Quarterly Report


Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended May 3, 2014
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 95134-1376
(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     x     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     x     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   o
 
Non-accelerated filer   o
 
Smaller reporting company   o
 
 
(Do not check if a 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     x
The number of shares outstanding of the registrant’s common stock as of May 30, 2014 , was 428,212,000 shares.


Table of Contents

BROCADE COMMUNICATIONS SYSTEMS, INC.
FORM 10-Q
For the Quarter Ended May 3, 2014
TABLE OF CONTENTS
 
 
Page
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 6.
 
 

2

Table of Contents

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, 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,” “projects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “continues,” “may,” and 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

Table of Contents

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

BROCADE COMMUNICATIONS SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
 
Three Months Ended
 
Six Months Ended
 
May 3,
2014
 
April 27,
2013
 
May 3,
2014
 
April 27,
2013
 
(In thousands, except per share amounts)
Net revenues
 
 
 
 
 
 
 
Product
$
442,280

 
$
451,746

 
$
917,485

 
$
953,993

Service
94,630

 
87,038

 
183,960

 
173,520

Total net revenues
536,910

 
538,784

 
1,101,445

 
1,127,513

Cost of revenues
 
 
 
 
 
 
 
Product
142,271

 
164,599

 
295,898

 
338,974

Service
40,347

 
40,073

 
78,585

 
80,502

Total cost of revenues
182,618

 
204,672

 
374,483

 
419,476

Gross margin
354,292

 
334,112

 
726,962

 
708,037

Operating expenses:
 
 
 
 
 
 
 
Research and development
90,554

 
98,429

 
177,710

 
196,119

Sales and marketing
139,597

 
145,316

 
272,262

 
294,327

General and administrative
21,112

 
20,037

 
41,255

 
39,114

Amortization of intangible assets
131

 
13,151

 
10,014

 
28,007

Restructuring, goodwill impairment, and other related costs (Note 7)
82,703

 

 
88,920

 

Gain on sale of network adapter business

 

 
(4,884
)
 

Total operating expenses
334,097

 
276,933

 
585,277

 
557,567

Income from operations
20,195

 
57,179

 
141,685

 
150,470

Interest expense
(9,234
)
 
(10,432
)
 
(18,430
)
 
(36,800
)
Interest and other income (loss), net
(20
)
 
31

 
(1,356
)
 
97

Income before income tax
10,941

 
46,778

 
121,899

 
113,767

Income tax expense (benefit)
24,625

 
(171
)
 
54,699

 
88,073

Net income (loss)
$
(13,684
)
 
$
46,949

 
$
67,200

 
$
25,694

Net income (loss) per share—basic
$
(0.03
)
 
$
0.10

 
$
0.15

 
$
0.06

Net income (loss) per share—diluted
$
(0.03
)
 
$
0.10

 
$
0.15

 
$
0.06

Shares used in per share calculation—basic
436,167

 
453,133

 
438,370

 
453,988

Shares used in per share calculation—diluted
436,167

 
466,919

 
451,999

 
466,620

See accompanying notes to condensed consolidated financial statements.

4



BROCADE COMMUNICATIONS SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
 
Three Months Ended
 
Six Months Ended
 
May 3,
2014
 
April 27,
2013
 
May 3,
2014
 
April 27,
2013
 
(In thousands)
Net income (loss)
$
(13,684
)
 
$
46,949

 
$
67,200

 
$
25,694

Other comprehensive income and loss, net of tax:
 
 
 
 
 
 
 
Unrealized gains (losses) on cash flow hedges:
 
 
 
 
 
 
 
Change in unrealized gains and losses
1,094

 
(1,915
)
 
170

 
(1,992
)
Net gains and losses reclassified into earnings
32

 
(32
)
 
1

 
(210
)
Net unrealized gains (losses) on cash flow hedges
1,126

 
(1,947
)
 
171

 
(2,202
)
Foreign currency translation adjustments
1,298

 
(1,762
)
 
475

 
(2,142
)
Total other comprehensive income (loss)
2,424

 
(3,709
)
 
646

 
(4,344
)
Total comprehensive income (loss)
$
(11,260
)
 
$
43,240

 
$
67,846

 
$
21,350

See accompanying notes to condensed consolidated financial statements.


5


BROCADE COMMUNICATIONS SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
May 3,
2014
 
October 26,
2013
 
(In thousands, except par value)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
1,137,613

 
$
986,997

Accounts receivable, net of allowances for doubtful accounts of $531 and $575 at May 3, 2014, and October 26, 2013, respectively
193,804

 
249,598

Inventories
40,773

 
45,344

Deferred tax assets
116,557

 
98,018

Prepaid expenses and other current assets
47,687

 
42,846

Total current assets
1,536,434

 
1,422,803

Property and equipment, net
452,722

 
472,940

Goodwill
1,556,733

 
1,645,437

Intangible assets, net
23,386

 
40,258

Non-current deferred tax assets
788

 
1,585

Other assets
38,846

 
38,368

Total assets
$
3,608,909

 
$
3,621,391

LIABILITIES AND STOCKHOLDERS’ EQUITY

 
 
Current liabilities:
 
 
 
Accounts payable
$
79,952

 
$
88,218

Accrued employee compensation
141,482

 
145,996

Deferred revenue
230,704

 
226,696

Current restructuring liabilities
2,876

 
16,418

Current portion of long-term debt
2,277

 
2,996

Other accrued liabilities
64,898

 
80,339

Total current liabilities
522,189

 
560,663

Long-term debt, net of current portion
595,452

 
596,208

Non-current restructuring liabilities
3,587

 
1,008

Non-current deferred revenue
72,956

 
76,426

Non-current income tax liability
46,271

 
38,680

Non-current deferred tax liabilities
31,124

 

Other non-current liabilities
1,583

 
1,593

Total liabilities
1,273,162

 
1,274,578

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: 435,452 and 445,285 shares at May 3, 2014, and October 26, 2013, respectively
436

 
445

Additional paid-in capital
1,836,249

 
1,915,152

Accumulated other comprehensive loss
(12,798
)
 
(13,444
)
Retained earnings
511,860

 
444,660

Total stockholders’ equity
2,335,747

 
2,346,813

Total liabilities and stockholders’ equity
$
3,608,909

 
$
3,621,391

See accompanying notes to condensed consolidated financial statements.

