XNAS:BRCD Brocade Communications Systems Inc Quarterly Report 10-Q Filing - 7/28/2012

Effective Date 7/28/2012

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended July 28, 2012
OR 
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the transition period from             to             
Commission file number: 000-25601
 
Brocade Communications Systems, Inc.
(Exact name of registrant as specified in its charter)
 
Delaware
 
77-0409517
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
130 Holger Way
San Jose, CA 95134
(408) 333-8000
(Address, including zip code, of principal
executive offices and registrant’s telephone
number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. 
Large accelerated filer
 
ý
 
Accelerated filer
 
¨
Non-accelerated filer
 
¨  (Do not check if a smaller reporting company)
 
Smaller reporting company
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes  ¨    No  ý
The number of shares outstanding of the registrant’s common stock as of August 24, 2012 was 458,695,877 shares.




BROCADE COMMUNICATIONS SYSTEMS, INC.
FORM 10-Q
QUARTER ENDED JULY 28, 2012
INDEX
 
 
Page
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 6.
 
 



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

3


PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

BROCADE COMMUNICATIONS SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited) 
 
Three Months Ended
 
Nine Months Ended
 
July 28,
2012
 
July 30,
2011
 
July 28,
2012
 
July 30,
2011
 
(In thousands, except per share amounts)
Net revenues
 
 
 
 
 
 
 
Product
$
467,281

 
$
414,298

 
$
1,399,687

 
$
1,328,821

Service
88,051

 
88,552

 
259,726

 
268,148

Total net revenues
555,332

 
502,850

 
1,659,413

 
1,596,969

Cost of revenues
 
 
 
 
 
 
 
Product
173,637

 
149,321

 
513,221

 
498,012

Service
41,217

 
47,002

 
123,863

 
142,939

Total cost of revenues
214,854

 
196,323

 
637,084

 
640,951

Gross margin
340,478

 
306,527

 
1,022,329

 
956,018

Operating expenses:
 
 
 
 
 
 
 
Research and development
90,530

 
87,320

 
272,780

 
270,669

Sales and marketing
146,378

 
153,345

 
457,921

 
462,991

General and administrative
18,612

 
16,617

 
55,752

 
53,176

Legal fees associated with indemnification obligations and other related costs, net

 

 

 
124

Amortization of intangible assets
14,737

 
15,023

 
44,467

 
46,236

Total operating expenses
270,257

 
272,305

 
830,920

 
833,196

Income from operations
70,221

 
34,222

 
191,409

 
122,822

Interest expense
(12,029
)
 
(42,066
)
 
(37,804
)
 
(84,357
)
Interest and other income (loss), net
103

 
(519
)
 
(1,345
)
 
(160
)
Income (loss) before income tax
58,295

 
(8,363
)
 
152,260

 
38,305

Income tax expense (benefit)
14,995

 
(10,300
)
 
11,080

 
(16,629
)
Net income
$
43,300

 
$
1,937

 
$
141,180

 
$
54,934

Net income per share — basic
$
0.09

 
$
0.00

 
$
0.31

 
$
0.12

Net income per share — diluted
$
0.09

 
$
0.00

 
$
0.30

 
$
0.11

Shares used in per share calculation — basic
457,147

 
483,744

 
455,727

 
474,020

Shares used in per share calculation — diluted
469,571

 
509,548

 
471,719

 
500,741

 
See accompanying notes to condensed consolidated financial statements.

4


BROCADE COMMUNICATIONS SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
July 28,
2012
 
October 29,
2011
 
(In thousands, except par value)
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
580,626

 
$
414,202

Short-term investments
808

 
774

Total cash, cash equivalents and short-term investments
581,434

 
414,976

Accounts receivable, net of allowances for doubtful accounts of $2,184 and $1,388 at July 28, 2012 and October 29, 2011, respectively
231,155

 
249,141

Inventories
74,200

 
74,172

Deferred tax assets
55,400

 
53,604

Prepaid expenses and other current assets
49,176

 
52,308

Total current assets
991,365

 
844,201

Property and equipment, net
523,405

 
532,384

Goodwill
1,626,754

 
1,630,967

Intangible assets, net
134,715

 
214,697

Non-current deferred tax assets
182,381

 
210,028

Other assets
38,904

 
42,031

Total assets
$
3,497,524

 
$
3,474,308

Liabilities and Stockholders’ Equity

 
 
Current liabilities:
 
 
 
Accounts payable
$
116,469

 
$
109,471

Accrued employee compensation
137,942

 
118,298

Deferred revenue
208,263

 
201,421

Current liabilities associated with facilities lease losses
868

 
1,456

Current portion of long-term debt
8,515

 
40,539

Other accrued liabilities
83,311

 
94,802

Total current liabilities
555,368

 
565,987

Long-term debt, net of current portion
621,206

 
748,904

Non-current liabilities associated with facilities lease losses
1,942

 
2,496

Non-current deferred revenue
71,560

 
69,024

Non-current income tax liability
46,366

 
63,593

Other non-current liabilities
9,481

 
10,166

Total liabilities
1,305,923

 
1,460,170

Commitments and contingencies (Note 8)


 


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

 

Common stock, $0.001 par value, 800,000 shares authorized:
 
 
 
Issued and outstanding: 460,903 and 448,022 shares at July 28, 2012 and October 29, 2011, respectively
461

 
448

Additional paid-in capital
2,028,305

 
1,984,830

Accumulated other comprehensive loss
(19,204
)
 
(11,996
)
Retained earnings
182,039

 
40,856

Total stockholders’ equity
2,191,601

 
2,014,138

Total liabilities and stockholders’ equity
$
3,497,524

 
$
3,474,308

See accompanying notes to condensed consolidated financial statements.

5


BROCADE COMMUNICATIONS SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
Nine Months Ended
 
July 28,
2012
 
July 30,
2011
 
(In thousands)
Cash flows from operating activities:
 
 
 
Net income
$
141,180

 
$
54,934

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Excess tax (benefits) detriments from stock-based compensation
(1,338
)
 
81

Depreciation and amortization
144,683

 
155,453

Loss on disposal of property and equipment
404

 
2,046

Amortization of debt issuance costs and original issue discount
3,767

 
11,924

Write-off of debt issuance costs and original issue discount on debt extinguishment

 
25,465

Net gains on investments
(35
)
 
(348
)
Provision for doubtful accounts receivable and sales allowances
9,533

 
8,057

Non-cash compensation expense
58,746

 
63,405

Changes in assets and liabilities:
 
 
 
Accounts receivable
8,454

 
13,802

Inventories
(2,099
)
 
(2,931
)
Prepaid expenses and other assets
2,675

 
(4,069
)
Deferred tax assets
181

 
23

Accounts payable
8,476

 
(31,874
)
Accrued employee compensation
5,554

 
(22,184
)
Deferred revenue
9,377

 
13,299

Other accrued liabilities
(8,038
)
 
(38,877
)
Liabilities associated with facilities lease losses
(1,142
)
 
(5,207
)
Net cash provided by operating activities
380,378

 
242,999

Cash flows from investing activities:
 
 
 
Purchases of short-term investments

 
(38
)
Proceeds from maturities and sale of short-term investments

 
1,604

Proceeds from sale of subsidiary
35

 

