Annual Report


Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-K
(Mark One)
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended October 26, 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
 
95134-1376
(Address of registrant’s principal executive offices)
 
(Zip code)
Registrant’s telephone number, including area code: (408) 333-8000
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
 
Name of each exchange on which registered
Common stock, $0.001 par value
 
The NASDAQ Stock Market LLC
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes   x     No   ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes   ¨     No   x
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   x
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 aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant, based upon the closing price of a share of the registrant’s common stock on April 27, 2013 , as reported by the NASDAQ Global Select Market on that date, was approximately $2,627,640,721 . This calculation does not reflect a determination that certain persons are affiliates of the registrant for any other purpose.
The number of shares outstanding of the registrant’s common stock as of December 9, 2013 , was 443,956,034 shares.
 
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s Proxy Statement for its 2014 Annual Meeting of Stockholders (the “Proxy Statement”), to be filed with the Securities and Exchange Commission, are incorporated by reference into Part III of this Annual Report on Form 10-K where indicated.

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Table of Contents


BROCADE COMMUNICATIONS SYSTEMS, INC.
FORM 10-K
For the Fiscal Year Ended October 26, 2013
INDEX
 
 
Page
 
PART I
 
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
 
PART II
 
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
 
PART III
 
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
 
PART IV
 
Item 15.
 


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Table of Contents

Forward-Looking Statements
This Annual Report on Form 10-K 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,” “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 I—Item 1A. Risk Factors” and elsewhere herein. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. Furthermore, Brocade undertakes no obligation to revise or update any forward-looking statements for any reason.


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Table of Contents

PART I
 
Item 1.
Business
General
Brocade Communications Systems, Inc. (“Brocade” or the “Company”) is a leading supplier of networking equipment and software, including Storage Area Networking (“SAN”) solutions and Internet Protocol (“IP”) networking solutions for data centers and other networking connectivity in businesses and organizations of many types and sizes, including service providers, global enterprises and public sector entities. Brocade offers a comprehensive line of high-performance networking hardware and software products as well as services that enable businesses and organizations to make their networks and data centers more efficient, reliable and adaptable to the changing demands of new network traffic patterns and volume. Brocade’s products and services are focused on meeting the stringent requirements of data center infrastructure and applications. Many of the Company’s products have been designed to enable customers to deploy next-generation data center architectures and technologies including virtualization, cloud computing, and software-defined networking (“SDN”).
Brocade products and services are marketed, sold and supported worldwide to end-user customers through distribution partners, including original equipment manufacturers (“OEMs”), distributors, systems integrators, value-added resellers (“VARs”) and directly to end users by the Brocade sales force.
For revenue and other information regarding Brocade’s operating segments, see Note 16 , “ Segment Information ,” of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Form 10-K, which is incorporated herein by reference.
Products and Services
SAN Products
Brocade’s storage networking products and services are designed to help customers reduce the cost and complexity of managing business information within a shared data storage environment, while enabling high levels of availability of mission-critical business applications. In addition, Brocade’s products and services assist customers in the development and delivery of storage and server consolidation, disaster recovery, data security, and in meeting compliance requirements regarding data management. Customers use Brocade’s Fibre Channel (“FC”) protocol based networking products to build storage area networks within their data center environments. Brocade’s products are generally used in conjunction with servers and storage subsystems, SAN interconnection components such as host bus adapters (“HBAs”), which connect host computers to an FC network, and server and storage management software applications and tools. By utilizing shared storage, or networked storage solutions, enterprises of all types and sizes can more easily share and consolidate server and storage resources, centralize and simplify data management, scale and provision storage resources more effectively, and improve application efficiency, performance and availability. As a result, these enterprises are able to better utilize information technology (“IT”) assets, improve productivity of IT personnel, reduce capital and operational expenditures, and more reliably and securely store, manage and administer business information.
Brocade’s family of FC SAN backbones, directors, and fabric/embedded switches provide interconnections, bandwidth and high-speed switching of data between servers and storage devices. Product models range from entry-level 8 port fabric switches to 512 port directors in a single chassis, addressing the needs of small departments and global enterprises alike. These high-performance solutions are available to support requirements both for open systems and mainframe operations. Switches and directors support key applications such as data backup, remote mirroring and high-availability clustering, as well as high-volume transaction processing applications such as enterprise resource planning and data warehousing. Brocade’s storage networking products have been designed to meet the storage networking needs of data center end users in environments ranging from small- and medium-sized businesses to large enterprises with storage network fabrics that scale to thousands of ports, spread across multiple locations around the world. These products also enable storage networks to meet the requirements for highly virtualized servers in enterprise and service provider data centers due to their high-performance, ultra-high reliability and low-latency capabilities.
Brocade offers a variety of FC fabric extension, switching and routing solutions that are designed to connect two or more data centers over long distances to enhance business continuity and disaster recovery. Brocade’s FC fabric extension solutions support FC SAN extension, mainframe extension (Fibre Connectivity), as well as other multiprotocol switching and routing technologies including optical, asynchronous transfer mode, and IP networks.

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Brocade offers high-speed, highly reliable hardware, in both modular and fixed-switch form factors, that provides fabric-based encryption and compression services. Brocade works with industry-leading security solution vendors to offer customers a wide choice of enterprise-class key management system options. These solutions provide high-performance disk encryption processing power to meet the needs of the most demanding enterprise environments with flexible, on-demand performance and enable industry-leading encryption-based security.
Brocade delivers reliable and simplified management of these SAN products through its management tools including Brocade Fabric Vision, a collection of technologies that maximizes uptime, dramatically simplifies SAN deployment and management, and provides unprecedented levels of visibility and insight into the storage network.
Brocade introduced Brocade Fabric Vision as a key element of its fifth generation (“Gen 5”) of industry standard FC products, which offer 16 gigabits per second (“Gbps”) performance and deliver higher levels of scalability and advanced capabilities in network management and diagnostics. Brocade’s Gen 5 (16 Gbps) FC portfolio builds upon its market leadership in FC storage networking solutions, which include the flagship Brocade DCX (R) 8510 Backbone family along with SAN directors, switches and HBAs. Brocade has also been a leader in the industry in every FC technology cycle, including the evolution from 1, 2, 4, 8, and recently, 16 Gbps technologies. Brocade has announced its commitment to deliver products and solutions based on the sixth generation (“Gen 6”) of FC technology that will offer 32 Gbps performance.
IP Networking Products—Ethernet Switching and Internet Protocol Routing
Brocade’s IP networking products are designed to connect users over an enterprise network and within and across global data centers. Brocade offers a variety of platforms to allow customers to design a network to meet their needs, including the Brocade ICX, FCX and VDX product families. Brocade’s Open Systems Interconnection Reference Model (“OSI”) Layer 2 and Layer 3 Ethernet switches provide cost-effective delivery of the intelligence, speed and manageability required to support the increasing use of virtualized, cloud-based applications.
Brocade’s Layer 2 and Layer 3 IP networking products are designed to simplify the physical infrastructure of the network. A specific set of these switches and software, also known as “Ethernet fabric” solutions, provide new levels of network automation, scalability, performance and operational simplicity that are essential in helping IT move to highly virtualized and cloud environments, as well as software-defined networks. Brocade delivers Ethernet fabric capabilities through its family of Brocade VDX Data Center Switches, which began shipping in early fiscal year 2011. The Brocade VDX family of switches, with Brocade Virtual Cluster Switching (“VCS”) or VCS Fabric technology, provides enterprise agility through automated, zero-touch Virtual Machine (“VM”) discovery, configuration, and mobility. Brocade offers a series of VDX fixed-port switches, as well as a modular switch, the Brocade VDX 8770, that deliver differing levels of performance, port density and functionality that customers may choose based on their needs.
Brocade also offers a comprehensive set of IP routing products through its MLX, MLXe, CES, CER and XMR families that are designed to handle network traffic within and across service provider networks, as well as data center and large enterprise networks. These IP routing products also provide network telemetry and analytics to help mobile service providers to extract key insights from their networks.
Brocade is also focused on helping its large enterprise, data center and global service provider customers fundamentally change their business and make them more agile, innovative and profitable by enabling their networks to deliver new services and capabilities based on cloud computing and SDN.
Both cloud computing and SDN are transforming how these customers architect their networks and are able to deliver IT services to their end users. Brocade believes it has taken a leadership position in delivering a variety of purpose-built innovations for cloud computing and SDN such as Ethernet fabrics, high-density 10, 40 and 100 Gigabit Ethernet, IPv6, OpenFlow support and software networking. Brocade’s strategy provides a clear upgrade path to these new networking solutions for Brocade’s customers, leveraging existing network investments and enabling network operators to start with a low level of risk as they begin to provide services in a highly predictable, non-disruptive manner.
IP Networking Products—Application Delivery Products (“ADP”)
Brocade’s OSI Layer 4-7 platforms, including the Brocade ADX Series family of ADPs, are designed for application traffic management and server load balancing, allowing customers to improve the performance of specific applications or improve the performance of a server farm. These high-performance data center traffic management systems with network intelligence capabilities allow enterprises and service providers to build reliable network infrastructures that efficiently manage the flow of traffic over extended distances, known as metro area networks and wide area networks.

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Global Services
Brocade offers a wide range of consulting and support services that assist customers in designing, implementing, deploying and managing advanced networking solutions, as well as post-contract customer support (“PCS”). These services address a number of customer priorities that must be managed during the life cycle of a storage network or data center network infrastructure and are meaningful to customers because Brocade brings valuable experience and expertise to a customer challenge. Brocade’s services may be delivered to end-user customers directly or through partners as a component of a broader service and support offering.
Industry Initiatives and Standards Development
Brocade believes that, as the need for networking solutions continues to evolve, enterprises will look to further simplify the tasks of storing, managing, and administering their data; at the same time, Brocade also believes that enterprises will also look to optimize or improve the efficiency of their IT investments and reduce both capital and operational expenditures. Brocade also believes enterprises will continue to expand the size and scope of their networks as well as the number and types of applications that these networks support.
Brocade believes that the future evolution of networking and data center management markets will be led by the providers of products and services that simplify the management of increasingly virtualized server and storage environments and improve returns on end users’ IT investments on an ongoing basis. Brocade also believes that networking and data center infrastructure solutions will evolve to provide increased capabilities that enable new types of data management applications that simplify the management of data, increase operational efficiencies and reduce operating expense. As a result, many of Brocade’s initiatives and investments are aimed at expanding the capabilities enabled by networks, increasing end-to-end interoperability, protecting end-user investments in existing and new IT resources, and making it easier for Brocade and its partners to deliver solutions that provide efficiencies in managing large, complex and growing enterprise data center environments.
Brocade works with industry-leading organizations to facilitate the development of standards, technologies, products and services that focus on the simplification of data center infrastructure management and the implementation and management of data networking environments. Brocade has a partner-centric approach to building solutions and works with nearly every leading provider of server, storage and storage network management applications and technologies.
Brocade has a long history of being a major contributor to the evolution of industry standards ranging from FC communication technology to storage network interoperability to storage and storage network management. Brocade contributes to related industry standards committees and has authored or co-authored many of the FC protocol standards used today. As Brocade continues to expand its leadership presence in new technologies, Brocade’s participation in associated standards groups continues to grow. In fiscal year 2013 , Brocade was a member of the Ethernet Alliance, Metro Ethernet Forum, IETF, IEEE, FCIA Board, SNIA Technical Council, DMTF Technical Council and FC-related industry associations and standards bodies. Brocade also currently chairs the INCITS T11 Committee, the lead governing body for all FC-related standards and a Brocade senior technologist serves as the president of the Ethernet Alliance. Brocade has also been an active participant with key leadership positions in next-generation data center initiatives promoting use of open technologies, including Open Networking Foundation, OpenStack Foundation, and Project Open Daylight.
Education and Technical Certification Services
Brocade’s education and training organization delivers technical education and training to its partners and their customers on Brocade technology that encompasses design, implementation and management solutions. This education and training curriculum is delivered worldwide using diverse methodologies, which include instructor-led classes and an online web-based training portfolio, as well as a “live” virtual classroom capability. The Brocade University also offers certification on Brocade solutions for IT professionals who have completed certain tests administered by an independent testing organization. The certification program is designed to measure the knowledge and proficiency of IT professionals in Brocade data center and data management solutions and technologies, and to help ensure that Brocade’s customers receive superior customer service and support. Approximately 39,000 certification tests have been delivered and 15,700 IT professionals have received Brocade credentials since inception of the program in October 2000. Brocade’s education and training services are made available through its own education facilities and through its worldwide training provider network.
Distribution Channels
Brocade’s products and services are marketed, sold and supported worldwide to end-user customers through distribution partners, including OEMs, distributors, systems integrators, VARs, and directly to end users by the Brocade sales force.

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Brocade’s OEM partners are leading server, storage and systems providers who offer Brocade’s products under their own private label or as Brocade-branded solutions. Sales of these products through OEM partners comprise the majority of Brocade’s business. Other distribution partners include a global network of authorized distributors, systems integrators and VARs. Brocade authorizes these partners to market, sell and support its products and services. Some of these partners also sell training and other value-added services.
Brocade has OEM or distribution agreements with most of the major companies that sell enterprise servers and storage systems. In addition, Brocade employs a worldwide sales force to assist its distribution partners in marketing Brocade solutions, assessing customer requirements and designing, implementing and maintaining Brocade-based solutions.
Customers
For the fiscal year ended October 26, 2013 , Brocade’s largest OEM customers, EMC Corporation (“ EMC ”), Hewlett-Packard Company (“ HP ”) and International Business Machines Corporation (“ IBM ”), each represented 10% or more of Brocade’s total net revenues, accounting for a combined total of 46% ( EMC with 18% , HP with 12% and IBM with 16% ) of Brocade’s total net revenues. For the fiscal year ended October 27, 2012 , the same OEM customers accounted for a combined total of 47% ( EMC with 16% , HP with 13% and IBM with 18% ) of Brocade’s total net revenues. For the fiscal year ended October 29, 2011 , the same OEM customers accounted for a combined total of 43% ( EMC with 15% , HP with 13% and IBM with 15% ) of Brocade’s total net revenues. Sales to any OEM customer may vary from quarter to quarter. While Brocade’s OEM partners are the principal route-to-market for our SAN products, in addition to OEMs, Brocade’s SAN routes-to-market include distributors, direct to end users, global systems integrators and VARs and the OEM channel.
In the IP networking market, Brocade cultivates business through its distributors in a number of key customer markets such as the data center, service provider, and enterprise segments including the public sector. Customers in these market segments represented a significant part of Brocade’s IP networking business. Brocade’s strategy to expand its sales of IP networking products includes leveraging current investments in direct sales, two-tier distribution and channel partnerships, and international markets, as well as selling into existing data center customer accounts, including Global 1000 companies and other targeted end users.
Geographic Information
For the fiscal year ended October 26, 2013 , domestic and international revenues were approximately 61% and 39% of total net revenues, respectively. For the fiscal year ended October 27, 2012 , domestic and international revenues were approximately 63% and 37% of total net revenues, respectively. For the fiscal year ended October 29, 2011 , domestic and international revenues were approximately 61% and 39% of total net revenues, respectively. International revenues primarily consist of sales to customers in Western Europe and the greater Asia Pacific region.
Revenues are attributed to geographic areas based on where Brocade’s products are shipped. However, certain OEM customers take possession of Brocade’s products in one country and then may distribute these products to their customers in different countries. Accordingly, Brocade cannot be certain of the extent to which its domestic and international revenue mix is impacted by the practices of its OEM customers. Nevertheless, data provided by OEM customers indicate that international customers may account for a higher percentage of end-user demand than that indicated by Brocade’s mix of domestic and international revenues.
The majority of Brocade’s assets as of October 26, 2013 , were attributable to its United States operations. For additional geographic information on Brocade’s revenues and long-lived assets, see Note  16 , “ Segment Information ,” of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Form 10-K, which is incorporated herein by reference. Also, for a discussion of the risks attendant to Brocade’s international operations, see Part I, Item 1A. Risk Factors of this Form 10-K, which is incorporated herein by reference.
Acquisitions and Investments
Brocade’s acquisition and investment strategy is focused on facilitating the evolution and expansion of shared storage, data management and IP networking.
On November 9, 2012, Brocade completed its acquisition of Vyatta, Inc. (“Vyatta”), a data center networking industry innovator through its software-based network operating system that is highly relevant for multiple applications in network virtualization, SDN and private/public cloud computing platforms. This acquisition complements Brocade’s investments in Ethernet fabrics and SDN, as well as enables Brocade to pursue new market opportunities in data center virtualization, public and enterprise virtual private cloud computing platforms, and managed services.
From time to time, Brocade has made equity investments in companies that develop technology or provide services that are complementary to or broaden the markets for its products or services and further its business objectives.