6


BROCADE COMMUNICATIONS SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
Six Months Ended
 
May 3,
2014
 
April 27,
2013
 
(In thousands)
Cash flows from operating activities:
 
 
 
Net income
$
67,200

 
$
25,694

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Excess tax benefits from stock-based compensation
(27,415
)
 
(5,440
)
Non-cash tax charges

 
78,206

Depreciation and amortization
59,927

 
93,358

Loss on disposal of property and equipment
3,178

 
3,046

Gain on sale of network adapter business
(4,884
)
 

Amortization of debt issuance costs and original issue discount
566

 
665

Call premium cost and write-off of original issue discount and debt issuance costs related to lenders that did not participate in refinancing

 
5,360

Provision for doubtful accounts receivable and sales allowances
3,528

 
4,560

Non-cash compensation expense
39,640

 
38,322

Goodwill impairment charge
83,382

 

Changes in assets and liabilities:
 
 
 
Accounts receivable
52,266

 
(10,561
)
Inventories
4,570

 
16,605

Prepaid expenses and other assets
(8,371
)
 
(1,714
)
Deferred tax assets
57

 
322

Accounts payable
(7,126
)
 
(14,692
)
Accrued employee compensation
(11,738
)
 
(54,163
)
Deferred revenue
573

 
7,924

Other accrued liabilities
33,324

 
(7,969
)
Restructuring liabilities
(10,964
)
 
(418
)
Net cash provided by operating activities
277,713

 
179,105

Cash flows from investing activities:
 
 
 
Purchases of non-marketable equity investments
(223
)
 

Purchases of property and equipment
(27,395
)
 
(31,568
)
Net cash paid in connection with acquisition

 
(44,629
)
Proceeds from collection of note receivable
250

 

Proceeds from sale of network adapter business
9,995

 

Net cash used in investing activities
(17,373
)
 
(76,197
)
Cash flows from financing activities:
 
 
 
Proceeds from senior unsecured notes

 
296,250

Payment of principal related to senior secured notes

 
(300,000
)
Payment of debt issuance costs related to senior unsecured notes

 
(549
)
Payment of principal related to capital leases
(1,749
)
 
(975
)
Common stock repurchases
(190,432
)
 
(86,179
)
Proceeds from issuance of common stock
54,530

 
35,899

Excess tax benefits from stock-based compensation
27,415

 
5,440

Net cash used in financing activities
(110,236
)
 
(50,114
)
Effect of exchange rate fluctuations on cash and cash equivalents
512

 
(1,722
)
Net increase in cash and cash equivalents
150,616

 
51,072

Cash and cash equivalents, beginning of period
986,997

 
713,226

Cash and cash equivalents, end of period
$
1,137,613

 
$
764,298

Supplemental disclosures of cash flow information:
 
 
 
Cash paid for interest
$
17,375

 
$
22,593

Cash paid for income taxes
$
16,408

 
$
8,557

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 26, 2013 , 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 26, 2013 .
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 or the first Saturday in November, respectively. Fiscal year 2014 is a 53-week fiscal year and fiscal year 2013 is a 52-week fiscal year. The second quarter of fiscal year 2014 is a 14-week quarter, which is one week longer than a typical 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 May 3, 2014 , as compared to the significant accounting policies disclosed in Brocade’s Annual Report on Form 10-K for the fiscal year ended October 26, 2013 .
New Accounting Pronouncements or Updates Recently Adopted
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”) into net income 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. The Company adopted this update in the first quarter of fiscal year 2014, presenting the required information in Note 12 , “ Accumulated Other Comprehensive Income (Loss) ,” of the Notes to Condensed Consolidated Financial Statements.
Recent Accounting Pronouncements or Updates That Are Not Yet Effective
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

8


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.
In July 2013, the FASB issued an update to ASC 740 Income Taxes (“ASC 740”): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. Under this update, an entity is required to present an unrecognized tax benefit, or a portion thereof, as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except to the extent that these instances are not available at the reporting date. This update to ASC 740 should be applied prospectively and will be adopted by the Company in the first quarter of fiscal year 2015. Early adoption and retrospective application are permitted. The Company does not expect the adoption of this update to ASC 740 to have a material impact on its financial position, results of operations or cash flows.
In April 2014, the FASB issued an update to ASC 205 Presentation of Financial Statements (“ASC 205”) and ASC 360 Property, Plant, and Equipment (“ASC 360”): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. Under this update, a discontinued operation may include a component of an entity or a group of components of an entity, or a business or nonprofit activity. Only those disposals of components of an entity that represent a strategic shift that has, or will have, a major effect on an entity’s operations and financial results will be reported as discontinued operations in the financial statements. This update to ASC 205 and ASC 360 should be applied prospectively and will be adopted by the Company in the first quarter of fiscal year 2016. Early adoption is permitted, but only for disposals that have not been reported in financial statements previously issued.
In May 2014, the FASB issued an update to ASC 606 Revenue from Contracts with Customers (“ASC 606”) that will supersede virtually all existing revenue guidance. Under this update, an entity is required to recognize revenue upon transfer of promised goods or services to customers, in an amount that reflects the expected consideration received in exchange for those goods or services. As such, an entity will need to use more judgment and make more estimates than under the current guidance. This update to ASC 606 should be applied retrospectively either to each prior reporting period presented in the financial statements, or only to the most current reporting period presented in the financial statements with a cumulative effect adjustment recorded in the retained earnings. This update to ASC 606 becomes effective and will be adopted by the Company in the first quarter of fiscal year 2018. Early adoption is not permitted. The Company is currently evaluating the impact of this update on its consolidated financial statements.
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 four 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 May 3, 2014 , three customers accounted for 15% , 11% , and 11% , respectively, of total accounts receivable, for a combined total of 37% of total accounts receivable. As of October 26, 2013 , four customers accounted for 18% , 12% , 11% , and 11% , respectively, of total accounts receivable, for a combined total of 52% 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 May 3, 2014 , four customers accounted for 17% , 16% , 12% , and 11% , respectively, of the Company’s total net revenues for a combined total of 56% of total net revenues. 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.
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.


