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Form 10-Q BROCADE COMMUNICATIONS For: Jul 30

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September 2, 2016 4:07 PM EDT
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 July 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
 
brcdlogo.jpg
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 August 26, 2016, was 400,870,091 shares.


BROCADE COMMUNICATIONS SYSTEMS, INC.
FORM 10-Q
For the Quarter Ended July 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,” “depend,” 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
 
Nine Months Ended
 
July 30,
2016
 
August 1,
2015
 
July 30,
2016
 
August 1,
2015
 
(In thousands, except per share amounts)
Net revenues:
 
 
 
 
 
 
 
Product
$
490,995

 
$
463,200

 
$
1,400,355

 
$
1,407,681

Service
99,726

 
88,619

 
287,956

 
266,952

Total net revenues
590,721


551,819


1,688,311


1,674,633

Cost of revenues:
 
 
 
 
 
 
 
Product
188,492

 
144,243

 
464,797

 
431,781

Service
45,330

 
35,672

 
127,489

 
109,056

Total cost of revenues
233,822

 
179,915

 
592,286

 
540,837

Gross margin
356,899


371,904


1,096,025


1,133,796

Operating expenses:
 
 
 
 
 
 
 
Research and development
114,996

 
85,072

 
297,516

 
262,173

Sales and marketing
167,983

 
144,883

 
468,743

 
428,199

General and administrative
32,960

 
20,422

 
78,180

 
65,815

Amortization of intangible assets
5,498

 
889

 
7,302

 
1,654

Acquisition and integration costs
14,868

 
789

 
20,625

 
3,133

Restructuring and other related benefits
—

 
—

 
(566
)
 
(637
)
Total operating expenses
336,305

 
252,055

 
871,800

 
760,337

Income from operations
20,594


119,849


224,225


373,459

Interest expense
(13,462
)
 
(9,778
)
 
(33,282
)
 
(45,754
)
Interest and other income, net
1,557

 
947

 
3,317

 
854

Income before income tax
8,689

 
111,018

 
194,260

 
328,559

Income tax expense (benefit)
(1,806
)
 
19,351

 
47,034

 
72,585

Net income
$
10,495

 
$
91,667

 
$
147,226

 
$
255,974

Net income per share—basic
$
0.02


$
0.22


$
0.36


$
0.61

Net income per share—diluted
$
0.02


$
0.21


$
0.35


$
0.59

Shares used in per share calculation—basic
426,671

 
417,299

 
411,709

 
422,184

Shares used in per share calculation—diluted
434,416

 
427,518

 
419,416

 
433,303

 
 
 
 
 
 
 
 
Cash dividends declared per share
$
0.055


$
0.045


$
0.145


$
0.115

See accompanying Notes to Condensed Consolidated Financial Statements.

1

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

August 1,
2015
 
July 30,
2016

August 1,
2015
 
(In thousands)
Net income
$
10,495


$
91,667


$
147,226


$
255,974

Other comprehensive income and loss, net of tax:
 
 
 
 
 
 
 
Unrealized gains (losses) on cash flow hedges:
 
 
 
 
 
 
 
Change in unrealized gains and losses
(700
)
 
(414
)
 
(1,035
)
 
(2,332
)
Net gains and losses reclassified into earnings
482

 
831

 
1,831

 
2,544

Net unrealized gains (losses) on cash flow hedges
(218
)
 
417

 
796

 
212

Foreign currency translation adjustments
(1,628
)
 
(492
)
 
(1,760
)
 
(5,781
)
Total other comprehensive loss
(1,846
)
 
(75
)
 
(964
)
 
(5,569
)
Total comprehensive income
$
8,649

 
$
91,592

 
$
146,262

 
$
250,405

See accompanying Notes to Condensed Consolidated Financial Statements.


2

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

October 31,
2015
 
(In thousands, except par value)
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
1,153,074

 
$
1,440,882

Accounts receivable, net of allowances for doubtful accounts of $3,836 and $1,838 as of July 30, 2016, and October 31, 2015, respectively
278,180

 
235,883

Inventories
81,182

 
40,524

Deferred tax assets
—

 
78,675

Prepaid expenses and other current assets
86,922

 
56,235

Total current assets
1,599,358

 
1,852,199

Property and equipment, net
459,812

 
439,224

Goodwill
2,324,315

 
1,617,161

Intangible assets, net
434,921

 
75,623

Non-current deferred tax assets
3,918

 
813

Other assets
51,441

 
51,133

Total assets
$
4,873,765

 
$
4,036,153

LIABILITIES AND STOCKHOLDERS’ EQUITY

 
 
Current liabilities:
 
 
 
Accounts payable
$
121,093

 
$
98,143

Accrued employee compensation
134,471

 
142,075

Deferred revenue
257,460


244,622

Current portion of long-term debt
76,627

 
298

Other accrued liabilities
111,559

 
77,226

Total current liabilities
701,210

 
562,364

Long-term debt, net of current portion
1,516,761

 
793,779

Non-current deferred revenue
87,875

 
72,065

Non-current income tax liability
100,208

 
47,010

Non-current deferred tax liabilities
—

 
24,024

Other non-current liabilities
6,908

 
3,376

Total liabilities
2,412,962

 
1,502,618

Commitments and contingencies (Note 9)


 


Stockholders’ equity:
 
 
 
Brocade 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: 400,679 and 413,923 shares as of July 30, 2016, and October 31, 2015, respectively
401

 
414

Additional paid-in capital
1,473,159

 
1,632,984

Accumulated other comprehensive loss
(25,966
)
 
(25,002
)
Retained earnings
1,010,659

 
925,139

Total Brocade stockholders’ equity
2,458,253

 
2,533,535

Noncontrolling interest
2,550

 
—

Total stockholders’ equity
2,460,803

 
2,533,535

Total liabilities and stockholders’ equity
$
4,873,765

 
$
4,036,153

See accompanying Notes to Condensed Consolidated Financial Statements.

3

BROCADE COMMUNICATIONS SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
Nine Months Ended
 
July 30,
2016
 
August 1,
2015
 
(In thousands)
Cash flows from operating activities:
 
 
 
Net income
$
147,226

 
$
255,974

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Excess tax benefits from stock-based compensation
(1,778
)
 
(41,981
)
Depreciation and amortization
80,979

 
62,569

Loss on disposal of property and equipment
458

 
1,620

Net gain on sale of investments
(122
)
 
—

Amortization of debt issuance costs and debt discount
13,493

 
9,443

Write-off of debt discount and debt issuance costs related to lenders that did not participate in refinancing
—

 
4,808

Provision (recovery) for doubtful accounts receivable and sales allowances
(1,946
)
 
7,189

Non-cash purchase accounting adjustments to inventory
20,775

 
—

Non-cash stock-based compensation expense
88,805

 
64,594

Changes in assets and liabilities, net of acquisitions:
 
 
 
Accounts receivable
988

 
17,959

Inventories
5,601

 
(1,778
)
Prepaid expenses and other assets
(9,725
)
 
(20,854
)
Deferred tax assets
(109
)
 
531

Accounts payable
5,519

 
2,266

Accrued employee compensation
(57,520
)
 
(94,852
)
Deferred revenue
5,359

 
(14,220
)
Other accrued liabilities
(43,874
)
 
16,478

Restructuring liabilities
(1,223
)
 
(2,514
)
Net cash provided by operating activities
252,906


267,232

Cash flows from investing activities:
 
 
 
Purchases of non-marketable equity and debt investments
(2,000
)
 
(2,150
)
Proceeds from maturities and sale of short-term investments
150,323

 
—

Proceeds from sale of non-marketable equity investment
—

 
1,489

Purchases of property and equipment
(59,810
)
 
(53,142
)
Purchase of intangible assets
—

 
(7,750
)
Net cash paid in connection with acquisitions
(564,888
)
 
(95,452
)
Proceeds from collection of note receivable
250

 
250

Net cash used in investing activities
(476,125
)
 
(156,755
)

4

BROCADE COMMUNICATIONS SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS—Continued
(Unaudited)
 
Nine Months Ended
 
July 30,
2016
 
August 1,
2015
 
(In thousands)
Cash flows from financing activities:
 
 
 
Payment of principal related to senior secured notes
—

 
(300,000
)
Payment of debt issuance costs
(891
)
 
(1,718
)
Payment of principal related to capital leases
(282
)
 
(1,677
)
Common stock repurchases
(841,562
)
 
(312,601
)
Proceeds from issuance of common stock
49,195

 
51,345

Payment of cash dividends to stockholders
(61,706
)
 
(48,819
)
Proceeds from term loan
787,255

 
—

Proceeds from convertible notes
—

 
565,656

Purchase of convertible note hedge
—

 
(86,135
)
Proceeds from issuance of warrants
—

 
51,175

Proceeds from noncontrolling interest
2,550

 
—

Excess tax benefits from stock-based compensation
1,778

 
41,981

Net cash used in financing activities
(63,663
)
 
(40,793
)
Effect of exchange rate fluctuations on cash and cash equivalents
(926
)
 
(5,030
)
Net increase (decrease) in cash and cash equivalents
(287,808
)
 
64,654

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

 
1,255,017

Cash and cash equivalents, end of period
$
1,153,074

 
$
1,319,671

Supplemental disclosures of cash flow information:
 
 
 
Cash paid for interest
$
24,264

 
$
29,560

Cash paid for income taxes
$
46,163

 
$
35,372

Supplemental schedule of non-cash investing activities:
 
 
 
Settlement of debt investment in relation to acquisition
$
—

 
$
150

Acquiring a business through the issuance of stock
$
623,116

 
$
—

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. In May 2016, the Company entered into a joint venture agreement with Guiyang High-Tech Industrial Investment Group Co., Ltd. (“HTII”) to create Guizhou Huiling Technology Co., Ltd (“GHTC”). The Company consolidates its investment in GHTC as this is a variable interest entity, and the Company is the primary beneficiary. The noncontrolling interest attributed to GHTC is presented as a separate component from the Company’s equity in the equity section of the Company’s Condensed Consolidated Balance Sheets. HTII’s share of GHTC’s earnings are not presented separately in the Company’s Condensed Consolidated Statements of Income as these amounts are not material for any of the fiscal periods presented.
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, and income taxes. Actual results may differ materially from these estimates.

2. Summary of Significant Accounting Policies
There have been no material changes in the Company’s significant accounting policies for the nine months ended July 30, 2016, as compared to those disclosed in Brocade’s Annual Report on Form 10-K for the fiscal year ended October 31, 2015.
Consolidation of Variable Interest Entities
The Company uses a qualitative approach in assessing the consolidation requirement for variable interest entities. The approach focuses on identifying which enterprise has the power to direct the activities that most significantly impact the variable interest entity’s economic performance and which enterprise has the obligation to absorb losses or the right to receive benefits from the variable interest entity. In the event that the Company is the primary beneficiary of a variable interest entity, the assets, liabilities, and results of operations of the variable interest entity will be included in the Company’s consolidated financial statements.

6

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.
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 non-current deferred tax liabilities and assets. Under this update, the deferred tax liabilities and assets are classified as non-current 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 ASC 606, Revenue from Contracts with Customers, that will supersede virtually all existing revenue guidance. Under this new revenue guidance, 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 new revenue guidance 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 new revenue guidance by one year. This new revenue guidance 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 new revenue guidance on its consolidated financial statements.
In March 2016, the FASB issued an update to ASC 606, Revenue from Contracts with Customers: Principal versus Agent Considerations (Reporting Revenue Gross versus Net), which clarifies the implementation guidance for principal versus agent considerations. In April 2016, the FASB issued an update to ASC 606, Revenue from Contracts with Customers: Identifying Performance Obligations and Licensing, which clarifies the guidance related to identifying performance obligations and accounting for licenses of intellectual property. In May 2016, the FASB issued an update to ASC 606, Revenue from Contracts with Customers: Narrow-Scope Improvements and Practical Expedients, which clarifies the guidance related to collectibility and non-cash consideration, as well as provides practical expedients for the transition to ASC 606. The Company must adopt these updates with the adoption of ASC 606, Revenue from Contracts with Customers. The Company is currently evaluating the impact of these updates 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 a 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.

7

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 ASC 842, Leases, that will supersede the existing lease guidance, including on-balance sheet recognition of operating leases for lessees. This new lease guidance 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 new lease guidance on its consolidated financial statements.
In March 2016, the FASB issued an update to ASC 718, Compensation—Stock Compensation: Improvements to Employee Share-Based Payment Accounting. This update simplifies certain aspects of the accounting for share-based payment transactions, including income taxes, forfeiture rates, classification of awards, and classification in the statement of cash flows. This update becomes effective in the first quarter of fiscal year 2018. Early adoption is permitted. The Company is currently evaluating the impact of this update on its consolidated financial statements.
In June 2016, the FASB issued ASC 326, Financial Instrument—Credit Losses, that will supersede the existing methodology for estimating expected credit losses on certain financial instruments. The new impairment methodology eliminates the probable initial recognition threshold and, instead, estimates the expected credit losses in consideration of past events, current conditions, and forecasted information. This update becomes effective in the first quarter of fiscal year 2021. Early adoption is permitted in the first quarter of fiscal year 2020. The Company is currently evaluating the impact of this update on its consolidated financial statements.
In August 2016, the FASB issued an update to ASC 230, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments. This update consists of eight provisions that provide guidance on the classification of certain cash receipts and cash payments. If practicable, this update should be applied using a retrospective transition method to each period presented. For the provisions that are impracticable to apply retrospectively, those provisions may be applied prospectively as of the earliest date practicable. This update becomes effective and will be adopted by the Company in the first quarter of fiscal year 2019. Early adoption is permitted. The Company is currently evaluating the impact of this update on its consolidated financial statements and related disclosures.
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 six 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 July 30, 2016, two customers individually accounted for 18% and 10% of total accounts receivable, for a combined total of 28% 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 July 30, 2016, two customers individually accounted for 12% and 12% of the Company’s total net revenues for a combined total of 24% of total net revenues. For the three months ended August 1, 2015, three customers individually accounted for 16%, 15%, and 12% of the Company’s total net revenues for a combined total of 43% of total net revenues.

8

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-source suppliers. The Company also entered into license agreements with some of its suppliers, including Qualcomm Inc., for technologies and components that are used in its products.

3. Acquisitions
Current Fiscal Year Acquisitions
Acquisition of Ruckus Wireless, Inc. (“Ruckus”)
On May 27, 2016 (“Acquisition Date”), the Company completed its acquisition of Ruckus, a public company incorporated in the state of Delaware, to strengthen its Internet Protocol (“IP”) Networking product portfolio by adding Ruckus’ wireless products and services to the Company’s networking solutions.
Pursuant to the terms of the Agreement and Plan of Merger entered into between the Company, Ruckus, and a Company subsidiary, Ruckus stockholders were entitled to receive $6.45 in cash and 0.75 shares of the Company’s common stock in exchange for each outstanding share of Ruckus common stock. The results of operations for the acquired business are included in the Company’s Condensed Consolidated Statements of Income from the Acquisition Date. Immediately prior to the completion of the acquisition, there were 92.2 million outstanding shares of Ruckus common stock, which included 3.2 million shares of Ruckus common stock owned by a dissenting former Ruckus stockholder who has submitted and not withdrawn a demand for appraisal of the fair value of those shares under Delaware law. As a result, no cash payment had been made and no shares had been issued to the dissenting stockholder as of July 30, 2016.
Based on the $8.60 per share closing price of the Company’s common stock on May 27, 2016, the total preliminary purchase consideration paid or payable was $1.3 billion, consisting of $574.0 million in cash for outstanding Ruckus shares less dissenting shares, $78.3 million in cash for outstanding vested Ruckus stock options allocated to preliminary purchase consideration, $574.0 million of equity interests in the Company, $7.4 million of the fair value of replacement awards allocated to the preliminary purchase consideration, and $41.7 million relating to the appraisal demand submitted by the dissenting former Ruckus stockholder, which was accrued as of July 30, 2016, and reported within “Other accrued liabilities” on the Company’s Condensed Consolidated Balance Sheets.
The Company recorded direct acquisition costs of $10.2 million and $15.2 million for the three and nine months ended July 30, 2016, respectively, and integration costs of $4.6 million and $5.4 million for the three and nine months ended July 30, 2016, respectively. These costs were expensed as incurred and are presented in the Company’s Condensed Consolidated Statements of Income for the three and nine months ended July 30, 2016, as “Acquisition and integration costs.”

9

In connection with this acquisition, the Company allocated the total preliminary purchase consideration to the net assets acquired and liabilities assumed, including identifiable intangible assets, based on their respective fair values at the Acquisition Date. The following table summarizes the preliminary allocation of the total preliminary purchase consideration to the fair value of the assets acquired and liabilities assumed (in thousands):
Assets acquired:
 
Cash and cash equivalents
$
95,515

Short-term investments
149,615

Accounts receivable, net of allowances for doubtful accounts of $2,100
41,339

Inventories
66,000

Prepaid expenses and other current assets
5,953

Property and equipment, net
21,777

Identifiable intangible assets
380,000

Other assets
1,697

Total assets acquired
761,896

Liabilities assumed:
 
Accounts payable
16,375

Accrued employee compensation
17,514

Deferred revenue
13,923

Other accrued liabilities
33,810

Non-current deferred revenue
9,364

Non-current deferred tax liabilities
57,677

Other non-current liabilities
40,561

Total liabilities assumed
189,224

Net assets acquired, excluding goodwill (a)
572,672

Total preliminary purchase consideration (b)
1,275,448

Estimated goodwill (b) - (a)
$
702,776

Goodwill represents the excess of the total preliminary purchase consideration over the fair value of the underlying assets acquired and liabilities assumed. Goodwill is attributable to planned growth in new markets and synergies expected to be achieved from the combined operations of the Company and Ruckus. Goodwill of $303.8 million was assigned to the IP Networking Products reporting unit, and goodwill of $398.9 million was assigned to the Global Services reporting unit. Goodwill recognized in the acquisition is not deductible for tax purposes.
A preliminary assessment of the fair value of identified intangible assets and their respective useful lives are as follows (in thousands, except for estimated useful life):
 
Approximate Fair Value
 
Estimated Useful Life
(In years)
Trade name/trademark
$
44,000

 
15.00
Customer relationships
118,000

 
1 - 7
Developed technology
195,000

 
6 - 7
In-process research and development (“IPR&D”) (1)
23,000

 
N/A (1)
Total intangible assets
$
380,000

 
 
(1) 
IPR&D will be accounted for as an indefinite-lived intangible asset until the underlying projects are completed or abandoned.
The total preliminary purchase consideration and allocation reflects the Company’s preliminary estimates and is subject to revision as additional information in relation to the preliminary purchase consideration and the fair value of the underlying assets acquired and liabilities assumed becomes available. Additional information that existed as of the Acquisition Date may become known to the Company during the remainder of the measurement period. This period is not to exceed 12 months from the acquisition date.

10

Pursuant to the terms of the Agreement and Plan of Merger, all unvested Ruckus awards, then comprised of restricted stock units (“RSUs”), performance-based RSUs, and stock options, were canceled and replaced with Company RSUs and stock options (“replacement awards”). Per ASC 805, Business Combinations, the replacement of stock options or other share-based payment awards in conjunction with a business combination represents a modification of share-based payment awards that must be accounted for in accordance with ASC 718, Compensation—Stock Compensation. As a result of the Company’s obligation to issue replacement awards, a portion of the fair-value-based measure of replacement awards is included in measuring the purchase consideration transferred in the business combination. To determine the portion of the replacement awards that is part of the purchase consideration, the Company measured the fair value of both the replacement awards and the historical Ruckus awards as of the Acquisition Date, in accordance with ASC 718. The fair value of the replacement awards, whether vested or unvested, was included in the preliminary purchase consideration to the extent that pre-acquisition services had been rendered. The preliminary purchase consideration also included the fair value of accelerated vesting for awards that vested at the Acquisition Date due to change-in-control provisions.
In addition, the Company accelerated 20% to 50% of the vesting of unvested replacement awards granted to eight Ruckus executives and modified the vesting schedules of unvested replacement awards granted to those eight plus an additional four Ruckus executives. As a result, the Company recorded $4.7 million as an expense in the three and nine months ended July 30, 2016.
As of July 30, 2016, the fair value of the remaining unvested replacement awards of $28.6 million will be recorded as stock-based compensation expense over the applicable future vesting periods.
For the three and nine months ended July 30, 2016, the Company’s Condensed Consolidated Statements of Income included revenue and loss from operations of $77.8 million and $37.6 million, respectively, attributable to the operations of the Ruckus business since the Acquisition Date.
Unaudited Pro Forma Financial Information
The following unaudited pro forma financial information presents the consolidated results of the Company and Ruckus for the three and nine months ended July 30, 2016, and August 1, 2015, giving effect to the acquisition and the related debt financing as if they had occurred on November 2, 2014, and combines the historical financial results of the Company and Ruckus. The unaudited pro forma financial information includes adjustments to give effect to pro forma events that are directly attributable to the acquisition and the related debt financing. The pro forma financial information includes adjustments to amortization and depreciation for intangible assets and property, plant, and equipment acquired, adjustments to stock-based compensation expense, the effect of acquisition on inventory acquired and deferred revenue, interest expense for the additional indebtedness, and acquisition and integration costs. The unaudited pro forma financial information is presented for illustrative purposes only and is not necessarily indicative of the results of operations of future periods. The unaudited pro forma financial information does not give effect to the potential impact of current financial conditions, regulatory matters, or any anticipated synergies, operating efficiencies, or cost savings that may be associated with the acquisition. Consequently, actual results will differ from the unaudited pro forma financial information presented below (in thousands, except for per share amounts):
 
Three Months Ended
 
Nine Months Ended
 
July 30,
2016
 
August 1,
2015
 
July 30,
2016
 
August 1,
2015
Unaudited pro forma consolidated results:
 
 
 
 
 
 
 
Pro forma revenues
$
600,530

 
$
655,663

 
$
1,900,664

 
$
1,953,490

Pro forma net income (loss)
$
(21,936
)
 
$
85,843

 
$
100,982

 
$
168,212

Pro forma net income (loss) per share—basic
$
(0.05
)
 
$
0.21

 
$
0.25

 
$
0.40

Pro forma net income (loss) per share—diluted
$
(0.05
)
 
$
0.20

 
$
0.24

 
$
0.38

Unaudited pro forma net income for the nine months ended August 1, 2015, includes nonrecurring pro forma adjustments directly attributable to the acquisition to the effect of inventory acquired and acquisition and integration costs of $39.8 million and $20.6 million, respectively. No such adjustments are included in any other periods.
Other Fiscal Year 2016 Acquisition
In March 2016, the Company completed its acquisition of a privately held developer of software for data center automation to strengthen its IP Networking product portfolio. The Company does not consider this acquisition to be material to its results of operations or financial position. Therefore, the Company is not presenting pro forma financial information of combined operations.