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Research and Development
The industry in which Brocade competes is impacted by rapid technological developments, evolving industry standards, changes in customer requirements, new product introductions and consolidation. As a result, Brocade’s success depends, in part, on its ability to continue to enhance its existing solutions and to develop and introduce new solutions that improve performance and reduce the total cost of ownership for networking. Brocade has invested significantly in product research and development. Brocade continues to enhance and extend its products and increase the speed, performance and port-density of its switching platform. Brocade also continues to expand its products’ operating system enhancements and other software feature development to further simplify storage management and to enable more functionality for end-user customers, OEM partners and application partners.
Brocade’s products are designed to support current industry standards and may continue to support emerging standards that are consistent with its product strategy. Brocade designs its products around a common platform architecture, which facilitates the product design, development and testing cycle, and reduces the time to market for new products and features. Products acquired through acquisitions are mapped to existing design roadmaps that leverage common platform designs and know-how. Brocade intends to continue to leverage this common architecture to develop and introduce additional hardware and software products and enhancements in the future.
Brocade’s product development process includes the certification of certain of its products by its OEM partners as well as additional certifications to comply with the requirements of the U.S. federal government and local regulations. During this process, Brocade supports its OEM partners in the testing of its new products to ensure that they meet quality, functionality and interoperability requirements. The process is completed once the OEM partner has certified the product and announced general availability of that product to its customers.
For the years ended October 26, 2013 October 27, 2012 , and October 29, 2011 , Brocade’s research and development expenses totaled $378.5 million , $363.1 million and $354.4 million , respectively. All expenditures for research and development costs have been expensed as incurred.
Competition
The market for networking solutions is intensely competitive. Brocade believes the competitive factors in this market include product performance and features, product reliability, price, size, extent of installed base, ability to meet delivery schedules, customer service, technical support and distribution channels. In particular, Cisco Systems, Inc. (“Cisco”) holds a large market share in the IP networking and SAN markets, and a number of its products compete directly with Brocade’s products. Brocade also competes with other IP networking companies, such as Alcatel-Lucent, Arista Networks, Inc., Avaya Inc., Extreme Networks, Inc. (which acquired Enterasys Networks, Inc. in November 2013), F5 Networks, Inc., Dell Inc., HP, Huawei Technologies Co. Ltd., IBM and Juniper Networks, Inc. (“Juniper”). Many of Brocade’s current and potential competitors have greater market leverage, longer operating histories, greater financial, technical, sales, marketing and other resources, more name recognition and larger installed customer bases.
In addition, Brocade faces significant competition from providers of SAN products and services for interconnecting servers and storage. These principal competitors include Cisco and QLogic Corporation (“QLogic”) in the FC switching market and QLogic and Emulex Corporation in the HBA/converged network adapter (“CNA”) markets. Brocade also faces competitors in other markets in which it participates, such as F5 Networks, Inc. and A10 Networks, Inc. in the application delivery market.
New competition is emerging from technology trends such as SDN. VMware, Inc.’s acquisition of Nicira, Inc. for network virtualization technology is an example of a company embracing a new technology trend and becoming a competitor to Brocade. These competitors may use emerging technologies and various routes-to-market to compete with Brocade. In addition, Brocade’s OEM partners, who also have relationships with some of Brocade’s current competitors, could become new competitors by developing, acquiring or introducing products and solutions that compete with Brocade’s product offerings. Competitive pressure will also likely intensify as technology trends impact long-standing alliances, partnerships and go-to-market routes.
As the networking solutions market evolves, additional technologies may become available for interconnecting servers and storage. To the extent that products based upon these technologies provide the ability to connect network servers and storage and support high-performance storage applications, they may compete with Brocade’s FC products. These storage networking technologies include, but are not limited to, IP storage products such as Internet Small Computer System Interface (“iSCSI”) and Network Attached Storage (“NAS”), InfiniBand and Direct Attached Storage. In addition, networking companies, manufacturers of networking equipment, and other companies may develop competitive products and technologies. For example, new technologies that store data in the server with flash memory or solid-state drives (“SSD”) could create competition for Brocade’s FC SAN products sold through traditional OEM business models. Fusion I/O, Inc. and Violin

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Memory, Inc. are examples of vendors that offer solutions based on these new technologies. These emerging competitive products and technologies, however, can present new business opportunities for Brocade’s IP networking products including Ethernet fabrics as well as Brocade FC SAN products to support mission-critical and data center applications. Brocade is working actively with IP storage and SSD vendors to create solution designs and reference architectures that integrate Brocade IP and FC SAN products.
Manufacturing
Brocade has manufacturing arrangements with Hon Hai Precision Industry Co., Ltd. (“Foxconn”), Accton Wireless Broadband Corporation (“Accton”), Motorola, Inc. (“Motorola”) and Quanta Computer Incorporated (“Quanta”) (collectively the contract manufacturers or “CMs”) and a service repair arrangement with Flextronics International Ltd. (“Flextronics”). Under the CMs’ manufacturing arrangements, Brocade provides product forecasts and places purchase orders with the CMs 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. The CMs invoice Brocade based on prices and payment terms mutually agreed upon and set forth in purchase orders Brocade issues to them. Although the purchase orders Brocade places with its CMs are cancellable, the terms of the CMs’ manufacturing agreements require Brocade to purchase all inventory materials not returnable, usable by, or sold to other customers of the CMs.
Brocade uses the CMs for final turnkey product assembly; however, Brocade also maintains key component selection and qualification expertise internally. Brocade designs and develops the key components of its products, including application-specific integrated circuits (“ASICs”), operating system and other software, as well as certain details in the fabrication and enclosure of its products. In addition, Brocade determines the components that are incorporated into its products and selects appropriate suppliers of those components.
Although Brocade uses standard parts and components for its products where possible, Brocade’s CMs currently purchase, on Brocade’s behalf, several key components used in the manufacture of its products from single or limited supplier sources. Brocade’s principal single source components include ASICs, built by third parties based on Brocade’s designs, and Brocade’s principal limited source components include memory, certain oscillators, microprocessors, certain connectors, certain logic chips, certain power supplies, enclosures, programmable logic devices, certain printed circuit boards, certain optical components, packet processors and switching fabrics.
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 Section 1502 (the “Dodd-Frank Act”) requires certain public companies to disclose whether certain minerals, commonly known as “conflict minerals,” are necessary to the functionality or production of a product manufactured by those companies and if those minerals originated in the Democratic Republic of the Congo (DRC) or an adjoining country. The implementation of these requirements by government regulators and Brocade’s partners and/or customers could adversely affect the sourcing, availability, and pricing of minerals used in the manufacture of certain components used in Brocade’s products. In addition, the supply-chain due diligence investigation required by the conflict minerals rules will require expenditures of resources and management attention regardless of the results of the investigation.
In addition, Brocade licenses certain software from third parties that is incorporated into its fabric operating system and other software. See Part I, Item 1A. Risk Factors of this Form 10-K, which is incorporated herein by reference.
Environmental Matters
Brocade is subject to various environmental and other regulations governing product safety, materials usage, packaging and other environmental impacts in the various countries where its products are sold. For example, many of Brocade’s products are subject to laws and regulations that restrict the use of lead, mercury, hexavalent chromium, cadmium and other substances, and require producers of electrical and electronic equipment to assume responsibility for collecting, treating, recycling and disposing of its products when they have reached the end of their useful life. In Europe, substance restrictions apply to products Brocade sells, and certain of Brocade’s OEM partners require compliance with these or more stringent requirements. Recycling, labeling, financing and related requirements also apply to products Brocade sells in Europe. China has also enacted legislation with similar requirements for Brocade’s products or its OEM partners for Brocade products sold in China. Brocade may be required to redesign its products to ensure that they comply with any new requirements as well as related requirements imposed by its OEM customers. Brocade also continues to work with its suppliers to ensure they provide Brocade with compliant materials, parts and components. Various other countries and states in the United States have issued, or are in the process of issuing, other environmental regulations that may impose additional restrictions or obligations and require further changes to Brocade’s products, or may require Brocade to incur additional costs to comply.

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Patents, Intellectual Property and Licensing
Brocade relies on a combination of patent, copyright, trademark and trade secret laws, and contractual restrictions on disclosure to protect its intellectual property rights in these proprietary technologies. Despite these precautions, the measures Brocade undertakes may not prevent misappropriation or infringement of its proprietary technology. These measures also may not preclude competitors from independently developing products with functionality or features similar to our products.
Brocade maintains a program to identify and obtain patent protection for its selected inventions. As of October 26, 2013 , Brocade had 462 patents in the United States and 24 patents in various foreign countries (based on certain U.S. patents or patent applications) that are currently in force and had approximately 310 patent applications pending in the United States and approximately 32 patent applications pending in various foreign countries (based on certain U.S. patents or patent applications). The normal expiration dates of Brocade’s issued patents in the United States range from 2013 to approximately 2031. Although Brocade has patent applications pending, there can be no assurance that patents will be issued from pending applications or that claims allowed on any future patents will be sufficiently broad to protect its technology.
Many of Brocade’s products are designed to include software or other intellectual property licensed from third parties. While it may be necessary in the future to seek or renew licenses relating to various aspects of its products, Brocade believes that such licenses generally could be obtained on commercially reasonable terms. However, failure to obtain such licenses on commercially reasonable terms could materially harm Brocade’s business. See Part I, Item 1A. Risk Factors of this Form 10-K, which is incorporated herein by reference.
From time to time, third parties have asserted patent, copyright and trade secret rights to technologies and standards that are important to Brocade. Third parties assert patent infringement claims against Brocade from time to time in the form of letters, lawsuits and other forms of communication. In addition, from time to time, Brocade receives notification from customers claiming that they are entitled to indemnification or other obligations from Brocade related to infringement claims made against them by third parties. Litigation, even if Brocade is ultimately successful, can be costly and divert management’s attention away from the day-to-day operations of Brocade. See Note 9 , “ Commitments and Contingencies ,” of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Form 10-K.
Seasonality
Historically, Brocade’s SAN product revenue in the first and fourth fiscal quarters is stronger than revenue in the second and third fiscal quarters. Historically, Brocade’s IP networking products revenue is strongest in the fourth fiscal quarter while revenue in the first fiscal quarter is weakest, driven primarily by the seasonality of Brocade’s federal business revenue.
The historical seasonal patterns may be materially different in any given year due to factors such as quarterly changes in SAN inventory levels at OEMs, higher or lower demand for products and services due to macroeconomic impacts, U.S. federal government budget changes, as well as other factors including Brocade’s fiscal reporting calendar that contains 52 or 53 weeks.
Backlog
Brocade’s business is characterized by short lead-time orders and fast delivery schedules. Sales of its products are generally made pursuant to contracts and purchase orders that are cancellable without significant penalties. These commitments are subject to price negotiations and to changes in quantities of products and delivery schedules in order to reflect changes in customers’ requirements and manufacturing availability. In addition, actual shipments depend on the manufacturing capacity of suppliers and the availability of products from such suppliers. As a result of the foregoing factors, Brocade does not believe that backlog at any given time is a meaningful indicator of its ability to achieve any particular level of overall revenue or financial performance.
Employees
As of November 23, 2013, Brocade had 4,143 employees. Brocade has not experienced any work stoppages and considers its relations with its employees to be good. Brocade’s employees are currently located at the United States headquarters in San Jose, California, as well as facilities in Broomfield, Colorado, Herndon, Virginia, Plymouth, Minnesota, Brocade’s European headquarters in Geneva, Switzerland, Brocade’s Asia Pacific headquarters in Singapore, and other offices throughout North America, Europe, Asia Pacific, and Central and South America.

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Other
Brocade was incorporated in California on August 24, 1995, and reincorporated in Delaware on May 14, 1999. Brocade’s mailing address and executive offices are located at 130 Holger Way, San Jose, California 95134-1376. Brocade’s telephone number is (408) 333-8000.
Brocade’s corporate Web site is www.brocade.com. Brocade’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge on Brocade’s Web site when such reports are available on the SEC Web site. The public may read and copy any materials filed by Brocade with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains a Web site at www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The content of any Web site referred to in this Form 10-K is not incorporated by reference into this filing. Further, Brocade’s references to the Uniform Resource Locators (“URLs”) for these Web sites are intended to be inactive textual references only.
ADX, AnyIO, Brocade, Brocade Assurance, the B-wing symbol, DCX, Fabric OS, ICX, MLX, MyBrocade, OpenScript, VCS, VDX and Vyatta are registered trademarks, and HyperEdge, The Effortless Network, and the The On-Demand Data Center are trademarks of Brocade Communications Systems, Inc., in the United States and/or in other countries. Other brands, products, or service names mentioned may be trademarks of their respective owners.

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Item 1A.
Risk Factors

Uncertainty about or a slowdown in the domestic and global economies has adversely affected, and may increasingly adversely affect, Brocade’s operating results and financial condition.

There is ongoing uncertainty about the domestic and global economies, and there may be a prolonged period of significant economic slowdown. Such uncertainty or slowdown has resulted in, and may continue to result in, lower growth or a decline in the networking industry as a whole and reduced demand for information technology (“IT”), including high-performance data networking solutions. Historically, IT spending has declined as general economic and market conditions have worsened and has also been impacted by reduced U.S. Federal spending and the budget-related government shutdown. Brocade is particularly susceptible to reductions in IT spending because the purchase of Brocade’s products is often discretionary and may involve a significant commitment of capital and other resources. The loss or delay of orders from any of Brocade’s more significant customers, such as the U.S. government or individual branches or agencies within the U.S. government (including the Department of Defense or certain intelligence agencies where Brocade’s revenue is concentrated), or customers within the service provider, financial services, education and health sectors, could also cause Brocade’s revenue and profitability to suffer. For example, Brocade’s revenue and operating results could be negatively impacted if the U.S. Federal government experiences delays in procurement due to a shutdown or budget reductions in agencies where Brocade’s revenue is concentrated. Economic uncertainty has caused—and may cause further—reductions in Brocade’s revenue, profitability and cash flows, increased price competition, increased operating costs and longer fulfillment cycles and may exacerbate many other risks noted elsewhere in this Form 10-K, which adversely affect Brocade’s business, results of operations and financial condition.

Intense competition or consolidation, and emergence of new technology options in networking solutions could prevent Brocade from increasing or maintaining revenue, profitability and cash flows with respect to its networking solutions.

The networking market is highly competitive and is in a state of transformation with new competitors entering the market offering products based on new technologies such as software networking, virtualization and infrastructure-as-a-service. While Cisco Systems, Inc. (“Cisco”) maintains a dominant position in the IP networking market, networking customers today have more choices in both traditional and emerging networking solutions. This may present a risk to Brocade if demand for traditional networking solutions wanes and the demand for emerging solutions from new competitors such as VMware, Inc. (“VMware”) and Plexxi, Inc. (“Plexxi”) increases.
Further, the traditional networking market in recent years has seen an influx of other companies enter, such as Dell Inc. (“Dell”), Hewlett-Packard Company (“HP”) and International Business Machines Corporation (“IBM”), who all have strengthened their networking portfolios through acquisitions. These companies have greater market leverage, longer operating histories, greater financial, technical, sales, marketing and other resources, more name recognition and larger installed customer bases. Their business may have better economies of scale and therefore, they could also adopt more aggressive pricing policies than Brocade. Brocade believes that competition based on price may become more aggressive than it has traditionally experienced. As a result of these factors, Brocade’s competitors could devote more resources to develop, promote and sell their own products, and, therefore, those competitors could respond more quickly to changes in customer or market requirements and adopt more aggressive pricing policies. Additionally, some of Brocade’s OEM partners also offer products that compete with Brocade’s, and those OEM partners could devote more resources to their own products rather than Brocade’s and therefore respond more quickly to such changes in customer or market requirements. Brocade’s failure to successfully compete in the market would harm Brocade’s business and financial results.
Other competitors in the traditional IP networking market include Arista Networks, Inc. (“Arista”), Alcatel-Lucent, Avaya, Inc. (“Avaya”), A10 Networks, Inc. (“A10”), Enterasys Networks, Inc., Extreme Networks, Inc. (which acquired Enterasys Networks, Inc. in November 2013), F5 Networks, Inc., Huawei Technologies Co. Ltd. and Juniper Networks, Inc. (“Juniper”).
Brocade also competes with providers of Storage Area Networking (“SAN”) products and services for interconnecting servers and storage. These principal competitors include Cisco in the Fibre Channel (“FC”) switching market and Emulex Corporation in the host bus adapter (“HBA”)/converged network adapter (“CNA”) markets.


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Brocade’s failure to execute on its overall sales strategy or successfully grow its channel and direct sales capabilities could significantly reduce Brocade’s revenues and negatively affect Brocade’s financial results.

Brocade offers its IP networking products through a multipath distribution strategy, including distributors, resellers, Brocade’s direct sales force and OEMs that have historically offered Brocade SAN products. However, Brocade’s efforts to increase sales through this multipath distribution strategy may not generate much, if any, incremental revenue opportunities for Brocade. This is further compounded by the fact that several of Brocade’s major OEM customers, including Dell, IBM, HP and Oracle Corporation, have acquired companies that offer IP networking products that are competitive with Brocade’s offerings. A loss of or significant reduction in revenue through one of Brocade’s paths to market would negatively impact Brocade’s financial results.
Brocade’s failure to successfully manage and grow its channel partner relationships or the failure of these partners to sell Brocade’s products could reduce Brocade’s revenues significantly, especially for its IP networking portfolio. In addition, Brocade’s ability to respond to the needs of its distribution and reseller partners in the future may also depend on third parties producing complementary products and applications for Brocade’s products to enable these partners to be competitive in the market. There can be no assurance that Brocade will be successful in expanding its go-to-market objectives, which include effectively maintaining or expanding sales through its distribution channels and managing distribution relationships successfully. If Brocade fails to respond successfully to the needs of these distribution partners, its business and financial results could be adversely affected.
Additionally, Brocade recently announced that it is making certain changes in its strategic direction by focusing on key technology segments, as well as investing in data center and public sector market opportunities. This change in focus will result in a rebalancing of resources, including changes to direct and channel sales, away from certain non-key areas of Brocade’s business and may impact its ability to generate revenue from certain markets, geographies and customers. There can be no assurance that this new strategic direction will succeed, and failure to execute on this strategy could adversely affect Brocade’s revenues and financial results. Also, this transition may result in uncertainty by employees, customers and partners that could adversely affect Brocade’s business and revenues.

The prices of Brocade’s products have declined in the past faster than declines in the costs of its products and Brocade expects the prices of Brocade’s products to decline in the future, which could reduce Brocade’s revenues, gross margins and profitability.

The average selling price for Brocade’s products has typically declined in the past and will likely decline in the future as a result of competitive pricing pressure, broader macroeconomic factors, product mix, increased sales discounts, new product introductions by Brocade or Brocade’s competitors, the entrance of new competitors and other factors. Furthermore, particularly if economic conditions deteriorate and drive a more cautious capital spending environment in the technology sector, Brocade and its competitors could pursue more aggressive pricing strategies in an effort to maintain or seek to increase sales levels. If Brocade is unable to offset the negative impact from the above factors on the average selling price of Brocade’s products by increasing the volume of products shipped or reducing product manufacturing costs, Brocade’s total revenues and gross margins will be negatively impacted.
Brocade may not be able to continue to reduce the cost of production at historical rates, or at all. Moreover, most of Brocade’s expenses are fixed in the short-term or incurred in advance of receipt of corresponding revenue. As a result, Brocade may not be able to decrease its spending quickly enough or in sufficient amounts to offset any unexpected shortfall in revenues. If this occurs, Brocade’s operating results and gross margins could fall below expectations or Brocade could incur losses.
Additionally, Brocade’s gross margins may be negatively affected by fluctuations in manufacturing volumes, component costs, foreign currency exchange rates, the mix of product configurations sold, the mix of distribution channels through which its products are sold or, if product or related warranty costs associated with Brocade’s products are greater than previously experienced.


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A limited number of major OEM partners comprise a significant portion of Brocade’s revenues; the loss of revenue from, or decreased inventory levels held by, any of these major OEM partners could significantly reduce Brocade’s revenues and negatively affect Brocade’s financial results.

Brocade’s SAN business depends on recurring purchases from a limited number of large OEM partners for a substantial portion of its revenues. As a result, revenues from these large OEM partners have a significant influence on Brocade’s quarterly and annual financial results. For fiscal years 2013 , 2012 , and 2011 , the same three customers each represented 10% or more of Brocade’s total net revenues, for a combined total of 46% , 47% and 43% of total net revenues, respectively. Brocade’s agreements with its OEM partners are typically cancellable, non-exclusive, and have no minimum or specific timing requirements for purchases. Brocade’s OEM partners could also elect to eliminate, reduce, or rebalance the amount they purchase from Brocade, increase the amount purchased from Brocade’s competitors or introduce their own technology.
Also, one or more of Brocade’s OEM partners could elect to consolidate or enter into a strategic partnership with one of Brocade’s competitors, which could reduce or eliminate Brocade’s future revenue opportunities with that OEM partner. Brocade anticipates that a significant portion of its revenues and operating results from its SAN business will continue to depend on sales to a relatively small number of OEM partners. The loss of any one significant OEM partner, or a decrease in the level of sales to any one significant OEM partner, or unsuccessful negotiation on key terms, conditions or timing of purchase orders placed during a quarter, would likely cause serious harm to Brocade’s business and financial results.

Brocade’s future revenue growth depends on its ability to introduce new products and services on a timely basis and achieve market acceptance of these new products and services.