9


3 . Acquisitions and Divestitures
Divestitures
On January 17, 2014, the Company completed the sale of its network adapter business to QLogic Corporation, as part of the Company’s business strategy to focus development on a portfolio of high performance networking products and services--both hardware and software-based--that meet the demands of today’s virtualized and cloud based data centers.
The net carrying amount of the divested network adapter business’ assets and liabilities was $5.1 million , comprised primarily of associated goodwill of $4.1 million . The sale resulted in a gain of $4.9 million , which is presented in the Company’s Condensed Consolidated Statements of Operations as “ Gain on sale of network adapter business .”
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 software-based network operating system suite is deployed on conventional computer hardware platforms for multiple applications in network virtualization, software-defined networking (“SDN”), Network Functions Virtualization (“NFV”), and other private/public cloud computing platforms. This acquisition complements Brocade’s investments in Internet Protocol (“IP”) switches and router products and enables Brocade to pursue new market opportunities in data center virtualization, including public cloud, 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, $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 . 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.

4 . Goodwill and Intangible Assets
The following table presents a summary of the net carrying value of the Company’s intangible assets (in thousands):
 
May 3,
2014
 
October 26,
2013
Indefinite-lived intangible assets
 
 
 
Goodwill
$
1,556,733

 
$
1,645,437

In-process research and development (1)
12,260

 
21,590

Finite-lived intangible assets
 
 
 
Total intangible assets subject to amortization
11,126

 
18,668

Total intangible assets
$
1,580,119

 
$
1,685,695

(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. As an indefinite-lived asset, the IPRD intangible asset is subject to testing for impairment annually, which the Company conducts 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 three months ended May 3, 2014, development work was completed on $9.3 million of the IPRD intangible asset and this completed IPRD intangible asset is being amortized as Core/developed technology. The development effort on the remaining IPRD intangible asset is expected to be completed in the first half of fiscal year 2015.
The Company performed its annual IPRD impairment test using measurement data as of the first day of the second fiscal quarter of 2014. During the test, the Company elected 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

10


is less than its carrying amount. After assessing the totality of events and circumstances, the Company determined that it was 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 summarizes goodwill activity by reportable segment for the six months ended May 3, 2014 (in thousands):
 
SAN 
Products
 
IP Networking Products
 
Global Services
 
Total
Balance at October 26, 2013
 
 
 
 
 
 
 
Goodwill
$
176,878

 
$
1,358,975

 
$
155,416

 
$
1,691,269

Accumulated impairment losses

 
(45,832
)
 

 
(45,832
)
 
176,878

 
1,313,143

 
155,416

 
1,645,437

Impairment (1)

 
(83,382
)
 

 
(83,382
)
Divestitures  (2)
(474
)
 
(3,657
)
 

 
(4,131
)
Tax and other adjustments during the six months ended May 3, 2014 (3)
(40
)
 
(1,151
)
 

 
(1,191
)
Balance at May 3, 2014
 
 
 
 
 
 
 
Goodwill
176,364

 
1,354,167

 
155,416

 
1,685,947

Accumulated impairment losses

 
(129,214
)
 

 
(129,214
)
 
$
176,364

 
$
1,224,953

 
$
155,416

 
$
1,556,733

(1)  
In the second quarter of fiscal year 2014, the Company has made a strategic shift in the allocation of its engineering resources and has reduced its investment in the hardware-based ADX products and increased investment in the software-based ADX products for the Layer 4-7 market. As a result of this change in strategy, the Company expects hardware-based ADX and related support revenue to be negatively impacted. Based on these changes in estimates, the Company recognized an impairment charge because the book value of its Application Delivery Products (“ADP”) reporting unit net assets, which includes the ADX products, exceeded the estimated fair value of these assets. The goodwill amount related to the Company’s other reporting units was not impacted.
(2)  
The goodwill disposed relates to the sale of the Company’s network adapter business, see Note 3 , “ Acquisitions and Divestitures ,” of the Notes to Condensed Consolidated Financial Statements.
(3)  
The goodwill adjustments during the six months ended May 3, 2014 , were primarily a result of tax benefits from the exercise of stock awards of acquired companies.
The Company conducts its goodwill impairment test annually, as of the first day of the second fiscal quarter, and whenever events occur or facts and circumstances change that would more likely than not reduce the fair value of a reporting unit below 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 applying various observable market-based multiples to the reporting unit’s operating results and then applying an appropriate control premium. For the fiscal year 2014 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 the impairment testing performed in the second fiscal quarter of 2014, 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 market segments that are comparable with the Company’s reporting units.

