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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NO. 000-31257
MCDATA CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
A DELAWARE CORPORATION 84-1421844
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
310 INTERLOCKEN PARKWAY, BROOMFIELD, COLORADO 80021
TELEPHONE NUMBER (303) 460-9200
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Securities registered pursuant to Section 12(b) of the Act:
NAME OF EACH EXCHANGE ON
TITLE OF EACH CLASS WHICH REGISTERED
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McDATA Class B Common Stock Nasdaq National Market
($0.01 per share, par value)
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Securities registered pursuant to Section 12(g) of the Act:
McDATA Class A Common Stock
($0.01 per share, par value)
Nasdaq National Market
At February 8, 2001, 81,000,000 shares of the registrant's Class A
Common Stock were outstanding and approximately 29,379,954, shares of the
registrant's Class B Common Stock were outstanding. At February 8, 2001, the
aggregate market value of the registrant's Class A Common Stock held by
non-affiliates was approximately $3.0 billion and the aggregate market value of
the registrant's Class B Common Stock held by non-affiliates was approximately
$798.0 million.
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
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Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K [ ]
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MCDATA CORPORATION
FORM 10-K
TABLE OF CONTENTS
DESCRIPTION
ITEM PAGE
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PART I
1. Business........................................................................................... 2
2. Properties......................................................................................... 13
3. Legal Proceedings.................................................................................. 13
4. Submission of Matters to a Vote of Security Holders................................................ 13
PART II
5. Market for Registrant's Common Equity and Related Stockholder Matters.............................. 14
6. Selected Financial Data............................................................................ 14
7. Management's Discussion and Analysis of Financial Condition and Results of Operations.............. 16
7A. Quantitative and Qualitative Disclosures about Market Risk......................................... 27
8. Consolidated Financial Statements and Supplementary Data........................................... 27
9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure............... 27
PART III
10. Directors and Executive Officers of the Registrant................................................. 28
11. Executive Compensation............................................................................. 32
12. Security Ownership of Certain Beneficial Owners and Management..................................... 39
13. Certain Relationships and Related Transactions..................................................... 40
PART IV
14. Financial Statement Schedules, Reports on Form 8-K and Exhibits.................................... 41
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MCDATA CORPORATION
FORM 10-K
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the information presented in this Annual Report on Form 10-K (the
"Annual Report") contains "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995 (the "Reform Act"). Although
McDATA Corporation ("McDATA" or the "Company"), which may also be referred to as
"we," "us" or "our") believes that its expectations are based on reasonable
assumptions within the bounds of its knowledge of its businesses and operations,
there can be no assurance that actual results will not differ materially from
our expectations. Factors that could cause actual results to differ materially
from expectations include:
o changes in our relationship with EMC Corporation ("EMC") and
International Business Machines Corporation ("IBM");
o a loss of any of our key customers, distributors, resellers or our
manufacturers;
o our ability to expand our product offerings and any transition to new
products;
o component quality and availability;
o the development of the storage area network and switch markets;
o any change in business conditions, our sales strategy or product
development plans;
o competition in the storage area network and switch markets (including
competitive pricing pressures);
o our ability to attract and retain highly skilled individuals;
o continued market acceptance of our products, name recognition of our
products and changes in customer buying patterns;
o delays in the development of new products and new technology; and
o one-time events and other important risks and factors disclosed
previously and from time to time in our filings with the U.S.
Securities and Exchange Commission, including the risk factors
discussed in this Annual Report.
You should not construe these cautionary statements as an exhaustive list
or as any admission by us regarding the adequacy of the disclosures made by us.
We cannot always predict or determine after the fact what factors would cause
actual results to differ materially from those indicated by our forward-looking
statements or other statements. In addition, you are urged to consider
statements that include the terms "believes," "belief," "expects," "plans,"
"objectives," "anticipates," "intends," or the like to be uncertain and
forward-looking. All cautionary statements should be read as being applicable to
all forward-looking statements wherever they appear. We do not undertake any
obligation to publicly update or revise any forward-looking statements.
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PART I
ITEM 1. BUSINESS
WHO WE ARE
McDATA Corporation is the leading provider of high availability storage area
network director switching devices that enable enterprises to connect and
centrally manage large numbers of storage and networking devices. We design,
develop, manufacture and sell switching devices that enable enterprise-wide high
performance storage area networks, or SANs. Our products enable business
enterprises to cost-effectively manage growth in storage capacity requirements,
improve the networking performance of their servers and storage systems, and
scale the size and scope of their SAN or other information infrastructure while
allowing them to operate data-intensive applications on the SAN. We sell our
products through industry leading original equipment manufacturers and
resellers, including EMC and IBM, as well as systems integrators. Our goal is to
build on our leadership position in providing director class switching devices
to become the leading provider of a full range of switching solutions for the
entire business enterprise.
RECENT DEVELOPMENTS
On August 9, 2000, we completed an initial public offering of 14,375,000
shares of our Class B common stock resulting in net proceeds of approximately
$377 million. On February 7, 2001, EMC distributed our Class A common stock to
its shareholders on a pro rata basis. As a result of the distribution, EMC no
longer owns our Class A common stock.
INDUSTRY BACKGROUND
SIGNIFICANT GROWTH IN CRITICAL DATA REQUIREMENTS
During the past decade, the volume and value of data created throughout
business enterprises has increased dramatically. As a result, the demand for
data storage capacity has exploded as enterprises increasingly need to access,
process and manipulate data that is critical to their businesses. International
Data Corporation, an independent information technology research firm known as
IDC, estimates that multi-user disk storage grew from more than 7,000 terabytes
in 1993 to more than 185,000 terabytes in 1999, and will reach more than 1.9
million terabytes in 2003. One terabyte is one trillion bytes. This growth in
the volume of data storage has been driven by a number of factors including:
o the rapid expansion of data intensive applications such as e-mail, data
mining and enterprise resource planning;
o the increase in complexity of enterprise computing environments and use
of multiple, incompatible servers and operating systems;
o the need to store redundant copies of enterprise data for business
continuance applications;
o the increase in the number of users accessing the network;
o the growth of e-commerce;
o the rapid growth of web hosting, digital video and other multimedia
applications; and
o the decline in the cost of storage as a result of advances in storage
technology.
In addition, organizations have recognized that rapid and reliable access to
enterprise data 24 hours a day, 7 days a week, 365 days a year (24x7) is
essential to operating a business. The growing dependence on data for
fundamental business processes has greatly increased the number of input-output
data storage transactions required of storage servers and systems. The continued
deployment of client-server and Internet-based
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applications combined with the rapid growth of enterprise data has placed
significant strain on traditional data storage architectures. Furthermore, the
increased use of open-system computing environments, which link multiple
applications, files and databases to networked computers, makes the task of data
management increasingly difficult. As a result, data storage products and
services have accounted for an increasing percentage of business enterprises'
information technology budgets and management resources.
Business enterprises have historically attempted to support and manage data
requirements by directly attaching storage devices to the individual servers on
a local area network. Servers communicate in this direct attached environment
using the small computer systems interface. The small computer systems interface
protocol, however, has several drawbacks, including a short transport distance,
limited performance and capacity of the connection, limited configuration
flexibility, low reliability and inability to support more than a limited number
of connections. According to IDC, advances in technology increased local area
network transmission speeds by 100 times during the 1990's, while storage-to-
server data transmission speeds utilizing the small computer systems input-
output interface have increased less than 20 times during this period. The
result has been significant congestion at the point of communication between
storage systems and servers.
To address the limitations of traditional server-to-storage connections,
Fibre Channel technology and related industry standards evolved in the early
1990's as a means to facilitate high-performance storage connectivity. Fibre
Channel technology supports large data transfers at transmission speeds of one
billion bits, or one gigabit, per second, and is therefore well-suited for data
transfers between storage systems and servers, with guaranteed delivery and
transmission distances of up to 10 kilometers. "Fibre" refers to the optical or
copper cable through which the communication among data storage systems and
workstations, servers and other peripherals flows. Connecting network devices
through Fibre Channel technology enables the efficient and reliable transfer of
data from one network device to another, allowing access from any server to any
storage device on the network. Fibre Channel offers the connectivity, distance
and access benefits of a network, combined with the high performance and
increased capacity of a channel. Since its introduction, Fibre Channel
technology has earned widespread acceptance from industry and independent
testing organizations. IDC forecasts that the market for Fibre Channel host bus
adapters, hubs and switches will exceed $4 billion by 2003.
THE EMERGENCE OF STORAGE AREA NETWORKS (SANS)
The introduction of Fibre Channel technology to facilitate high performance
storage connectivity has facilitated the development of storage area networks.
SANs enable fast, efficient and reliable transfer of data between multiple
storage devices and servers to improve the management of data within a business
enterprise. SANs also permit the traffic from storage applications to be handled
outside of the local area network by decoupling computer storage systems from
servers, which enhances the local area network's performance. SANs advance the
traditional small computer systems interface-based direct attached storage and
server configuration to a network of storage devices that can be accessed by
multiple servers and network users, significantly increasing the performance and
availability of enterprise data storage.
SANs are typically configured in either a switched fabric or arbitrated loop
topology. A Fibre Channel switch or two or more Fibre Channel switches
interconnected in such a way that data can be physically transmitted between any
two ports on any of the switches is referred to as a "fabric." Fabric allows
business enterprises to connect any device on the network to any other device on
the network. Fabric switching configurations enable every device on the network
to have full network bandwidth. Arbitrated loop topology is the simplest SAN
configuration, which interconnects up to approximately 126 devices on the
network. In an arbitrated loop configuration, unlike a fabric configuration, all
devices share available network bandwidth on the network, resulting in decreased
performance as the number of devices in the loop increases.
A SAN incorporates one or more classes of networking devices that connect
the SAN with server and storage devices. These devices are:
o SAN Director -- the backbone device that enables the broadest
connectivity of servers and storage devices in a SAN configuration. It
has the highest bandwidth performance and provides the highest number
of ports per size of device (which is referred to as port density) of
all SAN networking devices. A director class switch, unlike other types
of SAN networking devices, has incorporated throughout its design fault
tolerant technology and redundancy, which allows the switch to continue
performing its function when one or more of its components have failed.
The redundancy is achieved by including spare
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or backup components in the architecture of the switch that, in the
event of failure of functioning switch components, assume the function
of those failed components. SAN directors support a fabric
configuration and provide a highly available platform for a centralized
SAN management system. SAN directors can be used in configurations that
connect large numbers of servers with multi-terabyte storage arrays in
either a fabric or arbitrated loop configuration.
o SAN Switch -- a device that addresses typical department level
requirements to connect a range of server and storage devices with less
capability than a SAN director. SAN switches provide increased
flexibility in building larger SAN configurations and higher
performance than storage hubs. Typical configurations connect a limited
number of servers with multi-hundred gigabyte storage arrays.
o SAN Hub -- a networking device that addresses entry level, or
workgroup, performance requirements. SAN hubs link servers with storage
devices in an arbitrated loop configuration in which all devices on the
network share available bandwidth. Some hubs offer basic device level
management but do not offer fabric or centralized SAN management.
Typical workgroup configurations use a hub to connect one to four
servers with one or two storage array devices.
To date, many Fibre Channel SAN solutions are deployed only within
particular areas of an end-user's organization, as opposed to on an
enterprise-wide basis. This localized deployment requires that each SAN be
administered and managed locally, which hinders access to and sharing of
information on a centrally-managed enterprise-wide basis.
As organizations deploy SANs across the enterprise, they seek to address
the following requirements:
o Provide the ability to scale. Enterprises deploy SANs in order to
provide the ability to scale servers and storage capacity
independently, connecting hundreds of storage devices or subsystems to
multiple servers, allowing users to scale and upgrade the capabilities
of their information infrastructures for demanding enterprise data
needs.
o Ensure interoperability. Enterprises require SAN infrastructure
interoperability, which allows them to integrate SAN products into
existing storage architectures, thereby preserving investments in
legacy equipment.
o Offer on-demand availability to data. Enterprises demand SAN products
that are designed with significant high availability, functionality and
features that address the demand for information infrastructures with
substantial fault tolerance and higher availability of data.
o Promote cost effective use and management of data. Enterprises require
SAN products designed to provide centralized monitoring and control of
storage and networking devices across the enterprise. This enables
enterprise users to minimize downtime by monitoring, detecting,
isolating and troubleshooting faults as they occur, thereby lowering
the total cost of ownership as SAN resources are utilized more
efficiently.
o Optimize performance in an increasingly complex information
infrastructure. Enterprises rely on SANs to provide multiple users
simultaneous access to stored data over independent paths within the
SAN. This permits access to data by more users than is possible with
traditional storage architectures. SAN switches need to provide high
port count and throughput capability. These features enable higher
performance and more cost effective scaling because more devices can be
connected than with clustered switches.
In order to address these requirements, organizations are increasingly
adopting an enterprise-wide strategy to SAN deployment, requiring SAN
infrastructure providers to adopt features and practices that deliver on the
full promise of SANs.
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THE MCDATA SOLUTION
McDATA is the leading provider of high availability SAN backbone director
class switching devices for connecting servers and storage devices. We combine
years of experience in designing, developing and manufacturing high performance
switching technologies with a knowledge of business critical applications,
service and support to solve complex business problems at the core of a business
enterprise's data infrastructure. Our solutions include hardware and software
products, methodologies and education that enable businesses to scale their
operations globally through a comprehensive, manageable, flexible data
infrastructure that is optimized for rapid deployment and responsiveness to
customer needs. We believe that the completeness of our hardware, software and
services necessary to provide interoperable SAN solutions will enable us to be
one of the first companies to offer enterprise-wide SAN solutions to our
customers. The advantages of our solutions include the following:
o Scalability -- Dynamic Growth. Our solutions are designed to enable
users to consolidate, add or reconfigure servers and storage devices
within an enterprise-wide network of data storage and switching
devices. The architecture of our products is designed to permit
businesses to expand their computing and storage resource needs without
causing business interruption or a decline in overall storage system
performance.
o Connectivity -- Interoperability. We are at the forefront of providing
products that interoperate with the majority of popular servers and
storage devices. Our products are designed to protect customers'
investment in their information infrastructure.
o Availability -- Information Anywhere, Anytime. Our SAN solutions are
designed to offer users a reliable and a highly available information
infrastructure. Our products are designed to provide maximum
availability by using fault-tolerant technology incorporating spare, or
"redundant," components in the architecture of the product. These
products offer internally redundant capabilities that enable customers
to run their businesses on a 24x7 basis with 99.999%, or "five-nines,"
operational availability.
o Manageability -- Comprehensive Control for Low Total Cost of Ownership.
Our switching and network management software solutions are designed to
enable customers to manage their entire SAN fabric from a central
point. For example, our Enterprise Fabric Connectivity Manager
Software, or EFCM, is designed to minimize downtime by proactively
monitoring, detecting and isolating fabric conditions that may
interrupt the access to or availability of data. Our products are easy
to install and operate, have powerful, built-in diagnostic capabilities
designed to enhance troubleshooting methods that reduce the time it
takes to restore a fabric to full operation. Product features simplify
the overall administration, service and support of the infrastructure,
permitting more efficient use of personnel and increased data
availability.
o Performance -- High Price to Performance Value. Our products are
designed to offer maximum performance throughout a fabric as the
increase in business applications drives growth in storage and server
connections. We have designed the technology for our products to
provide customers with more data transmission ports per switch. This
results in a lower price per port than similarly sized products with
fewer ports that must be networked together in order to provide the
same number of available ports.
THE MCDATA STRATEGY
We are focused on becoming the leading provider of enterprise-wide SAN
switching solutions. The key elements of our strategy are the following:
o Capitalize on our market leadership. We intend to capitalize on our
market leadership in providing SAN backbone director class switching
devices through continual enhancement of our existing products and the
development of new products. We have experience in developing high
availability switching solutions that are essential to business
computing, including SAN solutions and other information
infrastructures.
o Leverage technology leadership to provide an enterprise-wide solution.
We intend to leverage our leadership in high availability SAN backbone
director class switching devices technology for the data center
environment with our common application specific integrated circuit, or
ASIC, architecture into
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products that are suitable for other segments of the enterprise. To
extend the industry leading technology of our high availability SAN
backbone director class switching devices, we plan to offer a complete
portfolio of managed switching solutions for the entire enterprise. We
will leverage our backbone infrastructure experience to enable
customers to architect, design and deploy large scale, centrally
managed, enterprise-wide SAN solutions with a high level of
infrastructure availability, performance and manageability. The key
attributes of our SAN backbone director class product, our experience
in the enterprise and our expanded hardware and software products will
provide customers with a complete line of solutions for their entire
enterprise SAN infrastructure requirements.
o Extend leadership in interoperability. We intend to lead the
development and establishment of the next generation of standards for
the SAN and information infrastructure industry. We have developed and
operate a state-of-the-art interoperability lab that enables us to
develop products that we certify as interoperable with a wide variety
of SAN and other information infrastructures. Our leadership of the
Open Standards Fabric Initiative and our continued investment in our
interoperability efforts will enable us to define and support standards
for new SAN market opportunities.
o Develop and deploy a fabric management system. We intend to leverage
our Enterprise Fabric Connectivity Manager installed base to deploy a
fabric switching and network management software system that enables
multi-device, multi-vendor software-based management. We will combine
the capabilities of our ASIC technology with our management software
products to achieve high availability through the fabric. We will
invest in our network management software tools to continuously improve
overall fabric performance. Our network management software works in
conjunction with McDATA management software tools and other system and
storage management platforms to provide a proactive, single system view
capability that is required to provide the highest availability of
data.
o Expand multi-channel distribution capability across the enterprise. We
will continue to develop and expand our direct assist sales model with
our existing and future original equipment manufacturer, reseller and
systems integrator customers. With these new relationships, we intend
to develop new markets both in the United States and abroad. In 2000 we
entered into renewed arrangements with EMC and IBM. In February 2001,
we entered into an OEM purchase agreement with Hewlett-Packard Company
regarding the sale of our products. Our future success depends in part
on the successful creation of an open market channel through
distributors and resellers. To this end, we have developed a network of
leading distributor and reseller partners. We intend to enter into
agreements with additional distributors and resellers, both in the
United States and abroad, to increase our geographic coverage and
address new vertical markets.
o Increase brand awareness. We plan to actively build awareness of our
brand to position ourselves as the leading provider of high
performance, highly available SAN and information infrastructure
products for enterprise business applications. We will extend our brand
through our distribution and original equipment manufacturer partners.