Developing new product and service offerings requires significant up-front investments that may not result in revenues for an extended period of time, if at all. Brocade must achieve widespread market acceptance of its new product and service offerings on a timely basis in order to realize the benefits of Brocade’s investments. However, the market for networking solutions, driven in part by the growth and evolution of the Internet, is characterized by rapidly changing technology, accelerating product introduction cycles, changes in customer requirements and evolving industry standards. Brocade’s future success depends largely upon its ability to address the rapidly changing needs of its customers by developing and supplying high-quality, reliable, cost-effective products, product enhancements and services on a timely basis and by keeping pace with technological developments and emerging industry standards.
Other factors that may affect Brocade’s successful introduction of new product and service offerings include Brocade’s ability to:
Properly determine the market for new products and services, including features, cost effectiveness and scalability, which can be particularly challenging for initial product offerings in new markets;
Differentiate Brocade’s new products and services from its competitors’ technology and product offerings;
Address the complexities of interoperability of Brocade’s products with its installed base, OEM partners’ server and storage products, and its competitors’ products; and
Successfully transition from older products to new products.
Failure to introduce competitive products and solutions may harm Brocade’s business.

If Brocade is not able to successfully transition from older products and services to new and enhanced products and services on a timely basis, its business and results of operations will likely be harmed.

As Brocade introduces new or enhanced products, Brocade must also successfully manage the transition from older products, such as certain SAN products, to minimize disruption in customers’ ordering patterns, avoid excessive levels of older product inventories and provide sufficient supplies of new products to meet customer demands. The introduction of new or enhanced products may shorten the life-cycle of Brocade’s existing products, or replace the sales of some of Brocade’s current products, thereby offsetting the benefit of a successful product introduction, and may cause customers to defer purchasing its existing products in anticipation of its new products. When Brocade introduces new or enhanced products, Brocade faces numerous risks relating to product transitions, including the inability to accurately forecast demand, manage excess and obsolete inventories, address new or higher product cost structures, and manage different sales and support requirements due to the type or complexity of the new products. In addition, any customer uncertainty regarding the timeline for rolling out new products or Brocade’s plans for future support of existing products may cause customers to delay purchase decisions or purchase competing products, which would adversely affect Brocade’s business and financial results.

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If Brocade loses key talent or is unable to hire additional qualified talent, its business may be negatively impacted.

Brocade’s success depends, to a significant degree, upon the continued contributions of key management, including executive officers, engineering, sales and other talent, many of whom would be difficult to replace. Departures, appointments and changes in roles and responsibilities of officers or other key members of management may disrupt Brocade’s business and adversely affect Brocade’s operating results.
Brocade believes its future success depends, in large part, upon Brocade’s ability to effectively attract highly skilled talent and on the ability of its management to operate effectively, both individually and as a group, in geographically diverse locations. There is limited qualified talent in each applicable market, and competition for such talent has become much more aggressive. Other companies in Brocade’s industry and geographic regions are recruiting from the same limited talent pool, which creates further compression on the availability of qualified talent. In particular, Brocade operates in various locations with highly competitive labor markets, including Bangalore, India, and San Jose, California. Brocade may experience difficulty in hiring key management and qualified talent with skills in nearly all areas of Brocade’s business and operations.
Additionally, in fiscal year 2013, Brocade announced certain changes in strategic direction focusing on key technology segments. As part of this change in focus, Brocade reduced costs of revenue and other operating expenses by $100 million on an annualized basis when comparing the fourth quarter to the first quarter of fiscal year 2013. Executing on this new strategic direction as well as the ongoing efficiency initiatives across the Company could adversely affect Brocade’s ability to retain and hire key personnel and may result in reduced productivity by its employees.
The loss of the services of any of Brocade’s key employees, the inability to attract or retain qualified talent in the future, or delays in hiring required talent—particularly sales and engineering talent—could delay the development and introduction of Brocade’s products or services, and negatively affect Brocade’s ability to sell its products or services.

Brocade has a substantial amount of acquired intangible assets, goodwill and deferred tax assets on its balance sheet, and Brocade could be required to record impairment charges for these assets; any impairment of the carrying value of those assets could adversely affect Brocade’s business and financial results.
Brocade has a substantial amount of acquired intangible assets, goodwill and deferred tax assets on its balance sheet related to Brocade’s prior acquisitions. Brocade’s determination of fair value of long-lived assets relies on management’s assumptions of future revenues, operating costs, and other relevant factors. If management’s estimates of future operating results change or if there are changes to other assumptions, such as the discount rate applied to future cash flows, then the estimate of the fair value of Brocade’s reporting units could change significantly, which could result in goodwill impairment charges. Brocade’s estimates with respect to the useful life or ultimate recoverability of Brocade’s carrying basis of assets, including purchased intangible assets, could change as a result of such assessments and decisions. If future impairment tests should result in a charge to earnings, Brocade’s financial results would be adversely affected.
Brocade has determined that, more likely than not, it will realize its deferred tax assets based on positive evidence of its historical operations and projections of future income, except for the deferred tax assets related to California and capital loss carryforwards for which a valuation allowance has been applied. In the event that future income by jurisdiction is less than what is currently projected, Brocade may be required to apply a valuation allowance to these deferred tax assets in jurisdictions where realization of such assets are no longer more likely than not, resulting in a charge to earnings and adversely affecting Brocade’s financial results.

Failure to accurately forecast demand for Brocade’s products or failure to successfully manage the production of Brocade’s products could increase Brocade’s product cost or adversely affect Brocade’s margins and profitability.

Brocade provides product forecasts to its contract manufacturers (“CMs”) and places purchase orders with them in advance of the scheduled delivery of products to Brocade’s customers. In preparing sales and demand forecasts, Brocade relies largely on input from its sales force, partners, resellers and end-user customers. If Brocade or these third parties are unable to accurately forecast demand, or if Brocade fails to effectively communicate with its distribution partners about end-user demand or other time-sensitive information, the sales and demand forecasts may not reflect the most accurate, up-to-date information. If these forecasts are inaccurate, Brocade may be unable to obtain adequate manufacturing capacity from its CMs to meet customers’ delivery requirements or Brocade may accumulate excess inventories or excess manufacturing capacity. If excess inventories accumulate, Brocade’s gross margins may be negatively impacted by write-downs for excess and/or obsolete inventory. In addition, Brocade will experience higher fixed costs as it expands its CMs’ capabilities for forecasted demand, which could negatively affect Brocade’s margins if demand decreases suddenly and Brocade is unable to rapidly reduce these fixed costs.

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Brocade’s ability to accurately forecast demand also may become increasingly more difficult as Brocade introduces new or enhanced products, begins phasing out certain products, or acquires other companies or businesses. Forecasting demand for products that are nearing end of life or are being replaced by new versions, and decreasing production on these older products, while at the same time ramping up production of new products, may be difficult. Brocade may be unable to obtain an adequate supply of new product components and/or manufacturing capacity from its CMs to meet customers’ delivery requirements and such a situation may negatively impact revenues. Brocade may also accumulate excess inventories that may negatively impact gross margins and profitability due to write-downs for excess and/or obsolete inventory.

Brocade’s revenues and operating results and financial position may fluctuate from period to period due to a number of factors, which make predicting results of operations difficult and could adversely affect the trading price of Brocade’s stock.

IT spending is subject to cyclical and uneven fluctuations. For example, the U.S. federal budget for government IT spending can be subject to delay, reductions and uncertainty from time to time due to political and legislative volatility, such as the U.S. federal government shutdown during Brocade’s fourth quarter of fiscal year 2013, which could cause Brocade’s financial results to fluctuate unevenly and unpredictably. It can be difficult to predict the degree to which end-customer demand, and the seasonality and uneven sales patterns of Brocade’s OEM partners or other customers will affect Brocade’s business in the future, particularly as Brocade releases new products. While Brocade’s first and fourth fiscal quarters have typically been seasonally stronger quarters than its second and third fiscal quarters, particularly for SAN products, future buying patterns may differ from historical seasonality.
Accordingly, Brocade’s quarterly and annual revenues, operating results, financial position and other financial and operating metrics may vary significantly in the future. The results of any prior periods should not be relied upon as an indication of future performance. Brocade cannot provide assurance that in future quarters, Brocade’s revenues or operating results will not be below Brocade’s projections or the expectations of stock market analysts or investors, which could affect Brocade’s financial position and cause Brocade’s stock price to decline.

Brocade may not realize the anticipated benefits of past or future acquisitions, divestitures and strategic investments, and integration of acquired companies or technologies or divestiture of businesses may negatively impact Brocade’s overall business.

Brocade has in the past acquired—or made strategic investments in—other companies, products or technologies. Most recently, Brocade acquired Vyatta, and Brocade expects to make additional acquisitions and strategic investments in the future. Brocade may not realize the anticipated benefits of any of its acquisitions or strategic investments, which involve numerous risks, including, but not limited to, the following:
Difficulties in successfully integrating the acquired businesses and realizing any expected synergies;
Inability to effectively coordinate sales and marketing efforts to communicate the capabilities of the combined company;
Unanticipated costs, litigation and other contingent liabilities;
Diversion of management’s attention from Brocade’s daily operations and business;
Adverse effects on existing business relationships with suppliers and customers including delays or cancellations of customer purchases, as well as revenue attrition in excess of anticipated levels if existing customers alter or reduce their historical buying patterns;
Risks associated with entering into markets in which Brocade has limited or no prior experience, including potentially less visibility into demand;
Inability to attract and retain key employees;
Inability to successfully develop new products and services on a timely basis that address the market opportunities of the combined company;
Inability to compete effectively against companies already serving the broader market opportunities expected to be available to the combined company;
Inability to qualify the combined company’s products with OEM partners on a timely basis, or at all;
Inability to successfully integrate and harmonize financial reporting and information technology systems;

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Failure to successfully manage additional remote locations, including the additional infrastructure and resources necessary to support and integrate such locations;
Assumption or incurrence of debt and contingent liabilities and related obligations to service such liabilities and Brocade’s ability to satisfy financial and other negative operating covenants;
Additional costs, such as increased costs of manufacturing and service costs, costs associated with excess or obsolete inventory, costs of employee redeployment, relocation and retention, including salary increases or bonuses, accelerated amortization of deferred equity compensation, severance payments, reorganization or closure of facilities, taxes, advisor and professional fees, and termination of contracts that provide redundant or conflicting services;
Incurrence of acquisition- and integration-related costs, or amortization costs for acquired intangible assets, that could negatively impact Brocade’s operating results and financial condition; and
Potential write-down of goodwill, acquired intangible assets and/or deferred tax assets, which could significantly impact Brocade’s operating results.
Brocade may also divest certain businesses from time to time. Such divestitures will likely involve risks, such as difficulty splitting up businesses, distracting employees, potential loss of revenue and negatively impacting margins, and potentially disrupting customer relationships. Brocade may also incur significant costs associated with exit or disposal activities, related impairment charges, or both, if Brocade exits or divests a business or product line.
If Brocade is not able to successfully integrate or divest products, technologies or personnel from businesses that Brocade acquires or divests, or if Brocade is not able to realize the expected benefits of Brocade’s acquisitions, divestitures or strategic investments, Brocade’s business and financial results would be adversely affected.

If product orders are received late in a fiscal quarter, Brocade may be unable to recognize revenue for these orders in the same period, which could adversely affect quarterly revenues.

Uneven sales patterns are difficult to predict and can result in irregular shipment patterns that can cause shortages or underutilized capacity, increase costs due to higher inventory levels and otherwise adversely impact inventory planning. For example, Brocade’s IP networking business has experienced significantly higher levels of sales toward the end of a fiscal period. Orders received toward the end of the period may not ship within the period due to Brocade’s manufacturing lead times. This pattern exposes Brocade to additional inventory risk because Brocade must order products in anticipation of expected future orders, and additional sales risk will result if Brocade is unable to fulfill unanticipated demand.

Brocade has extensive international operations, which subjects it to additional business risks.

Brocade has significant international operations and a significant portion of Brocade’s sales occur in international jurisdictions. In addition, Brocade’s CMs have significant operations in China. Brocade’s international sales of its IP networking products have primarily depended on a variety of its distributors and resellers. Maintenance or expansion of international sales or international operations involves inherent risks that Brocade may not be able to control, including, but not limited to the following:
Exposure to economic instability or fluctuations in international markets that could cause reductions in customer and public sector IT spending;
Exposure to inflationary risks in China and the continuing sovereign debt risk and economic instability in certain regions of Europe;
Reduced or limited protection of intellectual property rights, particularly in jurisdictions that have less developed intellectual property regimes, such as China and India;
Managing research and development teams in geographically diverse locations, including teams divided between the United States and India;
Significant wage inflation in certain growing economies, such as India;
Increased exposure to foreign currency exchange rate fluctuations, including the appreciation of foreign currencies such as the Chinese yuan or the European Union’s euro;

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Communicating effectively across multiple geographies, cultures and languages;
Recruiting sales and technical support personnel with the skills to design, manufacture, sell and support Brocade’s products in international markets;
Complying with governmental regulation of encryption technology and regulation of imports and exports, including obtaining required import or export approval for its products;
Increased complexity and costs of managing international operations;
Commercial laws and business practices that favor local competition;
Multiple, potentially conflicting, and changing governmental laws, regulations and practices, including differing data privacy, export, import, tax, labor, anti-bribery and employment laws;
Longer sales cycles and manufacturing lead times;
Increased complexity and cost of providing customer support and maintenance for international customers;
Difficulties in collecting accounts receivable; and
Increased complexity of logistics and distribution arrangements.
Any of the preceding could negatively impact Brocade’s business, revenues and profitability.

Brocade is subject to and will continue to be subject to other intellectual property infringement claims and litigation that are costly to defend and/or settle, and that could result in significant damages and cost awards against Brocade and limit Brocade’s ability to use certain technologies in the future.

Brocade competes in markets that are frequently subject to claims and related litigation regarding patent and other intellectual property rights. Third parties have asserted patent, copyright, trade secret, and/or other intellectual property-related claims against Brocade and/or employees of Brocade. These claims may be, and have been in the past, made in respect of Brocade’s products and services, subcomponents of its products, methods performed by its products, or a combination of products, including third-party products, methods used in its operations or uses of its products by its customers, or may concern Brocade’s hiring of a former employee of the third-party claimant. Brocade and companies acquired by Brocade, such as Foundry, have in the past incurred, and will likely incur in the future, substantial expenses to defend against such third-party claims. Brocade’s suppliers and customers also may be subject to third-party intellectual property claims, which could negatively impact their ability to supply Brocade or their willingness to purchase from Brocade, respectively. In addition, Brocade may be subject to claims, defense and indemnification obligations with respect to third-party intellectual property rights pursuant to Brocade agreements with suppliers, OEM and channel partners or customers. If Brocade refuses to indemnify or defend such claims, for instance, even in situations where the allegations are meritless, then suppliers, partners or customers may refuse to do business with Brocade. The third-party asserters of such intellectual property claims may be unreasonable in their demands, or may simply refuse to settle, which could lead to prolonged periods of litigation expenses, additional burden on employees or other resources, distraction from Brocade’s business initiatives and operations, component supply stoppages, expensive settlement payments, and lost sales. Further, there is little or no information publicly available concerning market or fair values for license fees, which can lead to overpayment of license or settlement fees. Any of the above scenarios could have a material adverse effect on Brocade’s financial position, results of operations, cash flows, and future business prospects.


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Brocade’s supply chain is dependent on sole-source and limited-source suppliers and a limited number of major CMs, either one or both of which may significantly impact results of operations.

Although Brocade uses standard parts and components for its products where possible, Brocade’s CMs currently purchase, on Brocade’s behalf, several key components used in the manufacture of its products from single or limited supplier sources. Brocade’s single-source components include, but are not limited to, its application-specific integrated circuits (“ASICs”), and Brocade’s principal limited-source components include memory, certain oscillators, microprocessors, certain connectors, certain logic chips, power supplies, programmable logic devices, printed circuit boards, certain optical components, packet processors and switch fabric components. Brocade generally acquires these components through purchase orders and has no long-term commitments regarding supply or pricing with such suppliers. If Brocade is unable to obtain these and other components when required, or if Brocade experiences component defects, Brocade may not be able to deliver Brocade’s products to Brocade’s customers in a timely manner and may be required to repair or retrofit products previously delivered to customers at significant expense to Brocade. In addition, a challenging economic or industry environment could cause some of these sole-source or limited-source suppliers to delay or halt production or to go out of business or be acquired by third parties, which could result in a disruption in Brocade’s supply chain. Brocade’s supply chain could also be disrupted in a variety of other circumstances that may impact its suppliers and partners, including adverse results from intellectual property litigation or natural disasters. Any manufacturing disruption by these sole-source or limited-source suppliers could severely impair Brocade’s ability to fulfill orders and may significantly impact results of operations.
In addition, the loss of any of Brocade’s major CMs, or portions of their capacity, could significantly impact Brocade’s ability to produce its products for an indefinite period of time. Qualifying a new CM and commencing volume production is typically a lengthy and expensive process. If Brocade changes any of its CMs or if any of its CMs experience delays, disruptions, capacity constraints, component parts shortages or quality control problems in its manufacturing operations, shipment of Brocade’s products to Brocade’s customers could be delayed and result in loss of revenues and Brocade’s competitive position and relationship with customers could be harmed.

Brocade’s intellectual property rights may be infringed or misappropriated by others, and Brocade may not be able to protect or enforce its intellectual property rights.

Brocade’s intellectual property rights may be infringed or misappropriated by others, including by competitors, partners, former employees, foreign governments or other third parties. In some cases, such infringement or misappropriation may be undetectable, or enforcement of Brocade’s rights may be impractical. Brocade has filed, and may in the future file, lawsuits against third parties in an effort to enforce its intellectual property rights. Intellectual property litigation is expensive and unpredictable. There can be no assurance that Brocade will prevail in such assertions or enforcement efforts, either on the merits, or with respect to particular relief sought, such as damages or an injunction, and no assurance that any awarded damages ultimately will be paid to Brocade. Further, the opposing party may attempt to prove that the asserted intellectual property rights are invalid or unenforceable, and, if successful, may seek recompense for its attorney fees and costs or countersue Brocade as part of its defense. Finally, there can be no assurance that any attempt by Brocade to enforce its intellectual property rights, even if successful in court, will improve Brocade’s sales or diminish the defendant’s sales or its allegedly unfair competition, for various reasons, such as, for example, a defendant’s efforts to design around Brocade’s intellectual property and/or marketplace desire to continue doing business with the defendant.
Brocade relies on a combination of patent, copyright, trademark and trade secret laws, and measures such as physical and operational security and contractual restrictions, to protect its intellectual property rights in its proprietary technologies, but none of these methods of protection may be entirely appropriate or adequate to address the particular risk, which could result in a loss of intellectual property rights. Loss or violation of Brocade’s intellectual property rights could adversely affect Brocade’s business and operating results, result in a loss of revenue and increase expenses.

Brocade relies on licenses from third parties and the loss or inability to obtain any such license could harm its business.

Many of Brocade’s products are designed to include software or other intellectual property licensed from third parties. While it may be necessary in the future to seek or renew licenses relating to various aspects of its products, Brocade believes that, based upon past experience and standard industry practice, such licenses generally can be obtained on commercially reasonable terms. Nonetheless, there can be no assurance that the necessary licenses will be available on acceptable terms, if at all. Brocade’s inability to obtain certain licenses or other rights on favorable terms could have an adverse effect on Brocade’s business, operating results and financial condition, including its ability to continue to distribute or support affected products.

