Attached files

file filename
EX-32.1 - CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER AND PRINCIPAL FINANCIAL OFFICER - BROCADE COMMUNICATIONS SYSTEMS INCbrcd-10qxfy16q1xex321.htm
EX-31.2 - RULE 13A-14(A)/15D-14(A) CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER - BROCADE COMMUNICATIONS SYSTEMS INCbrcd-10qxfy16q1xex312.htm
EX-31.1 - RULE 13A-14(A)/15D-14(A) CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER - BROCADE COMMUNICATIONS SYSTEMS INCbrcd-10qxfy16q1xex311.htm
EX-10.2 - FORM OF 2009 STOCK PLAN RESTRICTED STOCK UNIT AGREEMENT FY16 PERFORMANCE STOCK - BROCADE COMMUNICATIONS SYSTEMS INCbrcd-10qxfy16q1xex102.htm
EX-10.1 - AMENDMENT NUMBER 50 TO SOW NUMBER 1 OF THE GOODS AGREEMENT WITH IBM - BROCADE COMMUNICATIONS SYSTEMS INCbrcd-10qxfy16q1xex101.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended January 30, 2016
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission file number: 000-25601
 
Brocade Communications Systems, Inc.
(Exact name of registrant as specified in its charter)
Delaware
 
77-0409517
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
130 Holger Way
San Jose, CA 95134-1376
(408) 333-8000
(Address, including zip code, of principal
executive offices and registrant’s telephone
number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes   x    No   ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes   x    No   ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer  ý
 
Accelerated filer  o
 
Non-accelerated filer  o
 
Smaller reporting company  o
 
 
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes   ¨    No   x
The number of shares outstanding of the registrant’s common stock as of February 26, 2016, was 400,629,143 shares.



BROCADE COMMUNICATIONS SYSTEMS, INC.
FORM 10-Q
For the Quarter Ended January 30, 2016
TABLE OF CONTENTS
 
 
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, tax treatment, earnings, cash flows, benefit obligations, debt repayments, stock repurchases, or other financial items; any statements of the plans, strategies, and objectives of management for future operations, including planned investments or acquisitions; any statements concerning expected development, performance, success, market conditions, or market share relating to products or services; any statements regarding future economic conditions or performance; any statements regarding pending litigation, including claims or disputes; any statements of expectation or belief; and any statements of assumptions underlying any of the foregoing. Words such as “expects,” “anticipates,” “assumes,” “targets,” “projects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “continues,” “may,” “should,” “could,” and variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are based on current expectations, estimates, forecasts, and projections about the industries in which Brocade operates, and the beliefs and assumptions of management. Readers are cautioned that these forward-looking statements are only predictions and are subject to risks, uncertainties, and assumptions that are difficult to predict, including those identified below, under “Part II—Other Information, Item 1A. Risk Factors” and elsewhere herein. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. Furthermore, Brocade undertakes no obligation to revise or update any forward-looking statements for any reason.
Additional Information
Brocade and the B-wing symbol are registered trademarks of Brocade Communications Systems, Inc., in the United States and/or in other countries. Other brands, products, or service names mentioned may be trademarks of Brocade or others.




PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

BROCADE COMMUNICATIONS SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
 
Three Months Ended
 
January 30,
2016
 
January 31,
2015
 
(In thousands, except per share amounts)
Net revenues:
 
 
 
Product
$
481,167

 
$
486,238

Service
93,117

 
90,001

Total net revenues
574,284


576,239

Cost of revenues:
 
 
 
Product
144,097

 
149,926

Service
41,372

 
36,630

Total cost of revenues
185,469

 
186,556

Gross margin
388,815


389,683

Operating expenses:
 
 
 
Research and development
93,257

 
85,231

Sales and marketing
151,827

 
140,238

General and administrative
22,429

 
24,671

Amortization of intangible assets
902

 
138

Restructuring and other related benefits
(566
)
 

Total operating expenses
267,849

 
250,278

Income from operations
120,966


139,405

Interest expense
(9,865
)
 
(25,424
)
Interest and other income (loss), net
669

 
(559
)
Income before income tax
111,770

 
113,422

Income tax expense
18,124

 
26,155

Net income
$
93,646

 
$
87,267

Net income per share—basic
$
0.23


$
0.20

Net income per share—diluted
$
0.23


$
0.20

Shares used in per share calculation—basic
407,902

 
428,536

Shares used in per share calculation—diluted
415,085

 
439,156

 
 
 
 
Cash dividends declared per share
$
0.045


$
0.035

See accompanying Notes to Condensed Consolidated Financial Statements.

1


BROCADE COMMUNICATIONS SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
 
Three Months Ended
 
January 30,
2016

January 31,
2015
 
(In thousands)
Net income
$
93,646


$
87,267

Other comprehensive income and loss, net of tax:
 
 
 
Unrealized gains (losses) on cash flow hedges:
 
 
 
Change in unrealized gains and losses
(2,300
)
 
(1,774
)
Net gains and losses reclassified into earnings
626

 
603

Net unrealized losses on cash flow hedges
(1,674
)
 
(1,171
)
Foreign currency translation adjustments
(2,203
)
 
(4,221
)
Total other comprehensive loss
(3,877
)
 
(5,392
)
Total comprehensive income
$
89,769

 
$
81,875

See accompanying Notes to Condensed Consolidated Financial Statements.


2


BROCADE COMMUNICATIONS SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
January 30,
2016

October 31,
2015
 
(In thousands, except par value)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
1,392,009

 
$
1,440,882

Accounts receivable, net of allowances for doubtful accounts of $1,741 and $1,838 as of January 30, 2016, and October 31, 2015, respectively
174,757

 
235,883

Inventories
42,586

 
40,524

Deferred tax assets

 
78,675

Prepaid expenses and other current assets
51,708

 
56,235

Total current assets
1,661,060

 
1,852,199

Property and equipment, net
442,158

 
439,224

Goodwill
1,617,041

 
1,617,161

Intangible assets, net
71,290

 
75,623

Non-current deferred tax assets
68,968

 
813

Other assets
48,378

 
51,133

Total assets
$
3,908,895

 
$
4,036,153

LIABILITIES AND STOCKHOLDERS’ EQUITY

 
 
Current liabilities:
 
 
 
Accounts payable
$
74,019

 
$
98,143

Accrued employee compensation
112,951

 
142,075

Deferred revenue
228,582


244,622

Other accrued liabilities
69,287

 
77,524

Total current liabilities
484,839

 
562,364

Long-term debt, net of current portion
798,103

 
793,779

Non-current deferred revenue
74,571

 
72,065

Non-current income tax liability
47,651

 
47,010

Non-current deferred tax liabilities

 
24,024

Other non-current liabilities
2,538

 
3,376

Total liabilities
1,407,702

 
1,502,618

Commitments and contingencies (Note 9)


 


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

 

Common stock, $0.001 par value, 800,000 shares authorized:
 
 
 
Issued and outstanding: 402,556 and 413,923 shares as of January 30, 2016, and October 31, 2015, respectively
403

 
414

Additional paid-in capital
1,529,313

 
1,632,984

Accumulated other comprehensive loss
(28,879
)
 
(25,002
)
Retained earnings
1,000,356

 
925,139

Total stockholders’ equity
2,501,193

 
2,533,535

Total liabilities and stockholders’ equity
$
3,908,895

 
$
4,036,153

See accompanying Notes to Condensed Consolidated Financial Statements.

3


BROCADE COMMUNICATIONS SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
Three Months Ended
 
January 30,
2016
 
January 31,
2015
 
(In thousands)
Cash flows from operating activities:
 
 
 
Net income
$
93,646

 
$
87,267

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Excess tax benefits from stock-based compensation
(7,352
)
 
(16,102
)
Depreciation and amortization
22,812

 
19,575

Loss on disposal of property and equipment
207

 
444

Amortization of debt issuance costs and debt discount
4,325

 
1,056

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

 
15,122

Provision for doubtful accounts receivable and sales allowances
(96
)
 
2,403

Non-cash stock-based compensation expense
24,044

 
24,082

Changes in assets and liabilities, net of acquisitions:
 
 
 
Restricted cash

 
(11,918
)
Accounts receivable
61,222

 
(17,256
)
Inventories
(2,000
)
 
1,155

Prepaid expenses and other assets
609

 
(5,746
)
Deferred tax assets
16

 
494

Accounts payable
(23,859
)
 
(8,776
)
Accrued employee compensation
(38,993
)
 
(77,033
)
Deferred revenue
(13,535
)
 
(2,190
)
Other accrued liabilities
(7,991
)
 
(1,423
)
Restructuring liabilities
(855
)
 
(761
)
Net cash provided by operating activities
112,200


10,393

Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(23,839
)
 
(16,514
)
Purchase of intangible assets

 
(7,750
)
Proceeds from collection of note receivable
250

 
250

Net cash used in investing activities
(23,589
)
 
(24,014
)

4


BROCADE COMMUNICATIONS SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS—Continued
(Unaudited)
 
Three Months Ended
 
January 30,
2016
 
January 31,
2015
 
(In thousands)
Cash flows from financing activities:
 
 
 
Payment of debt issuance costs

 
(409
)
Payment of principal related to capital leases
(83
)
 
(1,154
)
Common stock repurchases
(144,490
)
 
(128,966
)
Proceeds from issuance of common stock
19,482

 
21,036

Payment of cash dividends to stockholders
(18,429
)
 
(15,106
)
Proceeds from convertible notes

 
565,656

Purchase of convertible note hedge

 
(86,135
)
Proceeds from issuance of warrants

 
51,175

Excess tax benefits from stock-based compensation
7,352

 
16,102

Increase in restricted cash

 
(300,000
)
Net cash provided by (used in) financing activities
(136,168
)
 
122,199

Effect of exchange rate fluctuations on cash and cash equivalents
(1,316
)
 
(4,230
)
Net increase (decrease) in cash and cash equivalents
(48,873
)
 
104,348

Cash and cash equivalents, beginning of period
1,440,882

 
1,255,017

Cash and cash equivalents, end of period
$
1,392,009

 
$
1,359,365

Supplemental disclosures of cash flow information:
 
 
 
Cash paid for interest
$
10,891

 
$
17,333

Cash paid for income taxes
$
4,798

 
$
13,128

See accompanying Notes to Condensed Consolidated Financial Statements.

