BROCADE COMMUNICATIONS SYSTEMS INC - 10-Q Quarterly Report

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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 27, 2002


[ ]		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from __________ to __________

Commission file number: 000-25601

BROCADE COMMUNICATIONS SYSTEMS, INC.

(Exact name of Registrant as specified in its charter)


Delaware (State or other jurisdiction of incorporation)		77-0409517 (I.R.S. employer identification no.)

1745 Technology Drive
San Jose, CA 95110
(408) 487-8000
(Address, including zip code, of Registrant’s
principal executive offices and 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 [ ]

The number of shares outstanding of the Registrant’s Common Stock on July 27, 2002 was 234,214,463 shares.

TABLE OF CONTENTS


PART I — FINANCIAL INFORMATION
	Item 1. Financial Statements
		CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
		CONDENSED CONSOLIDATED BALANCE SHEETS
		CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
		NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3. Quantitative and Qualitative Disclosures About Market Risk
PART II — OTHER INFORMATION
	Item 1. Legal Proceedings
	Item 2. Changes in Securities and Use of Proceeds
	Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
EXHIBIT 10.37
EXHIBIT 10.38
EXHIBIT 10.39
EXHIBIT 10.40
EXHIBIT 10.41
EXHIBIT 10.42
EXHIBIT 10.43
EXHIBIT 10.44
EXHIBIT 10.45
EXHIBIT 12.1
EXHIBIT 99.1

BROCADE COMMUNICATIONS SYSTEMS, INC.

FORM 10-Q

QUARTER ENDED JULY 27, 2002

INDEX


		Page

PART I — FINANCIAL INFORMATION
Item 1.	Financial Statements
	Condensed Consolidated Statements of Operations for the Three and Nine Months Ended July 27, 2002 and July 28, 2001		3
	Condensed Consolidated Balance Sheets as of July 27, 2002 and October 27, 2001		4
	Condensed Consolidated Statements of Cash Flows for the Nine Months Ended July 27, 2002 and July 28, 2001		5
	Notes to Condensed Consolidated Financial Statements		6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		13
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		26
PART II — OTHER INFORMATION
Item 1.	Legal Proceedings		27
Item 2.	Changes in Securities and Use of Proceeds		27
Item 6.	Exhibits and Reports on Form 8-K		28
SIGNATURES			31

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PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

BROCADE COMMUNICATIONS SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
(unaudited)


			Three Months Ended					Nine Months Ended

			July 27,			July 28,		July 27,			July 28,
			2002			2001		2002			2001

Net revenues			$	151,234		$	116,279	$	409,262		$	396,509
Cost of revenues				60,299			46,484		162,950			158,611

		Gross margin		90,935			69,795		246,312			237,898

Operating expenses:
	Research and development			33,209			27,419		95,523			81,952
	Sales and marketing			30,338			22,599		82,722			69,632
	General and administrative			4,756			4,387		14,139			13,373
	Amortization of deferred stock compensation			243			280		727			840

		Total operating expenses		68,546			54,685		193,111			165,797

Income from operations				22,389			15,110		53,201			72,101
Interest and other income, net				6,827			2,098		16,823			8,654
Interest expense				(3,387	)		—		(8,057	)		—

Income before provision for income taxes				25,829			17,208		61,967			80,755
Provision for income taxes				7,481			5,163		17,970			24,227

Net income			$	18,348		$	12,045	$	43,997		$	56,528

Net income per share — Basic			$	0.08		$	0.05	$	0.19		$	0.26

Net income per share — Diluted			$	0.08		$	0.05	$	0.18		$	0.23

Shares used in per share calculation — Basic				233,017			222,863		230,819			219,619

Shares used in per share calculation — Diluted				240,106			246,219		244,672			244,272

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

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BROCADE COMMUNICATIONS SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except par value)


				July 27,			October 27,
				2002			2001

				(unaudited)
Assets
Current assets:
	Cash and cash equivalents			$	195,784		$	150,118
	Short-term investments				76,723			105,030

			Total cash, cash equivalents and short-term investments		272,507			255,148
	Marketable equity securities				193			332
	Accounts receivable, net of allowances of $3,563 and $3,025, respectively				87,857			68,900
	Inventories, net				7,064			10,307
	Deferred tax assets, net				29,386			28,025
	Prepaid expenses and other current assets				15,910			10,022

			Total current assets		412,917			372,734
Long-term investments					609,802			—
Property and equipment, net					138,193			97,457
Deferred tax assets, net					219,385			207,209
Convertible subordinated debt issuance costs					10,891			—
Other assets					9,401			6,322

			Total assets	$	1,400,589		$	683,722

Liabilities and Stockholders’ Equity
Current liabilities:
	Accounts payable			$	58,292		$	25,082
	Accrued employee compensation				19,412			21,994
	Deferred revenue				18,332			12,630
	Current liabilities associated with lease losses				9,291			11,339
	Other accrued liabilities				52,881			43,895

			Total current liabilities		158,208			114,940
Non-current liabilities associated with lease losses					23,963			30,896
Convertible subordinated debt					550,000			—
Commitments and contingencies (Note 7)
Stockholders’ equity:
	Preferred stock, $0.001 par value 5,000 shares authorized, no shares outstanding				—			—
	Common stock, $0.001 par value, 800,000 shares authorized:
		Issued and outstanding: 234,214 and 229,762 shares at July 27, 2002 and October 27, 2001, respectively			234			230
	Additional paid-in capital				569,929			493,738
	Deferred stock compensation				(311	)		(1,038	)
	Accumulated other comprehensive income				10,135			522
	Retained earnings				88,431			44,434

			Total stockholders’ equity		668,418			537,886

			Total liabilities and stockholders’ equity	$	1,400,589		$	683,722

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

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BROCADE COMMUNICATIONS SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)


					Nine Months Ended

					July 27,			July 28,
					2002			2001

Cash flows from operating activities:
	Net income				$	43,997		$	56,528
	Adjustments to reconcile net income to net cash provided by operating activities:
		Tax benefits from employee stock option transactions				26,200			123,523
		Deferred taxes				(20,293	)		(105,830	)
		Depreciation, amortization, and loss on disposal of property and equipment				22,734			11,407
		Amortization of debt issuance costs				1,484			—
		Gain on sale of marketable equity securities				—			(6,632	)
		Impairment losses on investments				—			4,700
		Provision for doubtful accounts receivable and sales returns				1,700			1,145
		Non-cash compensation expense				727			857
		Changes in operating assets and liabilities:
			Accounts receivable			(20,657	)		(1,282	)
			Inventories			3,243			(7,183	)
			Prepaid expenses and other assets			(8,967	)		(9,378	)
			Accounts payable			33,210			1,460
			Accrued employee compensation			(2,582	)		(13,212	)
			Deferred revenue			5,702			11,340
			Other accrued liabilities			8,986			13,397
			Liabilities associated with lease losses			(5,580	)		—

				Net cash provided by operating activities		89,904			80,840

Cash flows from investing activities:
	Purchases of property and equipment					(65,179	)		(63,599	)
	Purchases of investments					(640,777	)		(23,195	)
	Proceeds from maturities of short-term investments					74,098			57,690
	Proceeds from sale of marketable equity securities					—			11,632
	Other investing activities					—			(17,062	)

				Net cash used in investing activities		(631,858	)		(34,534	)

Cash flows from financing activities:
	Proceeds from issuance of common stock, net					49,995			73,806
	Proceeds from issuance of convertible subordinated debt					537,625			—

				Net cash provided by financing activities		587,620			73,806

Net increase in cash and cash equivalents						45,666			120,112
Cash and cash equivalents, beginning of period						150,118			27,265

Cash and cash equivalents, end of period					$	195,784		$	147,377

The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

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BROCADE COMMUNICATIONS SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

1. Organization and Operations of Brocade

Brocade Communications Systems, Inc. (Brocade or the Company) is the world’s leading provider of infrastructure for Storage Area Networks (SANs), offering a product family of Fibre Channel fabric switches which provide an intelligent networking foundation for SANs. Brocade delivers products and provides education and services that allow companies to implement highly available, scalable, manageable, and secure environments for business-critical applications. The Brocade SilkWorm family of Fibre Channel fabric switches enables customers to create a high-performance SAN fabric that is highly reliable and scalable to support the interconnection of server and storage devices, providing investment protection for the customer. Brocade products are sold through original equipment manufacturer (OEM) partners, master resellers and fabric partners.

Brocade was incorporated on May 14, 1999 as a Delaware corporation and is the successor to operations originally begun on August 24, 1995. The Company’s headquarters are located in San Jose, California.

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying financial data as of July 27, 2002, and for the three and nine-month periods ended July 27, 2002 and July 28, 2001, have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. The October 27, 2001 Condensed Consolidated Balance Sheet was derived from audited consolidated financial statements, but does not include all disclosures required by generally accepted accounting principles. However, the Company believes that the disclosures are adequate to make the information presented not misleading. These 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 27, 2001.

In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present a fair statement of financial position as of July 27, 2002, results of operations for the three and nine-month periods ended July 27, 2002 and July 28, 2001, and cash flows for the nine-month periods ended July 27, 2002 and July 28, 2001, have been made. The results of operations for the three and nine-month periods ended July 27, 2002 are not necessarily indicative of the operating results for the full fiscal year or any future periods.

Cash, Cash Equivalents, Short-term Investments and Long-term Investments

The Company considers all highly liquid investment securities with original maturities of three months or less to be cash equivalents. Investment securities with original maturities of more than three months but less than one year are considered short-term investments. Investment securities with original maturities of one year or more are considered long-term investments. The Company’s investments consist of debt securities issued by United States government agencies. All investments are classified as available-for-sale. Unrealized gains and losses are included in accumulated other comprehensive income in the accompanying Condensed Consolidated Balance Sheets, net of any related tax effect.

Marketable Equity Securities and Other Investments

Marketable equity securities consist of equity holdings in public companies and are classified as available-for-sale when there are no restrictions on the Company’s ability to immediately liquidate such securities. The fair value of marketable equity securities is determined using quoted market prices for those securities. Unrealized gains and losses are included in accumulated other comprehensive income in the accompanying Condensed Consolidated Balance Sheets, net of any related tax effect. Realized gains and losses are calculated based on the specific identification method and are included in interest and other income, net in the Condensed Consolidated Statements of Operations.

The Company also has certain other minority equity investments in non-publicly traded companies. These investments are

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included in other assets in the accompanying Condensed Consolidated Balance Sheets, are carried at cost, and are accounted for under the cost method. The Company holds less than 20 percent of the voting equity of such companies, and neither has nor seeks control or significant influence over the respective company’s operating and financial policies. The Company monitors its investments for impairment on a quarterly basis and makes appropriate reductions in carrying values when such impairments are determined to be other-than-temporary. Factors used in determining an impairment include, but are not limited to, the current business environment including competition and uncertainty of financial condition; going concern considerations such as the inability to obtain additional private financing to fulfill the investee company’s stated business plan and cash burn rate; the need for changes to the respective investee company’s existing business model due to changing business environments and its ability to successfully implement necessary changes; and comparable valuations. If an investment is determined to be impaired, a determination is made as to whether such impairment is other-than-temporary.

For the three and nine-month periods ended July 28, 2001, the Company recorded impairment charges of $1.2 million and $4.7 million, respectively, related to other-than-temporary declines in the fair value of certain minority equity investments in non-publicly traded companies. The impairment charges reduced the carrying value of the Company’s investments to the estimated fair value. The impairment charges are included in interest and other income, net in the accompanying Condensed Consolidated Statements of Operations. No impairment charges were recorded for the three and nine-month periods ended July 27, 2002. As of July 27, 2002, and October 27, 2001, the carrying value of the Company’s minority equity investments in non-publicly traded companies was $2.2 million.

Notes Receivable from Non-Executive Employees

The Company occasionally provides loans to various employees generally related to the respective employees’ relocation to the San Francisco Bay area in connection with their employment with the Company. The loans are generally evidenced by secured promissory notes to the Company and bear interest at prevailing rates. Notes receivable from employees are included in prepaid expenses and other current assets, and other assets in the accompanying Condensed Consolidated Balance Sheets. None of these loans have been issued to executive officers.

Revenue Recognition

Product revenue. Product revenue is generally recognized when persuasive evidence of an arrangement exists, delivery has occurred, fee is fixed or determinable, and collectibility is probable. However, revenue recognition is deferred for shipments to new customers and for shipments to existing customers when significant support services are required to successfully integrate Brocade products into the customer’s products. These revenues, and related costs, are deferred and recognized when the customer has successfully integrated Brocade products into its product offerings and Brocade has met any support obligations. In addition, revenue from sales to master resellers is recognized upon reported sell-through.

