907

Non-current income tax liability
38,514

 
55,387

Other non-current liabilities
3,305

 
3,476

Total liabilities
1,264,230

 
1,345,441

Commitments and contingencies (Note 9)


 


Stockholders’ equity:
 
 
 
Preferred stock, $0.001 par value, 5,000 shares authorized, no shares issued and outstanding

 

Common stock, $0.001 par value, 800,000 shares authorized:
 
 
 
Issued and outstanding: 452,841 and 456,913 shares at April 27, 2013, and October 27, 2012, respectively
453

 
457

Additional paid-in capital
1,998,617

 
2,009,190

Accumulated other comprehensive loss
(14,208
)
 
(9,864
)
Retained earnings
261,731

 
236,037

Total stockholders’ equity
2,246,593

 
2,235,820

Total liabilities and stockholders’ equity
$
3,510,823

 
$
3,581,261

See accompanying notes to condensed consolidated financial statements.

6


BROCADE COMMUNICATIONS SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
Six Months Ended
 
April 27,
2013
 
April 28,
2012
 
(In thousands)
Cash flows from operating activities:
 
 
 
Net income
$
25,694

 
$
97,880

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Excess tax benefits from stock-based compensation
(5,440
)
 
(1,332
)
Non-cash tax charges
78,206

 

Depreciation and amortization
93,358

 
97,524

Loss on disposal of property and equipment
3,046

 
296

Amortization of debt issuance costs and original issue discount
665

 
2,626

Original issue discount and debt issuance costs related to lenders that did not participate in refinancing
5,360

 

Net gains on investments

 
(24
)
Provision for doubtful accounts receivable and sales allowances
4,560

 
5,864

Non-cash compensation expense
38,322

 
45,677

Changes in assets and liabilities:
 
 
 
Accounts receivable
(10,561
)
 
25,440

Inventories
16,605

 
(7,379
)
Prepaid expenses and other assets
(1,714
)
 
300

Deferred tax assets
322

 
192

Accounts payable
(14,692
)
 
(6,689
)
Accrued employee compensation
(54,163
)
 
8,643

Deferred revenue
7,924

 
7,657

Other accrued liabilities
(8,387
)
 
(9,356
)
Net cash provided by operating activities
179,105

 
267,319

Cash flows from investing activities:
 
 
 
Proceeds from sale of subsidiary

 
35

Purchases of property and equipment
(31,568
)
 
(38,269
)
Net cash paid in connection with acquisition
(44,629
)
 

Net cash used in investing activities
(76,197
)
 
(38,234
)
Cash flows from financing activities:
 
 
 
Proceeds from senior unsecured notes
296,250

 

Payment of principal related to senior secured notes
(300,000
)
 

Payment of principal related to the term loan

 
(120,000
)
Payment of debt issuance costs related to senior unsecured notes
(549
)
 

Payment of principal related to capital leases
(975
)
 
(920
)
Common stock repurchases
(86,179
)
 
(25,066
)
Proceeds from issuance of common stock
35,899

 
47,261

Excess tax benefits from stock-based compensation
5,440

 
1,332

Net cash used in financing activities
(50,114
)
 
(97,393
)
Effect of exchange rate fluctuations on cash and cash equivalents
(1,722
)
 
(1,555
)
Net increase in cash and cash equivalents
51,072

 
130,137

Cash and cash equivalents, beginning of period
713,226

 
414,202

Cash and cash equivalents, end of period
$
764,298

 
$
544,339

Supplemental disclosures of cash flow information:
 
 
 
Cash paid for interest
$
22,593

 
$
23,568

Cash paid for income taxes
$
8,557

 
$
474

Supplemental schedule of non-cash investing activities:
 
 
 
Acquisition of property and equipment through capital leases
$
999

 
$

See accompanying notes to condensed consolidated financial statements.

7


BROCADE COMMUNICATIONS SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. Basis of Presentation
Brocade Communications Systems, Inc. (“Brocade” or the “Company”) has prepared the accompanying Condensed Consolidated Financial Statements pursuant to the rules and regulations of the United States (“U.S.”) Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) have been condensed or omitted pursuant to such rules and regulations. The Condensed Consolidated Balance Sheet as of October 27, 2012, was derived from the Company’s audited consolidated financial statements, but does not include all disclosures required by U.S. GAAP. These unaudited Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended October 27, 2012.
The accompanying Condensed Consolidated Financial Statements are unaudited but, in the opinion of the Company’s management, reflect all adjustments—including normal recurring adjustments—that management considers necessary for a fair presentation of these Condensed Consolidated Financial Statements. The results for the interim periods presented are not necessarily indicative of the results for the full fiscal year or any other future period.
The Company’s fiscal year is a 52- or 53-week period ending on the last Saturday in October. Fiscal year 2013 is a 52-week fiscal year, and the second quarter of 2013 was a 13-week quarter. Fiscal year 2012 was a 52-week year, and the second quarter of 2012 was a 13-week quarter.
The Condensed Consolidated Financial Statements include the accounts of Brocade and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
Use of Estimates in Preparation of Condensed Consolidated Financial Statements
The preparation of condensed consolidated financial statements and related disclosures in conformity with U.S. GAAP requires management to make estimates and judgments that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Estimates are used for, but not limited to, revenue recognition, sales allowances and programs, allowance for doubtful accounts, stock-based compensation, purchase price allocations, warranty obligations, inventory valuation and purchase commitments, restructuring costs, commissions, facilities lease losses, impairment of goodwill and intangible assets, litigation, income taxes and investments. Actual results may differ materially from these estimates.

2. Summary of Significant Accounting Policies
There have been no material changes in the Company’s significant accounting policies for the six months ended April 27, 2013, as compared to the significant accounting policies disclosed in Brocade’s Annual Report on Form 10-K for the fiscal year ended October 27, 2012.
New Accounting Pronouncements or Updates Recently Adopted
In June 2011 and December 2011, the FASB issued updates to ASC 220 Comprehensive Income (“ASC 220”): Presentation of Comprehensive Income. The amendments from these updates increase the prominence of items reported in other comprehensive income and eliminate the option to present components of other comprehensive income as part of the statement of equity. The Company adopted these updates in the first quarter of fiscal year 2013, presenting the required information in the Condensed Consolidated Statements of Comprehensive Income.
Recent Accounting Pronouncements or Updates That Are Not Yet Effective
In February 2013, the FASB issued an update to ASC 220: Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. Under this update, an entity is required to provide information about the amounts reclassified out of accumulated other comprehensive income (“AOCI”) by component. In addition, an entity is required to present, either on the face of the financial statements or in the notes, significant amounts reclassified out of AOCI by the respective line items of net income but only if the amount reclassified is required to be reclassified in its entirety in the same reporting period. For amounts that are not required to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures that provide additional details about those amounts. This update to ASC 220 should be applied prospectively and will be adopted by the Company in the first quarter of fiscal year 2014. The adoption of this update to ASC 220 will not have an impact