5


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 (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. The Company’s Condensed Consolidated Balance Sheet as of October 31, 2015, 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 31, 2015.
The accompanying Condensed Consolidated Financial Statements are unaudited but, in the opinion of the Company’s management, reflect all adjustments—including normal recurring adjustments—that management considers necessary for a fair presentation of these Condensed Consolidated Financial Statements. The results for the interim periods presented are not necessarily indicative of the results for the full fiscal year or any other future period.
The Company’s fiscal year is a 52- or 53-week period ending on the last Saturday in October or the first Saturday in November, respectively. As is customary for companies that use the 52/53-week convention, every fifth year is a 53-week year. Fiscal year 2016 is a 52-week fiscal year and fiscal year 2015 was a 52-week fiscal year. The Company’s next 53-week fiscal year will be fiscal year 2019 and its next 14-week quarter will be the second quarter of fiscal year 2019.
The Company’s 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 the Company’s 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 Company’s 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, acquisition purchase price allocations, warranty obligations, inventory valuation and purchase commitments, restructuring costs, incentive compensation, facilities lease losses, impairment of goodwill and other indefinite-lived 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 three months ended January 30, 2016, as compared to those disclosed in Brocade’s Annual Report on Form 10-K for the fiscal year ended October 31, 2015.
New Accounting Pronouncements or Updates Recently Adopted
In April 2014, the Financial Accounting Standards Board (“FASB”) issued an update to Accounting Standards Codification (“ASC”) 205, Presentation of Financial Statements, and ASC 360, Property, Plant, and Equipment: Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity. Under this update, a discontinued operation may include a component of an entity or a group of components of an entity, a business, or nonprofit activity. Only those disposals of components of an entity that represent a strategic shift that has, or will have, a major effect on an entity’s operations and financial results will be reported as discontinued operations in the financial statements. This update should be applied prospectively. The Company adopted this update in the first quarter of fiscal year 2016. There was no material impact on the Company’s financial position, results of operations, or cash flows.

6


In April 2015, the FASB issued an update to ASC 835, Interest—Imputation of Interest: Simplifying the Presentation of Debt Issuance Costs. Under this update, debt issuance costs are required to be presented as a direct deduction from the carrying amount of the related debt liability, consistent with the presentation of debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by this update. This update should be applied retrospectively to all prior periods presented in the financial statements. The Company adopted this update in the first quarter of fiscal year 2016. There was no material impact on the Company’s financial position, results of operations, or cash flows.
In September 2015, the FASB issued an update to ASC 805, Business Combinations: Simplifying the Accounting Measurement-Period Adjustments. This update simplifies the accounting for adjustments made to provisional amounts recognized in a business combination by eliminating the requirement to retrospectively account for those adjustments. Under this update, the adjustments are recognized in the reporting period in which the adjustment amounts are determined. This update should be applied prospectively. The Company adopted this update in the first quarter of fiscal year 2016. There was no material impact on the Company’s financial position, results of operations, or cash flows.
In November 2015, the FASB issued an update to ASC 740, Income Taxes: Balance Sheet Classification of Deferred Taxes. This update simplifies the presentation of current and noncurrent deferred tax liabilities and assets. Under this update, the deferred tax liabilities and assets are classified as noncurrent on the balance sheet. The update does not impact the current requirement that deferred tax liabilities and assets be offset and presented as a single amount. This update may be applied either prospectively or retrospectively. The Company adopted this update in the first quarter of fiscal year 2016 and has elected to apply this update prospectively. There was no material impact on the Company’s financial position, results of operations, or cash flows.
Recent Accounting Pronouncements or Updates That Are Not Yet Effective
In May 2014, the FASB issued an update to ASC 606, Revenue from Contracts with Customers, that will supersede virtually all existing revenue guidance. Under this update, an entity is required to recognize revenue upon transfer of promised goods or services to customers, in an amount that reflects the expected consideration received in exchange for those goods or services. As such, an entity will need to use more judgment and make more estimates than under the current guidance. This update should be applied retrospectively either to each prior reporting period presented in the financial statements, or only to the most current reporting period presented in the financial statements with a cumulative effect adjustment recorded in retained earnings. In August 2015, the FASB issued an update to defer the effective date of this update by one year. This update becomes effective and will be adopted by the Company in the first quarter of fiscal year 2019. Early adoption is not permitted for reporting periods before the first quarter of fiscal year 2018. The Company is currently evaluating the impact of this update on its consolidated financial statements.
In April 2015, the FASB issued an update to ASC 350, Intangibles—Goodwill and Other—Internal-Use Software: Customer’s Accounting for Fees Paid in Cloud Computing Arrangement. This update provides guidance on the accounting for fees paid in a cloud computing arrangement if the arrangement was determined to include a software license. This update will not change U.S. GAAP for a customer’s accounting for service contracts. This update may be applied either prospectively or retrospectively and will be adopted by the Company in the first quarter of fiscal year 2017. Early adoption is permitted. The Company does not expect the adoption of this update to have a material impact on its consolidated financial statements.
In July 2015, the FASB issued an update to ASC 330, Inventory: Simplifying the Measurement of Inventory. Under this update, measurement of inventory is based on the lower of cost or net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less the estimated cost of completion and disposal. This update does not apply to inventory that is measured using last-in, first-out or the retail inventory method. This update should be applied prospectively and will be adopted by the Company in the first quarter of fiscal year 2018. Early adoption is permitted. The Company does not expect the adoption of this update to have a material impact on its consolidated financial statements.
In January 2016, the FASB issued an update to ASC 825, Financial Instruments—Overall: Recognition and Measurement of Financial Assets and Financial Liabilities. This update consists of eight provisions that provide guidance on the accounting for equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. This update should be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption and prospectively for equity investments without readily determinable fair values. This update becomes effective and will be adopted by the Company in the first quarter of fiscal year 2019. Early adoption is permitted for two of the eight provisions. The Company is currently evaluating the impact of this update on its consolidated financial statements and related disclosures.
In February 2016, the FASB issued an update to ASC 842, Leases, that will supersede the existing lease guidance, including on-balance sheet recognition of operating leases for lessees. This update should be applied using a modified retrospective approach and will be adopted by the Company in the first quarter of fiscal year 2020. Early adoption is permitted. The Company is currently evaluating the impact of this update on its consolidated financial statements.

7


Concentrations
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash, cash equivalents, and accounts receivable. Cash and cash equivalents are primarily maintained at five major financial institutions. Deposits held with banks may be redeemed upon demand and may exceed the amount of insurance provided on such deposits.
A majority of the Company’s accounts receivable balance is derived from sales to original equipment manufacturer (“OEM”) partners in the computer storage and server industry. As of January 30, 2016, one customer individually accounted for 10% of total accounts receivable and no other customers individually accounted for more than 10% of total accounts receivable. As of October 31, 2015, one customer individually accounted for 17% of total accounts receivable and no other customers individually accounted for more than 10% 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 and sales allowances.
For the three months ended January 30, 2016, two customers individually accounted for 20% and 14% of the Company’s total net revenues for a combined total of 34% of total net revenues. For the three months ended January 31, 2015, three customers individually accounted for 20%, 14%, and 10% of the Company’s total net revenues for a combined total of 44% 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 multiple contract manufacturers (“CMs”) for the production of its products, including Hon Hai Precision Industry Co., Ltd. and Accton Technology Corporation. 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 components used in the manufacture of products from single or limited supplier sources.

3. Acquisitions
In March 2015, the Company completed its acquisition of two businesses to strengthen its software networking portfolio. The total aggregate purchase price of the acquisitions was $96.1 million, consisting of $95.5 million in cash consideration, which is gross of $0.1 million of cash acquired as part of the acquisitions, and $0.5 million in non-cash consideration. No direct acquisition costs or integration costs were recorded for the three months ended January 30, 2016, or the three months ended January 31, 2015.
The results of operations for both acquisitions are included in the Company’s Condensed Consolidated Statements of Income from the respective dates of acquisition. The Company does not consider these acquisitions to be significant, individually or in the aggregate, to its results of operations or financial position. Therefore, the Company is not presenting pro-forma financial information of combined operations.
In connection with these acquisitions, the Company allocated the total purchase consideration to the net assets acquired and liabilities assumed, including identifiable intangible assets, based on their respective fair values at the acquisition dates.
In conjunction with the acquisitions, the Company granted restricted stock unit (“RSU”) awards and cash awards to transferring or continuing employees of the acquired businesses. These awards require the employees to continue providing services to the Company for the duration of the vesting or payout periods.
The RSUs are accounted for as stock-based compensation expense and reported, as applicable, within “Cost of revenues,” “Research and development,” “Sales and marketing,” and “General and administrative” on the Company’s Condensed Consolidated Statements of Income. For the three months ended January 30, 2016, the Company recognized $0.5 million of stock-based compensation expense related to these RSU awards.
The cash awards are accounted for as employee compensation expense and reported within “Research and development” on the Company’s Condensed Consolidated Statements of Income. For the three months ended January 30, 2016, the Company recognized $1.3 million of compensation expense related to these cash awards.