19


In addition, if Brocade has failed or in the future fails to adequately manage the use of “open source” software in Brocade’s products, or if companies acquired by Brocade failed in such regard, Brocade may be required to license proprietary portions of Brocade’s products on a royalty-free basis or expose proprietary parts of source code, or to commence costly product redesigns, which could result in a loss of intellectual property rights, product performance degradation or delay in shipping products to customers.

Undetected software or hardware errors could increase Brocade’s costs, reduce Brocade’s revenues and delay market acceptance of Brocade’s products.

Networking products frequently contain undetected software or hardware errors, or bugs, when first introduced or as new versions are released. Brocade’s products are becoming increasingly complex, and particularly as Brocade continues to expand its product portfolio to include software-centric products, including software licensed from third parties, errors may be found from time to time in Brocade’s products. In addition, through its acquisitions, Brocade has assumed—and may in the future assume—products previously developed by an acquired company that have not been through the same level of product development, testing and quality control processes used by Brocade, and may have known or undetected errors. Some types of errors may not be detected until the product is installed in a user environment. In addition, Brocade’s products are often combined with other products, including software from other vendors, and these products often need to interoperate with existing networks, each of which have different specifications and utilize multiple protocol standards and products from other vendors. As a result, when problems occur, it may be difficult to identify the source of the problem. These problems may cause Brocade to incur significant warranty and repair costs, may divert the attention of engineering personnel from product development efforts, and may cause significant customer relations problems such as reputational problems with customers resulting in increased costs and lower profitability. Moreover, the occurrence of hardware and software errors, whether caused by Brocade’s or another vendor’s products, could delay market acceptance of Brocade’s new products.

Business interruptions could adversely affect Brocade’s business operations.

Brocade’s operations and the operations of its suppliers, CMs and customers are vulnerable to interruptions caused by fires, earthquakes, tsunamis, nuclear reactor leaks, hurricanes, power losses, telecommunications failures and other events beyond Brocade’s control. For example, a substantial portion of Brocade’s facilities, including its corporate headquarters, are located near major earthquake faults. Brocade does not have multiple-site capacity for all of its services in the event of a business disruption. In the event of a major earthquake, Brocade could experience business interruption resulting from destruction of facilities or other infrastructure and from loss of life. Brocade carries a limited amount of earthquake insurance, which may not be sufficient to cover earthquake-related losses, and has not set aside funds or reserves to cover other potential earthquake-related losses. Additionally, major public health issues, such as an outbreak of a pandemic or epidemic, may interrupt business operations of Brocade or its suppliers in those geographic regions affected by that particular health issue. In addition, one of Brocade’s CMs has a major facility located in an area that is subject to hurricanes, and Brocade’s suppliers could face other natural disasters, such as floods, earthquakes, extreme weather and fires. In the event that a material business interruption occurs that affects Brocade, its suppliers, CMs or customers, shipments could be delayed and Brocade’s business and financial results could be harmed.
In addition, Brocade’s servers may be vulnerable to computer viruses, break-ins, and similar disruptions from unauthorized tampering with its computer systems despite Brocade’s implementation of network security measures. Brocade may not successfully limit attacks by malicious third parties if they attempt to undermine or disrupt Brocade’s network security. In addition, Brocade may suffer reputational harm and may not carry sufficient insurance to compensate for financial losses that may occur as a result of any of these events. Any such event could have a material adverse effect on Brocade’s business, operating results and financial condition, and could expose Brocade to significant third-party claims of liability and damages.


20


Brocade’s business is subject to increasingly complex corporate governance, public disclosure, accounting and tax requirements and environmental regulations that could adversely affect Brocade’s business and financial results.

Brocade is subject to changing rules and regulations of federal and state governments as well as the stock exchange on which Brocade’s common stock is listed. These entities, including the Public Company Accounting Oversight Board, the Financial Accounting Standards Board, the SEC, the Internal Revenue Service (the “IRS”), and the NASDAQ Stock Market LLC (“NASDAQ”), have issued a significant number of new and increasingly complex requirements and regulations over the course of the last several years and continue to develop additional regulations and requirements in response to laws enacted by Congress. In addition, the Department of Treasury, the Department of Labor and various Congressional representatives have proposed additional rules and regulations that may go into effect in the near future. Brocade is also subject to various rules and regulations of certain foreign jurisdictions, including applicable tax regulations. Brocade’s efforts to comply with these requirements have resulted in, and are likely to continue to result in, an increase in expenses and a diversion of management’s time from other business activities.
The Dodd-Frank Wall Street Reform and Protection Act (the “Dodd-Frank Act”) could also negatively impact Brocade’s supply chain or impose additional costs related to that supply chain as it requires certain public companies to disclose whether certain minerals, commonly known as “conflict minerals,” are necessary to the functionality or production of a product manufactured by those companies and if those minerals originated in the Democratic Republic of the Congo (DRC) or an adjoining country. It may be possible that conflict minerals may be part of the supply chain in the electronics industry and contained in Brocade’s products. The implementation of these requirements by government regulators and Brocade’s partners and/or customers could adversely affect the sourcing, availability, and pricing of minerals used in the manufacture of certain components used in Brocade’s products. In addition, Brocade will incur additional costs to comply with the disclosure requirements for conflict minerals, including costs related to determining the source of any of the relevant minerals and metals used in Brocade’s products. As a result, Brocade’s business and financial results could be adversely affected.
Similarly, any change in tax laws in the jurisdictions in which Brocade does business, including an increase in tax rates or an adverse change in the treatment of an item of income or expense, could result in a material increase in Brocade’s tax expense. For example, in the 2013 and 2014 federal budget proposals, the President of the United States and the U.S. Treasury Department proposed changing certain of the U.S. tax rules for U.S. corporations doing business outside the United States. Potential changes to U.S. and state tax laws could increase Brocade’s U.S. income tax liability in the future.
Brocade is subject to periodic audits or other reviews by such governmental agencies. For example, Brocade is still under examination by the IRS for fiscal years 2009 and 2010, and in several state and foreign tax jurisdictions for various years. The IRS has contested Brocade’s transfer pricing for the cost sharing and buy-in arrangements with its foreign subsidiaries in the past. The IRS may make similar claims against Brocade’s transfer pricing arrangements for fiscal years 2009 and 2010, and in future examinations. Audits by the IRS are subject to inherent uncertainties and could result in unfavorable outcomes, including potential fines or penalties. The occurrence of an unfavorable outcome in any specific period could have a material adverse effect on Brocade’s results of operations for that period or future periods. The expense of defending and resolving such an audit may be significant.
Brocade is subject to various environmental and other regulations governing product safety, materials usage, packaging and other environmental impacts in the various countries where Brocade’s products are sold. For example, many of Brocade’s products are subject to laws and regulations that restrict the use of lead, mercury, hexavalent chromium, cadmium and other substances, and require producers of electrical and electronic equipment, such as Brocade, to assume responsibility for collecting, treating, recycling and disposing of products when they have reached the end of their useful life.
For example, in Europe, environmental restrictions apply to products sold, and certain of Brocade’s partners require compliance with these or more stringent requirements. In addition, recycling, labeling, financing and related requirements apply to products Brocade sells in Europe. China has also enacted legislation with similar requirements for Brocade’s products or its partners’ sale of Brocade’s products. If Brocade’s products do not comply with the substance restrictions under local environmental laws, Brocade could become subject to fines, civil or criminal sanctions and contract damage claims. In addition, Brocade could be prohibited from shipping noncompliant products into one or more jurisdictions and required to recall and replace any noncompliant products already shipped, which would disrupt its ability to ship products and result in reduced revenue, increased warranty expense, increased obsolete or excess inventories, and harm to Brocade’s business and customer relationships. Brocade’s suppliers may also fail to provide it with compliant materials, parts and components despite Brocade’s requirement to do so, which could impact Brocade’s ability to produce compliant products and, accordingly, could disrupt its business or increase Brocade’s costs.

21


Brocade is subject to laws, rules and regulations in the U.S. and other countries relating to the collection, use and security of personal information data. Brocade’s possession and use of personal information and data subjects Brocade to legislative and regulatory burdens that may require Brocade to notify customers or employees of a data security breach. Brocade has incurred, and will continue to incur, expenses to comply with mandatory privacy and security standards and protocols imposed by law, regulation, industry standards or contractual obligations. Such data privacy laws and regulations may negatively impact Brocade’s ability to execute transactions and pursue business opportunities. Additionally, Brocade may suffer reputational harm as a result of a data security breach involving customers’ or employees’ information, all of which could negatively impact our profitability and/or increase expenses.

Brocade is exposed to various risks related to legal proceedings or claims that could adversely affect its operating results.

Brocade is a party to lawsuits in the normal course of its business. Litigation in general can be expensive, lengthy and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict. Responding to lawsuits brought against Brocade, or legal actions initiated by Brocade, can often be expensive and time-consuming. Unfavorable outcomes from these claims and/or lawsuits could adversely affect Brocade’s business, results of operations, or financial condition, and Brocade could incur substantial monetary liability and/or be required to change its business practices. In view of the uncertainties, potential risks and expenses of litigation, Brocade may, from time to time, settle such disputes, even where Brocade had meritorious claims or defenses, by agreeing to settlement agreements that, depending on their terms, may significantly impact Brocade’s financial condition or results.

Brocade has incurred substantial indebtedness that decreases Brocade’s business flexibility and access to capital, and increases its borrowing costs, which may adversely affect Brocade’s operations and financial results.

As of October 26, 2013 , Brocade had $600 million in principal amount of outstanding indebtedness, including $300 million of unsecured indebtedness under the 2023 Notes and $300 million of secured indebtedness under the 2020 Notes (see Note 8 , “ Borrowings ,” of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Form 10-K). In addition, Brocade had up to $125 million available for future borrowing under the Senior Secured Credit Facility. The financial and other covenants agreed to by Brocade in connection with such indebtedness have the effect, among other things, of reducing Brocade’s flexibility to respond to changing business and economic conditions and increasing borrowing costs should further debt financing be desired, and may adversely affect Brocade’s operations and financial results. This indebtedness may also adversely affect Brocade’s ability to access sources of capital or incur certain liens, including, without limitation, funding acquisitions, paying dividends, or repurchasing Brocade stock.
In addition, Brocade’s failure to comply with these covenants could result in a default under any of the applicable debt financing agreements, which could permit the holders to accelerate such debt or demand payment in exchange for a waiver of such default. If any of Brocade’s debt is accelerated, Brocade may not have sufficient funds available to repay such debt. In addition, any negative changes by rating agencies to Brocade’s credit rating may negatively impact the value and liquidity of Brocade’s debt and equity securities and Brocade’s ability to access sources of capital.

Provisions in Brocade’s charter documents, customer agreements and Delaware law could discourage, delay or prevent a change in control of Brocade, which could hinder stockholders’ ability to receive a premium for Brocade’s stock.

Provisions of Brocade’s certificate of incorporation and bylaws may discourage, delay or prevent a merger or mergers that a stockholder may consider favorable. These provisions include, but are not limited to:
Authorizing the issuance of preferred stock without stockholder approval;
Prohibiting cumulative voting in the election of directors;
Limiting the persons who may call special meetings of stockholders; and
Prohibiting stockholder actions by written consent.
Certain provisions of Delaware law also may discourage, delay or prevent someone from acquiring or merging with Brocade, and Brocade’s agreements with certain of Brocade’s customers require that Brocade give prior notice of a change of control and grant certain manufacturing rights following a change of control. Brocade’s various change-of-control provisions could prevent or delay a change in control of Brocade, which could hinder stockholders’ ability to receive a premium for Brocade’s stock.


22


Item 1B.
Unresolved Staff Comments
None.

Item 2.
Properties
Brocade’s principal administrative, sales, marketing, education, customer support, and research and development facilities include approximately 562,000 square feet owned by Brocade in San Jose, California. Additional administrative and research and development facilities are located in an aggregate of approximately 322,000 square feet in Broomfield, Colorado, Plymouth, Minnesota and Bangalore, India. Approximately 154,000 square feet of such space is leased and 168,000 square feet is owned. Brocade believes that its existing properties, both owned and leased, are in good condition and are suitable for conducting its business. Brocade also productively utilizes the majority of the space in its facilities, making adjustments as necessary.
Brocade’s leased properties have expirations through March 2021. In addition to the noted facilities, Brocade leases approximately 400,000 square feet of administrative, sales and marketing office space in various locations to serve its customers throughout the world.
Brocade has four operating segments. Due to the interrelation of these segments, these segments use substantially all of the properties at least in part, and Brocade retains the flexibility to use each of the properties in whole or in part for each of the segments.
Brocade’s properties are subject to a perfected first interest in and mortgages on its tangible and intangible assets as further described in Note 8 , “ Borrowings ,” of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Form 10-K.

Item 3.
Legal Proceedings
The information set forth in Note 9 , “ Commitments and Contingencies ,” (see “Legal Proceedings” of Note 9 ) of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Form 10-K is incorporated herein by reference.

Item 4.
Mine Safety Disclosures
None.

23


PART II

Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Brocade’s common stock is listed on the NASDAQ Global Select Market under the symbol “BRCD.” Information regarding the high and low closing sales prices per-share of Brocade’s common stock as reported on the NASDAQ Global Select Market for each full quarterly period for the last two fiscal years is set forth in “Quarterly Summary (Unaudited)” in Part II, Item 8 of this Form 10-K. According to records of Brocade’s transfer agent, Brocade had 799 stockholders of record as of December 9, 2013 , and it believes there are a substantially greater number of beneficial holders. Brocade has never declared or paid any dividends on its common stock. Brocade also currently expects to retain any future earnings for use in the operation and expansion of its business, to manage its debt, and repurchase the Company’s stock. Information with respect to restrictions on paying dividends is set forth in Note 8 , “ Borrowings ,” of the Notes to Consolidated Financial Statements in Part II, Item 8 of this Form 10-K.
There were no unregistered sales of equity securities during the three months ended October 26, 2013 .
Issuer Purchases of Equity Securities
The following table summarizes share repurchase activity for the three months ended October 26, 2013 (in thousands, except per-share amounts):
Period
Total Number
of Shares
Purchased
 
Average
Price Paid
per Share
 
Total Number of
Shares Purchased
as Part of Publicly
Announced
Program (1)
 
Approximate Dollar
Value of Shares That
May Yet Be
Purchased Under
the Program (1)
July 28, 2013 – August 24, 2013
7,778

 
$
6.77

 
7,778

 
$
308,246

August 25, 2013 – September 21, 2013

 
$

 

 
$
308,246

September 22, 2013 – October 26, 2013

 
$

 

 
$
1,000,000

Total
7,778

 
 
 
7,778

 


(1)  
As of October 26, 2013 , Brocade’s Board of Directors had authorized a stock repurchase program for an aggregate amount of up to $2.0 billion (consisting of an original $100 million authorization on August 18, 2004, plus subsequent authorizations of an additional $200 million on January 16, 2007, $500 million on November 29, 2007, $500 million on May 16, 2012, and $692 million on September 25, 2013), which was used for determining the amounts in this column. The number of shares purchased and the timing of purchases are based on the level of the Company’s cash balances, the trading price of our common stock, general business and market conditions, and other factors, including alternative investment opportunities.

24


Stock Performance Graph
The graph below shows a comparison for the period commencing on October 25, 2008 , and ending on October 26, 2013 , of the annual percentage change in the cumulative total stockholder return for Brocade common stock, assuming the investment of $100.00 on October 25, 2008 , with the cumulative total stockholder returns for the NASDAQ Composite Index and the NASDAQ Telecommunications Index, assuming the investment of $100.00 respectively on October 25, 2008 . The stockholder returns over the indicated periods below are weighted based on market capitalization at the beginning of each measurement point and are not indicative of, or intended to forecast, the future performance of Brocade’s common stock. Data for the NASDAQ Composite Index and the NASDAQ Telecommunications Index assume reinvestment of dividends and was prepared based on publicly available information.
 
10/25/2008
 
10/31/2009
 
10/30/2010
 
10/29/2011
 
10/27/2012
 
10/26/2013
Brocade Communications Systems, Inc.
$
100

 
$
278

 
$
206

 
$
146

 
$
172

 
$
253

NASDAQ Composite Index
$
100

 
$
133

 
$
165

 
$
182

 
$
201

 
$
268

NASDAQ Telecommunications Index
$
100

 
$
140

 
$
160

 
$
146

 
$
137

 
$
188



25


Item 6.
Selected Financial Data
The following selected financial data should be read in conjunction with the Consolidated Financial Statements and related notes, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and other financial information appearing elsewhere in this Annual Report on Form 10-K. The information set forth below is not necessarily indicative of Brocade’s future financial condition or results of operations.
 
Fiscal Year Ended
 
October 26,
2013 (1)
 
October 27,
2012
 
October 29,
2011
 
October 30,
2010
 
October 31,
2009 (2)
 
(In thousands, except per-share amounts)
Selected Financial Data:
 
 
 
 
 
 
 
 
 
Net revenues
$
2,222,864

 
$
2,237,770

 
$
2,147,442

 
$
2,091,153

 
$
1,950,376

Net income (loss)
$
208,623

 
$
195,181

 
$
50,610

 
$
116,523

 
$
(83,189
)
Net income (loss) per-share—basic
$
0.46

 
$
0.43

 
$
0.11

 
$
0.26

 
$
(0.21
)
Net income (loss) per-share—diluted
$
0.45

 
$
0.41

 
$
0.10

 
$
0.24

 
$
(0.21
)
Shares used in per-share calculation—basic
450,516

 
456,629

 
474,259

 
446,996

 
398,948

Shares used in per-share calculation—diluted
463,705

 
472,343

 
497,030

 
482,741

 
398,948

 
 
 
 
 
 
 
 
 
 
Net cash provided by operating activities
$
451,029

 
$
590,870

 
$
449,232

 
$
298,513

 
$
115,562

 
 
 
 
 
 
 
 
 
 
Cash, cash equivalents, investments, and marketable equity securities
$
986,997

 
$
713,226

 
$
414,976

 
$
335,982

 
$
338,871

Total assets
$
3,621,391

 
$
3,581,261

 
$
3,474,308

 
$
3,646,012

 
$
3,665,625

Non-current liabilities associated with facilities lease losses
$
1,008

 
$
1,606

 
$
2,496

 
$
3,984

 
$
10,150

Term loan
$

 
$

 
$
186,858

 
$
325,897

 
$
898,936

Senior unsecured notes
$
296,477

 
$

 
$

 
$

 
$

Senior secured notes
$
298,127

 
$
596,264

 
$
595,803

 
$
595,373

 
$

Convertible subordinated debt
$

 
$

 
$

 
$

 
$
169,332

Capital lease obligations
$
4,600

 
$
4,916

 
$
6,782

 
$
8,543

 
$

(1)  
The fiscal year ended October 26, 2013, includes the impact of the nonrecurring gain of $76.8 million resulting from the litigation settlement with A10 Networks, Inc.
(2)  
The fiscal year ended October 31, 2009, includes the impact of the acquisition of Foundry, which was completed in the first fiscal quarter and the nonrecurring $26.9 million in-process research and development charge in connection with this acquisition. The fiscal year ended October 31, 2009, also includes the impact of a $53.3 million impairment of goodwill and intangible assets in the Company’s former Files reporting unit.