Purchases of property and equipment
(56,005
)
 
(76,661
)
Net cash used in investing activities
(55,970
)
 
(75,095
)
Cash flows from financing activities:
 
 
 
Payment of principal related to the term loan
(160,000
)
 
(309,897
)
Payment of fees related to the term loan

 
(1,090
)
Proceeds from term loan

 
198,949

Payment of principal related to capital leases
(1,389
)
 
(1,311
)
Common stock repurchases
(70,153
)
 
(10,044
)
Proceeds from issuance of common stock
76,472

 
93,333

Excess tax benefits (detriments) from stock-based compensation
1,338

 
(81
)
Net cash used in financing activities
(153,732
)
 
(30,141
)
Effect of exchange rate fluctuations on cash and cash equivalents
(4,252
)
 
812

Net increase in cash and cash equivalents
166,424

 
138,575

Cash and cash equivalents, beginning of period
414,202

 
333,984

Cash and cash equivalents, end of period
$
580,626

 
$
472,559

Supplemental disclosures of cash flow information:
 
 
 
Cash paid for interest
$
44,489

 
$
55,124

Cash paid for income taxes
$
3,189

 
$
848

See accompanying notes to condensed consolidated financial statements.

6


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

1. Basis of Presentation
Brocade Communications Systems, Inc. (“Brocade” or the “Company”) has prepared the accompanying Condensed Consolidated Financial Statements pursuant to the rules and regulations of the United States (“U.S.”) Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) have been condensed or omitted pursuant to such rules and regulations. The Condensed Consolidated Balance Sheet as of October 29, 2011 was derived from the Company’s audited consolidated financial statements, but does not include all disclosures required by U.S. GAAP. These unaudited Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended October 29, 2011.
The accompanying Condensed Consolidated Financial Statements are unaudited but, in the opinion of the Company's management, reflect all adjustments, including normal recurring adjustments, that management considers necessary for a fair presentation of these Condensed Consolidated Financial Statements. The results for the interim periods presented are not necessarily indicative of the results for the full fiscal year or any other future period.
The Company's fiscal year is a 52 or 53 week period ending on the last Saturday in October. Fiscal year 2012 is a 52-week fiscal year, and the third quarter of 2012 was a 13-week quarter. Fiscal year 2011 was a 52-week year, and the third quarter of 2011 was a 13-week quarter.
The Condensed Consolidated Financial Statements include the accounts of Brocade and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
Use of Estimates in Preparation of Condensed Consolidated Financial Statements
The preparation of condensed consolidated financial statements and related disclosures in conformity with U.S. GAAP requires management to make estimates and judgments that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Estimates are used for, but not limited to, revenue recognition, sales allowances and programs, allowance for doubtful accounts, stock-based compensation, purchase price allocations, warranty obligations, inventory valuation and purchase commitments, restructuring costs, commissions, facilities lease losses, impairment of goodwill and intangible assets, litigation, income taxes and investments. Actual results may differ materially from these estimates.

2. Summary of Significant Accounting Policies
There have been no material changes in the Company’s significant accounting policies for the nine months ended July 28, 2012 as compared to the significant accounting policies disclosed in Brocade’s Annual Report on Form 10-K for the fiscal year ended October 29, 2011.
Recent Accounting Pronouncements
There have been no new accounting pronouncements during the nine months ended July 28, 2012, as compared to the recent accounting pronouncements disclosed in Brocade’s Annual Report on Form 10-K for the fiscal year ended October 29, 2011, that are expected to have a material impact on the Company's financial position, results of operations, cash flows or disclosure requirements.
Concentrations
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash, cash equivalents, short-term investments and accounts receivable. The Company’s cash, cash equivalents and short-term investments are primarily maintained at five major financial institutions. Deposits held with banks may be redeemed upon demand and may exceed the amount of insurance provided on such deposits.

7


A majority of the Company’s accounts receivable balance is derived from sales to original equipment manufacturer (“OEM”) partners in the computer storage and server industry. As of July 28, 2012, three customers accounted for 17%, 15% and 15%, respectively, of total accounts receivable, for a combined total of 47% of total accounts receivable. As of October 29, 2011, two customers accounted for 16% and 14%, respectively, of total accounts receivable, for a combined total of 30% of total accounts receivable. The Company performs ongoing credit evaluations of its customers and generally does not require collateral on accounts receivable balances. The Company has established reserves for credit losses, sales allowances, and other allowances.
For the three months ended July 28, 2012, four customers accounted for 16%, 16%, 13% and 10%, respectively, of the Company’s total net revenues for a combined total of 55% of total net revenues. For the three months ended July 30, 2011, three customers accounted for 16%, 12% and 15%, respectively, of the Company’s total net revenues for a combined total of 43% of total net revenues.
The Company currently relies on single and limited sources for multiple key components used in the manufacture of its products. Additionally, the Company relies on contract manufacturers (“CMs”) for the manufacturing of its products. Although the Company uses standard parts and components for its products where possible, the Company’s CMs currently purchase, on the Company's behalf, several key product components from single or limited supplier sources.

3. Goodwill and Intangible Assets
The following table summarizes goodwill activity by reportable segment for the nine months ended July 28, 2012 (in thousands):
 
Data Storage Products
 
Ethernet Products
 
Global Services
 
Total
Balance at October 29, 2011
 
 
 
 
 
 
 
Goodwill
$
176,968

 
$
1,344,415

 
$
155,416

 
$
1,676,799

Accumulated impairment losses

 
(45,832
)
 

 
(45,832
)
 
176,968

 
1,298,583

 
155,416

 
1,630,967

Tax and other adjustments during the nine months ended July 28, 2012 (1)
(8
)
 
(4,205
)
 

 
(4,213
)
Balance at July 28, 2012
 
 
 
 
 
 
 
Goodwill
176,960

 
1,340,210

 
155,416

 
1,672,586

Accumulated impairment losses

 
(45,832
)
 

 
(45,832
)
 
$
176,960

 
$
1,294,378

 
$
155,416

 
$
1,626,754

 
(1)
The goodwill adjustments during the nine months ended July 28, 2012 were primarily a result of tax benefits from the exercise of stock awards of acquired companies.
The Company conducts its goodwill impairment test annually, as of the first day of the second fiscal quarter, and whenever events or changes in facts and circumstances indicate that the fair value of the reporting unit may be less than its carrying amount. For the annual goodwill impairment test, the Company uses the income approach, the market approach, or a combination thereof, to determine each reporting unit’s fair value. The income approach provides an estimate of fair value based on discounted expected future cash flows (“DCF”). The market approach provides an estimate of fair value using various prices or market multiples applied to the reporting unit’s operating results and then applying an appropriate control premium. For the fiscal year 2012 annual goodwill impairment test, the Company used a combination of approaches to estimate each reporting unit’s fair value. The Company believed that at the time of impairment testing performed in the second fiscal quarter of 2012, the income approach and the market approach were equally representative of a reporting unit’s fair value.