8


4. Goodwill and Intangible Assets
The following table summarizes goodwill activity by reportable segment during the three months ended January 30, 2016 (in thousands):
 
Storage Area Networking (“SAN”) 
Products
 
Internet Protocol (“IP”) Networking Products
 
Global Services
 
Total
Balance at October 31, 2015
 
 
 
 
 
 
 
Goodwill
$
176,325

 
$
1,414,634

 
$
155,416

 
$
1,746,375

Accumulated impairment losses

 
(129,214
)
 

 
(129,214
)
 
176,325

 
1,285,420

 
155,416

 
1,617,161

Tax adjustments (1)
(4
)
 

 

 
(4
)
Translation adjustments

 
(116
)
 

 
(116
)
Balance at January 30, 2016
 
 
 
 
 
 
 
Goodwill
176,321

 
1,414,518

 
155,416

 
1,746,255

Accumulated impairment losses

 
(129,214
)
 

 
(129,214
)
 
$
176,321

 
$
1,285,304

 
$
155,416

 
$
1,617,041

(1) 
The goodwill adjustments were primarily a result of tax benefits from the exercise of stock awards of acquired companies.
The Company conducts its goodwill impairment test annually, as of the first day of the second fiscal quarter, and whenever events occur or facts and circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. For the annual goodwill impairment test, the Company uses the income approach, the market approach, or a combination thereof to determine each reporting unit’s fair value. The income approach provides an estimate of fair value based on discounted expected future cash flows (“DCF”). The market approach provides an estimate of fair value by applying various observable market-based multiples to the reporting unit’s operating results and then applying an appropriate control premium. For the fiscal year 2015 annual goodwill impairment test, the Company used a combination of approaches to estimate each reporting unit’s fair value. At the time that the fiscal year 2015 annual goodwill impairment test was performed, the Company believed that the income approach and the market approach were equally representative of a reporting unit’s fair value.
Determining the fair value of a reporting unit 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 are 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;
The Company’s forecasted 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 the Company’s regular long-range planning process. The control premium used in market or combined approaches is determined by considering control premiums offered as part of the acquisitions that have occurred in market segments that are comparable with the Company’s reporting units.
Based on the results of the annual goodwill impairment analysis performed during the second fiscal quarter of 2015, the Company determined that no impairment needed to be recorded. As of January 30, 2016, no new events had occurred nor had any facts or circumstances changed since the annual goodwill impairment analysis performed during the second quarter of fiscal year 2015 that indicated that the fair values of the reporting units may be less than their current carrying amounts.

9


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 Company did not incur costs to renew or extend the term of any acquired finite-lived intangible assets during the three months ended January 30, 2016.
The following tables present details of the Company’s intangible assets, excluding goodwill (in thousands, except for weighted-average remaining useful life):
 
January 30, 2016
 
Gross
Carrying
Value
 
Accumulated
Amortization
 
Net
Carrying
Value
 
Weighted-
Average
Remaining
Useful Life
(in years)
Finite-lived intangible assets:
 
 
 
 
 
 
 
Trade names
$
1,090

 
$
471

 
$
619

 
4.23
Core/developed technology (1) (2)
51,750

 
11,719

 
40,031

 
3.70
Patent portfolio license (3)
7,750

 
1,125

 
6,625

 
17.49
Customer relationships
23,110

 
3,233

 
19,877

 
6.94
Non-compete agreements
1,050

 
744

 
306

 
0.93
Patents with broader applications
1,040

 
58

 
982

 
14.13
Total finite-lived intangible assets
85,790

 
17,350

 
68,440

 
6.12
Indefinite-lived intangible assets, excluding goodwill:
 
 
 
 
 
 
 
In-process research and development (“IPR&D”) (1)
2,850

 

 
2,850

 
 
Total indefinite-lived intangible assets, excluding goodwill
2,850

 

 
2,850

 
 
Total intangible assets, excluding goodwill
$
88,640

 
$
17,350

 
$
71,290

 
 
 
 
 
 
 
 
 
 
 
October 31, 2015
 
Gross
Carrying
Value
 
Accumulated
Amortization
 
Net
Carrying
Value
 
Weighted-
Average
Remaining
Useful Life
(in years)
Finite-lived intangible assets:
 
 
 
 
 
 
 
Trade names
$
1,090

 
$
415

 
$
675

 
4.36
Core/developed technology (2)
40,530

 
9,605

 
30,925

 
3.49
Patent portfolio license (3)
7,750

 
849


6,901

 
17.74
Customer relationships
23,110

 
2,484

 
20,626

 
7.18
Non-compete agreements
1,050

 
664

 
386

 
1.17
Patents with broader applications
1,040

 
40

 
1,000

 
14.38
Total finite-lived intangible assets
74,570

 
14,057

 
60,513

 
6.55
Indefinite-lived intangible assets, excluding goodwill:
 
 
 
 
 
 
 
IPR&D (1)
15,110

 

 
15,110

 
 
Total indefinite-lived intangible assets, excluding goodwill
15,110

 

 
15,110

 
 
Total intangible assets, excluding goodwill
$
89,680

 
$
14,057

 
$
75,623

 
 
(1) 
Acquired IPR&D are intangible assets accounted for as indefinite-lived assets until the completion or abandonment of the associated research and development efforts. If the research and development efforts associated with the IPR&D are successfully completed, then the IPR&D intangible assets will be amortized over the estimated useful lives to be determined as of the date the efforts are completed. During the three months ended January 30, 2016, research and development efforts were completed on $12.3 million of the IPR&D intangible assets, and the completed IPR&D intangible assets are being amortized as Core/developed technology over an estimated useful life of five years. The research and development efforts associated with the remaining IPR&D intangible assets are expected to be completed in the second quarter of fiscal year 2016.

10


(2) 
During the three months ended January 30, 2016$1.0 million of finite-lived intangible assets became fully amortized and, therefore, were removed from the balance sheet.
(3) 
The patent portfolio license was assigned an estimated useful life that reflects the Company’s consumption of the expected defensive benefits related to this license to certain patents. The method of amortization for the patent portfolio license reflects the Company’s estimate of the pattern in which these expected defensive benefits will be used by the Company and is primarily based on the mix of expiration patterns of the individual patents included in the license.
The Company conducts the IPR&D impairment test annually, as of the first day of the second fiscal quarter, or when events occur or facts and circumstances indicate that it is more likely than not that the IPR&D is impaired. For the annual IPR&D impairment test, the Company elects the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of the IPR&D assets is less than the carrying amount. If, after assessing the totality of events and circumstances, the Company determines that it is more likely than not that the fair value of the IPR&D assets is less than the carrying amount, then the Company conducts a quantitative analysis to determine the fair value of the IPR&D assets. If the carrying amount of the IPR&D assets exceeds the fair value, then the Company recognizes an impairment loss equal to the difference.
Based on the results of the annual IPR&D impairment analysis performed during the second fiscal quarter of 2015, the Company determined that no impairment needed to be recorded. As of January 30, 2016, no new events had occurred nor had any facts or circumstances changed since the annual IPR&D impairment analysis performed during the second quarter of fiscal year 2015 that indicated that the fair value of the IPR&D assets may be less than the current carrying amount.
The amortization of finite-lived intangible assets is included in the following line items of the Company’s Condensed Consolidated Statements of Income as follows (in thousands):
 
Three Months Ended
 
January 30, 2016
 
January 31, 2015
Cost of revenues
$
3,154

 
$
637

General and administrative (1)
277



Amortization of intangible assets
902

 
138

Total
$
4,333

 
$
775

(1) 
The amortization is related to the $7.8 million of perpetual, nonexclusive license to certain patents purchased during the fiscal year ended October 31, 2015.
The following table presents the estimated future amortization of finite-lived intangible assets as of January 30, 2016 (in thousands):
Fiscal Year
 
Estimated
Future
Amortization
2016 (remaining nine months)
 
$
12,894

2017
 
16,757

2018
 
12,238

2019
 
8,709

2020
 
7,620

Thereafter
 
10,222

Total
 
$
68,440



11


5. Balance Sheet Details
The following tables provide details of selected balance sheet items (in thousands):
 
January 30,
2016
 
October 31,
2015
Inventories:
 
 
 
Raw materials
$
18,433

 
$
18,788

Finished goods
24,153

 
21,736

Inventories
$
42,586

 
$
40,524

 
January 30,
2016
 
October 31,
2015
Property and equipment, net:
 
 
 
Gross property and equipment
 
 
 
Computer equipment
$
16,262

 
$
14,820

Software
68,456

 
67,625

Engineering and other equipment (1)
417,183

 
407,342

Furniture and fixtures (1)
32,262

 
31,028

Leasehold improvements
35,776

 
33,986

Land and building
385,539

 
385,415

Total gross property and equipment
955,478

 
940,216

Accumulated depreciation and amortization (1), (2)
(513,320
)
 
(500,992
)
Property and equipment, net
$
442,158

 
$
439,224

(1) 
Engineering and other equipment, furniture and fixtures, and accumulated depreciation and amortization include the following amounts under capital leases as of January 30, 2016, and October 31, 2015 (in thousands):
 
January 30,
2016
 
October 31,
2015
Cost
$
1,312

 
$
1,312

Accumulated depreciation
(939
)
 
(857
)
Property and equipment, net, under capital leases
$
373

 
$
455

(2) 
The following table presents the depreciation of property and equipment included on the Company’s Condensed Consolidated Statements of Income (in thousands):
 
Three Months Ended
 
January 30,
2016
 
January 31,
2015
Depreciation expense
$
18,479

 
$
18,800


6. Fair Value Measurements
The Company applies fair value measurements for both financial and non-financial assets and liabilities. The Company does not have any non-financial assets or liabilities that are required to be measured at fair value on a recurring basis as of January 30, 2016.
The fair value accounting guidance permits companies to elect fair value measurement for many financial instruments and certain other items that are not required to be accounted for at fair value. The Company did not elect fair value measurement for any eligible financial instruments or other assets.
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.