11


Based on the results of the annual goodwill impairment analysis performed during the second fiscal quarter of 2014, the Company determined that no impairment needed to be recorded for Storage Area Networking (“SAN”) Products, Ethernet Switching & Internet Protocol (“IP”) Routing, and Global Services reporting units as these reporting units passed the first step of goodwill impairment testing.
However, the Company determined that the fair value of the ADP reporting unit was below the reporting unit’s carrying value. Accordingly, the Company performed the second step of the goodwill impairment test to measure the amount of the impairment. During the second step, the Company assigned the ADP reporting unit’s fair value to the reporting unit’s assets and liabilities, using the relevant acquisition accounting guidance, to determine the implied fair value of the reporting unit’s goodwill. The implied fair value of the reporting unit’s goodwill was then compared with the carrying value of the ADP reporting unit’s goodwill to record an impairment loss of $83.4 million , which is equal to the difference in values.
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 finite-lived intangible assets (in thousands, except for weighted-average remaining useful life):
May 3, 2014
Gross
Carrying
Value
 
Accumulated
Amortization
 
Net
Carrying
Value
 
Weighted-
Average
Remaining
Useful Life
(in years)
Trade name
$
460

 
$
167

 
$
293

 
2.51
Core/developed technology
10,370

 
812

 
9,558

 
4.65
Customer relationships
1,080

 
321

 
759

 
3.51
Non-compete agreements
810

 
294

 
516

 
2.51
Total intangible assets (1)
$
12,720

 
$
1,594

 
$
11,126

 
4.41
 
 
 
 
 
 
 
 
October 26, 2013
Gross
Carrying
Value
 
Accumulated
Amortization
 
Net
Carrying
Value
 
Weighted-
Average
Remaining
Useful Life
(in years)
Trade name
$
460

 
$
110

 
$
350

 
3.01
Core/developed technology
192,340

 
185,254

 
7,086

 
0.35
Customer relationships
287,090

 
276,473

 
10,617

 
0.51
Non-compete agreements
810

 
195

 
615

 
3.01
Total intangible assets
$
480,700

 
$
462,032

 
$
18,668

 
0.58
(1)  
During the six months ended May 3, 2014 , $477.3 million of intangible assets became fully amortized and, therefore, were removed from the balance sheet .
The following table presents the amortization of finite-lived intangible assets included in the Condensed Consolidated Statements of Operations (in thousands):
 
Three Months Ended
 
Six Months Ended
 
May 3, 2014
 
April 27, 2013
 
May 3, 2014
 
April 27, 2013
Cost of revenues
$
396

 
$
9,651

 
$
6,858

 
$
20,431

Operating expenses
131

 
13,151

 
10,014

 
28,007

Total
$
527

 
$
22,802

 
$
16,872

 
$
48,438


12


The following table presents the estimated future amortization of finite-lived intangible assets as of May 3, 2014 (in thousands):
Fiscal Year
Estimated
Future
Amortization
2014 (remaining six months)
$
1,366

2015
2,731

2016
2,419

2017
2,104

2018
1,884

Thereafter
622

Total
$
11,126


5 . Balance Sheet Details
The following table provides details of selected balance sheet items (in thousands):
 
May 3,
2014
 
October 26,
2013
Inventories:
 
 
 
Raw materials
$
12,749

 
$
14,048

Finished goods
28,024

 
31,296

Total
$
40,773

 
$
45,344


 
May 3,
2014
 
October 26,
2013
Property and equipment, net:
 
 
 
Computer equipment
$
13,732

 
$
16,006

Software
58,331

 
57,186

Engineering and other equipment (1)
371,232

 
416,573

Furniture and fixtures (1)
28,442

 
29,029

Leasehold improvements
19,695

 
24,287

Land and building
384,565

 
384,654

Subtotal
875,997

 
927,735

Less: Accumulated depreciation and amortization  (1), (2)
(423,275
)
 
(454,795
)
Total
$
452,722

 
$
472,940

(1)  
Engineering and other equipment, furniture and fixtures and accumulated depreciation and amortization include the following amounts under capital leases as of May 3, 2014 , and October 26, 2013 , respectively (in thousands):
 
May 3,
2014
 
October 26,
2013
Cost
$
11,925

 
$
11,925

Accumulated depreciation
(6,287
)
 
(5,366
)
Total
$
5,638

 
$
6,559

(2)  
The following table presents the depreciation and amortization of property and equipment included in the Condensed Consolidated Statements of Operations (in thousands):
 
Three Months Ended
 
Six Months Ended
 
May 3,
2014
 
April 27,
2013
 
May 3,
2014
 
April 27,
2013
Depreciation and amortization expense
$
20,519

 
$
21,162

 
$
43,055

 
$
44,920


13



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 May 3, 2014 .
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 May 3, 2014 , and October 26, 2013 .
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 May 3, 2014 , were as follows (in thousands):
 
 
 
Fair Value Measurements Using
 
 Balance as of
 May 3, 2014
 
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)
$
731,260

 
$
731,260

 
$

 
$

Derivative assets
1,310

 

 
1,310

 

Total assets measured at fair value
$
732,570

 
$
731,260

 
$
1,310

 
$

Liabilities:
 
 
 
 
 
 
 
Derivative liabilities
$
627

 
$

 
$
627

 
$

Total liabilities measured at fair value
$
627

 
$

 
$
627

 
$

 
(1)  
Money market funds are reported within “Cash and cash equivalents” in the Condensed Consolidated Balance Sheets.
Assets and liabilities measured and recorded at fair value on a recurring basis as of October 26, 2013 , were as follows (in thousands):
 
 
 
Fair Value Measurements Using
 
 Balance as of
 October 26, 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)
$
431,750

 
$
431,750

 
$

 
$

Derivative assets
1,814

 

 
1,814

 

Total assets measured at fair value
$
433,564

 
$
431,750

 
$
1,814

 
$

Liabilities:
 
 
 
 
 
 
 
Derivative liabilities
$
1,441

 
$

 
$
1,441

 
$

Total liabilities measured at fair value
$
1,441

 
$

 
$
1,441

 
$


(1)  
Money market funds are reported within “Cash and cash equivalents” in the Condensed Consolidated Balance Sheets.
During the six months ended May 3, 2014 , the Company had no transfers between levels of the fair value hierarchy of its assets and liabilities measured at fair value.