11

Prior Fiscal Year 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. The total net aggregate purchase price of the acquisitions, net of $0.1 million of cash acquired as part of the acquisitions, was $95.5 million in cash consideration and $0.5 million in non-cash consideration.
The Company recorded direct acquisition costs of $1.5 million for the nine months ended August 1, 2015, and integration costs of $0.8 million and $1.7 million for the three and nine months ended August 1, 2015, respectively. These costs were expensed as incurred and are presented in the Company’s Condensed Consolidated Statements of Income for the three and nine months ended August 1, 2015, as “Acquisition and integration costs.”
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. The Company also granted 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 and nine months ended July 30, 2016, the Company recognized $0.5 million and $1.4 million, respectively, of stock-based compensation expense related to these RSU awards. For the three and nine months ended August 1, 2015, the Company recognized $0.9 million and $1.1 million, respectively, 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 and nine months ended July 30, 2016, the Company recognized $0.9 million and $3.4 million, respectively, of compensation expense related to these cash awards. For the three and nine months ended August 1, 2015, the Company recognized $1.6 million and $2.0 million, respectively, of compensation expense related to these cash awards.

4. Goodwill and Intangible Assets
The following table summarizes goodwill activity by reportable segment during the nine months ended July 30, 2016 (in thousands):
 
Storage Area Networking (“SAN”) 
Products
 
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

Acquisitions (1)
—

 
308,456

 
398,936

 
707,392

Tax adjustments (2)
(5
)
 
—

 
—

 
(5
)
Translation adjustments
—

 
(233
)
 
—

 
(233
)
Balance at July 30, 2016
 
 
 
 
 
 
 
Goodwill
176,320

 
1,722,857

 
554,352

 
2,453,529

Accumulated impairment losses
—

 
(129,214
)
 
—

 
(129,214
)
 
$
176,320

 
$
1,593,643

 
$
554,352

 
$
2,324,315

(1) 
The goodwill acquired relates to the acquisitions completed in March 2016 and May 2016. See Note 3, “Acquisitions,” of the Notes to Condensed Consolidated Financial Statements.
(2) 
The goodwill adjustments were primarily a result of tax benefits from the exercise of stock awards of acquired companies.

12

The Company conducts its goodwill impairment test annually 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. Effective on the first day of the fourth fiscal quarter, the Company changed the date of its annual impairment test for goodwill from the first day of the second fiscal quarter to the first day of the fourth fiscal quarter. This change in the annual impairment test date was made to better coincide with the timing of when the Company prepares its annual budget and financial plans as part of its regular long-range planning process. 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 initial fiscal year 2016 annual goodwill impairment test, the Company used a combination of these approaches to estimate each reporting unit’s fair value. At the time that the initial fiscal year 2016 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 was determined by considering control premiums offered as part of the acquisitions where acquired companies were comparable with the Company’s reporting units.
Based on the results of the initial annual goodwill impairment analysis performed during the second fiscal quarter of 2016, the Company determined that no impairment needed to be recorded. As of July 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 2016 that indicated that the fair values of the reporting units may be less than their current carrying amounts.
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 nine months ended July 30, 2016.

13

The following tables present details of the Company’s intangible assets, excluding goodwill (in thousands, except for weighted-average remaining useful life):
 
July 30, 2016
 
Gross
Carrying
Value
 
Accumulated
Amortization
 
Net
Carrying
Value
 
Weighted-
Average
Remaining
Useful Life
(In years)
Finite-lived intangible assets:
 
 
 
 
 
 
 
Trade names
$
45,090

 
$
1,105

 
$
43,985

 
14.71
Core/developed technology (1) (2)
254,290

 
23,834

 
230,456

 
5.67
Patent portfolio license (3)
7,750

 
1,669

 
6,081

 
17.00
Customer relationships
141,110

 
8,805

 
132,305

 
6.52
Non-compete agreements
1,050

 
904

 
146

 
0.46
Patents with broader applications
1,040

 
92

 
948

 
13.63
Total finite-lived intangible assets
450,330

 
36,409

 
413,921

 
6.72
Indefinite-lived intangible assets, excluding goodwill:
 
 
 
 
 
 
 
IPR&D (1)
21,000

 
—

 
21,000

 
 
Total indefinite-lived intangible assets, excluding goodwill
21,000

 
—

 
21,000

 
 
Total intangible assets, excluding goodwill
$
471,330

 
$
36,409

 
$
434,921

 
 
 
 
 
 
 
 
 
 
 
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
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 July 30, 2016, the Company acquired $23.0 million in IPR&D intangible assets in connection with the acquisition of Ruckus. The research and development efforts associated with these IPR&D intangible assets are expected to be completed in fiscal years 2016 and 2017. During the nine months ended July 30, 2016, research and development efforts were completed on $17.1 million of the IPR&D intangible assets, and the completed IPR&D intangible assets are being amortized as core/developed technology over the estimated useful lives of five to seven years.

14

(2) 
During the nine months ended July 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 and whenever events occur or facts and circumstances indicate that it is more likely than not that the IPR&D is impaired. Effective on the first day of the fourth fiscal quarter, the Company changed the date of its annual impairment test for IPR&D from the first day of the second fiscal quarter to the first day of the fourth fiscal quarter. This change in the annual impairment test date was made to better coincide with the timing of when the Company prepares its annual budget and financial plans as part of its regular long-range planning process. 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.
The Company has not identified any changes in circumstances requiring an interim IPR&D impairment test for the nine months ended July 30, 2016, and therefore, the Company determined that no impairment needed to be recorded.
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
 
Nine Months Ended
 
July 30, 2016
 
August 1, 2015
 
July 30, 2016
 
August 1, 2015
Cost of revenues
$
8,922

 
$
2,549

 
$
15,269

 
$
5,043

General and administrative (1)
271


889

 
821

 
1,654

Amortization of intangible assets
5,498

 
280

 
7,302

 
570

Total
$
14,691

 
$
3,718

 
$
23,392

 
$
7,267

(1) 
The amortization is related to the $7.8 million of perpetual, non-exclusive 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 July 30, 2016 (in thousands):
Fiscal Year
 
Estimated
Future
Amortization
2016 (remaining three months)
 
$
18,998

2017
 
72,063

2018
 
63,562

2019
 
60,039

2020
 
59,082

Thereafter
 
140,177

Total
 
$
413,921



15

5. Balance Sheet Details
The following tables provide details of selected balance sheet items (in thousands):
 
July 30,
2016
 
October 31,
2015
Inventories:
 
 
 
Raw materials
$
17,613

 
$
18,788

Finished goods
63,569

 
21,736

Inventories
$
81,182

 
$
40,524

 
July 30,
2016
 
October 31,
2015
Property and equipment, net:
 
 
 
Gross property and equipment
 
 
 
Computer equipment
$
18,886

 
$
14,820

Software
84,337

 
67,625

Engineering and other equipment (1)
443,808

 
407,342

Furniture and fixtures (1)
33,468

 
31,028

Leasehold improvements
37,315

 
33,986

Land and building
386,163

 
385,415

Total gross property and equipment
1,003,977

 
940,216

Accumulated depreciation and amortization (1) (2)
(544,165
)
 
(500,992
)
Property and equipment, net
$
459,812

 
$
439,224

(1) 
Engineering and other equipment, furniture and fixtures, and accumulated depreciation and amortization include the following amounts under capital leases as of July 30, 2016, and October 31, 2015 (in thousands):
 
July 30,
2016
 
October 31,
2015
Cost of capitalized leases
$
270

 
$
1,312

Accumulated depreciation
(255
)
 
(857
)
Property and equipment, net, under capital leases
$
15

 
$
455

(2) 
The following table presents the depreciation of property and equipment included in the Company’s Condensed Consolidated Statements of Income (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
July 30,
2016
 
August 1,
2015
 
July 30,
2016
 
August 1,
2015
Depreciation expense
$
20,393

 
$
18,605

 
$
57,531

 
$
55,302


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 July 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.

16

During the nine months ended July 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 July 30, 2016, were as follows (in thousands):
 
 
 
Fair Value Measurements Using
 
 Balance as of
 July 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)
$
885,152

 
$
885,152

 
$
—

 
$
—

Derivative assets
477

 
—

 
477

 
—

Total assets measured at fair value
$
885,629

 
$
885,152

 
$
477

 
$
—

Liabilities:
 
 
 
 
 
 
 
Derivative liabilities
$
759

 
$
—

 
$
759

 
$
—

(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

 
$
—

(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” included in the Company’s Condensed Consolidated Statements of Income (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
July 30,
2016
 
August 1,
2015
 
July 30,
2016
 
August 1,
2015
Lease loss reserve and related benefits
$
—

 
$
—

 
$
(566
)
 
$
(637
)

17

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
—

 
(380
)
 
(260
)
 
(640
)
Translation adjustment
—

 
(17
)
 
—

 
(17
)
Restructuring liabilities at July 30, 2016
$
110

 
$
848

 
$
148

 
$
1,106


 
 
 
 
 
 
 
Current restructuring liabilities at July 30, 2016
$
110

 
$
350

 
$
148

 
$
608

Non-current restructuring liabilities at July 30, 2016
$
—

 
$
498

 
$
—

 
$
498

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 non-recurring 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 nine months ended July 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.


18

8. Borrowings
The following table provides details of the Company’s long-term debt (in thousands, except years and percentages):
 
 
 
 
 
 
July 30, 2016
 
October 31, 2015
 
 
Maturity
 
Stated Annual Interest Rate
 
Amount
Effective Interest Rate
 
Amount
Effective Interest Rate
Senior Credit Facility:
 
 
 
 
 
 
 
 
 
 
Term Loan Facility
 
2021
 
variable
 
$
800,000

2.50
%
 
$
—

—
%
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%
 
16

4.63
%
 
298

4.63
%
Total gross long-term debt
 
 
 
 
 
1,675,016

 
 
875,298

 
Unamortized discount
 
 
 
 
 
(78,755
)
 
 
(79,196
)
 
Unamortized debt issuance costs
 
 
 
 
 
(2,873
)
 
 
(2,025
)
 
Current portion of long-term debt
 
 
 
 
 
(76,627
)
 
 
(298
)
 
Long-term debt, net of current portion
 
 
 
 
 
$
1,516,761

 
 
$
793,779

 
Senior Credit Facility
In connection with the acquisition of Ruckus on May 27, 2016, the Company entered into a Credit Agreement (the “Credit Agreement”) with Wells Fargo Bank, N.A., as the administrative agent, swingline lender, and issuing lender, and certain other lenders (collectively, the “Lenders”). The Credit Agreement provides for a term loan facility of $800 million (the “Term Loan Facility”) and a revolving credit facility of $100 million (the “Revolving Facility,” and together with the Term Loan Facility, the “Senior Credit Facility”). The Revolving Facility includes a $25 million letter of credit subfacility and a $10 million swing line loan subfacility. The proceeds of the Term Loan Facility were used to finance a portion of the acquisition of Ruckus and related fees and expenses, the repurchase of shares of the Company’s common stock, and fees and expenses related to the Senior Credit Facility.
Loans made under the Senior Credit Facility bear interest, at the Company’s option, either (i) at a base rate which is based in part on the greatest of (A) the prime rate, (B) the federal funds rate plus 0.50%, or (C) LIBOR for an interest period of one month plus 1.00%, plus an applicable margin that will vary between 0.00% and 0.75% based on the Company’s total leverage ratio or (ii) at a LIBOR-based rate, plus an applicable margin that will vary between 1.00% and 1.75% based on the Company’s total leverage ratio. For purposes of calculating the applicable rate, the base rate and LIBOR-based rate are subject to a floor of 0.00%. For base rate loans, interest is payable on the last business day of January, April, July and October of each year. For LIBOR rate loans, interest is payable on the last day of each interest period for the LIBOR-based rate, and if such interest period extends over three months, at the end of each three-month interval during such interest period.
Commitments under the Revolving Facility are subject to an undrawn commitment fee starting at 0.30%, and are later subject to adjustment between 0.20% and 0.35% based on the Company’s total leverage ratio. Letters of credit issued under the letter of credit subfacility are subject to a commission fee starting at 1.50%, and are later subject to adjustment between 1.00% and 1.75% based on the Company’s total leverage ratio, and an issuance fee of 0.125%.
The final maturity of the Senior Credit Facility will occur on May 27, 2021, except that if any of the 1.375% convertible senior unsecured notes due 2020 remain outstanding on October 2, 2019, and certain other conditions have not been met, then the final maturity of the Senior Credit Facility will occur on October 2, 2019. Notwithstanding the foregoing, upon the request of the Company made to all applicable Lenders, and provided that no event of default exists or will occur immediately thereafter, individual Lenders may agree to extend the maturity date of its commitments under the Revolving Facility and loans under the Term Loan Facility.

19

The Company is permitted to make voluntary prepayments of the Senior Credit Facility at any time without payment of a premium or penalty. The Company is required to make mandatory prepayments of loans under the Term Loan Facility (without payment of a premium or penalty) with (i) net cash proceeds from issuances of debt (other than certain permitted debt), (ii) net cash proceeds from certain non-ordinary course asset sales (subject to reinvestment rights and other exceptions), and (iii) casualty proceeds and condemnation awards (subject to reinvestment rights and other exceptions). Commencing October 31, 2016, the loans under the Term Loan Facility will amortize in equal quarterly installments in an aggregate annual amount equal to 10% of the original principal amount thereof, with any remaining balance payable on the final maturity date of the loans under the Term Loan Facility. The loans under the Revolving Facility and all accrued and unpaid interest thereon are due in full on the maturity date.
There were no principal amounts outstanding under the revolving credit facility, and the full $100 million was available for future borrowing under the revolving credit facility as of July 30, 2016. No payments were made toward the principal of the Term Loan Facility during the nine months ended July 30, 2016.
As of July 30, 2016, the fair value of the Term Loan Facility was approximately $786.5 million, which was estimated based on fair value for similar instruments.
The obligations under the Senior Credit Facility and certain cash management and hedging obligations are fully and unconditionally guaranteed by certain of the Company’s direct and indirect subsidiaries (including Ruckus, but excluding certain immaterial subsidiaries, subsidiaries whose guarantee would result in material adverse tax consequences and subsidiaries whose guarantee is prohibited by applicable law) pursuant to a subsidiary guaranty agreement.
The Company’s obligations under the Senior Credit Facility are unsecured, provided that upon the occurrence of certain events (including if the Company’s corporate family rating from Moody’s falls below Ba1 and from S&P falls below BB+ at any time (referred to as a “Ratings Downgrade”)) or the incurrence of certain indebtedness in excess of $600 million (such occurrence or the occurrence of a Ratings Downgrade being a “Collateral Trigger Event”), then such obligations, as well as certain cash management and hedging obligations, will be required to be secured, subject to certain exceptions, by 100% of the equity interests of all present and future restricted subsidiaries directly held by the Company or any guarantor. The Company must provide such security within 90 days (or 20 business days with respect to the equity interests of material U.S. subsidiaries) of such Collateral Trigger Event.
The Credit Agreement contains financial maintenance covenants, including a (i) maximum total leverage ratio as of the last date of any fiscal quarter not to exceed 3.50:1.00; subject to certain step-downs to 3.25:1.00 and 3.00:1.00 for fiscal periods ending on or after April 30, 2017, and April 30, 2018, respectively, and (ii) a minimum interest coverage ratio of not less than 3.50:1.00. The Credit Agreement also contains restrictive covenants that limit, among other things, the Company’s and its restricted subsidiaries’ ability to:
•
Incur additional indebtedness or issue certain preferred equity, pay dividends or make other distributions or other restricted payments (including stock repurchases);
•
Sell assets other than on terms specified by the Credit Agreement;
•
Amend the terms of certain other indebtedness and organizational documents;
•
Create liens on certain assets to secure debt, consolidate, merge, sell, or otherwise dispose of all or substantially all of their assets; and
•
Enter into certain transactions with affiliates, or change their lines of business, fiscal years, and accounting practices, in each case, subject to customary exceptions.
The Credit Agreement also sets forth customary events of default, including upon the failure to make timely payments under the Senior Credit Facility, the failure to satisfy certain covenants, cross-default and cross-acceleration to other material debt for borrowed money, the occurrence of a change of control, and specified events of bankruptcy and insolvency.
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 the redemption of 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.”

20

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 nine months ended July 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):
 
July 30,
2016
 
October 31,
2015
Principal
$
575,000

 
$
575,000

Unamortized discount of the liability component
(63,706
)
 
(76,311
)
Net carrying amount of liability component
$
511,294

 
$
498,689

Carrying amount of equity component
$
59,293

 
$
70,765

As of July 30, 2016, the remaining period of amortization for the discount is 3.42 years.
The following table presents the amount of interest cost recognized for amortization of the discount and for the contractual interest coupon for the 2020 Convertible Notes for the following periods (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
July 30,
2016
 
August 1,
2015
 
July 30,
2016
 
August 1,
2015
Amortization of discount
$
4,254

 
$
4,048

 
$
12,606

 
$
8,792

Contractual interest coupon
$
1,977

 
$
1,977

 
$
5,930

 
$
4,323

As of July 30, 2016, and October 31, 2015, the fair value of the 2020 Convertible Notes was approximately $560.4 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 third fiscal quarter of 2016, the Board of Directors of the Company declared and paid a cash dividend in the amount of $0.055 per share. Accordingly, as of June 8, 2016, the conversion rate was adjusted to a rate of 63.1587 shares of the Company’s common stock per $1,000 principal amount of the notes, which is equal to 36.3 million shares at a conversion price of approximately $15.83 per share. The adjustment resulted in a change to the conversion rate of less than 1%, and by the terms of the indenture governing the 2020 Convertible Notes, the Company is allowed and elected to defer the 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;
•
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

21

•
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, through 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 July 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 July 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 July 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 $15.83 per share as of June 8, 2016. 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 June 8, 2016, the holders of the warrants have the right to acquire up to approximately 36.3 million shares of the Company’s common stock at a strike price of approximately $20.52 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 nine months ended July 30, 2016.
As of July 30, 2016, and October 31, 2015, the fair value of the 2023 Notes was approximately $296.2 million and $293.9 million, respectively, which was estimated based on broker trading prices.

22

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.
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 nine months ended August 1, 2015.

23

Debt Maturities
As of July 30, 2016, the Company’s aggregate debt maturities based on outstanding principal were as follows (in thousands):
Fiscal Year
 
Principal
Balances
2016 (remaining three months)
 
$
20,016

2017
 
80,000

2018
 
80,000

2019
 
80,000

2020
 
655,000

Thereafter
 
760,000

Total
 
$
1,675,016


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 nine months ended July 30, 2016, and August 1, 2015 (in thousands):
 
Accrued Warranty
 
Nine Months Ended
 
July 30,
2016
 
August 1,
2015
Beginning balance
$
7,599

 
$
7,486

Warranty liability assumed from acquisitions
760

 
—

Liabilities accrued for warranties issued during the period
2,768

 
3,059

Warranty claims paid and used during the period
(2,736
)
 
(3,221
)
Changes in liability for pre-existing warranties during the period
(60
)
 
(125
)
Ending balance
$
8,331

 
$
7,199

In addition, the Company has defense and indemnification clauses contained within its various customer contracts. As such, the Company indemnifies the parties to whom it sells its products with respect to the Company’s 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 July 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 that are 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 underutilizing the planned capacity.

24

As of July 30, 2016, the Company’s aggregate commitment to its CMs for inventory components used in the manufacture of Brocade products was $220.0 million, which the Company expects to utilize during future normal ongoing operations, net of a purchase commitments reserve of $3.6 million, which is reported within “Other accrued liabilities” on the Company’s Condensed Consolidated Balance Sheet as of July 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.
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, including those identified below, 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. The Company accrues a liability when management believes that it is both probable that a liability has been incurred and the amount of loss can be reasonably estimated. The Company believes it has recorded adequate provisions for any such matters and, as of July 30, 2016, it was not reasonably possible that a material loss had been incurred in excess of the amounts recognized in the Company’s financial statements. However, litigation is inherently uncertain, and the outcome of these matters cannot be predicted with certainty. Accordingly, cash flows or results of operations could be materially affected in any particular period by the resolution of one or more of these matters.
Ruckus Acquisition-Related Litigation
Subsequent to the announcement that Brocade had entered into an agreement to acquire Ruckus on April 3, 2016, three putative stockholder class action complaints relating to the acquisition were filed on behalf of purported Ruckus stockholders in the Superior Court of California, County of Santa Clara, a fourth putative stockholder class action complaint was filed in the United States District Court for the District of Delaware, and a fifth putative class action complaint was filed in the United States District Court for the Northern District of California. The complaints in the three California state court actions are captioned: Maguire v. Ruckus Wireless, Inc., et al. (filed April 12, 2016 and amended on May 10, 2016; referred to as the “Maguire action”); Jaljouli v. Ruckus Wireless, Inc., et al., (filed April 19, 2016; referred to as the “Jaljouli action”); and Small v. Ruckus Wireless, Inc., et al. (filed May 12, 2016; referred to as the “Small action”). The complaint in the Delaware federal court action is captioned Borrego v. Ruckus Wireless, Inc., et al. (filed May 11, 2016; referred to as the “Borrego action”). The complaint in the California federal court action is captioned Hussey v. Ruckus Wireless, Inc., et al. (filed June 3, 2016; referred to as the “Hussey action”).
The complaints in the Maguire, Jaljouli and Small actions contain similar allegations and name Ruckus and members of the Ruckus board of directors as defendants; the Maguire and Jaljouli actions also name Brocade and a Brocade subsidiary as defendants. In general, the complaints allege that the members of the Ruckus board of directors breached their fiduciary duties to Ruckus stockholders by purportedly doing one or more of the following: agreeing to unfair and inadequate transaction consideration for the Ruckus shares; accepting unreasonable deal protection measures in the merger agreement that would dissuade other potential bidders from making competing offers; failing to properly value Ruckus and take steps to maximize the sale value of Ruckus; engaging in self-dealing; and providing allegedly false, misleading, and/or incomplete disclosures regarding the transaction, the negotiations leading up to it, and the opinion of Ruckus’ financial advisor. The complaints in the Maguire and Jaljouli actions also allege that one or more of Ruckus, Brocade, and the Brocade subsidiary aided and abetted the members of the Ruckus board of directors in breaching their fiduciary duties to Ruckus stockholders.
The complaint in the Borrego action alleges that Ruckus and members of the Ruckus board of directors violated Sections 14(e), 14(d)(4) and 20(a) of the Exchange Act based on allegedly false and/or misleading statements and/or alleged omissions in the Solicitation/Recommendation Statement on Schedule 14D-9 filed by Ruckus with the SEC on April 29, 2016. The complaint in the Hussey action, which names Ruckus, members of the Ruckus board of directors, Ruckus’ chief financial officer, Brocade, and a Brocade subsidiary as defendants, contains a similar Section 14(e) claim and also alleges that the defendants violated Section14(d)(7) of the Exchange Act and Rule 14d-10 promulgated thereunder based on the allegedly differential consideration received by members of the Ruckus board of directors and Ruckus’ chief financial officer in connection with the acquisition.
The plaintiffs in one or more of these five actions have requested relief including, among other things, certification as a class, rescission and invalidation of the merger agreement or related agreements, injunctive relief, imposition of a constructive trust, an award of damages and an accounting, an award of the costs and disbursements of the action (including reasonable attorneys’ and experts’ fees), and other equitable relief that the court may deem just and proper.