12


During the three months ended January 30, 2016, the Company had no transfers between levels of the fair value hierarchy of its assets and liabilities measured at fair value.
Assets and liabilities measured and recorded at fair value on a recurring basis as of January 30, 2016, were as follows (in thousands):
 
 
 
Fair Value Measurements Using
 
 Balance as of
 January 30, 2016
 
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)
$
1,115,461

 
$
1,115,461

 
$

 
$

Derivative assets
212

 

 
212

 

Total assets measured at fair value
$
1,115,673

 
$
1,115,461

 
$
212

 
$

Liabilities:
 
 
 
 
 
 
 
Derivative liabilities
$
2,638

 
$

 
$
2,638

 
$

Total liabilities measured at fair value
$
2,638

 
$

 
$
2,638

 
$

(1) 
Money market funds are reported within “Cash and cash equivalents” on the Company’s Condensed Consolidated Balance Sheets.
Assets and liabilities measured and recorded at fair value on a recurring basis as of October 31, 2015, were as follows (in thousands):
 
 
 
Fair Value Measurements Using
 
 Balance as of
 October 31, 2015
 
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)
$
1,184,410

 
$
1,184,410

 
$

 
$

Derivative assets
709

 

 
709

 

Total assets measured at fair value
$
1,185,119

 
$
1,184,410

 
$
709

 
$

Liabilities:
 
 
 
 
 
 
 
Derivative liabilities
$
1,125

 
$

 
$
1,125

 
$

Total liabilities measured at fair value
$
1,125

 
$

 
$
1,125

 
$

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

7. Restructuring and Other Related Benefits
The following table provides details of “Restructuring and other related benefits” on the Company’s Condensed Consolidated Statements of Income (in thousands):
 
Three Months Ended
 
January 30,
2016
 
January 31,
2015
Lease loss reserve and related benefits
(566
)
 


13


The following table provides a reconciliation of the Company’s beginning and ending restructuring liability balances (in thousands):
 
Fiscal 2013 Fourth Quarter Restructuring Plan
 
Other Restructuring Plans
 
 
 
Severance and Benefits
 
Lease Loss Reserve and Related Costs
 
Lease Loss
Reserve and Related Costs
 
Total
Restructuring liabilities at October 31, 2015
$
110

 
$
1,811

 
$
408

 
$
2,329

Restructuring and other related benefits

 
(566
)
 

 
(566
)
Cash payments

 
(161
)
 
(91
)
 
(252
)
Translation adjustment
(2
)
 
(34
)
 

 
(36
)
Restructuring liabilities at January 30, 2016
$
108

 
$
1,050

 
$
317

 
$
1,475


 
 
 
 
 
 
 
Current restructuring liabilities at January 30, 2016
$
108

 
$
405

 
$
317

 
$
830

Non-current restructuring liabilities at January 30, 2016
$

 
$
645

 
$

 
$
645

Fiscal 2013 Fourth Quarter Restructuring Plan
During the fiscal year ended October 26, 2013, and the first quarter of fiscal year 2014, the Company restructured certain business operations and reduced the Company’s operating expense structure. The restructuring plan included a workforce reduction, as well as the cancellation of certain nonrecurring engineering agreements and exits from certain leased facilities. The restructuring plan was substantially completed in the first quarter of fiscal year 2014.
Other Restructuring Plans
The Company also recorded charges related to estimated facilities lease losses, net of expected sublease income, due to consolidation of real estate space as a result of acquisitions.
Cash payments for facilities that are part of the Company’s lease loss reserve are expected to be paid over the respective lease terms through fiscal year 2021.
General
The Company reevaluates its estimates and assumptions on a quarterly basis and makes adjustments to the restructuring liabilities balance if necessary. During the three months ended January 30, 2016, the Company reversed $0.6 million of charges related to estimated facilities lease losses due to a change in lease terms for a certain facility.

8. Borrowings
The following table provides details of the Company’s long-term debt (in thousands, except years and percentages):
 
 
 
 
 
 
January 30, 2016
 
October 31, 2015
 
 
Maturity
 
Stated Annual Interest Rate
 
Amount
Effective Interest Rate
 
Amount
Effective Interest Rate
Convertible Senior Unsecured Notes:
 
 
 
 
 
 
 
 
 
 
2020 Convertible Notes
 
2020
 
1.375%
 
$
575,000

4.98
%
 
$
575,000

4.98
%
Senior Unsecured Notes:
 
 
 
 
 
 
 
 
 
 
2023 Notes
 
2023
 
4.625%
 
300,000

4.83
%
 
300,000

4.83
%
Capital lease obligations
 
2016
 
4.625%
 
215

4.63
%
 
298

4.63
%
Total gross long-term debt
 
 
 
 
 
875,215

 
 
875,298

 
Unamortized discount
 
 
 
 
 
(74,962
)
 
 
(79,196
)
 
Unamortized debt issuance costs
 
 
 
 
 
(1,935
)
 
 
(2,025
)
 
Current portion of long-term debt
 
 
 
 
 
(215
)
 
 
(298
)
 
Long-term debt, net of current portion
 
 
 
 
 
$
798,103

 
 
$
793,779

 

14


Convertible Senior Unsecured Notes
On January 14, 2015, the Company issued $575.0 million in aggregate principal amount of 1.375% convertible senior unsecured notes due 2020 (the “2020 Convertible Notes”) pursuant to an indenture, dated as of January 14, 2015, between the Company and Wells Fargo Bank, National Association, as the trustee (the “Offering”). Net of an original issue discount, the Company received $565.7 million in proceeds from the Offering. Concurrently with the closing of the Offering, the Company called for redemption its outstanding 6.875% senior secured notes due 2020 (the “2020 Notes”) and irrevocably deposited a portion of the net proceeds from the Offering with the trustee to discharge the 2020 Indenture as described below under “Senior Secured Notes.
The 2020 Convertible Notes bear interest payable semiannually on January 1 and July 1 of each year, beginning on July 1, 2015. No payments were made toward the principal of the 2020 Convertible Notes during the three months ended January 30, 2016.
The Company separately accounts for the liability and equity components of the 2020 Convertible Notes. The fair value of the liability component, used in the allocation between the liability and equity components as of the date of issuance, was based on the present value of cash flows using a discount rate of 4.57%, the Company’s borrowing rate for a similar debt instrument without the conversion feature. The carrying values of the liability and equity components of the 2020 Convertible Notes are as follows (in thousands):
 
January 30,
2016
October 31,
2015
Principal
$
575,000

$
575,000

Unamortized discount of the liability component
(72,161
)
(76,311
)
Net carrying amount of liability component
$
502,839

$
498,689

Carrying amount of equity component
$
66,988

$
70,765

As of January 30, 2016, the remaining period of amortization for the discount is 3.92 years. The amount of interest cost recognized for amortization of the discount and for the contractual interest coupon for the 2020 Convertible Notes was $4.2 million and $2.0 million, respectively, during the three months ended January 30, 2016. The amount of interest cost recognized for amortization of the discount and for the contractual interest coupon for the 2020 Convertible Notes was $0.7 million and $0.4 million, respectively, during the three months ended January 31, 2015.
As of January 30, 2016, and October 31, 2015, the fair value of the 2020 Convertible Notes was approximately $532.8 million and $568.0 million, respectively, which was estimated based on broker trading prices.
The 2020 Convertible Notes mature on January 1, 2020, unless repurchased or converted in accordance with their terms prior to such date. The 2020 Convertible Notes are not callable prior to their maturity. The 2020 Convertible Notes are convertible into shares of common stock of the Company under the circumstances described below. The initial conversion rate is 62.7746 shares of the Company’s common stock per $1,000 principal amount of the notes, which is equal to 36.1 million shares at an initial conversion price of approximately $15.93 per share.
The 2020 Convertible Notes contain provisions where the conversion rate is adjusted upon the occurrence of certain events, including if the Company pays a regular, quarterly cash dividend in an amount greater than $0.035 per share. During the first fiscal quarter of 2016, the Board of Directors of the Company declared and paid a cash dividend in the amount of $0.045 per share. Accordingly, as of December 8, 2015, the conversion rate was adjusted to a rate of 62.9573 shares of the Company’s common stock per $1,000 principal amount of the notes, which is equal to 36.2 million shares at a conversion price of approximately $15.88 per share. However, because the adjustment resulted in a change to the conversion rate of less than 1%, as is allowed by the terms of the indenture governing the 2020 Convertible Notes, the Company elected to defer the administration and noteholder notification of such adjustment until the occurrence of (i) a subsequent adjustment to the conversion rate that results in a cumulative adjustment of at least 1% of the current conversion rate, (ii) the conversion of any 2020 Convertible Note, or (iii) certain other events requiring the adjustment to be made under the indenture governing the 2020 Convertible Notes.
Holders of the 2020 Convertible Notes may convert all or a portion of their notes prior to the close of business on the business day immediately preceding September 1, 2019, in multiples of $1,000 principal amount, only under the following circumstances:
During any fiscal quarter commencing after the fiscal quarter ending on May 2, 2015 (and only during such fiscal quarter), if the last reported sale price of the Company’s common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter is greater than or equal to 130% of the conversion price of the notes on each applicable trading day;