14


7 . Restructuring and Other Costs
The following table provides details of the Company’s restructuring and other charges (in thousands):
 
Three Months Ended
 
Six Months Ended
 
May 3,
2014
 
April 27,
2013
 
May 3,
2014
 
April 27,
2013
Goodwill impairment  (1)
$
83,382

 
$

 
$
83,382

 
$

Severance and Benefits
(43
)
 

 
(1,788
)
 

Lease Loss Reserve and Related Costs
(636
)
 

 
7,326

 

Restructuring, goodwill impairment, and other related costs
$
82,703

 
$

 
$
88,920

 
$


(1)  
For additional discussion on goodwill impairment, see Note 4 , “ Goodwill and Intangible Assets ,” of the Notes to Condensed Consolidated Financial Statements.
The following table provides a reconciliation of the Company’s beginning and ending restructuring liability balances (in thousands):
 
Fiscal 2013 Fourth Quarter Restructuring Plan
 
Prior Restructuring Plans
 
 
 
Severance and Benefits
 
Contract Terminations and Other
 
Lease Loss Reserve and Related Costs
 
Lease Loss
Reserve and Related Costs
 
Total
Restructuring liabilities at October 26, 2013
$
15,216

 
$
416

 
$

 
$
1,794

 
$
17,426

Restructuring and other charges
(1,788
)
 

 
7,326

 

 
5,538

Cash payments
(13,258
)
 
(249
)
 
(2,460
)
 
(561
)
 
(16,528
)
Translation adjustment

 

 
27

 

 
27

Restructuring liabilities at May 3, 2014
$
170

 
$
167

 
$
4,893

 
$
1,233

 
$
6,463


 
 
 
 
 
 
 
 
 
Current restructuring liabilities at May 3, 2014
$
170

 
$
167

 
$
2,078

 
$
461

 
$
2,876

Non-current restructuring liabilities at May 3, 2014
$

 
$

 
$
2,815

 
$
772

 
$
3,587

Fiscal 2013 Fourth Quarter Restructuring Plan
During the fiscal year ended October 26, 2013, and the first quarter of fiscal year 2014, the Company restructured certain business operations and reduced the Company’s operating expense structure. The restructuring plan was approved by the Company’s management and communicated to the Company’s employees in September 2013 . The restructuring plan included a workforce reduction of approximately 250 employees, primarily in the engineering, sales, and marketing organizations, as well as the cancellation of certain nonrecurring engineering agreements and exit from certain leased facilities.
In connection with the restructuring plan, the Company incurred aggregate charges of $31.0 million through May 3, 2014 , primarily related to severance and benefits charges and lease loss reserve and related costs, and substantially completed the restructuring plan by the end of the first quarter of fiscal year 2014 .
Severance and benefits charges incurred under this restructuring plan consisted of severance and related employee termination costs, including salary and other compensation payments to the employees during their post-notification retention period as well as associated outplacement services. The post-notification retention period for the employees terminated under the plan did not exceed the legal notification period, or, in the absence of a legal notification requirement, 60 days. Contract terminations and other charges were primarily related to the cancellation of certain contracts in connection with the restructuring of certain business functions. Lease loss reserve and related costs were primarily related to the costs that will continue to be incurred under exited facilities’ lease contracts for the remaining term of the leases without economic benefit to the Company, reduced by estimated sublease income that could be reasonably obtained for these facilities.
The Company reevaluates its estimates and assumptions on a quarterly basis and makes adjustments to the restructuring liabilities balance if necessary. During the six months ended May 3, 2014 , the Company reversed approximately $1.8 million of severance and benefits charges due to actual cash payments to certain terminated employees being lower than original estimates as a result of the completion of the severance arrangements with these employees during the first quarter of fiscal year 2014.

15


The above restructuring and other related charges are included in “ Restructuring, goodwill impairment, and other related costs ” in the Condensed Consolidated Statements of Operations .
Prior Restructuring Plans
Prior to fiscal year 2013, the Company also recorded charges related to estimated facilities lease losses, net of expected sublease income, due to consolidation of real estate space as a result of acquisitions.
Cash payments for facilities that are part of the Company’s lease loss reserve are expected to be paid over the respective lease terms through fiscal year 2021.

8 . Borrowings
The following table provides details of the Company’s long-term debt (in thousands, except years and percentages):
 
 
 
 
 
 
 
May 3, 2014
 
October 26, 2013
 
 
Maturity
 
Stated Annual Interest Rate
 
Amount
 
Effective Interest Rate
 
Amount
 
Effective Interest Rate
Senior Secured Notes:
 
 
 
 
 
 
 
 
 
 
 
 
 
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
%
 
300,000

 
4.83
%
Capital lease obligations
 
2016
 
5.671%
 
2,851

 
5.41
%
 
4,600

 
5.50
%
Total long-term debt
 
 
 
 
 
 
602,851

 
 
 
604,600

 
 
Less:
 
 
 
 
 
 
 
 
 
 
 
 
 
Unamortized discount
 
 
 
 
 
 
5,122

 
 
 
5,396

 
 
Current portion of long-term debt
 
 
 
 
 
 
2,277

 
 
 
2,996

 
 
Long-term debt, net of current portion
 
 
 
 
 
 
$
595,452

 
 
 
$
596,208

 
 
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 16 , “ 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 May 3, 2014 .
As of May 3, 2014 , and October 26, 2013 , the fair value of the 2023 Notes was approximately $288.0 million and $281.1 million , respectively, which was 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 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 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 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 the repurchase date.