8


on the Company’s financial position, results of operations or cash flows. The Company will include additional information required by this update prospectively starting from the first quarter of fiscal year 2014.
In March 2013, the FASB issued an update to ASC 830 Foreign Currency Matters (“ASC 830”): Parent’s Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity. Under this update, an entity is required to release any cumulative translation adjustment into net income when an entity ceases to have a controlling financial interest resulting in the complete or substantially complete liquidation of a subsidiary or group of assets within a foreign entity. This update to ASC 830 should be applied prospectively and will be adopted by the Company in the first quarter of fiscal year 2015. The Company does not expect the adoption of this update to ASC 830 to have a material impact on its financial position, results of operations or cash flows.
Concentrations
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash, cash equivalents and accounts receivable. The Company’s cash and cash equivalents are primarily maintained at five major financial institutions. Deposits held with banks may be redeemed upon demand and may exceed the amount of insurance provided on such deposits.
A majority of the Company’s accounts receivable balance is derived from sales to original equipment manufacturer (“OEM”) partners in the computer storage and server industry. As of April 27, 2013, two customers accounted for 17% and 11%, respectively, of total accounts receivable, for a combined total of 28% of total accounts receivable. As of October 27, 2012, three customers accounted for 16%, 12% and 10%, respectively, of total accounts receivable, for a combined total of 38% of total accounts receivable. The Company performs ongoing credit evaluations of its customers and generally does not require collateral on accounts receivable balances. The Company has established reserves for credit losses, sales allowances and other allowances.
For the three months ended April 27, 2013, three customers accounted for 18%, 16% and 11%, respectively, of the Company’s total net revenues for a combined total of 45% of total net revenues. For the three months ended April 28, 2012, four customers accounted for 20%, 15%, 13% and 10% respectively, of the Company’s total net revenues for a combined total of 58% of total net revenues.
The Company currently relies on single and limited sources for multiple key components used in the manufacture of its products. Additionally, the Company relies on contract manufacturers (“CMs”) for the manufacturing of its products. Although the Company uses standard parts and components for its products where possible, the Company’s CMs currently purchase, on the Company’s behalf, several key product components from single or limited supplier sources.

3. Acquisitions
On November 9, 2012, the Company completed its acquisition of Vyatta, Inc. (“Vyatta”), a privately held developer of a software-based network operating system suite headquartered in Belmont, California. Vyatta became a wholly-owned subsidiary of the Company as a result of the acquisition. The Vyatta operating suite is deployed on conventional computer hardware platforms for multiple applications in network virtualization, software-defined networking (“SDN”) and private/public cloud computing platforms. This acquisition complements Brocade’s investments in Ethernet switches and router fabrics and enables Brocade to pursue new market opportunities in data center virtualization, public cloud, enterprise virtual private cloud and managed services.
The results of operations of Vyatta are included in the Company’s Condensed Consolidated Statement of Operations from the date of the acquisition. The Company does not consider the acquisition of Vyatta to be material to its results of operations or financial position, and therefore, Brocade is not presenting pro-forma financial information of combined operations.
The total purchase price was $44.8 million, consisting of $43.6 million cash consideration and $1.2 million related to prepaid license fees paid by the Company to Vyatta that was effectively settled at the recorded amount as a result of the acquisition. Of the cash consideration paid, $7.0 million will be held in escrow for a period of 18 months from the closing of the acquisition and will be released subject to resolution of certain contingencies. In addition, the Company paid direct acquisition costs of $0.4 million.

9


In connection with this acquisition, the Company allocated the total purchase consideration to the net assets and liabilities acquired, including identifiable intangible assets, based on their respective fair values at the acquisition date. The following table summarizes the allocation of the purchase price to the fair value of the assets and liabilities acquired (in thousands):
Assets acquired
 
Cash
$
140

Accounts receivable
511

Identifiable intangible assets:
 
In-process technology
21,590

Customer relationships
1,080

Core/developed technology
1,040

Non-compete agreements
810

Trade name
460

Total identifiable intangible assets
24,980

Goodwill (1)
25,586

Other assets
1,017

Total assets acquired
52,234

Liabilities assumed
 
Deferred tax liability
3,401

Deferred revenue
1,333

Accounts payable and other accrued liabilities
2,731

Total liabilities assumed
7,465

Net assets acquired
$
44,769

(1)
None of the goodwill recognized is expected to be deductible for income tax purposes.
The allocation of the purchase price reflects the Company’s preliminary estimate in relation to the value of the Company’s deferred tax liability which is subject to change during the Vyatta acquisition’s measurement period.

4. Goodwill and Intangible Assets
The following table summarizes goodwill activity by reportable segment for the six months ended April 27, 2013 (in thousands):
 
SAN 
Products
 
IP Networking Products
 
Global Services
 
Total
Balance at October 27, 2012
 
 
 
 
 
 
 
Goodwill
$
176,956

 
$
1,337,549

 
$
155,416

 
$
1,669,921

Accumulated impairment losses

 
(45,832
)
 

 
(45,832
)
 
176,956

 
1,291,717

 
155,416

 
1,624,089

Acquisitions

 
25,586

 

 
25,586

Tax and other adjustments during the six months ended April 27, 2013 (1)
(4
)
 
(1,904
)
 

 
(1,908
)
Balance at April 27, 2013
 
 
 
 
 
 
 
Goodwill
176,952

 
1,361,231

 
155,416

 
1,693,599

Accumulated impairment losses

 
(45,832
)
 

 
(45,832
)
 
$
176,952

 
$
1,315,399

 
$
155,416

 
$
1,647,767


(1)
The goodwill adjustments during the six months ended April 27, 2013, were primarily a result of tax benefits from the exercise of stock awards of acquired companies.

10


The Company conducts its goodwill impairment test annually, as of the first day of the second fiscal quarter, and whenever events or changes in facts and circumstances indicate that the fair value of the reporting unit may be less than its carrying amount. For the annual goodwill impairment test, the Company uses the income approach, the market approach or a combination thereof to determine each reporting unit’s fair value. The income approach provides an estimate of fair value based on discounted expected future cash flows (“DCF”). The market approach provides an estimate of fair value using various prices or market multiples applied to the reporting unit’s operating results and then applying an appropriate control premium. For the fiscal year 2013 annual goodwill impairment test, the Company used a combination of approaches to estimate each reporting unit’s fair value. The Company believed that at the time of impairment testing performed in the second fiscal quarter of 2013, the income approach and the market approach were equally representative of a reporting unit’s fair value.
Determining the fair value of a reporting unit or an intangible asset requires judgment and involves the use of significant estimates and assumptions. The Company based its fair value estimates on assumptions it believes to be reasonable, but inherently uncertain. Estimates and assumptions with respect to the determination of the fair value of its reporting units using the income approach include, among other inputs:
The Company’s operating forecasts;
Revenue growth rates; and
Risk-commensurate discount rates and costs of capital.
The Company’s estimates of revenues and costs are based on historical data, various internal estimates and a variety of external sources, and are developed as part of our regular long-range planning process. The control premium used in market or combined approaches is determined by considering control premiums offered as part of the acquisitions that have occurred in the reporting units’ comparable market segments. Based on the results of the annual goodwill impairment analysis performed during the second fiscal quarter of 2013, the Company determined that no impairment needed to be recorded.
Intangible assets other than goodwill are amortized on a straight-line basis over the following estimated remaining useful lives, unless the Company has determined these lives to be indefinite. The following tables present details of the Company’s intangible assets (in thousands, except for weighted-average remaining useful life):
April 27, 2013
Gross
Carrying
Value
 
Accumulated
Amortization
 
Net
Carrying
Value
 
Weighted-
Average
Remaining
Useful Life
(in years)
Trade name
$
460

 
$
53

 
$
407

 
3.51

Core/developed technology
192,340

 
165,954

 
26,386

 
0.73

Customer relationships
287,090

 
250,381

 
36,709

 
0.79

Non-compete agreements
810

 
95

 
715

 
3.51

In-process research and development (1)
21,590

 

 
21,590

 

Total intangible assets (2)
$
502,290

 
$
416,483

 
$
85,807

 
0.81

 
 
 
 
 
 
 
 
October 27, 2012
Gross
Carrying
Value
 
Accumulated
Amortization
 
Net
Carrying
Value
 
Weighted-
Average
Remaining
Useful Life
(in years)
Trade name
$
100

 
$
97

 
$
3

 
0.17

Core/developed technology
218,845

 
173,070

 
45,775

 
1.14

Customer relationships
327,765

 
264,278

 
63,487

 
1.16

Total intangible assets
$
546,710

 
$
437,445

 
$
109,265

 
1.16

(1)
Acquired in-process research and development (“IPRD”) is an intangible asset accounted for as an indefinite-lived asset until the completion or abandonment of the associated research and development effort. While accounted as an indefinite-lived asset, the IPRD intangible asset is subject to testing for impairment annually, as of the first day of the second fiscal quarter, and whenever events or changes in facts and circumstances indicate that it is more likely than not that IPRD is impaired. If the research and development effort associated with the IPRD is successfully completed, then the IPRD intangible asset will be amortized over its estimated useful life to be determined at the date the effort is completed. During the six months ended April 27, 2013, the IPRD intangible asset was not amortized due to the current stage of the associated research and development effort.