25

The Small action was voluntarily dismissed by the plaintiff on August 29, 2016.
Ruckus Acquisition-Related Appraisal Demand
On May 25, 2016, Ruckus received an appraisal demand letter seeking an appraisal under Section 262 of the Delaware General Corporation Law (“Section 262”) of the fair value of 3.2 million Ruckus shares purported to be beneficially owned by a shareholder (the “Dissenter”) that purportedly dissented from the merger of Ruckus with and into a wholly-owned subsidiary of the Company. Under Section 262, the Dissenter is entitled to have those shares appraised by the Delaware Court of Chancery and receive payment of the “fair value” of such shares together with statutory interest as determined by the Delaware Court of Chancery, provided that Dissenter complies with the requirements of Section 262. The Company is not aware of any action being commenced in the Delaware Court of Chancery relating to the Dissenter’s appraisal demand. If the Dissenter does not timely and properly commence and prosecute to judgment such an appraisal action, the Dissenter may be entitled to receive $6.45 in cash and 0.75 shares of Brocade common stock with respect to each of the 3.2 million shares subject to its appraisal demand, with an aggregate value of $41.3 million as of July 30, 2016. Otherwise, the dollar amount that the Company may be required to pay to the Dissenter will be determined by the Delaware Court of Chancery and may be more than, less than, or equal to that amount.

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 and nine months ended July 30, 2016, were the euro, the British pound, the Indian rupee, the Chinese yuan, the Singapore dollar, the Japanese yen, and the Swiss franc. The Company has established a foreign currency risk management program to protect against the volatility of future cash flows caused by changes in foreign currency exchange rates. This program reduces, but does not eliminate, the impact of foreign currency exchange rate movements.
The Company 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 material for the three and nine months ended July 30, 2016, and August 1, 2015.
Ineffective cash flow hedges are included in the Company’s net income as part of “Interest and other income, net.” The amount recorded on ineffective cash flow hedges was not material for the three and nine months ended July 30, 2016, and August 1, 2015.

26

Net losses relating to the effective portion of foreign currency derivatives, which are offset by net gains on the underlying exposures, are recorded in the Company’s Condensed Consolidated Statements of Income as follows (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
July 30, 2016
 
August 1, 2015
 
July 30, 2016
 
August 1, 2015
Cost of revenues
$
(35
)
 
$
(141
)
 
$
(195
)
 
$
(605
)
Research and development
(342
)
 
(206
)
 
(968
)
 
(273
)
Sales and marketing
(120
)
 
(542
)
 
(764
)
 
(1,866
)
General and administrative
(10
)
 
(52
)
 
(54
)
 
(135
)
Total
$
(507
)
 
$
(941
)
 
$
(1,981
)
 
$
(2,879
)
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.
As a result of foreign currency fluctuations, the net foreign currency exchange gains and losses recorded as part of “Interest and other income, net” were losses of $0.2 million and $0.8 million for the three and nine months ended July 30, 2016, respectively, and gains of $0.3 million and losses of $0.6 million for the three and nine months ended August 1, 2015, respectively.
As of July 30, 2016, the Company had gross unrealized loss positions of $0.8 million and gross unrealized gain positions of $0.5 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 July 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
July 30, 2016
 
October 31, 2015
Euro
$
10,410

 
$
40,961

British pound
9,940

 
46,330

Indian rupee
8,836

 
35,647

Chinese yuan
3,629

 
15,129

Singapore dollar
3,484

 
13,745

Japanese yen
2,606

 
8,809

Swiss franc
2,365

 
9,265

Total
$
41,270

 
$
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
 
Nine Months Ended
 
July 30, 2016
 
August 1, 2015
 
July 30, 2016
 
August 1, 2015
Cost of revenues
$
5,965

 
$
3,955

 
$
12,400

 
$
9,757

Research and development
9,206

 
5,226

 
19,805

 
13,239

Sales and marketing
17,756

 
10,601

 
39,886

 
27,651

General and administrative
11,716

 
4,655

 
21,384

 
13,947

Total stock-based compensation expense
$
44,643

 
$
24,437

 
$
93,475

 
$
64,594

 

27

The following table presents stock-based compensation expense, net of estimated forfeitures, by grant type (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
July 30, 2016
 
August 1, 2015
 
July 30, 2016
 
August 1, 2015
Stock options
$
3,291

 
$
973

 
$
4,727

 
$
2,865

RSUs, including restricted stock units with market conditions
35,604

 
18,941

 
75,986

 
48,192

Employee stock purchase plan (“ESPP”)
5,748

 
4,523

 
12,762

 
13,537

Total stock-based compensation expense
$
44,643

 
$
24,437

 
$
93,475

 
$
64,594

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 July 30, 2016 (in thousands, except for the weighted-average period):
 
Unrecognized
Compensation
Expense
 
Weighted-
Average Period
(In years)
Stock options
$
2,161

 
1.10
RSUs, including restricted stock units with market conditions
$
166,357

 
2.69
ESPP
$
24,497

 
1.21
The following table presents details on grants made by the Company for the following periods:
 
Nine Months Ended
 
July 30, 2016
 
August 1, 2015
 
Granted
(Shares in thousands)
 
Weighted-Average
Grant Date Fair Value
 
Granted
(Shares in thousands)
 
Weighted-Average
Grant Date Fair Value
Stock options
1,390

 
$
1.36

 
1,117

 
$
3.09

RSUs, including stock units with market conditions
17,879

 
$
7.90

 
10,251

 
$
11.53

The total intrinsic value of stock options exercised for the nine months ended July 30, 2016, and August 1, 2015, was $1.2 million and $2.9 million, respectively.

12. Stockholders’ Equity
Dividends
During the nine months ended July 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
February 16, 2016
 
$
0.045

 
March 10, 2016
 
$
18,016

 
April 4, 2016
May 18, 2016
 
$
0.055

 
June 10, 2016
 
$
25,261

 
July 5, 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.

28

Accumulated Other Comprehensive Loss
The components of other comprehensive loss and related tax effects for the three months ended July 30, 2016, and August 1, 2015, are as follows (in thousands):
 
Three Months Ended
 
July 30, 2016
 
August 1, 2015
 
Before-Tax Amount
 
Tax Expense
 
Net-of-Tax Amount
 
Before-Tax Amount
 
Tax Expense
 
Net-of-Tax Amount
Unrealized gains (losses) on cash flow hedges:
 
 
 
 
 
 
 
 
 
 
 
Change in unrealized gains and losses, foreign exchange contracts
$
(715
)
 
$
15

 
$
(700
)
 
$
(361
)
 
$
(53
)
 
$
(414
)
Net gains and losses reclassified into earnings, foreign exchange contracts (1)
507

 
(25
)
 
482

 
941

 
(110
)
 
831

Net unrealized gains (losses) on cash flow hedges
(208
)
 
(10
)
 
(218
)
 
580

 
(163
)
 
417

Foreign currency translation adjustments
(1,628
)
 
—

 
(1,628
)
 
(492
)
 
—

 
(492
)
Total other comprehensive income (loss)
$
(1,836
)
 
$
(10
)
 
$
(1,846
)
 
$
88

 
$
(163
)
 
$
(75
)
The components of other comprehensive loss and related tax effects for the nine months ended July 30, 2016, and August 1, 2015, are as follows (in thousands):
 
Nine Months Ended
 
July 30, 2016
 
August 1, 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
$
(1,056
)
 
$
21

 
$
(1,035
)
 
$
(2,558
)
 
$
226

 
$
(2,332
)
Net gains and losses reclassified into earnings, foreign exchange contracts (1)
1,981

 
(150
)
 
1,831

 
2,879

 
(335
)
 
2,544

Net unrealized gains (losses) on cash flow hedges
925

 
(129
)
 
796

 
321

 
(109
)
 
212

Foreign currency translation adjustments
(1,760
)
 
—

 
(1,760
)
 
(5,781
)
 
—

 
(5,781
)
Total other comprehensive loss
$
(835
)
 
$
(129
)
 
$
(964
)
 
$
(5,460
)
 
$
(109
)
 
$
(5,569
)
(1)
For classification of amounts reclassified from accumulated other comprehensive loss into earnings as reported on the Company’s Condensed Consolidated Statements of Income, 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 nine months ended July 30, 2016, and August 1, 2015, are as follows (in thousands):
 
Nine Months Ended
 
July 30, 2016
 
August 1, 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
(1,035
)
 
(1,760
)
 
(2,795
)
 
(2,332
)
 
(5,781
)
 
(8,113
)
Net gains and losses reclassified into earnings
1,831

 
—

 
1,831

 
2,544

 
—

 
2,544

Net current-period other comprehensive income (loss)
796

 
(1,760
)
 
(964
)
 
212

 
(5,781
)
 
(5,569
)
Ending balance
$
(743
)
 
$
(25,223
)
 
$
(25,966
)
 
$
(1,695
)
 
$
(22,688
)
 
$
(24,383
)

29


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, non-deductible 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, Asia Pacific, and Japan businesses.
The Company recorded an income tax benefit for the three months ended July 30, 2016, primarily due to a discrete benefit from reserve releases as a result of reaching a settlement on certain transfer pricing issues with the Internal Revenue Service (“IRS”) and certain expired statute of limitations.
The effective tax rate for the three and nine months ended July 30, 2016, was lower than the U.S. federal statutory tax rate of 35% primarily due to a discrete benefit from reserve releases as a result of reaching a settlement on certain transfer pricing issues with the IRS and benefits from 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 effective tax rate for the nine months ended July 30, 2016, was higher compared with the effective tax rate for the nine months ended August 1, 2015, primarily due to an increase in unrecognized tax benefits related to certain intercompany transactions during the nine months ended July 30, 2016.
The Company’s total gross unrecognized tax benefits, excluding interest and penalties, were $189.1 million as of July 30, 2016. If the total gross unrecognized tax benefits as of July 30, 2016, were recognized in the future, approximately $144.0 million would decrease the Company’s effective tax rate.
The IRS and other tax authorities regularly examine the Company’s income tax returns. In June 2016, the Company reached agreement with the IRS on certain transfer pricing issues in the Company’s federal income tax returns for fiscal years 2009 and 2010. 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 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 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 $5 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. The results of the Ruckus business are included in the IP Networking Products and Global Services reportable segments from the date of acquisition.
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 July 30, 2016, were attributable to its U.S. operations.

30

Summarized financial information by reportable segment for the three and nine months ended July 30, 2016, and August 1, 2015, based on the internal management reporting system, is as follows (in thousands):
 
SAN Products
 
IP Networking Products
 
Global Services
 
Total
Three months ended July 30, 2016
 
 
 
 
 
 
 
Net revenues
$
282,114

 
$
208,881

 
$
99,726

 
$
590,721

Cost of revenues
70,630

 
117,862

 
45,330

 
233,822

Gross margin
$
211,484

 
$
91,019

 
$
54,396

 
$
356,899

Three months ended August 1, 2015
 
 
 
 
 
 
 
Net revenues
$
309,451

 
$
153,749

 
$
88,619

 
$
551,819

Cost of revenues
73,657

 
70,586

 
35,672

 
179,915

Gross margin
$
235,794

 
$
83,163

 
$
52,947

 
$
371,904

Nine months ended July 30, 2016
 
 
 
 
 
 
 
Net revenues
$
925,799

 
$
474,556

 
$
287,956

 
$
1,688,311

Cost of revenues
223,806

 
240,991

 
127,489

 
592,286

Gross margin
$
701,993

 
$
233,565

 
$
160,467

 
$
1,096,025

Nine months ended August 1, 2015
 
 
 
 
 
 
 
Net revenues
$
976,362

 
$
431,319

 
$
266,952

 
$
1,674,633

Cost of revenues
233,150

 
198,631

 
109,056

 
540,837

Gross margin
$
743,212

 
$
232,688

 
$
157,896

 
$
1,133,796


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
 
Nine Months Ended
 
July 30,
2016
 
August 1,
2015
 
July 30,
2016
 
August 1,
2015
Basic net income per share
 
 
 
 
 
 
 
Net income
$
10,495

 
$
91,667

 
$
147,226

 
$
255,974

Weighted-average shares used in computing basic net income per share
426,671

 
417,299

 
411,709

 
422,184

Basic net income per share
$
0.02

 
$
0.22

 
$
0.36

 
$
0.61

Diluted net income per share
 
 
 
 
 
 
 
Net income
$
10,495

 
$
91,667

 
$
147,226

 
$
255,974

Weighted-average shares used in computing basic net income per share
426,671

 
417,299

 
411,709

 
422,184

Dilutive potential common shares in the form of stock options
1,227

 
1,772

 
1,329

 
1,777

Dilutive potential common shares in the form of other share-based awards
6,518

 
8,447

 
6,378

 
9,342

Weighted-average shares used in computing diluted net income per share
434,416

 
427,518

 
419,416

 
433,303

Diluted net income per share
$
0.02

 
$
0.21

 
$
0.35

 
$
0.59

Antidilutive potential common shares in the form of: (1)
 
 
 
 
 
 
 
Warrants issued in conjunction with the 2020 Convertible Notes (2)
36,316

 
36,125

 
36,251

 
26,453

Stock options
2,838

 
1,109

 
2,029

 
934

Other share-based awards
2,120

 
100

 
1,140

 
33

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

31

(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 $15.83 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 $20.52 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,” “depend,”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.

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, wireless access points and controllers, 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, application delivery controller and load balancer, and a cloud-based wireless controller offering. 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. For example, we recently launched our Gen 6 Fibre Channel SAN platform. This next generation of switches and directors delivers superior performance and scalability designed to support the demanding workloads from mission-critical applications. In addition, we continue to add new SAN partners, expand relationships with existing partners, and introduce 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, acquisitions, and the development and expansion of our routes to market. Examples include Ethernet fabric switches, virtualized software networking products, and the acquisition of Ruckus Wireless, Inc. (“Ruckus”), which was completed on May 27, 2016. The Ruckus acquisition, which provides us access to both the Ruckus product portfolio and Ruckus’ channels to market, enhances our scale and competitive positioning in both the enterprise and service provider markets and compliments our mobility strategy that we announced in February 2016. Longer term, we expect the Ruckus acquisition to strengthen our ability to pursue emerging opportunities around 5G mobile services, Internet of Things, Smart Cities, in-building LTE, and cellular/Wi-Fi convergence.

32

The 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, upgrading their wireline and wireless infrastructure at the network edge, and adopting our virtualized software-based networking solutions. In particular, our future success in this area would be negatively impacted if the technological transition to virtual software-based solutions 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 software-defined networking (“SDN”), network functions virtualization (“NFV”), and network visibility and analytics (“NVA”), introducing new products, making strategic acquisitions, and enhancing our existing partnerships and forming new partnerships through our various distribution channels.
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 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.
We continue to face multiple challenges as customers consider moving specific workloads to the cloud, evaluate hyper-converged architectures, and assess 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, Russia-related geopolitical uncertainty, and the withdrawal of the United Kingdom from the European Union as voted by the British citizens during the June 23, 2016, referendum, also commonly known as Brexit. 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. However, it is difficult for us to offset the effects of short-term reductions in IT spending. In addition, we are making investments in software offerings and people with software-oriented skill sets to adapt as the market transitions.
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 we expect this dynamic to continue.
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 dividends. In September 2015, we reconfirmed our priorities for the use of operating cash flows and our intent to, after those priorities are met, 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 third quarter of fiscal year 2016, our Board of Directors declared and paid a quarterly cash dividend of $0.055 per share of our common stock for a total of $25.3 million. On August 24, 2016, our Board of Directors declared a quarterly cash dividend of $0.055 per share of our common stock to be paid on October 3, 2016, to stockholders of record as of the close of market on September 9, 2016. Future dividend payments are subject to review and approval on a quarterly basis by our Board of Directors.


33

Overview of Financial Results
The following table, which includes results of operations for the Ruckus business from the acquisition date of May 27, 2016, provides an overview of some of our financial results (in thousands, except percentages):
 
Three Months Ended
 
Nine Months Ended
 
July 30,
2016
 
August 1,
2015
 
July 30,
2016
 
August 1,
2015
Total net revenues
$
590,721

 
$
551,819

 
$
1,688,311

 
$
1,674,633

Gross margin
$
356,899

 
$
371,904

 
$
1,096,025

 
$
1,133,796

Gross margin, as a percentage of total net revenues
60.4
%
 
67.4
%
 
64.9
%
 
67.7
%
Income from operations
$
20,594

 
$
119,849

 
$
224,225

 
$
373,459

Income from operations, as a percentage of total net revenues
3.5
%
 
21.7
%
 
13.3
%
 
22.3
%
Net income
$
10,495

 
$
91,667

 
$
147,226

 
$
255,974


Results of Operations
Our results of operations for the three and nine months ended July 30, 2016, and August 1, 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
 
 
 
 
 
July 30, 2016
 
August 1, 2015
 
 
 
 
 
Net Revenues
 
% of Net
Revenues
 
Net Revenues
 
% of Net
Revenues
 
Increase/(Decrease)
 
%
Change
SAN Products
$
282,114

 
47.7
%
 
$
309,451

 
56.1
%
 
$
(27,337
)
 
(8.8
)%
IP Networking Products
208,881

 
35.4
%
 
153,749

 
27.9
%
 
55,132

 
35.9
 %
Global Services
99,726

 
16.9
%
 
88,619

 
16.0
%
 
11,107

 
12.5
 %
Total net revenues
$
590,721

 
100.0
%
 
$
551,819

 
100.0
%
 
$
38,902

 
7.0
 %

Nine Months Ended




 
July 30, 2016
 
August 1, 2015
 
 
 
 

Net Revenues

% of Net
Revenues

Net Revenues

% of Net
Revenues

Increase/(Decrease)

%
Change
SAN Products
$
925,799


54.8
%

$
976,362


58.3
%

$
(50,563
)

(5.2
)%
IP Networking Products
474,556


28.1
%

431,319


25.8
%

43,237


10.0
 %
Global Services
287,956


17.1
%

266,952


15.9
%

21,004


7.9
 %
Total net revenues
$
1,688,311


100.0
%

$
1,674,633


100.0
%

$
13,678


0.8
 %
The increase in total net revenues for the three months ended July 30, 2016, compared with the three months ended August 1, 2015, reflects higher sales for our IP Networking products and Global Services offerings, partially offset by lower sales for our SAN products, as further described below.
•
The decrease in SAN product revenues was caused by a decrease in director product revenues, primarily due to the weaker storage demand environment, partially offset by a slight increase in embedded and fixed-configuration switch product revenues. As a result, the number of ports shipped decreased by 10.0% during the three months ended July 30, 2016, the effect of which was partially offset by a 1.3% increase in the average selling price per port related to favorable product mix;

34

•
The increase in IP Networking product revenues primarily reflects $73.1 million in revenue from our newly acquired wireless products due to the recent acquisition of Ruckus and, to a lesser extent, higher software networking product revenue primarily due to growth in the virtual router, SDN controller, and network visibility and analytics offerings. The increase is partially offset by a decrease in switch and routing product revenues primarily due to weaker demand from federal, large network carrier, and enterprise customers; and
•
The increase in Global Services revenues was primarily due to an increase in SAN and IP hardware support renewal contracts, an increase in service volume related to our new wireless products from the acquisition of Ruckus, higher vADC software support revenue, and higher support and services revenue from federal customers.
The increase in total net revenues for the nine months ended July 30, 2016, compared with the nine months ended August 1, 2015, reflects higher sales for our IP Networking products and Global Services offerings, partially offset by lower sales for our SAN products, as further described below.
•
The decrease in SAN product revenues was caused by a decrease in director, embedded, and fixed-configuration switch product revenues, primarily due to the weaker storage demand environment. The number of ports shipped decreased by 9.6% during the nine months ended July 30, 2016, due to the challenging business environment, the effect of which was partially offset by a 4.9% increase in the average selling price per port related to improved product mix;
•
The increase in IP Networking product revenues primarily reflects $73.1 million in revenue from our newly acquired wireless products due to the recent acquisition of Ruckus and, to a lesser extent, increases in campus switching, data center switching, and software networking products. Campus switch revenue growth is attributed to the education vertical market, particularly the stimulus from the U.S. federal government funding of technology improvements for schools, commonly known as the E-Rate program. Data center switching revenues increased due to stronger enterprise customer demand for fixed switches. Software networking revenues increased primarily due to the vADC software product line acquired in the second quarter of fiscal year 2015. This increase was partially offset by decreases in revenue from data center routing products, primarily due to weaker demand from large network carrier, enterprise, and federal customers; and
•
The increase in Global Services revenues was primarily due to an increase in support revenue 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 and IP hardware products, an increase in service volume related to our newly acquired wireless products, an increase in support and services revenue from federal customers, as well as an increase in professional services revenues.

