Overview
We are a leading supplier of networking equipment and software for businesses and organizations of many types and sizes, including global enterprises, and service providers such as telecommunication firms, cable operators and mobile carriers. Our business model is focused on two key markets: our Storage Area Networking ("SAN") business, where we offer Fibre Channel ("FC") SAN directors, fixed form factor switches and embedded switches, host bus adapters ("HBAs"), and server virtualization solutions, and our Internet Protocol ("IP") Networking business, where we offer modular and stackable solutions, Ethernet routers, Ethernet switches, Ethernet fabrics, converged adapters, as well as application delivery, security and wireless solutions. We also provide product-related customer support and services.
Growth opportunities in the SAN market are expected to be driven by key customer Information Technology ("IT") initiatives such as server virtualization, enterprise mobility, data center consolidation, migration to higher performance technologies such as solid state storage, and cloud computing initiatives. Our IP Networking business strategies are intended to increase new customer accounts and expand our market share through product innovation and the development of and expansion of our routes to market. We plan to continue to support our SAN and IP Networking growth plans by continuous innovation, leveraging the strategic investments we have made in our core businesses, developing emerging technologies, new product introductions, and enhancing our existing partnerships and forming new ones through our various distribution channels.
We continue to face multiple challenges, including aggressive price discounting from competitors, rapid adoption of new technologies by customers, the uncertainty in the worldwide macroeconomic climate and its impact on IT spending patterns globally, as well as uncertain federal government spending in the United States. We are also cautious about the stability and health of certain international markets, including China and Europe, and current global and country specific dynamics, including inflationary risks in China and the continuing sovereign debt risk particularly in Europe. These factors may impact our business and that of our partners. While the diversification of our business model helps mitigate the effect of some of these challenges and we expect IT spending levels to generally rise in the long-term, it is difficult to offset short-term reductions in IT spending, which may adversely affect our financial results and stock price.
We expect the number of SAN and IP Networking products we ship to fluctuate depending on the demand for our existing and recently introduced products, sales support for our products from our distribution and resale partners, as well as the timing of product transitions by our OEM partners. The average selling prices per port for our SAN and IP Networking products have typically declined over time and will likely continue to decline in the future.
Our plans for our operating cash flows are to provide liquidity for operations, to repurchase our stock to reduce the dilutive effects of our equity award programs and, from time-to-time, we may also opportunistically repurchase our stock under our previously announced stock repurchase programs. In addition, we may opportunistically use our operating cash flows to strengthen our networking portfolios through acquisitions and strategic investments.

Results of Operations
Our results of operations for the three months ended January 26, 2013 and January 28, 2012 are reported in this discussion and analysis as a percentage of total net revenues, except for gross margin with respect to each segment, which is indicated as a percentage of the respective segment net revenues. Revenues. Our revenues are derived primarily from sales of our SAN products, IP Networking products, and support and services related to these products, which we call Global Services.

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

                                            Three Months Ended
                          January 26,      % of Net      January 28,      % of Net      Increase/          %
                             2013          Revenues         2012          Revenues      (Decrease)      Change
SAN Products            $     361,734         61.4 %   $     352,872         63.0 %   $      8,862         2.5 %
IP Networking Products        140,513         23.9 %         123,430         22.0 %         17,083        13.8 %
Global Services                86,482         14.7 %          84,340         15.0 %          2,142         2.5 %
Total net revenues      $     588,729        100.0 %   $     560,642        100.0 %   $     28,087         5.0 %

The increase in total net revenues for the three months ended January 26, 2013 compared to the three months ended January 28, 2012 reflects higher sales due to a combination of favorable factors for our SAN products and IP Networking products and our Global Services offerings.

• The increase in SAN product revenues was driven by a shift in mix to our high-end, higher bandwidth director and switch products, including strong growth in sales of our 16 Gbps products. Our average selling price per port increased by 6.5% during the three months ended January 26, 2013, which partially offset the 3.7% decrease in the number of ports shipped during the same period;

• The increase in IP Networking product revenues primarily reflects higher revenues from our Ethernet switch, IP routing and application delivery products. We also had continued growth in sales of our Brocade ICX products. We believe revenues from our enterprise and U.S. federal government customers increased, while revenues from our service provider customers remained flat. As the percentage of our IP Networking products being sold through two-tier distribution has increased, it has become increasingly difficult to quantify our revenues by end customer, therefore, these results are based on our estimates; and

• The increase in Global Services revenues was primarily attributable to an increase in the sales of initial support contracts and renewal support contracts for both our SAN products and IP Networking products.