Service Revenue. Service revenue, which to date has not been material, consists of training, warranty, and maintenance arrangements, including post-contract customer support (PCS) services. PCS services are offered under renewable, annual fee-based contracts or as part of multiple element arrangements and typically include upgrades and enhancements to the Company’s software operating system, and telephone support. For multiple element arrangements, the Company allocates revenue to each element based upon vendor-specific objective evidence (VSOE). VSOE for each element is based upon the price charged when the element is sold separately. Service revenue, including revenue allocated to undelivered elements, is deferred and recognized ratably over the contractual period, which is generally one to three years. Training revenue is recognized upon completion of the training.

The Company accrues for warranty costs and reduces revenue for estimated sales returns and other allowances at the time of shipment. Warranty costs, sales returns and other allowances are estimated based upon historical experience.

Computation of Net Income per Share

Basic net income per share is computed using the weighted-average number of common shares outstanding during the period, less shares subject to repurchase. Diluted net income per share is computed using the weighted-average number of common and dilutive potential common shares outstanding during the period. Dilutive potential common shares result from the assumed exercise of outstanding stock options that have a dilutive effect on earnings per share, and from the assumed conversion of outstanding convertible debt if it has a dilutive effect on earnings per share.

Concentrations

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Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash equivalents, short-term and long-term investments, and accounts receivable. Cash, cash equivalents, and short-term and long-term investments are primarily maintained at four major financial institutions in the United States. Deposits held with banks may exceed the amount of insurance provided on such deposits. Generally, these deposits may be redeemed upon demand. The Company generally invests in United States government agency debt securities and limits the amount of credit exposure to any one entity. During the nine months ended July 27, 2002, the Company invested $640.8 million, primarily consisting of the proceeds from its convertible debt offering, in debt securities of three separate United States government agencies.

For the quarters ended July 27, 2002 and July 28, 2001, four and three customers each contributed greater than 10 percent of the Company’s total revenues, for combined totals of 76 percent and 54 percent of total revenues, respectively. For the nine-month periods ended July 27, 2002 and July 28, 2001, four and two customers each contributed greater than 10 percent of the Company’s total revenues, for combined totals of 73 percent and 48 percent of total revenues, respectively. The level of sales to any single customer may vary and the loss of any one of these customers, or a decrease in the level of sales to any one of these customers, could have a material adverse impact on the Company’s financial condition or results of operations.

A majority of the Company’s trade receivable balance is derived from sales to OEM partners in the computer storage and server industry. As of July 27, 2002, and October 27, 2001, 72 percent and 76 percent of accounts receivable, respectively, were concentrated with five customers. The Company performs on-going credit evaluations of its customers and generally does not require collateral on accounts receivable. The Company has established reserves for credit losses and sales returns and other allowances. The Company has not experienced material credit losses in any of the periods presented.

The Company’s business is concentrated in the storage area networking industry, which has been impacted by unfavorable economic conditions and reduced information technology (IT) spending rates. Accordingly, the Company’s future success depends upon the buying patterns of customers in the storage area networking industry, their response to current and future IT investment trends, and the continued demand by such customers for the Company’s products. The Company’s continued success will depend upon its ability to enhance its existing products and to develop and introduce, on a timely basis, new cost-effective products and features that keep pace with technological developments and emerging industry standards.

Comprehensive Income

The components of comprehensive income, net of tax, are as follows (in thousands):


		Three Months Ended					Nine Months Ended

		July 27,		July 28,			July 27,		July 28,
		2002		2001			2002		2001

Net income		$	18,348	$	12,045		$	43,997	$	56,528
Other comprehensive income:
	Change in net unrealized gains (losses) on marketable equity securities and investments		9,241		(786	)		9,613		(30,666	)
	Reclassification adjustment for gains previously included in net income		—		632			—		4,642

Total comprehensive income		$	27,589	$	11,891		$	53,610	$	30,504

Reclassifications

Certain prior year amounts have been reclassified to conform to the current year presentation.

Recent Accounting Pronouncements

In October 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS 144). SFAS 144 supersedes SFAS No. 121 “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of” (SFAS 121), and certain provisions of APB Opinion No. 30 “Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions” (APB 30). SFAS 144 establishes standards for long-lived assets to be disposed of, and redefines the valuation and presentation of discontinued operations. SFAS 144 is effective for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years. Management does not expect the adoption of SFAS 144 to have a material effect on the Company’s financial position, results of operations, or cash flows.

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3. Fair Value of Financial Instruments

The following tables summarize the Company’s available-for-sale securities (in thousands):


					Gross		Gross
			Amortized		Unrealized		Unrealized			Fair
			Cost		Gains		Losses			Value

July 27, 2002
U.S. government agency debt securities			$	669,479	$	17,046	$	—		$	686,525
Marketable equity securities				347		—		(154	)		193

		Total	$	669,826	$	17,046	$	(154	)	$	686,718

Reported as:
	Short-term investments									$	76,723
	Marketable equity securities										193
	Long-term Investments										609,802

		Total								$	686,718

October 27, 2001
U.S. government agency debt securities			$	104,493	$	537	$	—		$	105,030
Marketable equity securities				347		24		(39	)		332

		Total	$	104,840	$	561	$	(39	)	$	105,362

Reported as:
	Short-term investments									$	105,030
	Marketable equity securities										332

		Total								$	105,362

No gains or losses were realized for the three and nine-month periods ended July 27, 2002. For the three and nine-month periods ended July 28, 2001, gross gains of $0.9 million and $6.6 million, respectively, were realized on the sale of marketable equity securities and are included in interest and other income, net in the accompanying Condensed Consolidated Statements of Operations. As of July 27, 2002, and October 27, 2001, net unrealized holding gains of $16.9 million and $0.5 million, respectively, were included in accumulated other comprehensive income in the accompanying Condensed Consolidated Balance Sheets, net of any related tax effect.

The following table summarizes maturities of the Company’s investments in debt securities issued by United States government agencies as of July 27, 2002 (in thousands):


		Amortized		Fair
		Cost		Value

Less than one year		$	76,275	$	76,723
Due in 1 - 2 years			46,031		47,151
Due in 2 - 3 years			547,173		562,651

	Total	$	669,479	$	686,525

4. Liabilities Associated with Facilities Lease Losses

During the quarter ended October 27, 2001, the Company recorded a charge of $39.8 million related to estimated facilities lease losses, net of expected sublease income, and a charge of $5.7 million in connection with the impairment of certain related leasehold improvements. These estimated charges represented the low-end of an estimated range that may be adjusted upon the occurrence of future triggering events. Under certain circumstances, the high-end of this range was estimated to be $63.0 million. Triggering events may include, but are not limited to, changes in estimated time to sublease the facilities, sublease terms, and sublease rates.

During the quarter ended July 27, 2002, the Company revised certain estimates and assumptions used to calculate its reserves for facilities lease losses and related asset impairment charges including those related to expected sublease rates, estimated time to sublease, expected future operating costs, and expected future use of the facilities. These revised estimates and assumptions were based on current conditions and events. The net impact of these changes in estimates and assumptions was not material. Should there be further changes in real estate market conditions or should it take longer than expected to find a suitable tenant to sublease the facilities, adjustments to the facilities lease losses reserve may be necessary in future

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periods based upon the then current actual events and circumstances.

The following table summarizes the activity for the facilities lease losses reserve, net of expected sublease income, for the nine-month period ended July 27, 2002 (in thousands):


		Facilities
		Lease Losses

Reserve balances at October 27, 2001		$	38,834
Cash payments			(5,209	)
Non-cash charges and adjustments			(371	)

	Reserve balances at July 27, 2002	$	33,254

Cash payments for facilities leases related to the above noted facilities lease losses will be paid over the respective lease terms through fiscal 2006.

5. Convertible Subordinated Debt

On December 21, 2001, and January 10, 2002, the Company sold, in private placements pursuant to Section 4(2) of the Securities Act of 1933, as amended, $550 million in aggregate principal amount of 2 percent convertible subordinated notes due 2007. The initial purchasers of the notes were Morgan Stanley & Co. Incorporated, Goldman, Sachs & Co., Salomon Smith Barney, Inc. and Merrill Lynch Pierce Fenner and Smith Incorporated, who purchased the notes from the Company at a discount of 2.25 percent of the aggregate principal amount. Holders of the notes may, in whole or in part, convert the notes into shares of the Company’s common stock at a conversion rate of 22.8571 shares per $1,000 principal amount of notes (aggregate of approximately 12.6 million shares) at any time prior to maturity on January 1, 2007. At any time on or after January 5, 2005, the Company may redeem the notes in whole or in part at the following prices expressed as a percentage of the principal amount:


Redemption Period	Price

Beginning on January 5, 2005 and ending on December 31, 2005		100.80	%
Beginning on January 1, 2006 and ending on December 31, 2006		100.40	%
On January 1, 2007		100.00	%

The Company is required to pay interest on January 1 and July 1 of each year, beginning July 1, 2002. Debt issuance costs of $12.4 million are being amortized over a five-year term using the straight-line method, which approximates the effective interest rate method. The amortization of debt issuance costs will accelerate upon early redemption or conversion of the notes. During the quarter ended April 27, 2002, the net proceeds of $537.6 million were invested in United States government agency debt securities. The net proceeds remain available for general corporate purposes, including working capital and capital expenditures.

6. Balance Sheet Detail

Inventories consisted of the following and are shown net of reserves for excess and obsolete inventory (in thousands):


		July 27,		October 27,
		2002		2001

Raw materials		$	1,835	$	6,572
Finished goods			5,229		3,735

	Total	$	7,064	$	10,307

Property and equipment, net consisted of the following (in thousands):


		July 27,			October 27,
		2002			2001

Computers, equipment and software		$	148,471		$	98,775
Furniture and fixtures			3,356			3,200
Leasehold improvements			28,730			18,435

			180,557			120,410
Less: Accumulated depreciation and amortization			(42,364	)		(22,953	)

	Total	$	138,193		$	97,457

Leasehold improvements at July 27, 2002, and October 27, 2001, are shown net of estimated impairments related to facilities lease losses (see Note 4).

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7. Commitments and Contingencies

Leases

The Company leases its facilities and certain equipment under various operating lease agreements expiring through November 2013. In connection with its facilities lease agreements, the Company has signed unconditional, irrevocable letters of credit totaling $18.7 million as security for the leases. Future minimum lease payments under all non-cancelable operating leases as of July 27, 2002 were $269.5 million. In addition to base rent on its facilities leases, many of the operating lease agreements require that the Company pay a proportional share of the respective facilities’ operating expenses.

As of July 27, 2002, the Company had a facilities lease losses reserve, net of expected sublease income, related to future facilities lease commitments of $33.3 million (see Note 4).

Manufacturing and Purchase Commitments

The Company has a manufacturing agreement with Solectron Corporation (Solectron) under which the Company provides to Solectron a twelve-month product forecast and places purchase orders with Solectron sixty calendar days in advance of the scheduled delivery of products to the Company’s customers. As of July 27, 2002, the Company’s commitment to Solectron for such inventory components, net of purchase commitment reserves, was $35.9 million, which the Company expects to utilize during future normal ongoing operations. Although the Company’s purchase orders placed with Solectron are cancelable, the terms of the agreement require the Company to purchase from Solectron all inventory components not returnable or usable by other Solectron customers.

In addition, the Company purchases several key components used in the manufacture of its products. As of July 27, 2002, the Company had non-cancelable purchase commitments for various components, net of purchase commitment reserves, totaling $12.4 million, which the Company expects to utilize during future normal ongoing operations.

The Company has established purchase commitment reserves of $3.2 million for excess inventory components committed to be purchased from Solectron and other key component vendors that it believes may not be realizable during future normal ongoing operations. These purchase commitment reserves represent the difference between the cost of the components and their estimated fair value based upon assumptions about market conditions and the Company’s current forecast of revenue. To the extent that such forecasts are not achieved or actual market conditions are less favorable than those projected, the Company’s commitments and associated reserve levels may change. The Company monitors its purchase commitment reserve requirements on a quarterly basis.

Legal Proceedings

On February 14, 2002, a suit captioned McDATA Corp. v. Brocade Communications Systems, Inc. was filed against the Company in the United States District Court for the District of Colorado. The complaint alleged that the Brocade SilkWorm 3800 Enterprise Fibre Channel Fabric Switch and Brocade SilkWorm 12000 Core Fabric Switch infringe U.S. Patent No. 6,233,236, entitled “Method and Apparatus for Measuring Traffic Within a Switch.” The complaint seeks unspecified compensatory and exemplary damages and to permanently enjoin the Company from infringing the patent in the future. On March 4, 2002, McDATA Corporation (McDATA) filed an amended complaint, in which it additionally alleged that the Brocade SilkWorm 3200 Entry Fabric Switch infringed this patent. In connection with this suit, on March 4, 2002, McDATA filed a motion for a preliminary injunction against the Company with regard to the patent. The Company filed an answer and counterclaims on April 8, 2002 asserting, among other things, no infringement and that the patent is invalid, unenforceable and covered by an existing covenant not to sue between the Company and McDATA. A hearing on McDATA’s motion for preliminary injunction was held on July 15, 2002, and the Company is awaiting a decision on the matter. The Company believes that it has meritorious defenses to the claims and intends to defend the action vigorously.

