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BROCADE COMMUNICATIONS SYSTEMS INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations
[September 05, 2014]

BROCADE COMMUNICATIONS SYSTEMS INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations


(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis should be read in conjunction with the Condensed Consolidated Financial Statements and the notes thereto included in Item 1 of this Quarterly Report on Form 10-Q and with Management's Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report filed on Form 10-K with the Securities and Exchange Commission on December 16, 2013. This section and other parts of this Quarterly Report on Form 10-Q 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" below.


Overview We are a leading supplier of networking hardware and software for businesses and organizations. Our end customers are enterprises 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 products and services are marketed, sold, and supported worldwide to end-user customers through distribution partners, including original equipment manufacturer ("OEM") partners, distributors, systems integrators, and value-added resellers, as well as directly to end users by our sales force. Our business model is focused on two key markets: our Storage Area Networking ("SAN") business, which offers our Fibre Channel ("FC") SAN backbones, directors, fixed form factor switches and embedded switches, and our Internet Protocol ("IP") Networking business, which offers our IP routers, Ethernet switches, network security and monitoring, as well as products used to manage application delivery. Our IP products are available in modular and fixed form factors, as well as in software, or virtualized, solutions that can be deployed in both traditional network designs and full-featured Ethernet fabrics. We also provide product-related customer support and services in both our SAN business and IP Networking business.

We expect growth opportunities in the SAN market over time to be driven by key customer Information Technology ("IT") initiatives such as server virtualization, enterprise mobility, data center consolidation, cloud computing initiatives, and migration to higher performance technologies, such as solid state storage. 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 and virtualized software networking products (also known as software-defined networking, or "SDN," and Network Functions Virtualization, or "NFV"), and the development 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. While our NFV revenues have not been material to date, customer interest in NFV is very high and we believe that customers prefer to buy networking products from suppliers that offer a portfolio of solutions that address their current and future needs. 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 (such as SDN and NFV), new product introductions, and enhancing our existing partnerships and forming new ones through our various distribution channels.

In the second quarter of fiscal year 2013, we announced that we were making certain changes in our strategic direction by focusing on key technology segments, such as our SAN fabrics, Ethernet fabrics, and software networking products, for the data center. As part of this change in focus, we reduced our cost of revenues and other operating expenses by $100 million on an annualized basis when comparing the first quarter of fiscal year 2014 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.

As previously disclosed, this change in focus will also result in a rebalancing of resources away from certain non-key areas of our business, which has impacted our ability to generate revenue from certain products, markets, geographies, and customers. In the second quarter of fiscal year 2014, we made a strategic decision to reduce our investment in the hardware-based Brocade ADX® products and to increase investment in the software-based Brocade ADX products for Layer 4-7 applications. As a result of this change in strategy, we expect over the next two years hardware-based Brocade ADX and related support revenue to be negatively impacted by $20 million to $40 million on an annualized basis compared with fiscal year 2013. Based on the decrease in the hardware-based Brocade ADX revenue forecast, we recognized an $83 million non-cash goodwill impairment charge during the second quarter of fiscal year 2014.

Combined with the other rebalancing actions taken through the first quarter of fiscal year 2014, which, among other actions, included the divestiture of our network adapter business and a change in our wireless business strategy, we believe our changes in strategic direction will cause our annualized revenues exiting fiscal year 2014 to be lower by approximately $60 million to $70 million compared with prior years.

35-------------------------------------------------------------------------------- Table of Contents We continue to face multiple challenges, including aggressive price discounting from competitors, new product introductions from competitors, rapid adoption of new technologies by customers, an uneven recovery in the worldwide macroeconomic climate and its impact on IT spending patterns globally, as well as uncertain federal government spending in the United States. We are also cautious about the stability and health of certain international markets and current global and country-specific dynamics, such as the geopolitical uncertainty in Russia and inflationary risks in China. These factors may impact our business and that of our partners. While the diversified portfolio of products that we offer 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 for us 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, and sales support for our products from our distribution and resale partners, as well as the timing of product transitions by our 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.

Our plans for our operating cash flows are to provide liquidity for operations, capital investments and other strategic initiatives, including mergers and acquisitions, and to return capital to shareholders in the form of stock repurchases and cash dividends. We repurchase our stock to reduce the dilutive effects of our equity award programs, and from time to time opportunistically, 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. In September 2013, we announced our intent to return at least 60% of our adjusted free cash flow, which we define as operating cash flow adjusted for the impact of the excess tax benefits from stock-based compensation, less capital expenditures, to investors in the form of share repurchases or dividends. In the third quarter of fiscal year 2014, our Board of Directors initiated a quarterly cash dividend of $0.035 per share of our common stock. The first dividend was paid on July 2, 2014, to stockholders of record as of the close of market on June 10, 2014, for an aggregate of $15.3 million. On August 21, 2014, our Board of Directors declared a second quarterly cash dividend of $0.035 per share of our common stock to be paid on October 2, 2014, to stockholders of record as of the close of market on September 10, 2014.

Future dividend payments are subject to review and approval by our Board of Directors.

36-------------------------------------------------------------------------------- Table of Contents Results of Operations Our results of operations for the three and nine months ended August 2, 2014, and July 27, 2013, 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): Three Months Ended August 2, % of Net % of Net Increase/ % 2014 Revenues July 27, 2013 Revenues (Decrease) Change SAN Products $ 325,238 59.6 % $ 314,087 58.5 % $ 11,151 3.6 % IP Networking Products 132,559 24.3 % 133,906 25.0 % (1,347 ) (1.0 )% Global Services 87,667 16.1 % 88,558 16.5 % (891 ) (1.0 )% Total net revenues $ 545,464 100.0 % $ 536,551 100.0 % $ 8,913 1.7 % Nine Months Ended % of Net % of Net Increase/ % August 2, 2014 Revenues July 27, 2013 Revenues (Decrease) Change SAN Products $ 1,001,858 60.8 % $ 994,909 59.8 % $ 6,949 0.7 % IP Networking Products 373,424 22.7 % 407,077 24.5 % (33,653 ) (8.3 )% Global Services 271,627 16.5 % 262,078 15.7 % 9,549 3.6 % Total net revenues $ 1,646,909 100.0 % $ 1,664,064 100.0 % $ (17,155 ) (1.0 )% The increase in total net revenues for the three months ended August 2, 2014, compared with the three months ended July 27, 2013, primarily reflects higher sales for our SAN products, partially offset by lower sales for our IP Networking products and Global Services offerings, as further described below.