26


Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements and the notes thereto included in Part II, Item 8 of this Annual Report on Form 10-K. This section and other parts of this Annual Report on Form 10-K contain forward-looking statements that involve risks and uncertainties. Forward-looking statements can also be identified by words such as “anticipates,” “expects,” “believes,” “plans,” “predicts,” and similar terms. Forward-looking statements are not guarantees of future performance and our actual results may differ significantly from the results discussed in the forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in the subsection entitled “Risk Factors” above.
Overview
We are a leading supplier of networking equipment and software for businesses and organizations of many types and sizes, including global enterprises that use our products and services as part of their communications infrastructure, and service providers such as telecommunication firms, cable operators and mobile carriers who use our products and services as part of their production operations. Our business model is focused on two key markets: our Storage Area Networking (“SAN”) business, where we offer Fibre Channel (“FC”) SAN backbones, directors, fixed form factor switches and embedded switches, host bus adapters (“HBAs”) and server virtualization solutions, and our Internet Protocol (“IP”) Networking business, where we offer modular and stackable solutions, IP routers, Ethernet switches, Ethernet fabrics, converged adapters, as well as application delivery, security and wireless solutions. We also provide product-related customer support and services.
We expect growth opportunities in the SAN market to be driven by key customer Information Technology (“IT”) initiatives such as server virtualization, enterprise mobility, data center consolidation, migration to higher performance technologies, such as solid state storage and cloud computing initiatives. Our IP Networking business strategies are intended to increase new customer accounts and expand our market share through product innovation, such as our Ethernet fabric products, and the development of and expansion of our routes to market. The success of Ethernet fabrics, in particular, will depend on customers recognizing the benefits of upgrading their data center networks to fabric-based networking architectures, and our future success in this area would be negatively impacted if this technological transition does not occur at the anticipated rate or at all. We plan to continue to support our SAN and IP Networking growth plans by continuous innovation, leveraging the strategic investments we have made in our core businesses, developing emerging technologies, new product introductions, and enhancing our existing partnerships and forming new ones through our various distribution channels.
We announced in the second quarter of fiscal year 2013 that we were making certain changes in our strategic direction by focusing on key technology segments, as well as investing in data center and public sector market opportunities. As part of this change in focus, we reduced cost of revenues and other operating expenses by $100 million on an annualized basis when comparing the fourth quarter to the first quarter of fiscal year 2013. We achieved our targeted cost reduction opportunities ahead of our previously announced schedule by focusing on the optimization of discretionary spending and rebalancing personnel resources. This change in focus will also result in a rebalancing of resources away from certain non-key areas of our business and may impact our ability to generate revenue from certain products, markets, geographies and customers, and may lower our revenue, in the near term, by $80 million to $100 million on an annualized basis.
We continue to face multiple challenges, including aggressive price discounting from competitors, new product introductions from competitors, rapid adoption of new technologies by customers, uncertainty in the worldwide macroeconomic climate and its impact on IT spending patterns globally, as well as uncertain federal government spending in the United States and the budget-related government shutdown. We are also cautious about the stability and health of certain international markets, including China and Europe, and current global and country-specific dynamics, including inflationary risks in China and the continuing sovereign debt risk, particularly in Europe. These factors may impact our business and that of our partners. While the diversification of our business model helps mitigate the effect of some of these challenges and we expect IT spending levels to generally rise in the long term, it is difficult to offset short-term reductions in IT spending, which may adversely affect our financial results and stock price.
We expect the number of SAN and IP Networking products we ship to fluctuate depending on the demand for our existing and recently introduced products, sales support for our products from our distribution and resale partners, as well as the timing of product transitions by our original equipment manufacturer (“OEM”) partners. The average selling prices per port for our SAN and IP Networking products have typically declined over time, unless impacted favorably by a new product introduction or mix, and will likely decline in the future.

27


Our plans for our operating cash flows are to provide liquidity for operations, to repurchase our stock to reduce the dilutive effects of our equity award programs and, from time to time, we may also opportunistically repurchase our stock under our previously announced stock repurchase programs. In addition, we may use our operating cash flows to strengthen our networking portfolios through acquisitions and strategic investments.
Results of Operations
We report our fiscal year on a 52/53-week period ending on the last Saturday in October. As is customary for companies that use the 52/53-week convention, every fifth year contains a 53-week year. Fiscal years 2013 , 2012 and 2011 were 52-week fiscal years. Our next 53-week fiscal year will be fiscal year 2014 , and our next 14-week quarter will be in the second quarter of fiscal year 2014 .
Our results of operations for the years ended October 26, 2013 , October 27, 2012 , and October 29, 2011 , are reported in this discussion and analysis as a percentage of total net revenues, except for gross margin with respect to each segment, which is indicated as a percentage of the respective segment net revenues.
Revenues. Our revenues are derived primarily from sales of our SAN and IP Networking products, and support and services related to these products, which we call Global Services.
Our total net revenues are summarized as follows (in thousands, except percentages):
 
Fiscal Year Ended
 
 
 
 
 
October 26,
2013
 
% of Net
Revenues
 
October 27,
2012
 
% of Net
Revenues
 
Increase/
(Decrease)
 
%
Change
SAN Products
$
1,318,509

 
59.3
%
 
$
1,356,099

 
60.6
%
 
$
(37,590
)
 
(2.8
)%
IP Networking Products
552,058

 
24.8
%
 
534,757

 
23.9
%
 
17,301

 
3.2
 %
Global Services
352,297

 
15.9
%
 
346,914

 
15.5
%
 
5,383

 
1.6
 %
Total net revenues
$
2,222,864

 
100.0
%
 
$
2,237,770

 
100.0
%
 
$
(14,906
)
 
(0.7
)%
 
Fiscal Year Ended
 
 
 
 
 
October 27,
2012
 
% of Net
Revenues
 
October 29,
2011
 
% of Net
Revenues
 
Increase/
(Decrease)
 
%
Change
SAN Products
$
1,356,099

 
60.6
%
 
$
1,237,994

 
57.6
%
 
$
118,105

 
9.5
 %
IP Networking Products
534,757

 
23.9
%
 
551,820

 
25.7
%
 
(17,063
)
 
(3.1
)%
Global Services
346,914

 
15.5
%
 
357,628

 
16.7
%
 
(10,714
)
 
(3.0
)%
Total net revenues
$
2,237,770

 
100.0
%
 
$
2,147,442

 
100.0
%
 
$
90,328

 
4.2
 %
The decrease in total net revenues for the fiscal year ended October 26, 2013 , compared with the fiscal year ended October 27, 2012 , reflects lower sales of our SAN products, partially offset by higher sales of our IP Networking products and Global Services offerings, as further described below:
The decrease in SAN product revenues was caused by a decrease in director and server product revenues due to weaker demand from our OEMs and weaker end-user demand in the high-end storage array market in fiscal year 2013. We continue to maintain a positive view of the long-term SAN market despite a soft storage market in the near term. The decrease in SAN product revenues was partially offset by the continued strong growth in sales of our Gen 5 Fibre Channel products. Our average selling price per port increased by 1.3% during the fiscal year ended October 26, 2013, which was offset by the 4.0% decrease in the number of ports shipped during the same period, resulting in lower SAN product revenues in fiscal year 2013;
The increase in IP Networking product revenues primarily reflects higher revenues from our IP routing and application delivery products. Based on our analysis of the information we collect in our sales management system, we estimate that revenues from our service provider and enterprise end customers have increased for the fiscal year ended October 26, 2013, compared with the fiscal year ended October 27, 2012, while revenues from our U.S. federal government end customers have decreased due to the current challenging federal budget environment and the budget-related government shutdown, which caused a delay in the orders for some funded projects. As the percentage of our IP Networking products being sold through two-tier distribution has increased, it has become increasingly difficult to quantify our revenues by end customer, and, therefore, these results are based solely on our estimates; and

28


The increase in Global Services revenues was primarily attributable to an increase in the sales of initial support contracts and renewal support contracts for our IP Networking products, partially offset by a decrease in professional services revenues.
The increase in total net revenues for the fiscal year ended October 27, 2012 , compared with the fiscal year ended October 29, 2011 , reflects higher sales of our SAN products, partially offset by lower revenues from our IP Networking products and Global Services offerings, as further described below:
The increase in SAN product revenues was driven by a shift in mix to our high-end, higher bandwidth director and switch products, including strong growth in sales of our Gen 5 Fibre Channel products. The number of ports shipped during the fiscal year ended October 27, 2012, increased by 3.5%, and average selling price per port increased by 5.7%;
The decrease in IP Networking product revenues reflects lower revenues from our IP routing and application delivery products while Ethernet switching product revenue was flat year-over-year. As more of our IP Networking products are being sold through our two-tier distribution channel, it has become increasingly difficult to consistently identify the customer split of our end users. Based on our analysis of the information we collect in our sales management system, we estimate that revenues from our enterprise customers decreased, partially offset by an increase in revenues from both service provider and U.S. federal government customers. Our IP Networking business was impacted by slower enterprise customer spending and the competitive enterprise environment. In addition, enterprise product revenue decreased in part due to our transition to a two-tier distribution channel model. This transition resulted in lower average selling prices through the distribution channel, which was not compensated by an increase in distribution channel sales volumes; and
The decrease in Global Services revenues was primarily attributed to the sale of Strategic Business Systems, Inc. (“SBS”), a wholly-owned subsidiary, in September 2011, partially offset by an increase in IP Networking support revenues.
Our total net revenues by geographical area are summarized as follows (in thousands, except percentages):
 
Fiscal Year Ended
 
 
 
 
 
October 26,
2013
 
% of Net
Revenues
 
October 27,
2012
 
% of Net
Revenues
 
Increase/
(Decrease)
 
%
Change
United States
$
1,351,242

 
60.8
%
 
$
1,414,390

 
63.2
%
 
$
(63,148
)
 
(4.5
)%
Europe, the Middle East and Africa (1)
552,734

 
24.9
%
 
493,979

 
22.1
%
 
58,755

 
11.9
 %
Asia Pacific
181,461

 
8.1
%
 
186,244

 
8.3
%
 
(4,783
)
 
(2.6
)%
Japan
97,259

 
4.4
%
 
99,887

 
4.5
%
 
(2,628
)
 
(2.6
)%
Canada, Central and South America
40,168

 
1.8
%
 
43,270

 
1.9
%
 
(3,102
)
 
(7.2
)%
Total net revenues
$
2,222,864

 
100.0
%
 
$
2,237,770

 
100.0
%
 
$
(14,906
)
 
(0.7
)%
 
 
 
 
 
 
 
 
 
 
 
 
 
Fiscal Year Ended
 
 
 
 
 
October 27,
2012
 
% of Net
Revenues
 
October 29,
2011
 
% of Net
Revenues
 
Increase/
(Decrease)
 
%
Change
United States
$
1,414,390

 
63.2
%
 
$
1,313,302

 
61.2
%
 
$
101,088

 
7.7
 %
Europe, the Middle East and Africa (1)
493,979

 
22.1
%
 
502,999

 
23.4
%
 
(9,020
)
 
(1.8
)%
Asia Pacific
186,244

 
8.3
%
 
212,636

 
9.9
%
 
(26,392
)
 
(12.4
)%
Japan
99,887

 
4.5
%
 
75,542

 
3.5
%
 
24,345

 
32.2
 %
Canada, Central and South America
43,270

 
1.9
%
 
42,963

 
2.0
%
 
307

 
0.7
 %
Total net revenues
$
2,237,770

 
100.0
%
 
$
2,147,442

 
100.0
%
 
$
90,328

 
4.2
 %
(1)  
Includes net revenues of $339.1 million , $259.2 million and $257.5 million for the fiscal years ended October 26, 2013 October 27, 2012 , and October 29, 2011 , respectively, relating to the Netherlands.
Revenues are attributed to geographic areas based on where our products are shipped. However, certain OEM partners take possession of our products domestically and then distribute these products to their international customers. Because we account for all of those OEM revenues as domestic revenues, we cannot be certain of the extent to which our domestic and international revenue mix is impacted by the practices of our OEM partners, but end-user location data indicate that international revenues comprise a larger percentage of our total net revenues than the attributed revenues above may indicate.

29


International revenues for the fiscal year ended October 26, 2013 , increased as a percentage of total net revenues compared to the prior year primarily due to a shift in the mix of SAN product sales to certain of our OEM partners from the United States region to the Europe, Middle East and Africa regions relative to total net revenues. International revenues for the fiscal year ended October 27, 2012 , decreased as a percentage of total net revenues compared to the prior year primarily due to higher revenues from our SAN product sales to U.S. OEM partners, which strengthened U.S. revenues, as well as lower product sales in EMEA due to a weak macroeconomic environment.
A significant portion of our revenues are concentrated among a relatively small number of OEM customers. For the fiscal years ended October 26, 2013 October 27, 2012 , and October 29, 2011 , the same three customers each represented 10% or more of our total net revenues for a combined total of 46% ( EMC Corporation (“ EMC ”) with 18% , Hewlett-Packard Company (“ HP ”) with 12% and International Business Machines Corporation (“ IBM ”) with 16% ), 47% (EMC with 16% , HP with 13% and IBM with 18% ) and 43% (EMC with 15% , HP with 13% and IBM with 15% ), respectively, of our total net revenues. We expect that a significant portion of our future revenues will continue to come from sales of products to a relatively small number of OEM partners and to the U.S. federal government and its individual agencies through our distributors and resellers. Therefore, the loss of, or a significant decrease in the level of sales to, or a change in the ordering pattern of any one of, these customers could seriously harm our financial condition and results of operations.
Gross margin. Gross margin as stated below is indicated as a percentage of the respective segment net revenues, except for total gross margin, which is stated as a percentage of total net revenues.
Gross margin is summarized as follows (in thousands, except percentages):
 
Fiscal Year Ended
 
 
 
 
 
October 26,
2013
 
% of Net
Revenues
 
October 27,
2012
 
% of Net
Revenues
 
Increase/
(Decrease)
 
% Points
Change
SAN Products
$
963,121

 
73.0
%
 
$
993,491

 
73.3
%
 
$
(30,370
)
 
(0.3
)%
IP Networking Products
249,084

 
45.1
%
 
207,509

 
38.8
%
 
41,575

 
6.3
 %
Global Services
196,674

 
55.8
%
 
182,019

 
52.5
%
 
14,655

 
3.3
 %
Total gross margin
$
1,408,879

 
63.4
%
 
$
1,383,019

 
61.8
%
 
$
25,860

 
1.6
 %
 
Fiscal Year Ended
 
 
 
 
 
October 27,
2012
 
% of Net
Revenues
 
October 29,
2011
 
% of Net
Revenues
 
Increase/
(Decrease)
 
% Points
Change
SAN Products
$
993,491

 
73.3
%
 
$
881,981

 
71.2
%
 
$
111,510

 
2.1
 %
IP Networking Products
207,509

 
38.8
%
 
230,637

 
41.8
%
 
(23,128
)
 
(3.0
)%
Global Services
182,019

 
52.5
%
 
170,916

 
47.8
%
 
11,103

 
4.7
 %
Total gross margin
$
1,383,019

 
61.8
%
 
$
1,283,534

 
59.8
%
 
$
99,485

 
2.0
 %
For the fiscal year ended October 26, 2013 , compared with the fiscal year ended October 27, 2012 , total gross margin increased in absolute dollars and as a percentage of total net revenues due to a combination of factors for our SAN products, IP Networking products and Global Services offerings, as further described below.
Gross margin percentage by reportable segment increased or decreased for the fiscal year ended October 26, 2013 , compared with the fiscal year ended October 27, 2012 , primarily due to the following factors (the percentages below reflect the impact on gross margin):
SAN gross margins relative to net revenues decreased due to a 1.4% increase in manufacturing overhead costs relative to net revenues primarily due to a decrease in our ports shipped versus our fixed overhead costs, partially offset by a 0.5% decrease in amortization of SAN-related intangible assets and a 0.4% decrease in discrete period costs, in each case, relative to net revenues;
IP Networking gross margins relative to net revenues increased primarily due to a 2.8% decrease in product costs, which is primarily due to a more favorable mix of IP Networking products, a 2.2% decrease in manufacturing overhead costs, and a 1.7% decrease in discrete period costs, which is primarily due to lower inventory revaluation and decreased warranty expense, in each case, relative to net revenues. These decreases were partially offset by the costs associated with certain Foundry pre-acquisition litigation, which caused a 0.6% increase in costs, relative to net revenues; and

30


Global Services gross margins relative to net revenues increased primarily due to a 3.4% decrease in service and support costs relative to net revenues, primarily due to a decrease in period costs related to improved utilization of service inventory assets within our spares depot, as well as decreases in legal, IT and facilities expenses.
For the fiscal year ended October 27, 2012 , compared with the fiscal year ended October 29, 2011 , total gross margin increased in absolute dollars and percentage primarily due to an increase in margins on SAN products and Global Services offerings, and a favorable product mix resulting from a year-over-year increase in the relative percentage of SAN products sold, which yield higher gross margins. This was partially offset by a decrease in margins on IP Networking products.
Gross margin percentage by reportable segment increased or decreased for the fiscal year ended October 27, 2012 , compared with the fiscal year ended October 29, 2011 , primarily due to the following factors (the percentages below reflect the impact on gross margin):
SAN gross margins relative to net revenues increased due to a 1.1% decrease in product costs relative to net revenues. Additionally, amortization of SAN-related intangible assets decreased by 0.9% relative to net revenues;
IP Networking gross margins relative to net revenues decreased due to a 4.3% increase in manufacturing costs, as well as a 1.1% increase in product costs relative to net revenues, which is primarily due to the impact of a decrease in average selling prices and an unfavorable mix due to an increase in the percentage of sales of our fixed form products, which yield lower gross margins. These increases were partially offset by a 2.6% decrease in other costs relative to net revenues, primarily by a decrease in inventory excess and obsolescence charges and warranty expense; and
Global Services gross margins relative to net revenues increased due to a 4.7% decrease in service and support costs relative to net revenues, primarily from decreased headcount as a result of the sale of SBS.
Research and development expenses. Research and development (“R&D”) expenses consist primarily of compensation and related expenses for personnel engaged in engineering and R&D activities, fees paid to consultants and outside service providers, engineering expenses, which primarily consist of nonrecurring engineering charges and prototyping expenses related to the design, development, testing and enhancement of our products, depreciation related to engineering and test equipment, and expenses related to legal, IT, facilities and other shared functions.
R&D expenses are summarized as follows (in thousands, except percentages):
 
October 26, 2013
 
October 27, 2012
 
 
 
 
Research and development expense:
Expense
 
% of Net
Revenues
 
Expense
 
% of Net
Revenues
 
Increase/
(Decrease)
 
%
Change
Fiscal year ended
$
378,521

 
17.0
%
 
$
363,090

 
16.2
%
 
$
15,431

 
4.2
%
 
October 27, 2012
 
October 29, 2011
 
 
 
 
 
Expense
 
% of Net
Revenues
 
Expense
 
% of Net
Revenues
 
Increase/
(Decrease)
 
%
Change
Fiscal year ended
$
363,090

 
16.2
%
 
$
354,401

 
16.5
%
 
$
8,689

 
2.5
%
R&D expenses increased for the fiscal year ended October 26, 2013 , compared with the fiscal year ended October 27, 2012 , due to the following (in thousands):
 
Increase/ (Decrease)
Salaries and other compensation
$
17,199

Depreciation and amortization expense
3,171

Engineering equipment expense
2,055

Various individually insignificant items
125

The increase in R&D expenses was partially offset by a decrease in the following:
 