On July 20, 2001, the first of a number of putative class actions was filed in the United States District Court for the Southern District of New York against the Company, certain of its officers and directors, and certain of the underwriters in the Company’s initial public offering. Those cases were consolidated under the caption Chae v. Brocade Communications Systems, Inc. et al. The complaints generally alleged that various investment bank underwriters engaged in improper and undisclosed activities related to the allocation of shares in the Company’s initial public offering. On March 1, 2002, the Court entered an order dismissing without prejudice all claims against the Company and its officers and directors named in the consolidated proceeding. On April 19, 2002, a consolidated amended class action captioned In Re Brocade Communications Systems, Inc. Initial Public Offering Securities Litigation, 01 CV 6613, was filed asserting claims against the Brocade parties that are substantially similar to those alleged in the earlier case. The complaint seeks unspecified damages on behalf of a purported class of purchasers of common stock from May 24, 1999 to December 6, 2000. Motions to dismiss have been filed. The Company believes that it has meritorious defenses to the claims and intends to defend the action vigorously.

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class of purchasers of common stock from May 24, 1999 to December 6, 2000. The Company believes that it has meritorious defenses to the claims and intends to defend the action vigorously.

8. Stockholder Rights Plan

On February 5, 2002, the Company’s Board of Directors adopted a stockholder rights plan. Under the plan, the Company declared and paid a dividend of one right for each share of common stock held by stockholders of record as of the close of business on February 19, 2002. Each right initially entitles stockholders to purchase a fractional share of the Company’s preferred stock at $280 per share. However, the rights are not immediately exercisable and will become exercisable only upon the occurrence of certain events. If a person or group acquires or announces a tender or exchange offer that would result in the acquisition of 15 percent or more of the Company’s common stock while the stockholder rights plan remains in place, then, unless the rights are redeemed by the Company for $0.001 per right, the rights will become exercisable by all rights holders except the acquiring person or group for shares of the Company or the third party acquirer having a value of twice the right’s then-current exercise price. The stockholder rights plan may have the effect of deterring or delaying a change in control of Brocade.

9. Net Income per Share

The following table presents the calculation of basic and diluted net income per common share (in thousands, except per share data):


		Three Months Ended						Nine Months Ended

		July 27,			July 28,			July 27,			July 28,
		2002			2001			2002			2001

Net income		$	18,348		$	12,045		$	43,997		$	56,528

Basic and diluted net income per share:
	Weighted-average shares of common stock outstanding		233,760			228,068			232,573			226,006
	Less: Weighted-average shares of common stock subject to repurchase		(743	)		(5,205	)		(1,754	)		(6,387	)

Weighted-average shares used in computing basic net income per share			233,017			222,863			230,819			219,619
Dilutive potential common shares			7,089			23,356			13,853			24,653

Weighted-average shares used in computing diluted net income per share			240,106			246,219			244,672			244,272

Basic net income per share		$	0.08		$	0.05		$	0.19		$	0.26

Diluted net income per share		$	0.08		$	0.05		$	0.18		$	0.23

For the quarters ended July 27, 2002 and July 28, 2001, potential common shares in the form of stock options to purchase 65.1 million and 27.9 million weighted-average shares of common stock, respectively, were antidilutive and, therefore, not included in the computation of diluted earnings per share. For the nine-month periods ended July 27, 2002 and July 28, 2001, potential common shares in the form of stock options to purchase 43.9 million and 18.8 million weighted-average shares of common stock, respectively, were antidilutive and, therefore, not included in the computation of diluted earnings per share. In addition, for the three and nine-month periods ended July 27, 2002, potential common shares resulting from the potential conversion of the Company’s convertible subordinated debt of 12.6 million and 10.0 million weighted-average common shares, respectively, were antidilutive and, therefore, not included in the computation of diluted earnings per share.

10. Segment Information

The Company is organized and operates as one operating segment: the design, development, manufacturing, marketing and selling of infrastructure for SANs. The Chief Executive Officer is the Company’s Chief Operating Decision Maker (CODM), as defined by SFAS 131, “Disclosures about Segments of an Enterprise and Related Information.” The CODM allocates resources and assesses the performance of the Company based on consolidated revenues and overall profitability.

Revenues are attributed to geographic areas based on the location of the customer to which products are shipped. Domestic and international revenues were 75 percent and 25 percent of total revenues, respectively, for the quarter ended July 27, 2002, and 71 percent and 29 percent, respectively, for the nine-month period ended July 27, 2002. Domestic and international revenues were 71 percent and 29 percent of total revenues, respectively, for the quarter ended July 28, 2001, and 72 percent and 28 percent of total revenues, respectively, for the nine-month period ended July 28, 2001. Domestic revenues include sales to certain OEM customers who then distribute Brocade product to their international customers. To date service

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revenue has not exceeded 10 percent of total revenues. Identifiable assets located in foreign countries were not material as of July 27, 2002, and October 27, 2001.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This report contains forward-looking statements, which are predictions about future events. These forward-looking statements include predictions regarding our:

       •    revenues and profits;

       •    customer concentration;

       •    research and development expenses;

       •    sales and marketing expenses;

       •    general and administrative expenses;

       •    provision for income taxes;

       •    realization of deferred tax assets;

       •    liquidity and sufficiency of existing cash, cash equivalents, and short-term investments for near-term requirements;

       •    purchase commitments; and

       •    the effect of recent accounting pronouncements on our financial condition and results of operations.

You can identify these and other forward-looking statements by the use of words such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “intend,” “potential,” “continue,” or the negative of such terms, or other comparable terminology. Forward-looking statements also include the assumptions underlying or relating to any of the foregoing statements.

Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth below under the heading “Risk Factors.” The following information should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Condensed Consolidated Financial Statements and 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 and the Consolidated Financial Statements and notes thereto contained in our Annual Report on Form 10-K filed with the SEC on January 24, 2002.

All forward-looking statements included in this document are based on information available to us on the date hereof. We assume no obligation to update any forward-looking statements.

Brocade, the B weave logo and SilkWorm are registered trademarks of Brocade Communications Systems, Inc. or its subsidiaries in the United States or in other countries. All other brands, products, or service names are or may be trademarks or service marks of, and are used to identify, products or services of their respective owners.

Recent Events

On August 9, 2002, Christopher B. Paisley joined our Board of Directors. Mr. Paisley will also serve on our Audit Committee and replaces Mark Leslie, who recently retired from our Board. Mr. Paisley currently serves as the Dean’s Executive Professor of Accounting and Finance at the Leavey School of Business at Santa Clara University.

On February 14, 2002, a suit captioned McDATA Corp. v. Brocade Communications Systems, Inc. was filed against Brocade in the United States District Court for the District of Colorado. The complaint alleged that the Brocade SilkWorm 3800 Enterprise Fibre Channel Fabric Switch and Brocade SilkWorm 12000 Core Fabric Switch infringe U.S. Patent No. 6,233,236, entitled “Method and Apparatus for Measuring Traffic Within a Switch.” The complaint seeks unspecified compensatory and exemplary damages and to permanently enjoin Brocade from infringing the patent in the future. On March 4, 2002, McDATA filed an amended complaint, in which it additionally alleged that the Brocade SilkWorm 3200 Entry Fabric Switch infringed this patent. In connection with this suit, on March 4, 2002, McDATA filed a motion for a preliminary injunction against Brocade with regard to the patent. We filed an answer and counterclaims on April 8, 2002 asserting, among other things, no infringement and that the patent is invalid, unenforceable and covered by an existing covenant not to sue between Brocade and McDATA. A hearing on McDATA’s motion for preliminary injunction was held on July 15, 2002, and

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we are awaiting a decision on the matter. We believe that we have meritorious defenses to the claims and intend to defend the action vigorously.

On July 20, 2001, the first of a number of putative class actions was filed in the United States District Court for the Southern District of New York against us, certain of our officers and directors, and certain of the underwriters in our initial public offering. Those cases were consolidated under the caption Chae v. Brocade Communications Systems, Inc. et al. The complaints generally alleged that various investment bank underwriters engaged in improper and undisclosed activities related to the allocation of shares in our initial public offering. On March 1, 2002, the Court entered an order dismissing without prejudice all claims against us and our officers and directors named in the consolidated proceeding. On April 19, 2002, a consolidated amended class action captioned In Re Brocade Communications Systems, Inc. Initial Public Offering Securities Litigation, 01 CV 6613, was filed asserting claims against the Brocade parties that are substantially similar to those alleged in the earlier case. The complaint seeks unspecified damages on behalf of a purported class of purchasers of common stock from May 24, 1999 to December 6, 2000. Motions to dismiss have been filed. We believe that we have meritorious defenses to the claims and intend to defend the action vigorously.

Results of Operations

The following table sets forth certain financial data for the periods indicated as a percentage of total net revenues:


			Three Months Ended						Nine Months Ended

			July 27,			July 28,			July 27,			July 28,
			2002			2001			2002			2001

Net revenues				100.0	%		100.0	%		100.0	%		100.0	%
Cost of revenues				39.9			40.0			39.8			40.0

	Gross margin			60.1			60.0			60.2			60.0

Operating expenses:
	Research and development			22.0			23.6			23.3			20.7
	Sales and marketing			20.0			19.4			20.2			17.5
	General and administrative			3.1			3.8			3.5			3.4
	Amortization of deferred stock compensation			0.2			0.2			0.2			0.2

		Total operating expenses		45.3			47.0			47.2			41.8

Income from operations				14.8			13.0			13.0			18.2
Interest and other income, net				4.5			1.8			4.1			2.2
Interest expense				(2.2	)		—			(1.9	)		—

Income before provision for income taxes				17.1			14.8			15.2			20.4
Provision for income taxes				5.0			4.4			4.4			6.1

Net income				12.1	%		10.4	%		10.8	%		14.3	%

Revenues. Our revenues are derived primarily from sales of our SilkWorm family of products. Net revenues for the quarter ended July 27, 2002 were $151.2 million, compared to $116.3 million for the quarter ended July 28, 2001. The increase in net revenues was primarily the result of sales of our SilkWorm 12000 Core Fabric Switch, introduced in March 2002. Net revenues for the nine months ended July 27, 2002 were $409.3 million, compared to $396.5 million for the nine months ended July 28, 2001. Net revenues for the nine months ended July 27, 2002 benefited from the inclusion of sales of our SilkWorm 12000 Core Fabric Switch and were negatively impacted by the unfavorable economic conditions and reduced information technology (IT) spending environment that began in fiscal 2001 and that has continued into fiscal 2002.

Domestic and international revenues for the quarter ended July 27, 2002, were 75 percent and 25 percent of total revenues, respectively, compared with 71 percent and 29 percent of total revenues, respectively, for the quarter ended July 28, 2001. Domestic and international revenues for the nine months ended July 27, 2002, were 71 percent and 29 percent of total revenues, respectively, compared with 72 percent and 28 percent of total revenues, respectively, for the nine months ended July 28, 2001. International revenues resulted primarily from sales to customers in Western Europe and the greater Asia Pacific region. Revenues are attributed to geographic areas based on the location of the customer to which products are shipped. Domestic revenues include sales to certain OEM customers who then distribute our products to their international customers.

A significant portion of our revenues is concentrated among a relatively small number of customers. For the quarters ended July 27, 2002 and July 28, 2001, four and three customers each contributed greater than 10 percent of our total revenues for combined totals of 76 percent and 54 percent of our total revenues, respectively. For the nine-month periods ended July 27, 2002 and July 28, 2001, four and two customers each contributed greater than 10 percent of our total revenues for combined totals of 73 percent and 48 percent of our total revenues, respectively. The level of sales to any single customer may vary and the loss of any one significant customer, or a decrease in the level of sales to any one significant customer,

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could seriously harm our financial condition and results of operations. We expect that a significant portion of our future revenues will continue to come from sales of products to a relatively small number of customers.

Gross margin. Gross margins for both the three and nine-month periods ended July 27, 2002, remained consistent with gross margins reported in the prior comparable periods.

Research and development expenses. Research and development (R&D) expenses increased to $33.2 million and $95.5 million for the three and nine-month periods ended July 27, 2002, respectively, compared to $27.4 million and $82.0 million for the three and nine-month periods ended July 28, 2001, respectively. R&D expenses consist primarily of salaries and related expenses for personnel engaged in engineering and R&D activities; fees paid to consultants and outside service providers; nonrecurring engineering charges; prototyping expenses related to the design, development, testing and enhancement of our products; depreciation related to engineering and test equipment; and IT and facilities expenses. The increase in R&D expenses reflects our continued belief that investment in R&D is a critical factor in maintaining our competitive position. The increases in R&D expenses were primarily related to additional personnel associated with the initial development of future products. We currently anticipate that R&D expenses will increase in absolute dollars during the next quarter.