15


During the five-business-day period after any 10 consecutive trading day period in which the trading price per $1,000 principal amount of the notes for each trading day of that 10 consecutive trading day period was less than 98% of the product of the last reported sale price of the Company’s common stock and the conversion rate of the notes on each such trading day; or
Upon the occurrence of certain corporate events as specified in the terms of the indenture governing the 2020 Convertible Notes.
On or after September 1, 2019, to the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert all or any portion of their notes regardless of the foregoing conditions.
As of January 30, 2016, the circumstances for conversion had not been triggered, and the 2020 Convertible Notes were not convertible. The if-converted value of the 2020 Convertible Notes as of January 30, 2016, did not exceed the principal amount of the 2020 Convertible Notes.
If a fundamental change, as specified in the terms of the indenture governing the 2020 Convertible Notes, occurs prior to the maturity date, holders of the notes may require the Company to repurchase the 2020 Convertible Notes at a repurchase price equal to 100% of the principal amount of the 2020 Convertible Notes repurchased, plus accrued and unpaid interest, if any, up to the repurchase date. As of January 30, 2016, a fundamental change had not occurred and the 2020 Convertible Notes were not re-purchasable.
Convertible Note Hedge and Warrants Related to the Convertible Senior Unsecured Notes
In connection with the issuance of the 2020 Convertible Notes, the Company entered into convertible note hedge transactions with certain financial institutions (the “counterparties”) with respect to its common stock. Upon conversion of the 2020 Convertible Notes, the convertible note hedge transactions give the Company the right to acquire from the counterparties, subject to anti-dilution adjustments substantially similar to those in the 2020 Convertible Notes, initially approximately 36.1 million shares of the Company’s common stock at an initial strike price of $15.93 per share. Because a dividend in an amount greater than $0.035 per share was declared and paid effective beginning in the third fiscal quarter of 2015, the strike price under the convertible note hedge transactions has been adjusted to approximately $15.88 per share as of December 8, 2015. The convertible note hedge transactions are expected generally to reduce the potential common stock dilution and/or offset potential cash payments in excess of the principal amount of converted notes upon conversion of the notes in the event that the market price per share of the Company’s common stock, as measured under the terms of the convertible note hedge transactions, is greater than the strike price of the convertible note hedge transactions. The convertible note hedge transactions will be terminated on the maturity date of the 2020 Convertible Notes or earlier under certain circumstances. The $86.1 million cost of the convertible note hedge transactions has been accounted for as an equity transaction.
Separately from the convertible note hedge transactions, the Company entered into warrant transactions with the counterparties, pursuant to which the Company sold warrants to the counterparties to acquire, subject to customary anti-dilution adjustments, up to 36.1 million shares in the aggregate at an initial strike price of $20.65 per share. The primary reason the Company entered into these warrant transactions was to partially offset the cost of the convertible note hedge transactions. The warrants mature over 60 trading days, commencing on April 1, 2020, and are exercisable solely on the maturity dates. The warrants are subject to net share settlement; however, the Company may elect to cash settle the warrants. The Company received gross proceeds of $51.2 million from the warrant transactions, which have been accounted for as an equity transaction.
Under the terms of the warrants, the strike price and number of shares to be acquired by the holders of the warrants are adjusted if the Company pays a regular, quarterly cash dividend in an amount greater than $0.035 per share. Accordingly, the terms of the warrants were adjusted to reflect the payment of a cash dividend in the amount of $0.045 per share beginning in the third fiscal quarter of 2015, and, as of December 8, 2015, the holders of the warrants have the right to acquire up to approximately 36.2 million shares of the Company’s common stock at a strike price of approximately $20.59 per share.
See Note 15, “Net Income per Share,” of the Notes to Condensed Consolidated Financial Statements for further discussion of the dilutive impact of the 2020 Convertible Notes and the convertible note hedge and warrant transactions.
Senior Unsecured Notes
In January 2013, the Company issued 4.625% senior unsecured notes in the aggregate principal amount of $300.0 million due 2023 (the “2023 Notes”) pursuant to an indenture, dated as of January 22, 2013 (the “2023 Indenture”), between the Company, certain domestic subsidiaries of the Company that have guaranteed the Company’s obligations under the 2023 Notes, and Wells Fargo Bank, National Association, as the trustee. The guarantees of the 2023 Notes were released upon the termination of the Senior Secured Credit Facility and discharge of the 2020 Indenture in the first fiscal quarter of 2015.
The 2023 Notes bear interest payable semiannually on January 15 and July 15 of each year. No payments were made toward the principal of the 2023 Notes during the three months ended January 30, 2016.

16


As of January 30, 2016, and October 31, 2015, the fair value of the 2023 Notes was approximately $289.0 million and $293.9 million, respectively, which was estimated based on broker trading prices.
On or after January 15, 2018, the Company may redeem all or part of the 2023 Notes at the redemption prices set forth in the 2023 Indenture, plus accrued and unpaid interest, if any, up to the redemption date. At any time prior to January 15, 2018, the Company may redeem all or a part of the 2023 Notes at a price equal to 100% of the principal amount of the 2023 Notes, plus an applicable premium and accrued and unpaid interest, if any, up to the redemption date. In addition, at any time prior to January 15, 2016, the Company may redeem up to 35% of the principal amount of the 2023 Notes, using the net cash proceeds of one or more sales of the Company’s capital stock, at a redemption price equal to 104.625% of the principal amount of the 2023 Notes redeemed, plus accrued and unpaid interest, if any, up to the redemption date.
If the Company experiences a specified change of control triggering event, it must offer to repurchase the 2023 Notes at a repurchase price equal to 101% of the principal amount of the 2023 Notes repurchased, plus accrued and unpaid interest, if any, up to the repurchase date.
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 subsidiaries guaranteeing the 2023 Notes on a pari passu basis; and
Enter into certain consolidation or merger transactions, or convey, transfer, or lease all or substantially all of the Company’s or its subsidiaries’ assets.
These covenants are subject to a number of limitations and exceptions as set forth in the 2023 Indenture. The 2023 Indenture also includes customary events of default, including cross-defaults to other debt of the Company and its subsidiaries.
Senior Secured Notes
In January 2010, the Company issued $300.0 million in aggregate principal amount of the 2020 Notes pursuant to an indenture, dated as of January 20, 2010, between the Company, certain domestic subsidiaries of the Company, and Wells Fargo Bank, National Association, as the trustee (the “2020 Indenture”). Interest on the 2020 Notes was payable semiannually on January 15 and July 15 of each year. The Company’s obligations under the 2020 Notes were previously guaranteed by certain of the Company’s domestic subsidiaries and secured by a lien on substantially all of the Company’s and the subsidiary guarantors’ assets.
On January 14, 2015, the Company called the 2020 Notes for redemption at a redemption price equal to 103.438% of the principal amount of the 2020 Notes, and irrevocably deposited $322.2 million with the trustee for the 2020 Notes to discharge the 2020 Indenture. Due to the deposit and discharge, the guarantees provided by certain of the Company’s domestic subsidiaries, and the liens granted by the Company and the subsidiary guarantors to secure their obligations with respect to the 2020 Notes, were released as of the date of the deposit.
The amount deposited with the trustee included $300.0 million to repay the principal amount of the 2020 Notes, $10.3 million representing the difference between the redemption price and the principal amount of the 2020 Notes (“Call Premium”), $10.3 million for accrued interest through January 15, 2015, and $1.6 million of interest payable up to the redemption date of February 13, 2015. The trustee redeemed the 2020 Notes on February 13, 2015, using the deposited amount, extinguishing the Company’s $300.0 million liability for the principal amount of the 2020 Notes.
In accordance with the applicable accounting guidance for debt modification and extinguishment, and for interest costs accounting, the Company expensed the Call Premium, remaining debt issuance costs, and remaining original issue discount relating to the 2020 Notes in the first quarter of fiscal year 2015, which totaled $20.4 million. The Company reported this expense within “Interest expense” on the Company’s Condensed Consolidated Statements of Income for the three months ended January 31, 2015.

17


Debt Maturities
As of January 30, 2016, the Company’s aggregate debt maturities based on outstanding principal were as follows (in thousands):
Fiscal Year
 
Principal
Balances
2016 (remaining nine months)
 
$
215

2017
 

2018
 

2019
 

2020
 
575,000

Thereafter
 
300,000

Total
 
$
875,215


9. Commitments and Contingencies
Product Warranties
The Company’s accrued liability for estimated future warranty costs is included in “Other accrued liabilities” in the accompanying Condensed Consolidated Balance Sheets. The following table summarizes the activity related to the Company’s accrued liability for estimated future warranty costs during the three months ended January 30, 2016, and January 31, 2015 (in thousands):
 
Accrued Warranty
 
Three Months Ended
 
January 30,
2016
 
January 31,
2015
Beginning balance
$
7,599

 
$
7,486

Liabilities accrued for warranties issued during the period
978

 
1,262

Warranty claims paid and used during the period
(1,144
)
 
(1,114
)
Changes in liability for pre-existing warranties during the period
(225
)
 
(446
)
Ending balance
$
7,208

 
$
7,188

In addition, the Company has defense and indemnification clauses contained within its various customer contracts. As such, the Company indemnifies the parties to whom it sells its products with respect to the Company’s products, both alone and in certain circumstances when in combination with other products and services, for infringement of 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 January 30, 2016, 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 its CMs under which Brocade provides 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. In addition, Brocade has an arrangement with one of its CMs regarding factory capacity that can be used by the Company. Under this arrangement, the Company receives a credit for exceeding the planned utilization of factory capacity and, conversely, is required to pay additional fees for under-utilizing the planned capacity.
As of January 30, 2016, the Company’s aggregate commitment to its CMs for inventory components used in the manufacture of Brocade products was $174.0 million, which the Company expects to utilize during future normal ongoing operations, net of a purchase commitments reserve of $1.4 million, which is reported within “Other accrued liabilities” on the Company’s Condensed Consolidated Balance Sheet as of January 30, 2016. The Company’s purchase commitments reserve reflects the Company’s estimate of purchase commitments it does not expect to utilize in normal ongoing operations.

18


Income Taxes
The Company is subject to several ongoing income tax audits and has received notices of proposed adjustments or assessments from certain tax authorities. For additional discussion, see Note 13, “Income Taxes,” of the Notes to Condensed Consolidated Financial Statements. The Company believes it has adequate reserves for all open tax years.
Legal Proceedings
From time to time, the Company is subject to various legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business, including claims of alleged infringement of patents and/or other intellectual property rights and commercial and employment contract disputes. While the outcome of these matters cannot be predicted with certainty, the Company does not believe that the outcome of any of these matters, individually or in the aggregate, will result in losses that are materially in excess of amounts already accrued by the Company.