8


Determining the fair value of a reporting unit or an intangible asset requires judgment and involves the use of significant estimates and assumptions. The Company based its fair value estimates on assumptions it believes to be reasonable, but inherently uncertain. Estimates and assumptions with respect to the determination of the fair value of its reporting units using the income approach include, among other inputs:
The Company’s operating forecasts;
Revenue growth rates; and
Risk-commensurate discount rates and costs of capital.
The Company’s estimates of revenues and costs are based on historical data, various internal estimates and a variety of external sources, and are developed as part of our regular long-range planning process. The control premium used in market or combined approaches is determined by considering control premiums offered as part of the acquisitions that have occurred in the reporting units’ comparable market segments. Based on the results of the annual goodwill impairment analysis performed during the second fiscal quarter of 2012, the Company determined that no impairment needed to be recorded. During the three months ended July 28, 2012, there were no facts and circumstances that indicated that the fair value of the reporting units may be less than their current carrying amount.
Intangible assets other than goodwill are amortized on a straight-line basis over the following estimated remaining useful lives, unless the Company has determined these lives to be indefinite. The following tables present details of the Company’s intangible assets (in thousands, except for weighted-average remaining useful life):
July 28, 2012
Gross
Carrying
Value
 
Accumulated
Amortization
 
Net
Carrying
Value
 
Weighted-
Average
Remaining
Useful Life
(in years)
Trade name
$
10,441

 
$
10,434

 
$
7

 
0.42

Core/developed technology
337,858

 
281,370

 
56,488

 
1.22

Customer relationships
352,581

 
274,361

 
78,220

 
1.28

Total intangible assets
$
700,880

 
$
566,165

 
$
134,715

 
1.25

 
 
 
 
 
 
 
 
October 29, 2011
Gross
Carrying
Value
 
Accumulated
Amortization
 
Net
Carrying
Value
 
Weighted-
Average
Remaining
Useful Life
(in years)
Trade name
$
10,441

 
$
10,422

 
$
19

 
1.17

Core/developed technology
337,858

 
245,855

 
92,003

 
2.04

Customer relationships
352,581

 
229,906

 
122,675

 
2.12

Total intangible assets
$
700,880

 
$
486,183

 
$
214,697

 
2.08

The following table presents the amortization of intangible assets included on the Condensed Consolidated Statements of Income (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
July 28, 2012
 
July 30, 2011
 
July 28, 2012
 
July 30, 2011
Cost of revenues
$
10,713

 
$
14,466

 
$
35,516

 
$
43,399

Operating expenses
14,737

 
15,023

 
44,467

 
46,236

Total
$
25,450

 
$
29,489

 
$
79,983

 
$
89,635



9


The following table presents the estimated future amortization of intangible assets as of July 28, 2012 (in thousands):
Fiscal Year
Estimated
Future
Amortization
2012 (remaining three months)
$
25,450

2013
93,109

2014
16,156

Total
$
134,715


4. Balance Sheet Details
The following table provides details of selected balance sheet items (in thousands):
 
July 28,
2012
 
October 29,
2011
Inventories:
 
 
 
Raw materials
$
21,501

 
$
25,535

Finished goods
52,699

 
48,637

Total
$
74,200

 
$
74,172

 
July 28,
2012
 
October 29,
2011
Property and equipment, net:
 
 
 
Computer equipment and software
$
56,419

 
$
55,175

Engineering and other equipment
395,185

 
357,827

Furniture and fixtures (1)
30,147

 
29,195

Leasehold improvements
25,731

 
23,793

Land and building (2)
384,666

 
384,666

Subtotal
892,148

 
850,656

Less: Accumulated depreciation and amortization (1), (3)
(368,743
)
 
(318,272
)
Total
$
523,405

 
$
532,384

 
(1)     Furniture and fixtures and accumulated depreciation and amortization include the following amounts under leases as of July 28, 2012 and October 29, 2011 (in thousands):
 
July 28,
2012
 
October 29,
2011
Cost
$
10,613

 
$
10,613

Accumulated depreciation
(3,268
)
 
(2,131
)
Total
$
7,345

 
$
8,482

 
(2)    In connection with the purchase of the property located in San Jose, California, the Company obtained a four-year option to purchase a fourth unimproved approximate four acre parcel for a fixed price of approximately $26.0 million as well as a right of first offer to purchase this parcel. The Company elected to not exercise the option and it terminated in November 2011. As of July 28, 2012, the Company retained the right of first offer.

10



(3)    The following table presents the depreciation of property and equipment included on the Condensed Consolidated Statements of Income (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
July 28,
2012
 
July 30,
2011
 
July 28,
2012
 
July 30,
2011
Depreciation expense
$
21,709

 
$
21,731

 
$
64,700

 
$
65,817


5. Fair Value Measurements
The Company applies fair value measurements for both financial and nonfinancial assets and liabilities. The Company has no nonfinancial assets and liabilities that are required to be measured at fair value on a recurring basis as of July 28, 2012.
The fair value accounting guidance permits companies to elect fair value measurement for many financial instruments and certain other items that are otherwise not required to be accounted for at fair value. The Company did not elect to measure any eligible financial instruments or other assets at fair value as of July 28, 2012 and October 29, 2011.
Fair Value Hierarchy
The Company utilizes a fair value hierarchy that maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. A financial instrument’s categorization within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
Assets and liabilities measured and recorded at fair value on a recurring basis as of July 28, 2012 were as follows (in thousands):
 
 
 
Fair Value Measurements Using
 
 Balance as of
 July 28, 2012
 
Quoted Prices in
Active Markets
For Identical
Instruments
(Level 1)
 
Significant  Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets:
 
 
 
 
 
 
 
Money market funds (1)
$
238,940

 
$
238,940

 
$

 
$

Corporate bonds
808

 

 
808

 

Derivative assets
272

 

 
272

 

Total assets measured at fair value
$
240,020

 
$
238,940

 
$
1,080

 
$

Liabilities:
 
 
 
 
 
 
 
Derivative liabilities
$
4,485

 
$

 
$
4,485

 
$

Total liabilities measured at fair value
$
4,485

 
$

 
$
4,485

 
$

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

11


Assets and liabilities measured and recorded at fair value on a recurring basis as of October 29, 2011 were as follows (in thousands):
 
 
 
Fair Value Measurements Using
 
 Balance as of
 October 29, 2011
 
Quoted Prices in
Active Markets
For Identical
Instruments
(Level 1)
 
Significant  Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets:
 
 
 
 
 
 
 
Money market funds (1)
$
138,959

 
$
138,959

 
$

 
$

Corporate bonds
774

 

 
774

 

Derivative assets
1,368

 

 
1,368

 

Total assets measured at fair value
$
141,101

 
$
138,959

 
$
2,142

 
$

Liabilities:
 
 
 
 
 
 
 
Derivative liabilities
$
1,790

 
$

 
$
1,790

 
$

Total liabilities measured at fair value
$
1,790

 
$

 
$
1,790

 
$

 
(1)
Money market funds are reported within “Cash and cash equivalents” on the Condensed Consolidated Balance Sheets.
During the nine months ended July 28, 2012, the Company had no transfers between levels of the fair value hierarchy of its assets measured at fair value.