Our total net revenues by geographic area are summarized as follows (in thousands, except percentages):
 
Three Months Ended
 
 
 
 
 
July 30, 2016
 
August 1, 2015
 
 
 
 
 
Net Revenues
 
% of Net
Revenues
 
Net Revenues
 
% of Net
Revenues
 
Increase/(Decrease)
 
%
Change
United States (“U.S.”)
$
339,460

 
57.4
%
 
$
317,183

 
57.5
%
 
$
22,277

 
7.0
 %
Europe, the Middle East and Africa (1)
122,371

 
20.7
%
 
142,050

 
25.7
%
 
(19,679
)
 
(13.9
)%
Asia Pacific
91,967

 
15.6
%
 
56,160

 
10.2
%
 
35,807

 
63.8
 %
Japan
25,315

 
4.3
%
 
22,065

 
4.0
%
 
3,250

 
14.7
 %
Canada, Central and South America
11,608

 
2.0
%
 
14,361

 
2.6
%
 
(2,753
)
 
(19.2
)%
Total net revenues
$
590,721

 
100.0
%
 
$
551,819

 
100.0
%
 
$
38,902

 
7.0
 %
(1) 
Includes net revenues of $59.3 million and $91.5 million for the three months ended July 30, 2016, and the three months ended August 1, 2015, respectively, relating to the Netherlands.

35


Nine Months Ended




 
July 30, 2016
 
August 1, 2015
 
 
 
 

Net Revenues

% of Net
Revenues

Net Revenues

% of Net
Revenues

Increase/(Decrease)

%
Change
U.S.
$
920,137


54.5
%

$
954,751


57.0
%

$
(34,614
)

(3.6
)%
Europe, the Middle East and Africa (1)
436,409


25.8
%

447,199


26.7
%

(10,790
)

(2.4
)%
Asia Pacific
222,978


13.2
%

163,861


9.8
%

59,117


36.1
 %
Japan
75,546


4.5
%

67,768


4.0
%

7,778


11.5
 %
Canada, Central and South America
33,241


2.0
%

41,054


2.5
%

(7,813
)

(19.0
)%
Total net revenues
$
1,688,311


100.0
%

$
1,674,633


100.0
%

$
13,678


0.8
 %
(1) 
Includes net revenues of $260.8 million and $295.6 million for the nine months ended July 30, 2016, and the nine months ended August 1, 2015, respectively, relating to the Netherlands.
Revenues are attributed to geographic areas based on where our products are shipped. However, certain OEM partners take possession of our products domestically and then distribute these products to their international customers. Because we account for 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 indicates 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 July 30, 2016, was flat as a percentage of total net revenues compared with the three months ended August 1, 2015. International revenues for the nine months ended July 30, 2016, increased to 45.5% as a percentage of total net revenues compared with 43.0% for the nine months ended August 1, 2015, primarily due to a shift in the mix of OEM customer delivery location 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 July 30, 2016, two customers each individually accounted for 12% of our total net revenues for a combined total of 24% of total net revenues. For the three months ended August 1, 2015, three customers individually accounted for 16%, 15%, and 12% of our total net revenues for a combined total of 43% of total net revenues. For the nine months ended July 30, 2016, three customers individually accounted for 17%, 11%, and 10% of our total net revenues for a combined total of 38% of total net revenues. For the nine months ended August 1, 2015, three customers individually accounted for 17%, 13%, and 11% of our total net revenues for a combined total of 41% 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.

36

Gross margin. Gross margin is summarized as follows (in thousands, except percentages). Gross margin as a percentage of net revenues 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.
 
Three Months Ended
 
 
 
 
 
July 30, 2016
 
August 1, 2015
 
 
 
 
 
Gross Margin
 
% of Net
Revenues
 
Gross Margin
 
% of Net
Revenues
 
Increase/(Decrease)
 
% Points
Change
SAN Products
$
211,484

 
75.0
%
 
$
235,794

 
76.2
%
 
$
(24,310
)
 
(1.2
)%
IP Networking Products
91,019

 
43.6
%
 
83,163

 
54.1
%
 
7,856

 
(10.5
)%
Global Services
54,396

 
54.5
%
 
52,947

 
59.7
%
 
1,449

 
(5.2
)%
Total gross margin
$
356,899

 
60.4
%
 
$
371,904

 
67.4
%
 
$
(15,005
)
 
(7.0
)%
 
Nine Months Ended
 
 
 
 
 
July 30, 2016
 
August 1, 2015
 
 
 
 
 
Gross Margin
 
% of Net
Revenues
 
Gross Margin
 
% of Net
Revenues
 
Increase/(Decrease)
 
% Points
Change
SAN Products
$
701,993

 
75.8
%
 
$
743,212

 
76.1
%
 
$
(41,219
)
 
(0.3
)%
IP Networking Products
233,565

 
49.2
%
 
232,688

 
53.9
%
 
877

 
(4.7
)%
Global Services
160,467

 
55.7
%
 
157,896

 
59.1
%
 
2,571

 
(3.4
)%
Total gross margin
$
1,096,025

 
64.9
%
 
$
1,133,796

 
67.7
%
 
$
(37,771
)
 
(2.8
)%
The changes in gross margin percentage for each reportable segment for the three months ended July 30, 2016, compared with the three months ended August 1, 2015, were primarily due to the following factors (the percentages below reflect the impact on gross margin):
•
SAN gross margins relative to net revenues decreased primarily due to higher salaries and higher variable incentive compensation;
•
IP Networking gross margins relative to net revenues decreased primarily due to the amortization of the purchase accounting adjustment in connection with the preliminary fair valuation of inventory acquired from Ruckus. In addition, IP Networking gross margins decreased due to amortization of IP Networking-related intangible assets acquired in the second and third quarters of fiscal year 2016; and
•
Global Services gross margins relative to net revenues decreased primarily due to higher salaries and higher variable incentive compensation, as well as increased personnel as a result of the Ruckus acquisition and increased staffing related to our continued focus on customer satisfaction and our software business.
The changes in gross margin percentage for each reportable segment for the nine months ended July 30, 2016, compared with the nine months ended August 1, 2015, were primarily due to the following factors (the percentages below reflect the impact on gross margin):
•
SAN gross margins relative to net revenues decreased primarily due to higher salaries and higher variable incentive compensation;
•
IP Networking gross margins relative to net revenues decreased primarily due to the amortization of the purchase accounting adjustment in connection with the preliminary fair valuation of inventory acquired from Ruckus. In addition, IP Networking gross margins decreased due to amortization of IP Networking-related intangible assets acquired in the second quarter of fiscal year 2015 and the second and third quarters of fiscal year 2016; and
•
Global Services gross margins relative to net revenues decreased primarily due to higher salaries and higher variable incentive compensation, as well as other compensation expense due to increased personnel from the Ruckus acquisition and increased staffing related to our continued focus on customer satisfaction and our software business.

37

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 non-recurring 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):
 
July 30, 2016
 
August 1, 2015
 
 
 
 
R&D expenses:
Expense
 
% of Net
Revenues
 
Expense
 
% of Net
Revenues
 
Increase
 
%
Change
Three months ended
$
114,996

 
19.5
%
 
$
85,072

 
15.4
%
 
$
29,924

 
35.2
%
Nine months ended
$
297,516

 
17.6
%
 
$
262,173

 
15.7
%
 
$
35,343

 
13.5
%
R&D expenses increased for the three months ended July 30, 2016, compared with the three months ended August 1, 2015, primarily due to the following (in thousands):
 
Increase
Salaries and other compensation
$
22,323

Stock-based compensation expense
3,980

Expenses related to legal, IT, facilities, and other shared functions
2,625

Various individually insignificant items
996

Total change
$
29,924

Salaries and other compensation increased primarily due to increased personnel as a result of the Ruckus acquisition and higher variable incentive compensation expense. Stock-based compensation expense increased primarily due to the restricted stock units and options assumed as part of the Ruckus acquisition. Expenses related to legal, IT, facilities, and other shared functions allocated to R&D activities increased overall primarily due to higher facilities costs primarily as a result of the incremental expense related to the Ruckus acquisition.
R&D expenses increased for the nine months ended July 30, 2016, compared with the nine months ended August 1, 2015, primarily due to the following (in thousands):
 
Increase/(Decrease)
Salaries and other compensation
$
29,441

Stock-based compensation expense
6,566

Various individually insignificant items
(664
)
Total change
$
35,343

Salaries and other compensation increased primarily due to increased personnel from the acquisitions that occurred in the second quarter of fiscal year 2015 and third quarter of fiscal year 2016. Stock-based compensation expense increased primarily due to the restricted stock units and options assumed as part of the Ruckus acquisition, higher grant-date fair values of grants being amortized in the recent years due to a gradual increase in our stock price since fiscal year 2014, and lower estimated forfeiture rates used in fiscal year 2016 than in fiscal year 2015.
Sales and marketing expenses. Sales and marketing (“S&M”) 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.
S&M expenses are summarized as follows (in thousands, except percentages):
 
July 30, 2016
 
August 1, 2015
 
 
 
 
S&M expenses:
Expense
 
% of Net
Revenues
 
Expense
 
% of Net
Revenues
 
Increase
 
%
Change
Three months ended
$
167,983

 
28.4
%
 
$
144,883

 
26.3
%
 
$
23,100

 
15.9
%
Nine months ended
$
468,743

 
27.8
%
 
$
428,199

 
25.6
%
 
$
40,544

 
9.5
%

38

S&M expenses increased for the three months ended July 30, 2016, compared with the three months ended August 1, 2015, primarily due to the following (in thousands):
 
Increase
Salaries and other compensation
$
9,735

Stock-based compensation expense
7,155

Expenses related to legal, IT, facilities, and other shared functions
2,734

Travel and entertainment expense
1,541

Various individually insignificant items
1,935

Total change
$
23,100

Salaries and other compensation increased primarily due to increased personnel as a result of the Ruckus acquisition, partially offset by lower variable incentive compensation expense. Stock-based compensation expense increased primarily due to the restricted stock units and options assumed as part of the Ruckus acquisition. Expenses related to legal, IT, facilities, and other shared functions allocated to S&M activities increased overall primarily due to higher facilities costs primarily as a result of the incremental expense related to the Ruckus acquisition. Travel and entertainment expense increased primarily due to the sales force assumed in connection with the Ruckus acquisition.
S&M expenses increased for the nine months ended July 30, 2016, compared with the nine months ended August 1, 2015, primarily due to the following (in thousands):
 
Increase/(Decrease)
Salaries and other compensation
$
23,278

Stock-based compensation expense
12,236

Outside services expense
3,186

Expenses related to legal, IT, facilities, and other shared functions
2,609

Various individually insignificant items
(765
)
Total change
$
40,544

Salaries and other compensation increased primarily due to increased personnel as a result of the Ruckus acquisition. Stock-based compensation expense increased primarily due to the restricted stock units and options assumed as part of the Ruckus acquisition, higher grant-date fair values of grants being amortized in the recent years due to a gradual increase in our stock price since fiscal year 2014, and lower estimated forfeiture rates used in fiscal year 2016 than in fiscal year 2015. Outside services expense increased primarily due to consulting services and sales training expenses. Expenses related to legal, IT, facilities, and other shared functions allocated to S&M activities increased primarily due to higher facilities costs primarily as a result of the incremental expense related to the Ruckus acquisition.
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):
 
July 30, 2016
 
August 1, 2015
 
 
 
 
G&A expenses:
Expense
 
% of Net
Revenues
 
Expense
 
% of Net
Revenues
 
Increase
 
%
Change
Three months ended
$
32,960

 
5.6
%
 
$
20,422

 
3.7
%
 
$
12,538

 
61.4
%
Nine months ended
$
78,180

 
4.6
%
 
$
65,815

 
3.9
%
 
$
12,365

 
18.8
%

39

G&A expenses increased for the three months ended July 30, 2016, compared with the three months ended August 1, 2015, primarily due to the following (in thousands):
 
Increase
Stock-based compensation expense
$
7,061

Salaries and other compensation
3,631

Expenses related to legal, IT, facilities, and other shared functions
1,100

Various individually insignificant items
746

Total change
$
12,538

Stock-based compensation increased primarily due to the restricted stock units and options assumed as part of the Ruckus acquisition, higher grant-date fair values of grants being amortized in the recent years due to a gradual increase in our stock price since fiscal year 2014, and lower estimated forfeiture rates used in the third quarter of fiscal year 2016 than in the previous year, as well as an increase in employee stock purchase plan expense. Salaries and other compensation expense increased primarily due to increased personnel as a result of the Ruckus acquisition and higher variable incentive compensation expense. Expenses related to legal, IT, facilities, and other shared functions allocated to G&A activities increased primarily due to higher facilities costs primarily as a result of the incremental expense related to the Ruckus acquisition.
G&A expenses increased for the nine months ended July 30, 2016, compared with the nine months ended August 1, 2015, primarily due to the following (in thousands):
 
Increase/(Decrease)
Stock-based compensation expense
$
7,437

Expenses related to legal, IT, facilities, and other shared functions
2,715

Salaries and other compensation
2,356

Various individually insignificant items
(143
)
Total change
$
12,365

Stock-based compensation expense increased primarily due to the restricted stock units and options assumed as part of the Ruckus acquisition, higher grant-date fair values of grants being amortized in the recent years due to a gradual increase in our stock price since fiscal year 2014, lower estimated forfeiture rates used in fiscal year 2016 than in fiscal year 2015, and an increase in restricted stock units with market conditions granted to employees in recent quarters. Expenses related to legal, IT, facilities, and other shared functions allocated to G&A activities increased primarily due to higher facilities costs primarily as a result of the incremental expense related to the Ruckus acquisition. Salaries and other compensation expense increased primarily due to increased personnel as a result of the Ruckus acquisition and higher variable incentive compensation expense.
Amortization of intangible assets. Amortization of intangible assets is summarized as follows (in thousands, except percentages):
 
July 30, 2016
 
August 1, 2015
 
 
 
 
Amortization of intangible assets:
Expense
 
% of Net
Revenues
 
Expense
 
% of Net
Revenues
 
Increase
 
%
Change
Three months ended
$
5,498

 
0.9
%
 
$
889

 
0.2
%
 
$
4,609

 
518.4
%
Nine months ended
$
7,302

 
0.4
%
 
$
1,654

 
0.1
%
 
$
5,648

 
341.5
%
The increase in amortization of intangible assets for the three months ended July 30, 2016, compared with the three months ended August 1, 2015, was primarily due to the addition of finite-lived intangible assets in connection with the acquisition of Ruckus, completion of the R&D efforts associated with our in-process research and development (“IPR&D”) intangible assets during the nine months ended July 30, 2016, as well as due to the acquisition completed in the second fiscal quarter of 2016. The increase in amortization of intangible assets for the nine months ended July 30, 2016, compared with the nine months ended August 1, 2015, was primarily due to the addition of intangible assets in connection with our acquisitions completed in the second fiscal quarter of 2015 and second and third fiscal quarters of 2016 (see Note 4, “Goodwill and Intangible Assets,” of the Notes to Condensed Consolidated Financial Statements).

40

Acquisition and integration costs. Acquisition and integration costs are summarized as follows (in thousands, except percentages):
 
July 30, 2016
 
August 1, 2015
 
 
 
 
Acquisition and integration costs:
Expense
 
% of Net
Revenues
 
Expense
 
% of Net
Revenues
 
Increase
 
%
Change
Three months ended
$
14,868

 
2.5
%
 
$
789

 
0.1
%
 
$
14,079

 
*

Nine months ended
$
20,625

 
1.2
%
 
$
3,133

 
0.2
%
 
$
17,492

 
558.3
%
*    Not meaningful
The increase in acquisition and integration costs for the three and nine months ended July 30, 2016, compared with the three and nine months ended August 1, 2015, was primarily due to initial consulting services and other professional fees incurred in the second and third fiscal quarters of 2016 in connection with the Ruckus acquisition, which was much larger and therefore resulted in greater costs being incurred than the comparatively smaller two acquisitions completed in the second fiscal quarter of 2015 (see Note 3, “Acquisitions,” of the Notes to Condensed Consolidated Financial Statements).
Restructuring and other related benefits. Restructuring and other related benefits are summarized as follows (in thousands, except percentages):
 
July 30, 2016
 
August 1, 2015
 
 
 
 
Restructuring and other related benefits:
Benefit
 
% of Net
Revenues
 
Benefit
 
% of Net
Revenues
 
(Increase)/Decrease
 
%
Change
Nine months ended
$
(566
)
 
—
 %
 
$
(637
)
 
—
 %
 
$
71

 
(11.1
)%
We did not incur any restructuring and other related benefits for the three months ended July 30, 2016, and the three months ended August 1, 2015. Restructuring and other related benefits for the nine months ended July 30, 2016, were primarily due to a favorable change in lease terms for a certain facility. In addition, restructuring and other related benefits for the nine months ended August 1, 2015, were due to favorable changes in expected sublease terms and other related assumptions for estimated facilities lease losses (see Note 7, “Restructuring and Other Related Benefits,” of the Notes to Condensed Consolidated Financial Statements).
Interest expense. Interest expense primarily represents the interest cost associated with our senior secured notes, senior unsecured notes, and convertible senior unsecured notes (see Note 8, “Borrowings,” of the Notes to Condensed Consolidated Financial Statements).
Interest expense is summarized as follows (in thousands, except percentages):
 
July 30, 2016
 
August 1, 2015
 
 
 
 
Interest expense:
Expense
 
% of Net
Revenues
 
Expense
 
% of Net
Revenues
 
(Increase)/Decrease
 
%
Change
Three months ended
$
(13,462
)
 
(2.3
)%
 
$
(9,778
)
 
(1.8
)%
 
$
(3,684
)
 
(37.7
)%
Nine months ended
$
(33,282
)
 
(2.0
)%
 
$
(45,754
)
 
(2.7
)%
 
$
12,472

 
27.3
 %
Interest expense increased for the three months ended July 30, 2016, compared with the three months ended August 1, 2015, primarily due to the completion of the $800.0 million term loan in connection with the Ruckus acquisition (see Note 8, “Borrowings,” of the Notes to Condensed Consolidated Financial Statements).
In January 2015, we issued $575.0 million in aggregate principal amount of 1.375% convertible senior unsecured notes due 2020 (the “2020 Convertible Notes”) in a private placement. The proceeds from this offering were used to redeem all of the outstanding 6.875% senior secured notes due 2020 (the “2020 Notes”), which had a higher interest rate, and for general corporate purposes. Interest expense decreased for the nine months ended July 30, 2016, compared with the nine months ended August 1, 2015, primarily due to the $15.1 million expense that we recorded in the first quarter of fiscal year 2015 for the call premium, debt issuance costs, and original issue discount relating to the redemption of our 2020 Notes. The decrease in interest expense was also due to the refinancing of the 2020 Notes at a lower interest rate.

41

Interest and other income, net. Interest and other income, net, is summarized as follows (in thousands, except percentages):
 
July 30, 2016
 
August 1, 2015
 
 
 
 
Interest and other income, net:
Income
 
% of Net
Revenues
 
Income
 
% of Net
Revenues
 
Increase
 
%
Change
Three months ended
$
1,557

 
0.3
%
 
$
947

 
0.2
%
 
$
610

 
64.4
%
Nine months ended
$
3,317

 
0.2
%
 
$
854

 
0.1
%
 
$
2,463

 
288.4
%
The increase in interest and other income, net, for the three and nine months ended July 30, 2016, was primarily related to an increase in interest income for our money market funds due to an increase in interest rates. Interest and other income, net, was not material for the three and nine months ended August 1, 2015.
Income tax expense (benefit). Income tax expense (benefit) and the effective tax rates are summarized as follows (in thousands, except effective tax rates):
 
Three Months Ended
 
Nine Months Ended
 
July 30,
2016
 
August 1,
2015
 
July 30,
2016
 
August 1,
2015
Income tax expense (benefit)
$
(1,806
)
 
$
19,351

 
$
47,034

 
$
72,585

Effective tax rate
(20.8
)%
 
17.4
%
 
24.2
%
 
22.1
%
In general, our 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, non-deductible stock-based compensation expense, tax credits, and adjustments to unrecognized tax benefits. Earnings of our subsidiaries outside of the United States primarily relate to our European, Asia Pacific, and Japan businesses.
We recorded an income tax benefit for the three months ended July 30, 2016, primarily due to a discrete benefit from reserve releases as a result of reaching a settlement on certain transfer pricing issues with the Internal Revenue Service (“IRS”) and certain expired statute of limitations.
The effective tax rate for the three and nine months ended July 30, 2016, was lower than the U.S. federal statutory tax rate of 35% primarily due to a discrete benefit from reserve releases as a result of reaching a settlement on certain transfer pricing issues with the IRS and benefits from 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 effective tax rate for the nine months ended July 30, 2016, was higher compared with the effective tax rate for the nine months ended August 1, 2015, primarily due to an increase in unrecognized tax benefits related to certain intercompany transactions during the nine months ended July 30, 2016.
Our income tax provision could change as a result of many factors, including the effects of changing tax laws and regulations or changes to the mix of IP Networking versus SAN products, which have different gross margins, and changes to the mix of domestic versus international profits. Many of these factors are largely impacted by the buying behavior of our OEM and channel partners. As estimates and judgments are used to project such domestic and international earnings, the impact to our future tax provision could vary if the current estimates or assumptions change. In addition, we do not forecast discrete events, such as settlement of tax audits with governmental authorities, due to their inherent uncertainty. Such settlements have in the past, and could in the future, materially impact our tax expense.
For further discussion of our income tax provision, see Note 13, “Income Taxes,” of the Notes to Condensed Consolidated Financial Statements.