We intend to promote our brand through increased investment in a range
of marketing programs, including advertising in industry print
publications, trade show participation, direct marketing and public
relations.
McDATA PRODUCTS
McDATA designs, develops, manufactures and sells switching devices and
related software that enable enterprise-wide high performance SANs. We are a
technology and market leader for SAN backbone director class switching devices.
We are developing a comprehensive suite of SAN switching products that leverage
the core technology advantages of our hardware and software design architecture
to address the connectivity needs of business enterprises. Our products are as
follows:
o ED-5000 Enterprise Fibre Channel Director. The ED-5000 provides high
performance switching for mass storage clusters and client-server
environments. The ED-5000 is a 32-port Fibre Channel switch that offers
high-performance connectivity and high availability as well as shared
network management protocol support in high-end open systems, such as
those using UNIX, Windows2000 and Linux. The product is a high-end
solution for applications requiring gigabit performance and 24x7
operation. The ED-5000 provides full redundancy in a non-blocking,
any-to-any, 32-port, configuration within the switch. The major
sub-assemblies of the ED-5000 are "hot-swappable," meaning that a
replacement may
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be substituted for a defective assembly while the product is performing
its normal functioning, thereby allowing customers to replace and
service the unit without interrupting the basic operation of the
switch.
o ES-3016 Switch. The ES-3016 is a 16-port enterprise fabric switch that
encompasses many of the high-availability features previously found
only in data center offerings. Targeted to the needs of department
environments, the ES-3016 Switch provides an excellent foundation from
which to build a department-sized SAN or to connect a growing
department network into the enterprise-wide SAN.
o ES-1000 Fibre Channel Switch. The ES-1000 is an entry level Fibre
Channel switching device that, when combined with the ED-5000 Director,
enables an end-to-end switching solution for the consolidation of
workgroup and department level storage and servers. High availability
features include redundant fans, power supplies and other components.
The ES-1000 switch is equipped to be managed with our enterprise
software products, providing a centralized, fabric-wide statistical
view of the entire storage network.
o Software Products. Our management software products, branded Enterprise
Fabric Connectivity Manager (or EFCM) and Product Manager (or PM),
which are licensed separately from our other products, leverage our
director class experience to provide open-systems network management
capabilities. This software platform utilizes standards-based and
proprietary technologies to provide user-friendly distributed network
management configuration and control capabilities. Using Java-based and
client-server technologies, we have designed the EFCM and PM management
architecture to be operating system independent.
o OpenReady(TM) Solutions. Our OpenReady(TM) solutions (formerly known as
FabricReady(TM)) are comprised of our director products and other SAN
networking devices and form comprehensive enterprise storage
connectivity solutions. These OpenReady offerings are preconfigured and
qualified with hardware, software and services necessary to provide
interoperable SAN solutions. OpenReady offerings provide customers and
channel partners with an integrated, application based SAN solution for
solving business critical problems across the enterprise. It offers
customers a predictable and reliable way to deploy SAN solutions into
their production environments while substantially minimizing overall
risks and the costs associated with new technologies. OpenReady
services combine our long standing commitment and investments in
interoperability with the capability to provide complete end-to-end SAN
infrastructure solutions based on the integration and rigorous testing
of applications. We currently provide OpenReady solutions for NT and
Sun consolidation and local area network-free back-up applications.
o Protocol routers and host bus adapters represent significant enabling
technologies that provide an essential part of a total OpenReady
solution. Host bus adapters are required to provide the Fibre Channel
interface on the server platforms. We offer the majority of popular
interfaces from leading vendors such as Emulex Corporation, JNI and
QLogic as part of a qualified packaged solution to end-user and systems
integrator channels.
o The small computer system interface to Fibre Channel router devices are
another key element in our OpenReady solutions portfolio. The EB-1200
is sold as part of a bundled solution to end-user and systems
integrator channels. The EB-1200 provides two 16-bit small computer
system interface ports and one 1.062 gigabit Fibre Channel port
connection for customers requiring Fibre Channel connectivity to
existing small computer system interface devices. Additionally, we are
working with router companies, including Crossroads Systems, Inc.,
Chaparral Network Storage, Inc. and Pathlight to integrate and qualify
third party software to enable serverless back-up.
o FICON(TM) Bridge. We designed and manufacture the FICON(TM) feature
card within IBM's 9032 Model 5 Director that functions as a bridge
between FICON and ESCON protocols. FICON is designed to provide Fibre
Channel connectivity to mainframe storage devices. FICON takes
advantage of the American National Standards Institute Fibre Channel
standard transport with the introduction of IBM's performance-enhancing
S/390 layer. The FICON Bridge card helps provide customers with
investment protection for currently installed ESCON control units, such
as disk storage and tape control units.
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TECHNOLOGY
We have developed ASIC technology that serves as the foundation for the
development of a complete family of SAN products. Our ASICs provide building
blocks at the circuit level for implementing Fibre Channel switches. These ASICs
combine a number of Fibre Channel functions in a single chip that substantially
reduces the number of components needed in our Fibre Channel switches. Our years
of design expertise in Fibre Channel technology and large scale switching
solutions allows us to deploy high availability SAN fabrics.
These ASICs are used in our next generation switch products, and have been
shipped and are in production. The implementation of our new switch architecture
is based on a common hardware and software design. The architecture enables
product designs that span from the high-end Data Center to low-end workgroup
storage computing environments with gigabit performance and 24x7 operation.
Our technology/architecture allows us to offer director class switches with
a higher number of data transmission ports per switch than similarly sized
products and department and workgroup switches with a higher port density per
unit of rack space than similarly sized products. Switches with fewer ports must
be networked together to provide the same number of available ports. Our
comparatively high number of available ports per switch allows our switches to
offer higher performance than switches that must be networked together because
none of our switch ports needs to be diverted to network to other switches,
which degrades overall performance of the switching solution. Our next
generation switch enables a fabric to scale up to 8000 ports. In addition to the
support of high data throughput speed of the switch, our architecture supports
very low latency, generally indicating a two microsecond delay regardless of the
number of the ports of the switch. The architecture supports transmission of up
to 2.125 gigabits per second and in the future will support transmission of up
to 10 gigabits per second.
We expect that our next generation of switch products will include the
following characteristics:
o system status monitoring;
o ability to automatically replace faulty internal component parts
without interruption of data transmission through the switch;
o non-disruptive serviceability;
o component failure detection and reporting;
o user friendly operation;
o automated call home facilities;
o network management that supports both in-band and out-of-band systems;
and
o management via our EFCM software management products.
Our software product architecture is based on a McDATA-developed embedded
real-time operating system which provides state-of-the-art characteristics.
Coupled with hardware architecture, the software design delivers Fibre Channel
services for the entire family of SAN products, using a single, common code
image.
CUSTOMERS
Two major customers in 2000, EMC and IBM, are significant providers of
enterprise storage systems. In 2000, EMC accounted for approximately 76%, and
IBM accounted for approximately 14% of our total revenue, respectively. In
addition to our original equipment manufacturers, we also have relationships
with resellers and systems integrators, including Hitachi Data Systems, MSI,
Inc., Netmarks Inc., and Salem Computer Group. These and our other systems
integrator partners will continue to be a strategic focus for us as we continue
to expand our business and deploy our OpenReady solutions.
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In February 2001, we announced that we entered into a distribution agreement
with Avnet, Inc. for the sale of our products. In February 2001, we entered into
an OEM purchase agreement with Hewlett-Packard Company regarding the sale of our
products.
BACKLOG
We manufacture our products on the basis of our forecast of near-term
demand and maintain inventory in advance of receipt of firm orders from
customers. Products are configured to customer specifications and are generally
shipped by us shortly after receipt of the order. For this reason, our backlog
at any particular time is not meaningful because it is not necessarily
indicative of future sales levels.
SALES AND MARKETING
Our sales and marketing approach is focused on an indirect sales model
executed through original equipment manufacturers, such as EMC, resellers, such
as IBM, and systems integrator customers. We support these distribution
customers in a direct assist model with our field sales and service personnel.
In addition, our professional and educational services teams are recognized
within the industry as technical experts with proven deployment methodologies
and a comprehensive Fibre Channel education curricula.
Our original equipment manufacturer and reseller customers incorporate our
switches into their end-user products that are installed and field-serviced by
the original equipment manufacturer technical support organizations. IBM Global
Services provides our first level of field support for all products that are
sold directly or through our indirect channel partners. The sales cycle used in
selling to an original equipment manufacturer customer can vary significantly in
terms of its length and complexity. Often, it involves the use of our testing
labs or those of our strategic partners, where substantial testing takes place.
It also often involves the submission of proposal documentation and
presentations to the customer. This sales process generally involves the
combined efforts of our sales and marketing, engineering and management teams
and can take from several weeks to more than one year.
In May of 2000, we entered into a five-year agreement to sell our products
to EMC under which we will manufacture our products for EMC's internal use or
for delivery directly to EMC's end user customers. Under the terms of this
agreement, we are obligated to provide varying degrees of support for these
products to EMC's end user customers.
We also entered into a Resale Agreement with IBM in February of 2000 that
governs IBM's purchases of our products and appoints IBM as a non-exclusive
authorized reselling agent of ours to resell our products and services to IBM
reseller and end-user customers. This agreement also grants to IBM the
non-exclusive, non-transferable worldwide right and license to use and to
distribute software in connection with these products. The agreement does not
transfer any intellectual property and does not commit IBM to purchase any
products from us. The agreement has an initial term of five years. Either IBM or
we may terminate the agreement in the event of a material breach without cure
within 30 days or in the event of any insolvency.
We also intend to continue to sell our products to a limited number of
systems integrators who combine our products with products of other vendors to
provide complete SAN solutions. Systems integrators typically provide
installation, service and technical support to their end-user customers.
As of December 31, 2000, our sales organization was located in several major
cities in North America and one in each of Germany, the United Kingdom and
Japan. Our sales and marketing organization consisted of 172 people, including
field sales personnel, systems engineers, channel sales professionals,
professional and educational services providers and sales operations
professionals.
CUSTOMER SERVICE AND SUPPORT
We believe that superior customer service and support are critical to
maintain successful long-term relationships with our customers and enhance our
leadership position in the SAN market. This service and support will also
contribute to building our brand, as our products are introduced and integrated
with products of other manufacturers and resellers.
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We provide technical support to our original equipment manufacturer
customers and systems integrators, enabling them to provide technical support to
their end users. We do this by providing training and documentation together
with 24x7 support. When a customer issue originates from our call center, we
remain in contact with the customer until the issue is resolved. Our customer
support includes a comprehensive array of full-service support elements,
including: 24x7 call home monitoring; spare parts depots; direct support through
IBM Global Services; and field engineers, manufacturer-based technical support
specialists and regional support specialists available to handle on-site
requirements.
MANUFACTURING
Our manufacturing facility, located in Louisville, Colorado, is
approximately 91,000 square feet. We perform final assembly and testing,
finished goods distribution, customer service repair and logistics in this
facility. We currently anticipate that this facility will be adequate for us to
meet demand for our products for the foreseeable future. In addition, we have
available additional manufacturing floor space, multiple shifts and outsourcing
options to provide significantly higher volume manufacturing capability if
required. As of December 31, 2000, we employed 132 people in manufacturing and
customer service.
We subcontract a majority of our production activities, including the
manufacture, assembly and testing of a substantial part of our products. We
currently utilize SCI Systems Inc. as the primary contract manufacturer for
printed circuit board assembly and testing and box build. SCI has multiple sites
in multiple countries that can be used for disaster recovery or to significantly
expand their manufacturing capacity. We currently depend upon LSI Logic for the
production of our ASICs.
We depend on SCI, LSI Logic and our other subcontractors to deliver
high-quality products in a timely manner, but we cannot assure you that they
will be able to do so. We currently do not have a long-term supply contract with
any of our subcontractors.
We design test processes for all of our products to identify the causes and
measure the frequency of product failures. We and our major component suppliers
use these test processes in connection with the manufacture of our products. Our
tests include environmental stress screening, which seeks to ensure product
performance and reduce premature product failures, and other test processes,
which are designed to identify product defects prior to shipping. In addition to
qualifying our products, we also qualify our component suppliers based on their
ability to manufacture components within defined specifications.
Recently, we have engaged Celestica Corporation, on a purchase order basis
only, as the manufacturer of our SAN switches.
RESEARCH AND DEVELOPMENT
The SAN and other information infrastructure markets are characterized by
rapid technological change, including changes in customer requirements, frequent
new product introductions and enhancements, and evolving industry standards. We
believe that continued research and development efforts are an important factor
in our ability to maintain technological competitiveness. As of December 31,
2000, we employed 197 individuals in engineering and development efforts that
are focused on the development, enhancement and testing of switches, ASICs and
the associated software offerings that address the needs of the SAN market. In
addition, we currently cooperate with leading software companies, including
Microsoft Corporation and Tivoli, a division of IBM, to develop and test the
interoperability of our products with their software to provide both our and
their end users with more fully tested, interoperable SAN solutions. We do not
believe that our relationships with these companies are material to our
business, financial condition or results of operation. We intend to dedicate
resources to the continued development of the Fibre Channel standards and to
achieve interoperability with the Fibre Channel devices of other companies.
Finally, our Systems Integration Lab is the industry's foremost Fibre Channel
switched fabric interoperability lab and is staffed by Fibre Channel and open
systems experts.
Our research and development expenditures were approximately $38 million in
2000, approximately $24 million in 1999 and approximately $18 million in 1998.
Expenses associated with our Systems Integration Lab are incorporated in our
marketing expenditures and are not included in our research and development
costs.
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COMPETITION
Although the competitive environment in the SAN market has not yet developed
fully, we anticipate that the current and potential market for our products will
be highly competitive, continually evolving and subject to rapid technological
change. New SAN products are being introduced by various server and storage
providers and existing products will be continually enhanced. Our primary
competitor in the Fibre Channel switch market is Brocade Communications Inc.
Other companies are also providing Fibre Channel switches and other products to
the SAN market, including Gadzoox Networks, Inc., Vixel Corporation, Qlogic
Corporation and InRange Technologies Corporation. In addition, a number of
companies, including Emulex Corporation, Interphase Corporation, JNI
Corporation, and Crossroads Systems, Inc. are developing, or have developed,
Fibre Channel products other than switches, including adapters and hubs. We
anticipate that these and other manufacturers of network equipment may introduce
new Fibre Channel switch products in the near future. In the future, we may also
compete with networking companies or other companies in related or other
industries for which future direct participation in the market for switching
devices may become strategic. In addition, although EMC has agreed for a period
of two years after the completion of our August 2000 initial public offering not
to develop or manufacture products that compete with our products, upon the
expiration of that two-year period, EMC may directly compete with us. Moreover,
we have granted EMC a license under our patents to make, use and sell any
products that EMC is selling or distributing up to the date of the offering,
including products that compete with ours.
It is also possible that our existing or potential customers could develop
and introduce products competitive with our product offerings. We believe the
competitive factors in this market segment include: product performance and
features; product reliability and interoperability; price; ability to meet
delivery schedules; customer service and technical support; and systems
management.
Some of our current and potential competitors have established operating
histories, greater resources and name recognition, and a larger installed base
of customers than we have. As a result, these competitors may have greater
credibility with our existing and potential customers. They also may be able to
adopt more aggressive pricing policies and devote greater resources to the
development, promotion and sale of their products than we can to ours. This may
allow them to respond more quickly than we can to new or emerging technologies
and changes in customer requirements. In addition, some of our current and
potential customers have already established supplier or joint development
relationships to discourage these customers from purchasing additional products
from us or persuade them to replace our products with their products. 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. We may not have the financial resources,
technical expertise or marketing, manufacturing, distribution and support
capabilities to compete successfully in the future. Additionally, we may not be
able to compete successfully against current or future competitors and
competitive pressures may materially harm our business.
INTELLECTUAL PROPERTY
Our success depends on our ability to protect our proprietary technology and
to operate without infringing the proprietary rights of third parties. We rely
on a combination of patents, copyrights, trademarks and trade secrets, as well
as confidentiality agreements and other contractual restrictions with employees
and third parties, to establish and protect our proprietary rights. We cannot be
certain that the steps we take to protect our intellectual property will
adequately protect our proprietary rights, that others will not copy or
otherwise obtain and use our products and technology without authorization,
independently develop or otherwise acquire equivalent or superior technology or
that we can maintain such technology as trade secrets. In addition, the laws of
some of the countries in which our products are or may be sold may not protect
our proprietary rights as fully as the laws of the United States.