6. Liabilities Associated with Facilities Lease Losses
The Company reevaluates its estimates and assumptions on a quarterly basis and makes adjustments to the reserve balance if necessary. The following table summarizes the activity related to the facilities lease loss reserve, net of expected sublease income (in thousands):
 
Lease Loss
Reserve
Reserve balance at October 29, 2011
$
3,952

Cash payments on facilities leases
(1,142
)
Reserve balance at July 28, 2012
$
2,810


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


12


7. Borrowings
The following table provides details of the Company's long-term debt (in thousands):
 
 
 
 
 
 
 
July 28, 2012
 
October 29, 2011
 
 
Maturity
 
Stated Annual Interest Rate
 
Amount

 
Effective Interest Rate
 
Amount

 
Effective Interest Rate
Senior Secured Notes:
 
 
 
 
 
 
 
 
 
 
 
 
 
2018 Notes
 
2018
 
 
6.625
%
 
$
300,000

 
7.05
%
 
$
300,000

 
7.05
%
2020 Notes
 
2020
 
 
6.875
%
 
300,000

 
7.26
%
 
300,000

 
7.26
%
Senior Secured Credit Facility:
 
 
 
 
 
 
 
 
 
 
 
 
 
Term loan
 
2014
 
LIBOR+
2.25
%
 
30,000

 
12.64
%
 
190,000

 
4.41
%
Capital lease obligations
 
2015
 
 
5.80
%
 
5,392

 
5.80
%
 
6,782

 
5.80
%
Total long-term debt
 
 
 
 
 
 
635,392

 
 
 
796,782

 
 
Less:
 
 
 
 
 
 
 
 
 
 
 
 
 
Unamortized discount
 
 
 
 
 
 
5,671

 
 
 
7,339

 
 
Current portion of long-term debt
 
 
 
 
 
 
8,515

 
 
 
40,539

 
 
Total long-term debt, net of current portion
 
 
 
 
 
 
$
621,206

 
 
 
$
748,904

 
 

Senior Secured Notes
In January 2010, the Company issued $300 million in aggregate principal amount of senior secured notes due 2018 (the “2018 Notes”) and $300 million in aggregate principal amount of senior secured notes due 2020 (the “2020 Notes" and together with the 2018 Notes, the “Senior Secured Notes”). The senior secured notes bear interest payable semi-annually. No payments were made towards the principal of the senior secured notes during the nine months ended July 28, 2012.
As of July 28, 2012 and October 29, 2011, the fair value of the Company’s senior secured notes was approximately $642 million and $626 million, respectively, estimated based on broker trading prices.
On or after January 2013, the Company may redeem all or a part of the 2018 Notes at the redemption prices set forth in the Indenture governing the 2018 Notes (the 2018 Indenture), plus accrued and unpaid interest and special interest, if any, to the applicable redemption date. In addition, at any time prior to January 2013, the Company may, on one or more than one occasion, redeem some or all of the 2018 Notes at any time at a redemption price equal to 100% of the principal amount of the 2018 Notes redeemed, plus a “make-whole” premium determined as of, and accrued and unpaid interest and special interest, if any, to, the applicable redemption date. On or after January 2015, the Company may redeem all or a part of the 2020 Notes at the redemption prices set forth in the Indenture governing the 2020 Notes (the 2020 Indenture), plus accrued and unpaid interest and special interest, if any, to the applicable redemption date. In addition, at any time prior to January 2015, the Company may, on one or more than one occasion, redeem some or all of the 2020 Notes at any time at a redemption price equal to 100% of the principal amount of the 2020 Notes redeemed, plus a “make-whole” premium determined as of, and accrued and unpaid interest and special interest, if any, to the applicable redemption date. At any time prior to January 2013, the Company may also redeem up to 35% of the aggregate principal amount of the 2018 Notes and 2020 Notes, using the proceeds of certain qualified equity offerings, at the redemption prices set forth in the 2018 Indenture and the 2020 Indenture, respectively.
If the Company experiences specified change of control triggering events, it must offer to repurchase the senior secured notes at a repurchase price equal to 101% of the principal amount of the senior secured notes repurchased, plus accrued and unpaid interest and special interest, if any, to the applicable repurchase date. If the Company or its subsidiaries sell assets under certain specified circumstances, the Company must offer to repurchase the senior secured notes at a repurchase price equal to 100% of the principal amount of the senior secured notes repurchased, plus accrued and unpaid interest and special interest, if any, to the applicable repurchase date.

13



Senior Secured Credit Facility
In October 2008, the Company entered into a credit facility agreement for (i) a five-year $1,100 million term loan facility and (ii) a five-year $125 million revolving credit facility, which includes a $25 million swing line loan sub-facility and a $25 million letter of credit sub-facility. The credit facility agreement was subsequently amended in January 2010 and June 2011. In accordance with the applicable accounting guidance for debt modification and extinguishment, the Company expensed $25.5 million of debt issuance costs and original issue discount relating to the portion of the term loan that was extinguished by the June 2011 amendment. This expense was reported within “Interest expense” in the Condensed Consolidated Statements of Income for the three and nine months ended July 30, 2011.
The Company may draw additional proceeds from the revolving credit facility in the future for ongoing working capital and other general corporate purposes. The term loan facility and revolving credit facility are referred to together as the “Senior Secured Credit Facility.” There were no principal amounts outstanding under the revolving credit facility as of July 28, 2012 and October 29, 2011.
During the nine months ended July 28, 2012, the Company paid $160.0 million towards the principal of the term loan, $142.6 million of which were voluntary prepayments.
The Company believes that the carrying value of its Senior Secured Credit Facility approximates its fair value as the interest rate is based on a floating market rate.
Debt Maturities
Fiscal Year
Estimated
Future
Maturities
2012 (remaining three months)
$
2,349

2013
9,477

2014
22,720

2015
846

2016

Thereafter
600,000

Total
$
635,392



8. Commitments and Contingencies
Product Warranties
The Company’s accrued liability for estimated future warranty costs is included in “Other accrued liabilities” in the accompanying Condensed Consolidated Balance Sheets. The following table summarizes the activity related to the Company’s accrued liability for estimated future warranty costs during the nine months ended July 28, 2012 and July 30, 2011 (in thousands):
 
Accrued Warranty
 
Nine Months Ended
 
July 28,
2012
 
July 30,
2011
Beginning balance
$
11,298

 
$
5,980

Liabilities accrued for warranties issued during the period
5,827

 
4,501

Warranty claims paid and used during the period
(1,095
)
 
(1,093
)
Changes in liability for pre-existing warranties during the period
(1,652
)
 
(1,444
)
Ending balance
$
14,378

 
$
7,944


14


In addition, the Company has standard indemnification clauses contained within its various customer contracts. As such, the Company indemnifies the parties to whom it sells its products with respect to the Company’s product, alone or potentially in combination with others, infringing upon any patents, trademarks, copyrights, or trade secrets, as well as against bodily injury or damage to real or tangible personal property caused by a defective Company product. As of July 28, 2012, there have been no known events or circumstances that have resulted in a material customer contract-related indemnification liability to the Company.
Manufacturing and Purchase Commitments
Brocade has manufacturing arrangements with CMs under which Brocade provides twelve-month product forecasts and places purchase orders in advance of the scheduled delivery of products to Brocade’s customers. The required lead time for placing orders with the CMs depends on the specific product. Brocade issues purchase orders and the CMs then generate invoices based on prices and payment terms mutually agreed upon and set forth in those purchase orders. Although the purchase orders Brocade places with its CMs are cancellable, the terms of the agreements require Brocade to purchase all inventory components not returnable, usable by, or sold to other customers of the CMs.
As of July 28, 2012, the Company’s aggregate commitment to the CMs for inventory components used in the manufacture of Brocade products was $223.5 million, which the Company expects to utilize during future normal ongoing operations, net of a purchase commitments reserve of $4.7 million. The Company’s purchase commitments reserve reflects the Company’s estimate of purchase commitments it does not expect to consume in normal ongoing operations within the next twelve months.
Income Taxes
The Company has several ongoing income tax audits. For additional discussions, see Note 11, “Income Taxes,” of the Notes to Condensed Consolidated Financial Statements. The Company believes it has adequate reserves for all open tax years.