10. Derivative Instruments and Hedging Activities
In the normal course of business, the Company is exposed to fluctuations in interest rates and the exchange rates associated with foreign currencies. The Company’s primary objective for holding derivative financial instruments is to manage foreign currency exchange rate risk. The Company currently does not manage its exposure to credit risk by entering into derivative instruments. However, the Company manages its exposure to credit risk through its investment policies. As part of these investment policies, the Company generally enters into transactions with high-credit quality counterparties and, by policy, limits the amount of credit exposure to any one counterparty based on its analysis of that counterparty’s relative credit standing.
The amounts subject to credit risk related to derivative instruments are generally limited to the amounts, if any, by which a counterparty’s obligations exceed the Company’s obligations with that counterparty.
Foreign Currency Exchange Rate Risk
A majority of the Company’s revenue, expense, and capital purchasing activities are transacted in U.S. dollars. However, the Company is exposed to foreign currency exchange rate risk inherent in conducting business globally in numerous currencies. The Company is primarily exposed to foreign currency fluctuations related to operating expenses denominated in currencies other than the U.S. dollar, of which the most significant to its operations for the three months ended January 30, 2016, were the British pound, the euro, the Indian rupee, the Chinese yuan, the Singapore dollar, the Swiss franc, and the Japanese yen. The Company has established a foreign currency risk management program to protect against the volatility of future cash flows caused by changes in foreign currency exchange rates. This program reduces, but does not eliminate, the impact of foreign currency exchange rate movements.
The Company utilizes a rolling hedge strategy for the majority of its foreign currency derivative instruments to hedge 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. The Company’s foreign currency risk management program includes foreign currency derivatives with a 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 15 months. For these derivatives, the Company initially reports the after-tax gain or loss from the effective portion of the hedge as a component of accumulated other comprehensive loss in stockholders’ equity and reclassifies it into earnings in the same period in which the hedged transaction affects earnings. The tax effect allocated to cash flow hedge-related components of other comprehensive loss was not significant for the three months ended January 30, 2016, and January 31, 2015.
Ineffective cash flow hedges are included in the Company’s net income as part of “Interest and other income (loss), net.” The amount recorded on ineffective cash flow hedges was not significant for the three months ended January 30, 2016, and January 31, 2015.

19


Net losses relating to the effective portion of foreign currency derivatives recorded in the Company’s Condensed Consolidated Statements of Income are as follows (in thousands):
 
Three Months Ended
 
January 30, 2016
 
January 31, 2015
Cost of revenues
$
(94
)
 
$
(136
)
Research and development
(199
)
 
(35
)
Sales and marketing
(374
)
 
(454
)
General and administrative
(27
)
 
(58
)
Total
$
(694
)
 
$
(683
)
Alternatively, the Company may choose not to hedge the foreign currency risk associated with its foreign currency exposures if the Company believes such exposure acts as a natural foreign currency hedge for other offsetting amounts denominated in the same currency or if the currency is difficult or too expensive to hedge.
The net foreign currency exchange gains and losses recorded as part of “Interest and other income (loss), net” were losses of $0.3 million and $1.0 million for the three months ended January 30, 2016, and January 31, 2015, respectively.
As of January 30, 2016, the Company had gross unrealized loss positions of $2.6 million and gross unrealized gain positions of $0.2 million included in “Other accrued liabilities” and “Prepaid expenses and other current assets,” respectively.
Volume of Derivative Activity
All derivatives are designated as hedging instruments as of January 30, 2016, and October 31, 2015. Total gross notional amounts, presented by currency, are as follows (in thousands):
 
Derivatives Designated
as Hedging Instruments
In U.S. dollars
January 30, 2016
 
October 31, 2015
British pound
$
32,080

 
$
46,330

Euro
30,249

 
40,961

India rupee
25,837

 
35,647

Chinese yuan
10,954

 
15,129

Singapore dollar
9,830

 
13,745

Swiss franc
6,708

 
9,265

Japanese yen
6,592

 
8,809

Total
$
122,250

 
$
169,886


11. Stock-Based Compensation
Stock-based compensation expense, net of estimated forfeitures, is included in the following line items of the Company’s Condensed Consolidated Statements of Income as follows (in thousands):
 
Three Months Ended
 
January 30, 2016
 
January 31, 2015
Cost of revenues
$
2,905

 
$
3,816

Research and development
5,476

 
4,933

Sales and marketing
11,078

 
9,843

General and administrative
4,585

 
5,490

Total stock-based compensation expense
$
24,044

 
$
24,082

 

20


The following table presents stock-based compensation expense, net of estimated forfeitures, by grant type (in thousands):
 
Three Months Ended
 
January 30, 2016
 
January 31, 2015
Stock options
$
729

 
$
1,356

RSUs, including restricted stock units with market conditions
19,793

 
17,934

Employee stock purchase plan (“ESPP”)
3,522

 
4,792

Total stock-based compensation expense
$
24,044

 
$
24,082

The following table presents the unrecognized compensation expense, net of estimated forfeitures, by grant type and the related weighted-average periods over which this expense is expected to be recognized as of January 30, 2016 (in thousands, except for the weighted-average period):
 
Unrecognized
Compensation
Expense
 
Weighted-
Average Period
(In years)
Stock options
$
1,820

 
0.99
RSUs, including restricted stock units with market conditions
$
121,904

 
1.99
ESPP
$
10,009

 
1.08
The following table presents details on grants made by the Company for the following periods:
 
Three Months Ended
 
January 30, 2016
 
January 31, 2015
 
Granted
(Shares in thousands)
 
Weighted-Average
Grant Date Fair Value
 
Granted
(Shares in thousands)
 
Weighted-Average
Grant Date Fair Value
Stock options

 
$

 
1,117

 
$
3.09

RSUs, including stock units with market conditions
3,476

 
$
7.96

 
3,641

 
$
10.87

The total intrinsic value of stock options exercised for the three months ended January 30, 2016, and January 31, 2015, was $0.1 million and $1.0 million, respectively.

12. Stockholders’ Equity
Dividends
During the three months ended January 30, 2016, the Company’s Board of Directors declared the following dividends (in thousands, except per share amounts):
Declaration Date
 
Dividend per Share
 
Record Date
 
Total Amount Paid
 
Payment Date
November 22, 2015
 
$
0.045

 
December 10, 2015
 
$
18,429

 
January 4, 2016
Future dividends are subject to review and approval on a quarterly basis by the Company’s Board of Directors or a committee thereof.
Convertible Note Hedge and Warrants Related to the Convertible Senior Unsecured Notes
In connection with the issuance of the 2020 Convertible Notes, the Company entered into convertible note hedge and warrant transactions with certain financial institutions with respect to its common stock. See Note 8, “Borrowings,” of the Notes to Condensed Consolidated Financial Statements for further discussion.

21


Accumulated Other Comprehensive Loss
The components of other comprehensive loss and related tax effects for the three months ended January 30, 2016, and January 31, 2015, are as follows (in thousands):
 
Three Months Ended
 
January 30, 2016
 
January 31, 2015
 
Before-Tax Amount
 
Tax (Expense) Benefit
 
Net-of-Tax Amount
 
Before-Tax Amount
 
Tax (Expense) Benefit
 
Net-of-Tax Amount
Unrealized gains (losses) on cash flow hedges:
 
 
 
 
 
 
 
 
 
 
 
Change in unrealized gains and losses, foreign exchange contracts
$
(2,413
)
 
$
113

 
$
(2,300
)
 
$
(2,179
)
 
$
405

 
$
(1,774
)
Net gains and losses reclassified into earnings, foreign exchange contracts (1)
694

 
(68
)
 
626

 
683

 
(80
)
 
603

Net unrealized gains (losses) on cash flow hedges
(1,719
)
 
45

 
(1,674
)
 
(1,496
)
 
325

 
(1,171
)
Foreign currency translation adjustments
(2,203
)
 

 
(2,203
)
 
(4,221
)
 

 
(4,221
)
Total other comprehensive loss
$
(3,922
)
 
$
45

 
$
(3,877
)
 
$
(5,717
)
 
$
325

 
$
(5,392
)
(1)
For Condensed Consolidated Statements of Income classification of amounts reclassified from accumulated other comprehensive loss, see Note 10, “Derivative Instruments and Hedging Activities,” of the Notes to Condensed Consolidated Financial Statements.
The changes in accumulated other comprehensive loss by component, net of tax, for the three months ended January 30, 2016, and January 31, 2015, are as follows (in thousands):
 
Three Months Ended
 
January 30, 2016
 
January 31, 2015
 
Losses on Cash Flow Hedges

Foreign Currency Translation Adjustments

Total Accumulated Other Comprehensive Loss

Losses on Cash Flow Hedges

Foreign Currency Translation Adjustments

Total Accumulated Other Comprehensive Loss
Beginning balance
$
(1,539
)
 
$
(23,463
)
 
$
(25,002
)
 
$
(1,907
)
 
$
(16,907
)
 
$
(18,814
)
Change in unrealized gains and losses
(2,300
)
 
(2,203
)
 
(4,503
)
 
(1,774
)
 
(4,221
)
 
(5,995
)
Net gains and losses reclassified into earnings
626

 

 
626

 
603

 

 
603

Net current-period other comprehensive loss
(1,674
)
 
(2,203
)
 
(3,877
)
 
(1,171
)
 
(4,221
)
 
(5,392
)
Ending balance
$
(3,213
)
 
$
(25,666
)
 
$
(28,879
)
 
$
(3,078
)
 
$
(21,128
)
 
$
(24,206
)

13. Income Taxes
In general, the Company’s provision for income taxes differs from the tax computed at the U.S. federal statutory tax rate due to state taxes, the effect of non-U.S. operations being taxed at rates lower than the U.S. federal statutory tax rate, nondeductible stock-based compensation expense, tax credits, and adjustments to unrecognized tax benefits. Earnings of the Company’s subsidiaries outside of the United States primarily relate to its European and Asia Pacific businesses.
The effective tax rate for the three months ended January 30, 2016, was lower than the U.S. federal statutory tax rate of 35% and lower compared with the three months ended January 31, 2015, primarily due to the benefits from the domestic manufacturing deduction, which was not available for the three months ended January 31, 2015, and the federal research and development tax credit, which was permanently reinstated retroactive to January 1, 2015, by the passage of the Protecting Americans from Tax Hikes Act of 2015. The Company recorded a discrete benefit related to the research and development credit which reduced the Company’s effective tax rate for the three months ended January 30, 2016, and a benefit reducing the effective annual tax rate for fiscal year 2016.
The Company’s total gross unrecognized tax benefits, excluding interest and penalties, were $126.6 million as of January 30, 2016. If the total gross unrecognized tax benefits as of January 30, 2016, were recognized in the future, approximately $87.4 million would decrease the Company’s effective tax rate.