• The increase in SAN product revenues reflects an increase in switch and director product revenues due to continued customer migration to our Gen 5 Fibre Channel products. The increase in SAN product revenues was partially offset by a decrease in revenues from embedded switches due to lower seasonal revenue from some OEM partners and due to the divestiture of our network adapter business in the first quarter of fiscal year 2014. In addition, our average selling price per port increased by 3.1% during the three months ended August 2, 2014, and the number of ports shipped during the same period increased by 0.4%, resulting in higher SAN product revenues for the three months ended August 2, 2014; • The slight decrease in IP Networking product revenues primarily reflects lower revenues from IP routing, the divestiture of our network adapter business in January 2014, and changes in our Brocade ADX product line and wireless business strategies. In addition, IP routing product revenues decreased primarily due to a pause in some customer orders in anticipation of new products scheduled for release in the fourth quarter of fiscal year 2014. The decrease was partially offset by an increase in our Ethernet switch products for data center customers. Based on our analysis of the information we collect in our sales management system, we estimate that revenues from our network carrier customers and enterprise end customers decreased for the three months ended August 2, 2014, compared with the three months ended July 27, 2013. The decrease in revenues from our network carrier customers and enterprise end customers was due to lower demand. 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 • The slight decrease in Global Services revenues was primarily attributable to a decrease in the revenue recognized from sales of initial support contracts for both our SAN and IP Networking products.

37-------------------------------------------------------------------------------- Table of Contents The decrease in total net revenues for the nine months ended August 2, 2014, compared with the nine months ended July 27, 2013, reflects lower sales for our IP Networking products, partially offset by higher sales for our SAN products and Global Services offerings, as further described below.

• The increase in SAN product revenues was caused by an increase in switch product revenue, partially offset by a decrease in director and server product revenues, due to demand changes from our OEM partners. Our average selling price per port decreased by 2.0% during the nine months ended August 2, 2014, as compared with the same period in the prior year, which was partially offset by the 2.7% increase in the number of ports shipped during the same period; • The decrease in IP Networking product revenues primarily reflects lower revenues from our IP routing, adapter, and application delivery products.

IP routing product revenues decreased primarily due to a pause in some customer orders in anticipation of new products scheduled for release in the fourth quarter of fiscal year 2014. Adapter revenues decreased primarily due to our divestiture of our network adapter business, and revenues from application delivery products decreased due to our change in strategy to reduce investment in the hardware-based Brocade ADX products and to increase investment in the software-based Brocade ADX products.

Based on our analysis of the information we collect in our sales management system, we estimate that revenues from our U.S. federal government, network carrier customers, and enterprise end customers have decreased for the nine months ended August 2, 2014, compared with the nine months ended July 27, 2013. The decrease in revenues from our U.S. federal government, network carrier customers, and enterprise end customers was due to the current challenging federal budget environment and lower overall demand in the United States and Japan. 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 • The increase in Global Services revenues was primarily attributable to an additional week of amortized support revenue from the 14-week quarter in the second quarter of fiscal year 2014, and an increase in the revenue recognized from sales of renewal support contracts for both our SAN and IP Networking products.

Our total net revenues by geographic area are summarized as follows (in thousands, except percentages): Three Months Ended August 2, % of Net % of Net Increase/ % 2014 Revenues July 27, 2013 Revenues (Decrease) Change United States $ 304,313 55.8 % $ 328,475 61.2 % $ (24,162 ) (7.4 )% Europe, the Middle East 154,141 28.3 % 127,241 23.7 % 26,900 21.1 % and Africa (1) Asia Pacific 43,229 7.9 % 46,164 8.6 % (2,935 ) (6.4 )% Japan 23,649 4.3 % 24,266 4.5 % (617 ) (2.5 )% Canada, Central and South 20,132 3.7 % 10,405 2.0 % 9,727 93.5 % America Total net revenues $ 545,464 100.0 % $ 536,551 100.0 % $ 8,913 1.7 % (1) Includes net revenues of $97.4 million and $80.5 million for the three months ended August 2, 2014, and the three months ended July 27, 2013, respectively, relating to the Netherlands.

Nine Months Ended % of Net % of Net Increase/ % August 2, 2014 Revenues July 27, 2013 Revenues (Decrease) Change United States $ 942,444 57.2 % $ 1,007,108 60.5 % $ (64,664 ) (6.4 )% Europe, the Middle East 453,972 27.6 % 415,332 25.0 % 38,640 9.3 % and Africa (2) Asia Pacific 135,687 8.3 % 135,216 8.1 % 471 0.3 % Japan 69,728 4.2 % 77,101 4.6 % (7,373 ) (9.6 )% Canada, Central and South 45,078 2.7 % 29,307 1.8 % 15,771 53.8 % America Total net revenues $ 1,646,909 100.0 % $ 1,664,064 100.0 % $ (17,155 ) (1.0 )% (2) Includes net revenues of $290.3 million and $257.9 million for the nine months ended August 2, 2014, and the nine months ended July 27, 2013, 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 38-------------------------------------------------------------------------------- Table of Contents 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 does indicate that international revenues comprise a larger percentage of our total net revenues than the attributed revenues above indicate.

International revenues for the three and nine months ended August 2, 2014, increased as a percentage of total net revenues compared with the three and nine months ended July 27, 2013, primarily due to lower revenue from SAN and IP Networking products sold into the U.S. federal market, as well as an increase in revenue from SAN products sold into the Europe, the Middle East, and Africa regions.