As of December 31, 2000, we held 21 U.S. patents and had 17 additional U.S.
patents pending. We are seeking additional patent protection for certain
additional aspects of our technology. However, it is possible that patents may
not be issued for these applications. It is possible that litigation may be
necessary in the future to enforce our intellectual property rights, to protect
our trade secrets or to determine the validity and scope of the proprietary
rights of others. Litigation could result in substantial costs and diversion of
our resources and could materially harm our business. From time to time, we have
received, and may receive in the future, notice of claims of infringement of
other parties' proprietary rights. Infringement or other claims could be
asserted or
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prosecuted against us in the future, and it is possible that past or future
assertions or prosecutions could harm our business. Any such claims, with or
without merit, could be time-consuming, result in costly litigation and
diversion of technical and management personnel, cause delays in the development
and release of our products, or require us to develop non-infringing technology
or enter into royalty or licensing arrangements. Such royalty arrangements, if
required, may not be available on terms acceptable to us, or at all. For these
reasons, infringement claims could materially harm our business.
Under the terms of the Master Confidential Disclosure and License Agreement
between EMC and us, EMC has granted us a license under existing EMC patents. If
we are acquired, our acquirer will retain this license as long as our acquirer
grants to EMC a license under all of the acquirer's patents for all products
licensed under the agreement under the same terms as the license we have granted
to EMC under the agreement. The potential loss of the license from EMC after an
acquisition of us by a third party may make an acquisition of us by a third
party unlikely.
EMC and IBM entered into a cross-license agreement on March 19, 1999, and
amended that agreement on May 12, 2000, under which each party, on behalf of
itself and its subsidiaries, granted the other a license under patents issued or
issuing on applications entitled to an effective filing date through December
31, 2005. Under the terms of this cross-license agreement, patents held by us
were licensed to IBM and patents held by IBM were sublicensed to us by EMC. Each
party released the other and its subsidiaries from claims of patent infringement
committed prior to the date of the cross-license. Effective as of the February
7, 2001 distribution of our Class A common stock by EMC, IBM, pursuant to the
cross-license agreement, retained the benefit of a license to our patents with
an effective filing date through the date of such distribution, but the
sublicense to us under IBM patents terminated upon such date in accordance with
the terms of the cross license agreement. We believe that the termination of the
sublicense does not materially affect our business. We believe that the
cross-license agreement further provides that if either party transfers a
product line after the effective date of the cross license agreement, either as
part of or separate from a disposition of a subsidiary to any third party, and
if such transfer includes patents and tangible assets having a net value of at
least $100,000,000, relating to the product line being transferred with the
subsidiary, then after written request by the transferring party and, if
applicable, by such third party, to the other party within 60 days following the
transfer, the other party will grant to the ex-subsidiary, in the case of a
disposition of a subsidiary, a royalty-free license under its licensed patents,
subject to the following limitations: (1) the field would be limited to only the
particular product line being transferred, including subsequent versions under
development by the transferring party at the time of the disposition, (2) the
license would only cover, in any twelve month period, a volume of licensed
products generating revenue equal to 110% of product revenue for the preceding
twelve month period, (3) the ex-subsidiary would be required to grant IBM a
royalty-free cross-license under its patents and (4) the license to the
ex-subsidiary would terminate should the license from IBM to EMC terminate.
Although we believe that the foregoing provision applies after the distribution
of our Class A common stock by EMC, there can be no assurance that IBM will
agree with our interpretation. In addition, even if IBM accepts our
interpretation, the cross-license agreement does not specify the consequences if
a transferred subsidiary exceeds the limit of 10% annual increases in product
revenue.
EMPLOYEES
At December 31, 2000, we had 606 full-time employees. Of these employees,
197 were engaged in engineering and development, 172 in sales and marketing, 132
in manufacturing and customer support, and 105 in finance and administration.
None of our employees are represented by a labor union. We have not experienced
any work stoppages and consider our relations with our employees to be good. We
anticipate that we will need to hire additional employees to meet the expected
growth of our business.
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ITEM 2. PROPERTIES
Our principal facilities for administration, sales, marketing, customer
support, manufacturing, research and development are located in two facilities
in the greater Broomfield, Colorado area. We currently occupy 122,000 square
feet of office space under a lease that expires in December 2003 and
approximately 91,000 square feet of manufacturing space under a lease that
expires in February 2003. We also occupy 12,895 square feet of office space in
Toronto, Ontario under a lease that expires in June 2003. We plan to occupy an
additional 96,000 square feet of office space in Broomfield, Colorado in the
first and second quarters of 2001 under a lease that expires in mid-February,
2006.
Our manufacturing and headquarters operations are currently in separate
locations in the greater Broomfield, Colorado area. After reviewing our
anticipated facility growth requirements over the next several years, and in
light of lease terms on our currently occupied space, we have approved the
development of the first phase of a centrally located corporate campus for the
purpose of consolidating our operations. Accordingly, on February 9, 2001, we
entered into a lease and associated agreements with Deutsche Bank AG, New York
Branch ("Deutsche Bank") for the lease of a 167,000 (approx.) square foot
multi-story office and engineering building to be constructed on a 109 acre
parcel of land located in Broomfield, Colorado. Construction of the building is
anticipated to commence in the first half of 2001 and is scheduled to be
completed no later than February 2003. The initial term of the lease is for 78
months and the lease rate is based on the one month LIBOR rate plus between 20
and 45 basis points.
We may, at our option, purchase the facility during or at the end of the
term of the lease at approximately the amount expended by Deutsche Bank to
acquire the land and construct the building (approximately $60 million). If we
do not renew the lease, exercise the purchase option by the end of the lease or
arrange for the sale of the property to a third party for an equivalent amount,
we have guaranteed a residual value of the facility as a percentage of the total
original cost (approximately 85% of such costs).
As part of the above transaction, we have agreed to restrict up to $60
million (plus 5 percent) of our investment securities as collateral for
specified obligations of ours under the lease. These investment securities are
restricted as to withdrawal and are managed by a third party subject to certain
limitations. In addition, the lease agreement requires that the we maintain
compliance with certain affirmative and negative covenants, representations and
warranties, including certain defined financial covenants.
ITEM 3. LEGAL PROCEEDINGS
From time to time, we become involved in various lawsuits and legal
proceedings that arise in the normal course of business. Litigation is subject
to inherent uncertainties and an adverse result in a matter that may arise from
time to time may harm our business, financial condition or results of operation.
In the opinion of management, the ultimate disposition of any of the claims will
not have a material adverse effect on our consolidated results of operations,
financial position or cash flow.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No shareholder meeting was held in the fourth quarter of 2000. We intend to
hold our annual meeting of shareholders in August of 2001. Accordingly,
shareholder proposals for inclusion in the annual meeting proxy statement should
be sent to our Secretary at 310 Interlocken Parkway, Broomfield, Colorado 80021
and must be received by April 2, 2001.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our Class B common stock has been quoted on the Nasdaq National Market
under the symbol "MCDT" since our initial public offering on August 9, 2000. Our
Class A common stock has been quoted on the Nasdaq National Market under the
symbol "MCDTA" since EMC's distribution of that stock on February 7, 2001. Prior
to those respective times there was no public market for either class of stock.
We currently expect to retain future earnings, if any, for use in the
operation and expansion of our business and we have not declared or paid any
cash dividends on our capital stock since inception, and do not anticipate
paying any cash dividends in the foreseeable future. At December 31, 2000, there
was one stockholder of record of our Class A common stock and approximately 380
stockholders of record of our Class B common stock.
The following table sets forth the range of high and low closing prices per
share of our Class B common stock reported on the Nasdaq National Market during
2000 and 2001:
2000 High Low
---- ---- ---
First Quarter N/A N/A
Second Quarter N/A N/A
Third Quarter $133.00 $78.25
Fourth Quarter $128.94 $43.00
2001
----
First Quarter $ 69.25 $22.625
(through Feb. 22, 2001)
Sale of Unregistered Securities
From January 1, 2000 to August 8, 2000, we granted stock options to
purchase 3,525,425 shares of our Class B common stock at exercise prices ranging
from $11.54 to $28.00 per share to employees and directors pursuant to our 1997
Stock Option Plan. On August 8, 2000, we filed a Form S-8 Registration Statement
that registered our Class B common stock relating to options granted on and
after August 8, 2000. From January 1, 2000 to August 8, 2000, we issued and sold
an aggregate of 1,902,852 shares of our Class B common stock to employees and
directors for aggregate consideration of $2,102,998 pursuant to exercise of
options granted under our 1997 Stock Option Plan. The issuance of options and
the issuance of Class B common stock upon the exercise of these options was
exempt from registration under the Securities Act of 1933 either pursuant to
Rule 701 under the Securities Act of 1933, as a transaction pursuant to a
compensatory benefit plan, or pursuant to this Section 4(2) of the Securities
Act of 1933, as a transaction by an issuer not involving a public offering. All
of the foregoing securities are deemed restricted securities for purposes of the
Securities Act of 1933.
ITEM 6. SELECTED FINANCIAL DATA
You should read the following selected consolidated financial data in
conjunction with our consolidated financial statements and related notes and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," and other financial information appearing elsewhere in this
document. The consolidated statements of operations data set forth below with
respect to the years ended December 31, 2000, 1999 and 1998, and the
consolidated balance sheets data as of December 31, 2000 and 1999 are derived
from our audited financial statements appearing in Item 14. The consolidated
statement of operations data set forth below with respect to the year ended
December 31, 1997, and the consolidated balance sheet data as of December 31,
1998 was derived from audited financial statements not included herein. The
consolidated statement of operations data set forth below with respect to the
year ended December 31, 1996 and the consolidated balance sheet data at December
31, 1997 and 1996 are derived from unaudited consolidated financial statements
not included herein, which, in the opinion of our management, reflect all normal
recurring adjustments that we consider necessary for a fair presentation of such
information in accordance with generally accepted accounting principles.
Historical results are not necessarily indicative of the results of any future
period.
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YEARS ENDED DECEMBER 31,
-----------------------------------------------------------------------
2000 1999 1998 1997(1) 1996(1)
---------- ---------- ---------- ---------- ----------
(in thousands, except per share data)
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Total revenue.................................. $ 248,686 $ 95,263 $ 36,548 $ 33,023 $ 32,200
Total cost of revenue.......................... 119,543 50,280 13,105 11,270 8,004
---------- ---------- ---------- ---------- ----------
Gross profit................................... 129,143 44,983 23,443 21,753 24,196
Operating expenses............................. 85,724 45,913 32,008 22,983 15,265
---------- ---------- ---------- ---------- ----------
Income (loss) from operations.................. 43,419 (930) (8,565) (1,230) 8,931
---------- ---------- ---------- ---------- ----------
Net income (loss).............................. $ 30,764 $ (1,616) $ (5,118) $ (574) $ 5,770
========== ========== ========== ========== ==========
Basic net income (loss) per share.............. $ 0.31 $ (0.02) $ (0.06) $ (0.01) $ 0.06
========== ========== ========== ========== ==========
Shares used in computing basic
net income (loss) per share(2)............... 99,989 91,638 91,000 91,000 91,000
Diluted net income (loss) per share............ $ 0.28 $ (0.02) $ (0.06) $ (0.01) $ 0.06
========== ========== ========== ========== ==========
Shares used in computing diluted
net income (loss) per share(2)............... 107,953 91,638 91,000 91,000 91,000
DECEMBER 31,
--------------------------------------------------------------
2000 1999 1998 1997 1996
---------- ---------- ---------- ---------- ----------
(in thousands)
CONSOLIDATED BALANCE SHEET DATA:
Total assets......................... $ 511,369 $ 48,424 $ 39,383 $ 39,463 $ 26,593
Working capital...................... 404,359 15,813 14,028 24,666 13,092
Debt payable to parent............... -- 1,900 1,900 1,900 --
Long-term portion of
Capital lease obligations.......... 1,624 1,175 1,262 335 388
Total stockholders equity............ 453,813 29,624 25,999 31,115 16,431
- ----------
(1) In October 1997, EMC reorganized McDATA to separate our Fibre Channel
devices business from EMC. As part of this reorganization, we became a
company focused on designing, developing, manufacturing and selling Fibre
Channel switching devices. As a result, the historical financial information
for the three years ended December 31, 1997 has been adjusted to reflect the
impact of the reorganization as if it occurred at the beginning of 1995.
(2) Per share computations for 1996 and 1997 have been calculated using the
actual number of shares issued on October 1, 1997 because the capital
structure for prior periods was not indicative of the current structure.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
You should read the following discussion and analysis in conjunction with
"Risk Factors" and our consolidated financial statements and the related notes
appearing elsewhere in this document.
RESULTS OF OPERATIONS
The following table sets forth certain financial data for the periods
indicated as a percentage of total revenues.
YEARS ENDED DECEMBER 31
2000 1999 1998
------ ------ ------
Revenue:
Product revenue 23.5% 30.9% 14.3%
Product revenue - Parent 69.5 50.5 15.4
Service revenue - Parent 7.0 18.6 70.3
------ ------ ------
Total revenue 100.0 100.0 100.0
Cost of revenue:
Cost of product revenue 12.7 22.4 10.4
Cost of product revenue - Parent 33.1 24.4 8.8
Cost of service revenue - Parent 2.3 6.0 16.7
------ ------ ------
Total cost of revenue 48.1 52.8 35.9
------ ------ ------
Gross profit 51.9 47.2 64.1
------ ------ ------
Operating Expenses:
Research and development 15.2 25.2 50.0
Selling and marketing 13.6 16.6 28.2
General and administrative 3.0 4.1 9.3
Amortization of deferred
Compensation 2.6 2.3 --
------ ------ ------
Total operating expenses 34.4 48.2 87.5
------ ------ ------
Income (loss) from operations 17.5 (1.0) (23.4)
Interest income (expense), net 3.3 (0.9) 0.8
------ ------ ------
Income (loss) before income taxes 20.8 (1.9) (22.6)
Income tax expense (benefit) 8.4 (0.2) (8.6)
------ ------ ------
Net income (loss) 12.4% (1.7)% (14.0)%
====== ====== ======
Years ended December 31, 2000 and 1999
REVENUES
Total revenue increased by approximately 161% to $248.7 million for 2000
from $95.3 million for 1999. This increase was primarily due to an increase in
product revenue, including sales of McDATA's ED-5000 Enterprise Director, which
is sold primarily to EMC and of the FICON Bridge card sold exclusively to IBM,
to $231.4 million in 2000 from $77.6 million in 1999. Service revenue from EMC
decreased to $17.3 million in 2000 from $17.7 million in 1999, primarily because
revenue under the Company's ESCON service agreement decreased by approximately
16.4% to $14.5 million in 2000 from $17.3 million in 1999. We anticipate that
service fee revenue from EMC under the ESCON service agreement will continue to
decrease in the future. As ESCON revenue continues to decrease we anticipate
that it will represent an increasingly smaller percentage of total revenue.
GROSS PROFIT
Gross profit increased by approximately 187% to $129.1 million in 2000 from
$45.0 million in 1999. Gross profit percentages increased to 51.9% in 2000 from
47.2% in 1999. Gross profit percentages on product sales were approximately 51%
in 2000 compared to approximately 43% in the prior year, reflecting a much
higher proportion of sales of our ED-5000 product in the current year, which has
earned significantly higher profits than the mix of products sold in the prior
year. We expect our gross profit percentage from product sales to EMC to decline
in future periods as a result of recently negotiated pricing on future products
partially offset by expected declines in unit manufacturing costs.
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OPERATING EXPENSES
Research and Development. Research and development expenses increased by
approximately 58% to $37.8 million for 2000 from $24.0 million for 1999. The
increase was due primarily to increased staffing levels, as the number of
engineering employees increased to 197 at December 31, 2000 from 154 at December
31, 1999, and to expenditures for prototype materials, design consulting
services and other materials and services.
Selling and Marketing Expenses. Selling and marketing expenses increased by
approximately 115% to $34.0 million for 2000 from $15.8 million for 1999. This
increase was due primarily to increased staffing levels, as the number of
selling and marketing employees increased to 172 at December 31, 2000 from 79 at
December 31, 1999, increases in costs associated with consulting and public
relations programs to increase brand awareness, and increases in costs
associated with expanding and operating our field offices and integration
laboratory for product demonstration and systems integration testing.
General and Administrative Expenses. General and administrative expenses
increased by approximately 90% to $7.5 million for 2000 from $3.9 million for
1999. This increase was due primarily to increased staffing levels, as the
number of administrative employees increased to 105 at December 31, 2000 from 56
at December 31, 1999, increases in costs associated with recruiting and
relocating employees and increases in costs for business system consulting and
facility move expenses.
Amortization of Deferred Compensation. During 2000 and 1999, we recorded
deferred compensation, net of forfeitures, of $9.0 million and $27.1 million,
respectively, in connection with stock options grants. We are amortizing this
amount on a straight-line basis over the vesting period of the applicable
options, resulting in amortization expense of $8.4 million and $2.9 million in
the years ended December 31, 2000 and 1999, respectively (of which approximately
$1,907,000 and $709,000, respectively, is included in cost of product and
service revenue).
Provision for Income Taxes. The effective tax rates for the years ended
December 31, 2000 and 1999 were 40.4% and 10.3%, respectively. The effective tax
rate in 2000 increased primarily due to the amortization of deferred
compensation, which is not deductible for income tax purposes. As a result of
becoming independent of the consolidated EMC group for tax filing purposes, we
expect our future tax rates to approximate statutory federal and state income
tax rates with the exception of the amortization of deferred compensation.