Expenses related to legal, IT, facilities and other shared functions
(7,119
)
Total change
$
15,431


31


Salaries and other compensation increased primarily due to an increase in salaries and incentive compensation for employees added from the Vyatta, Inc. (“Vyatta”) acquisition, as well as merit-based increases in salaries and headcount growth related to other Brocade personnel. Depreciation and amortization expense increased due to additional equipment acquired for use in our engineering laboratories. In addition, engineering equipment expense increased primarily due to a physical write-off of scrapped equipment in fiscal year 2013. Expenses related to legal, IT, facilities and other shared functions allocated to research and development activities decreased primarily due to lower legal expenses due to recent litigation settlements, and lower IT expenses as part of our spending reduction plan.
R&D expenses increased for the fiscal year ended October 27, 2012 , compared with the fiscal year ended October 29, 2011 , due to the following (in thousands):
 
Increase/ (Decrease)
Salaries and other compensation
$
6,999

Outside services expense
4,143

Depreciation and amortization expense
1,905

Engineering expense
1,187

The increase in R&D expenses was partially offset by decreases in the following:
 
Engineering equipment expense
(3,615
)
Stock-based compensation expense
(1,007
)
Various individually insignificant items
(923
)
Total change
$
8,689

Salaries and other compensation increased primarily due to an increase in our variable compensation due to improved financial results during fiscal year 2012. Outside services expense increased primarily due to increased certification and technical publication expenses as we penetrated new markets and fulfilled additional U.S. federal government customer testing requirements. In addition, depreciation and amortization expense increased due to additional depreciation expenses related to equipment for our laboratories. These increases were partially offset by the decrease in engineering equipment expense mainly due to reduced spending on equipment for product testing. In addition, stock-based compensation expense decreased mainly because of fewer grants of restricted stock units in fiscal year 2012 and forfeiture-related expense adjustments due to employee terminations.
Sales and marketing expenses. Sales and marketing expenses consist primarily of salaries, commissions and related expenses for personnel engaged in sales and marketing functions, costs associated with promotional and marketing programs, travel and entertainment expenses, and expenses related to legal, IT, facilities and other shared functions.
Sales and marketing expenses are summarized as follows (in thousands, except percentages):
 
October 26, 2013
 
October 27, 2012
 
 
 
 
Sales and marketing expense:
Expense
 
% of Net
Revenues
 
Expense
 
% of Net
Revenues
 
Increase/
(Decrease)
 
%
Change
Fiscal year ended
$
567,637

 
25.5
%
 
$
608,502

 
27.2
%
 
$
(40,865
)
 
(6.7
)%
 
October 27, 2012
 
October 29, 2011
 
 
 
 
 
Expense
 
% of Net
Revenues
 
Expense
 
% of Net
Revenues
 
Increase/
(Decrease)
 
%
Change
Fiscal year ended
$
608,502

 
27.2
%
 
$
608,513

 
28.3
%
 
$
(11
)
 
 %

32


Sales and marketing expenses decreased for the fiscal year ended October 26, 2013 , compared with the fiscal year ended October 27, 2012 , due to the following (in thousands):
 
Increase/ (Decrease)
Salaries and other compensation
$
(16,780
)
Outside services and other marketing expense

(10,419
)
Expenses related to legal, IT, facilities and other shared functions
(9,925
)
Stock-based compensation expense
(3,833
)
The decrease in sales and marketing expenses was partially offset by an increase in the following:
 
Various individually insignificant items
92

Total change
$
(40,865
)
Salaries and other compensation decreased primarily due to decreased headcount, which also resulted in lower variable compensation and commissions. Outside services and other marketing expense decreased primarily due to less spending on conferences and trade shows, as well as on advertising, in fiscal year 2013. Expenses related to legal, IT, facilities and other shared functions allocated to sales and marketing activities decreased primarily due to lower legal expenses due to recent litigation settlements, and to a lesser extent, lower IT and facilities expenses as part of our spending reduction plan. Stock-based compensation expense decreased primarily due to a decline in the grant date per-unit fair values of restricted stock units granted to employees in recent quarters, as well as due to certain executive departures in fiscal year 2013. The decline in grant date per-unit fair values was primarily due to lower average grant date stock prices for the restricted stock units amortized during fiscal year 2013 as compared to the restricted stock units amortized during fiscal year 2012 (see Note 12 , “ Stock-Based Compensation ,” of the Notes to Consolidated Financial Statements).
Sales and marketing expenses remained flat for the fiscal year ended October 27, 2012 , compared with the fiscal year ended October 29, 2011 , due to the following (in thousands):
 
Increase/ (Decrease)
Salaries and other compensation
$
(9,958
)
Stock-based compensation expense
(2,810
)
Outside services expense
(1,443
)
Sales office facilities expense
(1,094
)
Travel and entertainment expense
(961
)
Various individually insignificant items
(460
)
The decrease in sales and marketing expenses was offset by increases in the following:
 
Marketing expense
9,714

Expenses related to legal, IT, facilities and other shared functions
7,001

Total change
$
(11
)
Salaries and other compensation decreased primarily due to a reduction in variable compensation mainly attributable to lower sales commissions and lower headcount. Stock-based compensation expense decreased primarily due to fewer grants of restricted stock units in fiscal year 2012 and forfeiture-related expense adjustments due to employee terminations. Outside services expense decreased primarily due to a decrease in the use of outside consultants for business development and operational projects in fiscal year 2012. Sales office facilities expense decreased due to lower headcount and office consolidation. Travel and entertainment expense decreased due to lower headcount and lower spending due to cost control initiatives. These decreases were offset by an increase in marketing expense primarily due to our marketing awareness campaigns and various other marketing activities. In addition, expenses related to legal, IT, facilities and other shared functions increased primarily due to an increase in legal expenses allocated to sales and marketing.
General and administrative expenses. General and administrative (“G&A”) expenses consist primarily of compensation and related expenses for corporate management, finance and accounting, human resources, legal, IT, facilities and investor relations, as well as recruiting expenses, professional fees, and other corporate expenses.

33


G&A expenses are summarized as follows (in thousands, except percentages):
 
October 26, 2013
 
October 27, 2012
 
 
 
 
General and administrative expense:
Expense
 
% of Net
Revenues
 
Expense
 
% of Net
Revenues
 
Increase/
(Decrease)
 
%
Change
Fiscal year ended
$
74,518

 
3.4
%
 
$
74,583

 
3.3
%
 
$
(65
)
 
(0.1
)%
 
October 27, 2012
 
October 29, 2011
 
 
 
 
 
Expense
 
% of Net
Revenues
 
Expense
 
% of Net
Revenues
 
Increase/
(Decrease)
 
%
Change
Fiscal year ended
$
74,583

 
3.3
%
 
$
69,506

 
3.2
%
 
$
5,077

 
7.3
 %
G&A expenses remained flat for the fiscal year ended October 26, 2013 , compared with the fiscal year ended October 27, 2012 , due to the following (in thousands):
 
Increase/ (Decrease)
Outside services expense
$
(3,804
)
Various individually insignificant items
(418
)
The decrease in G&A expenses was offset by increases in the following:
 
Salaries and other compensation
2,517

Stock-based compensation expense
1,640

Total change
$
(65
)
Expense associated with outside services decreased primarily due to lower legal expense resulting from the settlement of litigation matters during fiscal year 2013, as well as decreased costs with respect to IT and finance-related projects as part of our spending reduction plan. Salaries and other compensation increased primarily due to an increase in salaries and incentive compensation for employees added from the Vyatta acquisition, as well as merit-based increases in salaries and headcount growth related to other Brocade personnel, and severance and recruiting costs related to the transition to a new Chief Executive Officer. Stock-based compensation expense increased mainly because of more grants of restricted stock units since fiscal year 2012, as well as due to incremental expense resulting from higher contributions for the ESPP purchase period that closed in the third fiscal quarter of 2013 as compared to the contributions for the purchase period that closed in the third fiscal quarter of 2012 (see Note 12 , “ Stock-Based Compensation ,” of the Notes to Consolidated Financial Statements).
G&A expenses increased for the fiscal year ended October 27, 2012 , compared with the fiscal year ended October 29, 2011 , due to the following (in thousands):
 
Increase/ (Decrease)
Outside services expense
$
6,408

Salaries and other compensation
6,007

The increase in G&A expenses was partially offset by decreases in the following:
 
Facilities expense
(2,675
)
Stock-based compensation expense
(1,917
)
Equipment and furniture expense
(1,888
)
Various individually insignificant items
(858
)
Total change
$
5,077

Outside services expense increased primarily due to increased costs for our ongoing litigation matters. Salaries and other compensation increased due to merit increases in salaries and increased severance costs in fiscal year 2012, as well as an increase in our variable compensation due to improved financial results during fiscal year 2012. These increases were partially offset by a decrease in various facilities expense, stock-based compensation expense and spending on equipment and furniture.

34


Amortization of intangible assets. Amortization of intangible assets is summarized as follows (in thousands, except percentages):
 
October 26, 2013
 
October 27, 2012
 
 
 
 
Amortization of intangible assets:
Expense
 
% of Net
Revenues
 
Expense
 
% of Net
Revenues
 
Increase/
(Decrease)
 
%
Change
Fiscal year ended
$
54,256

 
2.4
%
 
$
59,204

 
2.6
%
 
$
(4,948
)
 
(8.4
)%
 
October 27, 2012
 
October 29, 2011
 
 
 
 
 
Expense
 
% of Net
Revenues
 
Expense
 
% of Net
Revenues
 
Increase/
(Decrease)
 
%
Change
Fiscal year ended
$
59,204

 
2.6
%
 
$
60,713

 
2.8
%
 
$
(1,509
)
 
(2.5
)%
The decrease in amortization of intangible assets for the fiscal year ended October 26, 2013 , compared with the fiscal year ended October 27, 2012 , as well as for the fiscal year ended October 27, 2012 , compared with the fiscal year ended October 29, 2011 , was primarily due to the full amortization of certain of our intangible assets, partially offset by the additional amortization of the Vyatta intangible assets acquired in the first fiscal quarter of 2013.
Intangible assets are recorded based on estimates of fair value at the time of the acquisition and identifiable intangible assets are amortized on a straight-line basis over their estimated useful lives (see Note 4 , “ Goodwill and Intangible Assets ,” of the Notes to Consolidated Financial Statements).
Restructuring and other costs (recoveries) . Restructuring and other costs (recoveries) are summarized as follows (in thousands, except percentages):
 
October 26, 2013
 
October 27, 2012
 
 
 
 
Restructuring and other costs (recoveries):
Expense
 
% of Net
Revenues
 
Recovery
 
% of Net
Revenues
 
Increase/
(Decrease)
 
%
Change
Fiscal year ended
$
25,464

 
1.1
 %
 
$
(89
)
 
 %
 
$
25,553

 
*

 
October 27, 2012
 
October 29, 2011
 
 
 
 
 
Recovery
 
% of Net
Revenues
 
Expense
 
% of Net
Revenues
 
Increase/
(Decrease)
 
%
Change
Fiscal year ended
$
(89
)
 
 %
 
$
125

 
 %
 
$
(214
)
 
(171.2
)%
* Not meaningful
Restructuring and other charges for the fiscal year ended October 26, 2013, were primarily due to $20.4 million of severance and benefits related to a reduction in workforce, $4.0 million related to contract terminations and other charges, and $1.1 million related to estimated lease loss reserve and related costs recorded during the fiscal year ended October 26, 2013 (see Note 5 , “ Restructuring and Other Charges ,” of the Notes to Consolidated Financial Statements).
In May 2013, we announced that we were making certain changes in our strategic direction by focusing on key technology segments, as well as investing in data center and public sector market opportunities. As a result, during the fiscal year ended October 26, 2013, we reevaluated our business model to restructure certain business operations, reorganize certain business units, and reduce our operating expense structure.
As a result of the completion of our restructuring plan and other related spending changes, our cost of revenues and other operating expenses have been reduced by at least $100 million on an annualized basis relative to cost of revenues and other operating expenses incurred during the first quarter of fiscal year 2013. We anticipate that these savings will carry over into the future periods, however, actual savings realized may differ if our assumptions are incorrect or if other unanticipated events occur. Savings may also be offset, or additional expenses incurred, if, and when, we make additional investments in labor, materials or capital in our business in the future, or if we decide to strengthen our networking portfolios through acquisitions and strategic investments.
This change in focus will also result in a rebalancing of resources away from certain non-key areas of our business and may impact our ability to generate revenue from certain products, markets, geographies and customers, and may lower our revenue, in the near term, by $80.0 million to $100.0 million on an annualized basis.
We did not incur any restructuring costs during the fiscal years ended October 27, 2012, and October 29, 2011. In addition, other costs (recoveries) were immaterial for the fiscal years ended October 27, 2012, and October 29, 2011.

35


Loss on sale of subsidiary. We did not incur any loss on sale of subsidiary during the fiscal years ended October 26, 2013, and October 27, 2012. During the fiscal year ended October 29, 2011, a loss of $12.8 million was recorded in connection with the sale of SBS, consisting primarily of loss on disposal of goodwill of $1.7 million and write-down of intangible assets of $11.1 million (see Note 13 , “ Loss on Sale of Subsidiary ,” of the Notes to Consolidated Financial Statements).
Interest income. Interest income was immaterial for the fiscal years ended October 26, 2013, October 27, 2012, and October 29, 2011.
Other income (loss), net. Other income (loss), net, are summarized as follows (in thousands, except percentages):
 
October 26, 2013
 
October 27, 2012
 
 
 
 
Other income (loss), net:
Income
 
% of Net
Revenues
 
Loss
 
% of Net
Revenues
 
Increase/
(Decrease)
 
%
Change
Fiscal year ended
$
75,835

 
3.4
 %
 
$
(1,499
)
 
(0.1
)%
 
$
77,334

 
*

 
October 27, 2012
 
October 29, 2011
 
 
 
 
 
Loss
 
% of Net
Revenues
 
Loss
 
% of Net
Revenues
 
Increase/
(Decrease)
 
%
Change
Fiscal year ended
$
(1,499
)
 
(0.1
)%
 
$
(851
)
 
 %
 
$
(648
)
 
76.1
%
* Not meaningful
For the fiscal year ended October 26, 2013, compared with the fiscal year ended October 27, 2012, the increase in other income (loss), net, was primarily due to the nonrecurring gain of $76.8 million in the fiscal year ended October 26, 2013, resulting from the litigation settlement with A10 Networks, Inc. (additionally, see Note 14 , “ Other Income (Loss), net ,” of the Notes to Consolidated Financial Statements).
Other income (loss), net, was immaterial for the fiscal years ended October 27, 2012, and October 29, 2011.
Interest expense. Interest expense primarily represents the interest cost associated with our term loan, senior secured notes and senior unsecured notes (see Note 8 , “ Borrowings ,” of the Notes to Consolidated Financial Statements). Interest expense is summarized as follows (in thousands, except percentages):
 
October 26, 2013
 
October 27, 2012
 
 
 
 
Interest expense:
Expense
 
% of Net
Revenues
 
Expense
 
% of Net
Revenues
 
(Increase)/
Decrease
 
%
Change
Fiscal year ended
$
(55,261
)
 
(2.5
)%
 
$
(52,488
)
 
(2.3
)%
 
$
(2,773
)
 
5.3
 %
 
October 27, 2012
 
October 29, 2011
 
 
 
 
 
Expense
 
% of Net
Revenues
 
Expense
 
% of Net
Revenues
 
(Increase)/
Decrease
 
%
Change
Fiscal year ended
$
(52,488
)
 
(2.3
)%
 
$
(97,838
)
 
(4.6
)%
 
$
45,350

 
(46.4
)%
Interest expense increased for the fiscal year ended October 26, 2013, compared with the fiscal year ended October 27, 2012, primarily due to the $15.3 million expense that we recorded in the first quarter of fiscal year 2013, for the call premium, debt issuance costs and original issue discount relating to the redemption of the 6.625% senior secured notes due 2018 (the “2018 Notes”), in accordance with the applicable accounting guidance for debt modification and extinguishment, and for interest cost accounting (additionally, see Note 8 , “ Borrowings ,” of the Notes to Consolidated Financial Statements).
This increase was partially offset by the decrease in interest expense resulting from the term loan facility being fully paid off in the fourth quarter of fiscal year 2012, as well as due to the refinancing of the 2018 Notes. In January 2013, we issued $300.0 million in aggregate principal amount of 4.625% Senior Notes due 2023 (the “2023 Notes”) in a private placement (the “Offering”). The proceeds from the Offering, together with cash on hand, were used on February 21, 2013, to redeem all of the outstanding 2018 Notes, which had a higher interest rate. The transactions are described further below in “Liquidity and Capital Resources.”
Interest expense decreased for the fiscal year ended October 27, 2012, compared with the fiscal year ended October 29, 2011, as a result of a reduction in the principal amount of our outstanding debt and refinancing our term debt credit agreement in June 2011. In addition, as a result of the June 2011 refinancing, in accordance with the applicable accounting guidance for debt modification and extinguishment, we recorded an expense of $25.5 million of debt issuance costs and original issue discount relating to the portion of the term loan that was extinguished.

36


Income tax expense . Income tax expense and the effective tax rates are summarized as follows (in thousands, except effective tax rates):
 
Fiscal Year Ended
 
October 26,
2013
 
October 27,
2012
 
October 29,
2011
Income tax expense
$
121,838

 
$
29,220

 
$
28,818

Effective tax rate
36.9
%
 
13.0
%
 
36.3
%
In general, our 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 (additionally, see Note 15 , “ Income Taxes ,” of the Notes to Consolidated Financial Statements).
The effective tax rate in fiscal year 2013 is higher than the 35% U.S. Federal statutory rate. The tax provision in fiscal year 2013 was impacted by a detriment to reduce previously recognized California deferred tax assets as a result of a change in California tax law, partially offset by discrete benefits from reserve releases resulting from audit settlements and expiring statutes of limitations, and an increase in the Federal research and development tax credit that was reinstated on January 2, 2013, for two years, and made retroactive to January 1, 2012.
The effective tax rate in fiscal year 2012 is lower than the 35% U.S. Federal statutory rate primarily due to earnings in our subsidiaries outside of the U.S. in jurisdictions where our effective tax rate is lower than in the United States. Earnings of our subsidiaries outside of the U.S. primarily relate to our European and Asia Pacific businesses, which are headquartered in Switzerland and Singapore, respectively. The income tax expense recorded for the fiscal year ended October 27, 2012, includes discrete benefits from net reserve releases related to settling tax audits and from expiring statutes of limitations, and a lower benefit from the federal research and development tax credit which expired on December 31, 2011, and, therefore, was not applicable in calendar year 2012.
We recorded an income tax expense for the fiscal year ended October 29, 2011, primarily due to cash repatriated from our foreign subsidiary and foreign tax expenses, partially offset by discrete benefits from the retroactive reinstatement of the Federal research and development tax credit provision, reserve releases of settled tax audits and the expiration of certain statutes of limitations.
Based on the fiscal year 2014 financial forecast, we expect our effective tax rate in fiscal year 2014 to be lower than fiscal year 2013 . Factors such as the mix of IP Networking versus SAN products and domestic versus international profits affect our tax expense. As estimates and judgments are used to project such domestic and international earnings, the impact to our tax provision could vary if the current planning or assumptions change. Our income tax provision could change from either effects of changing tax laws and regulations or differences in international revenues and earnings from those historically achieved, a factor largely influenced by the buying behavior of our OEM and channel partners. In addition, we do not forecast discrete events, such as settlement of tax audits with governmental authorities due to their inherent uncertainty. Such settlements have in the past and could in the future materially impact our tax expense. Given that the tax rate is affected by several different factors, it is not possible to estimate our future tax rate with a high degree of certainty.
The Internal Revenue Service (the “IRS”) and other tax authorities regularly examine our income tax returns. The IRS is currently examining our federal tax returns for fiscal years 2009 and 2010. In addition, we are in negotiations with foreign tax authorities to obtain correlative relief on transfer pricing adjustments previously settled with the IRS. We believe that our 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. We believe 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 we reach settlement with the tax authorities, we expect 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, we estimate the range of potential decreases in underlying uncertain tax positions is between $0 and $4 million in the next twelve months. For additional discussion, see Note 15 , “ Income Taxes ,” of the Notes to Consolidated Financial Statements.
We believe 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 we will realize our deferred tax assets, except for California deferred tax assets and our capital loss carryforwards. Accordingly, we apply 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.