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

                                                Three Months Ended
                                               % of Net                           % of Net      Increase/         %
                         January 26, 2013      Revenues     January 28, 2012      Revenues     (Decrease)       Change
United States           $         364,052         61.8 %   $         341,633         61.0 %   $    22,419         6.6  %
Europe, the Middle East
and Africa (1)                    142,418         24.2 %             132,874         23.7 %         9,544         7.2  %
Asia Pacific                       47,051          8.0 %              55,589          9.9 %        (8,538 )     (15.4 )%
Japan                              25,479          4.3 %              18,645          3.3 %         6,834        36.7  %
Canada, Central and
South America                       9,729          1.7 %              11,901          2.1 %        (2,172 )     (18.3 )%
Total net revenues      $         588,729        100.0 %   $         560,642        100.0 %   $    28,087         5.0  %

(1) Includes net revenues of $84.0 million and $65.6 million for the three months ended January 26, 2013 and the three months ended January 28, 2012, respectively, relating to the Netherlands.

Revenues are attributed to geographic areas based on where our products are shipped. However, certain OEM partners take possession of our products domestically and then distribute these products to their international customers. Because we account for all of those OEM revenues as domestic revenues, we cannot be certain of the extent to which our domestic and international revenue mix is impacted by the practices of our OEM partners, but we believe that international revenues comprise a larger percentage of our total net revenues than the attributed revenues may indicate.

International revenues for the three months ended January 26, 2013 decreased as a percentage of total net revenues compared to the three months ended January 28, 2012 primarily due to higher revenues from our LAN product sales to the U.S. region relative to total net revenues, particularly to the U.S. federal government and its individual agencies, and lower revenues from our SAN and LAN product sales to the Asia Pacific and Canada, Central and South America regions relative to total net revenues, partially offset by higher revenues from our SAN and LAN product sales to Europe, the Middle East and Africa and Japan regions relative to total net revenues.
A significant portion of our revenues are concentrated among a relatively small number of OEM customers. For the three months ended January 26, 2013, three customers accounted for 18%, 18%, and 10%, respectively, of our total net revenues for a combined total of 46% of total net revenues. For the three months ended January 28, 2012, three customers accounted for 20%, 15% and 13%, respectively, of our total net revenues for a combined total of 48% of total net revenues. We expect that a significant portion of our future revenues will continue to come from sales of products to a relatively small number of OEM partners and to the U.S. federal government and its individual agencies through our distributors and resellers. Therefore, the loss of, or significant decrease in the level of sales to, or a change in the ordering pattern of any one of these customers could seriously harm our financial condition and results of operations.
Gross margin. Gross margin as stated below is indicated as a percentage of the respective segment net revenues, except for total gross margin, which is stated as a percentage of total net revenues.
Gross margin is summarized as follows (in thousands, except percentages):

                                         Three Months Ended
                        January 26,     % of Net    January 28,     % of Net      Increase/       % Points
                            2013        Revenues        2012        Revenues      (Decrease)       Change
SAN Products            $  264,781         73.2 %   $  257,034         72.8 %   $      7,747         0.4 %
IP Networking Products      63,091         44.9 %       43,861         35.5 %         19,230         9.4 %
Global Services             46,053         53.3 %       43,874         52.0 %          2,179         1.3 %
Total gross margin      $  373,925         63.5 %   $  344,769         61.5 %   $     29,156         2.0 %

For the three months ended January 26, 2013 compared to the three months ended January 28, 2012, total gross margin increased in absolute dollars and percentage due to a combination of favorable factors for our SAN products, IP Networking products and Global Services offerings.

Gross margin percentage by reportable segment increased for the three months ended January 26, 2013 compared to the three months ended January 28, 2012 primarily due to the following factors (the percentages below reflect the impact on gross margin):
• SAN gross margins relative to net revenues increased due to a 1.0% decrease in discrete period costs relative to net revenues. Additionally, amortization of SAN-related intangible assets decreased by 1.0% relative to net revenues, partially offset by a 1.8% increase in manufacturing costs relative to net revenues;

• IP Networking gross margins relative to net revenues increased due to a 4.1% decrease in product costs, a 2.2% decrease in manufacturing overhead costs, as well as a 2.2% decrease in discrete period costs, in each case, relative to net revenues, primarily due to a decrease in warranty expense and inventory excess and obsolescence charges; and

• Global Services gross margins relative to net revenues increased primarily due to a 1.0% decrease in service and support costs relative to net revenues, primarily due to a decrease in period costs due to improved utilization of service inventory assets within our spares depot, as well as decreases in facilities, IT and operating expenses. Additionally, stock-based compensation decreased by 0.2% relative to net revenues.