Years Ended December 31, 1999 and 1998
REVENUE
Product revenue, including sales to EMC, increased approximately 613% to
$77.6 in 1999 from $10.9 million in 1998. This increase primarily reflects
increased sales of our ED-5000 Fibre Channel Director to EMC and the FICON
Bridge card to IBM during 1999. Service revenue from EMC, which consists
primarily of fees earned under McDATA's service fee arrangement for producing
ESCON director products, decreased approximately 31% to $17.7 million for 1999
from $25.7 million for 1998. Actual revenue realized from McDATA's service fee
arrangement has declined due to reduced shipments of ESCON director products in
1999 in comparison to 1998.
GROSS PROFIT
Our gross profit increased approximately 92% to $45.0 million for 1999 from
$23.4 million for 1998. Our gross profit percentage decreased to 47% in 1999,
from 64% in 1998. This decrease in gross profit percentage is primarily due to
the change in mix between products and sales service fees. Gross profit
percentage on the service fee arrangement has exceeded those earned from product
sales. Gross profit percentage on product revenue in 1999 of approximately 43%
increased from 1998, reflecting a larger component of 1999 activity attributable
to sales of McDATA's director class product; the gross profit percentage on the
director class product is higher than the margins earned on non-director class
products manufactured by third parties and resold by us.
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OPERATING EXPENSES
Research and Development. Research and development expenses increased
approximately 31% to $24.0 million in 1999 from $18.3 million in 1998. This
increase in expenses primarily reflects increased staffing levels and expenses
related to the completion of development for Fibre Channel products introduced
during 1999.
Selling and Marketing. Selling and marketing expenses increased
approximately 53% to $15.8 million in 1999 from $10.3 million in 1998. The
increased expenditures in 1999 primarily reflect increased staffing levels,
establishment of compensation plans related to field sales and support
activities and investments in demonstration equipment and facilities.
General and Administrative. General and administrative expenses increased
approximately 16% to $3.9 million in 1999 from $3.4 million in, 1998. The
increased expenditures in 1999 primarily reflected increased staffing levels and
increased expenditures in facilities and networking equipment to support our
overall expansion in staffing levels.
Amortization of Deferred Compensation. During 1999, we recorded deferred
compensation, net of forfeitures, of $27.1 million in connection with stock
option grants. We are amortizing this amount on a straight-line basis over the
vesting period of the applicable options, resulting in amortization expense of
$2.9 million in 1999 (of which, approximately $709,000 is included in cost of
product and service revenue). No compensation was recorded in 1998.
Provision for Income Taxes. The effective tax rates for 1999 and 1998, were
10.3% and 37.9%, respectively. The effective tax rate for 1999 was significantly
reduced by the portion of the pre-tax loss associated with amortization of
deferred compensation, a portion of which is not deductible for income tax
purposes.
LIQUIDITY AND CAPITAL RESOURCES
We have funded our operations through the end of 2000 primarily through
funds generated from operations and funds received from the initial public
offering of our capital stock in August 2000. Net cash provided by operating
activities was $22.7 million for the year ended December 31, 2000, reflecting
net income for the year offset by net increases in working capital components
consistent with growth of the business.
Net cash used in investing activities was $229.7 million, primarily related
to purchases of short-term and long-term investments using proceeds from our
initial public offering, purchases of equipment for use by our employees and for
developing, testing and demonstrating our products, and expansion of our
facilities.
Net cash provided by financing activities totaled $374.7 million in 2000,
reflecting the sale of shares in our initial public offering as well as proceeds
from the exercise of employee stock options, partially offset by the repayment
of debt to Parent and increases in the repayment of capital lease obligations.
Our principal sources of liquidity at December 31, 2000 consisted of our
cash and short-term investment securities on hand, which totaled approximately
$365.7 million, and our equipment financing arrangements, which totaled
approximately $4.1 million at December 31, 2000. A note payable to Parent in the
principal amount of $1.9 million was repaid during 2000 with proceeds from the
initial public offering. Borrowings under our equipment financing arrangements
are secured by the related capital equipment and are payable through December
31, 2003.
We believe our existing cash and short-term investment balances and
borrowing facilities to be negotiated with a bank, if needed, will be sufficient
to meet our capital and operating requirements at least through the next twelve
months, although we could be required, or could elect, to seek additional
funding prior to that time.
On February 9, 2001, we entered into a lease and associated agreements with
Deutsche Bank AG, New York Branch ("Deutsche Bank") for the lease of a 167,000
(approx.) square foot multi-story office and engineering building to be
constructed on a 109 acre parcel of land located in Broomfield, Colorado. For
further information on the lease, please see "Item 2. Properties" in the Annual
Report. Construction must be completed no later than February 2003. As part of
the transaction, we have guaranteed a residual value of the facility to Deutsche
Bank of approximately 85% of the total original cost. We have agreed to restrict
up to $60 million (plus 5 percent) of our investment
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securities as collateral for specified obligations of ours under the lease.
These investment securities are restricted as to withdrawal and are managed by a
third party subject to certain limitations. In addition, the lease agreement
requires that the Company maintain compliance with certain affirmative and
negative covenants, representations and warranties, including certain defined
financial covenants.
Our future capital requirements will depend on many factors, including our
rate of revenue growth, the timing and extent of spending to support development
of new products and expansion of sales and marketing, the timing of new product
introductions and enhancements to existing products, and market acceptance of
our products.
INFLATION
We believe that our revenue and results of operations have not been
significantly impacted by inflation during the last three fiscal years.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities." SFAS 133 is effective for all fiscal quarters of all
fiscal years beginning after June 15, 2000. The Company adopted SFAS 133 on
January 1, 1999. To date, the Company has not entered into any derivative
instruments, so the adoption has had no effect on the financial position or
results of operations of the Company.
In December 1999, the Securities and Exchange Commission (the "Commission")
issued Staff Accounting Bulletin No. 101, Revenue Recognition in Financial
Statements, as amended. SAB 101 summarizes certain of the Commission's views in
applying generally accepted accounting principles to revenue recognition in
financial statements. The Company has applied the provisions of SAB 101 and the
related interpretive guidance in the consolidated financial statements. The
adoption of SAB 101 did not have a material impact on the Company's financial
condition or results of operations.
In March 2000, the Financial Accounting Standards Board issued FASB
Interpretation No. 44, Accounting for Certain Transactions Involving Stock
Compensation - an interpretation of APB Opinion No. 25, ("FIN 44"). FIN 44
clarifies the application of APB Opinion No. 25 and among other issues clarifies
the following: the definition of an employee for purposes of applying APB
Opinion No. 25, the criteria for determining whether a plan qualifies as a
noncompensatory plan, the accounting consequences of various modifications to
the terms of previously fixed stock options or awards, and the accounting for an
exchange of stock compensation awards in a business combination. FIN 44 was
effective as of July 1, 2000, but certain conclusions in FIN 44 cover specific
events that occurred after either December 15, 1998 or January 12, 2000. The
adoption of FIN 44 did not have a material impact on the Company's financial
condition or results of operations.
QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK
The Company is exposed to market risk, primarily from changes in interest
rates, foreign currency exchange rates and credit risks.
Interest Rate Risk
The Company earns interest income on both its cash and cash equivalents and
its investment portfolio. The Company's investment portfolio consists of readily
marketable investment-grade debt securities of various issuers and maturities
ranging from overnight to two years. All investments are denominated in U.S.
dollars and are classified as "available for sale." These instruments are not
leveraged, and are not held for trading purposes. As interest rates change, the
amount of unrealized gain or loss on these securities will change.
Changes in market interest rates may impact the future earnings of the
Company. For example, if interest rates were to increase or decrease 1% and such
increase or decrease affected the Company's entire balance of cash and cash
equivalents and investments as of December 31, 2000, and assuming that such
holdings remained constant through the year 2001, the result would be an
increase or decrease in the Company's interest income for the year 2001 of $3.9
million. A 1% increase or decrease in interest rates would approximate a 15%
increase or decrease from the interest rates earned by the Company during the
year ending December 31, 2000.
Foreign Currency Exchange Risk
The Company operates sales and support offices in several countries. All of
the Company's sales contracts have been denominated in U.S. dollars, therefore
the Company's transactions in foreign currencies are limited to operating
expense transactions. Due to the limited nature and amount of these
transactions, we do not believe we have had material exposure to foreign
currency exchange risk.
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Credit Risk
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of temporary cash investments,
short- and long-term investments and trade receivables. The Company places its
temporary cash investments and short- and long-term investments in investment
grade instruments and limits the amount of investment with any one financial
institution. The Company evaluates the credit risk associated with each of its
customers and has concluded that it does not have a material exposure to credit
risk with its customers.
RISK FACTORS
RISKS RELATED TO OUR BUSINESS
We have incurred losses in the past and may not sustain profitability in the
future.
We have incurred losses in all but the five most recent fiscal quarters
since 1997, when we focused our business on the design, development and
manufacture of Fibre Channel switching devices. We may incur losses in the
future. We cannot be certain that we can sustain our revenue growth rates or
that we can sustain profitability. Our future operating results will depend on
many factors, including the growth of the Fibre Channel market, market
acceptance of new products, demand for our products and levels of product and
price competition. In addition, we expect to incur continued significant product
development, sales and marketing, and general and administrative expenses and,
as a result, we may not be able to sustain profitability.
We depend on two key distribution relationships for most of our revenue and the
loss of either of them could significantly reduce our revenues.
We depend on EMC for most of our total revenue. Sales and services to EMC,
which is an original equipment manufacturer customer, represented approximately
76% of our total revenue for the fiscal year ended December 31, 2000. In
addition, IBM represented approximately 14% of our total revenue for the same
period. We anticipate that our future operating results will continue to depend
heavily on sales to EMC and IBM. Therefore, the loss of either EMC or IBM as a
customer, or a significant reduction in sales to either EMC or IBM in any fiscal
period, could significantly reduce our revenue.
A large percentage of our quarterly sales occurs at the end of the quarter,
contributing to possible quarterly fluctuations in revenue that could adversely
affect our operating results.
Our quarterly results have historically reflected an uneven pattern in
which a disproportionate percentage of a quarter's total sales occurs in the
last month, weeks or even days of each quarter. This pattern makes the
prediction of revenue, earnings and working capital for each financial period
especially difficult and increases the risk of unanticipated variations from
budgeted quarterly results and financial condition. Additional factors that
affect us which could cause our revenue and operating results to vary in future
periods include:
o the size, timing, terms and fluctuations of customer orders,
particularly large orders from our significant original equipment
manufacturer or reseller customers;
o our ability to attain and maintain market acceptance of our products;
o seasonal fluctuations in customer buying patterns;
o the timing of the introduction or enhancement of products by us, our
significant original equipment manufacturer or reseller customers or
our competitors;
o our ability to obtain sufficient supplies of single- or limited-source
components of our products; and
o increased operating expenses, particularly in connection with our
strategies to increase brand awareness or to invest in accelerated
research and development.
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Our uneven sales pattern makes it difficult for our management to predict
near-term demand and adjust manufacturing capacity accordingly. If orders for
our products vary substantially from the predicted demand, our ability to
assemble, test and ship orders received in the last weeks and days of each
quarter may be limited, which could seriously harm quarterly revenue or
earnings. Moreover, an unexpected decline in revenue without a corresponding and
timely reduction in expenses could intensify the impact of these factors on our
business, financial condition and results of operations.
We currently have limited product offerings and must successfully introduce new
and enhanced products that respond to rapid technological changes and evolving
industry standards.
In 2000, we derived approximately 68% of our revenue from sales of our
ED-5000 product. We expect that revenue from our Director class switching
products will continue to account for a substantial portion of our revenue for
the foreseeable future. Therefore, continued market acceptance of this product
is critical to our future success. Factors such as performance, market
positioning, the availability and price of competing products, the introduction
of new technologies and the success of our original equipment manufacturer,
reseller and systems integrator customers will affect the market acceptance of
our products.
In addition, our future success depends upon our ability to address the
changing needs of customers and to transition to new technologies and industry
standards. The introduction of competing products embodying new technologies or
the emergence of new industry standards could render our products
non-competitive, obsolete or unmarketable and seriously harm our market share,
revenue and gross margin. Risks inherent in this transition include the
inability to expand production capacity to meet demand for new products, the
impact of customer demand for new products or products being replaced, and
delays in the initial shipment of new products. There can be no assurance that
we will successfully manage these transitions.
If we fail to expand our distribution channels and manage our distribution
relationships, our revenue could be significantly reduced.
Our success will depend on our continuing ability to develop and manage
relationships with significant original equipment manufacturers, resellers and
systems integrators, as well as on the sales efforts and success of these
customers. We cannot assure you that we will be able to expand our distribution
channels, manage our distribution relationships successfully or that our
customers will market our products effectively. Our failure to expand our
distribution channels or manage successfully our distribution relationships or
the failure of our OEM and reseller customers to sell our products could reduce
our revenue.
We are dependent on a single or limited number of suppliers for certain key
components of our products, and the failure of any of those suppliers to meet
our production needs could seriously harm our ability to manufacture our
products, result in delays in the delivery of our products and harm our revenue.
We currently purchase several key components from single or limited sources.
We purchase application specific integrated circuits, or ASICs, printed circuit
boards and power supplies from single sources, and gigabit interface converters
and 1x9 transceivers from limited sources. Additional sole- or limited-sourced
components may be incorporated into our products in the future. Delays in the
delivery of components for our products could result in decreased revenue. We do
not have any long-term supply contracts to ensure sources of supply. In
addition, our suppliers may enter into exclusive arrangements with our
competitors, stop selling their products or components to us at commercially
reasonable prices or refuse to sell their products or components to us at any
price, which could harm our operating results. If our suppliers are unable to
provide, or we are unable otherwise to obtain these components for our products
on the schedule and in the quantities we require, we will be unable to
manufacture our products. We have experienced and may continue to experience
production delays and quality control problems with certain of our suppliers,
which, if not effectively managed, could prevent us from satisfying our
production requirements. If we fail to effectively manage our relationships with
these key suppliers, or if our suppliers experience delays, disruptions,
capacity constraints or quality control problems in their manufacturing
operations, our ability to manufacture and ship products to our customers could
be delayed, and our competitive position, reputation, business, financial
condition and results of operations could be seriously harmed.
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The loss of our contract manufacturer, or the failure to forecast demand
accurately for our products or to manage our relationship with our contract
manufacturer successfully, would negatively impact our ability to manufacture
and sell our products.
We rely on a third-party manufacturer to manufacture all of our circuit
boards and to perform extensive testing and assembly of our products. We do not
have a long-term supply contract with this manufacturer and, therefore, it is
not obligated to supply products to us for any specific period, or in any
specific quantity, except as may be provided in a particular purchase order. We
generally place orders for circuit boards with our contract manufacturer
approximately four to five months prior to the anticipated delivery date, with
order volumes based on forecasts of demand for our products. If we fail to
forecast demand for our products accurately, we may be unable to obtain adequate
manufacturing capacity from our contract manufacturer to meet our customers'
delivery requirements, or we may accumulate excess inventories. We may be unable
to respond adequately to unexpected increases in customer purchase orders, and
therefore be unable to benefit from this incremental demand. Our contract
manufacturer has not provided assurances to us that adequate capacity will be
available to us within the time required to meet additional demand for our
products.
In addition, we coordinate our efforts with those of our component suppliers
and our contract manufacturer in order to rapidly achieve volume production. We
have experienced and may continue to experience production delays and quality
control problems with certain of our suppliers and with our contract
manufacturer, which, if not effectively managed, could prevent us from
satisfying our production requirements. If we should fail to manage effectively
our relationships with our component suppliers and our contract manufacturer, or
if any of our suppliers or our manufacturer experience delays, disruptions,
capacity constraints or quality control problems in their 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 can be expensive and time
consuming. If we are required to change or choose to change contract
manufacturers, we may lose revenue and damage our customer relationships.
If we fail to successfully develop the McDATA brand, our revenue may not grow.
Our name is not widely recognized as a brand in the marketplace. We have
operated substantially as a separate company from McDATA Holdings Corporation
and EMC only since October 1997. EMC, which currently accounts for the majority
of our revenue, markets our products under its own brand name. As a result, we
have not fully established our brand name. We believe that establishing and
maintaining the McDATA brand is a critical component in maintaining and
developing strategic original equipment manufacturer, reseller and systems
integrator relationships, and the importance of brand recognition will increase
as the number of vendors of competitive products increases. Our failure to
successfully develop our brand may prevent us from expanding our business and
growing our revenue. Similarly, if we incur excessive expenses in an attempt to
promote and maintain the McDATA brand, our business, financial condition and
results of operations could be seriously harmed.
The storage area network market in which we compete is still developing, and if
this market does not continue to develop and expand as we anticipate, our
business will suffer.
The market for storage area networks, or SANs, and related products has
only recently begun to develop and continues to evolve. Because this market is
relatively new, it is difficult to predict its potential size or future growth
rate. Our ED-5000 product, from which we derived approximately 68% of our total
revenues in 2000, is used extensively in SANs. Accordingly, continued widespread
adoption of SANs as an integral part of data-intensive enterprise computing
environments is critical to our future success. Potential end-user customers who
have invested substantial resources in their existing data storage and
management systems may be reluctant or slow to adopt a new approach, like SANs.
Our success in generating net revenue in this developing market will depend on,
among other things, our ability to:
o educate our potential original equipment manufacturer, reseller and
systems integrator customers and end users about the benefits of SANs
and the use of our products in the SAN environment; and
o predict, develop and base our products on standards that ultimately
become industry standards.
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The sales cycle for our products is long, and we may incur substantial
non-recoverable expenses and devote significant resources to sales that do not
occur when anticipated or at all.