37


Liquidity and Capital Resources
 
October 26,
2013
 
October 27,
2012
 
Increase/
(Decrease)
 
(in thousands)
Cash and cash equivalents
$
986,997

 
$
713,226

 
$
273,771

Percentage of total assets
27
%
 
20
%
 
 
We use cash generated by operations as our primary source of liquidity. We expect that cash provided by operating activities will fluctuate in future periods as a result of a number of factors, including fluctuations in our revenues, the timing of product shipments during the quarter, accounts receivable collections, inventory and supply chain management, and the timing and amount of tax, and other payments or receipts. For additional discussion, see Part I, Item 1A. Risk Factors of this Form 10-K.
In January 2013, we issued $300.0 million of the 2023 Notes in the Offering. On January 22, 2013, we called the 2018 Notes for redemption. On February 21, 2013, we used the net proceeds from the Offering, together with cash on hand, to redeem all of our outstanding 2018 Notes, including the payment of the applicable premium and expenses associated with the redemption, and the interest on the 2018 Notes up to the date of redemption (see Note 8 , “ Borrowings ,” of the Notes to Consolidated Financial Statements).
Based on past performance and current expectations, we believe that internally generated cash flows and cash on hand will be generally sufficient to support business operations, capital expenditures, contractual obligations, and other liquidity requirements associated with our operations for at least the next twelve months. Also, we have up to $125.0 million available under our revolving credit facility, and we can factor up to an aggregate amount of $50.0 million of our trade receivables under our factoring facility to provide additional liquidity. There are no other transactions, arrangements, or other relationships with unconsolidated entities or other persons that are reasonably likely to materially affect liquidity of, availability of, or our requirements for capital resources.
Our existing cash and cash equivalents totaled $987.0 million as of October 26, 2013 . Of this amount, approximately 59% was held by our foreign subsidiaries. We do not currently anticipate a need of these funds held by our foreign subsidiaries for our domestic operations and our intent is to permanently reinvest such funds outside of the United States. Under current tax laws and regulations, if these funds are distributed to the U.S. in the form of dividends or otherwise, we may be subject to additional U.S. income taxes and foreign withholding taxes.
Financial Condition
Cash and cash equivalents as of October 26, 2013 , increased by $273.8 million over the balance as of October 27, 2012 , primarily due to the cash generated from operations, proceeds from the issuance of our common stock in connection with employee participation in our equity compensation plans, and the collection of the convertible note receivable from A10, partially offset by the cash used for the acquisition of Vyatta, purchases of property and equipment and the repurchase of outstanding shares of our common stock.
For the fiscal year ended October 26, 2013 , we generated $451.0 million in cash from operating activities, which was higher than our net income for the same period, primarily as a result of adjustments to net income for non-cash items related to depreciation and amortization, tax charges and stock-based compensation expense.
Net cash used in investing activities for the fiscal year ended October 26, 2013 , totaled $27.0 million and was primarily the result of $52.4 million in purchases of property and equipment and $44.6 million in the acquisition of Vyatta, partially offset by $70.0 million received from A10 for the payment of the convertible note receivable.
Net cash used in financing activities for the fiscal year ended October 26, 2013 , totaled $149.4 million and was primarily the result of stock repurchases of $240.0 million , partially offset by proceeds from the issuance of common stock from ESPP purchases and stock option exercises of $93.8 million . For the fiscal year ended October 26, 2013 , we repurchased approximately 41.2 million shares of our stock.
A majority of our accounts receivable balance is derived from sales to our OEM partners. As of October 26, 2013 , four customers individually accounted for 18% , 12% , 11% and 11% of total accounts receivable, for a combined total of 52% of total accounts receivable. As of October 27, 2012 , three customers individually accounted for 16% , 12% and 10% of total accounts receivable, for a combined total of 38% of total accounts receivable. We perform ongoing credit evaluations of our customers and generally do not require collateral or security interests on accounts receivable balances. We have established reserves for credit losses, sales allowances, and other allowances. While we have not experienced material credit losses in any of the periods presented, there can be no assurance that we will not experience material credit losses in the future.

38


Accounts receivable days sales outstanding, which is a measure of the average number of days that a company takes to collect revenue after a sale has been made, for the year ended October 26, 2013 , was 41 days, up from 38 days for the year ended October 27, 2012 , primarily due to better sales linearity in 2012.
Net proceeds from the issuance of common stock in connection with employee participation in our equity compensation plans have historically been a significant component of our liquidity. The extent to which we receive proceeds from these plans can increase or decrease based upon changes in the market price of our common stock, from the amount of awards granted to employees and from the types of awards that are granted to employees. As a result, our cash flow resulting from the issuance of common stock in connection with employee participation in equity compensation plans will vary.
Fiscal Year 2013 Compared to Fiscal Year 2012
Operating Activities. Cash provided by operating activities is net income adjusted for certain non-cash items and changes in certain assets and liabilities.
Net cash provided by operating activities decreased by $139.8 million primarily due to increased payments with respect to accrued employee incentive compensation and accounts payable, and decreased accounts receivable collections, partially offset by a reduction of inventory balance. Fiscal year 2013 includes an annual payout of the employee incentive compensation for fiscal year 2012, as well as a semi-annual payout for the first half of fiscal year 2013. Fiscal year 2012 only includes a semi-annual payout of the employee incentive compensation for the second half of fiscal year 2011.
Investing Activities. Net cash used in investing activities decreased by $44.8 million . The decrease was primarily due to cash received from A10 for the payment of the convertible note receivable during the fourth quarter of fiscal year 2013, as well as lower capital expenditures during fiscal year 2013, which more than offset the $44.6 million of cash used for the acquisition of Vyatta during the first quarter of fiscal year 2013.
Financing Activities. Net cash used in financing activities decreased by $68.7 million . The decrease was primarily due to no principal payments toward the term loan during the fiscal year 2013, as this was fully paid off in the fourth quarter of fiscal year 2012. However, repurchases of our Company’s stock increased in fiscal year 2013, and we received lower proceeds from the issuance of common stock during fiscal year 2013.
Fiscal Year 2012 Compared to Fiscal Year 2011
Operating Activities. Net cash provided by operating activities increased by $141.6 million for the fiscal year ended October 27, 2012, compared with the fiscal year ended October 29, 2011. The increase was primarily due to an increase in net income during fiscal year 2012 and decreased payments with respect to accrued employee compensation.
Investing Activities. Net cash used in investing activities decreased by $19.5 million for the fiscal year ended October 27, 2012, compared with the fiscal year ended October 29, 2011. The decrease was primarily due to lower purchases of property and equipment.
Financing Activities. Net cash used in financing activities decreased by $59.0 million for the fiscal year ended October 27, 2012, compared with the fiscal year ended October 29, 2011. The decrease was primarily due to lower repurchases of our Company’s stock during fiscal year 2012.
Liquidity
Manufacturing and Purchase Commitments. We have manufacturing arrangements with contract manufacturers under which we provide twelve-month product forecasts and place purchase orders in advance of the scheduled delivery of products to our customers. Our purchase commitments reserve reflects our estimate of purchase commitments we do not expect to use in normal operations within the next twelve months, in accordance with our policy (see Note 9 , “ Commitments and Contingencies ,” of the Notes to Consolidated Financial Statements).
Income Taxes. We accrue U.S. income taxes on the earnings of our foreign subsidiaries unless the earnings are considered indefinitely reinvested outside of the U.S. We intend to reinvest current and accumulated earnings of our foreign subsidiaries for expansion of our business operations outside the U.S. for an indefinite period of time.
The IRS and other tax authorities regularly examine our income tax returns (see Note 15 , “ Income Taxes ,” of the Notes to Consolidated Financial Statements). We believe we have adequate reserves for all open tax years.
Senior Secured Credit Facility. In October 2008, we 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 (the “Senior Secured Credit Facility”). The credit agreement was subsequently amended in January 2010, June 2011, and October 2013 to, among other things, provide us with greater operating

39


flexibility, 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 April 7, 2014 (see Note 8 , “ Borrowings ,” of the Notes to Consolidated Financial Statements).
We prepaid the term loan in full, and there were no principal amounts or commitments outstanding under the term loan facility as of either October 26, 2013 , or October 27, 2012 . We have the following amount available for borrowing under the Senior Secured Credit Facility for ongoing working capital and other general corporate purposes, if needed, as of October 26, 2013 (in thousands):
 
Original Amount
 
October 26, 2013
 
Available
 
Used
 
Available
Revolving credit facility
$
125,000

 
$

 
$
125,000

Senior Secured Notes. In January 2010, we issued $300.0 million in aggregate principal amount of senior secured notes due 2018 (the “2018 Notes”) and $300.0 million in aggregate principal amount of senior secured notes due 2020 (the “2020 Notes” and together with the 2018 Notes, the “Senior Secured Notes”) (see Note 8 , “ Borrowings ,” of the Notes to Consolidated Financial Statements). We used the proceeds to pay down a substantial portion of the outstanding term loan, and retire the convertible subordinated debt due on February 15, 2010, which had been assumed in connection with our acquisition of McDATA Corporation (“McDATA”). The 2018 Notes were redeemed in the second quarter of fiscal year 2013 as described further below.
Senior Unsecured Notes. In January 2013, we issued $300.0 million in aggregate principal amount of the 2023 Notes. We used the proceeds and cash on hand to redeem all of the outstanding 2018 Notes in the second quarter of fiscal year 2013 as described in Note 8 , “ Borrowings ,” of the Notes to Condensed Consolidated Financial Statements.
Trade Receivables Factoring Facility. We have an agreement with a financial institution to sell certain of our trade receivables from customers with limited, non-credit-related recourse provisions. The sale of receivables eliminates our credit exposure in relation to these receivables. No trade receivables were sold under our factoring facility during the fiscal years ended October 26, 2013 , and October 27, 2012 .
Under the terms of the factoring agreement, the total and available amounts of the factoring facility as of October 26, 2013 , were $50.0 million.
Covenant Compliance
Senior Unsecured Notes covenants. The 2023 Notes were issued pursuant to an Indenture, dated as of January 22, 2013, among the Company, the subsidiary guarantors named therein and Wells Fargo Bank, National Association, as trustee (the “2023 Indenture”). 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 other limitations and exceptions set forth in the indenture. The Company was in compliance with all applicable covenants of the 2023 Indenture as of October 26, 2013 .

40


Senior Secured Notes covenants. The 2020 Notes and the 2018 Notes were issued pursuant to two separate indentures (the “2020 Indenture” and the “2018 Indenture,” respectively), each dated as of January 20, 2010, among the Company, the subsidiary guarantors named therein and Wells Fargo Bank, National Association, as trustee. 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.
These covenants are subject to a number of limitations and exceptions set forth in the indenture. The Company was in compliance with all applicable covenants of the 2020 Indenture as of October 26, 2013 . The 2018 Indenture was discharged as of January 22, 2013 (see Note 8 , “ Borrowings ,” of the Notes to Consolidated Financial Statements). Prior to discharge, the 2018 Indenture contained substantially similar covenants and events of default to those in the 2020 Indenture. The Company was in compliance with all applicable covenants of the 2018 Indenture as of the date of discharge.
The 2020 Indenture provides for customary events of default, including, but not limited to, cross defaults to specified other debt of the Company and its subsidiaries. In the case of an event of default arising from specified events of bankruptcy or insolvency, all outstanding senior secured notes will become due and payable immediately without further action or notice. If any other event of default under the 2020 Indenture occurs or is continuing, the applicable trustee or holders of at least 25% in aggregate principal amount of the then outstanding 2020 Notes, as applicable, may declare all of the 2020 Notes to be due and payable immediately.
Senior Secured Credit Facility covenants. The credit agreement governing the Senior Secured Credit Facility contains customary representations and warranties and customary affirmative and negative covenants applicable to the Company and its subsidiaries, including, among other things, restrictions on liens, indebtedness, investments, fundamental changes, dispositions, capital expenditures, prepayment of other indebtedness, redemption or repurchase of subordinated indebtedness, share repurchases, dividends and other distributions. The credit agreement contains financial covenants that require the Company to maintain a minimum consolidated fixed charge coverage ratio and a maximum consolidated leverage ratio, each as defined in the credit agreement and described further below. The credit agreement also includes customary events of default, including cross-defaults on the Company’s material indebtedness and change of control. The Company was in compliance with all applicable Senior Secured Credit Facility’s covenants as of October 26, 2013 .
Consolidated Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”), as defined in the credit agreement, is used to determine the Company’s compliance with certain covenants in the Senior Secured Credit Facility. Consolidated EBITDA is defined as:
Consolidated net income;
Plus:
Consolidated interest charges;
Provision for federal, state, local and foreign income taxes;
Depreciation and amortization expense;
Fees, costs and expenses incurred on or prior to the closing date of the Foundry acquisition in connection with the acquisition and the financing thereof;

41


Any cash restructuring charges and integration costs in connection with the Foundry acquisition, in an aggregate amount not to exceed $75.0 million;
Approved non-cash restructuring charges incurred in connection with the Foundry acquisition and the financing thereof;
Other non-recurring expenses reducing consolidated net income which do not represent a cash item in such period or future periods;
Any non-cash stock-based compensation expense; and
Legal fees associated with the indemnification obligations for the benefit of former officers and directors in connection with Brocade’s historical stock option litigation;
Minus:
Federal, state, local and foreign income tax credits; and
All non-cash items increasing consolidated net income.
The financial covenants imposed under the Senior Secured Credit Facility are described below.
Consolidated Fixed Charge Coverage Ratio. Consolidated fixed charge coverage ratio means, at any date of determination, the ratio of (a) (i) consolidated EBITDA (excluding interest expense, if any, attributable to a campus sale-leaseback), plus (ii) rentals payable under leases of real property, less (iii) the aggregate amount of all capital expenditures to (b) consolidated fixed charges; provided that, for purposes of calculating the consolidated fixed charge coverage ratio for any period ending prior to the first anniversary of the closing date, consolidated interest charges shall be an amount equal to actual consolidated interest charges from the closing date through the date of determination multiplied by a fraction, the numerator of which is 365 and the denominator of which is the number of days from the closing date through the date of determination. Under the terms of the credit agreement, the Company is required to maintain a minimum fixed charge coverage ratio of at least 1.75:1.
Consolidated fixed charges, as defined in the credit agreement, is comprised of the following:
Consolidated interest charges;
Plus:
Regularly scheduled principal payments or redemptions or similar acquisitions for value of outstanding debt for borrowed money, but excluding any such payments to the extent refinanced through the incurrence of additional indebtedness;
Rentals payable under leases of real property;
Restricted payments; and
Federal, state, local and foreign income taxes paid in cash.
Consolidated Leverage Ratio. Consolidated leverage ratio means, as of any date of determination, the ratio of (a) consolidated funded indebtedness as of such date to (b) consolidated EBITDA for the measurement period ending on such date. Under the terms of the credit agreement, the Company may not permit the consolidated leverage ratio at any time to exceed 3:1.

42


Contractual Obligations
The following table summarizes our contractual obligations, including interest expense, and commitments as of October 26, 2013 (in thousands):
 
Total
 
Less than
1 Year
 
1 – 3 Years
 
3 – 5 Years
 
More than
5 Years
Contractual Obligations:
 
 
 
 
 
 
 
 
 
Senior secured notes due 2020 (1)
$
428,906

 
$
20,625

 
$
41,250

 
$
41,250

 
$
325,781

Senior unsecured notes due 2023  (1)
427,924

 
13,875

 
27,750

 
27,750

 
358,549

Non-cancellable operating leases (2)
70,255

 
22,253

 
32,353

 
9,773

 
5,876

Non-cancellable capital lease
4,870

 
3,215

 
1,655

 

 

Purchase commitments, gross (3)
191,082

 
191,082

 

 

 

Total contractual obligations
$
1,123,037

 
$
251,050

 
$
103,008

 
$
78,773

 
$
690,206

Other Commitments:
 
 
 
 
 
 
 
 
 
Standby letters of credit
$
220

 
n/a

 
n/a

 
n/a

 
n/a

Unrecognized tax benefits and related accrued interest (4)
$
114,767

 
n/a

 
n/a

 
n/a

 
n/a

(1)  
Amount reflects total anticipated cash payments, including anticipated interest payments.
(2)  
Amount excludes contractual sublease income of $22.7 million , which consists of $7.1 million to be received in less than one year, $14.4 million to be received in one to three years, and $1.2 million to be received in three to five years.
(3)  
Amount reflects total gross purchase commitments under our manufacturing arrangements with a third-party contract manufacturer. Of this amount, we have accrued $4.4 million for estimated purchase commitments that we do not expect to use in normal operations within the next twelve months, in accordance with our policy.
(4)  
As of October 26, 2013 , we had a gross liability for unrecognized tax benefits of $112.5 million and a net accrual for the payment of related interest and penalties of $2.3 million .
Share Repurchase Program. As of October 26, 2013 , our Board of Directors had authorized, since the inception of the program in August 2004, a total of $2.0 billion for the repurchase of our common stock. The purchases may be made, from time to time, in the open market or by privately negotiated transactions, and are funded from available working capital. The number of shares to be purchased and the timing of purchases are based on the level of our cash balances, general business and market conditions, our debt covenants, the trading price of our common stock and other factors, including alternative investment opportunities. For the fiscal year ended October 26, 2013 , we repurchased 41.2 million shares for an aggregate purchase price of $240.0 million . Approximately $1.0 billion remained authorized for future repurchases under this program as of October 26, 2013 . Subsequent to October 26, 2013 , and through the date of the filing of this Annual Report on Form 10-K, we repurchased 8.1 million shares of our common stock for an aggregate purchase price of $65.1 million . We are subject to certain covenants relating to our borrowings that may potentially restrict the amount of our Company’s shares that we can repurchase. As of October 26, 2013 , we were in compliance with all covenants.
Off-Balance Sheet Arrangements
As part of our ongoing business, we do not participate in transactions that generate material relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or for other contractually narrow or limited purposes. As of October 26, 2013 , we did not have any significant off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Securities and Exchange Commission (“SEC”) Regulation S-K.