A significant portion of our revenues are concentrated among a relatively small number of OEM customers. For the three months ended August 2, 2014, three customers accounted for 21%, 16%, and 11%, respectively, of our total net revenues for a combined total of 48% of total net revenues. For the three months ended July 27, 2013, three customers accounted for 20%, 15%, and 12%, respectively, of our total net revenues for a combined total of 47% of 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 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): Three Months Ended August 2, % of Net % of Net Increase/ % Points 2014 Revenues July 27, 2013 Revenues (Decrease) Change SAN Products $ 241,300 74.2 % $ 228,476 72.7 % $ 12,824 1.5 % IP Networking Products 70,979 53.5 % 59,076 44.1 % 11,903 9.4 % Global Services 49,434 56.4 % 50,650 57.2 % (1,216 ) (0.8 )% Total gross margin $ 361,713 66.3 % $ 338,202 63.0 % $ 23,511 3.3 % Nine Months Ended % of Net % of Net Increase/ % Points August 2, 2014 Revenues July 27, 2013 Revenues (Decrease) Change SAN Products $ 740,465 73.9 % $ 724,448 72.8 % $ 16,017 1.1 % IP Networking Products 193,401 51.8 % 178,123 43.8 % 15,278 8.0 % Global Services 154,809 57.0 % 143,668 54.8 % 11,141 2.2 % Total gross margin $ 1,088,675 66.1 % $ 1,046,239 62.9 % $ 42,436 3.2 % The gross margin percentage for each reportable segment increased or decreased for the three months ended August 2, 2014, compared with the three months ended July 27, 2013, primarily due to the following factors (the percentages below reflect the impact on gross margin): • SAN gross margins relative to net revenues increased primarily due to a 1.1% decrease in manufacturing overhead costs primarily due to lower headcount and lower outside services spending, partially offset by an increase in variable performance-based compensation. The decrease in outside services spending was due to lower labor repair rates negotiated with our contract manufacturer; • IP Networking gross margins relative to net revenues increased primarily due to a 6.8% decrease in amortization of IP Networking-related intangible assets, as most of these assets were acquired during the acquisition of Foundry Networks, LLC ("Foundry") and were fully amortized prior to the three months ended August 2, 2014. In addition, period costs decreased 1.5%, relative to net revenues, which is mainly attributable to lower excess and obsolete reserves during the three months ended August 2, 2014. Manufacturing overhead costs decreased 0.9%, relative to net revenues, primarily due to lower headcount and lower outside services spending, partially offset by an increase in variable performance-based compensation. The decrease in outside services spending was due to lower labor repair rates negotiated with our contract manufacturer; and • Global Services gross margins relative to net revenues decreased primarily due to lower sales volume, as well as the increase in variable performance-based compensation for the three months ended August 2, 2014.

The decrease in Global Services gross margins relative to net revenues was partially offset by lower global services headcount, as well 39-------------------------------------------------------------------------------- Table of Contents as reduced legal, IT, and facilities expenses allocated to Global Services as part of the spending reduction plan that we implemented in fiscal year 2013.

The gross margin percentage for each reportable segment increased for the nine months ended August 2, 2014, compared with the nine months ended July 27, 2013, primarily due to the following factors (the percentages below reflect the impact on gross margin): • SAN gross margins relative to net revenues increased primarily due to a 1.0% decrease in manufacturing overhead costs primarily due to lower headcount and lower outside services spending, partially offset by an increase in variable performance-based compensation and an additional week of payroll expense from the 14-week quarter in the second quarter of fiscal year 2014. The decrease in outside services spending was due to lower labor repair rates negotiated with our contract manufacturer; • IP Networking gross margins relative to net revenues increased primarily due to a 5.1% decrease in amortization of IP Networking-related intangible assets, as most of these assets were acquired during the acquisition of Foundry and were fully amortized during the first quarter of fiscal year 2014. In addition, product costs decreased 1.6%, relative to net revenues, primarily as a result of a more favorable mix of IP Networking products.

We also incurred costs associated with certain Foundry pre-acquisition litigation, which caused a 0.8% increase in costs, relative to net revenues, during the nine months ended July 27, 2013; and • Global Services gross margins relative to net revenues increased primarily due to higher sales volume, partially offset by an increase in variable performance-based compensation, for the nine months ended August 2, 2014.

In addition, Global Services gross margins relative to net revenues increased due to a decrease in service and support costs relative to net revenues as a result of lower global services headcount, as well as reduced legal, IT, and facilities expenses allocated to Global Services as part of the spending reduction plan that we implemented in fiscal year 2013.

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 allocated expenses related to legal, IT, facilities, and other shared functions.

R&D expenses are summarized as follows (in thousands, except percentages): August 2, 2014 July 27, 2013 Research and development % of Net % of Net Increase/ % expense: Expense Revenues Expense Revenues (Decrease) Change Three months ended $ 84,152 15.4 % $ 92,969 17.3 % $ (8,817 ) (9.5 )% Nine months ended $ 261,862 15.9 % $ 289,088 17.4 % $ (27,226 ) (9.4 )% R&D expenses decreased for the three months ended August 2, 2014, compared with the three months ended July 27, 2013, due to the following (in thousands): Increase (Decrease) Engineering expense $ (2,903 ) Salaries and other compensation (2,361 ) Expenses related to legal, IT, facilities, and other shared functions (1,791 ) Depreciation and amortization expense (1,657 ) Various individually insignificant items (105 ) Total change $ (8,817 ) Engineering expense decreased primarily due to lower nonrecurring engineering spending related to new product development and lower prototype costs for the three months ended August 2, 2014. Salaries and other compensation decreased primarily due to decreased engineering headcount and a related decrease in payroll expense, partially offset by an increase in variable performance-based compensation. Expenses related to legal, IT, facilities, and other shared functions allocated to R&D activities decreased overall primarily due to decreased costs with respect to IT-related projects and IT personnel, and lower facilities costs, as part of the spending reduction plan that we implemented in fiscal year 2013, as well as due to lower overall legal expense resulting from the settlement of litigation matters during fiscal year 2013. In addition, depreciation and 40-------------------------------------------------------------------------------- Table of Contents amortization expense decreased primarily due to a decrease in engineering capital spending as part of the spending reduction plan that we implemented in fiscal year 2013.