11


(2)
During the six months ended April 27, 2013, $69.4 million of intangible assets became fully amortized and, therefore, were removed from the balance sheet.
The Company performed its annual development period’s IPRD impairment test using measurement data as of the first day of the second fiscal quarter of 2013. During the test, the Company exercised the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of its IPRD asset is less than its carrying amount. After assessing the totality of events and circumstances, the Company determined that it is not more likely than not that the fair value of its IPRD assets is less than its carrying amount and no further testing is required.
The following table presents the amortization of intangible assets included in the Condensed Consolidated Statements of Income (in thousands):
 
Three Months Ended
 
Six Months Ended
 
April 27, 2013
 
April 28, 2012
 
April 27, 2013
 
April 28, 2012
Cost of revenues
$
9,651

 
$
10,713

 
$
20,431

 
$
24,803

Operating expenses
13,151

 
14,737

 
28,007

 
29,730

Total
$
22,802

 
$
25,450

 
$
48,438

 
$
54,533

The following table presents the estimated future amortization of intangible assets, including IPRD, that is estimated to be amortized in the remaining six months of fiscal year 2013, and thereafter, as of April 27, 2013 (in thousands):
Fiscal Year
Estimated
Future
Amortization
2013 (remaining six months)
$
45,549

2014
21,312

2015
5,183

2016
4,871

2017
4,556

Thereafter
4,336

Total
$
85,807


5. Balance Sheet Details
The following table provides details of selected balance sheet items (in thousands):
 
April 27,
2013
 
October 27,
2012
Inventories:
 
 
 
Raw materials
$
14,534

 
$
24,240

Finished goods
38,377

 
43,939

Total
$
52,911

 
$
68,179

 
April 27,
2013
 
October 27,
2012
Property and equipment, net:
 
 
 
Computer equipment
$
17,439

 
$
17,953

Software
54,942

 
51,680

Engineering and other equipment (1)
409,432

 
409,524

Furniture and fixtures (1)
31,230

 
30,516

Leasehold improvements
26,597

 
26,306

Land and building
384,666

 
384,666

Subtotal
924,306

 
920,645

Less: Accumulated depreciation and amortization (1), (2)
(424,338
)
 
(401,705
)
Total
$
499,968

 
$
518,940



12


(1)
Engineering and other equipment, furniture and fixtures and accumulated depreciation and amortization include the following amounts under capital leases as of April 27, 2013, and October 27, 2012, respectively (in thousands):
 
April 27,
2013
 
October 27,
2012
Cost
$
11,612

 
$
10,613

Accumulated depreciation
(4,468
)
 
(3,647
)
Total
$
7,144

 
$
6,966


(2)
The following table presents the depreciation of property and equipment included in the Condensed Consolidated Statements of Income (in thousands):
 
Three Months Ended
 
Six Months Ended
 
April 27,
2013
 
April 28,
2012
 
April 27,
2013
 
April 28,
2012
Depreciation expense
$
21,162

 
$
21,969

 
$
44,920

 
$
42,991


6. Fair Value Measurements
The Company applies fair value measurements for both financial and nonfinancial assets and liabilities. The Company has no nonfinancial assets and liabilities that are required to be measured at fair value on a recurring basis as of April 27, 2013.
The fair value accounting guidance permits companies to elect fair value measurement for many financial instruments and certain other items that are otherwise not required to be accounted for at fair value. The Company did not elect to measure any eligible financial instruments or other assets at fair value as of April 27, 2013, and October 27, 2012.
Fair Value Hierarchy
The Company utilizes a fair value hierarchy that maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
Assets and liabilities measured and recorded at fair value on a recurring basis as of April 27, 2013, were as follows (in thousands):
 
 
 
Fair Value Measurements Using
 
 Balance as of
 April 27, 2013
 
Quoted Prices in
Active Markets
For Identical
Instruments
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets:
 
 
 
 
 
 
 
Money market funds (1)
$
238,972

 
$
238,972

 
$

 
$

Derivative assets
1,934

 

 
1,934

 

Total assets measured at fair value
$
240,906

 
$
238,972

 
$
1,934

 
$

Liabilities:
 
 
 
 
 
 
 
Derivative liabilities
$
1,481

 
$

 
$
1,481

 
$

Total liabilities measured at fair value
$
1,481

 
$

 
$
1,481

 
$

 
(1)
Money market funds are reported within “Cash and cash equivalents” in the Condensed Consolidated Balance Sheets.

13


Assets and liabilities measured and recorded at fair value on a recurring basis as of October 27, 2012, were as follows (in thousands):
 
 
 
Fair Value Measurements Using
 
 Balance as of
 October 27, 2012
 
Quoted Prices in
Active Markets
For Identical
Instruments
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets:
 
 
 
 
 
 
 
Money market funds (1)
$
308,960

 
$
308,960

 
$

 
$

Derivative assets
2,941

 

 
2,941

 

Total assets measured at fair value
$
311,901

 
$
308,960

 
$
2,941

 
$

Liabilities:
 
 
 
 
 
 
 
Derivative liabilities
$
296

 
$

 
$
296

 
$

Total liabilities measured at fair value
$
296

 
$

 
$
296

 
$


(1)
Money market funds are reported within “Cash and cash equivalents” in the Condensed Consolidated Balance Sheets.
During the six months ended April 27, 2013, the Company had no transfers between levels of the fair value hierarchy of its assets and liabilities measured at fair value.

7. Liabilities Associated with Facilities Lease Losses
The Company reevaluates its estimates and assumptions on a quarterly basis and makes adjustments to the reserve balance if necessary. The following table summarizes the activity related to the facilities lease loss reserve included in “Other accrued liabilities” and “Other non-current liabilities” in the Condensed Consolidated Balance Sheets, net of expected sublease income (in thousands):
 
Lease Loss
Reserve
Reserve balance at October 27, 2012
$
2,582

Cash payments on facilities leases
(417
)
Reserve balance at April 27, 2013
$
2,165


Cash payments for facilities that are part of our lease loss reserve are expected to be paid over the respective lease terms through fiscal year 2017.


14


8. Borrowings
The following table provides details of the Company’s long-term debt (in thousands, except percentages):
 
 
 
 
 
 
 
April 27, 2013
 
October 27, 2012
 
 
Maturity
 
Stated Annual Interest Rate
 
Amount
 
Effective Interest Rate
 
Amount
 
Effective Interest Rate
Senior Secured Notes:
 
 
 
 
 
 
 
 
 
 
 
 
 
2018 Notes
 
2013
 
6.625%
 
$

 
%
 
$
300,000

 
7.05
%
2020 Notes
 
2020
 
6.875%
 
300,000

 
7.26
%
 
300,000

 
7.26
%
Senior Unsecured Notes:
 
 
 
 
 
 
 
 
 
 
 
 
2023 Notes
 
2023
 
4.625%
 
300,000

 
4.83
%
 

 
%
Capital lease obligations
 
2016
 
5.699%
 
4,940

 
5.56
%
 
4,916

 
5.80
%
Total long-term debt
 
 
 
 
 
 
604,940

 
 
 
604,916

 
 
Less:
 
 
 
 
 
 
 
 
 
 
 
 
 
Unamortized discount
 
 
 
 
 
 
5,663

 
 
 
3,736

 
 
Current portion of long-term debt
 
 
 
 
 