Stock-based compensation expense. Stock-based compensation expense is summarized as follows (in thousands, except percentages):

                          January 26,      % of Net       January 28,      % of Net       Increase/         %
                             2013          Revenues          2012          Revenues      (Decrease)       Change
Three months ended      $      19,150          3.3 %    $      21,819          3.9 %    $    (2,669 )     (12.2 )%

The decrease in stock-based compensation expense for the three months ended January 26, 2013 compared to the three months ended January 28, 2012 was due to fewer restricted stock units granted to employees in recent quarters as well as a decline in grant date fair values due to lower stock prices (see Note 11, "Stock-Based Compensation," of the Notes to Condensed Consolidated Financial Statements). This was partially offset by higher expenses related to our 2009 Employee Stock Purchase Plan ("ESPP") for which higher compensation expense was recognized for the two new offering periods within the last year. Research and development expenses. Research and development ("R&D") expenses consist primarily of compensation and related expenses for personnel engaged in engineering and R&D activities, fees paid to consultants and outside service providers, engineering expenses, which primarily consist of nonrecurring engineering charges and prototyping expenses related to the design, development, testing and enhancement of our products, depreciation related to engineering and test equipment, and related IT and facilities expenses.
R&D expenses are summarized as follows (in thousands, except percentages):

                                                % of Net                            % of Net      Increase/          %
                          January 26, 2013      Revenues      January 28, 2012      Revenues      (Decrease)      Change
Three months ended      $           97,690         16.6 %   $           89,319         15.9 %   $      8,371         9.4 %

R&D expenses increased for the three months ended January 26, 2013 compared to the three months ended January 28, 2012 due to the following (in thousands):

                                                                      Increase (Decrease)
Salaries and wages                                                   $            4,411
Engineering expenses                                                              2,973
Engineering equipment                                                             1,182
Depreciation and amortization expense                                               890
The increase in R&D expenses was partially offset by decreases in
the following:
Stock-based compensation expense                                                   (343 )
Various individually insignificant items                                           (742 )
Total change                                                         $            8,371

Salaries and wages increased primarily due to merit-based increases in salaries and growth in personnel, as well as from the employees hired as part of the Vyatta, Inc. ("Vyatta") acquisition. Engineering expenses increased primarily due to higher engineering spending related to new product development and higher prototype costs. In addition, engineering equipment expenses increased primarily due to the indefinite suspension of a program that resulted in equipment being deemed obsolete, and depreciation and amortization expense increased due to additional depreciation expenses related to equipment acquired for use in our engineering laboratories. These increases were partially offset by a decrease in stock-based compensation expense mainly due to fewer restricted stock units granted to employees in recent quarters as well as a decline in grant date fair values due to lower stock prices (see Note 11, "Stock-Based Compensation," of the Notes to Condensed Consolidated Financial Statements).
Sales and marketing expenses. Sales and marketing expenses consist primarily of salaries, commissions and related expenses for personnel engaged in sales and marketing functions, costs associated with promotional and marketing programs, travel and entertainment expenses, and expenses related to IT and facilities and other shared functions.
Sales and marketing expenses are summarized as follows (in thousands, except percentages):

                                               % of Net                           % of Net      Increase/         %
                         January 26, 2013      Revenues     January 28, 2012      Revenues     (Decrease)       Change
Three months ended      $         149,011         25.3 %   $         152,688         27.2 %   $    (3,677 )      (2.4 )%

Sales and marketing expenses decreased for the three months ended January 26, 2013 compared to the three months ended January 28, 2012 due to the following (in thousands):

                                               Increase (Decrease)
Outside services and other marketing expenses $            (1,036 )
Salaries and wages                                           (917 )
Stock-based compensation expense                           (1,631 )
Various individually insignificant items                      (93 )
Total change                                  $            (3,677 )

Outside services and other marketing expenses decreased primarily due to less spending on conferences and trade shows in the three months ended January 26, 2013. Salaries and wages decreased primarily due to decreased headcount, partially offset by higher bonuses, headcount growth from the Vyatta acquisition and increased severance costs for the three months ended January 26, 2013. Stock-based compensation expense decreased primarily due to fewer restricted stock units granted to employees in recent quarters as well as a decline in grant date fair values due to lower stock prices (see Note 11, "Stock-Based Compensation," of the Notes to Condensed Consolidated Financial Statements).