22


The IRS and other tax authorities regularly examine the Company’s income tax returns. In October 2014, the IRS issued a Revenue Agent’s Report related to its field examination of the Company’s federal income tax returns for fiscal years 2009 and 2010. The IRS is contesting certain assumptions used to support the Company’s transfer pricing with its foreign subsidiaries. In November 2014, the Company filed a protest to challenge the proposed adjustment, and in March 2015, the issue was moved to the Office of Appeals. In addition, in October 2014, the Geneva Tax Administration issued its final assessments for fiscal years 2003 to 2012, disputing certain of the Company’s transfer pricing arrangements. In November 2014, the Company filed a protest to challenge the final assessments. The Company believes that reserves for unrecognized tax benefits are adequate for all open tax years. The timing of income tax examinations, as well as the amounts and timing of related settlements, if any, are highly uncertain. Before the end of fiscal year 2016, it is reasonably possible that either certain audits will conclude or the statutes of limitations relating to certain income tax examination periods will expire, or both. After the Company reaches settlement with the tax authorities, the Company expects to record a corresponding adjustment to its unrecognized tax benefits. Taking into consideration the inherent uncertainty as to settlement terms, the timing of payments, and the impact of such settlements on the uncertainty in income taxes, the Company estimates the range of potential decreases in underlying uncertainty in income tax is between $0 and $4 million in the next 12 months.

14. Segment Information
Operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly by the Chief Operating Decision Maker (“CODM”), or decision-making group, in deciding how to allocate resources and in assessing performance. Financial decisions and the allocation of resources are based on the information from the Company’s internal management reporting system. Currently, the Company’s CODM is its Chief Executive Officer.
Brocade is organized into three operating segments, each of which is an individually reportable segment: SAN Products, IP Networking Products, and Global Services. These reportable segments are organized principally by product category.
At this time, the Company does not track its operating expenses by operating segments because management does not consider this information in its measurement of the performance of the operating segments. The Company also does not track all of its assets by operating segments. The majority of the Company’s assets as of January 30, 2016, were attributable to its U.S. operations.
Summarized financial information by reportable segment for the three months ended January 30, 2016, and January 31, 2015, based on the internal management reporting system, is as follows (in thousands):
 
SAN Products
 
IP Networking Products
 
Global Services
 
Total
Three months ended January 30, 2016
 
 
 
 
 
 
 
Net revenues
$
347,058

 
$
134,109

 
$
93,117

 
$
574,284

Cost of revenues
81,204

 
62,893

 
41,372

 
185,469

Gross margin
$
265,854

 
$
71,216

 
$
51,745

 
$
388,815

Three months ended January 31, 2015
 
 
 
 
 
 
 
Net revenues
$
353,399

 
$
132,839

 
$
90,001

 
$
576,239

Cost of revenues
85,725

 
64,201

 
36,630

 
186,556

Gross margin
$
267,674

 
$
68,638

 
$
53,371

 
$
389,683



23


15. 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
 
January 30,
2016
 
January 31,
2015
Basic net income per share
 
 
 
Net income
$
93,646

 
$
87,267

Weighted-average shares used in computing basic net income per share
407,902

 
428,536

Basic net income per share
$
0.23

 
$
0.20

Diluted net income per share
 
 
 
Net income
$
93,646

 
$
87,267

Weighted-average shares used in computing basic net income per share
407,902

 
428,536

Dilutive potential common shares in the form of stock options
1,332

 
1,734

Dilutive potential common shares in the form of other share-based awards
5,851

 
8,886

Weighted-average shares used in computing diluted net income per share
415,085

 
439,156

Diluted net income per share
$
0.23

 
$
0.20

Antidilutive potential common shares in the form of: (1)
 
 
 
Warrants issued in conjunction with the 2020 Convertible Notes (2)
36,200

 
7,140

Stock options
1,874

 
577

Other share-based awards
984

 

(1) 
These amounts are excluded from the computation of diluted net income per share.
(2) 
In connection with the issuance of the 2020 Convertible Notes, the Company entered into convertible note hedge and warrant transactions as described in Note 8, “Borrowings.” The 2020 Convertible Notes have no impact on diluted earnings per share until the average quarterly price of the Company’s common stock exceeds the adjusted conversion price of $15.88 per share. If the common stock price exceeds this adjusted conversion price, then, prior to conversion, the Company will calculate the effect of the additional shares that may be issued using the treasury stock method. If the average price of the Company’s common stock exceeds $20.59 per share for a quarterly period, the Company’s weighted-average shares used in computing diluted net income per share will be impacted by the effect of the additional potential shares that may be issued related to the warrants using the treasury stock method. The convertible note hedge is not considered for purposes of the diluted earnings per share calculation, as its effect would be antidilutive.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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 22, 2015. 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 “expects,” “anticipates,” “assumes,” “targets,” “projects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “continues,” “may,” “should,” “could,” and variations of such words and similar expressions. 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.


24


Overview
We are a leading supplier of networking hardware, software, and services for businesses and organizations of various types and sizes. Our end customers include global enterprises and other organizations that use our products and services as part of their communications infrastructure and service providers, such as telecommunication firms, cable operators, and mobile carriers that use our products and services as part of their commercial operations. Our business model is focused on two key markets: Storage Area Networking (“SAN”), where we offer our SAN products, including modular directors, fixed-configuration and embedded switches, as well as network management and monitoring capabilities; and Internet Protocol (“IP”) Networking, where we offer IP routers, Ethernet switches, network security, analytics, and monitoring, as well as products used to manage application delivery. Our IP Networking products are available in modular and fixed hardware-based form factors and can be deployed in both traditional network and next-generation fabric designs. Our IP Networking products also include a range of virtualized network software offerings, including a virtual routing software suite and application delivery controller and load balancer offerings. In addition, for mobile service providers, our products include a virtual evolved packet core (“vEPC”) solution and a software analytics probe and application monitoring application. We also provide product-related customer support and services in both our SAN business and IP Networking business.
Key customer information technology (“IT”) initiatives, such as virtualization, enterprise mobility, data center consolidation, cloud computing, and migration to higher-performance technologies, such as solid state storage, continue to rely on our mission-critical SAN-based solutions. We are known as a storage networking innovator and have a leading SAN market share position. Our SAN business strategy is to continue to expand and diversify our partner base and introduce new, innovative solutions for both our large installed base and potential new customers. During the past fiscal year, we added several new SAN partners, expanded relationships with existing partners, and introduced new products, such as the Brocade Analytics Monitoring Platform. This new platform provides customers the ability to improve operational performance, stability, and security within their storage environments.
Our IP Networking business strategies are intended to increase new customer accounts and expand our current market share through product innovations, such as our Ethernet fabric switches and virtualized software networking products (also known as software-defined networking (“SDN”), network functions virtualization (“NFV”), and network visibility and analytics (“NVA”)), and the development and expansion of our routes to market. Success of our IP Networking business, 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 software networking product revenues have not been material to date, there is customer interest in software networking products, 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 growth strategy with continuous innovation, leveraging the strategic investments we have made in our core businesses, developing emerging technologies such as SDN, NFV, and NVA, introducing new products, making strategic acquisitions, and enhancing our existing partnerships and forming new partnerships through our various distribution channels.
We continue to face multiple challenges, including aggressive price discounting from competitors, new product introductions from competitors, and rapid adoption of new technologies by customers, as our industry transitions from network architectures based solely on specialized networking hardware to new architectures based on software, servers, and a mix of proprietary and commodity networking hardware. We also continue to be affected by worldwide macroeconomic conditions, and face the possibility that these conditions could deteriorate and create a more cautious capital spending environment in the IT sector. In addition, U.S. federal customers are important to our business, and spending by the U.S. government can be variable and difficult to predict. We are also cautious about the stability and health of certain international markets and current global and country-specific dynamics, such as the drop in the value of the euro and the Chinese yuan versus the U.S. dollar in the past fiscal year, slowing economic growth in China, and Russia-related geopolitical uncertainty. These factors may impact our business and those of our partners. Our diversified portfolio of products helps mitigate the effect of some of these challenges, and we expect IT spending levels to generally rise in the long term. In addition, we are making investments in software offerings and people with software-oriented skill sets to adapt as the market transitions. However, it is difficult for us to offset the effects of short-term reductions in IT spending.
We expect our SAN and IP Networking revenues to fluctuate depending on the demand for our existing and future products and services, and the quality of the sales support for our products and services from our distribution and reseller partners, as well as the timing of product transitions by our original equipment manufacturer (“OEM”) partners. The average selling prices per port for our SAN and IP Networking products have typically declined over time, unless impacted favorably by a new product introduction or product mix, and will likely decline in the future.

25


We continue to expand our software networking capabilities through technology innovation and strategic acquisitions. In September 2014, we completed an acquisition that enhances our leadership in NFV technology and gives us a new market to address with visibility and analytics solutions for mobile operators. In March 2015, we completed two acquisitions, in which we acquired a virtual application delivery controller (“vADC”) software product line and a vEPC software product line, respectively. The acquired vADC software expands our NFV portfolio and addresses the needs of service providers and enterprise accounts. The acquired vEPC software, which has formed the basis for a mobility platform for building open, next-generation networks, primarily addresses emerging mobile applications and services, including advanced mobile virtual network operators and enterprise mobile services, like mobile virtual private networks. In addition to these acquisitions, in April 2015, we launched a portfolio of IP Networking products designed specifically to support IP storage deployments.
Our plans for our operating cash flows are to provide liquidity for operations, capital investment, and other strategic initiatives, including investments and acquisitions to strengthen our networking portfolios, and to return capital to stockholders in the form of stock repurchases and cash dividends. In September 2015, we reconfirmed our intent to return at least 60% of our annual adjusted free cash flow to stockholders in the form of stock repurchases or dividends. We define adjusted free cash flow as operating cash flow, adjusted for the impact of the excess tax benefits from stock-based compensation, less capital expenditures. In the first quarter of fiscal year 2016, our Board of Directors declared and paid a quarterly cash dividend of $0.045 per share of our common stock for a total of $18.4 million. On February 16, 2016, our Board of Directors declared a quarterly cash dividend of $0.045 per share of our common stock to be paid on April 4, 2016, to stockholders of record as of the close of market on March 10, 2016. Future dividend payments are subject to review and approval on a quarterly basis by our Board of Directors.