 
2,306

 
 
 
1,977

 
 
Long-term debt, net of current portion
 
 
 
 
 
 
$
596,971

 
 
 
$
599,203

 
 
Senior Unsecured Notes
In January 2013, the Company issued 4.625% senior unsecured notes in the aggregate principal amount of $300.0 million due 2023 (the “2023 Notes”) pursuant to an Indenture, dated as of January 22, 2013 (the “2023 Indenture”), between the Company, certain domestic subsidiaries of the Company that have guaranteed the Company’s obligations under the 2023 Notes (as described in Note 15, “Guarantor and Non-Guarantor Subsidiaries”) and Wells Fargo Bank, National Association as the trustee. The Company irrevocably deposited the net proceeds from this offering, together with cash on hand, with the trustee to redeem all of the Company’s outstanding 6.625% senior secured notes due 2018 (the “2018 Notes”) as described below under “Senior Secured Notes.
The 2023 Notes bear interest payable semi-annually on January 15 and July 15 of each year. No payments were made toward the principal of the 2023 Notes during the six months ended April 27, 2013.
As of April 27, 2013, the fair value of the Company’s 2023 Notes was approximately $297.0 million, estimated based on broker trading prices.
On or after January 15, 2018, the Company may redeem all or part of the 2023 Notes at the redemption prices set forth in the 2023 Indenture, plus accrued and unpaid interest, if any, up to but excluding the redemption date. At any time prior to January 15, 2018, the Company may redeem all or a part of the 2023 Notes at a price equal to 100% of the principal amount of the 2023 Notes, plus an applicable premium and accrued and unpaid interest, if any, up to but excluding the redemption date. In addition, at any time prior to January 15, 2016, the Company may redeem up to 35% of the principal amount of the 2023 Notes, using the net cash proceeds of one or more sales of the Company’s capital stock at a redemption price equal to 104.625% of the principal amount of the 2023 Notes redeemed, plus accrued and unpaid interest, if any, up to but excluding the redemption date.
If the Company experiences a specified change of control triggering event, it must offer to repurchase the 2023 Notes at a repurchase price equal to 101% of the principal amount of the 2023 Notes repurchased, plus accrued and unpaid interest, if any, up to but excluding the repurchase date.
The 2023 Indenture contains covenants that, among other things, restrict the ability of the Company and its subsidiaries to:
incur certain liens and enter into certain sale leaseback transactions;
create, assume, incur or guarantee additional indebtedness of the Company’s subsidiaries without such subsidiary guaranteeing the 2023 Notes on a pari passu basis; and
consolidate or merge with, or convey, transfer or lease all or substantially all of the Company’s or its subsidiaries’ assets.
These covenants are subject to a number of limitations and exceptions set forth in the 2023 Indenture. The 2023 Indenture also includes customary events of default, including cross-defaults to other debt of the Company and its subsidiaries.

15


Senior Secured Notes
In January 2010, the Company issued $300.0 million aggregate principal amount of the 2018 Notes and $300.0 million in aggregate principal amount of 6.875% senior secured notes due 2020 (the “2020 Notes” and together with the 2018 Notes, the “Senior Secured Notes”) pursuant to separate indentures, each dated as of January 20, 2010, between the Company, certain domestic subsidiaries of the Company that have guaranteed the Company's obligations under the Senior Secured Notes and Wells Fargo Bank, National Association as the trustee (the “2020 Indenture” and “2018 Indenture”, respectively). The Senior Secured Notes bear interest payable semi-annually. During the six months ended April 27, 2013, the Company paid $300.0 million to pay in full the principal of the 2018 Notes. The Company’s obligations under the 2020 Notes are—and prior to January 22, 2013, the Company’s obligations under the 2018 Notes were—guaranteed by certain of the Company’s domestic subsidiaries and secured by a lien on substantially all of the Company’s and the subsidiary guarantors’ assets. See Note 15, “Guarantor and Non-Guarantor Subsidiaries.”
As of April 27, 2013, and October 27, 2012, the fair value of the Senior Secured Notes was approximately $330.0 million and $638.3 million, respectively, estimated based on broker trading prices.
On January 22, 2013, the Company called the 2018 Notes for redemption at a redemption price equal to 103.313% of the principal amount of the 2018 Notes and irrevocably deposited $311.9 million with the trustee for the 2018 Notes to discharge the 2018 Indenture. As a result of the deposit and discharge, the guarantees provided by certain of the Company’s domestic subsidiaries and the liens granted by the Company and the subsidiary guarantors to secure their obligations with respect to the 2018 Notes were released as of the date of the deposit. The amount deposited with the trustee included $300.0 million to repay the principal amount of the 2018 Notes, $9.9 million representing the difference between the redemption price and the principal amount of the 2018 Notes (“Call Premium”) and $2.0 million of unpaid interest payable up to the redemption date of February 21, 2013, but excluding the date of redemption. On February 21, 2013, the trustee redeemed the 2018 Notes using the deposited amount, extinguishing the Company’s $300.0 million liability in relation to the principal amount of the 2018 Notes.
In accordance with the applicable accounting guidance for debt modification and extinguishment, and for interest costs accounting, the Company expensed the Call Premium, remaining debt issuance costs and remaining original issue discount relating to the 2018 Notes, which totaled $15.3 million. The Company reported this expense within “Interest expense” in the Condensed Consolidated Statements of Operations for the six months ended April 27, 2013.
On or after January 2015, the Company may redeem all or a part of the 2020 Notes at the redemption prices set forth in the 2020 Indenture, plus accrued and unpaid interest and special interest, if any, to the applicable redemption date. In addition, at any time prior to January 2015, the Company may, on one or more than one occasion, redeem some or all of the 2020 Notes at any time at a redemption price equal to 100% of the principal amount of the 2020 Notes redeemed, plus a “make-whole” premium determined as of the applicable redemption date, and accrued and unpaid interest and special interest, if any, to the applicable redemption date.
If the Company experiences specified change of control triggering events, it must offer to repurchase the 2020 Notes at a repurchase price equal to 101% of the principal amount of the 2020 Notes repurchased, plus accrued and unpaid interest and special interest, if any, to the applicable repurchase date. If the Company or its subsidiaries sell assets under certain specified circumstances, the Company must offer to repurchase the 2020 Notes at a repurchase price equal to 100% of the principal amount of the 2020 Notes repurchased, plus accrued and unpaid interest and special interest, if any, to the applicable repurchase date.
The 2020 Indenture contains covenants that, among other things, restrict the ability of the Company and its restricted subsidiaries to:
pay dividends, make investments or make other restricted payments;
incur additional indebtedness;
sell assets;
enter into transactions with affiliates;
incur liens;
permit consensual encumbrances or restrictions on the Company’s restricted subsidiaries’ ability to pay dividends or make certain other payments to the Company;
consolidate, merge, sell or otherwise dispose of all or substantially all of the Company’s or its restricted subsidiaries’ assets; and
designate subsidiaries as unrestricted.