16


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.
Senior Secured Notes
In January 2010, the Company issued $300.0 million in 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 on January 15 and July 15 of each year. During the three 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 16 , “ Guarantor and Non-Guarantor Subsidiaries ,” of the Notes to Condensed Consolidated Financial Statements.
As of May 3, 2014 , and October 26, 2013 , the fair value of the 2020 Notes was approximately $321.8 million and $324.4 million , respectively, which was 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. 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, the Company expensed the Call Premium, remaining debt issuance costs and remaining original issue discount relating to the 2018 Notes in the first quarter of fiscal year 2013, 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.

17


The 2020 Indenture contains covenants that, among other things, restrict the ability of the Company and certain of its 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.
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 debts of the Company and its subsidiaries. Prior to discharge, the 2018 Indenture contained covenants and events of default substantially similar to those in the 2020 Indenture.
Senior Secured Credit Facility
In October 2008, the Company entered into a credit 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 credit agreement was subsequently amended in January 2010, June 2011, October 2013 and April 2014, to, among other things, remove and update certain covenants, reduce interest rates on the term loan facility, reduce interest rates and fees on the revolving credit facility, and extend the maturity date of the revolving credit facility to January 7, 2015. The term loan was prepaid in full, and there were no principal amounts or commitments outstanding under the term loan facility as of either May 3, 2014 , or October 26, 2013 .
The Company may borrow under 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 May 3, 2014 , and October 26, 2013 .
The credit agreement contains financial covenants that require the Company to maintain a minimum consolidated fixed charge coverage ratio and maximum consolidated leverage ratio. The credit agreement also includes customary nonfinancial 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. 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.
Debt Maturities
As of May 3, 2014 , our aggregate debt maturities based on outstanding principal were as follows (in thousands):
Fiscal Year
Principal
Balances
2014 (remaining six months)
$
1,275

2015
1,286

2016
290

2017

2018

Thereafter
600,000

Total
$
602,851



18


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 May 3, 2014 , and April 27, 2013 , respectively (in thousands):
 
Accrued Warranty
 
Six Months Ended
 
May 3,
2014
 
April 27,
2013
Beginning balance
$
15,915

 
$
14,453

Liabilities accrued for warranties issued during the period
2,288

 
2,263

Warranty claims paid and used during the period
(2,987
)
 
(3,910
)
Changes in liability for pre-existing warranties during the period
(383
)
 
(1,607
)
Ending balance
$
14,833

 
$
11,199


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 May 3, 2014 , 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 contract manufacturers (“CMs”) under which Brocade provides 12 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 May 3, 2014 , the Company’s aggregate commitment to the CMs for inventory components used in the manufacture of Brocade products was $158.7 million , which the Company expects to utilize during future normal ongoing operations within the next 12 months , net of a purchase commitments reserve of $3.3 million , which is reported within “Other accrued liabilities” in the Condensed Consolidated Balance Sheet as of May 3, 2014 . 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 13 , “ Income Taxes ,” of the Notes to Condensed Consolidated Financial Statements. The Company believes it has adequate reserves for all open tax years.
Legal Proceedings
From time to time, the Company is subject to various legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business, including claims of alleged infringement of patents and/or other intellectual property rights and commercial and employment contract disputes. While the outcome of these matters cannot be predicted with certainty, the Company does not believe that the outcome of any of these matters, individually or in the aggregate, will result in losses that are materially in excess of amounts already accrued by the Company.

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. Instead, the Company manages its exposure to credit risk through its investment policies. The Company generally enters into

19


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 a counterparty’s obligations exceed the Company’s obligations with that counterparty.
Foreign Currency Exchange Rate Risk
A majority of the Company’s revenue, expense, and capital purchasing activities are 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 three and six months ended May 3, 2014 , and 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 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 May 3, 2014 , and April 27, 2013 .
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 May 3, 2014 , and April 27, 2013 , respectively.
Net gains (losses) relating to the effective portion of foreign currency derivatives recorded in the Condensed Consolidated Statements of Operations are as follows (in thousands):
 
Three Months Ended
 
Six Months Ended
 
May 3, 2014
 
April 27, 2013
 
May 3, 2014
 
April 27, 2013
Cost of revenues
$
48

 
$
(4
)
 
$
120

 
$
29

Research and development
(285
)
 
60

 
(585
)
 
55

Sales and marketing
182

 
(24
)
 
421

 
142

General and administrative
16

 
(3
)
 
38

 
5

Total
$
(39
)
 
$
29

 
$
(6
)
 
$
231

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, if the currency is difficult or too expensive to hedge, or if such exposure or the associated risk is insignificant. 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 $0.2 million for the three and six months ended May 3, 2014 , respectively, and losses of $0.1 million and gains of $0.1 million for the three and six months ended April 27, 2013 , 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 May 3, 2014 , the Company had gross unrealized loss positions of $0.6 million and gross unrealized gain positions of $1.3 million included in “Other accrued 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 U.S. dollars
As of May 3, 2014
 
As of October 26, 2013
 
As of May 3, 2014
 
As of October 26, 2013
Euro
$
20,302

 
$
16,012

 
$

 
$
25,478

British pound
13,332

 
25,053

 

 

Indian rupee
8,822

 
17,444

 

 

Singapore dollar
6,382

 
12,867

 

 

Japanese yen
6,162

 
16,172

 

 

Swiss franc
5,741

 
11,066

 

 

Total
$
60,741

 
$
98,614

 
$

 
$
25,478


The Company utilizes a rolling hedge strategy for the majority of its foreign currency derivative instruments with cash flow hedge accounting designation. All of the Company’s foreign currency forward contracts are single delivery, which are settled at maturity involving one cash payment.