Sales and marketing expenses. Sales and marketing expenses increased to $30.3 million and $82.7 million for the three and nine-month periods ended July 27, 2002, respectively, compared to $22.6 million and $69.6 million for the three and nine-month periods ended July 28, 2001, respectively. Sales and marketing expenses consist primarily of salaries, commissions and related expenses for personnel engaged in marketing and sales activities; costs associated with promotional and travel expenses; and IT and facilities expenses. The increases in sales and marketing expenses were primarily due to the continued expansion of our sales and marketing organizations, and, for the three months ended July 27, 2002, an increase in commissions associated with increased revenue levels. We believe that continued investment in sales and marketing is critical to the success of our strategy to expand relationships with our OEM customers; to expand our presence in the master reseller and fabric integration channel; to communicate with, understand and anticipate the current and future needs of the end users of our products in order to increase demand for our partners; and to maintain our leadership position in the SAN market. In addition, we are currently expanding our international sales activities to various countries in Europe and the greater Asia Pacific region. We currently anticipate that sales and marketing expenses will increase in absolute dollars during the next quarter.

General and administrative expenses. General and administrative (G&A) expenses increased to $4.8 million and $14.1 million for the three and nine-month periods ended July 27, 2002, respectively, compared to $4.4 million and $13.4 million for the three and nine-month periods ended July 28, 2001, respectively. G&A expenses consist primarily of salaries and related expenses for corporate executives, finance, human resources and investor relations, as well as recruiting expenses, professional fees, corporate legal expenses, other corporate expenses, and IT and facilities expenses. We currently anticipate that G&A expenses will remain relatively constant in terms of absolute dollars during the next quarter.

Amortization of deferred stock compensation. Amortization of deferred stock compensation was $0.2 million and $0.7 million for the three and nine-months periods ended July 27, 2002, respectively, compared to $0.3 million and $0.8 million, for the three and nine-month periods ended July 28, 2001, respectively. As of July 27, 2002, unamortized deferred stock compensation was approximately $0.3 million.

Interest and other income, net. Interest and other income, net increased to $6.8 million and $16.8 million for the three and nine-month periods ended July 27, 2002, respectively, compared to $2.1 million and $8.7 million for the three and nine-month periods ended July 28, 2001, respectively. The increases were primarily the result of increased cash and investment balances associated with the investment of the proceeds received from our convertible debt offering. Interest and other income, net for the quarter ended July 28, 2001, includes realized gains of $0.9 million from the sale of marketable equity securities and impairment charges of $1.2 million related to other-than-temporary declines in the fair value of certain minority equity investments in non-publicly traded companies. Interest and other income, net for the nine-month period ended July 28, 2001, includes realized gains of $6.6 million from the sale of marketable equity securities and impairment charges of $4.7 million related to other-than-temporary declines in the fair value of certain minority equity investments in non-publicly traded companies. No impairment charges related to other-than-temporary declines in the fair value of minority equity investments were recorded for the three and nine-month periods ended July 27, 2002.

Interest expense. Interest expense was $3.4 million and $8.1 million for the three and nine-month periods ended July 27, 2002, respectively, and was primarily the result of the issuance of convertible subordinated debt.

Provision for income taxes. Our effective tax rate for both the three and nine-month periods ended July 27, 2002, was 29 percent compared to 30 percent for the three and nine-month periods ended July 28, 2001. Our ability to maintain our current effective tax rate requires that international revenues and earnings be achieved as planned. To the extent that international

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revenues and earnings differ from plan, a factor largely influenced by the buying behavior of our OEM customers, or unfavorable changes in tax laws and regulations occur, our effective tax rate could change.

Liquidity and Capital Resources

Cash, cash equivalents, short-term investments and long-term investments were $882.3 million as of July 27, 2002, an increase of $627.2 million from October 27, 2001. For the nine-month period ended July 27, 2002, we generated $89.9 million in cash from operating activities, primarily from net income and an increase in accounts payable which was partially offset by an increase in accounts receivable due to increased sales during the quarter ended July 27, 2002. Also included in cash from operations were income tax benefits related to employee stock option transactions of $26.2 million, which were partially offset by an increase in net deferred tax assets of $20.3 million. As of July 27, 2002, we had $248.8 million in net deferred tax assets, which we believe will be realizable through future profitable operations.

Net cash used in investing activities for the nine-month period ended July 27, 2002 was $631.9 million, resulting primarily from purchases of investments of $640.8 million and purchases of capital equipment of $65.2 million. Net cash provided by financing activities totaled $587.6 million and was the result of $537.6 million in net proceeds from the issuance of convertible subordinated notes (see Note 5, “Convertible Subordinated Debt,” of the Notes to Condensed Consolidated Financial Statements), and $50.0 million in net proceeds from the issuance of common stock related to employee participation in employee stock plans.

We have a manufacturing agreement with Solectron under which we provide to Solectron a twelve-month product forecast and place purchase orders with Solectron sixty calendar days in advance of the scheduled delivery of products to our customers. As of July 27, 2002, our commitment to Solectron for such inventory components, net of purchase commitment reserves, was $35.9 million, which we expect to utilize during future normal ongoing operations. Although the purchase orders we place with Solectron are cancelable, the terms of the agreement require us to purchase from Solectron all inventory components not returnable or usable by other Solectron customers.

In addition, we purchase several key components used in the manufacture of our products. As of July 27, 2002, we had non-cancelable purchase commitments for various components, net of purchase commitment reserves, totaling $12.4 million, which we expect to utilize during future normal ongoing operations.

We have established purchase commitment reserves of $3.2 million for excess inventory components committed to be purchased from Solectron and other key component vendors that we believe may not be realizable during future normal ongoing operations. These purchase commitment reserves represent the difference between the cost of the components and their estimated fair value based upon assumptions about market conditions and our current forecast of revenue. To the extent that such forecasts are not achieved or actual market conditions are less favorable than those projected, our commitments and associated reserve levels may change. We monitor these purchase commitment reserve requirements on a quarterly basis, and as of July 27, 2002 continue to believe our reserves are adequate and sufficient to meet any unrealizable purchase commitments.

On December 21, 2001, and January 10, 2002, we sold $550 million in aggregate principal amount of 2 percent convertible subordinated notes due 2007 (see Note 5, “Convertible Subordinated Debt,” of the Notes to Condensed Consolidated Financial Statements). Holders of the notes may, in whole or in part, convert the notes into shares of our common stock at a conversion rate of 22.8571 shares per $1,000 principal amount of notes (aggregate of approximately 12.6 million shares) at any time prior to maturity on January 1, 2007. At any time on or after January 5, 2005, we may redeem the notes in whole or in part at the following prices expressed as a percentage of the principal amount:


Redemption Period	Price

Beginning on January 5, 2005 and ending on December 31, 2005		100.80	%
Beginning on January 1, 2006 and ending on December 31, 2006		100.40	%
On January 1, 2007		100.00	%

The following table summarizes our contractual obligations (including interest expense) and commitments as of July 27, 2002 (in thousands):

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				Less than				After
		Total		1 year		1 - 3 years		3 years

Contractual Obligations:
Convertible subordinated notes, including interest		$	599,500	$	11,000	$	22,000	$	566,500
Non-cancelable operating leases			269,494		28,834		54,618		186,042
Unconditional purchase obligations, gross			51,489		51,489		—		—

	Total contractual obligations	$	920,483	$	91,323	$	76,618	$	752,542

Other Commitments:
Standby letters of credit		$	18,749	$	n/a	$	n/a	$	n/a

We believe that our existing cash, cash equivalents, short-term and long-term investments, and cash expected to be generated from future operations will be sufficient to meet our capital requirements at least through the next 12 months, although we could elect to seek additional funding prior to that time. Our future capital requirements will depend on many factors, including the rate of revenue growth, the timing and extent of spending to support product development efforts and the expansion of sales and marketing, the timing of introductions of new products and enhancements to existing products, and the market acceptance of our products.

Related Party Transactions

Larry W. Sonsini, a director of Brocade, serves as a member and Chairman and CEO of Wilson Sonsini Goodrich & Rosati, Professional Corporation (WSGR), our principal outside legal counsel. Aggregate fees billed to us by WSGR for legal services rendered during the nine-month periods ended July 27, 2002 and July 28, 2001, were $2.5 million and $0.5 million, respectively. We believe that the services rendered to us by WSGR were on terms no more favorable than those with unrelated parties.

Mark Leslie was a director of Brocade until May 2002, and served on the Board of Directors of VERITAS Software Corporation (Veritas), a company with whom we do business. During the nine-month periods ended July 27, 2002, and July 28, 2001, total revenues from sales to Veritas were $2.0 million and $2.1 million, respectively. We believe that sales to Veritas were on terms no more favorable than those with unrelated parties.

Critical Accounting Policies

Our discussion and analysis of financial condition and results of operations is based upon our Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these Consolidated Financial Statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We evaluate, on an on-going basis, our estimates and judgments, including those related to sales returns, bad debts, excess inventory and purchase commitments, investments, warranty obligations, lease losses, income taxes, and contingencies and litigation. We base our estimates on historical experience and assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

We believe the following critical accounting policies, among others, affect our more significant judgments and estimates used in the preparation of our Consolidated Financial Statements:

       •    Revenue recognition and allowances;

       •    Inventory and purchase commitment reserves;

       •    Lease losses; and

       •    Accounting for income taxes.

Product revenue is generally recognized when persuasive evidence of an arrangement exists, delivery has occurred, fee is fixed or determinable, and collectibility is probable. However, revenue recognition is deferred for shipments to new customers and for shipments to existing customers when significant support services are required to successfully integrate our product into our customer’s products. These revenues, and related costs, are deferred and recognized when the customer has successfully integrated our product into its product offerings and we have met any support obligations. In addition, revenue from sales to master resellers is recognized upon reported sell-through.

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Service revenue, which to date has not been material, consists of training, warranty, and maintenance arrangements, including post-contract customer support (PCS) services. PCS services are offered under renewable, annual fee-based contracts or as part of multiple element arrangements and typically include upgrades and enhancements to our software operating system, and telephone support. For multiple element arrangements, we allocate revenue to each element based upon vendor-specific objective evidence (VSOE). VSOE for each element is based upon the price charged when the element is sold separately. Service revenue, including revenue allocated to undelivered elements, is deferred and recognized ratably over the contractual period, which is generally one to three years. Training revenue is recognized upon completion of the training.

We accrue for warranty costs and reduces revenue for estimated sales returns and other allowances at the time of shipment. Warranty costs, sales returns and other allowances are estimated based upon historical experience. If the data used to calculate these estimates does not properly anticipate future returns, revenue could be misstated. To date, actual experience has been consistent with our estimates.

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We analyze accounts receivable and historical bad debts, customer concentrations, customer creditworthiness, current economic trends and changes in customer payment terms and practices when evaluating the adequacy of the allowance for doubtful accounts. If the financial condition of our customers was to deteriorate, resulting in an impairment of their ability to make payments, additional allowances and charges against earnings may be required. To date, actual experience has been consistent with our estimates.

We write down inventory and record purchase commitment reserves for estimated excess and obsolete inventory equal to the difference between the cost of inventory and the estimated fair value based upon assumptions about future demand and market conditions. Although we strive to ensure the accuracy of our forecasts of future product demand, any significant unanticipated changes in demand or technological developments could have a significant impact on the value of our inventory and commitments, and our reported results. If actual market conditions are less favorable than those projected, additional inventory write-downs, purchase commitment reserves, and charges against earnings might be required. To date actual experience has been consistent with our estimates.

As a result of continuing unfavorable economic conditions and a reduction in IT spending rates, during the quarter ended October 27, 2001, we performed a comprehensive analysis of our real estate facility requirements and identified existing vacant excess facility space, which was subsequently offered for sublease. Based upon the results of this analysis, during the quarter ended October 27, 2001, we recorded a charge of $39.8 million related to estimated facilities lease losses, net of expected sublease income, and a charge of $5.7 million in connection with the impairment of certain related leasehold improvements. In determining the net facilities lease losses and related asset impairment charges, various assumptions were made including the time period over which the facilities will be vacant, expected sublease terms and rates. The estimated charges represented the low-end of an estimated range that may be adjusted upon the occurrence of future triggering events. Under certain circumstances, we estimated the high-end of this range to be $63.0 million. Triggering events may include, but are not limited to, changes in estimated time to sublease the facilities, sublease terms, and sublease rates.

During the quarter ended July 27, 2002, we revised certain estimates and assumptions used to calculate our reserves for facilities lease losses and related asset impairment charges, including those related to expected sublease rates, estimated time to sublease, expected future operating costs, and expected future use of the facilities. These revised estimates and assumptions were based on current conditions and events. The net impact of these changes in estimates and assumptions was not material. Should there be further changes in real estate market conditions or should it take longer than expected to find a suitable tenant to sublease the facilities, adjustments to the facilities lease losses reserve may be necessary in future periods based upon the then current actual events and circumstances.