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 and investor relations, as well as recruiting expenses, professional fees, other corporate expenses, and related IT and facilities expenses.
G&A expenses are summarized as follows (in thousands, except percentages):

                                                % of Net                             % of Net       Increase/          %
                          January 26, 2013      Revenues       January 28, 2012      Revenues       (Decrease)      Change
Three months ended      $           19,077          3.2 %    $           18,350          3.3 %    $        727         4.0 %

G&A expenses increased for the three months ended January 26, 2013 compared to the three months ended January 28, 2012 due to the following (in thousands):

                                                                      Increase (Decrease)
Salaries and wages                                                   $            2,591
Depreciation and amortization expense                                             1,028
Various individually insignificant items                                            403
The increase in G&A expenses was partially offset by the decrease in
the following:
Outside services expense                                                         (3,295 )
Total change                                                         $              727

Salaries and wages expense increased primarily due to merit-based increases in salaries, increased personnel including from the Vyatta acquisition, and increased severance and recruiting costs related to the transition of our Chief Executive Officer for the three months ended January 26, 2013. Depreciation and amortization expense increased primarily due to increased capital additions in recent periods. These increases were partially offset by a decrease in expenses associated with outside services primarily due to decreased costs in consulting services, as well as lower legal expense for ongoing litigation matters. Amortization of intangible assets. Amortization of intangible assets is summarized as follows (in thousands, except percentages):

                                                % of Net                             % of Net      Increase/         %
                          January 26, 2013      Revenues       January 28, 2012      Revenues      (Decrease)      Change
Three months ended      $           14,856          2.5 %    $           14,993          2.7 %    $     (137 )      (0.9 )%

The decrease in amortization of intangible assets for the three months ended January 26, 2013 compared to the three months ended January 28, 2012 was primarily due to the full amortization of certain of our intangible assets, partially offset by the amortization of the Vyatta intangible assets acquired in the first fiscal quarter of 2013.

Interest expense. Interest expense primarily represents the interest cost associated with our term loan, senior secured notes and senior unsecured notes (see Note 8, "Borrowings," of the Notes to Condensed Consolidated Financial Statements). Interest expense is summarized as follows (in thousands, except percentages):

                                              % of Net                           % of Net      (Increase)/         %
                         January 26, 2013     Revenues      January 28, 2012     Revenues        Decrease        Change
Three months ended      $        (26,368 )       (4.5 )%   $        (13,046 )       (2.3 )%   $    (13,322 )    (102.1 )%

In January 2013, we issued $300 million in aggregate principal amount of 4.625% Senior Notes due 2023 (the "2023 Notes") in a private placement (the "Offering"). The proceeds from the Offering, together with cash on hand, were used in the second quarter of fiscal year 2013 to redeem all of the 2018 Notes. The transactions are described further below in "Liquidity and Capital Resources." In accordance with the applicable accounting guidance for debt modification and extinguishment, and for interest costs accounting, we recorded an expense of $15.3 million for the call premium, debt issuance costs and original issue discount relating to the 2018 Notes, thereby resulting in the increase in interest expense for the three months ended January 26, 2013 compared to the three months ended January 28, 2012 (additionally, see Note 8, "Borrowings," of the Notes to Condensed Consolidated Financial Statements). Interest and other income (loss), net. Interest and other income (loss), net, are summarized as follows (in thousands, except percentages):

                                                 % of Net                             % of Net       Increase/          %
                          January 26, 2013       Revenues       January 28, 2012      Revenues       (Decrease)       Change
Three months ended      $               66            - %      $          (996 )         (0.2 )%   $      1,062      (106.6 )%

Interest and other income (loss), net, were immaterial for the three months ended January 26, 2013 and the three months ended January 28, 2012.
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
                              January 26,      January 28,
                                  2013             2012
Income tax expense (benefit) $     88,244     $    (3,207 )
Effective tax rate                  131.7 %          (5.8 )%

In general, our provision for income taxes differs from the tax computed at the U.S. federal statutory income tax rate due to state taxes, the effect of non-U.S. operations, non-deductible stock-based compensation expense and adjustments to unrecognized tax benefits (additionally, see Note 12, "Income Taxes," of the Notes to Condensed Consolidated Financial Statements). We recorded an income tax expense for the three months ended January 26, 2013 primarily due to a discrete charge of $78.2 million to reduce our previously recognized California deferred tax assets, partially offset by a discrete benefit from an increase in the federal research and development tax credit of $5.7 million which was reinstated on January 2, 2013 for two years retroactively to January 1, 2012. The discrete charge is as a result of the passage of Proposition 39 which revised certain provisions of the California State Tax Code, requiring mandatory single sales factor apportionment in California for most multi-state taxpayers for tax years beginning on or after January 1, 2013. We currently expect that in fiscal year 2013 and beyond, our income subject to tax in California will be lower than under prior tax law and that our California deferred tax assets are, therefore, less likely to be realized. This charge will not impact cash tax outlays and conformance to the new law is not expected to have a material impact on our future tax provision.

We recorded a tax benefit for the three months ended January 28, 2012 primarily due to a discrete benefit from net reserve releases related to settling tax . . .