R&D expenses decreased for the nine months ended August 2, 2014, compared with the nine months ended July 27, 2013, due to the following (in thousands): Increase (Decrease) Engineering expense $ (8,808 ) Expenses related to legal, IT, facilities, and other shared functions (7,092 ) Depreciation and amortization expense (3,332 ) Salaries and other compensation (3,270 ) Outside services expense (2,891 ) Various individually insignificant items (1,833 ) Total change $ (27,226 ) Engineering expense decreased primarily due to lower nonrecurring engineering spending related to new product development and lower prototype costs for the nine months ended August 2, 2014. Expenses related to legal, IT, facilities, and other shared functions allocated to R&D activities decreased overall primarily due to decreased costs with respect to IT-related projects and IT personnel, and lower facilities costs, as part of the spending reduction plan that we implemented in fiscal year 2013, as well as due to lower overall legal expense resulting from the settlement of litigation matters during fiscal year 2013.

Depreciation and amortization expense decreased primarily due to a decrease in engineering capital spending in prior periods, which also is continuing into the current fiscal year. In addition, salaries and other compensation decreased primarily due to decreased engineering headcount and a related decrease in payroll expense, partially offset by an increase in variable performance-based compensation and an additional week of payroll expense from the 14-week quarter in the second quarter of fiscal year 2014. Outside services expense decreased primarily due to a reduction in outside engineering services and decreased support expenses for our engineering laboratories.

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 allocated expenses related to legal, IT, facilities, and other shared functions.

Sales and marketing expenses are summarized as follows (in thousands, except percentages): August 2, 2014 July 27, 2013 % of Net % of Net Increase/ % Sales and marketing expense: Expense Revenues Expense Revenues (Decrease) Change Three months ended $ 137,262 25.2 % $ 139,220 25.9 % $ (1,958 ) (1.4 )% Nine months ended $ 409,524 24.9 % $ 433,547 26.1 % $ (24,023 ) (5.5 )% Sales and marketing expenses decreased for the three months ended August 2, 2014, compared with the three months ended July 27, 2013, due to the following (in thousands): Increase (Decrease)Expenses related to legal, IT, facilities, and other shared functions $ (5,662 ) The decrease in sales and marketing expenses was partially offset by an increase in: Salaries and other compensation 2,895 Various individually insignificant items 809 Total change $ (1,958 ) Expenses related to legal, IT, facilities, and other shared functions allocated to sales and marketing activities decreased overall primarily due to decreased costs with respect to IT-related projects and IT personnel, and lower facilities costs, as part of the spending reduction plan that we implemented in fiscal year 2013, as well as due to lower overall legal expense resulting from the settlement of litigation matters during fiscal year 2013. Salaries and other compensation increased primarily due to an increase in commissions and variable performance-based compensation, partially offset by a decrease in headcount.

41-------------------------------------------------------------------------------- Table of Contents Sales and marketing expenses decreased for the nine months ended August 2, 2014, compared with the nine months ended July 27, 2013, due to the following (in thousands): Increase (Decrease)Expenses related to legal, IT, facilities, and other shared functions $ (17,077 ) Salaries and other compensation (3,074 ) Outside services and other marketing expense (2,753 ) Various individually insignificant items (1,119 ) Total change $ (24,023 ) Expenses related to legal, IT, facilities, and other shared functions allocated to sales and marketing activities decreased overall primarily due to decreased costs with respect to IT-related projects and IT personnel, and lower facilities costs, as part of the spending reduction plan that we implemented in fiscal year 2013, as well as lower overall legal expense resulting from the settlement of litigation matters during fiscal year 2013. Salaries and other compensation decreased primarily due to decreased headcount, partially offset by an increase in variable performance-based compensation and an additional week of payroll expense from the 14-week quarter in the second quarter of fiscal year 2014. In addition, as part of our spending reduction plan, outside services and other marketing expense also decreased primarily due to less spending on advertising and other marketing, as well as on conferences and trade shows, in the nine months ended August 2, 2014, partially offset by increased costs related to the build out of our digital marketing platform and salesforce training delivered during the nine months ended August 2, 2014.

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, less certain expenses allocated to R&D and sales and marketing as described above.

G&A expenses are summarized as follows (in thousands, except percentages): August 2, 2014 July 27, 2013 % of Net % of Net Increase/ % G&A expense: Expense Revenues Expense Revenues (Decrease) Change Three months ended $ 22,140 4.1 % $ 18,526 3.5 % $ 3,614 19.5 % Nine months ended $ 63,395 3.8 % $ 57,640 3.5 % $ 5,755 10.0 % G&A expenses increased for the three months ended August 2, 2014, compared with the three months ended July 27, 2013, due to the following (in thousands): Increase (Decrease) Stock-based compensation expense $ 1,784 Salaries and other compensation 1,339 Various individually insignificant items 491 Total change $ 3,614 Stock-based compensation expense increased primarily due to an increase in the grant date per-unit fair values of restricted stock units granted to employees in recent quarters as a result of our higher stock price, as well as more performance-based restricted stock unit grants made in fiscal year 2014 (see Note 11, "Stockholders' Equity and Stock-Based Compensation," of the Notes to Condensed Consolidated Financial Statements). Salaries and other compensation increased primarily due to an increase in variable performance-based compensation, partially offset by a decrease in headcount as part of the spending reduction plan that we implemented in fiscal year 2013.