16


These covenants are subject to a number of limitations and exceptions set forth in the 2020 Indenture. The 2020 Indenture also includes customary events of default, including cross-defaults to other debt of the Company and its subsidiaries. Prior to discharge, the 2018 Indenture contained substantially similar covenants and events of default to those in the 2020 Indenture.
Senior Secured Credit Facility
In October 2008, the Company entered into a credit facility agreement for (i) a five-year $1,100.0 million term loan facility and (ii) a five-year $125.0 million revolving credit facility, which includes a $25.0 million swing line loan sub-facility and a $25.0 million letter of credit sub-facility (“Senior Secured Credit Facility”). The Company’s obligations under the Senior Secured Credit Facility are guaranteed by certain of the Company’s domestic subsidiaries and secured by a lien on substantially all of the Company’s and the subsidiary guarantors’ assets. The credit facility agreement was subsequently amended in January 2010 and June 2011 to extend the maturity date of the Senior Secured Credit Facility to October 31, 2014.
There was no principal amount outstanding under the term loan facility as of either April 27, 2013, or October 27, 2012.
The Company may draw additional proceeds from the revolving credit facility in the future for ongoing working capital and other general corporate purposes. There were no principal amounts outstanding under the revolving credit facility, and the full $125.0 million was available for future borrowing under the revolving credit facility as of April 27, 2013, and October 27, 2012.
The credit agreement contains financial covenants that require the Company to maintain a minimum consolidated fixed charge coverage ratio, a maximum consolidated leverage ratio and a maximum consolidated senior secured leverage ratio. The credit agreement also includes customary non-financial covenants (similar in nature to those under the Senior Secured Notes) and customary events of default, including cross-defaults to the Company’s material indebtedness and change of control.
Debt Maturities
As of April 27, 2013, our aggregate debt maturities based on outstanding principal were as follows (in thousands):
Fiscal Year
Principal
Balances
2013 (remaining six months)
$
1,116

2014
2,413

2015
1,180

2016
231

2017

Thereafter
600,000

Total
$
604,940


9. Commitments and Contingencies
Product Warranties
The Company’s accrued liability for estimated future warranty costs is included in “Other accrued liabilities” in the accompanying Condensed Consolidated Balance Sheets. The following table summarizes the activity related to the Company’s accrued liability for estimated future warranty costs during the six months ended April 27, 2013, and April 28, 2012, respectively (in thousands):
 
Accrued Warranty
 
Six Months Ended
 
April 27,
2013
 
April 28,
2012
Beginning balance
$
14,453

 
$
11,298

Liabilities accrued for warranties issued during the period
2,263

 
4,640

Warranty claims paid and used during the period
(3,910
)
 
(536
)
Changes in liability for pre-existing warranties during the period
(1,607
)
 
(1,040
)
Ending balance
$
11,199

 
$
14,362


In addition, the Company has defense and indemnification clauses contained within its various customer contracts. As such, the Company indemnifies the parties to whom it sells its products with respect to the Company’s product, alone or potentially in combination with others, infringing upon any patents, trademarks, copyrights or trade secrets, as well as against bodily injury or damage to real or tangible personal property caused by a defective Company product. As of April 27, 2013,

17


there have been no known events or circumstances that have resulted in a material customer contract-related indemnification liability to the Company.
Manufacturing and Purchase Commitments
Brocade has manufacturing arrangements with CMs under which Brocade provides twelve-month product forecasts and places purchase orders in advance of the scheduled delivery of products to Brocade’s customers. The required lead time for placing orders with the CMs depends on the specific product. Brocade issues purchase orders and the CMs then generate invoices based on prices and payment terms mutually agreed upon and set forth in those purchase orders. Although the purchase orders Brocade places with its CMs are cancellable, the terms of the agreements require Brocade to purchase all inventory components not returnable, usable by, or sold to other customers of the CMs.
As of April 27, 2013, the Company’s aggregate commitment to the CMs for inventory components used in the manufacture of Brocade products was $205.8 million, which the Company expects to utilize during future normal ongoing operations within the next twelve months, net of a purchase commitments reserve of $3.4 million. The Company’s purchase commitments reserve reflects the Company’s estimate of purchase commitments it does not expect to consume in normal ongoing operations.
Income Taxes
The Company has several ongoing income tax audits. For additional discussion, see Note 12, “Income Taxes,” of the Notes to Condensed Consolidated Financial Statements. The Company believes it has adequate reserves for all open tax years.
Legal Proceedings

Stockholder Litigation
In the litigation matter Stephen Knee vs. Brocade Communications Systems, Inc., et al., the Court granted final approval of the settlement on December 14, 2012, and a final judgment was then entered on December 19, 2012. Brocade completed the payment of attorney fees and expenses to plaintiff's counsel in an amount immaterial to Brocade in accordance with the settlement and the final judgment.

Intellectual Property Litigation
On June 21, 2005, Enterasys Networks, Inc. (“Enterasys”) filed a lawsuit against Foundry Networks, LLC (formerly Foundry Networks, Inc.) (“Foundry”) (and Extreme Networks, Inc.) in the United States District Court for the District of Massachusetts alleging that certain of Foundry’s products infringe six of Enterasys’ patents and seeking injunctive relief, as well as unspecified damages. The Court severed the claims against Extreme from the claims against Foundry for trial, and Enterasys subsequently added Brocade as a defendant. On May 1, 2013, the Court entered an order of dismissal with prejudice pursuant to a settlement and patent cross-license agreement reached by the parties on April 19, 2013. As a result of this agreement, Brocade recorded a charge to “Cost of revenues, product” in the Condensed Consolidated Statements of Operations for the three months ended April 27, 2013.
On September 6, 2006, ChriMar Systems, Inc. (“ChriMar”) filed a lawsuit against Foundry in the United States District Court for the Eastern District of Michigan alleging that certain of Foundry’s products infringe ChriMar’s U.S. Patent 5,406,260 and seeking injunctive relief, as well as unspecified damages. On August 1, 2012, the Court issued an order granting summary judgment in favor of Brocade and dismissed the case.
ChriMar appealed the District Court's ruling to the Federal Circuit Court of Appeals. On April 4, 2013 (Case No. 2012-1641), the Federal Circuit Court of Appeals affirmed the District Court ruling in favor of Brocade which invalidated ChriMar’s 5,406,260 patent and dismissed the case.
On August 4, 2010, Brocade and Foundry (collectively and for this paragraph only, "Brocade") filed a lawsuit against A10 Networks, Inc. (“A10”), A10’s founder and other individuals in the United States District Court for the Northern District of California. On October 29, 2010, Brocade filed an amended complaint. In the amended complaint, Brocade alleged that A10 and the individual defendants have misappropriated Brocade’s trade secrets, infringed Brocade’s copyrighted works, interfered with existing contracts between Brocade and its employees, whereby certain of Brocade's current and ex-employees breached contracts, and breached their fiduciary duties and duties of loyalty to Brocade, and that certain of A10’s products infringe 13 of Brocade’s patents. Brocade sought injunctive relief, as well as monetary damages. On May 16, 2011, A10 filed an answer and counterclaim alleging that certain of Brocade’s products infringe a patent recently acquired by A10 and seeking injunctive relief, as well as unspecified damages. In addition, A10 filed petitions with the USPTO to have each of the 13 patents