42

Liquidity and Capital Resources
 
July 30,
2016
 
October 31,
2015
 
Decrease
 
(In thousands)
Cash and cash equivalents
$
1,153,074

 
$
1,440,882

 
$
(287,808
)
Percentage of total assets
24
%
 
36
%
 
 
We use cash generated by operations as our primary source of liquidity. We expect that cash provided by operating activities will fluctuate in future periods as a result of a number of factors, including fluctuations in our revenues, the timing of product shipments during the quarter, accounts receivable collections, inventory and supply chain management, the timing and amount of tax, and other payments or receipts. For additional discussion, see “Part II—Other Information, Item 1A. Risk Factors” of this Quarterly Report on Form 10-Q.
Based on past performance and current expectations, we believe that internally generated cash flows and cash on hand will be generally sufficient to support business operations, capital expenditures, stock repurchases, cash dividends, contractual obligations, and other liquidity requirements, including our debt service requirements (which increased as a result of the additional indebtedness incurred in connection with the Ruckus acquisition on May 27, 2016), associated with our operations for at least the next 12 months. We may also use our operating cash flows or access sources of capital, or a combination thereof, to strengthen our networking portfolios through acquisitions and strategic investments. In addition, we have up to $100 million available under our revolving credit facility to provide additional liquidity. There are no other transactions, arrangements, or other relationships with unconsolidated entities or other persons that are reasonably likely to materially affect liquidity of, availability of, or our requirements for, capital resources.

Financial Condition
Our operating cash flows 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 or dividends. We have in the past stated our priorities for the use of operating cash flows and our intent to, after those priorities are met, return at least 60% of our annual adjusted free cash flow to stockholders in the form of stock repurchases or dividends. Adjusted free cash flow is operating cash flow, adjusted for the impact of the excess tax benefits from stock-based compensation, less capital expenditures. In the third quarter of fiscal year 2014, our Board of Directors initiated a quarterly cash dividend of $0.035 per share of our common stock. Beginning in the third quarter of fiscal year 2015, our Board of Directors increased our quarterly cash dividend to $0.045 per share of our common stock. Dividends of $0.045 per share were declared and paid in the first and second quarters of fiscal year 2016. Beginning in the third quarter of fiscal year 2016, our Board of Directors increased our quarterly cash dividend to and subsequently declared a dividend of $0.055 per share of our common stock. On August 24, 2016, our Board of Directors declared a quarterly cash dividend of $0.055 per share of our common stock to be paid on October 3, 2016, to stockholders of record as of the close of market on September 9, 2016. Future dividends are subject to review and approval on a quarterly basis by our Board of Directors.
For the nine months ended July 30, 2016, we generated $252.9 million in cash from operating activities, which was due to our net income excluding non-cash items, partially offset by cash used for changes in assets and liabilities.
Net cash used in investing activities for the nine months ended July 30, 2016, totaled $476.1 million and was primarily the result of $564.9 million in cash paid for acquisitions and $59.8 million in purchases of property and equipment, partially offset by the $150.3 million in proceeds from maturities and sale of short-term investments acquired from Ruckus.
Net cash used in financing activities for the nine months ended July 30, 2016, totaled $63.7 million and was primarily the result of $841.6 million in stock repurchases and $61.7 million in cash dividend payments, partially offset by the $787.3 million in proceeds from the term loan and $49.2 million in proceeds from the issuance of common stock from Employee Stock Purchase Plan purchases and stock option exercises. For the nine months ended July 30, 2016, we repurchased 92.0 million shares of our common stock pursuant to our stock repurchase program.
Net proceeds from the issuance of common stock in connection with employee participation in our equity compensation plans have historically been a significant component of our liquidity. The extent to which we receive proceeds from these plans can increase or decrease based upon changes in the market price of our common stock, and from the amount and type of awards granted. For example, we have changed the mix of restricted stock unit and stock option awards granted towards granting fewer stock option awards in recent years, which reduces the net proceeds from the issuance of common stock in connection with participation in our equity compensation plans. As a result, our cash flow resulting from the issuance of common stock in connection with employee participation in our equity compensation plans has varied over time.

43

A majority of our accounts receivable balance is derived from sales to our OEM partners. We perform ongoing credit evaluations of our customers and generally do not require collateral or security interests on accounts receivable balances. We have established reserves for credit losses and sales allowances. While we have not experienced material credit losses in any of the periods presented, there can be no assurance that we will not experience material credit losses in the future.

Nine Months Ended July 30, 2016, Compared to Nine Months Ended August 1, 2015
Operating Activities. Cash provided by operating activities is net income adjusted for certain non-cash items and changes in certain assets and liabilities.
Net cash provided by operating activities decreased by $14.3 million primarily due to decreased accounts receivable collections and higher payments with respect to increased operating expenses and acquisition costs due to Ruckus. Lower payments with respect to employee variable incentive compensation partially offset this decrease in net cash provided by operating activities.
Investing Activities. Net cash used in investing activities increased by $319.4 million primarily due to an increase of $469.4 million of cash used for the acquisitions during the nine months ended July 30, 2016, as compared to the cash used for the acquisitions during the nine months ended August 1, 2015, partially offset by the $150.3 million in proceeds from maturities and sale of short-term investments during the nine months ended July 30, 2016.
Financing Activities. Net cash used in financing activities increased by $22.9 million primarily due to the increase in common stock repurchases in the nine months ended July 30, 2016, as compared with the nine months ended August 1, 2015, partially offset by the increase in net proceeds received from borrowings in the nine months ended July 30, 2016, as compared with the nine months ended August 1, 2015.

Liquidity
Manufacturing and Purchase Commitments. We have manufacturing arrangements with contract manufacturers under which we provide up to 12-month product forecasts and place purchase orders in advance of the scheduled delivery of products to our customers. Our purchase commitments reserve reflects our estimate of purchase commitments we do not expect to utilize in normal operations in accordance with our policy (see Note 9, “Commitments and Contingencies,” of the Notes to Condensed Consolidated Financial Statements).
Income Taxes. We intend to reinvest indefinitely all current and accumulated earnings of our foreign subsidiaries for expansion of our business operations outside the United States. Therefore, we do not currently accrue U.S. income taxes on the earnings of our foreign subsidiaries.
Our existing cash and cash equivalents totaled $1.2 billion as of July 30, 2016. Of this amount, approximately 86% was held by our foreign subsidiaries. We do not currently anticipate a need for these funds held by our foreign subsidiaries for our domestic operations. Under current tax laws and regulations, if these funds are distributed to any of our U.S. entities in the form of dividends or otherwise, we may be subject to additional U.S. income taxes (subject to an adjustment for foreign tax credits) and foreign withholding taxes.
The IRS and other tax authorities regularly examine our income tax returns (see Note 13, “Income Taxes,” of the Notes to Condensed Consolidated Financial Statements). We believe we have adequate reserves for all open tax years.
Senior Unsecured Notes. In January 2013, we issued $300.0 million in aggregate principal amount of the 2023 Notes. We used the proceeds from the issuance of the 2023 Notes and cash on hand to redeem all of the outstanding principal amount of senior secured notes due 2018 in the second quarter of fiscal year 2013. See Note 8, “Borrowings,” of the Notes to Condensed Consolidated Financial Statements.
The 2023 Notes were issued pursuant to an indenture, dated as of January 22, 2013, among the subsidiary guarantors named therein, us, and Wells Fargo Bank, National Association, as trustee (the “2023 Indenture”). The 2023 Indenture contains covenants that, among other things, restrict our ability and the ability of our subsidiaries to:
•
Incur certain liens and enter into certain sale-leaseback transactions;
•
Create, assume, incur, or guarantee additional indebtedness of our 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 our or our subsidiaries’ assets.

44

These covenants are subject to a number of other limitations and exceptions as set forth in the 2023 Indenture. We were in compliance with all applicable covenants of the 2023 Indenture as of July 30, 2016.
Convertible Senior Unsecured Notes. In January 2015, we issued $575.0 million in aggregate principal amount of the 2020 Convertible Notes pursuant to an indenture, dated as of January 14, 2015, between us and Wells Fargo Bank, National Association, as the trustee (the “2015 Indenture”). Net of an original issue discount, we received $565.7 million in proceeds from the offering of the 2020 Convertible Notes. We used a portion of the net proceeds to discharge the 2020 Indenture and redeem all of the outstanding principal amount of the 2020 Notes, pay $35.0 million for the cost of the convertible note hedge transactions, net of the proceeds from the issuance of warrants, and to repurchase approximately 4.1 million shares of our common stock for $48.9 million at a purchase price of $11.80 per share, which was the closing price on January 8, 2015, the date of the pricing of the 2020 Convertible Notes. We intend to use the remaining net proceeds of $159.6 million for general corporate purposes, including potential acquisitions and other business development activities. The 2020 Convertible Notes are unsecured and have a significantly lower interest rate of 1.375% compared to 6.875% for the 2020 Notes. Interest is payable on January 1 and July 1 of each year, beginning on July 1, 2015. See Note 8, “Borrowings,” of the Notes to Condensed Consolidated Financial Statements.
Senior Credit Facility. On May 27, 2016, we entered into a credit agreement (the “Credit Agreement”) with Wells Fargo Bank, Deutsche Bank AG New York Branch, SunTrust Bank and certain other lenders. The Credit Agreement provided us with a term loan facility of $800 million, which was fully drawn at the time of, and the proceeds used to fund in part, the Ruckus acquisition, and a revolving credit facility of $100 million, which is available to finance ongoing working capital requirements and other general corporate purposes. The initial term loan has a term of five years and bears interest at floating rates based on LIBOR, plus a 1.5% interest margin. See Note 8, “Borrowings,” of the Notes to Condensed Consolidated Financial Statements.
There were no principal amounts outstanding under the revolving credit facility, and the full $100 million was available for future borrowing under the revolving credit facility as of July 30, 2016.
We are required to make mandatory prepayments of the term loan facility (without payment of a premium or penalty) with net cash proceeds from issuances of debt (other than certain permitted debt), net cash proceeds from certain non-ordinary course asset sales (subject to reinvestment rights and other exceptions), and casualty proceeds and condemnation awards (subject to reinvestment rights and other exceptions). Commencing October 31, 2016, the loans under the term loan facility will amortize in equal quarterly installments in an aggregate annual amount equal to 10% of the original principal amount thereof, with any remaining balance payable on the final maturity date of the loans under the term loan facility.
The Credit Agreement contains financial maintenance covenants, including a maximum total leverage ratio as of the last date of any fiscal quarter not to exceed 3.50:1.00, subject to certain step-downs to 3.25:1.00 and 3.00:1.00 for fiscal periods ending on or after April 30, 2017, and April 30, 2018, respectively, and a minimum interest coverage ratio of not less than 3.50:1.00. The Credit Agreement also contains restrictive covenants that limit, among other things, our and certain of our subsidiaries’ ability to:
•
Incur additional indebtedness or issue certain preferred equity, pay dividends or make other distributions or other restricted payments (including stock repurchases);
•
Sell assets other than on terms specified by the Credit Agreement;
•
Amend the terms of certain other indebtedness and organizational documents;
•
Create liens on certain assets to secure debt, consolidate, merge, sell, or otherwise dispose of all or substantially all of their assets; and
•
Enter into certain transactions with affiliates, or change their lines of business, fiscal years, and accounting practices, in each case, subject to customary exceptions.
These covenants are subject to a number of other limitations and exceptions as set forth in the Credit Agreement. We were in compliance with all applicable covenants of the Credit Agreement as of July 30, 2016.
The obligations under the term loan facility and certain cash management and hedging obligations are fully and unconditionally guaranteed by certain of our direct and indirect subsidiaries. On May 27, 2016, subsequent to the completion of the Ruckus acquisition, and in accordance with the covenants contained in the 2023 Indenture and 2015 Indenture, Ruckus, us, and certain other of our subsidiaries, and Wells Fargo Bank, N.A., as trustee, entered into supplemental indentures pursuant to which such subsidiaries fully and unconditionally guaranteed our obligations under the 2023 Indenture and 2015 Indenture.

45

Stock Repurchase Program. As of July 30, 2016, our Board of Directors had authorized a total of approximately $3.5 billion for the repurchase of our common stock since the inception of the program in August 2004. The purchases may be made, from time to time, in the open market or by privately negotiated transactions, and are funded from available working capital. The number of shares to be purchased and the timing of purchases are based on the level of our cash balances, general business and market conditions, the trading price of our common stock, and other factors, including alternative investment opportunities. For the three months ended July 30, 2016, we repurchased 72.7 million shares primarily due to our efforts to repurchase shares equivalent to the number of shares issued as stock consideration in connection with the completion of the Ruckus acquisition for an aggregate purchase price of $660.7 million. Approximately $979.4 million remained authorized for future repurchases under this program as of July 30, 2016.

Contractual Obligations
The following table summarizes our contractual obligations, including interest expense, and commitments as of July 30, 2016 (in thousands):
 
Total
 
Less Than
1 Year
 
1–3 Years
 
3–5 Years
 
More Than
5 Years
Contractual Obligations:

 
 
 
 
 
 
 
 
Term loan facility (1)
$
860,263

 
$
95,537

 
$
186,465

 
$
578,261

 
$
—

Convertible senior unsecured notes due 2020 (1)
601,999

 
7,906

 
15,813

 
578,280

 
—

Senior unsecured notes due 2023 (1)
389,768

 
13,875

 
27,750

 
27,750

 
320,393

Non-cancellable operating leases (2)
92,955

 
23,070

 
26,798

 
19,920

 
23,167

Non-cancellable capital leases (1)
16

 
16

 
—

 
—

 
—

Purchase obligations (1)
16,205

 
3,023

 
4,056

 
4,056

 
5,070

Purchase commitments, gross (3)
223,580

 
223,580

 
—

 
—

 
—

Total contractual obligations
$
2,184,786

 
$
367,007

 
$
260,882

 
$
1,208,267

 
$
348,630

Other Commitments:
 
 
 
 
 
 
 
 
 
Standby letters of credit
$
236

 
n/a

 
n/a

 
n/a

 
n/a

Unrecognized tax benefits and related accrued interest (4)
$
191,867

 
n/a

 
n/a

 
n/a

 
n/a

(1) 
Amount reflects total anticipated cash payments, including anticipated interest payments.
(2) 
Amount excludes contractual sublease income of $3.8 million, which consists of $3.4 million to be received in less than one year, $0.3 million to be received in one to three years, and $0.1 million to be received in three to five years.
(3) 
Amount reflects total gross purchase commitments under our manufacturing arrangements with a third-party contract manufacturer. Of this amount, we have accrued reserves of $3.6 million for estimated purchase commitments that we do not expect to utilize in normal operations within the next 12 months, in accordance with our policy.
(4) 
As of July 30, 2016, we had a gross liability for unrecognized tax benefits of $189.1 million and an accrual for the payment of related interest and penalties of $2.7 million.

Off-Balance Sheet Arrangements
As part of our ongoing business, we do not participate in transactions that generate material relationships with unconsolidated entities or financial partnerships, such as entities often referred to as “structured finance” or “special purpose entities,” which would have been established for the purpose of facilitating off-balance sheet arrangements or for other contractually narrow or limited purposes. As of July 30, 2016, we did not have any significant off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Securities and Exchange Commission (“SEC”) Regulation S-K.

Critical Accounting Policies and Estimates
There have been no material changes in the matters for which we make critical accounting policies and estimates in the preparation of our Condensed Consolidated Financial Statements during the nine months ended July 30, 2016, as compared to those disclosed in our Annual Report on Form 10-K for the fiscal year ended October 31, 2015, except for the areas discussed below.

46

Impairment of Goodwill and Other Indefinite-Lived Intangible Assets.
Goodwill and other indefinite-lived intangible assets are generated as a result of business combinations. Our indefinite-lived assets consist of acquired IPR&D and goodwill.
Change in Annual Impairment Testing Date. Effective on the first day of the fourth fiscal quarter, we changed the date of our annual impairment test for IPR&D and goodwill from the first day of the second fiscal quarter to the first day of the fourth fiscal quarter. This change in the annual impairment test date was made to better coincide with the timing of when we prepare our annual budget and financial plans as part of our regular long-range planning process. These financial plans are a key component in estimating the fair value of our reporting units, which is the basis for performing our annual impairment test. We believe that the change in our annual impairment test date is preferable as it allows us to better utilize our most current projections in the annual impairment test.
IPR&D Impairment Testing. IPR&D is an intangible asset accounted for as an indefinite-lived asset until the completion or abandonment of the associated research and development effort. During the development period, we conduct our IPR&D impairment test annually and whenever events or changes in facts and circumstances indicate that it is more likely than not that the IPR&D is impaired. Events that might indicate impairment include, but are not limited to, adverse cost factors, deteriorating financial performance, strategic decisions made in response to economic and competitive conditions, the impact of the economic environment on us and our customer base, and/or other relevant events, such as changes in management, key personnel, litigation, or customers. Our ongoing consideration of factors such as these could result in IPR&D impairment charges in the future, which could adversely affect our net income.
Goodwill Impairment Testing. We conduct our goodwill impairment test annually and whenever events occur or facts and circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. Events that might indicate impairment include, but are not limited to, strategic decisions made in response to economic and competitive conditions, the impact of the economic environment on our customer base, material negative changes in relationships with significant customers, and/or a significant decline in our stock price for a sustained period. Our ongoing consideration of factors such as these could result in goodwill impairment charges in the future, which could adversely affect our net income.
We perform the two-step goodwill impairment test to identify potential goodwill impairment and measure the amount of a goodwill impairment loss to be recognized, if any. The first step tests for potential impairment by comparing the fair value of reporting units with reporting units’ net asset values. The reporting units are determined by the components of our operating segments that constitute a business for which both (i) discrete financial information is available and (ii) segment management regularly reviews the operating results of that component. If the fair value of the reporting unit exceeds the carrying value of the reporting unit’s net assets, then goodwill is not impaired, and no further testing is required. If the fair value of the reporting unit is below the carrying value of the reporting unit’s net assets, then the second step is required to measure the amount of potential impairment. The second step requires an assignment of the reporting unit’s fair value to the reporting unit’s assets and liabilities, using the relevant acquisition accounting guidance, to determine the implied fair value of the reporting unit’s goodwill. The implied fair value of the reporting unit’s goodwill is then compared with the carrying amount of the reporting unit’s goodwill to determine the goodwill impairment loss to be recognized, if any. If the carrying value of a reporting unit’s goodwill exceeds its implied fair value, we record an impairment loss equal to the difference. In the normal course of business, we generate a significant amount of unrecorded intangible assets through R&D and other activities. As a result, this greatly reduces the implied fair value of the reporting unit’s goodwill that is calculated when the second step is required to be performed. Thus, the impairment loss may be much more significant than the difference between the fair value of the reporting unit determined during the first step and the carrying value of the reporting unit’s net assets.
To determine the reporting units’ fair values, we use the income approach, the market approach, or a combination thereof. The income approach provides an estimate of fair value based on discounted expected future cash flows. The market approach provides an estimate of the fair value by applying various observable market-based multiples to the reporting units’ operating results and then applying an appropriate control premium.
Determining the fair value of a reporting unit is judgmental in nature and involves the use of significant estimates and assumptions. We based our fair value estimates on assumptions we believe to be reasonable, but these estimates and assumptions are inherently uncertain. Estimates and assumptions with respect to the determination of the fair value of our reporting units using the income approach include, among other inputs:
•
Our operating forecasts;
•
Our forecasted revenue growth rates; and
•
Risk-commensurate discount rates and costs of capital.

47

Our estimates of revenues and costs are based on historical data, various internal estimates, and a variety of external sources, and are developed as part of our regular long-range planning process. The control premium used in market or combined approaches was determined by considering control premiums offered as part of the acquisitions where acquired companies were comparable with our reporting units.
Consistent with prior years, and before the change in our annual impairment test date, we performed our annual goodwill impairment test using measurement data as of the first day of the second fiscal quarter of 2016. At the time of the initial fiscal year 2016 annual goodwill impairment testing, our reporting units were: SAN Products; IP Networking Products; and Global Services.
During our initial fiscal year 2016 annual goodwill impairment test, we used a combination of the income approach and market approach, weighted equally, to estimate each reporting unit’s fair value.
During the first step of the initial goodwill impairment testing, we determined that all our reporting units passed the first step of goodwill impairment testing and no further testing was required. However, changes in the underlying assumptions can adversely impact fair value because some of the inherent estimates and assumptions used in determining the fair value of these reportable segments are complex and subjective. Accordingly, for the IP Networking Products reporting unit, we performed the sensitivity analysis below to quantify the impact of certain key assumptions on that reporting unit’s fair value estimate. The key assumptions impacting our estimates were (i) discount rates and (ii) discounted cash flow (“DCF”) terminal value multipliers. As these assumptions ultimately reflect the risk of achieving reporting units’ revenue and cash flow projections, we determined that a separate sensitivity analysis for changes in revenue and cash flow projections was not meaningful.
The respective fair values of the SAN Products and Global Services reporting units were substantially in excess of these reporting units’ carrying values, and the fair values of those reporting units were, therefore, not subject to a sensitivity analysis.
As of the date of the initial fiscal year 2016 annual goodwill impairment testing, the carrying value of the IP Networking Products reporting unit’s goodwill was $1.3 billion. Based on our initial fiscal year 2016 annual goodwill impairment test, the estimated fair value of the IP Networking Products reporting unit’s net assets, which include goodwill, exceeded the carrying value of these net assets by approximately $80 million. The following table summarizes the approximate impact that a change in certain key assumptions would have on the estimated fair value of the IP Networking Products reporting unit, leaving all other assumptions unchanged:
 
Change
 
Approximate
Impact on Fair
Value
(In millions)
 
Excess of
Fair Value over
Carrying Value
(In millions)
Discount rate
±1%
 
$(44) - 47
 
$37 - 128
DCF terminal value multiplier
±0.5x
 
$(34) - 34
 
$46 - 115

Recent Accounting Pronouncements
For a description of recent accounting pronouncements, including the expected dates of adoption and estimated effects, if any, on our Condensed Consolidated Financial Statements, see Note 2, “Summary of Significant Accounting Policies,” of the Notes to Condensed Consolidated Financial Statements.