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Critical Accounting Estimates
Our discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these Consolidated Financial Statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We evaluate, on an ongoing basis, our estimates and judgments, including, but not limited to, those related to sales allowances and programs, bad debts, stock-based compensation, commissions, allocation of purchase price of acquisitions, excess inventory and purchase commitments, restructuring costs, facilities lease losses, impairment of goodwill and other indefinite-lived intangible assets, litigation, uncertain tax positions and investments. We base our estimates on historical experience and assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.
The methods, estimates and judgments we use in applying our most critical accounting policies have a significant impact on the results that we report in our Consolidated Financial Statements. We believe the following critical accounting policies, among others, require significant estimates and judgments used in the preparation of our consolidated financial statements.
Revenue recognition. Our multiple-element product offerings include networking hardware with embedded software products and support, which are considered separate units of accounting. For certain of our products, software and non-software components function together to deliver the tangible products’ essential functionality. We allocate revenue to each element in a multiple-element arrangement based upon their relative selling price. When applying the relative selling price method, we determine the selling price for each deliverable using vendor-specific objective evidence (“VSOE”) of selling price, if it exists, or third-party evidence (“TPE”) of selling price. If neither VSOE nor TPE of selling price exist for a deliverable, we use our best estimate of selling price for that deliverable. Revenue allocated to each element is then recognized when the basic revenue recognition criteria are met for each element.
We determine VSOE based on our normal pricing and discounting practices for the specific product or service when sold separately. In determining VSOE, we require that a substantial majority of the selling prices for a product or service fall within a reasonably narrow pricing range. For post-contract customer support, we consider stated renewal rates in determining VSOE.
In most instances, we are not able to establish VSOE for all deliverables in an arrangement with multiple elements. This may be due to infrequently selling each element separately, not pricing products within a narrow range, or only having a limited sales history. When VSOE cannot be established, we attempt to establish a selling price for each element based on TPE. TPE is determined based on competitor prices for similar deliverables when sold separately. Generally, our go-to-market strategy differs from that of our competitors, and our offerings contain a significant level of customization and differentiation such that the comparable pricing of products with similar functionality cannot be obtained. Furthermore, we are unable to reliably determine what similar competitor products’ selling prices are on a stand-alone basis. Therefore, we are typically not able to determine TPE.
When we are unable to establish selling price using VSOE or TPE, we use estimated selling price (“ESP”) in our allocation of the arrangement consideration. The objective of ESP is to determine the price at which we would transact a sale if the product or service were sold on a stand-alone basis. ESP is generally used for offerings that are not typically sold on a stand-alone basis or for new or highly-customized offerings.
We determine ESP for a product by considering multiple factors including, but not limited to, geographies, market conditions, competitive landscape, internal costs, gross margin objectives and pricing practices. The determination of ESP is made through consultation with and formal approval by our management, taking into consideration the go-to-market strategy. If circumstances related to our estimates for revenue recognition change, our allocation of revenue to each element in a multiple-element arrangement may also change.
Stock-based compensation. We grant stock options for shares in the Company’s common stock, restricted stock units and other types of equity compensation awards to our employees and directors under various equity compensation plans. For additional discussion, see Note 12 , “ Stock-Based Compensation ,” of the Notes to Consolidated Financial Statements.
The compensation expense for stock-based awards is adjusted for an estimated impact of forfeitures and is recognized over the vesting period of the award under a graded or straight-line vesting method. In addition, we record stock-based compensation expense in connection with shares issued under our employee stock purchase plan using the graded vesting method over the twenty-four month offering period.

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We use the Black-Scholes option pricing model to determine the fair value of stock options granted when the measurement date is certain. We also use the Black-Scholes option pricing model to determine the fair value of the option component of employee stock purchase plan shares. The determination of the fair value of stock-based awards using the option pricing model is affected by our stock price, as well as assumptions regarding a number of complex and subjective variables. These variables include our expected stock price volatility over the expected term of the awards, projected and actual employee stock option exercise behaviors, risk-free interest rates, estimated forfeitures and expected dividend yields.
We estimate the expected term of stock options granted by calculating the average term from our historical stock option exercise experience. We have never declared or paid any cash dividends, and therefore we use an expected dividend yield of zero in the option pricing model. We are required to estimate forfeitures at the time of the grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. We use historical data to estimate pre-vesting option forfeitures and record stock-based compensation expense only for those awards that are expected to vest. We use implied volatilities from traded options of the Company’s common stock and historical volatilities of the Company’s common stock to estimate volatility over the expected term of the awards.
The assumptions used in calculating the fair value of stock-based awards represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future.
Acquisitions—purchase price allocation. We allocate the purchase price of an acquired business to the assets acquired and liabilities assumed, including identifiable intangible assets, based on their respective fair values at the acquisition date. The excess of the purchase price over the fair value of the underlying acquired net tangible and intangible assets, if any, is recorded as goodwill. We estimate the fair value of assets and liabilities based upon quoted market prices, the carrying value of the acquired assets and widely accepted valuation techniques. We adjust the preliminary purchase price allocation, as necessary, typically up to one year after the acquisition closing date as we obtain more information regarding asset valuations and liabilities assumed. For additional discussion, see Note 3 , “ Acquisition ,” of the Notes to Consolidated Financial Statements.
Inventory valuation and purchase commitment liabilities. We write down inventory and record purchase commitment liabilities for estimated excess and obsolete inventory equal to the difference between the cost of inventory and the estimated fair value based upon forecast of future product demand, product transition cycles and market conditions. Any significant unanticipated changes in demand or technological development could have a significant impact on the value of our inventory and purchase commitments and our reported results. If actual market conditions are less favorable than those projected, additional inventory write-downs, purchase commitment liabilities and charges against earnings may be required.
Restructuring costs. We monitor and regularly evaluate our organizational structure and associated operating expenses. Depending on events and circumstances, we may decide to take additional actions to reduce future operating costs as our business requirements evolve. In determining restructuring charges, we analyze our future operating requirements, including the required headcount by business functions and facility space requirements. Our restructuring costs and any resulting accruals involve significant estimates made by management using the best information available at the time the estimates are made. In recording severance accruals, we record a liability when all of the following conditions have been met: employees’ rights to receive compensation for future absences is attributable to employees’ services already rendered; the obligation relates to rights that vest or accumulate; payment of the compensation is probable; and the amount can be reasonably estimated. In recording facilities lease loss accruals, we make various assumptions, including the time period over which the facilities are expected to be vacant, expected sublease terms, expected sublease rates, expected future operating costs, and expected future use of the facilities. Our estimates involve a number of risks and uncertainties, some of which are beyond our control, including future real estate market conditions and our ability to successfully enter into subleases or lease termination agreements with terms as favorable as those assumed when arriving at our estimates. We regularly evaluate a number of factors to determine the appropriateness and reasonableness of our restructuring accruals, including the various assumptions noted above. If actual results differ significantly from our estimates, we may be required to adjust our restructuring accruals in the future.
Impairment of goodwill and other indefinite-lived intangible assets. Goodwill and other indefinite-lived intangible assets are generated as a result of business combinations. Our indefinite-lived assets are comprised of acquired in-process research and development (“IPRD”) and goodwill.
IPRD impairment testing. IPRD is an intangible asset accounted as an indefinite-lived asset until the completion or abandonment of the associated research and development effort. During the development period, we conduct our IPRD impairment test 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. Events that might indicate impairment include, but are not limited to, adverse cost factors, deteriorating financial performance, strategic decisions made in response to economic and competitive conditions, the impact of the economic environment on us and our customer base, and/or other relevant events such as changes in management, key personnel, litigations, or customers. Our ongoing consideration of all these factors could result in IPRD impairment charges in the future, which could adversely affect our net income.

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We performed our 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, we first assessed 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 our IPRD asset is less than its carrying amount. After assessing the totality of events and circumstances, we determined that it was not more likely than not that the fair values of our IPRD assets were less than their carrying amounts and no further testing was required.
Goodwill impairment testing. We conduct our 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. Events that might indicate impairment include, but are not limited to, strategic decisions made in response to economic and competitive conditions, the impact of the economic environment on our customer base, material negative changes in relationships with significant customers, and/or a significant decline in our stock price for a sustained period. Our ongoing consideration of all these factors could result in goodwill impairment charges in the future, which could adversely affect our net income.
We use the income approach, the market approach, or a combination thereof, in testing goodwill for impairment for each reporting unit, which we have determined to be at the operating segment level. The reporting units are determined by the components of our operating segments that constitute a business for which both (i) discrete financial information is available and (ii) segment management regularly reviews the operating results of that component. Our four reporting units are: Storage Area Networking (“SAN”) Products; Ethernet Switching & Internet Protocol (“IP”) Routing, which includes Open Systems Interconnection Reference Model (“OSI”) Layer 2-3 products; Application Delivery Products (“ADP”), which includes OSI Layer 4-7 products; and Global Services.
The first step tests for potential impairment by comparing the fair value of reporting units with reporting units’ net asset values. If the fair value of the reporting unit exceeds the carrying value of the reporting unit’s net assets, then goodwill is not impaired and no further testing is required. If the fair value of the reporting unit is below the reporting unit’s carrying value, then the second step is required to measure the amount of potential impairment. The second step requires an assignment of the reporting unit’s fair value to the reporting unit’s assets and liabilities, using the initial acquisition accounting guidance in Accounting Standards Codification (“ASC”) 805 Business Combinations, to determine the implied fair value of the reporting unit’s goodwill. The implied fair value of the reporting unit’s goodwill is then compared with the carrying amount of the reporting unit’s goodwill to determine the goodwill impairment loss to be recognized, if any. If the carrying value of a reporting unit’s goodwill exceeds its implied fair value, we record an impairment loss equal to the difference.
To determine the reporting unit’s fair values, we use the income approach, the market approach, or a combination thereof. The income approach provides an estimate of fair value based on discounted expected future cash flows. The market approach provides an estimate of the fair value of our four reporting units using various prices or market multiples applied to the reporting unit’s operating results and then applying an appropriate control premium.
Determining the fair value of a reporting unit or an intangible asset is judgmental in nature and involves the use of significant estimates and assumptions. We based our fair value estimates on assumptions we believe to be reasonable, but inherently uncertain. Estimates and assumptions with respect to the determination of the fair value of our 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.
Our 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 acquisitions that have occurred in a reporting unit’s comparable market segments.
Consistent with prior years, we performed our annual goodwill impairment test using measurement data as of the first day of the second fiscal quarter of 2013 . During our fiscal year 2013 annual goodwill impairment test, under the first step, we used a combination of approaches to estimate reporting units’ fair values. We believe 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.

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Based on the results of our step-one analysis, we believe that all our reporting units pass the step-one test and no further testing is required. However, because some of the inherent assumptions and estimates used in determining the fair value of these reportable segments are outside the control of management, changes in these underlying assumptions can adversely impact fair value. The sensitivity analysis below quantifies the impact of key assumptions on certain reporting units’ fair value estimates. The principal key assumptions impacting our estimates were (i) discount rates and (ii) DCF terminal value multipliers. As the discount rates ultimately reflect the risk of achieving reporting units’ revenue and cash flow projections, we determined that a separate sensitivity analysis for changes in revenue and cash flow projections is not meaningful or useful.
The estimated fair value of the Ethernet Switching & IP Routing reporting unit exceeded its carrying value by approximately $91 million and the ADP reporting unit exceeded its carrying value by approximately $15 million. The respective fair values of our remaining reporting units exceeded carrying value by significant amounts and were not subject to the sensitivity analysis presented below.
The following table summarizes the approximate impact that a change in principal key assumptions would have on the estimated fair value of the Ethernet Switching & IP Routing reporting unit, leaving all other assumptions unchanged:
 
Change
 
Approximate
Impact on Fair
Value
(In millions)
 
Excess of
Fair Value over
Carrying Value
(In millions)
Discount rate
±1%
 
$ (27) - 28
 
$ 64 - 119
DCF terminal value multiplier
±0.5x
 
$ (40) - 40
 
$ 51 - 131
The following table summarizes the approximate impact that a change in principal key assumptions would have on the estimated fair value of the ADP reporting unit, leaving all other assumptions unchanged:
 
Change
 
Approximate
Impact on Fair
Value
(In millions)
 
Excess of
Fair Value over
Carrying Value
(In millions)
Discount rate
±1%
 
$ (4) – 4
 
$ 11 – 19
DCF terminal value multiplier
±0.5x
 
$ (4) – 4
 
$ 11 – 19
Accounting for income taxes. The determination of our tax provision is subject to estimates and judgments due to operations in multiple tax jurisdictions inside and outside the United States. Sales to our international customers are principally taxed at rates that are lower than the United States statutory rates. The ability to maintain our current effective tax rate is contingent upon existing tax laws in both the United States and in the respective countries in which our international subsidiaries are located. Future changes in domestic or international tax laws could affect the continued realization of the tax benefits we are currently receiving and expect to receive from international sales. In addition, an increase in the percentage of our total revenue from international customers, or in the mix of international revenue among particular tax jurisdictions, could change our overall effective tax rate. We intend to reinvest current and remaining accumulated earnings of our foreign subsidiaries for expansion of our business operations outside the United States for an indefinite period of time. These earnings could become subject to United States federal and state income taxes and foreign withholding taxes, as applicable, should they be either deemed or actually remitted from our international subsidiaries to the United States. In addition, we evaluate the expected realization of our deferred tax assets and assess the need for a valuation allowance on a quarterly basis. As of October 26, 2013 , our net deferred tax asset balance was $ 99.6 million . We believe that sufficient positive evidence exists from historical operations and projections of U.S. taxable income in future years to conclude that it is more likely than not that we would realize our deferred tax assets, except for California deferred tax assets and capital loss carryforwards. Historical operations showed that we have cumulative profits for the prior twelve quarters ended October 26, 2013 . We only apply 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 and the character of such tax attributes. In the event future income by jurisdiction is less than what is currently projected, we may be required to apply a valuation allowance to these deferred tax assets in jurisdictions for which realization is no longer determined to be more likely than not.
Accounting for uncertain tax benefits. The calculation of tax liabilities involves significant judgment in estimating the impact of uncertainties in the application of complex tax laws. We apply a recognition threshold and measurement attribute for financial statement disclosure of tax positions taken or expected to be taken on a tax return. Recognition of a tax position is determined when it is more likely than not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation process. A tax position that meets the more-likely-than-not recognition threshold is measured at the largest amount of benefit that is greater than 50% likely of being realized upon ultimate settlement with a taxing authority. The threshold and measurement attribute requires significant judgment by management. Resolution of these uncertainties in a manner inconsistent with our expectations could have a material impact on our results of operations.

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Recent Accounting Pronouncements
For a description of recent accounting pronouncements, including the expected dates of adoption and estimated effects, if any, on our consolidated financial statements, see Note 2 , “ Summary of Significant Accounting Policies ,” of the Notes to Consolidated Financial Statements.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
In the normal course of business, we are exposed to market risks related to changes in interest rates, foreign currency exchange rates and equity prices that could impact our financial position and results of operations. Our risk management strategy with respect to these three market risks may include the use of derivative financial instruments. We use derivative contracts only to manage existing underlying exposures of the Company. Accordingly, we do not use derivative contracts for speculative purposes. Our risks and risk management strategy are outlined below. Actual gains and losses in the future may differ materially from the sensitivity analysis presented below based on changes in the timing and amount of interest rates and our actual exposures and hedges.
Interest Rate Risk
Our exposure to market risk due to changes in the general level of United States interest rates relates primarily to our cash equivalents. Our cash and cash equivalents are primarily maintained at seven major financial institutions. The primary objective of our investment activities is the preservation of principal while maximizing investment income and minimizing risk.
The Company did not have any material investments as of October 26, 2013 , that are sensitive to changes in interest rates.
Foreign Currency Exchange Rate Risk
We are exposed to foreign currency exchange rate risk inherent in conducting business globally in numerous currencies. We are 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 our operations for fiscal year 2013 were the Chinese yuan, the euro, the Japanese yen, the Indian rupee, the British pound, the Singapore dollar and the Swiss franc. As such, we benefit from a stronger U.S. dollar and may be adversely affected by a weaker U.S. dollar relative to the foreign currency. We use foreign currency forward and option contracts designated as cash flow hedges to protect against the foreign currency exchange rate risks inherent in our forecasted operating expenses denominated in currencies other than the U.S. dollar. We recognize the gains and losses on foreign currency forward contracts in the same period as the remeasurement losses and gains of the related foreign currency denominated exposures.
We also may enter into other non-designated derivatives that consist primarily of forward contracts to minimize the risk associated with the foreign exchange effects of revaluing monetary assets and liabilities. Monetary assets and liabilities denominated in foreign currencies and any associated outstanding forward contracts are marked-to-market with realized and unrealized gains and losses included in earnings.
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. As of October 26, 2013 , we held $124.1 million in cash flow derivative instruments. The maximum length of time over which we are hedged as of October 26, 2013 , is through October 8, 2014.
We have performed a sensitivity analysis as of October 26, 2013 , using a modeling technique that measures the change in the fair values arising from a hypothetical 10% adverse movement in the levels of foreign currency exchange rates relative to the U.S. dollar, with all other variables held constant. The analysis covers all of our foreign currency contracts offset by the underlying exposures. The foreign currency exchange rates we used were based on market rates in effect on October 26, 2013 . The sensitivity analysis indicated that a hypothetical 10% adverse movement in foreign currency exchange rates would not result in a material foreign exchange loss as of October 26, 2013 .

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Equity Price Risk
We had no investments in publicly traded equity securities as of October 26, 2013 . The aggregate cost of our equity investments in non-publicly traded companies was $7.7 million as of October 26, 2013 . We monitor our equity investments for impairment on a periodic basis. In the event that the carrying value of the equity investment exceeds its fair value, and we determine the decline in value to be other-than-temporary, we reduce the carrying value to its current fair value. Generally, we do not attempt to reduce or eliminate our market exposure on these equity securities. We do not purchase our equity securities with the intent to use them for speculative purposes.
Our common stock is quoted on the NASDAQ Global Select Market under the symbol “BRCD.” On October 25, 2013, the last business day of our fourth fiscal quarter of 2013 , the last reported sale price of our common stock on the NASDAQ Global Select Market was $7.83 per-share.


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Item 8.
Financial Statements and Supplementary Data
BROCADE COMMUNICATIONS SYSTEMS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 

50


Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Brocade Communications Systems, Inc.:
We have audited the accompanying consolidated balance sheets of Brocade Communications Systems, Inc. and subsidiaries (the Company) as of October 26, 2013 and October 27, 2012 , and the related consolidated statements of income, comprehensive income, cash flows, and stockholders’ equity for each of the years in the three-year period ended October 26, 2013 . In connection with our audits of the consolidated financial statements, we also have audited the accompanying financial statement schedule. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Brocade Communications Systems, Inc. and subsidiaries as of October 26, 2013 and October 27, 2012 , and the results of their operations and their cash flows for each of the years in the three-year period ended October 26, 2013 , in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of October 26, 2013 , based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated December 16, 2013 , expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

/s/    KPMG LLP

Santa Clara, California
December 16, 2013

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BROCADE COMMUNICATIONS SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF INCOME
 
Fiscal Year Ended
 
October 26, 2013
 
October 27, 2012
 
October 29, 2011
 
(In thousands, except per-share amounts)
Net revenues