The determination of our tax provision is subject to judgments and estimates due to operations in several tax jurisdictions outside the United States. Sales to our international customers are generally taxed at rates that are lower than United States rates, resulting in a reduction of our effective tax rate. The ability to maintain our current effective tax rate is contingent upon existing tax laws in both the United States and in the respective countries in which our international subsidiaries are located. Future changes in domestic or international tax laws could affect the continued realization of the tax benefits we are currently receiving and expect to receive from international sales. In addition, a decrease in the percentage of our total revenue from international customers or in the mix of international revenue among particular tax jurisdictions could change our overall effective tax rate. Also, our current effective tax rate assumes that United States income taxes are not provided for undistributed earnings of certain non-United States subsidiaries. These earnings could become subject to incremental foreign withholding, or Federal and state income taxes should they be either deemed or actually remitted to the United States.

The carrying value of our net deferred tax assets, which is made up primarily of income tax deductions and credits resulting from stock option exercises, assumes that we will be able to generate sufficient future income to fully utilize these

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tax deductions and credits. If we do not generate sufficient future income, the realization of these deferred tax assets may be impaired resulting in additional income tax expense. We evaluate the expected realization of our deferred tax assets and assess the need for valuation allowances quarterly.

Recent Accounting Pronouncements

In October 2001, the FASB issued Statement of Financial Accounting Standards No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS 144). SFAS 144 supersedes SFAS No. 121 “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of” (SFAS 121), and certain provisions of APB Opinion No. 30 “Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions” (APB 30). SFAS 144 establishes standards for long-lived assets to be disposed of, and redefines the valuation and presentation of discontinued operations. SFAS 144 is effective for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years. We do not expect the adoption of SFAS 144 to have a material effect on our financial position, results of operations, or cash flows.

Risk Factors

Our quarterly revenues and operating results may fluctuate in future periods for a number of reasons, which could adversely affect the trading price of our stock.

Our quarterly revenues and operating results may vary significantly in the future due to a number of factors, any of which may cause our stock price to fluctuate. The primary factors that may impact the predictability of our quarterly results include the following:

       •    changes in general economic conditions and specific economic conditions in the computer, storage, and networking industries. In particular, recent economic uncertainty has resulted in a general reduction in information technology (IT) spending. This reduction in IT spending has lead to a decline in our growth rates compared to historical trends;

       •    the timing of customer orders and product implementations, particularly large orders from and product implementations of our OEM customers;

       •    the effects of terrorist activity and armed conflict, such as disruptions or downturns in general economic activity;

       •    announcements, introductions, and transitions of new products by us and our competitors;

       •    the ability of new competitors to enter the market and effectively compete against us;

       •    deferrals of customer orders in anticipation of new products, services, or product enhancements introduced by us or our competitors;

       •    our ability to obtain sufficient supplies of sole or limited sourced components, including application specific integrated circuits (ASICs), microprocessors, certain logic chips, programmable logic devices, chassis, printed circuit boards and power supplies;

       •    increases in prices of components used in the manufacture of our products;

       •    our ability to attain and maintain production volumes and quality levels;

       •    variations in the mix of our products sold and the mix of distribution channels through which they are sold;

       •    litigation; and

       •    legislation or regulatory developments.

Accordingly, the results of any prior periods should not be relied upon as an indication of future performance. If our operating results are below the expectations of stock market analysts or investors, our stock price may decline.

Our revenues may be impacted by changes in IT spending levels.

In recent quarters, unfavorable economic conditions and reduced global IT spending rates have adversely affected our operating results and led to a decline in our growth rates compared to historical trends. While we have begun to experience some resumption of growth in our business, the extent and duration of growth are influenced by overall IT spending rates. We are unable to predict when IT spending rates will return to historical levels, if at all. If there are further reductions in either domestic or international IT

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spending rates, or if IT spending rates do not return to historical levels, our revenues, operating results and financial condition may be adversely affected.

Our success depends on our ability to develop new and enhanced products that achieve widespread market acceptance.

We currently derive substantially all of our revenues from sales of our SilkWorm family of products. We expect that revenue from this product family will continue to account for a substantial portion of our revenues for the foreseeable future. Therefore, widespread market acceptance of these products is critical to our future success. Some of our products have been only recently introduced and, therefore, the demand and market acceptance of these products is uncertain. Factors that may affect the market acceptance of our products include the performance, price and total cost of ownership of our products; the features and functionality of our products; the availability and price of competing products and technologies; and the success and development of our OEM partners, master resellers and fabric partners. Many of these factors are beyond our control.

Our future success depends upon our ability to address the rapidly changing needs of our customers by developing and introducing high-quality, cost-effective products and product enhancements on a timely basis and by keeping pace with technological developments and emerging industry standards. We recently introduced the SilkWorm 12000 Core Fabric Switch which is targeted at expanding our existing market, but is also targeted toward the “director” class market. We expect that a significant portion of our future growth will depend upon the market acceptance of this product. We expect to launch new products during the next year and our future revenue growth will be dependent on the success of the SilkWorm 12000 Core Fabric Switch and these new products. We have in the past experienced delays in product development and such delays may occur in the future. If we are unable to achieve market acceptance of our new products, our business and results of operations could be harmed.

As we introduce new products, we must manage the transition between our new products and our older products.

As new or enhanced products are introduced, we must successfully manage the transition from older products in order to minimize disruption in customers’ ordering patterns, avoid excessive levels of older product inventories, and ensure that enough supplies of new products can be delivered to meet customers’ demands. Our failure to manage the transition to newer products in the future or to develop and successfully introduce new products and product enhancements could adversely affect our business and financial results. In particular, in conjunction with the transition of our product offerings from 1 to 2 Gbit/sec technology, we have begun introducing products with new features and functionality. We face risks relating to this product transition, including risks relating to forecasting demand for 2 Gbit/sec products and related transition issues, as well as possible product and software defects and a potentially different sales and support environment due to the complexity of these new systems. If any of the foregoing occurs, our business could be seriously harmed.

Increased market competition may lead to reduced sales of our products, reduced profits, and reduced market share.

The markets for our SAN switching products are competitive, and are likely to become even more competitive. Increased competition could result in pricing pressures, reduced sales, reduced margins, reduced profits, reduced market share, or the failure of our products to achieve or maintain market acceptance. Our products face competition from multiple sources and we may not be able to compete successfully against current and future competitors. Furthermore, as the SAN market evolves, non-Fibre Channel-based products may become available to interconnect servers and storage. To the extent that these products provide the ability to network servers and storage and support high-performance, block-data storage applications, they may compete with our current and future products. These products may include, but are not limited to, non-Fibre Channel based emerging products based on Gigabit Ethernet, 10-Gigabit Ethernet and Infiniband.

International political instability may increase our cost of doing business and disrupt our business.

Increased international political instability, as demonstrated by the September 2001 terrorist attacks, disruption in air transportation and further enhanced security measures as a result of the September 2001 terrorist attacks, the military action taken in Afghanistan, and the conflicts in the Middle East, may halt or hinder our ability to do business and may increase our costs. This increased instability may, for example, negatively impact the reliability and cost of transportation, negatively impact the desire of our employees and customers to travel, adversely affect our ability to obtain adequate insurance at reasonable rates, and require us to take extra security precautions for our operations. In addition, to the extent that air transportation is delayed or disrupted, the operations of our contract manufacturers and suppliers may be disrupted, particularly if shipments of components and raw materials are delayed. If this international political instability continues or escalates, our business and results of operations could be harmed.

Failure to manage expansion effectively could seriously harm our business, financial condition, and prospects.

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Our ability to successfully implement our business plan, develop and offer products, and manage expansion in a rapidly evolving market requires a comprehensive and effective planning and management process. We continue to increase the scope of our operations domestically and internationally, and have grown headcount substantially. In addition, we plan to continue to hire employees in the foreseeable future. Our growth in business, headcount, and relationships with customers and other third parties has placed, and will continue to place, a significant strain on management systems and resources. Our failure to continue to improve upon our operational, managerial, and financial controls, reporting systems, and procedures, and our failure to continue to expand, train, and manage our work force worldwide, could seriously harm our business and financial results.

Failure to adequately anticipate future OEM and end-user product needs and failure to forecast OEM and end-user demand could negatively impact the demand for our products and reduce our revenues.

We market and sell our products through OEM partners, master resellers and fabric partners. We must continually assess, anticipate, and respond to the needs of these OEM partners, master resellers and fabric partners. We must also ensure that our products integrate with solutions provided by these OEM partners, master resellers and fabric partners. In addition, we must continually assess, anticipate, and respond to the needs of their customers, who are the end-users of our products. If we fail to respond to the needs of these groups, our business and operating results could be harmed.

Because we market and sell our products through OEM partners, master resellers and fabric partners, our direct contact with the end-users of our products is often limited. Although we make every effort to communicate with, understand, and anticipate the current and future needs of the end-users of our products, to a large extent we rely on our OEM partners, master resellers and fabric partners for visibility into those end-user requirements. Our failure to adequately assess and anticipate future end-user needs could negatively impact the demand for our products and reduce our revenues.

Similarly, we have limited ability to forecast the demand for our products. In preparing sales and demand forecasts, we rely largely on input from our OEM partners, master resellers and fabric partners. If our customers are unable to accurately forecast demand, or we fail to effectively communicate with our customers about end-user demand or other time sensitive information, sales and demand forecasts may not reflect the most accurate, up-to-date information. Because we make business decisions based on our sales and demand forecasts, if these forecasts do not materialize, our business and financial results could be negatively impacted. Furthermore, we may not be able to identify these forecast differences until late in our fiscal quarter. Consequently, we may not be able to make adjustments to our business model without negatively impacting our earnings.

We plan to continue to increase our international sales activities significantly, which will subject us to additional business risks.

We plan to continue to expand our international sales activities significantly. Expansion of international operations will involve inherent risks that we may not be able to control, including:

       •    supporting multiple languages;

       •    recruiting sales and technical support personnel with the skills to support our products;

       •    increased complexity and costs of managing international operations;

       •    commercial laws and business practices that favor local competition;

       •    multiple, potentially conflicting, and changing governmental laws and regulations, including differing labor and employment laws;

       •    longer sales cycles;

       •    difficulties in collecting accounts receivable;

       •    reduced or limited protections of intellectual property rights; and

       •    political and economic instability.

To date, none of our international revenues and costs of revenues has been denominated in foreign currencies. As a result, an increase in the value of the United States dollar relative to foreign currencies could make our products more expensive and, thus, less competitive in foreign markets. In the future, a portion of our international revenues may be denominated in foreign currencies, including the Euro, which will subject us to risks associated with fluctuations in those foreign currencies. Additionally, we receive significant tax benefits from sales to our international customers. These benefits are contingent upon existing tax laws in both the United States and in the respective countries in which our international customers are located.

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Future changes in domestic or international tax laws could affect the continued realization of the tax benefits we are currently receiving and expect to receive from sales to our international customers. In addition, a decrease in the percentage of our total revenue from international customers, or in the mix of international revenue among particular tax jurisdictions, could increase our overall effective tax rate.

We depend on OEM customers. The loss of any of these OEM customers could significantly reduce our revenues.

Although our customer base has increased, we still depend on large, recurring purchases from a limited number of large OEM customers. Our agreements with our OEM customers are typically cancelable, non-exclusive, and have no minimum purchase requirements. For the fiscal quarter ended July 27, 2002, four customers each represented greater than ten percent of our total revenues for a combined total of 76 percent of our total revenues. In addition, HP and Compaq, two of our larger OEM customers, recently merged. This merger may result in a decrease or a disruption in our sales to the combined company. We anticipate that our revenues and operating results will continue to depend on sales to a relatively small number of customers. Therefore, the loss of any one significant customer, or a decrease in the level of sales to any one significant customer, could seriously harm our financial condition and results of operations.

Failure to expand distribution channels and manage distribution relationships could significantly reduce our revenues.

Our success will depend on our continuing ability to develop and manage relationships with significant OEM partners, master resellers and fabric partners, as well as on the sales efforts and success of these customers. Our OEM customers may evaluate our products for a limited time period before they begin to market and sell them. Assisting these customers through the evaluation process may require significant sales, marketing, and management efforts on our part, particularly if our products are being qualified with multiple customers at the same time. In addition, once our products have been qualified, our customer agreements have no minimum purchase commitments. We may not be able to maintain or expand our distribution channels, manage distribution relationships successfully, or market our products through OEMs effectively. Our failure to manage successfully our distribution relationships or the failure of our customers to sell our products could reduce our revenues.

The loss of our relationship with Solectron Corporation, our principal manufacturer, or the failure to accurately forecast demand for our products or successfully manage our relationship with Solectron, could negatively impact our ability to manufacture and sell our products.

We currently depend on Solectron, a third party manufacturer, to manufacture our products. If we should fail to effectively manage our relationship with Solectron, or if Solectron experiences delays, disruptions, capacity constraints, or quality control problems in its manufacturing operations, our ability to ship products to our customers could be delayed and our competitive position and reputation could be harmed. Qualifying a new contract manufacturer and commencing volume production is a lengthy and expensive process. Although we recently qualified an additional third-party contract manufacturer to manufacture some of our products, if we are required or choose to change our principal contract manufacturer, we may lose revenue and damage our customer relationships.