Our original equipment manufacturer, reseller and systems integrator
customers typically conduct significant evaluation, testing, implementation and
acceptance procedures before they begin to market and sell new solutions that
include our products. This evaluation process is lengthy and may extend up to
one year or more. This process is complex and may require significant sales,
marketing and management efforts on our part. This process becomes more complex
as we simultaneously qualify our products with multiple customers. As a result,
we may expend significant resources to develop customer relationships before we
recognize any revenue from these relationships.
Undetected software or hardware defects in our products could result in loss of
or delay in market acceptance of our products and could increase our costs or
reduce our revenue.
Our products may contain undetected software or hardware errors when first
introduced or when new versions are released. Our products are complex, and we
have from time to time detected errors in existing products, and we may from
time to time find errors in our existing, new or enhanced products. In addition,
our products are combined with products from other vendors. As a result, should
problems occur, it may be difficult to identify the source of the problem. These
errors could result in a loss of or delay in market acceptance of our products
and would increase our costs, reduce our revenue and cause significant customer
relations problems.
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 our key management, technical, sales and marketing, finance and
operations personnel, many of whom would be difficult to replace. In particular,
we believe that our future success is highly dependent on John F. McDonnell, our
President and Chief Executive Officer and the Chairman of our Board of
Directors. In addition, our engineering and product development teams are
critical in developing our products and have developed important relationships
with customers and their technical staffs. The loss of any of these key
personnel could harm our operations and customer relationships. We do not have
key person life insurance on any of our key personnel.
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, and finance and operations personnel. As we increase our production
and sales levels, we will need to attract and retain additional qualified
skilled workers for our operations. In recent years there has been great demand
among companies in the technology industry for these personnel. In particular,
competition for these personnel has become increasingly intense in the greater
Denver, Colorado metropolitan area, where we have our headquarters and certain
of our manufacturing facilities, and the greater Toronto, Canada metropolitan
area, where we have an engineering group. We cannot assure you that we will
continue to be able to attract and retain qualified personnel, or that delays in
hiring required personnel, particularly engineers, will not delay the
development or introduction of products or negatively impact our ability to sell
our products.
If we cannot compete successfully in the future against existing or potential
competitors, our operating results will suffer.
The market for our Fibre Channel switching products is competitive, and is
likely to become even more so. Our primary competitor in the Fibre Channel
switch market is Brocade Communications Systems, Inc. Other companies are also
providing Fibre Channel switches and other products to the SAN market, including
Qlogic Corporation, Gadzoox Networks, Inc., Vixel Corporation and INRANGE
Technologies Corporation. In the future, we may also compete with networking
companies that may develop SAN products or other companies in related or other
industries for which future direct participation in the market for switching
devices may become strategic.
EMC has agreed not to develop or manufacture products that compete with our
products for two years after the completion of our initial public offering in
August 2000. Upon the expiration of the two-year period, we have no agreement
that would restrict EMC from competing with us in the development or manufacture
of these products. In addition, EMC has recently agreed to resell certain
products offered by two of our competitors. Moreover, under a cross license
agreement between us and EMC, we have granted EMC a license under our patents to
make, use and sell any products that EMC was selling or distributing up to
August 9, 2000, including products that compete with ours.
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Continued or 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. Some of our
competitors and potential competitors have longer operating histories, greater
name recognition, access to larger customer bases, more established distribution
channels or substantially greater resources than we have. As a result, they may
be able to respond more quickly than we can to new or changing opportunities,
technologies, standards or customer requirements.
We do not have significant experience in international markets and may have
unexpected costs and difficulties in developing international revenue.
We intend to expand the marketing and sales of our products
internationally. We have limited experience in marketing, distributing and
supporting our products internationally and may not be able to maintain or
increase international market demand for our products. In addition, our
international operations are generally subject to inherent risks and challenges
that could harm our operating results, including:
o expenses associated with developing and customizing our products for
foreign countries;
o multiple, conflicting and changing governmental laws and regulations;
o tariffs, quotas and other import restrictions on computer peripheral
equipment;
o longer sales cycles for our products;
o reduced or limited protections of intellectual property rights;
o compliance with international standards that differ from domestic
standards; and
o political and economic instability.
Any negative effects on our international business could harm our business,
operating results and financial condition as a whole. To date, none of our
international revenue or costs have been denominated in foreign currencies. As a
result, an increase in the value of the U.S. dollar relative to foreign
currencies could make our products more expensive and thus less competitive in
foreign markets. A portion of our international revenue may be denominated in
foreign currencies in the future, which will subject us to risks associated with
fluctuations in those foreign currencies.
If we are unable to adequately protect our intellectual property, we may not be
able to compete effectively.
We rely on a combination of patent, copyright, trademark and trade secret
laws and restrictions on disclosure to protect our intellectual property rights.
We also enter into confidentiality and/or license agreements with our employees,
consultants and corporate partners. Despite our efforts to protect our
proprietary rights, unauthorized parties may copy or otherwise obtain and use
our products or technology. Monitoring unauthorized use of our products is
difficult and the steps we have taken may not prevent unauthorized use of our
technology, particularly in foreign countries where the laws may not protect our
proprietary rights as fully as in the United States.
We may be a party to intellectual property litigation in the future, either
to protect our intellectual property or as a result of alleged infringements of
others' intellectual property. These claims and any resulting litigation could
subject us to significant liability for damages or could cause our proprietary
rights to be invalidated. Litigation, regardless of the merits of the claim or
outcome, would likely be time consuming and expensive to resolve and would
divert management time and attention. Any potential intellectual property
litigation could also force us to do one or more of the following:
o stop using the challenged intellectual property or selling our products
or services that incorporate it;
o obtain a license to use the challenged intellectual property or to sell
products or services that incorporate it, which license may not be
available on reasonable terms, or at all; and
o redesign those products or services that are based on or incorporate
the challenged intellectual property.
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If we are forced to take any of these actions, we may be unable to
manufacture and sell our products, and our revenue would be reduced.
We currently hold a sublicense to certain IBM patents under the terms of a
cross license agreement between IBM and EMC. We have granted IBM a license to
all of our patents under this cross license agreement. Under the terms of that
agreement, effective upon EMC's February 7, 2001 distribution of our shares of
our Class A common stock indirectly held by it to its stockholders, the
sublicense we hold to those IBM patents terminated. We are not aware of any
issued or pending IBM patents that are infringed by our products, but if IBM
were to allege any such infringement, we may have difficulty negotiating a
settlement. If we were unable to negotiate a settlement with IBM, our ability to
produce an infringing product could be affected, which could materially and
adversely affect our business.
If we become subject to unfair hiring claims, we could incur substantial costs
in defending ourselves.
Companies in our industry whose employees accept positions with competitors
frequently claim that their competitors have engaged in unfair hiring practices
or that employees have misappropriated confidential information or trade
secrets. We may receive claims of this kind or other claims relating to our
employees in the future as we seek to hire qualified personnel. We could incur
substantial costs in defending ourselves or our employees against such claims,
regardless of their merits. In addition, defending ourselves or our employees
from such claims could divert the attention of our management away from our
operations.
Our stock price is volatile.
Since the initial public offering of our Class B common stock in August
2000 and the distribution of our Class A common stock by EMC in February 2001,
the market price of our stock has been volatile. Because we are a technology
company, the market price of our stock is subject to the same volatility and
fluctuations that have recently characterized the stock prices of other
technology companies. This volatility is often unrelated or disproportionate to
the operating performance of these companies and, as a result, the price of our
stock could fall regardless of our performance.
RISK RELATED TO OUR RELATIONSHIP WITH EMC
We have entered into agreements with EMC that, due to our prior
parent-subsidiary relationship, may contain terms less beneficial to us than if
they had been negotiated with unaffiliated third parties.
In October 1997, in connection with the reorganization of our business, we
entered into certain agreements with EMC relating to our business relationship
with EMC after the 1997 reorganization. In addition, we have recently entered
into agreements with EMC relating to our relationship with EMC after the
completion of our initial public offering in August 2000 and the distribution by
EMC of our Class A common stock in February 2001. We have also recently entered
into an OEM Purchase and License Agreement with EMC that governs EMC's purchases
of McDATA products and grants EMC rights to use, support and distribute software
for use in connection with these products. The agreement does not provide for
the purchase of a guaranteed minimum amount of product. These agreements were
negotiated and made in the context of our prior parent-subsidiary relationship.
As a result, some of these agreements may have terms and conditions, in the case
of the OEM agreement, including the terms of pricing, that are less beneficial
to us than agreements negotiated with unaffiliated third parties. Revenue from
EMC represented approximately 76% of our total revenue for the fiscal year ended
December 31, 2000. In addition, in some instances, our ability to terminate
these agreements is limited, which may prevent us from being able to negotiate
more favorable terms with EMC or from entering into similar agreements with
third parties.
We depend heavily on EMC as our key OEM customer; if our relationship with EMC
adversely changes, our revenue will be significantly reduced.
For the fiscal year ended December 31, 2000, our product sales to EMC
represented approximately 69% of our total revenue. In addition, during the same
period, revenue under our service agreement with EMC Corporation, pursuant to
which we manufacture and supply ESCON switching devices for IBM, represented
approximately 6% of our total revenue. EMC has recently agreed to resell
products offered by two of our competitors, and nothing restricts EMC from
expanding those relationships in a manner that could be adverse to us. If our
business
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relationship with EMC ends or significantly changes, resulting in reduced sales
to EMC, our revenue will be significantly reduced.
Provisions of our agreements with EMC relating to our relationship with EMC
after the distribution by EMC of our Class A common stock indirectly held by it
to its stockholders may affect the operation of our business, limit our ability
to finance our operations or prevent a change in control of our company.
Under the terms of the Tax Sharing Agreement between EMC and us, until 27
months after the date of EMC's distribution of our Class A common stock
indirectly held by it to its stockholders, we may not, without the consent of
EMC or the receipt by EMC of a private letter ruling from the Internal Revenue
Service that the tax treatment of the distribution will not be adversely
affected:
o enter into any transaction that would result in any person acquiring a
50% or greater interest in us;
o take or fail to take any other action which would cause the
distribution to be taxable to EMC stockholders;
o issue stock or other equity interests in us, or redeem or repurchase
any of our capital stock which would involve the acquisition by one or
more persons of more than 35% of our stock; or
o undertake any transaction which would be treated as a liquidation or
reorganization for tax purposes.
These restrictions may prevent us from being acquired, either in a
negotiated transaction or otherwise, from using shares of our common stock as
payment in the acquisition by us of other companies or from financing our
operations through sales of securities.
Under the terms of the Master Confidential Disclosure and License Agreement
between EMC and us, EMC has granted us a license under existing EMC patents. If
we are acquired, our acquirer will retain this license as long as our acquirer
grants to EMC a license under all of the acquirer's patents for all products
licensed under the agreement under the same terms as the license we have granted
to EMC under the agreement. The potential loss of the license from EMC after an
acquisition of us by a third party may make an acquisition of us by a third
party unlikely.
We may be obligated to indemnify EMC if the distribution is not tax free.
The Tax Sharing Agreement that we have entered into with EMC obligates us
to indemnify EMC from taxes relating to the failure of EMC's distribution to
EMC's stockholders of our Class A common stock (that it indirectly holds) to be
tax free if that failure results from, among other things:
o any act or omission by us that would cause the distribution to fail to
qualify as a tax free distribution under the Internal Revenue Code;
o any act or omission by us that is inconsistent with any representation
made to the Internal Revenue Service in connection with the request for
a private letter ruling regarding the tax-free nature of the
distribution by EMC of our Class A common stock indirectly held by it
to its stockholders;
o any acquisition by a third party of our stock or assets; or
o any issuance by us of stock or any change in ownership of our stock.
As a result, we may be liable to EMC under the Tax Sharing Agreement upon
the occurrence of events that are beyond our control. If the distribution of our
Class A common stock fails to qualify as a tax-free distribution, EMC would
incur tax liability as if our Class A common stock that was distributed by EMC
had been sold by EMC for its fair market value in a taxable transaction. In the
event that we are required to indemnify EMC because the distribution of our
Class A common stock fails to qualify as a tax-free distribution, our liability
could exceed 35% of the value of the Class A common stock distributed by EMC as
determined on the date of the distribution.
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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
For a discussion of the information required by this item, you should refer
to page 19 under the caption entitled "Quantitative and Qualitative Disclosures
About Market Risk."
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
For a discussion of the information required by this item, you should refer
to pages F-1 through F-21.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
We have nothing to report under this item.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information regarding our executive
officers and directors as of the date of this Annual Report:
NAME AGE POSITION
- ---- --- --------
John F. McDonnell 56 Chairman of the Board of Directors, Chief Executive
Officer and President
Earl T. Carothers 55 Vice President of Corporate Quality and
Customer Services
Janet K. Cooper 47 Chief Financial Officer and Senior Vice President
of Finance and Administration
Michael B. Gustafson 34 Vice President of Worldwide Sales
James E. Kuenzel 47 Vice President of Engineering
Thomas O. McGimpsey 39 Vice President of Corporate Services, Secretary
and General Counsel
Dee J. Perry 49 Vice President of Finance
John H. Runne 52 Senior Vice-President of Corporate Development
Jeffery O. Vogel 45 Vice President of Solutions and Systems Integration Services
David M. Weishaar 49 Vice President of Manufacturing
John W. Gerdelman(1) 48 Director
Charles C. Johnston(1) 65 Director
D. Van Skilling(1) 67 Director
Thomas M. Uhlman(2) 53 Director
Laurence G. Walker(2) 52 Director
- ---------
(1) Member of Audit Committee
(2) Member of Compensation Committee
EXECUTIVE OFFICERS AND DIRECTORS
John F. McDonnell is a founder of McDATA and has served as Chief Executive
Officer and President of McDATA since its inception in 1982, and has served as
Chairman of the Board of Directors since 1998. Mr. McDonnell has more than 31
years of experience in the data communications field, including 26 years in
corporate and technical management and 5 years in engineering. Prior to founding
McDATA, he held various corporate management and engineering positions at
Storage Technology Corporation and Computer Communications, Inc. Mr. McDonnell
attended California State University at Long Beach.
Earl T. Carothers has been Vice President of Corporate Quality and Customer
Services since December 2000. Prior to joining McDATA, Mr. Carothers was
President and CEO of Global Knowledge Group, Inc. from January 2000 to November
2000, Vice President and General Manager of the IT Solutions Division of
Intergraph Corporation from October 1998 to January 2000, Vice President of
Customer Service and Quality at Compaq Computer Corporation from July 1996 to
September 1997, Vice President of Customer Services, Systems Integration and
Sales Operations at Dell Computer Corporation from January 1994 to July 1996,
and held various management positions with Digital Equipment Corporation from
1971 to 1994. Mr. Carothers has a Certificate of International Management from
INSEAD, Fontainebleau, France.
Janet K. Cooper has been the Senior Vice President of Finance and
Administration and Chief Financial Officer since January 2001. Prior to joining
McDATA, Ms. Cooper was Senior Vice President of Finance at Qwest Communications
International, Inc. from June 2000 to January 2001, Vice President of Finance
and Controller of US WEST from June 1999 to June 2000, Vice President, Treasurer
and Controller of US WEST from March 1999 to June 1999, Vice President and
Treasurer of US WEST from May 1998 to March 1999, Vice President of Treasury and
Tax Business of The Quaker Oats Company from 1997 to 1998, and Vice President
and Treasurer of The Quaker Oats Company from 1992 to 1997. Ms. Cooper joined
The Quaker Oats Company in 1978 and held various financial and managerial
positions. Ms. Cooper received a B.S. in Math, Computer Science and Economics
and an M.S. in Applied Mathematics from the University of Illinois, and an
M.B.A. in Finance and International
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Business from the University of Chicago. Ms. Cooper also sits on the Board of
Directors for Lennox International Inc. and The Toro Company.
Michael B. Gustafson has been Vice President of Worldwide Sales since March
1999. From May 1998, when he joined McDATA, until March 1999, Mr. Gustafson
served as a regional sales manager of McDATA. Prior to joining McDATA, Mr.
Gustafson spent 9 years with IBM serving in various sales management positions,
including most recently as Business Unit Executive and Director of U.S. Channel
Field Sales of IBM from June 1997 until May 1998. Mr. Gustafson received his
Bachelor of Science degree in business administration from Washington University
in St. Louis.
James E. Kuenzel has been Vice President of Engineering since joining McDATA
in November 1999. He was previously Vice President of Engineering at Cabletron
Systems Inc. from February 1998 until October 1999 and held a variety of
engineering management positions at Digital Equipment Corporation over a period
of twenty years, including having served as the Vice President of Engineering
from January 1997 until February 1998 and as a Director of Engineering from
March 1994 until January 1997. Mr. Kuenzel received his associate degree in
electronics from the Philco Ford Technical Institute.
Thomas O. McGimpsey has been Vice President of Corporate Services since
February 2001 and Vice President, Secretary and General Counsel since July 2000.
Prior to joining McDATA, Mr. McGimpsey was the Senior Corporate and Securities
Attorney at U S WEST, Inc. and U S WEST Communications, Inc. from 1998 until
July 2000. From 1996 to 1998, Mr. McGimpsey was in private practice as an
associate attorney at the law firm of Ballard Spahr Andrews & Ingersoll, LLP.
From 1994 to 1996, Mr. McGimpsey was in private practice as an associate
attorney at the law firm of Holland & Knight, LLP. Mr. McGimpsey received his
Juris Doctor degree from the University of Colorado in 1991 and his Bachelor of
Science Degree in Computer Science from Embry-Riddle Aeronautical University in
1984.