Legal Proceedings

Stockholder Litigation

In March 2012, a stockholder filed a complaint in Santa Clara County Superior Court captioned Stephen Knee vs. Brocade Communications Systems, Inc., et al. alleging that the proposal in Brocade’s proxy for its 2012 annual meeting of stockholders seeking additional shares for the 2009 Stock Plan pool was misleading and incomplete; the plaintiff claimed the right to enjoin the stockholders’ vote. In early April 2012, the plaintiff filed a motion for preliminary injunction seeking to enjoin the stockholders’ vote on the proposal. Brocade filed an opposition to the plaintiff’s motion for preliminary injunction. On April 10, 2012, the Court held a hearing and issued an order granting the plaintiff’s motion. On April 12, 2012, the Court entered a stipulation and order regarding settlement in which Brocade agreed to postpone the vote on the proposal at least seven days and to issue supplemental disclosures regarding the proposal. The supplemental disclosures were filed with the SEC on April 12, 2012. Brocade’s stockholders approved the proposal on April 20, 2012. On July 26, 2012, the parties signed a Stipulation of Settlement regarding the matter. On August 10, 2012, plaintiff filed a Motion for Preliminary Approval of Settlement. The Preliminary Approval of Settlement Hearing is currently scheduled for September 28, 2012.

Intellectual Property Litigation
On June 21, 2005, Enterasys Networks, Inc. (“Enterasys”) filed a lawsuit against Foundry Networks, LLC (formerly Foundry Networks, Inc.) (“Foundry”) (and Extreme Networks, Inc.) in the United States District Court for the District of Massachusetts alleging that certain of Foundry’s products infringe six of Enterasys’ patents and seeking injunctive relief, as well as unspecified damages. The Court severed the claims against Extreme from the claims against Foundry for trial, and Enterasys subsequently added Brocade as a defendant. On August 28, 2007, the Court granted Foundry’s motion to stay the case based on petitions that Foundry had filed with the United States Patent and Trademark Office (“USPTO”) in 2007 for reexamination of five of the six Enterasys patents. Two of the patents received final rejections during their respective reexaminations, in which the USPTO held that the claims were invalid. Enterasys filed appeals of those rejections with the USPTO’s Board of Patent Appeals and Interferences in 2009. The USPTO’s Board affirmed one, and partially affirmed and partially reversed the other of those two rejections on January 24, 2011, and Enterasys did not appeal further, which ended the proceedings on those two patents. The USPTO has issued reexamination certificates for the remaining three patents undergoing reexamination indicating that the patents were valid over the references that had been submitted. Meanwhile, on May 21, 2010, the Court lifted the stay of the litigation, and Enterasys subsequently dropped from the litigation the two patents it appealed at the USPTO. Accordingly, four patents remain at issue in the litigation. No trial date has been set.

15


On September 6, 2006, Chrimar Systems, Inc. (“Chrimar”) filed a lawsuit against Foundry (and D-Link Corporation and PowerDsine, Ltd.) in the United States District Court for the Eastern District of Michigan alleging that certain of Foundry’s products infringe Chrimar’s U.S. Patent 5,406,260 and seeking injunctive relief, as well as unspecified damages. Discovery has been completed. On June 1, 2012, Brocade filed its second Supplemental Statement of Material Facts In Support of Motion for Summary Judgment of Invalidity of Paradigm Claim 17 of the 5,406,260 patent. On August 1, 2012, the Court issued its Memorandum and Order Granting Defendant’s Motion for Summary Judgment of Invalidity and dismissed the case.
On August 4, 2010, Brocade and Foundry (“Plaintiffs”) filed a lawsuit against A10 Networks, Inc. (“A10”), A10’s founder and other individuals in the United States District Court for the Northern District of California. On October 29, 2010, Plaintiffs filed an amended complaint. In the amended complaint, Brocade alleged that A10 and the individual defendants have misappropriated Plaintiff’s trade secrets, infringed copyrighted works, interfered with existing contracts between the Plaintiffs and their employees, breached contracts, breached their fiduciary duties and duties of loyalty, and that certain of A10’s products infringe 13 of Brocade’s patents. Brocade is seeking injunctive relief, as well as monetary damages. On May 16, 2011, A10 filed an answer and counterclaim alleging that certain of Brocade’s products infringe a patent recently acquired by A10 and seeking injunctive relief, as well as unspecified damages. In addition, A10 filed petitions with the USPTO to have each of 13 of the patents reexamined, in view of prior art that A10 alleges invalidates the patents. The petitions were granted, and reexaminations of the patents are in progress. On January 6, 2012, the Court granted Brocade’s summary judgment motion of non-infringement of the A10 patent. Trial on Brocade’s claims against A10 and the individual defendants commenced on July 16, 2012. On August 6, 2012, the jury found A10 responsible for intellectual property infringement and unfair competition, awarding approximately $112 million to Brocade. On August 7, 2012, A10 issued a press release that reflects a different interpretation of the jury verdict. A10 has stated that it will take appropriate action to set aside the verdict and reverse the award of damages. A10 also stated that it intends to seek judgment in its favor as a matter of law. On August 27, 2012, the Court entered a judgment without commenting on the differing interpretations of the jury verdict or any post-trial motions. Brocade expects that the Court will address post-trial motions in the coming months. The outcome of such motions cannot be predicted with any certainty.
On September 9, 2011, A10 filed a lawsuit against Brocade in the United States District Court for the Northern District of California. A10 alleged that certain of Brocade’s products infringed two patents acquired by A10. After Brocade moved to dismiss the complaint, A10 dismissed one of its patents-in-suit, leaving only one patent at issue. In lieu of answering the complaint, Brocade filed a new motion to dismiss the complaint, which was granted. On June 27, 2012, the Court entered a Final Judgment dismissing A10’s action. On June 28, 2012, A10 filed a notice of its intent to appeal.

General
From time to time, the Company is subject to other legal proceedings and claims in the ordinary course of business, including claims of alleged infringement of trademarks, copyrights, patents and/or other intellectual property rights and commercial contract disputes. Third parties assert patent infringement claims against the Company from time to time in the form of letters, lawsuits and other forms of communication. In addition, from time to time, the Company receives notification from customers claiming that they are entitled to indemnification or other obligations from the Company related to infringement claims made against them by third parties. Litigation, even if the Company is ultimately successful, can be costly and divert management’s attention away from the day-to-day operations of the Company.
On a quarterly basis, the Company reviews relevant information with respect to litigation contingencies and updates its accruals, disclosures and, when possible, estimates of reasonably possible losses or ranges of loss based on such reviews. However, litigation is inherently unpredictable, and outcomes are typically uncertain, and the Company’s past experience does not provide any additional visibility or predictability to estimate the range of loss that may occur because the costs, outcome and status of these types of claims and proceedings have varied significantly in the past. The Company is not currently able to reasonably estimate the possible loss or range of loss from the above legal proceedings where the Company is the defendant and, accordingly, the Company is unable to estimate the effects of the above on its financial condition, results of operations or cash flows.
The Company records a liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated.