We have entered into a manufacturing agreement with Solectron under which we provide to Solectron a 12-month product forecast and place purchase orders with Solectron 60 calendar days in advance of the scheduled delivery of products to our customers. Although our purchase orders placed with Solectron are cancelable, the terms of the agreement require us to purchase from Solectron all inventory components not returnable or usable by other Solectron customers. Accordingly, if we inaccurately forecast demand for our products, we may be unable to obtain adequate manufacturing capacity from Solectron to meet customers’ delivery requirements or we may accumulate excess inventories.

We are dependent on sole source and limited source suppliers for certain key components including ASICs and power supplies.

We currently purchase several key components used in the manufacture of our products from single or limited sources. We purchase ASICs, microprocessors, certain connectors, certain logic chips, programmable logic devices, and chassis from single sources, and printed circuit boards and power supplies from limited sources. In addition, we license certain software from third parties that is incorporated into the operating system of our products. If we are unable to buy or license these components on a timely basis, we will not be able to deliver our products to our customers in a timely manner. We use a rolling six-month forecast based on anticipated product orders to determine component requirements. If we overestimate component requirements, we may have excess inventory, which would increase our costs. If we underestimate component requirements, we may have inadequate inventory, which could interrupt the manufacturing process and result in lost or deferred revenue. In addition, lead times for components vary significantly and depend on factors such as the specific supplier, contract terms, and demand for a component at a given time. We also may experience shortages of certain

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components from time to time, which also could delay the manufacturing and sales processes.

The prices of our products may decline which would reduce our revenues and gross margins.

The average unit prices of our products may decrease in the future in response to changes in product mix, competitive pricing pressures, increased sales discounts, new product introductions by us or our competitors, or other factors. If we are unable to offset these factors by increasing sales volumes, our total revenues will decline. In addition, to maintain our gross margins we must maintain or increase current shipment volumes and develop and introduce new products and product enhancements, and we must continue to reduce the manufacturing cost of our products. Failure to reduce the manufacturing cost of our products in response to declines in unit selling prices would result in a decline in our gross margins.

Undetected software or hardware errors could increase our costs and reduce our revenues.

Networking products frequently contain undetected software or hardware errors when first introduced or as new versions are released. Our products are becoming increasingly complex and errors may be found from time to time in our new or enhanced products. In addition, our products are combined with products from other vendors. As a result, when problems occur, it may be difficult to identify the source of the problem. These problems may cause us to incur significant warranty and repair costs, divert the attention of engineering personnel from product development efforts and cause significant customer relations problems. Moreover, the occurrence of hardware and software errors, whether caused by another vendor’s SAN products, or ours, could delay or prevent the development of the SAN market.

We may not be able to maintain profitability.

We may not be able to maintain profitability in the future. We expect to incur significant costs and expenses for product development, sales and marketing, customer support, and expansion of corporate infrastructure. We make investment decisions based upon anticipated revenues and margins. If these anticipated revenues and margins do not materialize our future profitability could be adversely affected.

In addition, we have a limited operating history. Therefore, it is difficult to forecast future operating results based on historical results. We plan our operating expenses based in part on future revenue projections. Our ability to accurately forecast quarterly revenue is limited for the reasons discussed above in “Our quarterly revenues and operating results may fluctuate in future periods for a number of reasons, which could adversely affect the trading price of our stock.” Moreover, most of our expenses are fixed in the short-term or incurred in advance of receipt of corresponding revenue. As a result, we may not be able to decrease our spending to offset any unexpected shortfall in revenues. If this occurs, we could incur losses and our operating results may be below our expectations and those of investors and stock market analysts.

If we lose key personnel or are unable to hire additional qualified personnel, we may not be successful.

Our success depends to a significant degree upon the continued contributions of key management, engineering, and sales and marketing personnel, many of whom would be difficult to replace. We do not have key person life insurance on any of our key personnel. We also believe that our success depends to a significant extent on the ability of management to operate effectively, both individually and as a group.

We believe our future success will also depend in large part upon our ability to attract and retain highly skilled managerial, engineering, sales and marketing, finance, and operations personnel. We have experienced difficulty in hiring qualified ASIC, software, system and test, sales and marketing, and customer support personnel. We may not be successful in attracting and retaining these individuals in the future. The loss of the services of any of our key employees, the inability to attract or retain qualified personnel in the future, or delays in hiring required personnel, particularly engineers and sales personnel, could delay the development and introduction of, and negatively impact our ability to sell, our products.

In addition, companies in the computer storage and server industry whose employees accept positions with competitors frequently claim that their competitors have engaged in unfair hiring practices. We may receive such claims in the future as we seek to hire qualified personnel. Such claims, if received, may result in material litigation. We could incur substantial costs in defending against these claims, regardless of their merits.

We may be unable to protect our intellectual property, which would negatively affect our ability to compete.

We rely on a combination of patent, copyright, trademark, and trade secret laws, confidentiality agreements, and other contractual restrictions on disclosure to protect our intellectual property rights. We also enter into confidentiality or license agreements with our employees, consultants, and corporate partners, and control access to and distribution of our technology, software, documentation, and other confidential information. These measures may not preclude competitors from

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independently developing products with functionality or features similar to our products. Despite efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology. Monitoring unauthorized use of our products is difficult and we cannot be certain that the steps we take to prevent unauthorized use of our technology, particularly in foreign countries where the laws may not protect proprietary rights as fully as in the United States, will be effective.

Others may bring infringement claims, which could be time-consuming and expensive to defend, against us.

In recent years, there has been significant litigation in the United States involving patents and other intellectual property rights. On February 14, 2002, a suit captioned McDATA Corp. v. Brocade Communications Systems, Inc. was filed against Brocade in the United States District Court for the District of Colorado. The complaint alleged that the Brocade SilkWorm 3800 Enterprise Fibre Channel Fabric Switch and Brocade SilkWorm 12000 Core Fabric Switch infringe U.S. Patent No. 6,233,236, entitled “Method and Apparatus for Measuring Traffic Within a Switch.” The complaint seeks unspecified compensatory and exemplary damages and to permanently enjoin Brocade from infringing the patent in the future. On March 4, 2002, McDATA filed an amended complaint, in which it additionally alleged that the Brocade SilkWorm 3200 Entry Fabric Switch infringed this patent. In connection with this suit, on March 4, 2002, McDATA filed a motion for a preliminary injunction against Brocade with regard to the patent. We filed an answer and counterclaims on April 8, 2002. A hearing on the motion for preliminary injunction was held on July 15, 2002, and we are awaiting a decision on the matter. We believe that we have meritorious defenses to the claims and intend to defend the action vigorously.

We may be a party to litigation in the future to protect our intellectual property or as a result of an alleged infringement of others’ intellectual property. These claims and any resulting lawsuit, including the McDATA lawsuit, could subject us to significant liability for damages and invalidation of proprietary rights. These lawsuits, regardless of their success, would likely be time-consuming and expensive to resolve and would divert management’s time and attention. Any potential intellectual property litigation, including the McDATA litigation, also could force us to do one or more of the following:

       •    stop selling, incorporating or using products or services that use the challenged intellectual property;

       •    obtain from the owner of the infringed intellectual property a license to the relevant intellectual property, which license may require us to license our intellectual property to such owner, or may not be available on reasonable terms or at all; and

       •    redesign those products or services that use technology that is the subject of an infringement claim.

If we are forced to take any of the foregoing actions, we may be unable to manufacture, use, sell, import and export our products, which would reduce our revenues.

We may engage in future acquisitions that dilute our stockholders and cause us to use cash, incur debt, or assume contingent liabilities.

As part of our strategy, we expect to review opportunities to buy other businesses or technologies that would complement our current products, expand the breadth of our markets or enhance our technical capabilities, or that may otherwise offer growth opportunities. We may buy businesses, products, or technologies in the future. In the event of any future purchases, we could:

       •    issue stock that would dilute our current stockholders’ percentage ownership;

       •    use cash, which may result in a reduction of our liquidity;

       •    incur debt; or

       •    assume liabilities.

These purchases also involve numerous risks, including:

       •    problems combining the purchased operations, technologies, personnel or products;

       •    unanticipated costs;

       •    diversion of management’s attention from our core business;

       •    adverse effects on existing business relationships with suppliers and customers;

       •    risks associated with entering into markets in which we have no, or limited, prior experience; and

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• potential loss of key employees of acquired organizations.

We may not be able to successfully integrate any businesses, products, technologies, or personnel that we might acquire in the future.

Our products must comply with evolving industry standards and government regulations.

Industry standards for SAN products are continuing to emerge, evolve, and achieve acceptance. To remain competitive, we must continue to introduce new products and product enhancements that meet these industry standards. All components of the SAN must interoperate together. Industry standards are in place to specify guidelines for interoperability and communication based on standard specifications. Our products comprise only a part of the entire SAN solution utilized by the end-user, and we depend on the companies that provide other components of the SAN solution, many of whom are significantly larger than us, to support the industry standards as they evolve. The failure of these providers to support these industry standards could adversely affect the market acceptance of our products.

In addition, in the United States, our products comply with various regulations and standards defined by the Federal Communications Commission and Underwriters Laboratories. Internationally, products that we develop will be required to comply with standards established by authorities in various countries. Failure to comply with existing or evolving industry standards or to obtain timely domestic or foreign regulatory approvals or certificates could materially harm our business.

Provisions in our charter documents, customer agreements, Delaware law, and our stockholder rights plan could prevent or delay a change in control of Brocade, which could hinder stockholders’ ability to receive a premium for our stock.

Provisions of our certificate of incorporation and bylaws may discourage, delay or prevent a merger or acquisition that a stockholder may consider favorable. These provisions include:

       •    authorizing the issuance of preferred stock without stockholder approval;

       •    providing for a classified board of directors with staggered, three-year terms;

       •    prohibiting cumulative voting in the election of directors;

       •    limiting the persons who may call special meetings of stockholders;

       •    prohibiting stockholder actions by written consent; and

       •    requiring super-majority voting to effect amendments to the foregoing provisions of our certificate of incorporation and bylaws.

Certain provisions of Delaware law also may discourage, delay, or prevent someone from acquiring or merging with us. Further, our agreements with certain of our customers require that we give prior notice of a change of control and grant certain manufacturing rights following the change of control. In addition, we currently have in place a stockholder rights plan. Any of these things could prevent or delay a change in control of Brocade, which could hinder stockholders’ ability to receive a premium for our stock.

We expect to experience volatility in our stock price, which could negatively affect stockholders’ investments.

The market price of our common stock has experienced significant volatility in the past and may continue to fluctuate significantly in response to the following factors, some of which are beyond our control:

       •    macroeconomic conditions;

       •    actual or anticipated fluctuations in our operating results;

       •    changes in financial estimates by securities analysts;

       •    changes in market valuations of other technology companies;

       •    announcements of financial results by us or other technology companies;

       •    announcements by us, our competitors, customers, or similar businesses of significant technical innovations, contracts, acquisitions, strategic partnerships, joint ventures or capital commitments;

       •    losses of major OEM customers;

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       •    additions or departures of key personnel;

       •    sales by us of common stock or convertible securities; and

       •    incurring additional debt.

In addition, the stock market has experienced extreme volatility that often has been unrelated to the performance of particular companies. These market fluctuations may cause our stock price to fall regardless of how the business performs.

Our business may be harmed by class action litigation due to stock price volatility.

In the past, securities class action litigation often has been brought against a company following periods of volatility in the market price of its securities. We are currently in litigation regarding alleged nondisclosure of improprieties in the distribution of shares in our initial public offering by our underwriters, including undisclosed fees and commissions received by the underwriters and alleged laddering arrangements. We believe that the claims are without merit and intend to defend ourselves vigorously. In addition, in the future we may be the target of other securities litigation. Securities litigation could result in substantial costs and divert management’s attention and resources.

Business interruptions could adversely affect our business.

Our operations are vulnerable to interruption by fire, earthquake, power loss, telecommunications failure, and other events beyond our control. A substantial portion of our facilities, including our corporate headquarters, is located near major earthquake faults. In the event of a major earthquake, we could experience business interruptions, destruction of facilities and loss of life. We neither carry earthquake insurance nor have we set aside funds or reserves to cover such earthquake-related losses. Our facilities located in the State of California have, from time to time, been subject to rolling electrical blackouts resulting from shortages of available electrical power. Should these blackouts continue to occur or increase in severity in the future, they could disrupt the operations of our affected facilities. Although we carry business interruption insurance to mitigate the impact of potential business interruptions, should a business interruption occur, our business could be seriously harmed.

Our private minority equity investments are subject to equity price risk and their value may fluctuate.

From time to time, we make equity investments for the promotion of business and strategic objectives. The market price and valuation of the securities that we hold in these companies may fluctuate due to market conditions and other circumstances over which we have little or no control. To the extent that the fair value of these securities is less than our cost over an extended period of time, our operating results and financial condition could be harmed.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We are exposed to market risk related to changes in interest rates.