18


reexamined, in view of prior art that A10 alleges invalidates the patents. The petitions were granted, and reexaminations of the patents are in progress. On January 6, 2012, the Court granted Brocade’s summary judgment motion of non-infringement of the A10 patent. Trial on Brocade’s claims against A10 and the individual defendants commenced on July 16, 2012. On August 6, 2012, the jury found A10 responsible for intellectual property infringement and unfair competition, and awarded damages to Brocade. On January 11, 2013, the Court issued an order that affirmed the jury’s finding of A10’s liability for patent and copyright infringement, trade secret misappropriation and unfair competition due to A10’s interference with the employment contract of a Foundry Networks employee beginning in 2007. The Court also confirmed the jury’s award of $60 million to Brocade in damages for copyright infringement. The Court did, however, vacate the jury's award of damages for patent infringement and its award of punitive damages for A10's and Lee Chen's interference with the employment contract of the Foundry employee, and the Court ordered a new trial to redetermine the amount of any such damages. On January 11, 2013, the Court also issued a permanent injunction prohibiting A10 from shipping any A10 products that infringe Brocade’s patents. On January 23, 2013, the Court issued a permanent injunction prohibiting A10 from further use of the misappropriated trade secrets. On February 8, 2013, A10 filed a Notice of Appeal of the permanent injunctions. A10 also asked the Court to stay both of the injunctions pending appeal. On February 12, 2013, the Court denied A10’s request to stay the injunctions. Both of the Court-ordered permanent injunctions against A10 are in effect and, among other restrictions imposed by the Court, prohibit A10 from shipping any of its infringing products. A retrial on the sole issue of the amount of patent damages to be awarded to Brocade for A10's infringement was set for May 20, 2013. On May 20, 2013, before the start of the retrial, Brocade and A10 reached an agreement to settle all matters between the parties including the lawsuit A10 filed against Brocade on September 9, 2011 (as further described in Note 16, “Subsequent Event”).
General
From time to time, the Company is subject to other legal proceedings and claims in the ordinary course of business, including claims of alleged infringement of trademarks, copyrights, patents and/or other intellectual property rights and commercial contract disputes. Third parties assert patent infringement claims against the Company from time to time in the form of letters, lawsuits and other forms of communication. In addition, from time to time, the Company receives notification from customers claiming that they are entitled to indemnification or other obligations from the Company related to infringement claims made against them by third parties. Litigation, even if the Company is ultimately successful, can be costly and divert management’s attention away from the day-to-day operations of the Company.
On a quarterly basis, the Company reviews relevant information with respect to litigation contingencies and updates its accruals, disclosures and, when possible, estimates of reasonably possible losses or ranges of loss based on such reviews. However, litigation is inherently unpredictable, outcomes are typically uncertain, and the Company’s past experience does not provide any additional visibility or predictability to estimate the range of loss that may occur because the costs, outcome and status of these types of claims and proceedings have varied significantly in the past. Other than in the Stephen Knee v. Brocade litigation matter for which the Company has paid the settlement amount and the Enterasys litigation matter for which the Company has paid Enterasys a settlement amount on April 29, 2013, subsequent to the end of the second quarter of fiscal year 2013, the Company is not currently able to reasonably estimate the possible loss or range of loss from the above legal proceedings and, accordingly, the Company is unable to estimate the effects of the above on its financial condition, results of operations or cash flows.
The Company records a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated.

10. Derivative Instruments and Hedging Activities
In the normal course of business, the Company is exposed to fluctuations in interest rates and the exchange rates associated with foreign currencies. The Company’s primary objective for holding derivative financial instruments is to manage foreign currency exchange rate risk. The Company currently does not enter into derivative instruments to manage credit risk. However, the Company manages its exposure to credit risk through its investment policies. The Company generally enters into derivative transactions with high-credit quality counterparties and, by policy, limits the amount of credit exposure to any one counterparty based on its analysis of that counterparty’s relative credit standing.
The amounts subject to credit risk related to derivative instruments are generally limited to the amounts, if any, by which counterparty’s obligations exceed the Company’s obligations with that counterparty.

19


Foreign Currency Exchange Rate Risk
A majority of the Company’s revenue, expense and capital purchasing activities is transacted in U.S. dollars. However, the Company is exposed to foreign currency exchange rate risk inherent in conducting business globally in numerous currencies. The Company is primarily exposed to foreign currency fluctuations related to operating expenses denominated in currencies other than the U.S. dollar, of which the most significant to its operations for the six months ended April 27, 2013, were the Chinese yuan, the euro, the Japanese yen, the Indian rupee, the British pound, the Singapore dollar and the Swiss franc. The Company has established a foreign currency risk management program to protect against the volatility of future cash flows caused by changes in foreign currency exchange rates. This program reduces, but does not always entirely eliminate, the impact of foreign currency exchange rate movements.
The Company’s foreign currency risk management program includes foreign currency derivatives with cash flow hedge accounting designation that utilizes foreign currency forward and option contracts to hedge exposures to the variability in the U.S. dollar equivalent of anticipated non-U.S. dollar-denominated cash flows. These instruments generally have a maturity of less than fifteen months. For these derivatives, the Company reports the after-tax gain or loss from the effective portion of the hedge as a component of accumulated other comprehensive loss in stockholders’ equity and reclassifies it into earnings in the same period in which the hedged transaction affects earnings. The tax effect allocated to cash flow hedge-related components of other comprehensive income was not significant for the three and six months ended April 27, 2013, and April 28, 2012, respectively.
Ineffective cash flow hedges are included in the Company’s net income as part of “Interest and other income (loss), net.” The amount recorded on ineffective cash flow hedges was not significant for the three and six months ended April 27, 2013, and April 28, 2012, respectively.
Net gains (losses) relating to the effective portion of foreign currency derivatives recorded in the condensed consolidated statements of income are as follows (in thousands):
 
Three Months Ended
 
Six Months Ended
 
April 27, 2013
 
April 28, 2012
 
April 27, 2013
 
April 28, 2012
Cost of revenues
$
(4
)
 
$
(217
)
 
$
29

 
$
(412
)
Research and development
60

 
(181
)
 
55

 
(346
)
Sales and marketing
(24
)
 
(1,321
)
 
142

 
(2,384
)
General and administrative
(3
)
 
(90
)
 
5

 
(165
)
Total
$
29

 
$
(1,809
)
 
$
231

 
$
(3,307
)
Alternatively, we may choose not to hedge the foreign currency risk associated with our foreign currency exposures if we believe such exposure acts as a natural foreign currency hedge for other offsetting amounts denominated in the same currency or if the currency is difficult or too expensive to hedge. The net foreign currency exchange gains and losses recorded as part of “Interest and other income (loss), net” were losses of $0.1 million and gains of $0.1 million for the three and six months ended April 27, 2013, respectively, and losses of $0.2 million and $1.4 million for the three and six months ended April 28, 2012, respectively.
Gross unrealized loss positions are recorded within “Other accrued liabilities” and “Other non-current liabilities,” and gross unrealized gain positions are recorded within “Prepaid expenses and other current assets.” As of April 27, 2013, the Company had gross unrealized loss positions of $1.4 million and $0.1 million, and gross unrealized gain positions of $1.9 million included in “Other accrued liabilities,” “Other non-current liabilities” and “Prepaid expenses and other current assets,” respectively.

20


Volume of Derivative Activity
Total gross notional amounts, presented by currency, are as follows (in thousands):
 
Derivatives Designated
as Hedging Instruments
 
Derivatives Not Designated
as Hedging Instruments
In United States dollars
As of April 27, 2013
 
As of October 27, 2012
 
As of April 27, 2013
 
As of October 27, 2012
Euro
$
38,039

 
$
43,357

 
$

 
$

British pound
14,819

 
20,499

 

 

Indian rupee
21,607

 
16,046

 

 

Singapore dollar
8,849

 
12,918

 

 

Japanese yen
12,700

 
3,776

 
6,398

 
12,068

Swiss franc
6,325

 
8,575

 

 

Total
$
102,339

 
$
105,171

 
$
6,398

 
$
12,068


The Company utilizes a rolling hedge strategy for the majority of its foreign currency derivative instruments with cash flow hedge accounting designation that hedges exposures to the variability in the U.S. dollar equivalent of anticipated non-U.S. dollar-denominated cash flows. All of the Company’s foreign currency forward contracts are single delivery, which are settled at maturity involving one cash payment exchange.