Item 3. Quantitative and Qualitative Disclosures About Market Risk
In the normal course of business, we are exposed to market risks related to changes in interest rates, foreign currency exchange rates, and equity prices that could impact our financial position and results of operations. Our risk management strategy with respect to these three market risks may include the use of derivative financial instruments. We use derivative contracts only to manage our existing underlying exposures. Accordingly, we do not use derivative contracts for speculative purposes. Our risks and risk management strategy are outlined below. Actual gains and losses in the future may differ materially from the sensitivity analysis presented below based on changes in the timing and level of interest rates and our actual exposures and hedges.
Interest Rate Risk
Our exposure to market risk due to changes in the general level of U.S. interest rates relates primarily to our term loan and cash equivalents.
We are exposed to changes in interest rates as a result of our borrowings under our term loan, which in the third quarter of fiscal year 2016, bore interest at floating rates based on LIBOR, plus a 1.5% interest margin. Based on outstanding principal indebtedness of $800.0 million under our term loan as of July 30, 2016, if market rates average 1% above the current interest

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rate, our annual interest expense would increase by approximately $8.0 million. Our remaining material borrowings as of July 30, 2016, bear interest at fixed rates and therefore were not sensitive to changes in interest rates.
Our cash and cash equivalents are primarily maintained at six major financial institutions. The primary objective of our investment activities is the preservation of principal while maximizing investment income and minimizing risk. We had $0.9 billion invested in money market funds as of July 30, 2016, which were not materially sensitive to changes in interest rates due to the short duration of these investments.
We were not subject to material interest rate risk in geographical areas outside of the United States as a substantial portion of our cash and cash equivalents is invested in money market funds in U.S. dollars that have a fixed share price.
Foreign Currency Exchange Rate Risk
We are exposed to foreign currency exchange rate risk inherent in conducting business globally in numerous currencies. We are primarily exposed to foreign currency fluctuations related to operating expenses denominated in currencies other than the U.S. dollar, of which the most significant to our operations for the nine months ended July 30, 2016, were the euro, the British pound, the Indian rupee, the Chinese yuan, the Singapore dollar, the Japanese yen, and the Swiss franc. Because we report in U.S. dollars and we have a net expense position in foreign currencies, we benefit from a stronger U.S. dollar and may be adversely affected by a weaker U.S. dollar relative to the foreign currency. We use foreign currency forward and option contracts designated as cash flow hedges to protect against the foreign currency exchange rate risks inherent in our forecasted operating expenses denominated in certain currencies other than the U.S. dollar. We recognize the gains and losses on foreign currency forward contracts in the same period as the remeasurement losses and gains of the related foreign currency denominated exposures.
We also may enter into other non-designated derivatives that consist primarily of forward contracts to minimize the risks associated with the foreign exchange effects of revaluing monetary assets and liabilities. Monetary assets and liabilities denominated in foreign currencies and any associated outstanding forward contracts are marked-to-market, with realized and unrealized gains and losses included in earnings.
Alternatively, we may choose not to hedge the foreign currency risk associated with our foreign currency exposures if we believe such exposure acts as a natural foreign currency hedge for other offsetting amounts denominated in the same currency or if the currency is difficult or too expensive to hedge. As of July 30, 2016, the gross notional amount of our cash flow derivative instruments was $41.3 million, and we had hedges in place through October 13, 2016.
We have performed a sensitivity analysis as of July 30, 2016, using a modeling technique that measures the change in the fair values arising from a hypothetical 10% adverse movement in the levels of foreign currency exchange rates relative to the U.S. dollar, with all other variables held constant. The analysis covers all of our foreign currency contracts offset by the underlying exposures. The foreign currency exchange rates we used were based on market rates in effect on July 30, 2016. The sensitivity analysis indicated that a hypothetical 10% adverse movement in foreign currency exchange rates would not result in a material foreign exchange loss as of July 30, 2016.
Equity Price Risk
From time to time, we have made equity investments in companies that develop technology or provide services that are complementary to, or broaden the markets for, our products or services and further our business objectives. We had no investments in publicly traded equity securities as of July 30, 2016. The aggregate cost of our equity investments in non-publicly traded companies was $4.5 million as of July 30, 2016. We monitor our equity investments for impairment on a periodic basis. In the event that the carrying value of the equity investment exceeds its fair value, and we determine the decline in value to be other than temporary, we reduce the carrying value to its current fair value. Generally, we do not attempt to reduce or eliminate our market exposure on these equity securities. We do not purchase our equity securities with the intent to use them for speculative purposes.
Our common stock is quoted on the NASDAQ Global Select Market under the symbol “BRCD.” On July 29, 2016, the last business day of our third fiscal quarter of 2016, the last reported sale price of our common stock on the NASDAQ Global Select Market was $9.30 per share.


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Item 4. Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures. Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Act”), as of the end of the period covered by this Quarterly Report on Form 10-Q (the “Evaluation Date”).
The purpose of this evaluation is to determine if, as of the Evaluation Date, our disclosure controls and procedures are effective such that the information required to be disclosed in the reports we file or submit under the Act (i) is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms and (ii) is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective.
(b) Changes in Internal Control over Financial Reporting. There were no changes in our internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the Act, that occurred during the quarter ended July 30, 2016, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Under guidelines established by the SEC, a company is allowed to exclude the internal control over financial reporting of an acquired business from its assessment of its internal control over financial reporting for the fiscal year in which the business was acquired. We acquired Ruckus on May 27, 2016, and are in the process of integrating the acquired business’ internal control over financial reporting into our overall internal control over financial reporting process. Accordingly, we expect to exclude the internal control over financial reporting of the Ruckus business from our assessment of internal control over financial reporting as of October 29, 2016. Ruckus’ post-acquisition revenue included in our Condensed Consolidated Statements of Income for the three months ended July 30, 2016, was approximately 13.2% of our consolidated net revenues for the three months ended July 30, 2016, and Ruckus’ total assets reported on our Condensed Consolidated Balance Sheet as of July 30, 2016, was approximately 15.6% of our consolidated total assets as of July 30, 2016.
Limitations on the Effectiveness of Disclosure Controls and Procedures.
Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well designed and implemented, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues within a company are detected. The inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple errors or mistakes. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and may not be detected. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings
Ruckus Acquisition-Related Litigation
The information set forth under the heading “Ruckus Acquisition-Related Litigation” in Note 9, “Commitments and Contingencies,” of the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Form 10-Q is incorporated herein by reference.

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Other Legal Proceedings
From time to time, the Company is subject to various legal other 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.

Item 1A. Risk Factors

Failure to successfully compete in the networking market could prevent Brocade from increasing or maintaining revenue, profitability, and cash flows with respect to its networking solutions.

The networking market, particularly the data center market, is highly competitive and is undergoing significant transitions due to the adoption of new technologies, such as cloud computing, virtualization, software networking, and infrastructure-as-a-service. For example, companies such as Amazon Web Services, Inc., Microsoft Corporation, and more recently both Cisco Systems, Inc. (“Cisco”) and Hewlett Packard Enterprise Company (“HPE”), offer cloud computing services for the enterprise market, and some customers may choose to procure networking as a service rather than implement on-site networking solutions. Brocade sells into certain sections of the enterprise market which, over time, could shift their information technology (“IT”) spending substantially or completely to cloud services. If Brocade is unable to build and sustain relationships with companies that will continue to invest in their own on-site networks, Brocade’s revenue and profitability could be adversely affected.
Other shifts in the networking market are also creating competitive challenges for Brocade. For example, data center buying patterns are shifting to converged infrastructures in which computer, network, and storage systems are sold as bundled solutions. If Brocade is unsuccessful in having its products included in those bundled solutions, Brocade’s market share could be adversely affected. Also, Juniper Networks, Inc. (“Juniper”) and HPE have launched new offerings, including “whitebox” switches, which those companies have promoted as a low-cost option for networking equipment purchasers. These and other market dynamics, as well as further commoditization of networking products, could negatively impact Brocade’s business and financial results.
Following its acquisition of Ruckus Wireless, Inc. (“Ruckus”), Brocade became a vendor of wireless networking products. Previously, Brocade had relied on partner relationships developed with other companies for access to wireless networking technologies, including access to wireless networking products to supplement Brocade’s wireline campus business. Those partner relationships may be adversely affected by the fact that Brocade now competes with those companies’ wireless networking businesses.
Cisco maintains a dominant position in the networking market; however, customers also have many choices in both traditional and emerging networking technology and networking providers. These other competitors in the networking market include A10 Networks, Inc.; Alcatel-Lucent (recently acquired by Nokia Corporation); Arista Networks, Inc.; Avaya Inc.; Extreme Networks, Inc.; F5 Networks, Inc.; Huawei Technologies Co. Ltd.; Juniper; and QLogic Corporation (“QLogic”). Many of Brocade’s competitors have longer operating histories; greater financial, technical, sales, marketing, and other resources; more name recognition; and larger customer-installed bases than Brocade. These companies’ businesses may have better economies of scale, and therefore these companies could also adopt more aggressive pricing policies than Brocade. Some of these companies’ brands are better known by end users than Brocade’s brand, and channel partners often prefer to sell well-known brands to end-user accounts. In addition, these companies have in the past, and could in the future, enhance their business models through divestitures and acquisitions, which could impact Brocade’s partner ecosystem and Brocade’s go-to-market model. Also, any one of these competitors could devote more resources to develop, promote, and sell their products, and, therefore, could respond more quickly to changes in customer or market requirements and adopt more aggressive pricing policies. Brocade’s failure to successfully compete in the networking market would harm its business and financial results.

Conditions in the Storage Area Networking (“SAN”) market could adversely affect Brocade’s business, financial results, and growth prospects.

Approximately two-thirds of Brocade’s fiscal year 2015 revenue was generated from its SAN business. As such, Brocade’s business, financial results, and growth prospects may be impacted significantly by SAN market conditions. For example, the overall size of the SAN market contracted in 2015 from a revenue perspective due to, among other factors, the increasing efficiency of SAN products, the adoption of other networking protocols, changes in data center architectures, hyper-converged solutions and other new storage technologies, and the other competitive factors described in the risk factor above.

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Revenue generated from sales of Brocade’s SAN products is also impacted by the amount of storage capacity deployed by its SAN customers. While the amount of storage capacity deployed is growing, the rate of that growth has declined in recent years.
In addition, revenue generated from sales of Brocade’s SAN products is impacted by the average selling price for those products. While the overall average selling price for Brocade’s SAN products has increased in recent periods, that increase has been largely due to the introduction of new products. Accordingly, that trend may not be sustained if Brocade is unable to continue to successfully introduce and obtain customer acceptance of new SAN products at the same rate, or at all.
The health of the overall SAN market will also depend on continued market participation by other SAN ecosystem vendors, such as Avago Technologies and QLogic, who produce Fibre Channel host bus adapters for servers and storage arrays.
If Brocade fails to successfully address these SAN market conditions, Brocade’s business, financial results, and growth prospects may be adversely affected.

A limited number of major original equipment manufacturer (“OEM”) partners comprise a significant portion of Brocade’s revenues; the loss of revenue from, or decreased inventory levels held by, any of these major OEM partners could significantly reduce Brocade’s revenues and adversely affect its financial results.

Brocade’s SAN business depends on recurring purchases from a limited number of large OEM partners for a substantial portion of its revenues, specifically EMC Corporation (“EMC”), HPE, and International Business Machines Corporation (“IBM”). As a result, revenues from these large OEM partners have a significant impact on Brocade’s quarterly and annual financial results. For fiscal years 2015, 2014, and 2013, these three OEM partners each represented 10% or more of Brocade’s total net revenues, for a combined total of 41%, 46%, and 46% of total net revenues, respectively. Brocade’s agreements with its OEM partners are typically cancellable, non-exclusive, and have no minimum or specific timing requirements for purchases. Brocade’s OEM partners could increase the amount purchased from Brocade’s competitors, introduce their own technology, or experience lower demand for Brocade SAN products from their end customers.
Also, one or more of Brocade’s OEM partners could elect to divest certain lines of business, split their business, or consolidate or enter into a strategic partnership with one of Brocade’s competitors, such as IBM’s sale of certain lines of business to Lenovo Group Limited, HPE recently becoming a separate public company, and the pending acquisition of EMC by Dell Inc. (“Dell”), which could reduce or eliminate Brocade’s future revenue opportunities with that OEM partner. In addition, business execution or other operating performance issues experienced by Brocade’s OEM partners may adversely affect Brocade’s revenue and financial results. Brocade anticipates that a significant portion of its revenues and operating results from its SAN business will continue to depend on sales to a relatively small number of OEM partners. Brocade’s business and financial results could be harmed by the loss of any one significant OEM partner, a decrease in the level of sales to any one such partner, a change in any one such partner’s go-to-market strategy, or an unsuccessful negotiation on key terms, conditions, or timing of purchase orders placed during a quarter.

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

Brocade has acquired—or made strategic investments in—other companies, products, or technologies, and Brocade expects to make additional acquisitions and strategic investments in the future. In the third quarter of fiscal year 2016, Brocade acquired Ruckus. In the second quarter of fiscal year 2015, Brocade acquired its virtual evolved packet core, also known as vEPC, software product line and related assets from Connectem Inc. and its virtual application delivery controller, also known as vADC, software product line and related assets from Riverbed Technology, Inc. The ability of Brocade to realize the anticipated benefits of its acquisitions and strategic investments involves numerous risks, including, but not limited to, the following:
•
Difficulties in successfully integrating the acquired businesses and realizing any expected synergies;
•
Failure to communicate to customers the capabilities of the combined company;
•
Unanticipated costs, litigation, and other contingent liabilities, including liabilities associated with acquired intellectual property;
•
Diversion of management’s attention from Brocade’s daily operations and business;

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•
Adverse effects on existing business relationships with suppliers and customers, including delays or cancellations of customer purchases, as well as revenue attrition in excess of anticipated levels if existing customers alter or reduce their historical buying patterns;
•
Risks associated with entering into markets in which Brocade has limited or no prior experience, including the potential for a lower level of understanding of specific market dynamics;
•
Inability to attract and retain key employees;
•
Inability to successfully develop new products and services on a timely basis to address the market opportunities of the combined company;
•
Inability to compete effectively against companies already serving the broader market opportunities expected to be available to the combined company;
•
Inability to qualify the combined company’s products with OEM partners on a timely basis, or at all;
•
Inability to successfully integrate financial reporting and IT systems;
•
Inability to develop software-oriented back office systems and processes necessary to sell and support a variety of software-based offerings;
•
Failure to successfully manage additional business locations, including the infrastructure and resources necessary to support and integrate such locations;
•
Assumption or incurrence of debt and contingent liabilities and related obligations to service such liabilities and potential limitations on Brocade’s operations in order to satisfy financial and other negative operating covenants;
•
Additional costs, such as increased costs of manufacturing and service; costs associated with excess or obsolete inventory; costs of employee redeployment, relocation, and retention, including salary increases or bonuses; accelerated amortization of deferred equity compensation, severance payments, reorganization, or closure of facilities; taxes; advisor and professional fees; and termination of contracts that provide redundant or conflicting services;
•
The impact of acquisition- and integration-related costs, goodwill or in-process research and development impairment charges, amortization costs for acquired intangible assets, and acquisition accounting treatment, including the loss of deferred revenue and increases in the fair values of inventory and other acquired assets, on Brocade’s operating results and financial condition; and
•
The target market for the acquired products may not develop within the expected time frame or may evolve in a different technical direction.
Integration and other risks associated with acquisitions can be more pronounced for larger and more complicated transactions. For example, Brocade completed its acquisition of Ruckus in May 2016 and is in the process of combining the businesses and operations of the two companies. The size of the acquisition of Ruckus increases both the scope and consequence of the ongoing risks and challenges associated with those efforts. Brocade may not successfully address those risks and challenges in a timely manner, or at all. If that occurs, Brocade may not fully realize all of the anticipated benefits of the Ruckus acquisition, and its revenue, expenses, operating results and financial condition could be adversely affected.
Brocade may also divest certain businesses or product lines from time to time. For example, Brocade sold its network adapter business to QLogic during the first quarter of fiscal year 2014. Such divestitures involve risks, such as difficulty separating out portions of or entire businesses, distracting employees, incurring potential loss of revenue, negatively impacting margins, and potentially disrupting customer relationships. Brocade may also incur significant costs associated with exit or disposal activities, related impairment charges, or both.


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

In recent years, the rate of economic growth in the United States and in certain other countries, including China, has declined. In addition, uncertainty exists about the future growth of the domestic and international economies. Such uncertainty and slowdowns have resulted in, and may again result in, lower growth or a decline in IT-related spending, and, consequently, lead to lower growth or a decline in the networking market (including high-performance data networking solutions). Historically, IT spending has declined as general economic and market conditions have worsened due to geopolitical uncertainty. In addition, IT spending by international customers may decline as the value of the local currencies weaken against the U.S. dollar. Brocade is particularly susceptible to reductions in IT spending because the purchase of networking solutions is often discretionary and may involve a significant commitment of capital and other resources. The loss or delay of orders from any of Brocade’s more significant customers, such as individual branches or agencies within the U.S. federal government (including the Department of Defense or certain intelligence agencies where Brocade’s revenue is concentrated), or customers within the service provider, financial services, education (including technology improvements for schools funded by the U.S. federal government commonly known as the E-Rate program), and health sectors, could also cause Brocade’s revenue and profitability to suffer. For example, Brocade’s revenue and operating results could be negatively impacted if the U.S. federal government experiences delays in procurement due to longer decision-making time frames and/or a shift in IT procurement priorities. Economic uncertainty has caused, and may cause further, reductions in Brocade’s revenue, profitability, and cash flows, along with increased price competition, increased operating costs, and longer fulfillment cycles. Moreover, economic uncertainty may exacerbate many other risks noted elsewhere in this Form 10-Q, which could adversely affect Brocade’s business operations and financial condition.

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

Developing new products, services (including software networking), and support offerings requires significant up-front investments that may not result in revenues for an extended period of time, if at all. Brocade must achieve market acceptance of its new product and support offerings on a timely basis in order to realize the benefits of its investments. However, the market for networking solutions, driven in part by the growth and evolution of the Internet and adoption of new technologies, such as software-defined networking (“SDN”), network functions virtualization (“NFV”), and Wi-Fi-related cloud services, is characterized by rapidly changing technology, accelerated product introduction cycles, changes in customer requirements, and evolving industry standards. In addition, many of Brocade’s new products, services, and support offerings will be directed towards customers, including hyperscale cloud providers and large service providers, with whom Brocade does not have strong existing sales relationships and who may require longer periods of time to evaluate products prior to making purchases. Sales to these customers may be challenging because sales are often based on long-term relationships and network incumbency and the complex system environments maintained by these customers often require interoperation with a variety of other vendors and back office applications. Brocade’s future success depends largely upon its ability to address the rapidly changing needs of both new and existing customers by: allowing connectivity to other devices and partnering effectively; keeping pace with technological developments and emerging industry standards; and delivering high-quality, reliable, and cost-effective products, product enhancements, and services and support offerings on a timely basis.
Other factors that may affect Brocade’s successful introduction of new products, services, and support offerings include, but are not limited to, Brocade’s ability to:
•
Properly predict the market for new products, services, and support offerings, including features, cost-effectiveness, scalability, and pricing—all of which can be particularly challenging for initial product offerings in new markets;
•
Differentiate Brocade’s new products, services, and support offerings from its competitors’ offerings;
•
Address the interoperability complexities of Brocade’s products with its OEM partners’ server and storage products and Brocade’s competitors’ products;
•
Determine which route(s) to market will be most effective; and
•
Manage product transitions, including forecasting demand, managing excess and obsolete inventories, addressing product cost structures, and managing different sales and support requirements.
Failure to successfully introduce competitive products, services, and support offerings on a timely basis may harm Brocade’s business and adversely affect Brocade’s financial results.


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If Brocade is unable to successfully transition from older products and corresponding support and service offerings to new products and corresponding support and service offerings on a timely basis, its business and financial results could be adversely affected.

As Brocade introduces new or enhanced products, such as Brocade’s recently introduced Gen 6 Fibre Channel SAN platform, it must successfully manage the transition from older products to minimize disruption in customers’ ordering patterns, avoid excessive levels of older product inventories, maintain existing support revenue streams, and provide sufficient supplies of new products to meet customer demands. The introduction of new or enhanced products may shorten the life cycle of Brocade’s existing products or replace the sales of some of Brocade’s current products, thereby offsetting the benefit of a successful product introduction. When Brocade introduces new or enhanced products, it faces numerous risks related to product transitions, including the inability to accurately forecast demand, manage excess and obsolete inventories, address new or higher product cost structures, and manage different sales and support requirements due to the type or complexity of the new or enhanced products. In addition, customer evaluation periods or any customer uncertainty regarding the timeline for rolling out new products, or Brocade’s plans for future support of existing products, may cause customers to delay purchase decisions or to purchase competing products, which would adversely affect Brocade’s business and financial results.

The prices of Brocade’s Internet Protocol (“IP”) Networking products have declined in the past and Brocade expects the prices of its products to decline in the future, which could reduce Brocade’s revenues, gross margins, and profitability.

The average selling price for Brocade’s IP Networking products has typically declined in the past and will likely decline in the future as a result of competitive pricing pressures, broader macroeconomic factors, product mix, new product introductions by Brocade or competitors, the entrance of new competitors, and other factors. In particular, if economic conditions deteriorate and create a more cautious capital spending environment in the IT sector, Brocade and its competitors could pursue more aggressive pricing strategies in an effort to maintain or increase revenues. If Brocade is unable to offset a decline in the average selling price of Brocade’s IP Networking products by increasing the volume of products shipped and/or reducing product manufacturing costs, including key components such as optics, Brocade’s revenues, gross margins, and profitability could be adversely affected.

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

Brocade offers networking solutions through a multipath distribution strategy, including distributors, resellers, a direct sales force, and OEMs. However, Brocade’s efforts to increase sales through this multipath distribution strategy may not generate incremental revenue opportunities. Several of Brocade’s major OEM customers, including Dell, IBM, HPE, and Oracle Corporation, have acquired companies that offer IP Networking solutions that are competitive with Brocade offerings. A loss of, or significant reduction in, revenue through one of Brocade’s paths to market would negatively impact its business and financial results.
As the networking industry continues to evolve, partners with which Brocade does not have long-standing relationships, such as cloud service providers that provide routing and infrastructure-as-a-service and global systems integrators that provide complete solutions to end users interested in upgrading to more modern architectures, may become increasingly important. In addition, as more enterprises purchase infrastructure-as-a-service offerings from hyperscale cloud providers and large service providers, sales through some of Brocade’s existing paths to market could decline. If Brocade fails to build or grow successful relationships with these partners and service providers, Brocade’s business and financial results could be adversely affected.
Brocade’s failure to successfully develop new and/or maintain its current channel partner relationships, or the failure of these partners to sell Brocade’s products, could reduce Brocade’s growth prospects significantly. In addition, Brocade’s ability to respond to the needs of its distribution and reseller partners in the future may also depend on third parties producing complementary products and applications for Brocade products to enable these partners to be competitive in the market. In addition, Brocade may not successfully achieve its expanded go-to-market objectives, which include effectively maintaining or expanding sales through its distribution channels and successfully managing distribution and reseller partner relationships. If Brocade fails to respond successfully to the needs of these distribution and reseller partners and their customers, Brocade’s business and financial results could be adversely affected.