Interest Rate Risk

Our exposure to market risk due to changes in the general level of United States interest rates relates primarily to our cash equivalents, and short-term and long-term investment portfolios. Our cash, cash equivalents, and short-term and long-term investments are primarily maintained at four major financial institutions in the United States. As of July 27, 2002, we did not hold any derivative instruments. The primary objective of our investment activities is the preservation of principal while maximizing investment income and minimizing risk. Our short-term investments consist of United States Treasury and Federal agency debt securities with original maturity dates between three months and one year. Due to the nature of our short-term investments, we believe that market risk due to changes in interest rates is not material.

The following table presents the hypothetical changes in fair values of our investments in debt securities issued by United States government agencies as of July 27, 2002 that are sensitive to changes in interest rates (in thousands):


	Valuation of Securities								Valuation of Securities
	Given an Interest Rate						Fair Value		Given an Interest Rate
	Decrease of X Basis Points						As of		Increase of X Basis Points
							July 27,
Issuer	(150BP)		(100BP)		(50BP)		2002		50BP		100BP		150BP

U.S. government agency debt securities	$	708,665	$	701,222	$	693,833	$	686,525	$	679,215	$	671,984	$	664,804

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These instruments are not leveraged and are classified as available-for-sale. The modeling technique used above measures the change in fair values arising from selected potential changes in interest rates. Market changes reflect immediate hypothetical parallel shifts in the yield curve of plus or minus 50 basis points (BP), 100 BP, and 150 BP. A 50 BP move in the Federal Funds Rate has occurred in nine of the last 10 years; a 100 BP move in the Federal Funds Rate has occurred in six of the last 10 years; and a 150 BP move in the Federal Funds Rate has occurred in four of the last 10 years.

The following table (in thousands) presents our cash equivalents and short-term and long-term investments subject to interest rate risk and their related weighted-average interest rates as of July 27, 2002. Carrying value approximates fair value.


				Average
		Amount		Interest Rate

Cash and cash equivalents		$	195,784		1.55	%
Short-term investments			76,723		2.42	%
Long-term investments			609,802		3.91	%

	Total	$	882,309		3.26	%

Our convertible subordinated debt is subject to a fixed interest rate and the notes are based on a fixed conversion ratio into common stock. Therefore, we are not exposed to changes in interest rates related to our long-term debt instruments. The notes are not listed on any securities exchange or included in any automated quotation system; however, the notes are eligible for trading on the PortalSM Market. On July 26, 2002, the average bid and ask price on the Portal Market of our convertible subordinated notes due 2007 was 75.25, resulting in an aggregate fair value of approximately $413.9 million. Our common stock is quoted on the Nasdaq National Market under the symbol “BRCD.” On July 26, 2002, the last reported sale price of our common stock on the Nasdaq National Market was $16.54 per share.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

Item 2. Changes in Securities and Use of Proceeds

On December 21, 2001, and January 10, 2002, we sold, in private placements pursuant to Section 4(2) of the Securities Act of 1933, as amended, $550 million in aggregate principal amount of 2 percent convertible subordinated notes due 2007. The initial purchasers of the notes were Morgan Stanley & Co. Incorporated, Goldman, Sachs & Co., Salomon Smith Barney, Inc. and Merrill Lynch, Pierce Fenner and Smith Incorporated, who purchased the notes from us at a discount of 2.25 percent of the aggregate principal amount. Holders of the notes may, in whole or in part, convert the notes into shares of our common

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stock at a conversion rate of 22.8571 shares per $1,000 principal amount of notes (aggregate of approximately 12.6 million shares) at any time prior to maturity on January 1, 2007. At any time on or after January 5, 2005, we may redeem the notes in whole or in part at the following prices expressed as a percentage of the principal amount:


Redemption Period	Price

Beginning on January 5, 2005 and ending on December 31, 2005		100.80	%
Beginning on January 1, 2006 and ending on December 31, 2006		100.40	%
On January 1, 2007		100.00	%

We are required to pay interest on January 1 and July 1 of each year, beginning July 1, 2002. Debt issuance costs of $12.4 million are being amortized over a five-year term using the straight-line method, which approximates the effective interest rate method. The amortization of these debt issuance costs will accelerate upon early redemption or conversion of the notes. The offer and sale of the notes was exempt from the registration requirements of the Securities Act of 1933, as amended, pursuant to Section 4(2). On March 21, 2002 we filed a registration statement (Reg. No. 333-84698) for the resale of the notes and the shares of common stock issuable upon conversion of the notes. This registration statement was declared effective by the SEC on May 23, 2002. The net proceeds of $537.6 million were invested in United States government agency debt securities and remain available for general corporate purposes, including working capital and capital expenditures.

On February 5, 2002, our Board of Directors adopted a stockholder rights plan. Under the plan, we declared and paid a dividend of one right for each share of common stock held by stockholders of record as of the close of business on February 19, 2002. Each right initially entitles stockholders to purchase a fractional share of our preferred stock at $280 per share. However, the rights are not immediately exercisable and will become exercisable only upon the occurrence of certain events. If a person or group acquires or announces a tender or exchange offer that would result in the acquisition of 15 percent or more of our common stock while the stockholder rights plan remains in place, then, unless the rights are redeemed by us for $0.001 per right, the rights will become exercisable by all rights holders except the acquiring person or group for shares of us or the third party acquirer having a value of twice the right’s then-current exercise price. The stockholder rights plan may have the effect of deterring or delaying a change in control of Brocade.

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits.

The exhibits listed below are required by Item 601 of Regulation S-K. Each management contract or compensatory plan or arrangement required to be filed as an exhibit to this Form 10-Q has been identified.


Exhibit
Number		Description of Document

3.1 (8)		Amended and Restated Certificate of Incorporation.
3.2 (1)		Bylaws of the Registrant.
3.3 (10)		Certificate of Designation of Rights, Preferences and Privileges of Series A Participating Preferred Stock of Brocade Communications Systems, Inc. (included in Exhibit 10.32)
4.1 (1)		Form of Registrant’s Common Stock certificate.
4.2 (9)		Indenture, dated as of December 21, 2001, between Brocade and State Street Bank and Trust Company of California, N.A.
4.3 (9)		Form of Note (included in Exhibit 4.2)
4.4 (9)		Registration Rights Agreement, dated as of December 21, 2001, by and among Brocade and Morgan Stanley & Co. Incorporated, Goldman, Sachs & Co., Salomon Smith Barney Inc. and Merrill Lynch Pierce Fenner and Smith Incorporated.
10.1 (1) *		Form of Indemnification Agreement entered into between Brocade and each of its directors and executive officers.
10.2 (1) *		1995 Equity Incentive Plan and forms of agreements thereunder.
10.3 (1) *		1998 Equity Incentive Plan and forms of agreements thereunder.
10.4 (1) *		1998 Executive Equity Incentive Plan and forms of agreements thereunder.
10.5 (6) *		Amended and Restated 1999 Director Option Plan as of April 17, 2001, and form of agreement thereunder.
10.6 (2) *		1999 Employee Stock Purchase Plan.
10.7 (2) *		1999 Stock Plan and forms of agreements thereunder.
10.8 (2) *		1999 Nonstatutory Stock Option Plan and forms of agreements thereunder.
10.9 (1)		Master Equipment Lease Agreement between Venture Lending & Leasing, Inc. and Brocade, dated September 5, 1996.
10.10 (1) #		Acknowledgement between Wind River Systems, Inc. and Brocade, dated April 22, 1999.

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Exhibit
Number		Description of Document

10.11 (1) *		Letter Agreement with Michael J. Byrd, dated April 5, 1999.
10.12 (3) #		Manufacturing Agreement between Solectron California Corporation and Brocade, dated July 30, 1999.
10.13 (3)		Master Lease Agreement between Spieker Properties and Brocade, dated December 17, 1999.
10.14 (7)		First Amendment to Lease between Spieker Properties and Brocade, dated February 16, 2000.
10.15 (7)		Second Amendment to Lease between Spieker Properties and Brocade, dated August 11, 2000.
10.16 (4)		Credit Agreement between Comerica Bank-California and Brocade, dated January 5, 2000.
10.17 (7)		First Amendment to Credit Agreement between Comerica Bank-California and Brocade, dated March 21, 2000.
10.18 (7)		Second Amendment to Credit Agreement between Comerica Bank-California and Brocade, dated September 20, 2000.
10.19 (7)		Master Lease Agreement between Spieker Properties and Brocade, dated July 26, 2000.
10.20 (7) #		Purchase Agreement between Compaq Computer Corporation and Brocade, dated February 1, 2000.
10.21 (7) #		Purchase Agreement between EMC Corporation and Brocade, dated January 25, 2000.
10.22 (7) *		Promissory Note between David A. Smith and Brocade, dated April 27, 2000.
10.23 (8) #		Extension Agreement between EMC Corporation and Brocade, dated December 18, 2000.
10.24 (8) #		Goods Agreement between International Business Machines Corporation and Brocade, dated April 15, 1999.
10.25 (8)		Amendment #1 to the Goods Agreement between International Business Machines Corporation and Brocade.
10.26 (8) #		Statement of Work #1 between International Business Machines Corporation and Brocade.
10.27 (8) #		Amendment #3 to Statement of Work #1 between International Business Machines Corporation and Brocade.
10.28 (8) #		Amendment #4 to Statement of Work #1 between International Business Machines Corporation and Brocade.
10.29 (8) #		Statement of Work #2 between International Business Machines Corporation and Brocade.
10.30 (5)		Third Amendment to Credit Agreement between Comerica Bank-California and Brocade, dated January 22, 2001.
10.31 (5)		Lease Agreement between MV Golden State San Jose, LLC and Brocade, dated December 1, 2000.
10.32 (11)		Preferred Stock Rights Agreement, dated as of February 7, 2002, between Brocade and Wells Fargo Bank, MN N.A., including the Certificate of Designation, the form of Rights Certificate and the Summary of Rights attached thereto as Exhibits A, B, and C, respectively.
10.33 (10) #		Amendment No. 5 to Statement of Work No. 1 between International Business Machines Corporation and Brocade.
10.34 (10) #		Amendment No. 6 to Statement of Work No. 1 between International Business Machines Corporation and Brocade.
10.35 (10) #		Amendment No. 1 to Statement of Work No. 2 between International Business Machines Corporation and Brocade.
10.36 (10)		Amendment No. 2 to Statement of Work No. 2 between International Business Machines Corporation and Brocade.
10.37 +		Amendment No. 7 to Statement of Work No. 1 between International Business Machines Corporation and Brocade.
10.38 +		OEM Purchase Agreement between Brocade and Hewlett-Packard Company, dated January 28, 2000 (2000 OEM Purchase Agreement).
10.39 +		Amendment to 2000 OEM Purchase Agreement between Brocade and Hewlett-Packard Company, dated April 20, 2001.
10.40		Letter Amendment to 2000 OEM Purchase Agreement between Brocade and Hewlett-Packard Company, dated January 25, 2002.
10.41 +		OEM Purchase Agreement between Brocade and Hewlett-Packard Company, dated April 20, 2001 (2001 OEM Purchase Agreement).
10.42 +		Amendment No. 1 to 2001 OEM Purchase Agreement between Brocade and Hewlett-Packard Company, dated July 1, 2001.
10.43 +		Amendment No. 2 to 2001 OEM Purchase Agreement between Brocade and Hewlett-Packard Company, dated November 6, 2001.
10.44 +		Amendment No. 3 to 2001 OEM Purchase Agreement between Brocade and Hewlett-Packard Company, dated February 1, 2002.
10.45 +		Amendment No. 4 to 2001 OEM Purchase Agreement between Brocade and Hewlett-Packard Company, dated June 5, 2002.
12.1		Statement of Computation of Ratio of Earnings to Fixed Charges
99.1		Certification Pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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*		Indicates management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 14(c) of Form 10-K.




#		Confidential treatment granted as to certain portions, which portions were omitted and filed separately with the Securities and Exchange Commission.




+		Confidential treatment requested as to certain portions, which portions are omitted and filed separately with the Securities and Exchange Commission.




(1)		Incorporated by reference from Brocade’s Registration Statement on Form S-1 (Reg. No. 333-74711), as amended.




(2)		Incorporated by reference from Brocade’s Registration Statement on Form S-8 (Reg. No. 333-95653) filed on January 28, 2000.




(3)		Incorporated by reference from Brocade’s Annual Report on Form 10-K for the fiscal year ended October 31, 1999, as amended.




(4)		Incorporated by reference from Brocade’s Quarterly Report on Form 10-Q for the fiscal quarter ended January 29, 2000.




(5)		Incorporated by reference from Brocade’s Quarterly Report on Form 10-Q for the fiscal quarter ended January 27, 2001.




(6)		Incorporated by reference from Brocade’s Quarterly Report on Form 10-Q for the fiscal quarter ended July 28, 2001.