Dee J. Perry has been Vice President of Finance since January 2001 and was
the Chief Financial Officer and Vice President of Finance and Administration
from January 1991 to January 2001. Ms. Perry was previously Controller at
Celestial Seasonings from April 1989 to September 1990 and Controller at NBI,
Inc. from April 1985 to March 1989. Ms. Perry received her Bachelor of Arts and
Master of Science degrees in accounting from the University of Colorado and her
Master of Business Administration degree from Arizona State University.
John H. Runne has been Senior Vice President of Corporate Development since
December 2000. Prior to joining McDATA, Mr. Runne was President of Runne &
Associates Inc. from 1995 and has served as Vice Chairman of the Board of EDSS,
Inc, Director of Helus, Inc., a member of the Advisory Board of Presideo, Inc.
and a member of the Advisory Board of SalesRepsOnline.com since 1997. Mr. Runne
received his bachelor degree in Business from the University of Texas.
Jeffery O. Vogel has been the Vice President of Solutions and Systems
Integration Services since November 2000, and prior to that was Vice President
of Marketing and System Integration Services since joining McDATA in December
1998. He served as Vice President of Marketing and Business Development at Vixel
Corporation, a provider of Fibre Channel software, switches, hubs and other
components for storage area networks, from November 1993 until November 1998.
Previously, he held sales, marketing and IT management positions at Hitachi Data
Systems, Seagate Technology, Inc., Western Digital Corporation and Bank of
America. Mr. Vogel received his Bachelor of Science degree in engineering from
the DeVry Institute.
David M. Weishaar has been the Vice President of Manufacturing since joining
McDATA in July 1999. From January 1999 to June 1999, Mr. Weishaar was a
self-employed consultant. From November 1994 to December 1998 Mr. Weishaar
served as Vice President of Manufacturing and Customer Service, and Chief
Quality Officer for Stratus Computer and from June 1993 to November 1994 he
served as the Vice President of Manufacturing at Stratus Computer. He has also
held executive management positions at Sun Microsystems, Sequoia Systems, and
ZTEL, Inc., and management positions at Digital Equipment Corporation. He
received his Bachelor of Science degree in Electrical Engineering from the
University of Wyoming and his Master of Business Administration degree from
Northeastern University.
John W. Gerdelman, Managing Member, Mortonsgroup LLC, has served as a
director of McDATA since May 1998. Mr. Gerdelman has been Managing Member of
Mortonsgroup LLC, an early stage venture firm, since October 1999. From April
1999 to October 1999, Mr. Gerdelman was Chief Executive Officer of USA.NET, a
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provider of outsourced e-mail applications for consumers and business customers.
Mr. Gerdelman was employed by MCI Telecommunications Corporation as an Executive
Vice President from 1986 through April 1999. He received his Bachelor of Science
degree in chemistry from the College of William and Mary. Mr. Gerdelman
currently serves as a director of Sycamore Networks, Inc. and Genuity.
Charles C. Johnston, Chairman, Ventex Technology, Inc. and AFD Technologies,
LLC, has served as a director of McDATA since May 1998. Mr. Johnston has been
Chairman of Ventex Technology, Inc., an electronic transformer company, and AFD
Technologies, LLC, a chemical company, since 1993. Mr. Johnston was founder,
Chairman and CEO of ISI Systems, a computer software company, from 1970 to 1992
before it was sold to Teleglobe Corporation of Montreal, Canada. He served in
various capacities at International Business Machines Corporation from 1959
until 1965 and served as Director of Grumman Corporation and Teleglobe
Corporation from 1989 to 1994. He received his Bachelor of Science degree in
1957 from the Worcester Polytechnic Institute. He currently serves as a director
of Bitwise Designs, Inc., Hydron Technologies, Inc., Internet Commerce
Corporation and Waste Systems International, Inc.
D. Van Skilling, President, Skilling Enterprises, Chairman Emeritus,
Experian, has served as a director of McDATA since May 1998. Mr. Skilling
retired as Chairman and Chief Executive Officer of Experian Information
Solutions, Inc., formerly TRW Information Systems & Services, in April 1999.
From September 1996 until April 1999, Mr. Skilling was Chairman and Chief
Executive Officer of Experian. From March 1970 until September 1996, Mr.
Skilling was the Executive Vice President of TRW Information Systems and
Services. He received his Bachelor of Science degree in chemistry from Colorado
College and his Master of Business Administration degree in International
Business from Pepperdine University. He currently serves on the Boards of
Directors of The Lamson & Sessions Company, First American l Corporation and
American Business Bank.
Thomas M. Uhlman, President, New Ventures Group, Lucent Technologies, Inc.,
has served as a director of McDATA since May 1998. Mr. Uhlman has been
President, New Ventures Group of Lucent Technologies since 1997. From 1996 to
1997, Mr. Uhlman was Senior Vice President, Corporate Strategy, Business
Development and Public Affairs of Lucent Technologies. From 1995 to 1996 Mr.
Uhlman was the Vice President, Corporate Development of AT&T Corp. Prior to
joining AT&T, he was with Hewlett-Packard Company in various advisory and
management roles. He received his Ph.D. in Political Science from the University
of North Carolina, his Masters Degree in management from Stanford University and
his Bachelor of Arts degree in political science and psychology from the
University of Rochester.
Laurence G. Walker, Chief Executive Officer, C-Port Corporation, which
recently became a wholly-owned subsidiary of Motorola, has served as a director
of McDATA since May 1998. Mr. Walker co-founded C-Port in November 1997 and has
been Chief Executive Officer since that time. From June 1997 until October 1997,
Mr. Walker was self employed. From August 1996 until May 1997, Mr. Walker served
as Chief Executive Officer of CertCo, a digital certification supplier. Prior to
that, he was Vice President and General Manager, Network Product Business Unit,
Digital Equipment Corporation from January 1994 to July 1996. From 1981 to 1994,
he held a variety of other management positions at Digital Equipment
Corporation. He received his Ph.D. and Master of Science degree in electrical
engineering from the Massachusetts Institute of Technology and his Bachelor of
Science degree in Electrical Engineering from Princeton.
Our Board of Directors is divided into three classes, the members of which
serve for a staggered three-year term and until they or their successors are
duly elected and qualified. Mr. Gerdelman serves in the class whose term expires
at the annual meeting of stockholders in 2001; Messrs. Skilling and Uhlman serve
in the class whose term expires at the annual meeting of stockholders in 2002;
and Messrs. Johnston, McDonnell and Walker serve in the class whose term expires
at the annual meeting of stockholders in 2003. Upon the expiration of the term
of a class of directors, directors in that class will be elected for three-year
terms at the annual meeting of stockholders in the year in which that term
expires.
Our officers serve at the discretion of the Board of Directors. There are no
family relationships among our directors and officers.
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OTHER MATTERS
On February 8, 2001, David A. Donatelli resigned from the Board of
Directors as part of EMC's distribution of our Class A common stock. Dee J.
Perry is expected to assist the Company in transition efforts until her
retirement, which is expected to occur during the first quarter of 2001.
BOARD OF DIRECTORS COMMITTEES AND OTHER INFORMATION
Our Board of Directors has an Audit Committee and a Compensation Committee.
The Audit Committee, currently comprised of Messrs. Gerdelman, Johnston and
Skilling, determines our accounting policies and practices and financial
reporting and internal control structures, recommends to our Board of Directors
the appointment of independent auditors to audit our financial statements each
year and confers with the auditors and our officers for purposes of reviewing
our internal controls, accounting practices, financial structures and financial
reporting. The Compensation Committee, currently comprised of Messrs. Uhlman and
Walker reviews salaries, incentives and other forms of compensation for our
executive officers and administers our incentive compensation plan. The
Compensation Committee has delegated its duties with respect to option grants
for non-executive officers to a compensation subcommittee, which is chaired by
Mr. McDonnell, in accordance with the terms of the Company's 1997 Stock Option
Plan.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires our executive
officers and directors, and persons who own more than 10% of our common stock,
to file with the Commission reports of ownership and changes in ownership of
common stock and other equity securities of our Company. Executive officers,
directors and greater than 10% shareholders are required by the Securities and
Exchange Commission regulation to furnish to us copies of all Section 16(a)
forms they file.
Based solely on a review of the copies of Section 16(a) forms furnished to
us and written representations that no other filings were required, we believe
that all the Securities and Exchange Commission filing requirements applicable
to our executive officers, directors and greater than 10% shareholders were
complied with for 2000 with the exception of James E. Kuenzel, our Vice
President of Engineering. On August 9, 2000, Mr. Kuenzel purchased 100 shares of
McDATA Class B common stock. On August 14, 2000, 100 shares of McDATA Class B
common stock were inadverteantly sold on Mr. Kuenzel's behalf by his broker. No
Form 4 was filed for the purchase or sale at that time. On February 27, 2001, a
Form 4 was filed which reported the purchase and sale. Mr. Kuenzel has disgorged
the profit received upon the sale of these shares to the Company.
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ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth information for the fiscal year ended
December 31, 2000 concerning the compensation paid to our Chief Executive
Officer and our four other most highly compensated executive officers whose
total salary and bonus for such fiscal year exceeded $100,000, collectively
referred to below as the Named Executive Officers:
SUMMARY COMPENSATION TABLE
LONG-TERM
COMPENSATION
AWARDS
------------
ANNUAL COMPENSATION SECURITIES OTHER
------------------------ UNDERLYING COMPENSATION
NAME AND PRINCIPAL POSITION SALARY($) BONUS($)(1) OPTIONS(#) ($)
- --------------------------- --------- ----------- ------------- ------------
John F. McDonnell................................ 2000 $ 280,883 $ 92,155 -- $ 5,373(2)
Chief Executive Officer and President 1999 $ 269,039 $ 35,131 -- $ 9,525(3)
Michael B. Gustafson............................. 2000 $ 115,935 $275,626 200,000 $ 8,055(4)
Vice President of Worldwide Sales 1999 $ 100,384 $112,916 120,000 $45,547(5)
David M Weishaar................................. 2000 $ 200,000 $ 51,363 -- $ 630(6)
Vice President of Manufacturing 1999 $ 92,308 $ 2,231 -- $77,339(7)
James E. Kuenzel................................. 2000 $ 200,000 $ 50,578 -- $39,257(8)
Vice President of Engineering 1999 $ 33,846 $ -- -- $28,003(9)
Dee J. Perry..................................... 2000 $ 176,718 $ 48,064 -- $ 4,102(10)
Chief Financial Officer and Vice President 1999 $ 140,002 $ 14,785 -- $ 5,776(11)
of Finance and Administration
- ----------
(1) Includes performance bonuses and commissions accrued in 2000 and 1999
whether paid in that year or a succeeding year.
(2) For 2000, this amount includes $2,580 for term life insurance premiums,
$2,347 paid to Mr. McDonnell's account in our 401(k) plan and $445 for
reimbursement of travel expenses.
(3) For 1999, this amount includes $1,806 for term life insurance premiums,
$2,000 paid to Mr. McDonnell's account in our 401(k) plan and $5,719 for
reimbursement of travel expenses.
(4) For 2000, this amount includes $144 for term life insurance premiums for
Mr. Gustafson, $2,000 paid to Mr. Gustafson's account in our 401(k) plan
and $5,911 for reimbursement of travel expenses.
(5) For 1999, this amount includes $96 for term life insurance premiums for Mr.
Gustafson, $4,765 paid to Mr. Gustafson's account in our 401(k) plan and
$40,686 for reimbursement of relocation expenses.
(6) For 2000, this amount includes $630 for term life insurance premiums for
Mr. Weishaar.
(7) For 1999, this amount includes $301 for term life insurance premiums for
Mr. Weishaar and $77,038 for reimbursement of relocation expenses.
(8) For 2000, this amount includes $630 for term life insurance premiums,
$5,605 paid to Mr. Kuenzel's account in our 401(k) plan, and $33,022 for
reimbursement of relocation expenses.
(9) For 1999, this amount includes $117 for term life insurance premiums for
Mr. Kuenzel, and $27,886 for reimbursement of relocation expenses.
(10) For 2000, this amount includes $522 for term life insurance premiums and
$3,580 paid to Ms. Perry's account in our 401(k) plan.
(11) For 1999, this amount includes $412 for term life insurance premiums for
Ms. Perry and $5,364 paid to Ms. Perry's account in our 401(k) plan.
OPTION GRANTS IN LAST FISCAL YEAR
The following table sets forth certain information for each grant of stock
options during the year ended December 31, 2000 to each of the Named Executive
Officers. All of these options granted by us were granted under our 1997 Stock
Option Plan and have a term of 10 years, subject to earlier termination in the
event an optionee's services to us cease. For more information, see "Employee
Benefit Plans" below for descriptions of the material terms of these options.
During the year ended December 31, 2000, we granted options to purchase an
aggregate of 3,882,375 shares of Class B common stock under the 1997 Stock
Option Plan. Options were granted at an exercise price equal to the fair market
value (as determined under the 1997 Stock Option Plan) of our Class
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B common stock on the date prior to the grant. Potential realizable values are
net of exercise prices before taxes, and are based on the assumption that our
Class B common stock appreciates at the annual rate shown, compounded annually,
from the date of grant until the expiration of the ten-year term and that the
option is exercised at the exercise price and sold on the last day of its term
at the appreciated price. These numbers are calculated based on Securities and
Exchange Commission requirements and do not reflect any projection or estimate
of future stock price growth. No stock appreciation rights were granted during
the fiscal year ended December 31, 2000.
INDIVIDUAL GRANTS
-----------------
POTENTIAL REALIZABLE
PERCENT OF VALUE AT ASSUMED
NUMBER TOTAL ANNUAL RATES OF
OF OPTIONS STOCK PRICE
SECURITIES GRANTED TO EXERCISE APPRECIATION FOR
UNDERLYING EMPLOYEES PRICE PER OPTION TERM
OPTIONS IN SHARE EXPIRATION ----------------------
NAME GRANTED 2000 ($/SHARE) DATE 5% 10%
- --------------------------- ---------- ---------- --------- ---------- ---------- ----------
John F. McDonnell.......... -- -- -- -- -- --
Michael B. Gustafson....... 200,000 5.15 $11.54 3/15/10 $1,451,489 $3,678,358
David M. Weishaar.......... -- -- -- -- -- --
James E. Kuenzel........... -- -- -- -- -- --
Dee J. Perry............... -- -- -- -- -- --
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
The following table sets forth information with respect to the Named
Executive Officers concerning exercisable and unexercisable options held as of
December 31, 2000. The dollar value of in-the-money options at December 31, 2000
is calculated by determining the difference between the fair market value of
$54.75 per share and the option exercise price.
NUMBER OF SECURITIES VALUE OF
UNDERLYING UNEXERCISED
UNEXERCISED IN-THE-MONEY
OPTIONS AT OPTIONS AT
DECEMBER 31, 2000 DECEMBER 31, 2000
SHARES --------------------------- ---------------------------
ACQUIRED ON VALUE
NAME EXERCISE(#) REALIZED($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---------------------- ----------- ----------- ----------- ------------- ----------- -------------
John F. McDonnell..... -- -- 690,000 250,000 $37,087,500 $ 13,437,500
Michael B. Gustafson.. 40,000 $ 754,800 30,000 330,000 1,593,600 15,567,600
David M. Weishaar..... -- -- 150,000 450,000 7,837,500 23,512,500
James E. Kuenzel...... 322 17,408 149,678 450,000 7,783,256 23,400,000
Dee J. Perry.......... 300,000 14,375,000 -- 200,000 -- 10,750,000
MANAGEMENT BONUS PROGRAM
All of our executive officers and many of our other senior employees are
eligible for a bonus based upon achievement of specified annual or quarterly
objectives. There is no formal agreement with respect to this program and
objectives for bonuses are set annually by the Board of Directors. Currently the
bonus is calculated as a percentage of base compensation and can range from 10%
to 35% for non-executive officers and from 25% to 50% for executive officers.
For non-executive officers, the bonus is tied to achievement of quarterly
objectives agreed to by the employee and their manager. For executive officers,
the bonus is tied to achievement of annual planned operating profit or revenue
and achievement of quarterly objectives. Typically, 70% of an executive
officer's bonus is tied to achievement of annual planned profit and 30% to
achievement of quarterly objectives. Unlike other executive officers, Mr.
Gustafson's compensation is tied more directly to bonuses based on the
achievement of annual and quarterly objectives.
CHANGE OF CONTROL ARRANGEMENTS/EMPLOYMENT AGREEMENTS
All of our executive officers have entered into severance agreements and key
employee agreements with us. Our severance agreements grant our executive
officers a payment, in a lump sum or according to our normal payroll timetable,
equal to four times (eight times for Ms. Cooper, our new Chief Financial
Officer) the average
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of their quarterly compensation over the preceding eight calendar quarters,
payment for all accrued but unused vacation days, the provision of health
benefits for a period of time and automatic acceleration of the vesting of all
stock options held if we terminate their employment upon a change in control and
provide that our executive officers will not engage in any activity that
conflicts with their obligations to us, induce other employees to leave us, or
compete with us for a period of one year after termination of their employment.
Under the terms of the key employee agreement, all confidential, proprietary or
other trade secret information and all other discoveries, inventions, processes,
methods and improvements made by the employee are our property. In addition,
pursuant to the agreement, employees may not compete with us for one year after
termination of their employment.
LIMITATION OF LIABILITY AND INDEMNIFICATION
Our amended and restated certificate of incorporation and amended and
restated by-laws provide that we shall indemnify our directors and officers to
the fullest extent that Delaware law permits. Delaware law permits a corporation
to indemnify any director, officer, employee or agent made or threatened to be
made a party to any pending or completed proceeding if the person acted in good
faith and in a manner that the person reasonably believed to be in the best
interests of the corporation and, with respect to any criminal proceeding, had
no reasonable cause to believe that his or her conduct was unlawful.