If Brocade does not manage the risks associated with its wireless networking business properly, its revenue and profitability could be adversely affected.

As described below, the risks that accompany Brocade’s new wireless networking business differ from those of Brocade’s other businesses.

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The success of Brocade’s wireless networking business depends on the continued growth and reliance on Wi-Fi, particularly in the service provider and enterprise markets. The recent growth of the market for Wi-Fi networks is being driven by the increased use of Wi-Fi-enabled mobile devices and the use of Wi-Fi as a preferred connectivity option to support video, voice, and other higher-bandwidth uses. As a result, mobile service providers and enterprises are struggling to address the capacity gap. A number of barriers may prevent service providers or their subscribers from adopting Wi-Fi technology to address the capacity gap in wireless networks. For example, Wi-Fi operates over an unlicensed radio spectrum, and if the Wi-Fi spectrum becomes crowded, Wi-Fi solutions will be a less attractive option for service providers. In addition, in order for Wi-Fi solutions to adequately address the capacity gap, mobile devices should automatically switch from a cellular data network to the service provider’s Wi-Fi network, when available and appropriate, which does not generally occur. There is no guarantee that service providers and enterprises will continue to utilize Wi-Fi technology, that use of Wi-Fi-enabled mobile devices will continue to increase, or that Wi-Fi will continue to be the preferred connectivity option for the uses described above. If another technology were found to be superior to Wi-Fi by service providers or enterprises, it could adversely affect Brocade’s revenue and profitability.
Brocade’s wireless products are designed to interoperate with cellular networks and mobile devices using Wi-Fi technology. These networks and devices have varied and complex specifications. As a result, Brocade must attempt to ensure that its products interoperate effectively with all of these existing and planned networks and devices. To meet these requirements, Brocade must continue to undertake development and testing efforts that require significant capital and employee resources. Brocade may not accomplish these development efforts quickly or cost-effectively, or at all. If Brocade’s wireless products do not interoperate effectively, orders for Brocade’s wireless products could be delayed or canceled, potentially resulting in the loss of existing and potential end customers; Brocade could experience significant warranty, support and repair costs; and the attention of Brocade’s engineering personnel could be diverted from its product development efforts. In addition, Brocade’s end customers may require Brocade’s products to comply with new and rapidly evolving security or other certifications and standards. If Brocade’s wireless products are late in achieving or fail to achieve compliance with these certifications and standards, and/or if Brocade’s competitors achieve compliance with these certifications and standards, such end customers may not purchase Brocade’s products, which would adversely affect Brocade’s revenue and profitability.
Brocade’s wireless products have been deployed in many different locations and user environments and are capable of providing connectivity to many different types of Wi-Fi-enabled devices operating a variety of applications. The ability of Brocade’s wireless products to operate effectively can be negatively impacted by many different elements unrelated to its products. For example, a user’s experience may suffer from an incorrect setting in a Wi-Fi device. Although certain technical problems experienced by users may not be caused by Brocade’s products, users often perceive the underlying cause to be a result of poor performance of the wireless network. This perception, even if incorrect, could harm Brocade’s business and reputation.

Brocade has a substantial amount of acquired intangible assets, goodwill, and deferred tax assets on its balance sheet, and if Brocade is required to record impairment charges for these assets, such impairment charges could adversely affect Brocade’s financial results.

Brocade has a substantial amount of acquired intangible assets and goodwill on its balance sheet related to Brocade’s prior acquisitions. Brocade’s determination of the fair value of its long-lived assets relies on management’s assumptions of future revenues, operating costs, and other relevant factors. Brocade’s estimates with respect to the useful life or ultimate recoverability of Brocade’s carrying basis of assets, including acquired intangible assets, could change as a result of changes in management’s assumptions. If management’s estimates of future operating results change or if there are changes to other assumptions, such as the discount rate applied to future cash flows, then the estimated fair value of Brocade’s reporting units could change significantly, which could result in goodwill impairment charges. The risk of a future goodwill impairment charge is comparatively high for the IP Networking Products reporting unit because based on the Company’s initial fiscal year 2016 annual goodwill impairment test, the estimated fair value of that reporting unit’s net assets, which include goodwill, exceeded the carrying value of those net assets by only approximately $80 million. For a sensitivity analysis that quantifies the impact of certain key assumptions used by Brocade on the fair value estimates for the IP Networking Products reporting unit, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates” in Part I, Item 2 of this Form 10-Q. If future impairment tests should result in a charge to earnings, Brocade’s financial results would be adversely affected.

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Brocade has determined that, more likely than not, it will realize its deferred tax assets based on positive evidence of its historical operations and projections of future income, except for the deferred tax assets related to California and remaining capital loss carryforwards for which a valuation allowance has been applied. In the event that future income by jurisdiction is less than what is currently projected, Brocade may be required to apply a valuation allowance to these deferred tax assets in jurisdictions where realization of such assets is no longer more likely than not, which could result in a charge to earnings that would adversely affect Brocade’s financial results.

Cyberattacks and data security breaches could disrupt Brocade’s operations, negatively impact Brocade’s reputation, and erode customers’ trust.

Cyberattacks and other malicious attacks could lead to data breaches, computer break-ins, malware, viruses, and unauthorized tampering with Brocade’s computer systems, intellectual property, and confidential information about its customers and partners. These attacks could disrupt Brocade’s operations, negatively impact Brocade’s reputation, and erode customers’ trust. Despite implementation of cybersecurity measures, Brocade may not successfully limit attacks by malicious third parties if they attempt to undermine or disrupt those cybersecurity measures.
Additionally, if an actual or perceived cyberattack or data security breach occurs in Brocade’s network or in one of Brocade’s customer’s network, regardless of whether the breach is attributable to Brocade’s products, the market perception of the effectiveness of Brocade’s products could be harmed. Brocade may suffer reputational harm and Brocade’s customers’ trust may be eroded as a result of a data security breach involving customers’ or employees’ information, which could negatively impact profitability and/or increase expenses. Customers have become increasingly sensitive to government-sponsored surveillance and may believe that, as a U.S.-based manufacturer, Brocade’s equipment contains “backdoor” code that would allow customer data to be compromised by either governmental bodies or other third parties. As a result, customers may choose not to deploy Brocade networking products, which could negatively impact Brocade’s business and financial results.

Brocade’s revenues, operating results, and cash flows may fluctuate from period to period due to a number of factors, which makes predicting financial results difficult.

IT spending is subject to cyclical and uneven fluctuations, which could cause Brocade’s financial results to fluctuate unevenly and unpredictably. For example, the U.S. federal budget for government IT spending can be highly seasonal and subject to delays, reductions, and uncertainty due to changes in the political and legislative environment. It can also be difficult to predict the degree to which end-customer demand and the seasonality and uneven sales patterns of Brocade’s OEM partners or other customers will affect Brocade’s business in the future, particularly as Brocade releases new or enhanced products. While Brocade’s first and fourth fiscal quarters are typically stronger quarters for SAN products and Brocade’s third and fourth fiscal quarters are typically stronger quarters for IP Networking solutions, future buying patterns may differ from historical seasonality. If the mix of revenue changes, it may also cause results to differ from historical seasonality. Accordingly, Brocade’s quarterly and annual revenues, operating results, cash flows, and other financial and operating metrics may vary significantly in the future, and the results of any prior periods should not be relied upon as an indication of future performance.

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

Brocade’s success depends, to a significant degree, upon the continued contributions of its employees, including executive officers, engineers, sales representatives, and others, many of whom would be difficult to replace. Departures, appointments, and changes in roles and responsibilities of officers or other key members of management may disrupt Brocade’s business and adversely affect Brocade’s operating results.
Brocade believes its future success depends, in large part, upon its ability to attract highly skilled employees and operate effectively in geographically diverse locations. Brocade has relied heavily on equity awards in the form of stock options and restricted stock units as one means for recruiting and retaining highly skilled employees. The number of shares available for issuance under Brocade’s 2009 Stock Plan is limited, and any increase in the number of shares available under that plan must be approved by Brocade’s stockholders. The extent to which Brocade is able to obtain such stockholder approval depends on a variety of factors, including assessments by stockholders and proxy advisory firms of Brocade’s historical equity award granting practices. The effectiveness of these equity awards in recruiting and retaining employees could be reduced if Brocade has to reduce the size of the equity awards granted to its employees or if there is a sustained decline in the trading price of Brocade’s shares. There are also limited qualified employees in each of Brocade’s markets, and competition for such employees is very aggressive. In particular, Brocade operates in various locations with highly competitive labor markets, including Bangalore, India, and San Jose, California. Brocade may experience difficulty in hiring key management and qualified employees with skills in nearly all areas of Brocade’s business and operations.

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The loss of the services of any of Brocade’s key employees, the inability to attract or retain qualified employees in the future, or delays in hiring required employees—particularly sales and engineering employees—could delay the development and introduction of Brocade’s products or services and/or negatively affect its ability to sell products or services.

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

Brocade provides product forecasts to its contract manufacturers (“CMs”) and places purchase orders with them in advance of the scheduled delivery of products to Brocade’s customers. In preparing sales and demand forecasts, Brocade relies largely on input from its sales force, partners, resellers, and end-user customers. If Brocade is unable to accurately forecast demand, or if Brocade fails to effectively communicate with its distribution partners about end-user demand or other time-sensitive information, Brocade’s ability to successfully manage production could be negatively impacted. Brocade’s ability to accurately forecast demand also may become increasingly limited as Brocade introduces new or enhanced products, begins phasing out certain products, or acquires other companies or businesses. If these forecasts are inaccurate, Brocade may be unable to obtain adequate manufacturing capacity from its CMs to meet customers’ delivery requirements, which could cause customers to cancel their orders for Brocade products. Inaccurate forecasts also could cause Brocade to accumulate excess inventories or incur costs associated with excess manufacturing capacity. If customers cancel their orders, Brocade’s revenue may be adversely affected. If excess inventories accumulate, Brocade’s gross margins may be negatively impacted by write-downs for excess and/or obsolete inventory. In addition, Brocade will experience higher fixed costs as it expands its CMs’ capabilities for forecasted demand, which could negatively affect Brocade’s margins if demand decreases suddenly and Brocade is unable to reduce these fixed costs.
Additionally, most of Brocade’s manufacturing overhead and expenses are fixed in the short term or incurred in advance of receipt of corresponding revenue, and Brocade may not be able to reduce such expenses sufficiently to offset declining product prices. As a result, Brocade’s gross margins may be adversely affected by fluctuations in manufacturing volumes, component costs, foreign currency exchange rates, the mix of product configurations sold, and the mix of distribution channels through which its products are sold. Brocade’s gross margins may also be adversely affected if product or related warranty costs associated with Brocade’s products are greater than previously experienced.

Brocade has extensive international operations, which expose its business and operations to additional risks.

Brocade has significant international operations, and a significant portion of Brocade’s sales occur in international jurisdictions. In addition, Brocade’s CMs have significant operations in China and other locations outside the United States. Brocade’s international sales of its IP Networking solutions have primarily depended on its distributors and resellers. Maintenance or expansion of international sales or international operations involves inherent risks that Brocade may not be able to control, including, but not limited to, the following:
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Compliance with U.S. and other applicable government regulations prohibiting certain end-uses and restricting trade with embargoed or sanctioned countries, such as Iran and Russia, and with denied parties;
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Difficulty in conducting due diligence with respect to business partners in certain international markets;
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Exposure to economic instability or fluctuations in international markets, such as China, that could cause reductions in IT spending;
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Exposure to inflationary risks and/or wage inflation in certain countries, such as India;
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Increased exposure to foreign currency exchange rate fluctuations, including currencies such as the British pound, the Chinese yuan, the euro, the Indian rupee, the Japanese yen, the Singapore dollar, and the Swiss franc;
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Exposure to sovereign debt risk and political and economic instability in certain regions of Europe, including Russia and Turkey, and certain countries with newly advanced economies, including China and Brazil;
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Multiple potentially conflicting and changing governmental laws, regulations, and practices, including differing environmental, data privacy, export, import, trade, manufacturing, tax, labor, and employment laws;
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Compliance with U.S. and other applicable government regulation of exports and imports, and associated licensing requirements, particularly in the area of encryption technology;
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Reduced or limited protection of intellectual property rights, particularly in jurisdictions that have less developed intellectual property regimes, such as China and India;

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Commercial laws and business practices that favor local competition;
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In certain international regions, particularly those with rapidly developing economies, it may be common to engage in business practices that are prohibited by anti-bribery laws, such as the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act;
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Increased complexity, time, and costs of managing international operations;
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Managing research and development and sales teams in geographically diverse locations, including teams divided between the United States, the United Kingdom, and India;
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Effective communications across multiple geographies, cultures, and languages;
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Recruiting sales and technical support personnel with the skills to design, manufacture, sell, and support Brocade’s products in international markets;
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Longer sales cycles and manufacturing lead times;
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Increased complexity and cost of providing customer support and maintenance for international customers;
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Difficulties in collecting accounts receivable;
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Increased complexity of logistics and distribution arrangements; and
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Increased complexity of accounting rules and financial reporting requirements.
In addition, the June 2016 announcement of the results of the United Kingdom European Union membership referendum (commonly referred to as Brexit) advising for the exit of the United Kingdom from the European Union has created economic, financial, and regulatory uncertainty, which may cause Brocade’s customers to closely monitor their costs and reduce their spending on Brocade’s products and services.
Any of these factors could negatively impact Brocade’s business, revenues, and profitability.

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

Brocade’s IP Networking business typically experiences significantly higher levels of customer orders toward the end of a fiscal period. Customer orders received toward the end of the period may not ship within the period due to a lack of available inventory and manufacturing lead times. The inability to ship within the quarter in which the customer orders are received could negatively impact Brocade’s financial results in a particular quarter.


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

Brocade competes in markets in which companies are frequently subject to claims and related litigation regarding patent and other intellectual property rights. Third parties have, from time to time, asserted patent, copyright, trade secret, and/or other intellectual property-related claims against Brocade and/or employees of Brocade. These claims may be, and have in the past been, made against Brocade’s products and services, subcomponents of its products, methods performed by its products or a combination of products, including third-party products, methods used in its operations, or uses of its products by its customers. The claimant may seek various remedies against Brocade, such as money damages, disgorgement of profits, injunctions barring sales of infringing goods, or exclusion orders barring import of products into the U.S., among other possible remedies. Moreover, these claims may concern Brocade’s hiring of a former employee of the third-party claimant. Brocade and companies acquired by Brocade have in the past incurred, and will likely incur in the future, substantial expenses to defend against such third-party claims. In particular, as a result of the acquisition of Ruckus, Brocade now competes in new markets, including the Wireless LAN market, that may result in relatively greater numbers of third-party intellectual property claims. Brocade’s suppliers and customers also may be subject to third-party intellectual property claims with respect to their own products, which could negatively impact the suppliers’ ability to supply Brocade with components or customers’ willingness to purchase products from Brocade. In addition, Brocade may be subject to claims, defenses, and indemnification obligations with respect to third-party intellectual property rights pursuant to Brocade’s agreements with suppliers, OEM and channel partners, or customers. If Brocade refuses to indemnify or defend such claims, for instance, even in situations where the allegations are meritless, then suppliers, partners, or customers may refuse to do business with Brocade. Parties that assert such intellectual property claims may be unreasonable in their demands, or may simply refuse to settle, which could lead to prolonged periods of litigation, additional burdens on employees or other resources, distraction from Brocade’s business operations, component supply stoppages, expensive settlement payments, and lost sales. Furthermore, there is little or no information publicly available concerning market or fair values for licenses and/or settlement fees, which can lead to overpayment of license or settlement fees. Any of the above scenarios could have an adverse effect on Brocade’s financial position, financial results, cash flows, and future business prospects.

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

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


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

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

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

Brocade’s intellectual property rights may be infringed upon or misappropriated by others, including by competitors, partners, former employees, foreign governments, or other third parties. In some cases, such infringement or misappropriation may be undetectable, or enforcement of Brocade’s intellectual property rights may be impractical. Brocade has filed, and may in the future file, lawsuits against third parties in an effort to enforce its intellectual property rights. Intellectual property litigation is expensive and unpredictable. There can be no assurance that Brocade will prevail in such assertions or enforcement efforts, either on the merits, or with respect to particular relief sought, such as damages or an injunction. Nor can there be any assurance that any awarded damages ultimately will be paid to Brocade. Furthermore, the opposing party may attempt to prove that the asserted intellectual property rights are invalid or unenforceable, and, if successful, may seek recompense for its attorneys’ fees and costs or countersue Brocade as part of its defense. Finally, there can be no assurance that any attempt by Brocade to enforce its intellectual property rights, even if successful in court, will improve Brocade’s sales, diminish the defendant’s sales, or stop the defendant’s allegedly unfair competition.
Brocade relies on a combination of patent, copyright, trademark, and trade secret laws, along with measures such as physical and operational security and contractual restrictions, to protect its intellectual property rights in its proprietary technologies, but none of these methods of protection may be entirely appropriate or adequate to address all risks that could result in a loss of intellectual property rights. Loss or violation of Brocade’s intellectual property rights could adversely affect Brocade’s business and operating results, through a loss of revenue or an increase in expenses.

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

Many Brocade products are designed to include software or other intellectual property licensed from third parties. There can be no assurance that the necessary licenses will be available on acceptable terms, if at all. Brocade’s inability to obtain certain licenses or other rights on favorable terms could have an adverse effect on Brocade’s business, operating results, and financial condition, including its ability to continue to distribute or support affected products.

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In addition, if Brocade has failed, or in the future fails, to adequately manage the use of commercial or “open-source” software in Brocade’s products, or if companies acquired by Brocade fail in such regard, Brocade may be subject to copyright infringement litigation or other claims. Furthermore, Brocade may be required, for commercially licensed software, to pay penalties or undergo costly audits pursuant to the license agreement. In the case of open-source software, Brocade may be required to license proprietary portions of its products on a royalty-free basis, disclose proprietary parts of source code, or commence costly product redesigns that could result in a loss of intellectual property rights, product performance degradation, or a delay in shipping products to customers and result in loss of revenue.

Brocade’s planned upgrade of its enterprise resource planning (“ERP”) software solution could result in significant disruptions to its operations.

Brocade is in the process of upgrading its ERP software solution to a newer version. Brocade expects the upgrade to be completed in fiscal year 2017. Implementation of the upgraded solution is highly dependent on coordination of numerous software and system providers and internal business teams. Brocade may experience difficulties as it transitions to the upgraded systems and processes, including loss or corruption of data, delayed shipments, decreases in productivity as its personnel implement and become familiar with new systems and processes, increased costs and lost revenues. In addition, transitioning to the upgraded solution requires a significant investment of capital and personnel resources. Difficulties in implementing the upgraded solution or significant system failures could disrupt Brocade’s operations and have an adverse effect on its capital resources, financial condition, results of operations or cash flows.
Implementation of the upgraded ERP solution will have a significant impact on Brocade’s business processes and information systems across a significant portion of its operations. As a result, Brocade will be undergoing significant changes in its operational processes and internal controls as the implementation progresses, which in turn will require significant change management. If Brocade is unable to successfully manage these changes as it implements the upgraded ERP solution, its ability to conduct, manage and control routine business functions could be negatively affected, and significant disruptions to its business could occur. In addition, Brocade could incur material unanticipated expenses, including additional costs of implementation or costs of conducting business. These risks could result in significant business disruptions or divert management’s attention from key strategic initiatives and have an adverse effect on Brocade’s capital resources, financial condition, results of operations, or cash flows.

Business interruptions could adversely affect Brocade’s business operations.

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

Any failure by Brocade to meet its current capital return objectives could have an adverse effect on its reputation and stock price.

Based on past performance and current expectations, Brocade believes that internally generated cash flows and cash on hand will be generally sufficient to support business operations, contractual obligations, and other liquidity requirements, including its debt service requirements, associated with its operations for at least the next 12 months. Brocade also uses its operating cash flows, proceeds from the issuance of new shares, access sources of capital, or a combination thereof, to strengthen its business through acquisitions and strategic investments.

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Brocade has, in the past, stated its priorities for the use of operating cash flows and its intent to, after those priorities are met, return at least 60% of its annual adjusted free cash flow to stockholders in the form of stock repurchases or dividends. Brocade’s ability to return at least 60% of its annual adjusted free cash flow to stockholders is limited by, among other things, Delaware law. In addition, Brocade’s plans and expectations relating to its return of capital to stockholders may change, as they did in May 2016, due to, among other things, the need to allocate capital to other priorities, such as the acquisition of Ruckus. If Brocade is unable to meet its stated past or current capital return objectives, or if the Board of Directors decides to further alter the capital return objective, Brocade’s reputation and its stock price may be adversely affected.

Brocade is required to assess its internal control over financial reporting on an annual basis, and any adverse findings from such assessment could result in a loss of investor confidence in its financial reports, significant expense to remediate any internal control deficiencies, and ultimately have an adverse effect on its stock price.

Brocade is required to assess the effectiveness of its internal control over financial reporting annually, as required by Section 404 of the Sarbanes-Oxley Act of 2002. Brocade does not expect its evaluation of the effectiveness of its internal control over financial reporting as of October 29, 2016, to include the internal controls of Ruckus, which Brocade acquired in May 2016. Even though, as of October 31, 2015, its most recent internal control effectiveness evaluation date, Brocade concluded that its internal control over financial reporting was effective, Brocade needs to maintain its processes and systems and adapt them as its business grows and changes, including to reflect its integration of Ruckus, as well as any future acquisitions Brocade may undertake. This continuous process of maintaining and adapting its internal controls and complying with Section 404 is expensive, time consuming, and requires significant management attention. In addition, Brocade cannot be certain that its internal control measures will continue to provide adequate control over its financial processes and reporting or ensure compliance with Section 404.
If Brocade or its independent registered public accounting firm identifies material weaknesses in Brocade’s internal controls, the disclosure of that fact, even if quickly remedied, may cause investors to lose confidence in Brocade’s financial statements and its stock price may decline. Remediation of a material weakness could require Brocade to incur significant expenses and, if Brocade fails to remedy any material weakness, its financial statements may be inaccurate, its ability to report its financial results on a timely and accurate basis may be adversely affected, its access to the capital markets may be restricted, its stock price may decline, and Brocade may be subject to sanctions or investigation by regulatory authorities, including the U.S. Securities and Exchange Commission (“SEC”) or the NASDAQ Stock Market LLC (“NASDAQ”). Brocade may also be required to restate its financial statements from prior periods.