11. Stock-Based Compensation
Stock-based compensation expense, net of estimated forfeitures, was included in the following line items of the Condensed Consolidated Statements of Income as follows (in thousands):
 
Three Months Ended
 
Six Months Ended
 
April 27, 2013
 
April 28, 2012
 
April 27, 2013
 
April 28, 2012
Cost of revenues
$
3,541

 
$
4,596

 
$
7,487

 
$
8,971

Research and development
4,500

 
5,603

 
9,185

 
10,631

Sales and marketing
8,012

 
10,687

 
16,157

 
20,463

General and administrative
3,119

 
2,972

 
5,493

 
5,612

Total stock-based compensation
$
19,172

 
$
23,858

 
$
38,322

 
$
45,677

 
The following table presents stock-based compensation expense, net of estimated forfeitures, by grant type (in thousands):
 
Three Months Ended
 
Six Months Ended
 
April 27, 2013
 
April 28, 2012
 
April 27, 2013
 
April 28, 2012
Stock options, including variable options
$
781

 
$
455

 
$
990

 
$
730

Restricted stock awards and restricted stock units (“RSUs”)
13,479

 
19,650

 
27,149

 
36,721

Employee stock purchase plan (“ESPP”)
4,912

 
3,753

 
10,183

 
8,226

Total stock-based compensation
$
19,172

 
$
23,858

 
$
38,322

 
$
45,677

The following table presents unrecognized compensation expense, net of estimated forfeitures, of the Company’s equity compensation plans as of April 27, 2013, which is expected to be recognized over the following weighted-average periods (in thousands, except for weighted-average period):
 
Unrecognized
Compensation
Expense
 
Weighted-
Average Period
(in years)
Stock options
$
4,951

 
1.78
RSUs
$
80,584

 
1.88
ESPP
$
9,984

 
0.87


21


The following table presents details on grants made by the Company for the following periods:
 
Six Months Ended
 
Six Months Ended
 
April 27, 2013
 
April 28, 2012
 
Granted
(in thousands)
 
Weighted-Average
Grant Date  Fair Value
 
Granted
(in thousands)
 
Weighted-Average
Grant Date  Fair Value
Stock options
2,625

 
$
2.37

 
160

 
$
2.39

RSUs
4,646

 
$
5.61

 
1,491

 
$
5.60

The total intrinsic value of stock options exercised for the six months ended April 27, 2013, and April 28, 2012, was $13.3 million and $19.8 million, respectively.

12. Income Taxes
In general, the Company’s provision for income taxes differs from the tax computed at the U.S. federal statutory income tax rate due to state taxes, the effect of non-U.S. operations, non-deductible stock-based compensation expense and adjustments to unrecognized tax benefits.
For the three and six months ended April 27, 2013, the Company recorded an income tax benefit of $0.2 million and tax expense of $88.1 million, respectively. The tax reported included a discrete benefit of $10.6 million from reserve releases resulting from the settlement of an IRS audit for the three months ended April 27, 2013, and a discrete charge of $78.2 million to reduce previously recognized California deferred tax assets due to California law changes, partially offset by a discrete benefit from an increase in the federal research and development tax credit of $5.7 million that was reinstated on January 2, 2013, for two years and made retroactive to January 1, 2012, for the six months ended April 27, 2013.
For the three and six months ended April 28, 2012, the Company recorded an income tax benefit of $0.7 million and $3.9 million, respectively, primarily due to a discrete benefit from net reserve releases related to settling tax audits and from expiring statutes of limitations, offset by a decrease to the federal research and development tax credit which expired on December 31, 2011, and, therefore, was not applicable in 2012.
The total amount of unrecognized tax benefits of $72.9 million, net of federal benefit, as of April 27, 2013, would affect the Company’s effective tax rate, if recognized. Although the timing of the closure of audits is highly uncertain, it is reasonably possible that the balance of unrecognized tax benefits could change during the remainder of fiscal year 2013.
The IRS and other tax authorities regularly examine the Company’s income tax returns. The IRS is currently examining fiscal years 2009 and 2010. In addition, the Company is in negotiations with foreign tax authorities to obtain correlative relief on transfer pricing adjustments previously settled with the IRS. The Company believes that reserves for unrecognized tax benefits are adequate for all open tax years. The timing of income tax examinations, as well as the amounts and timing of related settlements, if any, are highly uncertain. The Company believes that before the end of fiscal year 2013, it is reasonably possible that either certain audits will conclude or the statutes of limitations relating to certain income tax examination periods will expire, or both. After the Company reaches settlement with the tax authorities, the Company expects to record a corresponding adjustment to our unrecognized tax benefits. Taking into consideration the inherent uncertainty as to settlement terms, the timing of payments and the impact of such settlements on other uncertain tax positions, the Company estimates the range of potential decreases in underlying uncertain tax positions is between $0 and $3.9 million in the next twelve months.
The Company believes that sufficient positive evidence exists from historical operations and projections of taxable income in future years to conclude that it is more likely than not that the Company will realize its deferred tax assets except for California deferred tax assets and capital loss carryforwards. Accordingly, the Company applies a valuation allowance to the California deferred tax assets due to the recent change in California law and to capital loss carryforwards due to the limited carryforward periods of these tax assets.

13. Segment Information
Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the Chief Operating Decision Maker (“CODM”), or decision-making group, in deciding how to allocate resources and in assessing performance. Currently, the Company’s CODM is its Chief Executive Officer.

22


Brocade is organized into four operating segments, of which two are individually reportable segments: Storage Area Networking (“SAN”) Products, formerly referred to as Data Storage Products, and Global Services. The other two operating segments, Ethernet Switching & Internet Protocol (“IP”) Routing and Application Delivery Products (“ADP”), combine to form a third reportable segment: IP Networking Products, formerly referred to as Ethernet Products. These segments are organized principally by product category.
Financial decisions and the allocation of resources are based on the information from the Company’s internal management reporting system. At this point in time, the Company does not track all of its assets by operating segments. The majority of the Company’s assets as of April 27, 2013, were attributable to its United States operations.
Summarized financial information by reportable segment for the three and six months ended April 27, 2013, and April 28, 2012, based on the internal management reporting system, is as follows (in thousands):
 
SAN
Products
 
IP Networking Products
 
Global Services
 
Total
Three months ended April 27, 2013
 
 
 
 
 
 
 
Net revenues
$
319,088

 
$
132,658

 
$
87,038

 
$
538,784

Cost of revenues
87,897

 
76,702

 
40,073

 
204,672

Gross margin
$
231,191

 
$
55,956

 
$
46,965

 
$
334,112

Three months ended April 28, 2012
 
 
 
 
 
 
 
Net revenues
$
342,922

 
$
113,182

 
$
87,335

 
$
543,439

Cost of revenues
90,357

 
73,820

 
42,180

 
206,357

Gross margin
$
252,565

 
$
39,362

 
$
45,155

 
$
337,082

Six months ended April 27, 2013
 
 
 
 
 
 
 
Net revenues
$
680,822

 
$
273,171

 
$
173,520

 
$
1,127,513

Cost of revenues
184,850

 
154,124

 
80,502

 
419,476

Gross margin
$
495,972

 
$
119,047

 
$
93,018

 
$
708,037

Six months ended April 28, 2012
 
 
 
 
 
 
 
Net revenues
$
695,794

 
$
236,612

 
$
171,675

 
$
1,104,081

Cost of revenues
186,195

 
153,389

 
82,646

 
422,230

Gross margin
$
509,599

 
$
83,223

 
$
89,029

 
$
681,851



23


14. Net Income per Share
The following table presents the calculation of basic and diluted net income per share (in thousands, except per share amounts):
 
Three Months Ended
 
Six Months Ended
 
April 27,
2013
 
April 28,
2012
 
April 27,
2013
 
April 28,
2012
Basic net income per share
 
 
 
 
 
 
 
Net income
$
46,949

 
$
39,296

 
$
25,694

 
$
97,880

Weighted-average shares used in computing basic net income per share
453,133

 
457,541

 
453,988

 
455,017

Basic net income per share
$
0.10

 
$
0.09

 
$
0.06

 
$
0.22

Diluted net income per share
 
 
 
 
 
 
 
Net income
$
46,949

 
$
39,296

 
$
25,694

 
$
97,880

Weighted-average shares used in computing basic net income per share
453,133

 
457,541

 
453,988

 
455,017

Dilutive potential common shares in the form of stock options
3,744

 
9,112

 
4,109

 
9,501

Dilutive potential common shares in the form of other share-based awards
10,042

 
10,195

 
8,523

 
8,275

Weighted-average shares used in computing diluted net income per share
466,919

 
476,848

 
466,620

 
472,793

Diluted net income per share
$
0.10

 
$
0.08

 
$
0.06

 
$
0.21

Antidilutive potential common shares in the form of (1)
 
 
 
 
 
 
 
Stock options
14,940

 
14,750

 
15,382

 
17,284

Other share-based awards
6

 
108

 
250

 
592


(1)
These amounts are excluded from the computation of diluted net income per share.