16


9. Derivative Instruments and Hedging Activities
In the normal course of business, the Company is exposed to fluctuations in interest rates and the exchange rates associated with foreign currencies. The Company’s primary objective for holding derivative financial instruments is to manage foreign currency exchange rate risk. The Company currently does not enter into derivative instruments to manage credit risk. However, the Company manages its exposure to credit risk through its investment policies. The Company generally enters into derivative transactions with high-credit quality counterparties and, by policy, limits the amount of credit exposure to any one counterparty based on its analysis of that counterparty’s relative credit standing.
The amounts subject to credit risk related to derivative instruments are generally limited to the amounts, if any, by which counterparty’s obligations exceed the Company’s obligations with that counterparty.
Foreign Currency Exchange Rate Risk
A majority of the Company’s revenue, expense and capital purchasing activities is transacted in U.S. dollars. However, the Company is exposed to foreign currency exchange rate risk inherent in conducting business globally in numerous currencies. The Company is primarily exposed to foreign currency fluctuations related to operating expenses denominated in currencies other than the U.S. dollar, of which the most significant to its operations for the nine months ended July 28, 2012 were the Chinese yuan, the euro, the Japanese yen, the Indian rupee, the British pound, the Singapore dollar and the Swiss franc. The Company has established a foreign currency risk management program to protect against the volatility of future cash flows caused by changes in foreign currency exchange rates. This program reduces, but does not always entirely eliminate, the impact of foreign currency exchange rate movements. The Company’s foreign currency risk management program includes foreign currency derivatives with cash flow hedge accounting designation that utilizes foreign currency forward and option contracts to hedge exposures to the variability in the U.S. dollar equivalent of anticipated non-U.S. dollar-denominated cash flows. These instruments generally have a maturity of less than one year. For these derivatives, the Company reports the after-tax gain or loss from the effective portion of the hedge as a component of accumulated other comprehensive loss in stockholders’ equity and reclassifies it into earnings in the same period in which the hedged transaction affects earnings. Net gains (losses) relating to the effective portion of foreign currency derivatives recorded in the condensed consolidated statements of income are as follows (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
July 28, 2012
 
July 30, 2011
 
July 28, 2012
 
July 30, 2011
Cost of revenues
$
(278
)
 
$
311

 
$
(690
)
 
$
597

Research and development
(410
)
 
96

 
(756
)
 
282

Sales and marketing
(1,551
)
 
1,817

 
(3,935
)
 
3,740

General and administrative
(113
)
 
167

 
(278
)
 
297

Total
$
(2,352
)
 
$
2,391

 
$
(5,659
)
 
$
4,916

The net foreign currency exchange gains and losses recorded as part of “Interest and other income (loss), net” were losses of $0.2 million and $1.6 million for the three and nine months ended July 28, 2012, respectively, and losses of $0.9 million and $0.4 million for the three and nine months ended July 30, 2011, respectively.
Gross unrealized loss positions are recorded within “Other accrued liabilities” and “Other non-current liabilities,” and gross unrealized gain positions are recorded within “Prepaid expenses and other current assets.” As of July 28, 2012, the Company had gross unrealized loss positions of $4.5 million and gross unrealized gain positions of $0.3 million included in “Other accrued liabilities” and “Prepaid expenses and other current assets,” respectively. Effective cash flow hedges are reported as a component of accumulated other comprehensive loss. Ineffective cash flow hedges are included in the Company’s net income as part of “Interest and other income (loss), net.” The amount recorded on ineffective cash flow hedges was not significant.

17


Volume of Derivative Activity
Total gross notional amounts, presented by currency, are as follows (in thousands):
 
Derivatives Designated
as Hedging Instruments
 
Derivatives Not Designated
as Hedging Instruments
In United States Dollars
    As of July 28, 2012
 
As of October 29, 2011
 
    As of July 28, 2012
 
As of October 29, 2011
Euro
$
28,993

 
$
57,935

 
$

 
$

British pound
14,758

 
25,282

 

 

Indian rupee
12,474

 

 

 

Singapore dollar
9,336

 
16,136

 

 

Japanese yen
7,942

 
17,957

 

 

Swiss franc
5,412

 
13,060

 
2,787

 
5,012

Total
$
78,915

 
$
130,370

 
$
2,787

 
$
5,012


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

10. Stock-Based Compensation
Stock-based compensation expense, net of estimated forfeitures, was included in the following line items of the Condensed Consolidated Statements of Income as follows (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
July 28, 2012
 
July 30, 2011
 
July 28, 2012
 
July 30, 2011
Cost of revenues
$
3,074

 
$
4,235

 
$
12,045

 
$
11,262

Research and development
3,110

 
5,581

 
13,741

 
14,975

Sales and marketing
4,483

 
8,670

 
24,946

 
27,081

General and administrative
2,402

 
2,483

 
8,014

 
10,087

Total stock-based compensation
$
13,069

 
$
20,969

 
$
58,746

 
$
63,405

 
The following table presents stock-based compensation expense, net of estimated forfeitures, by grant type (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
July 28, 2012
 
July 30, 2011
 
July 28, 2012
 
July 30, 2011
Stock options, including variable options
$
169

 
$
563

 
$
899

 
$
3,211

Restricted stock awards and restricted stock units (“RSUs”)
7,720

 
15,253

 
44,441

 
40,636

Employee stock purchase plan (“ESPP”)
5,180

 
5,153

 
13,406

 
19,558

Total stock-based compensation
$
13,069

 
$
20,969

 
$
58,746

 
$
63,405


18


The following table presents unrecognized compensation expense, net of estimated forfeitures, of the Company’s equity compensation plans as of July 28, 2012, which is expected to be recognized over the following weighted-average periods (in thousands, except for weighted-average period):
 
Unrecognized
Compensation
Expense
 
Weighted-
Average Period
(in years)
Stock options
$
956

 
0.65

RSUs
$
90,291

 
2.26

ESPP
$
22,630

 
1.26


The following table presents details on grants made by the Company for the following periods:
 
Nine Months Ended
 
Nine Months Ended
 
July 28, 2012
 
July 30, 2011
 
Granted
(in  thousands)
 
Weighted-Average
Grant Date  Fair Value
 
Granted
(in  thousands)
 