Brocade’s business is subject to increasingly complex and changing legal and regulatory requirements that could adversely affect its business, financial results, and stock price.

Brocade is subject to the changing rules and regulations of federal and state governments, as well as the stock exchange on which Brocade’s common stock is listed. These entities, including the Public Company Accounting Oversight Board, the Financial Accounting Standards Board, the SEC, the Internal Revenue Service (the “IRS”), the Financial Industry Regulatory Authority, Inc., and NASDAQ, have issued a significant number of new regulations over the last several years and continue to develop additional regulations and requirements. Further, Brocade is subject to various rules and regulations of certain foreign jurisdictions. Brocade’s efforts to comply with these requirements have resulted in, and are likely to continue to result in, an increase in expenses and a diversion of management’s time from other business activities.
For example, the Dodd-Frank Wall Street Reform and Consumer Protection Act requires that public companies disclose whether certain minerals, commonly known as “conflict minerals,” are necessary to the functionality or production of a product manufactured or contracted to be manufactured by those companies, and, if so, if those minerals originated in the Democratic Republic of the Congo or an adjoining country. These requirements could adversely affect the sourcing, availability, and pricing of minerals used in the manufacture of certain components that are incorporated in Brocade products. In addition, Brocade’s supply chain is complex, so Brocade may face reputational challenges with its partners, customers, stockholders, and other stakeholders if the origins of the conflict minerals used in its products cannot be verified sufficiently.

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Similarly, Brocade is subject to environmental and other regulations governing product safety, materials usage, packaging, and other environmental impacts in the countries where Brocade products are sold. For example, many Brocade products are subject to laws and regulations that restrict the use of certain substances such as lead, mercury, hexavalent chromium, and cadmium, and that require Brocade to assume responsibility for collecting, treating, recycling, and disposing of products when they have reached the end of their useful life. For example, in Europe, environmental restrictions apply to products sold in that region, and certain Brocade partners require compliance with these or other more stringent requirements. In addition, recycling, labeling, and related requirements apply to Brocade products sold in Europe and China. If Brocade products do not comply with local environmental laws, Brocade could be subject to fines, civil and criminal sanctions, and contract damage claims. In addition, Brocade could be prohibited from shipping non-compliant products into certain jurisdictions and required to recall and replace any non-compliant products already shipped, which would disrupt the ability to ship products and result in reduced revenue, increased warranty expense, increased obsolete or excess inventories, and harm to Brocade’s business and customer relationships.
Brocade’s wireless products are subject to governmental regulations in a variety of jurisdictions. In order to achieve and maintain market acceptance, Brocade’s wireless products must continue to comply with these regulations, as well as a significant number of industry standards. In the United States, Brocade’s products must comply with various regulations defined by the Federal Communications Commission (“FCC”), Underwriters Laboratories, and others. Brocade must also comply with similar international regulations. For example, Brocade’s wireless communication products operate through the transmission of radio signals, and radio emissions are subject to regulation in the United States and in other countries in which Brocade does business. In the United States, various federal agencies including the Center for Devices and Radiological Health of the United States Food and Drug Administration, the FCC, the Occupational Safety and Health Administration, and various state agencies have promulgated regulations that concern radio/electromagnetic emissions standards. Member countries of the European Union have enacted similar standards concerning electrical safety and electromagnetic compatibility and emissions, as well as chemical substances and use standards. As these regulations and standards evolve, and if new regulations or standards are implemented, Brocade will be required to modify its products or develop and support new versions of its products, and Brocade’s compliance with these regulations and standards may become more burdensome. The failure of Brocade’s wireless products to comply, or delays in compliance, with the various existing and evolving industry regulations and standards could prevent or delay introduction of Brocade’s products, which could harm Brocade’s business. End-customer uncertainty regarding future policies may also affect demand for communications products, including Brocade’s wireless products. If existing laws or regulations regarding the use of Brocade’s wireless products or related services are enforced in a manner not contemplated by Brocade’s end customers, it could expose them or Brocade to liability and adversely affect Brocade’s wireless networking business. Moreover, channel partners or end customers may require Brocade, or Brocade may otherwise deem it necessary or advisable, to alter its wireless products to address actual or anticipated changes in the regulatory environment. Brocade’s inability to alter its wireless products to address these requirements and any regulatory changes may adversely affect Brocade’s wireless networking business.
In addition, Brocade is subject to laws, rules, and regulations in the United States and other countries relating to the collection, use, and security of personal information and data. Brocade has incurred, and will continue to incur, expenses to comply with privacy and security standards, protocols, and obligations imposed by applicable laws, regulations, industry standards, and contracts. In addition, such data privacy laws, regulations, and other obligations may negatively impact Brocade’s ability to execute transactions and pursue business opportunities. The privacy and data protection-related laws, rules, and regulations applicable to Brocade are also subject to significant change. For example, in October 2015, the Court of Justice of the European Union invalidated a safe harbor framework that allowed Brocade and other U.S. companies to meet certain European legal requirements for transferring personal data from Europe to the United States. Brocade is in the process of evaluating and considering changes to its data handling practices as a result of this court decision. In April 2016, the European Parliament approved the General Data Protection Regulation. This regulation, when effective in May 2018, will impose more stringent data protection requirements on U.S. companies collecting personal data from European Union residents and establish greater penalties for noncompliance. Any inability to comply with applicable privacy or data protection laws, regulations, or other obligations could result in significant cost and liability, damage Brocade’s reputation, and adversely affect its business.


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Changes to Brocade’s provision for income taxes or unfavorable outcomes of tax audits could adversely impact Brocade’s financial condition or results.

Brocade is subject to income and other taxes in the United States, including those required by both state and federal governmental agencies, such as the IRS, and numerous foreign jurisdictions. Brocade’s provision for income taxes could be increased due to changes in tax laws in the jurisdictions in which Brocade does business, including an increase in tax rates or an adverse change in the treatment of an item of income or expense. In this regard, the United States, countries in the European Union, and other countries where Brocade operates have enacted or are proposing changes to relevant tax, accounting, and other laws, regulations, and interpretations, including fundamental changes to tax laws applicable to multinational corporations. In addition, future effective tax rates could be subject to volatility or adversely affected by changes in the geographic mix of earnings in countries with differing statutory rates, changes in the valuation of deferred tax assets and liabilities, and tax effects of stock-based compensation. These potential changes could increase Brocade’s effective tax rate or result in other costs in the future.
Brocade is subject to periodic audits or other reviews by such governmental agencies, and is currently under examination by the IRS and several state and foreign tax jurisdictions for various years. Audits by the IRS and other governmental tax agencies are subject to inherent uncertainties and could result in unfavorable outcomes, including potential fines or penalties. While Brocade regularly assesses the likely outcomes of these audits in order to determine the appropriateness of its tax provision, the occurrence of an unfavorable outcome in any specific period could have an adverse effect on Brocade’s financial condition or results for that period or future periods. The expense of defending and resolving such an audit may be significant.

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

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

Brocade’s stock price may fluctuate, which could cause the value of an investment in Brocade’s shares to decline.

Brocade’s stock price has fluctuated in the past and may be subject to wide fluctuations in the future in response to various factors. Brocade does not have the ability to influence or control many of these factors. In addition to the factors discussed elsewhere in this “Risk Factors” section, factors that could affect Brocade’s stock price include, among others:
•
Actual or anticipated changes in Brocade’s operating results;
•
Whether Brocade’s operating results or forecasts meet the expectations of securities analysts or investors;
•
Actual or anticipated changes in the expectations of securities analysts or investors;
•
Recommendations by securities analysts or changes in their earnings estimates;
•
The announcement or timing of announcement of Brocade’s quarterly or annual operating results;
•
Announcements of actual or anticipated operating results by Brocade’s competitors, Brocade’s OEM partners, and other companies in the IT industry;
•
Speculation, coverage or sentiment in the media or the investment community about, or actual changes in, Brocade’s business, strategic position, competitive position, market share, operations, prospects, future stock price performance, or Brocade’s industry in general;
•
The announcement of new, planned, or contemplated products; services; commercial relationships; technological innovations; acquisitions; divestitures; or other significant transactions by Brocade or its competitors;
•
Brocade’s level of success, or perceived level of success, in integrating acquisitions, including the Ruckus acquisition;

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•
Adverse changes to Brocade’s relationships with any of its OEM partners;
•
Changes in the business strategy or execution of any of Brocade’s OEM partners;
•
Departures of key employees;
•
Litigation or disputes involving Brocade, Brocade’s industry, or both;
•
General economic conditions and trends;
•
Uncertainties relating to the potential outcome of the November 2016 presidential election in the United States;
•
Sales of Brocade’s stock by Brocade’s officers, directors, or significant stockholders; and
•
The timing and amount of dividends and stock repurchases.
In addition, the stock market in general, and the market for technology companies in particular, has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. Accordingly, broad market and industry factors may adversely affect Brocade’s stock price regardless of Brocade’s operating performance. In addition, Brocade’s stock price might also fluctuate in reaction to events that affect other companies in Brocade’s industry even if these events do not directly affect or involve Brocade.
If Brocade’s stock price fluctuates widely, Brocade may become the target of securities litigation. Securities litigation could result in substantial costs and divert Brocade’s management’s attention and resources from Brocade’s business.

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

As of July 30, 2016, Brocade had approximately $1.7 billion in principal amount of outstanding indebtedness, including $575 million of indebtedness under the 1.375% convertible senior unsecured notes due 2020 (the “2020 Convertible Notes”), $300 million of unsecured indebtedness under the 4.625% senior notes due 2023 (the “2023 Notes”), and $800 million of indebtedness under a term loan facility. In connection with the completion of the Ruckus acquisition in May 2016, Brocade entered into a Credit Agreement (the “Credit Agreement”) with Wells Fargo Bank, National Association, and certain other lenders (collectively, the “Lenders”) pursuant to which the Lenders have provided Brocade with a term loan facility of $800 million (the “Term Loan Facility”) and a revolving credit facility of $100 million (the “Revolving Facility,” and together with the Term Loan Facility, the “Senior Credit Facility”) (see Note 8, “Borrowings,” of the Notes to Condensed Consolidated Financial Statements in Part I, Item 1 of this Form 10-Q). Brocade’s substantially increased indebtedness could have the effect, among other things, of reducing Brocade’s flexibility to respond to changing business and economic conditions. In addition, a substantial amount of cash will be required to pay interest, make scheduled principal amortization payments, and repay at maturity Brocade’s indebtedness, which may adversely impact Brocade’s cash resources, reduce Brocade’s business flexibility and reduce the funds otherwise available for working capital, capital expenditures, acquisitions, share repurchases, and other general corporate purposes, and may limit the ability of Brocade to meet its target of returning at least 60% of its annual adjusted free cash flow to Brocade stockholders in the form of share repurchases or cash dividends. Moreover, Brocade’s increased indebtedness may put the company at a competitive disadvantage relative to other companies with lower indebtedness levels.
The Credit Agreement contains financial maintenance covenants, including a maximum total leverage ratio and a minimum interest coverage ratio. The Credit Agreement also contains restrictive covenants that limit, among other things, Brocade’s and certain of its subsidiaries’ ability to incur additional indebtedness or issue certain preferred equity, pay dividends or make other distributions or other restricted payments (including stock repurchases), sell assets other than on terms specified by the Credit Agreement, amend the terms of certain other indebtedness and organizational documents, create liens on certain assets to secure debt, consolidate, merge, sell or otherwise dispose of all or substantially all of their assets, enter into certain transactions with affiliates, or change their lines of business, fiscal years and accounting practices, in each case, subject to certain exceptions. The indenture governing the 2023 Notes contains several negative covenants that restrict the incurrence of debt by Brocade’s subsidiaries, restrict the incurrence of liens on principal properties, and restrict Brocade and its subsidiaries from engaging in certain sale-leaseback transactions. In addition, the indentures governing both the 2020 Convertible Notes and the 2023 Notes impose covenants that restrict Brocade’s ability to effect certain mergers, consolidations, or sales of assets and require Brocade to offer to repurchase the notes upon the occurrence of certain “Fundamental Changes” or “Change of Control Triggering Events.”

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The financial and other covenants agreed to by Brocade in connection with such indebtedness could, among other things, reduce Brocade’s flexibility to respond to changing business and economic conditions, increase borrowing costs (if further debt financing is desired), and adversely affect Brocade’s operations and financial results. Brocade’s failure to comply with these covenants would result in a default under the applicable indenture or the Credit Agreement, which could permit the holders to accelerate such debt or demand payment in exchange for a waiver of such default. A default under one debt instrument could also result in cross-defaults under Brocade’s other debt instruments, negatively impact the price and liquidity of Brocade’s debt and equity securities, negatively impact Brocade’s credit ratings, and impair Brocade’s ability to access sources of capital. If any of Brocade’s debt is accelerated, Brocade may not have sufficient funds available to repay such debt.
Agencies rating Brocade’s debt securities may lower Brocade’s credit rating. This could further negatively impact the price and liquidity of Brocade’s debt and equity securities and Brocade’s ability to access sources of capital. In addition, in the event of certain credit rating downgrades, Brocade’s obligations under the Senior Credit Facility, which are currently unsecured, will be required to be secured, subject to certain exceptions, by the equity interests of certain Brocade subsidiaries.
Although interest rates have remained at low levels in recent years, they may increase for various reasons, including an increase in inflation, Federal Reserve Board actions, domestic or international fiscal policies, or domestic or international events impacting financial or capital markets. Higher interest rates or an increase in the credit spread for Brocade’s rating could negatively impact Brocade’s ability to raise additional debt or refinance existing debt. In addition, the indebtedness under the Senior Credit Facility has a floating interest rate, and an increase in interest rates may negatively impact Brocade’s financial results.

The occurrence of a “Fundamental Change” with respect to the 2020 Convertible Notes or a “Change of Control Triggering Event” with respect to the 2023 Notes or a conversion of the 2020 Convertible Notes could negatively impact Brocade’s cash flows and financial position.

Holders of the 2020 Convertible Notes have the right to require Brocade to repurchase their convertible notes upon the occurrence of a “Fundamental Change” and holders of the 2023 Notes have the right to require Brocade to repurchase their senior notes upon the occurrence of a “Change of Control Triggering Event” (as defined in the indentures governing the 2020 Convertible Notes and the 2023 Notes, respectively), in each case at a repurchase price equal to 100% of the principal amount of the applicable notes to be repurchased, plus accrued and unpaid interest, if any. In addition, upon conversion of the 2020 Convertible Notes, Brocade will be required to make cash payments up to the full conversion value in respect of the convertible notes being converted, unless Brocade elects to only deliver shares of its common stock to settle such conversion (other than paying cash in lieu of delivering any fractional share). It is Brocade’s current intent and policy to settle conversions of the 2020 Convertible Notes through the delivery of cash up to the principal amount of converted convertible notes, together with shares of common stock, to satisfy any conversion obligation in excess of such specified dollar amount. However, if Brocade elects to settle conversions of the 2020 Convertible Notes solely in shares of common stock, such settlement would result in additional dilution to Brocade’s stockholders and could result in more dilutive accounting treatment for the 2020 Convertible Notes. The 2020 Convertible Notes may be converted at the option of the holders during certain periods as a result of, among other things, fluctuations in Brocade’s stock price.
If Brocade is required to make repurchases of the 2020 Convertible Notes or the 2023 Notes or make cash payments in respect of conversions of the 2020 Convertible Notes, Brocade may not have enough available cash or be able to obtain financing on acceptable terms (or at all) at the time. Further, these obligations would negatively impact Brocade’s cash flows and could limit its ability to use its available cash and cash flow for other liquidity needs, including working capital, capital expenditures, acquisitions, investments, and other general corporate purposes. Brocade’s ability to repurchase the notes or to pay cash upon conversions of the 2020 Convertible Notes may also be limited by law, by regulatory authority, or by agreements governing its future indebtedness.

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

Provisions of Brocade’s certificate of incorporation and bylaws may discourage, delay, or prevent a merger or mergers that a stockholder may consider favorable. These provisions include, but are not limited to:
•
Authorizing the issuance of preferred stock without stockholder approval;
•
Prohibiting cumulative voting in the election of directors;

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•
Limitations on who may call special meetings of stockholders and when special meetings of stockholders may be called; and
•
Prohibiting stockholder actions by written consent.
Certain provisions of Delaware law also may discourage, delay, or prevent someone from acquiring or merging with Brocade, and Brocade’s agreements with certain Brocade customers require that Brocade give prior notice of a change of control and grant certain manufacturing rights following a change of control. Brocade’s various change of control provisions could prevent or delay a change in control of Brocade, which could hinder stockholders’ ability to receive a premium for Brocade’s common stock and could adversely affect the value of Brocade’s convertible notes.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
There were no unregistered sales of equity securities during the three months ended July 30, 2016.
Issuer Purchases of Equity Securities
The following table summarizes stock repurchase activity for the three months ended July 30, 2016 (in thousands, except per share amounts):
Period
 
Total Number
of Shares
Purchased
 
Average
Price Paid
per Share
 
Total Number of
Shares Purchased
as Part of Publicly
Announced
Program (1)
 
Approximate Dollar
Value of Shares That
May Yet Be
Purchased Under
the Program (1)
May 1, 2016 to May 28, 2016
 
1,575

 
$
8.66

 
1,575

 
$
1,626,435

May 29, 2016 to June 25, 2016
 
39,350

 
$
9.07

 
39,350

 
$
1,269,689

June 26, 2016 to July 30, 2016
 
31,746

 
$
9.14

 
31,746

 
$
979,372

Total
 
72,671

 
$
9.09

 
72,671

 

(1) 
As of July 30, 2016, Brocade’s Board of Directors had authorized a stock repurchase program for an aggregate amount of up to approximately $3.5 billion (consisting of an original $100 million authorization on August 18, 2004, plus subsequent authorizations of an additional $200 million on January 16, 2007, $500 million on November 29, 2007, $500 million on May 16, 2012, $692 million on September 25, 2013, $700 million on September 25, 2015, and $800 million on April 3, 2016), which was used for determining the amounts in these columns. The number of shares purchased and the timing of purchases are based on the level of the Company’s cash balances, general business and market conditions, the trading price of the Company’s common stock, and other factors, including alternative investment opportunities.


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Item 6. Exhibits
EXHIBIT INDEX
Exhibit
Number
 
Description of Document
 
 
 
10.1
 
Credit Agreement, dated as of May 27, 2016, among Brocade Communications Systems, Inc., Wells Fargo Bank, National Association, as Administrative Agent, Swingline Lender and Issuing Lender, and the other Lenders party thereto (incorporated by reference to Exhibit 10.1 from Brocade’s current report on Form 8-K filed on May 27, 2016)
 
 
 
10.2*
 
Brocade Communications Systems, Inc. Amended and Restated Inducement Award Plan, effective as of May 24, 2016 (incorporated by reference to Exhibit 10.1 from Brocade’s Post-Effective Amendment Number 1 to Form S-4 on Form S-8 Registration Statement filed on June 3, 2016)
 
 
 
31.1
 
Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer
 
 
 
31.2
 
Rule 13a-14(a)/15d-14(a) Certification of Principal Financial Officer
 
 
 
32.1
 
Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
 
 
 
101.INS
 
XBRL Instance Document
 
 
 
101.SCH
 
XBRL Taxonomy Extension Schema Document
 
 
 
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document
 
 
 
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document
 
 
 
101.LAB
 
XBRL Taxonomy Extension Label Linkbase Document
 
 
 
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document
 
 
 
*
 
Indicates management compensatory plan, contract, or arrangement.

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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 
 
Brocade Communications Systems, Inc.
 
 
 
 
Date:
September 2, 2016
By:
/s/ Daniel W. Fairfax
 
 
 
Daniel W. Fairfax
Senior Vice President and Chief Financial Officer

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Exhibit 31.1
CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER PURSUANT TO EXCHANGE ACT RULE 13a-14(a)/15(d)-14(a) AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Lloyd A. Carney, certify that:
1. I have reviewed this Quarterly Report on Form 10-Q for the quarter ended July 30, 2016 of Brocade Communications Systems, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Date: September 2, 2016

 
/s/ Lloyd A. Carney
 
Lloyd A. Carney
 
Chief Executive Officer
 
(Principal Executive Officer)




Exhibit 31.2
CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER PURSUANT TO EXCHANGE ACT RULE 13a-14(a)/15(d)-14(a) AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Daniel W. Fairfax, certify that:
1. I have reviewed this Quarterly Report on Form 10-Q for the quarter ended July 30, 2016 of Brocade Communications Systems, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Date: September 2, 2016

 
/s/ Daniel W. Fairfax
 
Daniel W. Fairfax
 
Senior Vice President and Chief Financial Officer
 
(Principal Financial and Accounting Officer)




Exhibit 32.1
CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER
AND PRINCIPAL FINANCIAL OFFICER PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
I, Lloyd A. Carney, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report on Form 10-Q of Brocade Communications Systems, Inc. for the fiscal quarter ended July 30, 2016 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Quarterly Report on Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of Brocade Communications Systems, Inc.
Date: September 2, 2016

 
By:
 
/s/ Lloyd A. Carney
 
 
 
Lloyd A. Carney
 
 
 
Chief Executive Officer
 
 
 
(Principal Executive Officer)
I, Daniel W. Fairfax, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that the Quarterly Report on Form 10-Q of Brocade Communications Systems, Inc. for the fiscal quarter ended July 30, 2016 fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 and that information contained in such Quarterly Report on Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of Brocade Communications Systems, Inc.
Date: September 2, 2016

 
By:
 
/s/ Daniel W. Fairfax
 
 
 
Daniel W. Fairfax
 
 
 
Senior Vice President and Chief Financial Officer
 
 
 
(Principal Financial and Accounting Officer)



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