15. Guarantor and Non-Guarantor Subsidiaries
On January 20, 2010, the Company issued $600.0 million aggregate principal amount of the 2018 Notes and 2020 Notes. In addition, on January 22, 2013, the Company issued $300.0 million aggregate principal amount of the 2023 Notes. The Company’s obligations under the 2023 Notes and the 2020 Notes are, and prior to January 22, 2013, the Company’s obligations under the 2018 Notes were, guaranteed by certain of the Company’s domestic subsidiaries (the “Subsidiary Guarantors”). Each of the Subsidiary Guarantors is 100% owned by the Company and all guarantees are joint and several. The senior secured notes are not guaranteed by certain of the Company’s domestic subsidiaries and all of the Company’s foreign subsidiaries (the “Non-Guarantor Subsidiaries”).
Pursuant to the terms of the Indentures governing the Senior Secured Notes, the guarantees are full and unconditional, but are subject to release under the following circumstances:
upon the sale of the subsidiary or all or substantially all of its assets;
upon the discharge of the guarantees under the credit facility and any other debt guaranteed by the applicable subsidiary provided that the credit facility has been paid in full and the applicable series of senior secured notes have an investment grade rating from both Standard & Poor’s and Moody’s;
upon designation of the subsidiary as an “unrestricted subsidiary” under the applicable Indenture;
upon the merger, consolidation or liquidation of the subsidiary into the Company or another subsidiary guarantor; and
upon legal or covenant defeasance or the discharge of the Company’s obligations under the applicable indenture.
The guarantees of the 2018 Notes were released on January 22, 2013, upon the discharge of the 2018 Indenture.

24


Pursuant to the terms of the Indenture governing the 2023 Notes, the guarantees are full and unconditional but are subject to release under the following circumstances:
upon the sale of the subsidiary or all or substantially all of its assets;
upon the discharge of the guarantees under the Senior Secured Credit Facility, the 2020 Notes and any other debt guaranteed by the applicable subsidiary;
upon the merger, consolidation or liquidation of the subsidiary into the Company or another subsidiary guarantor; and
upon legal or covenant defeasance or the discharge of the Company’s obligations under the applicable indenture.
Because the guarantees are subject to release under the above described circumstances, they would not be deemed “full and unconditional” for purposes of Rule 3-10 of Regulation S-X. However, as these circumstances are customary, the Company concluded that it may rely on Rule 3-10 of Regulation S-X, as the other requirements of Rule 3-10 have been met.
The following tables present condensed consolidated financial statements for the parent company, the Subsidiary Guarantors and the Non-Guarantor Subsidiaries, respectively.
The following is the condensed consolidated balance sheet as of April 27, 2013 (in thousands):
 
Brocade
Communications
Systems, Inc.
 
Subsidiary
Guarantors
 
Non-Guarantor Subsidiaries
 
Consolidating
Adjustments
 
Total
Assets
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
258,692

 
$
3,318

 
$
502,288

 
$

 
$
764,298

Accounts receivable, net
150,993

 
347

 
87,971

 

 
239,311

Inventories
42,637

 

 
10,274

 

 
52,911

Intercompany receivables

 
483,744

 

 
(483,744
)
 

Other current assets
93,396

 
371

 
13,265

 
943

 
107,975

Total current assets
545,718

 
487,780

 
613,798

 
(482,801
)
 
1,164,495

Property and equipment, net
483,495

 
697

 
15,776

 

 
499,968

Investment in subsidiaries
949,737

 

 

 
(949,737
)
 

Other non-current assets
1,738,214

 
106,730

 
1,416

 

 
1,846,360

Total assets
$
3,717,164

 
$
595,207

 
$
630,990

 
$
(1,432,538
)
 
$
3,510,823

Liabilities and Stockholders’ Equity
 
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
 
Accounts payable
$
77,885

 
$
71

 
$
23,310

 
$

 
$
101,266

Current portion of long-term debt
2,306

 

 

 

 
2,306

Intercompany payables
414,746

 

 
68,998

 
(483,744
)
 

Other current liabilities
307,135

 
7,453

 
130,119

 
943

 
445,650

Total current liabilities
802,072

 
7,524

 
222,427

 
(482,801
)
 
549,222

Long-term debt, net of current portion
596,971

 

 

 

 
596,971

Other non-current liabilities
71,528

 
2,428

 
44,081

 

 
118,037

Total liabilities
1,470,571

 
9,952

 
266,508

 
(482,801
)
 
1,264,230

Total stockholders’ equity
2,246,593

 
585,255

 
364,482

 
(949,737
)
 
2,246,593

Total liabilities and stockholders’ equity
$
3,717,164

 
$
595,207

 
$
630,990

 
$
(1,432,538
)
 
$
3,510,823


25


The following is the condensed consolidated balance sheet as of October 27, 2012 (in thousands):
 
Brocade
Communications
Systems, Inc.
 
Subsidiary
Guarantors
 
Non-Guarantor Subsidiaries
 
Consolidating
Adjustments
 
Total
Assets
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
284,466

 
$
680

 
$
428,080

 
$

 
$
713,226

Accounts receivable, net
150,367

 
(1,847
)
 
84,619

 

 
233,139

Inventories
55,084

 

 
13,095

 

 
68,179

Intercompany receivables

 
478,133

 

 
(478,133
)
 

Other current assets
124,690

 
514

 
15,606

 
225

 
141,035

Total current assets
614,607

 
477,480

 
541,400

 
(477,908
)
 
1,155,579

Property and equipment, net
500,530

 
213

 
18,197

 

 
518,940

Investment in subsidiaries
871,157

 

 

 
(871,157
)
 

Other non-current assets
1,814,729

 
90,766

 
1,247

 

 
1,906,742

Total assets
$
3,801,023

 
$
568,459

 
$
560,844

 
$
(1,349,065
)
 
$
3,581,261

Liabilities and Stockholders’ Equity
 
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
 
Accounts payable
$
92,661

 
$

 
$
24,689

 
$

 
$
117,350

Current portion of long-term debt
2,226

 
(249
)
 

 

 
1,977

Intercompany payables
434,981

 

 
43,152

 
(478,133
)
 

Other current liabilities
346,959

 
7,628

 
136,329

 
225

 
491,141

Total current liabilities
876,827

 
7,379

 
204,170

 
(477,908
)
 
610,468

Long-term debt, net of current portion
599,203

 

 

 

 
599,203

Other non-current liabilities
89,173

 
2,429

 
44,168

 

 
135,770

Total liabilities
1,565,203

 
9,808

 
248,338

 
(477,908
)
 
1,345,441

Total stockholders’ equity
2,235,820

 
558,651

 
312,506

 
(871,157
)
 
2,235,820

Total liabilities and stockholders’ equity
$
3,801,023

 
$
568,459

 
$
560,844

 
$
(1,349,065
)
 
$
3,581,261


26


The following is the condensed consolidated statement of operations for the three months ended April 27, 2013 (in thousands):
 
Brocade
Communications
Systems, Inc.
 
Subsidiary
Guarantors
 
Non-Guarantor Subsidiaries
 
Consolidating
Adjustments
 
Total
Revenues
$
313,525

 
$
1,056

 
$
224,203

 
$

 
$
538,784

Intercompany revenues
6,453

 

 
6,470

 
(12,923
)
 

Total net revenues
319,978

 
1,056

 
230,673

 
(12,923
)
 
538,784

Cost of revenues
131,123

 
11,649

 
59,726

 
2,174

 
204,672

Intercompany cost of revenues
(18,103
)