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 Operations as follows (in thousands):
 
Three Months Ended
 
Six Months Ended
 
May 3, 2014
 
April 27, 2013
 
May 3, 2014
 
April 27, 2013
Cost of revenues
$
3,474

 
$
3,541

 
$
6,617

 
$
7,487

Research and development
4,422

 
4,500

 
8,757

 
9,185

Sales and marketing
8,462

 
8,012

 
15,227

 
16,157

General and administrative
4,694

 
3,119

 
9,039

 
5,493

Total stock-based compensation
$
21,052

 
$
19,172

 
$
39,640

 
$
38,322

 
The following table presents stock-based compensation expense, net of estimated forfeitures, by grant type (in thousands):
 
Three Months Ended
 
Six Months Ended
 
May 3, 2014
 
April 27, 2013
 
May 3, 2014
 
April 27, 2013
Stock options, including variable options
$
1,249

 
$
781

 
$
2,530

 
$
990

Restricted stock units, including stock units with market conditions (altogether “RSUs”)
17,404

 
13,479

 
31,987

 
27,149

Employee stock purchase plan (“ESPP”)
2,399

 
4,912

 
5,123

 
10,183

Total stock-based compensation
$
21,052

 
$
19,172

 
$
39,640

 
$
38,322

The following table presents the unrecognized compensation expense, net of estimated forfeitures, of the Company’s equity compensation plans as of May 3, 2014 , 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
$
5,463

 
1.60
RSUs
$
92,562

 
1.79
ESPP
$
3,158

 
0.86


21


The following table presents details on grants made by the Company for the following periods:
 
Six Months Ended
 
May 3, 2014
 
April 27, 2013
 
Granted
(in thousands)
 
Weighted-Average
Grant Date Fair Value
 
Granted
(in thousands)
 
Weighted-Average
Grant Date Fair Value
Stock options
250

 
$
3.32

 
2,625

 
$
2.37

RSUs
1,108

 
$
10.05

 
4,646

 
$
5.61

The total intrinsic value of stock options exercised for the six months ended May 3, 2014 , and April 27, 2013 , was $17.5 million and $13.3 million , respectively.

12 . Accumulated Other Comprehensive Income (Loss)
The tax effects allocated to each component of other comprehensive income (loss) for the three months ended May 3, 2014 , and April 27, 2013 , are as follows (in thousands):
 
Three Months Ended
 
May 3, 2014

April 27, 2013
 
Before-Tax Amount

Tax (Expense) or Benefit

Net-of-Tax Amount

Before-Tax Amount

Tax (Expense) or Benefit

Net-of-Tax Amount
Unrealized gains (losses) on cash flow hedges:
 
 
 
 
 
 
 
 
 
 
 
Change in unrealized gains and losses, foreign exchange contracts
$
1,248

 
$
(154
)
 
$
1,094

 
$
(2,142
)
 
$
227

 
$
(1,915
)
Net gains and losses reclassified into earnings, foreign exchange contracts (1)
39

 
(7
)
 
32

 
(29
)
 
(3
)
 
(32
)
Net unrealized gains (losses) on cash flow hedges
1,287

 
(161
)
 
1,126

 
(2,171
)
 
224

 
(1,947
)
Foreign currency translation adjustments
1,298

 

 
1,298

 
(1,762
)
 

 
(1,762
)
Total other comprehensive income (loss)
$
2,585

 
$
(161
)
 
$
2,424

 
$
(3,933
)
 
$
224

 
$
(3,709
)
The tax effects allocated to each component of other comprehensive income (loss) for the six months ended May 3, 2014 , and April 27, 2013 , are as follows (in thousands):
 
Six Months Ended
 
May 3, 2014
 
April 27, 2013
 
Before-Tax Amount
 
Tax (Expense) or Benefit
 
Net-of-Tax Amount
 
Before-Tax Amount
 
Tax (Expense) or Benefit
 
Net-of-Tax Amount
Unrealized gains (losses) on cash flow hedges:
 
 
 
 
 
 
 
 
 
 
 
Change in unrealized gains and losses, foreign exchange contracts
$
227

 
$
(57
)
 
$
170

 
$
(1,969
)
 
$
(23
)
 
$
(1,992
)
Net gains and losses reclassified into earnings, foreign exchange contracts (1)
6

 
(5
)
 
1

 
(231
)
 
21

 
(210
)
Net unrealized gains (losses) on cash flow hedges
233

 
(62
)
 
171

 
(2,200
)
 
(2
)
 
(2,202
)
Foreign currency translation adjustments
475

 

 
475

 
(2,142
)
 

 
(2,142
)
Total other comprehensive income (loss)
$
708

 
$
(62
)
 
$
646

 
$
(4,342
)
 
$
(2
)
 
$
(4,344
)
(1)
For Condensed Consolidated Statements of Operations classification of amounts reclassified from Accumulated Other Comprehensive Income (Loss), see Note 10 , “ Derivative Instruments and Hedging Activities ,” of the Notes to Condensed Consolidated Financial Statements.