Overview of Financial Results
The following table provides an overview of some of our financial results (in thousands, except percentages):
 
Three Months Ended
 
January 30,
2016
 
January 31,
2015
Total net revenues
$
574,284

 
$
576,239

Gross margin
$
388,815

 
$
389,683

Gross margin, as a percentage of total net revenues
67.7
%
 
67.6
%
Income from operations
$
120,966

 
$
139,405

Income from operations, as a percentage of total net revenues
21.1
%
 
24.2
%
Net income
$
93,646

 
$
87,267



26


Results of Operations
Our results of operations for the three months ended January 30, 2016, and January 31, 2015, are reported in this discussion and analysis as a percentage of total net revenues, except for gross margin with respect to each reportable segment, which is indicated as a percentage of the respective reportable 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




 
January 30, 2016
 
January 31, 2015
 
 
 
 

Net Revenues

% of Net
Revenues

Net Revenues

% of Net
Revenues

Increase/(Decrease)

%
Change
SAN Products
$
347,058


60.4
%

$
353,399


61.3
%

$
(6,341
)

(1.8
)%
IP Networking Products
134,109


23.4
%

132,839


23.1
%

1,270


1.0
 %
Global Services
93,117


16.2
%

90,001


15.6
%

3,116


3.5
 %
Total net revenues
$
574,284


100.0
%

$
576,239


100.0
%

$
(1,955
)

(0.3
)%
The decrease in total net revenues for the three months ended January 30, 2016, compared with the three months ended January 31, 2015, reflects lower sales for our SAN products, partially offset by higher sales for our Global Services offerings and IP Networking products, as further described below.
The decrease in SAN product revenues was caused by a decrease in embedded and fixed-configuration switch product revenues, primarily due to softer industry storage demand, partially offset by an increase in director product revenues primarily due to continued demand for modular directors, which provide higher performance, port density, and scalability than fixed-configuration switches. The number of ports shipped decreased by 8.4% during the three months ended January 30, 2016, due to the decrease in embedded and fixed-configuration switch sales, the effect of which was partially offset by a 7.2% increase in the average selling price per port due to a shift in product mix towards more feature-rich director products;
The increase in IP Networking product revenues primarily reflects higher revenues from our campus switching products, partly due to the increased revenue generated by the U.S federal government funding technology improvements for schools, commonly known as the E-Rate program, as well as higher software networking revenues. This increase was partially offset by a decrease in data center routing and switching product revenues primarily due to weaker demand from large network carrier and federal customers. Software networking revenues increased due to the vADC software product line acquired in the second quarter of fiscal year 2015 and increased usage of our virtual routers by cloud service providers; and
The increase in Global Services revenues was primarily due to an increase in initial and renewal support contracts related to our vADC software product line acquired in the second quarter of fiscal year 2015, an increase in renewal support contracts for our SAN products, and an increase in IP Networking professional services revenues.

Our total net revenues by geographic area are summarized as follows (in thousands, except percentages):

Three Months Ended




 
January 30, 2016
 
January 31, 2015
 
 
 
 

Net Revenues

% of Net
Revenues

Net Revenues

% of Net
Revenues

Increase/(Decrease)

%
Change
United States (“U.S.”)
$
316,351


55.1
%

$
331,094


57.5
%

$
(14,743
)

(4.5
)%
Europe, the Middle East and Africa (1)
153,055


26.6
%

160,568


27.9
%

(7,513
)

(4.7
)%
Asia Pacific
66,578


11.6
%

54,925


9.5
%

11,653


21.2
 %
Japan
24,585


4.3
%

20,332


3.5
%

4,253


20.9
 %
Canada, Central and South America
13,715


2.4
%

9,320


1.6
%

4,395


47.2
 %
Total net revenues
$
574,284


100.0
%

$
576,239


100.0
%

$
(1,955
)

(0.3
)%
(1) 
Includes net revenues of $104.2 million and $110.8 million for the three months ended January 30, 2016, and the three months ended January 31, 2015, respectively, relating to the Netherlands.

27


Revenues are attributed to geographic areas based on where our products are shipped. However, certain OEM partners take possession of our products domestically and then distribute these products to their international customers. Because we account for all of those OEM revenues as domestic revenues, we cannot be certain of the extent to which our domestic and international revenue mix is impacted by the logistics practices of our OEM partners, but the end-user location data that is available 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 months ended January 30, 2016, increased to 44.9% as a percentage of total net revenues compared with 42.5% for the three months ended January 31, 2015, primarily due to a shift in OEM customer mix for our SAN products.
A significant portion of our revenues is concentrated among a relatively small number of OEM customers. For the three months ended January 30, 2016, two customers individually accounted for 20% and 14% of our total net revenues for a combined total of 34% of total net revenues. For the three months ended January 31, 2015, three customers individually accounted for 20%, 14%, and 10% of our total net revenues for a combined total of 44% 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 reportable 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
 
 
 
 
 
January 30, 2016
 
January 31, 2015
 
 
 
 
 
Gross Margin
 
% of Net
Revenues
 
Gross Margin
 
% of Net
Revenues
 
Increase/(Decrease)
 
% Points
Change
SAN Products
$
265,854

 
76.6
%
 
$
267,674

 
75.7
%
 
$
(1,820
)
 
0.9
 %
IP Networking Products
71,216

 
53.1
%
 
68,638

 
51.7
%
 
2,578

 
1.4
 %
Global Services
51,745

 
55.6
%
 
53,371

 
59.3
%
 
(1,626
)
 
(3.7
)%
Total gross margin
$
388,815

 
67.7
%
 
$
389,683

 
67.6
%
 
$
(868
)
 
0.1
 %
The changes in gross margin percentage for each reportable segment for the three months ended January 30, 2016, compared with the three months ended January 31, 2015, were primarily due to the following factors (the percentages below reflect the impact on gross margin):
SAN gross margins relative to net revenues increased 0.7% due to product cost reductions, as well as a more favorable mix of SAN products as the mix shifted towards director products, which, being more feature-rich, carry a higher product margin than embedded and fixed-configuration switch products;
IP Networking gross margins relative to net revenues increased 3.4% due to product cost reductions, a favorable shift towards higher margin software networking products, and favorable product transitions on campus switching products. The increases in IP Networking gross margins were partially offset by a 1.9% increase relative to net revenues related to amortization of IP Networking-related intangible assets acquired in the second quarter of fiscal year 2015. In addition, IP Networking gross margins also decreased 0.3% relative to net revenues primarily due to higher excess and obsolete inventory charges; and
Global Services gross margins relative to net revenues decreased primarily due to higher salaries for increased staffing related to our continued focus on customer satisfaction and our software business, as well as higher variable incentive compensation.

28


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):
 
Three Months Ended
 
 
 
 
 
January 30, 2016
 
January 31, 2015
 
 
 
 
 
Expense
 
% of Net
Revenues
 
Expense
 
% of Net
Revenues
 
Increase
 
%
Change
R&D expenses
$
93,257

 
16.2
%
 
$
85,231

 
14.8
%
 
$
8,026

 
9.4
%
R&D expenses increased for the three months ended January 30, 2016, compared with the three months ended January 31, 2015, primarily due to the following (in thousands):
 
Increase/(Decrease)
Salaries and other compensation
$
9,213

Outside services expense
(506
)
Various individually insignificant items
(681
)
Total change
$
8,026

Salaries and other compensation increased primarily due to increased personnel from the acquisitions that occurred in fiscal year 2015 and from the growth in our engineering staffing due to the expanded focus on our software product lines, higher variable incentive compensation, annual merit-based increases in salaries, and an increase in the cost of employment-related benefits. Outside services expense decreased primarily due to a decrease in outside engineering services for software networking product development as much of this work is now being performed by our engineering workforce.
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):
 
Three Months Ended
 
 
 
 
 
January 30, 2016
 
January 31, 2015
 
 
 
 
 
Expense
 
% of Net
Revenues
 
Expense
 
% of Net
Revenues
 
Increase
 
%
Change
Sales and marketing expenses
$
151,827

 
26.4
%
 
$
140,238

 
24.3
%
 
$
11,589

 
8.3
%
Sales and marketing expenses increased for the three months ended January 30, 2016, compared with the three months ended January 31, 2015, primarily due to the following (in thousands):
 
Increase/(Decrease)
Salaries and other compensation
$
9,531

Stock-based compensation expense
1,235

Outside services and other marketing expense
1,053

Various individually insignificant items
(230
)
Total change
$
11,589

Salaries and other compensation increased primarily as a result of increased personnel associated with the acquired vADC software product line, annual merit-based increases in salaries, an increase in the cost of employment-related benefits, and higher variable incentive compensation. Stock-based compensation expense increased primarily due to higher grant date per-unit fair values of restricted stock units granted to employees in the recent years. Outside services and other marketing expense increased primarily due to increased investment in the go-to-market strategy for our software business.

29


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 cost of revenue, R&D, and sales and marketing.
G&A expenses are summarized as follows (in thousands, except percentages):
 
Three Months Ended
 
 
 
 
 
January 30, 2016
 
January 31, 2015
 
 
 
 
 
Expense
 
% of Net
Revenues
 
Expense