42-------------------------------------------------------------------------------- Table of Contents G&A expenses increased for the nine months ended August 2, 2014, compared with the nine months ended July 27, 2013, due to the following (in thousands): Increase (Decrease) Stock-based compensation expense $ 5,330 Salaries and other compensation 3,777 The increase in G&A expenses was partially offset by a decrease in: Depreciation and amortization expense (1,025 ) Various individually insignificant items (2,327 ) Total change $ 5,755 Stock-based compensation expense increased primarily due to an increase in the grant date per-unit fair values of restricted stock units granted to employees in recent quarters as a result of our higher stock price, as well as more performance-based restricted stock unit grants made in fiscal year 2014 (see Note 11, "Stockholders' Equity and Stock-Based Compensation," of the Notes to Condensed Consolidated Financial Statements). Salaries and other compensation increased primarily due to an increase in variable performance-based compensation and an additional week of payroll expense from the 14-week quarter in the second quarter of fiscal year 2014. Depreciation and amortization expense decreased primarily due to a decrease in capital spending as part of the spending reduction plan that we implemented in fiscal year 2013.

Amortization of intangible assets. Amortization of intangible assets is summarized as follows (in thousands, except percentages): August 2, 2014 July 27, 2013 Amortization of intangible % of Net % of Net Increase/ % assets: Expense Revenues Expense Revenues (Decrease) Change Three months ended $ 131 - % $ 13,124 2.4 % $ (12,993 ) (99.0 )% Nine months ended $ 10,145 0.6 % $ 41,131 2.5 % $ (30,986 ) (75.3 )% The decrease in amortization of intangible assets for the three and nine months ended August 2, 2014, compared with the three and nine months ended July 27, 2013, was primarily due to the completion of amortization of certain of our intangible assets in connection with our acquisitions of Foundry and McDATA Corporation ("McDATA") (see Note 4, "Goodwill and Intangible Assets," of the Notes to Condensed Consolidated Financial Statements).

Restructuring, goodwill impairment, and other related costs. Restructuring, goodwill impairment, and other related costs are summarized as follows (in thousands, except percentages): August 2, 2014 July 27, 2013 Restructuring, goodwill impairment, and other related % of Net % of Net Increase/ % costs: Expense Revenues Expense Revenues (Decrease) Change Three months ended $ 131 - % $ - - % $ 131 * Nine months ended $ 89,051 5.4 % $ - - % $ 89,051 * * Not meaningful In May 2013, we announced that we were making certain changes in our strategic direction by focusing on key technology segments, such as our SAN fabrics, Ethernet fabrics and software networking products, for the data center. 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. In connection with this restructuring plan, we incurred restructuring charges and other costs primarily related to severance and benefits charges and lease loss reserve and related costs beginning in the fourth quarter of fiscal year 2013. We substantially completed the restructuring plan by the end of the first quarter of fiscal year 2014.

During the second quarter of fiscal year 2014, we made the decision to reduce our investment in the hardware-based Brocade ADX products and to increase investment in the software-based Brocade ADX products for Layer 4-7 applications. As a result of this decision, we expect over the next two years hardware-based Brocade ADX and related support revenue to be negatively impacted by $20 million to $40 million on an annualized basis compared with fiscal year 2013. Based on the 43-------------------------------------------------------------------------------- Table of Contents decrease in the hardware-based Brocade ADX revenue forecast, we recognized an $83.4 million goodwill impairment charge during the second quarter of fiscal year 2014.

Restructuring, goodwill impairment, and other related costs of $0.1 million for the three months ended August 2, 2014, were related to a charge to our lease loss reserve.

Restructuring, goodwill impairment, and other related costs for the nine months ended August 2, 2014, were primarily due to the $83.4 million in goodwill impairment and $7.5 million in estimated lease loss reserve and other related costs recorded during the nine months ended August 2, 2014, partially offset by a $1.8 million reduction in expense for severance and benefits due to actual cash payments made during the nine months ended August 2, 2014, being lower than originally estimated (see Note 7, "Restructuring and Other Costs," of the Notes to Condensed Consolidated Financial Statements).

We did not incur any restructuring or other related costs during the nine months ended July 27, 2013.

As a result of the completion of our restructuring plan and other related spending changes, our cost of revenues and other operating expenses during the first quarter of fiscal year 2014 have been reduced by more than $100 million on an annualized basis relative to annualized 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 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 may be incurred, if and when we make additional investments in new technologies or solutions related to our strategy in the future, or if we decide to strengthen our networking portfolios through acquisitions and strategic investments.

Combining the change in strategy for our Brocade ADX products with the other rebalancing actions taken through the first quarter of fiscal year 2014, which, among other actions, included our divestiture of our network adapter business and the change in our wireless business strategy, we believe our changes in strategic direction will cause our annualized revenues exiting fiscal year 2014 to be lower by approximately $60 million to $70 million compared with prior years.

Gain on sale of network adapter business. During the nine months ended August 2, 2014, a gain of $4.9 million was recorded in connection with the sale of our network adapter business to QLogic Corporation ("QLogic") (see Note 3, "Acquisitions and Divestitures," of the Notes to Condensed Consolidated Financial Statements). We had no similar divestitures during the nine months ended July 27, 2013.

Interest expense. Interest expense primarily represents the interest cost associated with our senior secured notes and senior unsecured notes (see Note 8, "Borrowings," of the Notes to Condensed Consolidated Financial Statements).

Interest expense is summarized as follows (in thousands, except percentages): August 2, 2014 July 27, 2013 % of Net % of Net (Increase)/ % Interest expense: Expense Revenues Expense Revenues Decrease Change Three months ended $ (9,176 ) (1.7 )% $ (9,247 ) (1.7 )% $ 71 (0.8 )% Nine months ended $ (27,606 ) (1.7 )% $ (46,047 ) (2.8 )% $ 18,441 (40.0 )% Interest expense decreased for the three and nine months ended August 2, 2014, compared with the three and nine months ended July 27, 2013, 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 our 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 Condensed Consolidated Financial Statements).