22


The changes in accumulated other comprehensive income (loss) by component, net of tax, for the six months ended May 3, 2014 , and April 27, 2013 , are as follows (in thousands):
 
Six Months Ended
 
May 3, 2014
 
April 27, 2013
 
Gains (Losses) on Cash Flow Hedges

Foreign Currency Translation Adjustments

Total Accumulated Other Comprehensive Loss

Gains (Losses) on Cash Flow Hedges

Foreign Currency Translation Adjustments

Total Accumulated Other Comprehensive Loss
Beginning balance
$
267

 
$
(13,711
)
 
$
(13,444
)
 
$
2,390

 
$
(12,257
)
 
$
(9,867
)
Change in unrealized gains and losses
170

 
475

 
645

 
(1,992
)
 
(2,142
)
 
(4,134
)
Net gains and losses reclassified into earnings
1

 

 
1

 
(210
)
 

 
(210
)
Net current-period other comprehensive income (loss)
171

 
475

 
646

 
(2,202
)
 
(2,142
)
 
(4,344
)
Ending balance
$
438

 
$
(13,236
)
 
$
(12,798
)
 
$
188

 
$
(14,399
)
 
$
(14,211
)

13 . Income Taxes
In general, the Company’s provision for income taxes differs from tax computed at the U.S. federal statutory tax rate of 35% due to state taxes, the effect of non-U.S. operations, non-deductible stock-based compensation expense and adjustments to unrecognized tax benefits.    The effective tax rates for the three and six months ended May 3, 2014 , were higher than the federal statutory rate of 35% primarily due to a goodwill impairment charge of $83.4 million , which is non-deductible for tax purposes, and an increase in certain unrecognized tax benefits, partially offset by an increase of earnings in foreign jurisdictions taxed at rates lower than the U.S. federal statutory tax rate.
The effective tax rate for the three months ended April 27, 2013, was lower than the federal statutory rate of 35% primarily due to a discrete benefit from reserve releases resulting from audit settlements. In addition, the effective tax rate for the six months ended April 27, 2013 , was higher than the federal statutory tax rate of 35% primarily due to a charge of $78.2 million to reduce our previously recognized California deferred tax assets as a result of a change in California tax law. This charge was partially offset by the effect of change in foreign earnings, discrete benefits from reserve releases resulting from audit settlements, and an increase in the federal research and development tax credit that was reinstated on January 2, 2013, for calendar year 2013 and made retroactive to January 1, 2012.
The total amount of net unrecognized tax benefits of $81.3 million as of May 3, 2014 , would affect the Company’s effective tax rate, if recognized. The timing of the closure of audits is highly uncertain and it is reasonably possible that the balance of unrecognized tax benefits could change during the remainder of fiscal year 2014.
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 2014, 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  $5.0 million in the next 12 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 certain California deferred tax assets and capital loss carryforwards. Accordingly, the Company applies a valuation allowance to the California deferred tax assets due to the change in California law in 2012 and to capital loss carryforwards due to the limited carryforward periods of these tax assets.


23


14 . 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. Financial decisions and the allocation of resources are based on the information from the Company’s internal management reporting system. Currently, the Company’s CODM is its Chief Executive Officer.
Prior to the second quarter of fiscal year 2014, Brocade was organized into four operating segments, and three individually reportable segments, summarized as follows:
Operating Segments
 
Individually Reportable Segments (1)
SAN Products
 
SAN Products
Global Services
 
Global Services
Ethernet Switching & IP Routing
ADP
 
IP Networking Products (2)
(1)  
These reportable segments were organized principally by product category.
(2)  
Ethernet Switching & IP Routing and ADP were combined to form the reportable segment: IP Networking Products.
In the second quarter of fiscal year 2014, Brocade changed its internal financial reporting, realigning it with the changes in Brocade’s strategic focus on key technology segments. As a result of this change, the number of the Company’s operating segments was reduced from four to three operating segments. Ethernet Switching & IP Routing and ADP business components were combined into the IP Networking Products operating segment, and separate discrete financial information is no longer available for either Ethernet Switching & IP Routing or ADP components. The reportable segments did not change as a result of this change in the Company’s internal financial reporting. Therefore the restatement of previously reported segment information is not necessary.
At this time, the Company does not track all of its assets by operating segments. The majority of the Company’s assets as of May 3, 2014 , were attributable to its U.S. operations.
Summarized financial information by reportable segment for the three and six months ended May 3, 2014 , and April 27, 2013 , based on the internal management reporting system, is as follows (in thousands):
 
SAN
Products
 
IP Networking Products
 
Global Services
 
Total
Three months ended May 3, 2014
 
 
 
 
 
 
 
Net revenues
$
321,164

 
$
121,116

 
$
94,630

 
$
536,910

Cost of revenues
84,514

 
57,757

 
40,347

 
182,618

Gross margin
$
236,650

 
$
63,359

 
$
54,283

 
$
354,292

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

Six months ended May 3, 2014
 
 
 
 
 
 
 
Net revenues
$
676,620

 
$
240,865

 
$
183,960

 
$
1,101,445

Cost of revenues
177,455

 
118,443

 
78,585

 
374,483

Gross margin
$
499,165

 
$
122,422

 
$
105,375

 
$
726,962

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



24


15 . Net Income (Loss) Per Share
The following table presents the calculation of basic and diluted net income (loss) per share (in thousands, except per share amounts):
 
Three Months Ended
 
Six Months Ended
 
May 3,
2014
 
April 27,
2013
 
May 3,
2014
 
April 27,
2013
Basic net income (loss) per share
 
 
 
 
 
 
 
Net income (loss)
$
(13,684
)
 
$
46,949

 
$