Weighted-Average
Grant Date  Fair Value
Stock options
160

 
$
2.39

 
243

 
$
2.23

RSUs
8,582

 
$
4.84

 
9,185

 
$
6.12

The total intrinsic value of stock options exercised for the nine months ended July 28, 2012 and July 30, 2011 was $23.1 million and $44.3 million, respectively.
11. Income Taxes
In general, the Company’s provision for income taxes differs from the tax computed at the U.S. federal statutory income tax rate due to state taxes, the effect of non-U.S. operations, non-deductible stock-based compensation expense and adjustments to unrecognized tax benefits.
For the three and nine months ended July 28, 2012, the Company recorded an income tax expense of $15.0 million and $11.1 million, respectively. The tax reported for both periods was impacted by the net effect of a decrease in benefit from the federal research and development tax credit which expired on December 31, 2011, partially offset by discrete benefits from reserve releases of settled tax audits, and the expiration of certain statutes of limitations.
For the three and nine months ended July 30, 2011, the Company recorded an income tax benefit of $10.3 million and $16.6 million, respectively, primarily as a result of discrete benefits from the retroactive reinstatement of the federal research and development tax credit provision and reserve releases of settled tax audits, and the expiration of certain statutes of limitations.
The total amount of unrecognized tax benefits of $103.2 million as of July 28, 2012 would affect the Company’s effective tax rate, if recognized. Although the timing of the closure of audits is highly uncertain, it is reasonably possible that the balance of unrecognized tax benefits could significantly change during the remainder of fiscal year 2012.
The Internal Revenue Service (“IRS”) and other tax authorities regularly examine the Company’s income tax returns. The IRS is currently examining fiscal years 2009 and 2010. In addition, the IRS has also examined the Company’s income tax returns for fiscal years 2007 and 2008 and is contesting the Company’s transfer pricing for the cost sharing and buy-in arrangements with its foreign subsidiaries. The Company has filed a protest to appeal the amount of proposed adjustments in the Revenue Agent’s Report with the Appeals Office of the IRS. The Company believes it has sufficient reserves recorded for the ultimate settlement amount on this issue. Furthermore, the Company is in discussion with foreign tax authorities to obtain correlative relief on transfer pricing adjustments settled with the IRS. We believe that our reserves for unrecognized tax benefits are adequate for all open tax years. The timing of the resolution of income tax examinations, as well as the amounts and timing of related settlements, is highly uncertain. The Company believes that before the end of fiscal year 2012, 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. As such, after we reach settlement with the tax authorities, we expect to record a corresponding adjustment to our unrecognized tax benefits. Given the uncertainty as to settlement terms, the timing of payments and the impact of such settlements on other uncertain tax positions, the range of estimated potential decreases in underlying uncertain tax positions is between $0 and $23 million in the next twelve months.

19


The Company believes that sufficient positive evidence exists from historical operations and projections of taxable income in future years to conclude that it is more likely than not that the Company will realize its deferred tax assets. Accordingly, the Company applies a valuation allowance only on the deferred tax assets relating to capital loss carryforwards, due to limited carryforward periods and the character of such tax attributes. The Governor of the State of California and the California state legislature have introduced tax proposals affecting future state income tax apportionment that may have a significant impact on our ability to realize certain California deferred tax assets. We will reevaluate the realization of these California deferred tax assets if and when the current law changes.

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

Brocade is organized into four operating segments. Two of the operating segments, Data Storage Products and Global Services are individually reportable segments. The other two operating segments, Ethernet Switching & Internet Protocol (“IP”) Routing and Application Delivery Products (“ADP”), combine to form a third reportable segment: Ethernet Products. These segments are organized principally by product category.
Financial decisions and the allocation of resources are based on the information from the Company’s internal management reporting system. The Company does not track its assets by operating segments. The majority of the Company’s assets as of July 28, 2012 were attributable to its United States operations.
Summarized financial information by reportable segment for the three and nine months ended July 28, 2012 and July 30, 2011, based on the internal management reporting system, is as follows (in thousands):
 
Data Storage Products
 
Ethernet Products
 
Global Services
 
Total
Three months ended July 28, 2012
 
 
 
 
 
 
 
Net revenues
$
321,464

 
$
145,817

 
$
88,051

 
$
555,332

Cost of revenues
87,113

 
86,524

 
41,217

 
214,854

Gross margin
$
234,351

 
$
59,293

 
$
46,834

 
$
340,478

Three months ended July 30, 2011
 
 
 
 
 
 
 
Net revenues
$
275,391

 
$
138,907

 
$
88,552

 
$
502,850

Cost of revenues
69,219

 
80,102

 
47,002

 
196,323

Gross margin
$
206,172

 
$
58,805

 
$
41,550

 
$
306,527

Nine months ended July 28, 2012
 
 
 
 
 
 
 
Net revenues
$
1,017,258

 
$
382,429

 
$
259,726

 
$
1,659,413

Cost of revenues
273,308

 
239,913

 
123,863

 
637,084

Gross margin
$
743,950

 
$
142,516

 
$
135,863

 
$
1,022,329

Nine months ended July 30, 2011
 
 
 
 
 
 
 
Net revenues
$
935,129

 
$
393,692

 
$
268,148

 
$
1,596,969

Cost of revenues
267,522

 
230,490

 
142,939

 
640,951

Gross margin
$
667,607

 
$
163,202

 
$
125,209

 
$
956,018



20


13. Net Income per Share
The following table presents the calculation of basic and diluted net income per share (in thousands, except per share amounts): 
 
Three Months Ended
 
Nine Months Ended
 
July 28,
2012
 
July 30,
2011
 
July 28,
2012
 
July 30,
2011
Basic net income per share
 
 
 
 
 
 
 
Net income
$
43,300

 
$
1,937

 
$
141,180

 
$
54,934

Weighted-average shares used in computing basic net income per share
457,147

 
483,744

 
455,727

 
474,020

Basic net income per share
$
0.09

 
$

 
$
0.31

 
$
0.12

Diluted net income per share
 
 
 
 
 
 
 
Net income
$
43,300

 
$
1,937

 
$
141,180

 
$
54,934

Weighted-average shares used in computing basic net income per share
457,147

 
483,744

 
455,727

 
474,020

Dilutive potential common shares in the form of stock options
6,172

 
14,657

 
8,391

 
15,664

Dilutive potential common shares in the form of other share based awards
6,252

 
11,147

 
7,601

 
11,057

Weighted-average shares used in computing diluted net income per share
469,571

 
509,548

 
471,719

 
500,741

Diluted net income per share
$
0.09

 
$

 
$
0.30

 
$
0.11

Antidilutive potential common shares in the form of (1)
 
 
 
 
 
 
 
Stock options
17,742

 
15,367

 
17,437

 
19,493

Other share based awards
1,000

 
67

 
728

 
537


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

14. Comprehensive Income
The components of comprehensive income (loss), net of tax, are as follows (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
July 28,
2012
 
July 30,
2011
 
July 28,
2012
 
July 30,
2011
Net income
$
43,300

 
$
1,937

 
$
141,180

 
$
54,934

Other comprehensive income (loss):
 
 
 
 
 
 
 
Change in net unrealized losses on cash flow hedges
(1,419
)
 
(2,953
)
 
(2,778
)
 
(3,818
)
Change in cumulative translation adjustments
(2,951
)
 
(316
)
 
(4,427
)
 
888

Total comprehensive income (loss)
$
38,930

 
$
(1,332
)
 
$
133,975

 
$
52,004


15. Guarantor and Non-Guarantor Subsidiaries
On January 20, 2010, the Company issued in total $600.0 million aggregate principal amount of its senior secured notes. The Company's obligations under the senior secured notes are guaranteed by certain of the Company's domestic subsidiaries (the “Subsidiary Guarantors”). Each of the Subsidiary Guarantors is 100% owned by the Company and all guarantees are joint and several. The senior secured notes are not guaranteed by certain of the Company's domestic subsidiaries and all of the Company’s foreign subsidiaries (the “Non-Guarantor Subsidiaries”).