The decrease in interest expense was also due to the refinancing of the 2018 Notes at a lower interest rate in fiscal year 2013. 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." 44-------------------------------------------------------------------------------- Table of Contents Interest and other income, net. Interest and other income, net, is summarized as follows (in thousands, except percentages): August 2, 2014 July 27, 2013 Interest and other income % of Net % of Net Increase/ % (loss), net: Income Revenues Income Revenues (Decrease) Change Three months ended $ 5,299 1.0 % $ 76,684 14.3 % $ (71,385 ) (93.1 )% Nine months ended $ 3,943 0.2 % $ 76,781 4.6 % $ (72,838 ) (94.9 )% Interest and other income, net, for the three and nine months ended August 2, 2014, was primarily related to the one-time gain of $5.2 million resulting from the sale of one of our non-marketable equity investments, partially offset by the loss on the sale of certain property and equipment during the period.

Interest and other income, net, for the three and nine months ended July 27, 2013, was primarily related to the one-time gain of $76.8 million resulting from the litigation settlement with A10 Networks, Inc. ("A10").

Income tax expense. Income tax expense and the effective tax rates are summarized as follows (in thousands, except effective tax rates): Three Months Ended Nine Months Ended August 2, July 27, August 2, July 27, 2014 2013 2014 2013 Income tax expense $ 26,668 $ 23,104 $ 81,367 $ 111,177 Effective tax rate 23.4 % 16.3 % 34.5 % 43.5 % In general, our provision for income taxes differs from tax computed at the U.S.

federal statutory tax rate of 35% due to state taxes, the effect of non-U.S.

operations, nondeductible stock-based compensation expense, and adjustments to unrecognized tax benefits.

The effective tax rates for the three and nine months ended August 2, 2014, were lower than the federal statutory tax rate of 35% primarily due to the effects of earnings in foreign jurisdictions taxed at rates lower than the U.S. federal statutory tax rate, and a discrete benefit from release of tax reserves due to expired statute of limitations, partially offset by an increase in certain unrecognized tax benefits. In addition, the effective tax rate for the nine months ended August 2, 2014, was negatively impacted by a goodwill impairment charge of $83.4 million, which is nondeductible for tax purposes (additionally, see Note 13, "Income Taxes," of the Notes to Condensed Consolidated Financial Statements).

The effective tax rate for the three months ended July 27, 2013, was lower than the federal statutory tax rate of 35% primarily due to a discrete benefit from favorable audit settlements. In addition, the effective tax rate for the nine months ended July 27, 2013, was higher than the federal statutory tax rate of 35% primarily due to a charge of $78.2 million to reduce our previously recognized California deferred tax assets as a result of a change in California tax law with the passage of Proposition 39. This charge was partially offset by an increase in foreign earnings, discrete benefits from reserve releases resulting from audit settlements, and an increase in the federal research and development tax credit that was reinstated on January 2, 2013, for calendar year 2013 and made retroactive to January 1, 2012.

The higher effective tax rate for the three months ended August 2, 2014, compared to the same period in fiscal year 2013, is attributable to the discrete benefit from favorable audit settlements during the three months ended July 27, 2013, as well as the federal R&D tax credit not being extended as of August 2, 2014, while the July 27, 2013, effective tax rate includes the 2013 federal R&D tax credit. The lower effective tax rate for the nine months ended August 2, 2014, compared to the same period in fiscal year 2013, is primarily due to the charge of $78.2 million to reduce our previously recognized California deferred tax assets as a result of a change in California tax law with the passage of Proposition 39 during the nine months ended July 27, 2013.

Based on our fiscal year 2014 financial forecast, we expect our effective tax rate in fiscal year 2014 to be lower than that of fiscal year 2013. Factors such as the mix of IP Networking versus SAN products, which have different gross margins, 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.

45-------------------------------------------------------------------------------- Table of Contents The Internal Revenue Service ("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 that the range of potential decreases in underlying uncertain tax positions is between $0 and $5 million in the next 12 months. For additional discussion, see Note 13, "Income Taxes," of the Notes to Condensed 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 certain California deferred tax assets and capital loss carryforwards. Accordingly, we apply a valuation allowance to the California deferred tax assets due to the 2012 change in California law with the passage of Proposition 39, and to capital loss carryforwards due to the limited carryforward periods of these tax assets.

Liquidity and Capital Resources August 2, October 26, Increase/ 2014 2013 (Decrease) (In thousands) Cash and cash equivalents $ 1,149,387 $ 986,997 $ 162,390 Percentage of total assets 32 % 27 % 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, the timing and amount of tax, and other payments or receipts. For additional discussion, see "Part II-Other Information, Item 1A. Risk Factors." In November 2012, we completed our acquisition of Vyatta, Inc. ("Vyatta"). The total purchase price was $44.8 million, consisting of a $43.6 million cash consideration, $7.0 million of which was held in escrow for a period of 18 months from the closing of the acquisition, and $1.2 million related to prepaid license fees paid to Vyatta that was effectively settled at the recorded amount as a result of the acquisition. In May 2014, $7.0 million in cash consideration was released from escrow upon resolution of certain contingencies (see Note 3, "Acquisitions and Divestitures," of the Notes to Condensed Consolidated Financial Statements).

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 Condensed Consolidated Financial Statements).

In May 2013, we reached an agreement with A10 to settle both the lawsuit that we filed against A10, A10's founder and other individuals in the United States District Court for the Northern District of California on August 4, 2010, and the lawsuit that A10 filed against us on September 9, 2011. Among other agreed upon terms, A10 has granted us a broad patent license and agreed to pay the Company $5.0 million in cash and issued a $70.0 million unsecured convertible promissory note payable to the Company, which bore interest at 8% per annum. A10 fully paid the unsecured convertible promissory note in the fourth quarter of fiscal year 2013. The litigation settlement resulted in a one-time gain of $76.8 million.

In January 2014, we completed the sale of our network adapter business to QLogic. The net carrying amount of the divested network adapter business' assets and liabilities was $5.1 million, comprised primarily of associated goodwill of $4.1 million. The sale resulted in a gain of $4.9 million (see Note 3, "Acquisitions and Divestitures," of the Notes to Condensed Consolidated Financial Statements).