Our amended and restated certificate of incorporation limits the liability
of our directors to the maximum extent permitted by Delaware law. Delaware law
provides that directors will not be personally liable for monetary damages for
breach of their fiduciary duties as directors, except liability for:
- any breach of their duty of loyalty to the corporation or its
stockholders;
- acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;
- unlawful payments of dividends or unlawful stock repurchases or
redemptions; or
- any transaction from which the director derived an improper personal
benefit.
This provision has no effect on any non-monetary remedies that may be
available to us or our stockholders, nor does it relieve us or our officers or
directors from compliance with federal or state securities laws.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers, or persons controlling us under
the provisions that we describe above or otherwise, we have been informed that
in the opinion of the Securities and Exchange Commission, this indemnification
is against public policy as expressed in the Securities Act of 1933 and is
therefore unenforceable.
Our amended and restated by-laws also permit us to purchase and maintain
insurance on behalf of any officer or director for any liability arising out of
his or her actions in that capacity, regardless of whether our by-laws would
otherwise permit indemnification for that liability. We currently have liability
insurance for our officers and directors.
At the present time, there is no pending litigation or proceeding involving
any of our directors, officers, employees or agents in which indemnification
will be required or permitted. We are not aware of any threatened litigation or
proceeding which may result in a claim for indemnification.
EMPLOYEE BENEFIT PLANS
1997 Stock Option Plan
Our Board of Directors and our stockholders approved and adopted our 1997
Stock Option Plan in October 1997. As of December 31, 2000, approximately
2,576,175 million shares of our Class B common stock were reserved for issuance
under the 1997 Stock Option Plan. Under the terms of the 1997 Stock Option Plan,
our Board of Directors may grant incentive stock options and non-qualified stock
options to our employees and non-qualified stock options to our directors,
provided that certain eligibility requirements are satisfied. Our Board of
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Directors administers the 1997 Stock Option Plan, but has delegated to the
Compensation Committee the authority to administer the plan.
Subject to the provisions of the 1997 Stock Option Plan, our Board of
Directors or Compensation Committee has the authority to select eligible persons
to whom options will be granted and determine the terms of each option,
including:
o the duration of the option, which may not exceed 10 years;
o whether an option will be an incentive stock option or a non-qualified
stock option;
o the number of shares of Class B common stock covered by the option; and
o when the option becomes exercisable.
The exercise price per share of Class B common stock for:
o non-qualified options must be no less than 85% of the fair market value
per share of the Class B common stock subject to the option;
o incentive stock options must be no less than the fair market value of the
Class B common stock subject to the option; and
o incentive stock options granted to an employee owning more than 10% of
the total combined voting power of all classes of our capital stock, or
of any related company, must not be less than 110% of the fair market
value per share of the Class B common stock.
Initially, each incentive stock option granted is exercisable over a period
determined by the Board of Directors or the Compensation Committee in its
discretion, not to exceed ten years from the date of the grant as required by
the Internal Revenue Code of 1986. In addition, the exercise period for an
incentive stock option may not exceed five years from the date of the grant if
the option is granted to an individual who, at the time of the grant, owns more
than 10% of the total combined voting power of all classes of our capital stock.
The Board of Directors or the Compensation Committee generally has the right to
accelerate the exercisability of any options granted under the 1997 Stock Option
Plan that would otherwise be unexercisable. In the event of certain changes in
control, the acquiring or successor corporation may assume or grant substitute
options for options then outstanding under the 1997 Stock Option Plan, or such
options shall terminate.
The 1997 Stock Option Plan expires on September 30, 2007, except as to
options or awards outstanding on that date. Subject to the terms of the 1997
Stock Option Plan, the Board of Directors or the Compensation Committee may
terminate or amend the 1997 Stock Option Plan at any time.
As of December 31, 2000, options for the purchase of an aggregate of
11,891,136 shares of Class B common stock at a weighted average exercise price
of $7.41 were outstanding under the 1997 Stock Option Plan.
401(k) Plan
The Company has adopted a 401(k) Plan. Participants in our 401(k) plan may
contribute up to 15% of their total annual compensation, not to exceed the
specified statutory limit, which was $10,500 in calendar year 2000. The 401(k)
plan permits, but does not require, us to make contributions to the 401(k) plan
on behalf of our employees. Our current practice is to match $.50 on each dollar
of an employee's contributions up to the first 6% of an employee's compensation
with a total maximum matching contribution of 3% of an employee's compensation.
All contributions to the 401(k) plan by or on behalf of employees are subject to
the aggregate annual limits prescribed by the Internal Revenue Service. Under
our 401(k) plan, our participants received full and immediate vesting of their
contributions and are vested in matching contributions over a three year period.
35
38
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
No interlocking relationship exists between our Board of Directors or
Compensation Committee and the board of directors or compensation committee of
any other entity, nor has any interlocking relationship existed in the past.
DIRECTOR COMPENSATION
With the exception of John F. McDonnell and David A. Donatelli, all of our
directors are compensated for their services as board or committee members in
fiscal year 2000. Each director other than Mr. McDonnell and Mr. Donatelli
received in fiscal year 2000 an annual director's fee of $10,000, plus $1,000
for each board meeting and $1,000 for each committee meeting. Our practice has
been to grant directors options to purchase 50,000 shares of our Class B common
stock when they became directors and to grant them options to purchase an
additional 20,000 shares of our Class B common stock each year thereafter. In
October 1997, before he became a director, Mr. McDonnell was granted an option
to purchase 1,000,000 shares of our Class B common stock and has not been
granted options since. Mr. Donatelli has not been granted any options to
purchase our common stock.
REPORT OF THE COMPENSATION COMMITTEE OF THE BOARD OF DIRECTORS
The following is the report of the Compensation Committee of the Board of
Directors with respect to the compensation paid to the Company's executive
officers during fiscal year 2000. Actual compensation earned during fiscal year
2000 by the Named Executive Officers is shown in the Summary Compensation Table.
COMPENSATION PHILOSOPHY
The Company operates in the extremely competitive and rapidly changing high
technology industry. The Compensation Committee believes that the compensation
programs for the executive officers should be designed to attract, motivate and
retain talented executives responsible for the success of the Company and should
be determined within a competitive framework and based on the achievement of
designated business objectives, individual contribution, customer satisfaction
and financial performance. Within this overall philosophy, the Compensation
Committee's objectives are to:
o Provide a competitive total compensation package that takes into
consideration the compensation practices of companies with which the
Company competes for executive talent.
o Provide variable compensation opportunities that are linked to
achievement of financial, organization, management and individual
performance goals.
o Align the financial interests of executive officers with those of
stockholders by providing executives with an equity stake in the
Company.
COMPONENTS OF EXECUTIVE COMPENSATION
The compensation program for the Company's executive officers consists of the
following components:
o Base Salary
o Management Bonus Program
o Long-Term Stock Option Incentives
BASE SALARY
The Compensation Committee reviewed fiscal 2000 salaries for the Chief
Executive Officer in January 2000, and the other Named Executive Officers in
late 1999. Base salaries were established by the Compensation Committee based
upon competitive compensation data, an executive's job responsibilities, level
of experience, individual performance and contribution to the business. No
specific formula was applied to determine the
36
39
weight of each factor. The Compensation Committee based its determination of Mr.
McDonnell's salary on both his individual performance and the salaries paid to
chief executive officers of peer companies. Based on its review, Mr. McDonnell's
salary was increased by five percent for 2000.
MANAGEMENT BONUS PROGRAM
All of our executive officers are eligible for a bonus based upon achievement
of specified annual or quarterly objectives. There is no formal agreement with
respect to this program and objectives for bonuses are set annually by the Board
of Directors. Currently the bonus is calculated as a percentage of base
compensation and can range from 25% to 50% for executive officers. For executive
officers, the bonus is tied to achievement of annual planned operating profit or
revenue and achievement of quarterly objectives. Typically, 70% of an executive
officer's bonus is tied to achievement of annual planned profit and 30% to
achievement of quarterly objectives. Unlike other executive officers, Mr.
Gustafson's compensation is tied more directly to bonuses based on the
achievement of annual and quarterly objectives.
LONG-TERM STOCK OPTION INCENTIVES
The Compensation Committee provides the Company's executive officers with
long-term incentive compensation through grants of options to purchase the
Company's Class B common stock. The goal of the long-term stock option incentive
program is to align the interests of executive officers with those of the
Company's stockholders and to provide each executive officer with a significant
incentive to manage the Company from the perspective of an owner with an equity
stake in the business. It is the belief of the Compensation Committee that stock
options directly motivate an executive to maximize long-term stockholder value.
The options also utilize vesting periods that encourage key executives to
continue in employ of the Company. The Compensation Committee considers the
grant of each option subjectively, reviewing factors such as the anticipated
future contribution of the executive toward the attainment of the Company's
long-term strategic performance goals. In 2000, the Compensation Committee
typically granted new hire options to executive officers joining the Company.
The Compensation Committee is evaluating the use of options for retention and
the possibility of having annual option grants for executive officers. In fiscal
2000, no options were granted to Mr. McDonnell because the Compensation
Committee believed that his current option status was competitive based on
market data and his future vesting.
SECTION 162(m)
The Company has considered the potential future effects of Section 162(m)
of the Internal Revenue Code on the compensation paid to the Company's executive
officers. Section 162(m) disallows a tax deduction for any publicly held
corporation for individual compensation exceeding $1.0 million in any taxable
year for any of the Named Executive Officers, unless compensation is
performance-based. The Company will seek to qualify the variable compensation
paid to its executive officers for an exemption from the deductibility
limitations of Section 162(m).
Respectfully submitted by:
The Compensation Committee
Thomas M. Uhlman, Chairman
Laurence G. Walker
37
40
PERFORMANCE GRAPH
Set forth below is a line graph comparing the annual percentage change in
the cumulative return to the stockholders of our Class B Common Stock with the
cumulative return of the NASDAQ Market Index and the SIC Code Computer
Peripheral Equipment Index for the period commencing August 9, 2000 and ending
on December 31, 2000. Returns for the indices are weighted based on market
capitalization at the beginning of each measurement point.
[GRAPH]
COMPANY/INDEX 8/9/2000 8/31/2000 9/29/2000 10/31/2000 11/30/2000 12/29/2000
- ------------------------------ -------- --------- --------- ---------- ---------- ----------
McDATA Corporation $ 100.00 $ 125.71 $ 143.63 $ 97.42 $ 63.11 $ 63.99
SIC Code Computer
Perip. Equipment Index 100.00 112.31 86.41 83.39 66.72 72.85
NASDAQ 100.00 111.50 97.44 88.85 68.69 65.17
- ----------
(1) The graph assumes that $100 was invested on August 9, 2000 in the Company's
Class B common stock, in the NASDAQ Market Index and the SIC Code Computer
Peripheral Equipment Index, and that all dividends were reinvested. No dividends
have been declared or paid on the Company's Class B common stock. Stockholder
returns over the indicated period should not be considered indicative of future
stockholder returns.
The information contained above under the captions "Report of the
Compensation Committee of the Board of Directors" and "Performance Graph" shall
not be deemed to be "soliciting material" or to be "filed" with the Securities
and Exchange Commission, nor shall such information be incorporated by reference
into any future filing under the Securities Act of 1933, as amended, or the
Securities Exchange Act of 1934, as amended, except to the extent that the
Company specifically incorporates it by reference into such filing.
38
41
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information concerning the beneficial
ownership of our common stock as of December 31, 2000. Unless otherwise
indicated, the address of each listed shareholder is c/o McDATA Corporation, 310
Interlocken Parkway, Broomfield, CO 80021.
We have determined beneficial ownership in accordance with the rules of the
Securities and Exchange Commission. Except as indicated by the footnotes below,
we believe, based on the information furnished to us, that the persons and
entities named in the tables below have sole voting and investment power with
respect to all shares of common stock that they beneficially own, subject to
applicable community property laws. We have based our calculation of the
percentage of beneficial ownership on the number of shares of Class A common
stock outstanding on December 31, 2000, or the number of shares of Class B
common stock outstanding on December 31, 2000, as the case may be. There were
81,000,000 shares of Class A common stock outstanding on December 31, 2000, and
28,907,689 shares of Class B common stock outstanding on December 31, 2000.
In computing the number of shares of Class B common stock beneficially owned
by a person and the percentage ownership of that person, we deemed outstanding
shares of common stock subject to options held by that person that are currently
exercisable or exercisable within 60 days of December 31, 2000. Asterisks
represent beneficial ownership of less than one percent.
NUMBER OF SHARES OF PERCENT OF SHARES OF
COMMON STOCK COMMON STOCK CLASS
BENEFICIALLY OWNED BENEFICIALLY OWNED
----------------------- ------------------
NAME AND ADDRESS OF THE BENEFICIAL OWNER CLASS NUMBER
---------------------------------------- ----- ------
5% STOCKHOLDER
EMC Corporation.......................... Class A 81,000,000 100.00%
Waddell & Reed Investment Management
Company............................... Class B 2,419,650 8.37%
T. Rowe Price Associates, Inc............ Class B 1,819,700 6.29%
Patricia L. McDonnell(1)................. Class B 4,051,500 14.02%
John F. McDonnell(2)..................... Class B 6,700,000 23.18%
EXECUTIVE OFFICERS AND DIRECTORS
John F. McDonnell(2)..................... Class B 6,700,000 23.18%
Richard A. Carlson(3).................... Class B 600,000 2.08%
Earl T. Carothers........................ Class B -- --
Michael B. Gustafson(4).................. Class B 100,000 *
James E. Kuenzel......................... Class B 150,000 *
Thomas O. McGimpsey(5)................... Class B -- --
Dee J. Perry............................. Class B 600,000 2.08%
John H. Runne............................ Class B 811 *
Jeffery O. Vogel(6)...................... Class B 100,000 *
David M. Weishaar........................ Class B 150,000 *
David A. Donatelli....................... Class B -- --
John W. Gerdelman(7)..................... Class B 35,000 *
Charles C. Johnston(8)................... Class B 35,000 *
D. Van Skilling(9)....................... Class B 35,000 *
Thomas M. Uhlman(10)..................... Class B 35,000 *
Laurence G. Walker(11)................... Class B 35,100 *
All Executive Officers and Directors as a
group (16 persons)..................... Class B 8,575,911 29.67%
- ----------
(1) Includes 50,500 shares held by Patricia L. McDonnell, as custodian for
a custodial account.
(2) Includes 40,000 shares held by the McDonnell Family Partnership,
L.L.L.P., a limited liability limited partnership of which Mr.
McDonnell is the general partner and 690,000 shares subject to options
exercisable within 60 days after December 31, 2000. The number of
shares of common stock beneficially
39
42
owned by John F. McDonnell does not include 4,001,000 shares held by
Patricia L. McDonnell, Mr. McDonnell's wife, and 50,500 shares held by
Patricia L. McDonnell, as custodian for a custodial account.
Mr. McDonnell disclaims beneficial ownership of the shares of Class B
common stock held by Mrs. McDonnell personally and as custodian.
(3) Includes 100,000 shares held by Kelly L. Carlson, Mr. Carlson's
daughter, and 100,000 shares held by Alan J. Carlson, Mr. Carlson's
son. Mr. Carlson disclaims beneficial ownership of the shares of Class
B common stock held by Kelly Carlson and Alan Carlson.
(4) Includes 60,000 shares subject to stock options exercisable within 60
days after December 31, 2000.
(5) Mr. McGimpsey joined McDATA in July 2000 and does not beneficially hold
any shares of common stock of McDATA as of December 31, 2000.
(6) Includes 100,000 shares subject to stock options exercisable within 60
days after December 31, 2000.
(7) Includes 35,000 shares subject to stock options exercisable within 60
days after December 31, 2000.
(8) Includes 35,000 shares subject to stock options exercisable within 60
days after December 31, 2000.
(9) Includes 35,000 shares subject to stock options exercisable within 60
days after December 31, 2000.
(10) Includes 35,000 shares subject to stock options exercisable within 60
days after December 31, 2000.
(11) Includes 35,000 shares subject to stock options exercisable within 60
days after December 31, 2000.
(*) Less than 1 percent.
OTHER MATTERS
In October 2000, new SEC rules went into effect that establish affirmative
defenses to insider trading claims under certain defined circumstances,
irrespective of the possession of material non-public information, for
transactions planned before coming into possession of such information.
Generally, such persons may purchase or sell such securities pursuant to a
binding pre-existing plan, contract or instruction (collectively a "Pre-Existing
Plan") which sets forth either (1) the amount, price and date of such trade, (2)
a formula, algorithm or computer program for determining amounts, prices and
dates; or (3) such Pre-Existing Plan does not permit the person to exercise any
subsequent influence over the trade. We anticipate that a number of executives
may establish Pre-Existing Plans in the near future for the purpose of selling a
portion of their shares of Class B common stock on or after May 2001 for
purposes of diversifying their holdings. Mr. Kuenzel is in the process of
establishing a Pre-Existing Plan and we anticipate other officers may do so in
the near future.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Since January 1, 1999, there has not been nor is there currently proposed
any transaction or series of similar transactions to which we were or are a
party in which the amount involved exceeds $60,000 and in which any director,
executive officer, holder of more than 5% of our common stock or any member of
the immediate family of any of the foregoing persons had or will have a direct
or indirect material interest other than (1) compensation agreements and other
arrangements, which are described in "Item 11 - Executive Compensation" and (2)
the transactions described in our Registration Statement on Form S-1, SEC File
No. 333-38106, declared effective on August 8, 2000.