21


Pursuant to the terms of the senior secured notes, the guarantees are full and unconditional, but are subject to release under the following circumstances:
upon the sale of the subsidiary or all or substantially all of its assets;
upon the discharge of the guarantees under the credit facility or other debt provided that the credit facility has been paid in full and the applicable series of senior secured notes have an investment grade rating from both Standard & Poor's and Moody's;
upon designation of the subsidiary as an “unrestricted subsidiary” under the applicable Indenture;
upon the merger, consolidation or liquidation of the subsidiary into another subsidiary guarantor; and
upon legal or covenant defeasance or the discharge of the Company's obligations under the applicable indenture.
Because the guarantees are subject to release under the above described circumstances, they would not be deemed “full and unconditional” for purposes of Rule 3-10 of Regulation S-X. However, as these circumstances are customary, the Company concluded that it may rely on Rule 3-10 of Regulation S-X, as the other requirements of Rule 3-10 have been met.
The following tables present condensed consolidated financial statements for the parent company, the Subsidiary Guarantors and the Non-Guarantor Subsidiaries, respectively.
The following is the condensed consolidated balance sheet as of July 28, 2012 (in thousands):
 
Brocade
Communications
Systems, Inc.
 
Subsidiary
Guarantors
 
Non-Guarantor Subsidiaries
 
Consolidating
Adjustments
 
Total
Assets
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
 
 
Cash, cash equivalents and short-term investments
$
204,938

 
$
1,620

 
$
374,876

 
$

 
$
581,434

Accounts receivable, net
149,061

 
(1,554
)
 
83,648

 

 
231,155

Inventories
63,751

 

 
10,449

 

 
74,200

Intercompany receivables

 
465,891

 

 
(465,891
)
 

Other current assets
91,810

 
664

 
11,545

 
557

 
104,576

Total current assets
509,560

 
466,621

 
480,518

 
(465,334
)
 
991,365

Property and equipment, net
450,454

 
54,206

 
18,745

 

 
523,405

Investment in subsidiaries
1,284,970

 

 

 
(1,284,970
)
 

Other non-current assets
1,471,483

 
510,021

 
1,250

 

 
1,982,754

Total assets
$
3,716,467

 
$
1,030,848

 
$
500,513

 
$
(1,750,304
)
 
$
3,497,524

Liabilities and Stockholders’ Equity
 
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
 
Accounts payable
$
91,883

 
$
353

 
$
24,233

 
$

 
$
116,469

Current portion of long-term debt
8,515

 

 

 

 
8,515

Intercompany payables
423,467

 

 
42,424

 
(465,891
)
 

Other current liabilities
290,665

 
12,758

 
126,404

 
557

 
430,384

Total current liabilities
814,530

 
13,111

 
193,061

 
(465,334
)
 
555,368

Long-term debt, net of current portion
621,206

 

 

 

 
621,206

Other non-current liabilities
89,130

 
43

 
40,176

 

 
129,349

Total liabilities
1,524,866

 
13,154

 
233,237

 
(465,334
)
 
1,305,923

Total stockholders’ equity
2,191,601

 
1,017,694

 
267,276

 
(1,284,970
)
 
2,191,601

Total liabilities and stockholders’ equity
$
3,716,467

 
$
1,030,848

 
$
500,513

 
$
(1,750,304
)
 
$
3,497,524


22


The following is the condensed consolidated balance sheet as of October 29, 2011 (in thousands):
 
Brocade
Communications
Systems, Inc.
 
Subsidiary
Guarantors
 
Non-Guarantor Subsidiaries
 
Consolidating
Adjustments
 
Total
Assets
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
 
 
Cash, cash equivalents and short-term investments
$
101,367

 
$
2,301

 
$
311,308

 
$

 
$
414,976

Accounts receivable, net
157,839

 
(2,149
)
 
93,451

 

 
249,141

Inventories
50,000

 

 
24,172

 

 
74,172

Intercompany receivables

 
446,455

 

 
(446,455
)
 

Other current assets
87,495

 
805

 
15,609

 
2,003

 
105,912

Total current assets
396,701

 
447,412

 
444,540

 
(444,452
)
 
844,201

Property and equipment, net
460,347

 
55,594

 
16,443

 

 
532,384

Investment in subsidiaries
1,285,356

 

 

 
(1,285,356
)
 

Other non-current assets
1,506,086

 
590,318

 
1,319

 

 
2,097,723

Total assets
$
3,648,490

 
$
1,093,324

 
$
462,302

 
$
(1,729,808
)
 
$
3,474,308

Liabilities and Stockholders’ Equity
 
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
 
Accounts payable
$
85,700

 
$
376

 
$
23,395

 
$

 
$
109,471

Current portion of long-term debt
40,539

 

 

 

 
40,539

Intercompany payables
377,228

 

 
69,227

 
(446,455
)
 

Other current liabilities
276,982

 
17,261

 
119,731

 
2,003

 
415,977

Total current liabilities
780,449

 
17,637

 
212,353

 
(444,452
)
 
565,987

Long-term debt, net of current portion
748,904

 

 

 

 
748,904

Other non-current liabilities
104,999

 
580

 
39,700

 

 
145,279

Total liabilities
1,634,352

 
18,217

 
252,053

 
(444,452
)
 
1,460,170

Total stockholders’ equity
2,014,138

 
1,075,107

 
210,249

 
(1,285,356
)
 
2,014,138

Total liabilities and stockholders’ equity
$
3,648,490

 
$
1,093,324

 
$
462,302

 
$
(1,729,808
)
 
$
3,474,308


23


The following is the condensed consolidated statement of income for the three months ended July 28, 2012 (in thousands):
 
Brocade
Communications
Systems, Inc.
 
Subsidiary
Guarantors
 
Non-Guarantor Subsidiaries
 
Consolidating
Adjustments
 
Total
Revenues
$
353,594

 
$
1,038

 
$
200,700

 
$

 
$
555,332

Intercompany revenues
11,442

 

 
5,239

 
(16,681
)
 

Total net revenues
365,036

 
1,038

 
205,939

 
(16,681
)
 
555,332

Cost of revenues
145,292

 
10,291

 
56,246

 
3,025

 
214,854

Intercompany cost of revenues
(8,078
)
 

 
24,759

 
(16,681
)
 

Total cost of revenues
137,214

 
10,291

 
81,005

 
(13,656
)
 
214,854

Gross margin (loss)
227,822

 
(9,253
)
 
124,934

 
(3,025
)
 
340,478

Operating expenses
204,948

 
12,893

 
55,441

 
(3,025
)
 
270,257

Intercompany operating expenses (income)
(38,781
)
 
(7,971
)
 
46,752

 

 

Total operating expenses
166,167

 
4,922

 
102,193

 
(3,025
)
 
270,257

Income (loss) from operations
61,655

 
(14,175
)
 
22,741

 

 
70,221

Other income (expense)
(11,495
)
 
45

 
(476
)
 

 
(11,926
)
Income (loss) before income tax provision and equity in net earnings (losses) of subsidiaries
50,160