In July 2014, we completed the sale of one of our non-marketable equity investments, which resulted in a gain of $5.2 million.

46-------------------------------------------------------------------------------- Table of Contents Based on past performance and current expectations, we believe that internally generated cash flows and cash on hand are generally sufficient to support business operations, capital expenditures, stock repurchases, cash dividends, contractual obligations, and other liquidity requirements associated with our operations for at least the next 12 months, including our debt service requirements. 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.

Financial Condition Cash and cash equivalents as of August 2, 2014, increased by $162.4 million over the balance as of October 26, 2013, 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 proceeds from the sales of our non-marketable equity investment and network adapter business, partially offset by the cash used for the purchases of property and equipment and the repurchase of outstanding shares of our common stock.

In September 2013, we announced our intent to return at least 60% of our adjusted free cash flow to investors in the form of share repurchases or other alternatives such as dividends. In the third quarter of fiscal year 2014, our Board of Directors initiated a quarterly cash dividend of $0.035 per share of our common stock. The first dividend payment was made on July 2, 2014, to stockholders of record as of the close of market on June 10, 2014. On August 21, 2014, our Board of Directors declared a second quarterly cash dividend of $0.035 per share of our common stock to be paid on October 2, 2014, to stockholders of record as of the close of market on September 10, 2014. Future dividend payments are subject to review and approval by our Board of Directors.

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, and from the amount and type of awards granted to employees. For example, a change in the mix of granted restricted stock unit and stock option awards towards granting fewer stock option awards reduces the net proceeds from the issuance of common stock in connection with employee participation in our equity compensation plans. As a result, our cash flow resulting from the issuance of common stock in connection with employee participation in our equity compensation plans will vary.

A majority of our accounts receivable balance is derived from sales to our OEM partners. As of August 2, 2014, three customers individually accounted for 13%, 12%, and 10% of total accounts receivable, for a combined total of 35% of total accounts receivable. 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. 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.

Nine Months Ended August 2, 2014, Compared to Nine Months Ended July 27, 2013 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 increased by $102.5 million primarily due to increased accounts receivable collections and decreased payments with respect to accrued employee incentive compensation. The nine months ended August 2, 2014, only includes a semiannual payout of the employee incentive compensation for the second half of fiscal year 2013, and the first half of fiscal year 2014, due to a change in our employee incentive compensation plan structure. The nine months ended July 27, 2013, includes an annual payout of the employee incentive compensation for fiscal year 2012, as well as a semiannual payout for the first half of fiscal year 2013.

Investing Activities. Net cash used in investing activities decreased by $66.2 million. The decrease was primarily due to the $44.6 million of cash used for the Vyatta acquisition during the first quarter of fiscal year 2013. The decrease was also due to the $10.7 million of cash received from the sale of a non-marketable equity investment during the third quarter of fiscal year 2014, as well as the $10.0 million of cash received from QLogic for the purchase of our network adapter business during the first quarter of fiscal year 2014.

Financing Activities. Net cash used in financing activities increased by $86.4 million. The increase was primarily due to $115.2 million more in repurchases of our Company's stock and $15.3 million in payment of dividends to stockholders during the nine months ended August 2, 2014, partially offset by an increase of $30.8 million in excess tax benefits from stock-based 47-------------------------------------------------------------------------------- Table of Contents compensation, as well as $9.4 million more in proceeds from the issuance of common stock pursuant to our equity compensation plans during the nine months ended August 2, 2014.

Liquidity Manufacturing and Purchase Commitments. We have manufacturing arrangements with contract manufacturers under which we provide 12-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 consume in normal operations within the next 12 months, in accordance with our policy (see Note 9, "Commitments and Contingencies," of the Notes to Condensed Consolidated Financial Statements).

Income Taxes. We accrue U.S. income taxes on the earnings of our foreign subsidiaries unless the earnings are considered to be indefinitely reinvested outside of the United States. We intend to indefinitely reinvest current and accumulated earnings of our foreign subsidiaries for expansion of our business operations outside the United States.

Our existing cash and cash equivalents totaled $1,149.4 million as of August 2, 2014. Of this amount, approximately 67% was held by our foreign subsidiaries. We do not currently anticipate a need for 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 any of our United States entities in the form of dividends or otherwise, we may be subject to additional United States income taxes and foreign withholding taxes.

The IRS and other tax authorities regularly examine our income tax returns (see Note 13, "Income Taxes," of the Notes to Condensed 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, January 2013, October 2013, and April 2014 to, among other things, provide us with greater operating 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 January 7, 2015 (see Note 8, "Borrowings," of the Notes to Condensed Consolidated Financial Statements).

We prepaid the term loan in full in the fourth quarter of fiscal year 2012, and there were no principal amounts or commitments outstanding under the term loan facility as of either August 2, 2014, or October 26, 2013. 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 August 2, 2014 (in thousands): Original Amount August 2, 2014 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 Condensed Consolidated Financial Statements). We used the proceeds to pay down a substantial portion of the outstanding term loan, and to retire the convertible subordinated debt due on February 15, 2010, which had been assumed in connection with our acquisition of 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 nine months ended August 2, 2014, or the nine months ended July 27, 2013.

Under the terms of the factoring agreement, the total and available amounts of the factoring facility as of August 2, 2014, were $50.0 million.

48-------------------------------------------------------------------------------- Table of Contents 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 August 2, 2014.

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 August 2, 2014. The 2018 Indenture was discharged as of January 22, 2013 (see Note 8, "Borrowings," of the Notes to Condensed 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 covenants as of August 2, 2014.

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; 49-------------------------------------------------------------------------------- Table of Contents 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 acquisition of Foundry in connection with the acquisition and the financing thereof; • Any cash restructuring charges and integration costs in connection with the acquisition of Foundry, in an aggregate amount not to exceed $75.0 million; • Approved non-cash restructuring charges incurred in connection with the acquisition of Foundry and the financing thereof; • Other nonrecurring expenses reducing consolidated net income that 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, are 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.