(7)		Incorporated by reference from Brocade’s Annual Report on Form 10-K for the fiscal year ended October 28, 2000.




(8)		Incorporated by reference from Brocade’s Annual Report on Form 10-K for the fiscal year ended October 27, 2001.




(9)		Incorporated by reference from Brocade’s Quarterly Report on Form 10-Q for the fiscal quarter ended January 26, 2002.




(10)		Incorporated by reference from Brocade’s Quarterly Report on Form 10-Q for the fiscal quarter ended April 27, 2002.




(11)		Incorporated by reference from Brocade’s Registration Statement on Form 8-A filed on February 11, 2002.

(b) Reports on Form 8-K.

We filed one report on Form 8-K during the quarter ended July 27, 2002. Information regarding the items reported on is as follows:

Items 3, 4 and 5 are not applicable and have been omitted.

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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: August 27, 2002 By: /s/ ANTONIO CANOVA

Antonio Canova
Vice President, Finance and
Chief Financial Officer

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EXHIBIT INDEX


Exhibit
Number		Description of Document

3.1 (8)		Amended and Restated Certificate of Incorporation.
3.2 (1)		Bylaws of the Registrant.
3.3 (10)		Certificate of Designation of Rights, Preferences and Privileges of Series A Participating Preferred Stock of Brocade Communications Systems, Inc. (included in Exhibit 10.32)
4.1 (1)		Form of Registrant’s Common Stock certificate.
4.2 (9)		Indenture, dated as of December 21, 2001, between Brocade and State Street Bank and Trust Company of California, N.A.
4.3 (9)		Form of Note (included in Exhibit 4.2)
4.4 (9)		Registration Rights Agreement, dated as of December 21, 2001, by and among Brocade and Morgan Stanley & Co. Incorporated, Goldman, Sachs & Co., Salomon Smith Barney Inc. and Merrill Lynch Pierce Fenner and Smith Incorporated.
10.1 (1) *		Form of Indemnification Agreement entered into between Brocade and each of its directors and executive officers.
10.2 (1) *		1995 Equity Incentive Plan and forms of agreements thereunder.
10.3 (1) *		1998 Equity Incentive Plan and forms of agreements thereunder.
10.4 (1) *		1998 Executive Equity Incentive Plan and forms of agreements thereunder.
10.5 (6) *		Amended and Restated 1999 Director Option Plan as of April 17, 2001, and form of agreement thereunder.
10.6 (2) *		1999 Employee Stock Purchase Plan.
10.7 (2) *		1999 Stock Plan and forms of agreements thereunder.
10.8 (2) *		1999 Nonstatutory Stock Option Plan and forms of agreements thereunder.
10.9 (1)		Master Equipment Lease Agreement between Venture Lending & Leasing, Inc. and Brocade, dated September 5, 1996.
10.10 (1) #		Acknowledgement between Wind River Systems, Inc. and Brocade, dated April 22, 1999.


Exhibit
Number		Description of Document

10.11 (1) *		Letter Agreement with Michael J. Byrd, dated April 5, 1999.
10.12 (3) #		Manufacturing Agreement between Solectron California Corporation and Brocade, dated July 30, 1999.
10.13 (3)		Master Lease Agreement between Spieker Properties and Brocade, dated December 17, 1999.
10.14 (7)		First Amendment to Lease between Spieker Properties and Brocade, dated February 16, 2000.
10.15 (7)		Second Amendment to Lease between Spieker Properties and Brocade, dated August 11, 2000.
10.16 (4)		Credit Agreement between Comerica Bank-California and Brocade, dated January 5, 2000.
10.17 (7)		First Amendment to Credit Agreement between Comerica Bank-California and Brocade, dated March 21, 2000.
10.18 (7)		Second Amendment to Credit Agreement between Comerica Bank-California and Brocade, dated September 20, 2000.
10.19 (7)		Master Lease Agreement between Spieker Properties and Brocade, dated July 26, 2000.
10.20 (7) #		Purchase Agreement between Compaq Computer Corporation and Brocade, dated February 1, 2000.
10.21 (7) #		Purchase Agreement between EMC Corporation and Brocade, dated January 25, 2000.
10.22 (7) *		Promissory Note between David A. Smith and Brocade, dated April 27, 2000.
10.23 (8) #		Extension Agreement between EMC Corporation and Brocade, dated December 18, 2000.
10.24 (8) #		Goods Agreement between International Business Machines Corporation and Brocade, dated April 15, 1999.
10.25 (8)		Amendment #1 to the Goods Agreement between International Business Machines Corporation and Brocade.
10.26 (8) #		Statement of Work #1 between International Business Machines Corporation and Brocade.
10.27 (8) #		Amendment #3 to Statement of Work #1 between International Business Machines Corporation and Brocade.
10.28 (8) #		Amendment #4 to Statement of Work #1 between International Business Machines Corporation and Brocade.
10.29 (8) #		Statement of Work #2 between International Business Machines Corporation and Brocade.
10.30 (5)		Third Amendment to Credit Agreement between Comerica Bank-California and Brocade, dated January 22, 2001.
10.31 (5)		Lease Agreement between MV Golden State San Jose, LLC and Brocade, dated December 1, 2000.
10.32 (11)		Preferred Stock Rights Agreement, dated as of February 7, 2002, between Brocade and Wells Fargo Bank, MN N.A., including the Certificate of Designation, the form of Rights Certificate and the Summary of Rights attached thereto as Exhibits A, B, and C, respectively.
10.33 (10) #		Amendment No. 5 to Statement of Work No. 1 between International Business Machines Corporation and Brocade.
10.34 (10) #		Amendment No. 6 to Statement of Work No. 1 between International Business Machines Corporation and Brocade.
10.35 (10) #		Amendment No. 1 to Statement of Work No. 2 between International Business Machines Corporation and Brocade.
10.36 (10)		Amendment No. 2 to Statement of Work No. 2 between International Business Machines Corporation and Brocade.
10.37 +		Amendment No. 7 to Statement of Work No. 1 between International Business Machines Corporation and Brocade.
10.38 +		OEM Purchase Agreement between Brocade and Hewlett-Packard Company, dated January 28, 2000 (2000 OEM Purchase Agreement).
10.39 +		Amendment to 2000 OEM Purchase Agreement between Brocade and Hewlett-Packard Company, dated April 20, 2001.
10.40		Letter Amendment to 2000 OEM Purchase Agreement between Brocade and Hewlett-Packard Company, dated January 25, 2002.
10.41 +		OEM Purchase Agreement between Brocade and Hewlett-Packard Company, dated April 20, 2001 (2001 OEM Purchase Agreement).
10.42 +		Amendment No. 1 to 2001 OEM Purchase Agreement between Brocade and Hewlett-Packard Company, dated July 1, 2001.
10.43 +		Amendment No. 2 to 2001 OEM Purchase Agreement between Brocade and Hewlett-Packard Company, dated November 6, 2001.
10.44 +		Amendment No. 3 to 2001 OEM Purchase Agreement between Brocade and Hewlett-Packard Company, dated February 1, 2002.
10.45 +		Amendment No. 4 to 2001 OEM Purchase Agreement between Brocade and Hewlett-Packard Company, dated June 5, 2002.
12.1		Statement of Computation of Ratio of Earnings to Fixed Charges
99.1		Certification Pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

*		Indicates management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 14(c) of Form 10-K.




#		Confidential treatment granted as to certain portions, which portions were omitted and filed separately with the Securities and Exchange Commission.




+		Confidential treatment requested as to certain portions, which portions are omitted and filed separately with the Securities and Exchange Commission.




(1)		Incorporated by reference from Brocade’s Registration Statement on Form S-1 (Reg. No. 333-74711), as amended.




(2)		Incorporated by reference from Brocade’s Registration Statement on Form S-8 (Reg. No. 333-95653) filed on January 28, 2000.




(3)		Incorporated by reference from Brocade’s Annual Report on Form 10-K for the fiscal year ended October 31, 1999, as amended.




(4)		Incorporated by reference from Brocade’s Quarterly Report on Form 10-Q for the fiscal quarter ended January 29, 2000.




(5)		Incorporated by reference from Brocade’s Quarterly Report on Form 10-Q for the fiscal quarter ended January 27, 2001.




(6)		Incorporated by reference from Brocade’s Quarterly Report on Form 10-Q for the fiscal quarter ended July 28, 2001.




(7)		Incorporated by reference from Brocade’s Annual Report on Form 10-K for the fiscal year ended October 28, 2000.




(8)		Incorporated by reference from Brocade’s Annual Report on Form 10-K for the fiscal year ended October 27, 2001.




(9)		Incorporated by reference from Brocade’s Quarterly Report on Form 10-Q for the fiscal quarter ended January 26, 2002.




(10)		Incorporated by reference from Brocade’s Quarterly Report on Form 10-Q for the fiscal quarter ended April 27, 2002.




(11)		Incorporated by reference from Brocade’s Registration Statement on Form 8-A filed on February 11, 2002.

Item Reported On

June 18, 2002

Change in Certifying Accountant, as amended on June 25, 2002.

	•		revenues and profits;

	•		customer concentration;

	•		research and development expenses;

	•		sales and marketing expenses;

	•		general and administrative expenses;

	•		provision for income taxes;

	•		realization of deferred tax assets;

	•		liquidity and sufficiency of existing cash, cash equivalents, and short-term investments for near-term requirements;

	•		purchase commitments; and

	•		the effect of recent accounting pronouncements on our financial condition and results of operations.

	•		Revenue recognition and allowances;

	•		Inventory and purchase commitment reserves;

	•		Lease losses; and

	•		Accounting for income taxes.

	•		changes in general economic conditions and specific economic conditions in the computer, storage, and networking industries. In particular, recent economic uncertainty has resulted in a general reduction in information technology (IT) spending. This reduction in IT spending has lead to a decline in our growth rates compared to historical trends;

	•		the timing of customer orders and product implementations, particularly large orders from and product implementations of our OEM customers;

	•		the effects of terrorist activity and armed conflict, such as disruptions or downturns in general economic activity;

	•		announcements, introductions, and transitions of new products by us and our competitors;

	•		the ability of new competitors to enter the market and effectively compete against us;

	•		deferrals of customer orders in anticipation of new products, services, or product enhancements introduced by us or our competitors;

	•		our ability to obtain sufficient supplies of sole or limited sourced components, including application specific integrated circuits (ASICs), microprocessors, certain logic chips, programmable logic devices, chassis, printed circuit boards and power supplies;

	•		increases in prices of components used in the manufacture of our products;

	•		our ability to attain and maintain production volumes and quality levels;

	•		variations in the mix of our products sold and the mix of distribution channels through which they are sold;

	•		litigation; and

	•		legislation or regulatory developments.

	•		supporting multiple languages;

	•		recruiting sales and technical support personnel with the skills to support our products;

	•		increased complexity and costs of managing international operations;

	•		commercial laws and business practices that favor local competition;

	•		multiple, potentially conflicting, and changing governmental laws and regulations, including differing labor and employment laws;

	•		longer sales cycles;

	•		difficulties in collecting accounts receivable;

	•		reduced or limited protections of intellectual property rights; and

	•		political and economic instability.

	•		stop selling, incorporating or using products or services that use the challenged intellectual property;

	•		obtain from the owner of the infringed intellectual property a license to the relevant intellectual property, which license may require us to license our intellectual property to such owner, or may not be available on reasonable terms or at all; and

	•		redesign those products or services that use technology that is the subject of an infringement claim.

	•		issue stock that would dilute our current stockholders’ percentage ownership;

	•		use cash, which may result in a reduction of our liquidity;

	•		incur debt; or

	•		assume liabilities.

	•		problems combining the purchased operations, technologies, personnel or products;

	•		unanticipated costs;

	•		diversion of management’s attention from our core business;

	•		adverse effects on existing business relationships with suppliers and customers;

	•		risks associated with entering into markets in which we have no, or limited, prior experience; and

	•		authorizing the issuance of preferred stock without stockholder approval;

	•		providing for a classified board of directors with staggered, three-year terms;

	•		prohibiting cumulative voting in the election of directors;

	•		limiting the persons who may call special meetings of stockholders;

	•		prohibiting stockholder actions by written consent; and

	•		requiring super-majority voting to effect amendments to the foregoing provisions of our certificate of incorporation and bylaws.

	•		macroeconomic conditions;

	•		actual or anticipated fluctuations in our operating results;

	•		changes in financial estimates by securities analysts;

	•		changes in market valuations of other technology companies;

	•		announcements of financial results by us or other technology companies;

	•		announcements by us, our competitors, customers, or similar businesses of significant technical innovations, contracts, acquisitions, strategic partnerships, joint ventures or capital commitments;

	•		losses of major OEM customers;

	•		additions or departures of key personnel;

	•		sales by us of common stock or convertible securities; and

	•		incurring additional debt.


	Brocade Communications Systems, Inc.

Date: August 27, 2002	By:	/s/ ANTONIO CANOVA

		Antonio Canova Vice President, Finance and Chief Financial Officer