50-------------------------------------------------------------------------------- Table of Contents Contractual Obligations The following table summarizes our contractual obligations, including interest expense, and commitments as of August 2, 2014 (in thousands): Less Than More Than Total 1 Year 1-3 Years 3-5 Years 5 Years Contractual Obligations: Senior secured notes due 2020 (1) $ 413,438 $ 20,625 $ 41,250 $ 41,250 $ 310,313 Senior unsecured notes due 414,049 13,875 27,750 27,750 344,674 2023 (1) Non-cancellable operating leases 64,867 7,163 39,322 11,695 6,687 (2) Non-cancellable capital leases (1) 2,296 1,884 412 - - Purchase commitments, gross (3) 175,319 175,319 - - - Total contractual obligations $ 1,069,969 $ 218,866 $ 108,734 $ 80,695 $ 661,674 Other Commitments: Standby letters of credit $ 152 n/a n/a n/a n/a Unrecognized tax benefits and related accrued interest (4) $ 124,957 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 $17.9 million, which consists of $1.8 million to be received in less than one year, $13.7 million to be received in one to three years, and $2.4 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 $3.3 million for estimated purchase commitments that we do not expect to consume in normal operations within the next 12 months, in accordance with our policy.

(4) As of August 2, 2014, we had a gross liability for unrecognized tax benefits of $122.7 million and a net accrual for the payment of related interest and penalties of $2.2 million.

Share Repurchase Program. As of August 2, 2014, our Board of Directors had authorized a total of $2.0 billion for the repurchase of our common stock since the inception of the program in August 2004. 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 three months ended August 2, 2014, we repurchased 12.8 million shares for an aggregate purchase price of $112.1 million. Approximately $697.4 million remained authorized for future repurchases under this program as of August 2, 2014. Subsequently, between August 2, 2014, and the date of the filing of this Quarterly Report on Form 10-Q, we repurchased 1.2 million shares of our common stock for an aggregate purchase price of $11.9 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 August 2, 2014, 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 August 2, 2014, 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.

Critical Accounting Estimates There have been no material changes in the matters for which we make critical accounting estimates in the preparation of our condensed consolidated financial statements during the nine months ended August 2, 2014, as compared to those disclosed in our Annual Report on Form 10-K for the fiscal year ended October 26, 2013.

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.

51-------------------------------------------------------------------------------- Table of Contents 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 of these factors could result in IPRD impairment charges in the future, which could adversely affect our net income.

We performed our annual development period's IPRD impairment test using measurement data as of the first day of the second fiscal quarter of 2014.

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 occur or facts and circumstances change that would more likely than not reduce the fair value of a reporting unit below 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 of these factors could result in goodwill impairment charges in the future, which could adversely affect our net income.

We perform the two-step goodwill impairment test to identify potential goodwill impairment and measure the amount of a goodwill impairment loss to be recognized, if any. The first step tests for potential impairment by comparing the fair value of reporting units with reporting units' net asset values. 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. 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 relevant acquisition accounting guidance, to determine the implied fair value of the reporting unit's goodwill. The implied fair value of the reporting unit's goodwill 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 applying various observable market-based multiples 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 2014.

At the time of goodwill impairment testing, our reporting units were: SAN Products; Ethernet Switching & 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. As of the date of the fiscal year 2014 annual goodwill impairment testing, Ethernet Switching & IP Routing and ADP reporting units' goodwill carrying value was $1,102 million and $207 million, respectively. In the second quarter of fiscal year 2014, we changed our 52-------------------------------------------------------------------------------- Table of Contents internal financial reporting, realigning it with the changes in our strategic direction to focus on key technology segments. As a result of this change, Ethernet Switching & IP Routing and ADP business components were combined into the IP Networking Products operating segment, and separate discrete financial information is no longer available for either Ethernet Switching & IP Routing or ADP components.

During our fiscal year 2014 annual goodwill impairment test, we used a combination of the income approach and the market approach. We believe that, at the time of impairment testing performed in the second fiscal quarter of 2014, the income approach and the market approach were equally representative of a reporting unit's fair value.

During the first step of goodwill impairment testing, we determined that the fair value of the ADP reporting unit was below the reporting unit's carrying value. Accordingly, we performed the second step of goodwill impairment testing to measure the amount of the impairment. During the second step, we assigned the ADP reporting unit's fair value to the reporting unit's assets and liabilities, using the relevant acquisition accounting guidance, to determine the implied fair value of the reporting unit's goodwill. The implied fair value of the reporting unit's goodwill was then compared with the carrying value of the ADP reporting unit's goodwill to record an impairment loss equal to the difference in values. For additional information, see Note 4, "Goodwill and Intangible Assets," of the Notes to Condensed Consolidated Financial Statements.

During the first step of goodwill impairment testing, we also determined that no impairment needed to be recorded for the SAN Products, Ethernet Switching & IP Routing, and Global Services reporting units as these reporting units passed the first step of goodwill impairment testing. 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 key assumptions impacting our estimates were (i) discount rates and (ii) discounted cash flow ("DCF") terminal value multipliers. As these assumptions 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 respective fair values of the SAN and Global Services reporting units were substantially in excess of these reporting units' carrying values and were not subject to the sensitivity analysis presented below for the Ethernet Switching & IP Routing reporting unit, which estimated fair value exceeded its net assets' carrying value by approximately $57 million.

The following table summarizes the approximate impact that a change in key assumptions would have on the estimated fair value of the Ethernet Switching & IP Routing reporting unit, leaving all other assumptions unchanged: Approximate Excess of Impact on Fair Fair Value over Value Carrying Value Change (In millions) (In millions) Discount rate ±1% $(38) - 41 $19 - 98DCF terminal value multiplier ±0.5x $(33) - 33 $24 - 90 Recent Accounting Pronouncements For a description of recent accounting pronouncements, including the expected dates of adoption and estimated effects, if any, on our condensed consolidated financial statements, see Note 2, "Summary of Significant Accounting Policies," of the Notes to Condensed Consolidated Financial Statements.

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