In connection with the February 7, 2001 distribution of our Class A common
stock by EMC, the Investors' Rights Agreement to which Mr. McDonnell was a
party, was terminated in accordance with its terms.
40
43
PART IV
ITEM 14. FINANCIAL STATEMENT SCHEDULES, REPORTS ON FORM 8-K AND EXHIBITS
Page
----
(a) Documents filed as part of this report
(i) Index to Consolidated Financial Statements........................................ F-1
Report of Independent Accountants................................................. F-2
Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 2000 and 1999...................... F-3
Consolidated Statements of Operations for the years ended December 31, 2000, 1999
and 1998....................................................................... F-4
Consolidated Statements of Changes in Stockholders' Equity for the years ended
December 31, 2000, 1999 and 1998............................................... F-5
Consolidated Statements of Cash Flows for the years ended December 31, 2000,
1999 and 1998.................................................................. F-6
Consolidated Statements of Comprehensive Income (Loss) for the years ended
December 31, 2000, 1999 and 1998............................................... F-7
Notes to Consolidated Financial Statements........................................ F-8 through F-21
(ii) Consolidated Financial Statement Schedule:
Schedule II-Valuation and Qualifying Accounts..................................... S-1
Financial statement schedules other than the one listed above have been omitted
because the required information is contained in the consolidated financial
statements and notes thereto or because such schedules are not required or
applicable.
(b) Reports on Form 8-K:
We filed the following reports on Form 8-K during the fourth quarter of
2000 and through the filing of this Annual Report:
(i) Form 8-K dated January 12, 2001 providing notification that EMC's Board
approved the declaration of a dividend of McDATA Class A common stock.
(ii) Form 8-K dated January 25, 2001 providing excerpts from the EMC
Information Statement relating to the dividend of McDATA Class A common
stock.
(iii) Form 8-K dated February 1, 2001 providing notification that McDATA and
Hewlett-Packard Company entered into an OEM Purchase Agreement.
(iv) Form 8-K dated February 2, 2001 providing notification that established
"when-issued" trading for McDATA Class A common stock.
(v) Form 8-K dated February 8, 2001 providing notification that the
dividend of McDATA Class A common stock had occurred.
(c) Exhibits:
Exhibits identified in parentheses below are on file with the
Commission and are incorporated herein by reference. All other exhibits are
provided as part of this submission.
41
44
(3.1) Amended and Restated Certificate of Incorporation of the Company
(3.2) Amended and Restated By-laws of the Company
(4.1) Form of Company's Class B Common Stock Certificates
(4.1.1) Form of Company's Class A Common Stock Certificates
(4.2) Investors' Rights Agreement dated as of October 1, 1997 by and
among the Company, EMC Corporation, McDATA Holdings Corporation
and Certain Investors
(4.3) Amendment No. 1 to the Investors' Rights Agreement dated May 23,
2000 by and among the Company, McDATA Holdings Corporation and
certain Investors
(10.1) Asset Transfer Agreement dated as of October 1, 1997 by and among
the Company, EMC Corporation, and McDATA Holdings Corporation
(10.2) Investors' Rights Agreement dated as of October 1, 1997 by and
among the Company, EMC Corporation, McDATA Holdings Corporation
and certain Investors (see Exhibit 4.2)
(10.3) Amendment No. 1 to the Investors' Rights Agreement dated May 23,
2000 by and among the Company, McDATA Holdings Corporation and
certain Investors (see Exhibit 4.3)
10.3.1 Termination of Investors' Rights Agreement, dated as of January
24, 2001, by and among the Company, McDATA Holdings Corporation
and Certain Investors.
(10.4) Services Agreement dated as of October 1, 1997 by and among EMC
Corporation, McDATA Holdings Corporation and the Company
(10.5) Letter Agreement dated April 19, 1999 by and between the Company
and McDATA Holdings Corporation
(10.6) Technology Rights Agreement dated as of October 1, 1997 by and
among the Company, EMC Corporation and McDATA Holdings Corporation
(10.7) Amended and Restated Tax Sharing Agreement dated as of May 31,
2000 by and among EMC Corporation, McDATA Holdings Corporation and
the Company
(10.8) Form of Master Transaction Agreement entered into by and among the
Company and EMC Corporation dated May 31, 2000
(10.9) Form of Indemnification and Insurance Matters Agreement entered
into by and among the Company and EMC Corporation dated May 31,
2000
(10.10) Master Confidential Disclosure and License Agreement dated as of
May 31, 2000 by and among the Company and EMC Corporation
(10.11)+ Reseller Agreement dated as of February 22, 2000 by and between
International Business Machines Corporation and the Company
(10.12) Amendment Number One to the Resale Agreement dated June 30, 2000
by and between International Business Machines Corporation and the
Company
(10.13)+ OEM Purchase and License Agreement dated as of May 19, 2000 by and
between EMC Corporation and the Company
(10.14)+ Development Agreement dated as of May 19, 2000 by and between EMC
Corporation and the Company
(10.15)+ Manufacturing Agreement dated as of June 17, 1992 by and between
SCI Systems, Inc. and the Company
(10.16)+ OEM and License Agreement dated as of April 27, 1999 by and
between Brocade Communication Systems, Inc. and the Company
(10.17) Lease dated September 12, 1997 by and between the Company and
WHLNF Real Estate Limited Partnership
(10.18) Lease dated November 2, 1999 by and between the Company and the
Mills Family LLC
(10.19) Lease dated May 28, 1997 by and between the Company and 1211486
Ontario Limited
[10.19.1] Lease dated October 6, 2000, by and between the Company and Amber
Drive I, LLC
10.19.2 Lease dated February 9, 2001 by and between the Company and
Deutsche Bank
10.19.3 Participation Agreement dated February 9, 2001 by and between the
Company and Deutsche Bank
(10.20)* Form of Severance Agreement
(10.21)* 1997 Stock Option Plan
(10.22)* Form of Stock Option Agreement for 1997 Stock Option Plan
(10.23)* Description of the Company's Management Bonus Program
21 Subsidiaries of Company
42
45
23 Consent of PricewaterhouseCoopers LLP
24 Power of Attorney
- ----------
( ) Exhibits previously filed in the Company's Registration Statement on Form
S-1, SEC File No. 333-38106, declared effective on August 8, 2000.
[ ] Exhibits previously filed in the Company's Quarterly Report on Form 10-Q for
the fiscal quarter ended September 30, 2000.
+ Portions of these Exhibits have been omitted and filed separately with the
Securities and Exchange Commission pursuant to an order for confidential
treatment.
* Executive compensation plans and arrangements.
43
46
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, in the City of
Broomfield, State of Colorado, on March 2, 2001.
McDATA Corporation
By: /s/ Janet K. Cooper
Senior Vice President of
Finance and Administration
and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the date indicated.
PRINCIPAL EXECUTIVE OFFICER
/s/ John F. McDonnell President and Chief Executive Officer
PRINCIPAL FINANCIAL OFFICER
/s/ Janet K. Cooper Senior Vice President of Finance and
Administration and Chief Financial Officer
PRINCIPAL ACCOUNTING OFFICER
/s/ Janet K. Cooper Senior Vice President of Finance and
Administration and Chief Financial Officer
DIRECTORS:
/s/ John F. McDonnell Chairman of the Board
/s/ John W. Gerdelman
/s/ Charles C. Johnston
/s/ D. Van Skilling
/s/ Thomas M. Uhlman
/s/ Laurence G. Walker
44
47
McDATA CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE
----
Report of Independent Accountants.................................................... F-2
Consolidated Balance Sheets.......................................................... F-3
Consolidated Statements of Operations................................................ F-4
Consolidated Statements of Changes in Stockholders' Equity........................... F-5
Consolidated Statements of Cash Flows................................................ F-6
Consolidated Statements of Comprehensive Income (Loss)............................... F-7
Notes to Consolidated Financial Statements........................................... F-8
Schedule:
Schedule II - Valuation and Qualifying Accounts.................................. S-1
Note: All other financial statement schedules are omitted because they
are not applicable or required information is included in the
consolidated financial statements or notes thereto.
F-1
48
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of McDATA Corporation:
In our opinion, the consolidated financial statements listed in the index
appearing under Item 14(a)(i) on page 41 present fairly, in all material
respects, the financial position of McDATA Corporation and its subsidiaries at
December 31, 2000 and 1999, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2000, in
conformity with accounting principles generally accepted in the United States of
America. In addition, in our opinion, the financial statement schedule listed in
the index appearing under Item 14(a)(ii) on page 41 presents fairly, in all
material respects, the information set forth therein when read in conjunction
with the related consolidated financial statements. These financial statements
and financial statement schedule are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements and financial statement schedule based on our audits. We conducted
our audits of these statements in accordance with auditing standards generally
accepted in the United States of America, which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
Broomfield, Colorado
January 24, 2001, except for Note 16 which is as of February 9, 2001
F-2
49
McDATA CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
DECEMBER 31,
------------------------
2000 1999
---------- ----------
ASSETS
Current assets:
Cash and cash equivalents ......................................... $ 174,630 $ 6,897
Short-term investments ............................................ 191,060 --
Accounts receivable, net of allowance for doubtful
accounts of $284 and $95, respectively ........................ 14,708 9,993
Receivable from Parent ............................................ 44,089 3,591
Inventories, net .................................................. 23,105 6,952
Deferred tax asset ................................................ 9,232 2,615
Prepaid expenses and other current assets ......................... 3,467 3,115
---------- ----------
Total current assets .................................................. 460,291 33,163
Property and equipment, net ........................................... 26,894 13,800
Long-term investments ................................................. 22,378 --
Other assets, net ..................................................... 1,806 1,461
---------- ----------
Total assets ................................................ $ 511,369 $ 48,424
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term debt--Parent ........................................... $ -- $ 1,900
Accounts payable .................................................. 26,547 9,013
Accrued liabilities ............................................... 9,058 4,480
Deferred revenue .................................................. 7,778 371
Income taxes payable .............................................. 10,103 --
Obligations under capital leases .................................. 2,446 1,586
---------- ----------
Total current liabilities ............................................. 55,932 17,350
Obligations under capital leases ...................................... 1,624 1,175
Deferred tax liability ................................................ -- 275
Commitments and contingencies (Note 13)
Stockholders' equity:
Preferred stock, $0.01 par value, 25,000,000 shares
Authorized, no shares issued or outstanding ................... -- --
Common stock, Class A, $0.01 par value, 250,000,000
shares authorized, 81,000,000 shares issued and
outstanding ................................................... 810 810
Common stock, Class B, $0.01 par value, 200,000,000
shares authorized, 28,907,689 and 11,980,936 shares issued
and outstanding, respectively ................................. 289 120
Additional paid-in capital ........................................ 454,009 60,265
Deferred compensation ............................................. (24,850) (24,245)
Accumulated other comprehensive income ............................ 117 --
Retained earnings (accumulated deficit) ........................... 23,438 (7,326)
---------- ----------
Total stockholders' equity ............................................ 453,813 29,624
---------- ----------
Total liabilities and stockholders' equity .................. $ 511,369 $ 48,424
========== ==========
The accompanying notes are an integral part of these
consolidated financial statements.
F-3
50
McDATA CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31,
--------------------------------------
2000 1999 1998
---------- ---------- ----------
Revenues:
Product revenue ............................................... $ 58,541 $ 29,466 $ 5,242
Product revenue--Parent ...................................... 172,824 48,111 5,632
Service revenue--Parent ...................................... 17,321 17,686 25,674
---------- ---------- ----------
Total revenue ....................................... 248,686 95,263 36,548
Cost of revenues:
Cost of product revenue ....................................... 31,518 21,337 3,786
Cost of product revenue--Parent .............................. 82,314 23,245 3,208
Cost of service revenue--Parent .............................. 5,711 5,698 6,111
---------- ---------- ----------
Gross profit ........................................ 129,143 44,983 23,443
Operating expenses:
Research and development ...................................... 37,818 24,001 18,298
Selling and marketing ......................................... 33,955 15,787 10,305
General and administrative .................................... 7,492 3,940 3,405
Amortization of deferred compensation (excludes
amortization of deferred compensation included in
costs of product and service revenue of $1,907,
$709 and $0, respectively) ................................ 6,459 2,185 --
---------- ---------- ----------
Operating expenses .................................. 85,724 45,913 32,008
---------- ---------- ----------
Income (loss) from operations ................................. 43,419 (930) (8,565)
Interest income ............................................... 8,761 241 632
Interest expense .............................................. (525) (1,113) (309)
---------- ---------- ----------
Income (loss) before income taxes ............................. 51,655 (1,802) (8,242)
Income tax expense (benefit) .................................. 20,891 (186) (3,124)
---------- ---------- ----------
Net income (loss) ............................................. $ 30,764 $ (1,616) $ (5,118)
========== ========== ==========
Basic net income (loss) per share ............................. $ 0.31 $ (0.02) $ (0.06)
========== ========== ==========
Shares used to compute basic net income (loss) per share ...... 99,989 91,638 91,000
========== ========== ==========
Diluted net income (loss) per share ........................... $ 0.28 $ (0.02) $ (0.06)
========== ========== ==========
Shares used to compute diluted net income (loss) per share .... 107,953 91,638 91,000
========== ========== ==========
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
51
McDATA CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
Common Stock
------------------------------------------ Accumulated
Class A Class B Additional Other
-------------------- -------------------- Paid-In Deferred Comprehensive
Shares Amount Shares Amount Capital Compensation Income
----------- ------ ----------- ------ ---------- ------------ -------------
Balances at December 31, 1997 .... 81,000,000 $ 810 10,000,000 $ 100 $ 30,797 $ -- $ --
Issuance of common stock,
Class B upon exercise of
stock options .................... -- -- 2,000 -- 2 -- --
Net loss ......................... -- -- -- -- -- -- --
---------- ------ ---------- ------ ---------- ---------- ----------
Balances at December 31, 1998 .... 81,000,000 810 10,002,000 100 30,799 -- --
Issuance of common stock,
Class B upon exercise of stock
options .......................... -- -- 1,978,936 20 1,960 -- --
Deferred compensation ............ -- -- -- -- 27,139 (27,139) --
Amortization of deferred
compensation .................. -- -- -- -- -- 2,894 --
Tax benefit of stock
options ........................ -- -- -- -- 367 -- --
Net loss ......................... -- -- -- -- -- -- --
---------- ------ ---------- ------ ---------- ---------- ----------
Balances at December 31, 1999 .... 81,000,000 810 11,980,936 120 60,265 (24,245) --
Issuance of common stock,
Class B through initial
public offering, net of
issuance costs.................... -- -- 14,375,000 144 376,463 -- --
Issuance of common stock,
Class B upon exercise of
stock options..................... -- -- 2,551,753 25 2,760 -- --
Deferred compensation ............ -- -- -- -- 8,971 (8,971) --
Amortization of deferred
compensation ..................... -- -- -- -- -- 8,366 --
Tax benefit of stock options ..... -- -- -- -- 5,550 -- --
Unrealized gain on investments ... -- -- -- -- -- -- 117
Net income ....................... -- -- -- -- -- -- --
---------- ------ ---------- ------ ---------- ---------- ----------
Balances at December 31, 2000 .... 81,000,000 $ 810 28,907,689 $ 289 $ 454,009 $ (24,850) $ 117
========== ====== ========== ====== ========== ========== ==========
Retained Total
Earnings Stockholders'
(Deficit) Equity
--------- -------------
Balances at December 31, 1997 .... $ (592) $ 31,115
Issuance of common stock,
Class B upon exercise of
stock options .................... -- 2
Net loss ......................... (5,118) (5,118)
---------- ----------
Balances at December 31, 1998 .... (5,710) 25,999
Issuance of common stock,
Class B upon exercise of stock
options .......................... -- 1,980
Deferred compensation ............ -- --
Amortization of deferred
compensation .................. -- 2,894
Tax benefit of stock
options ........................ -- 367
Net loss ......................... (1,616) (1,616)
---------- ----------
Balances at December 31, 1999 .... (7,326) 29,624
Issuance of common stock,
Class B through initial
public offering, net of
issuance costs.................... -- 376,607
Issuance of common stock,
Class B upon exercise of
stock options..................... -- 2,785
Deferred compensation ............ -- --
Amortization of deferred
compensation ..................... -- 8,366
Tax benefit of stock options ..... -- 5,550
Unrealized gain on investments ... -- 117
Net income ....................... 30,764 30,764
---------- ----------
Balances at December 31, 2000 .... $ 23,438 $ 453,813
========== ==========
The accompanying notes are an integral part of these
consolidated financial statements.
F-5
52
McDATA CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
--------------------------------------
2000 1999 1998
---------- ---------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) ...................................... $ 30,764 $ (1,616) $ (5,118)
Adjustments to reconcile net income (loss) to cash
Flows from operating activities:
Depreciation and amortization ...................... 8,689 5,734 4,213
Inventory provision ................................ 2,541 1,907 1,326
Noncash compensation expense ....................... 8,366 2,894 --
Deferred income taxes .............................. (7,149) (701) 1,011
Tax benefit from stock options exercised ........... 5,550 367 --
Changes in current assets and liabilities:
Accounts receivable, net.......................... (4,715) (7,357) (2,344)
Receivable from Parent ........................... (40,498) 6,818 9,318
Inventories ...................................... (19,487) (6,054) (4,693)
Prepaid expenses and other current assets ........ (352) (1,090) (1,145)
Other assets, net ................................ (592) 1,605 (1,946)
Accounts payable ................................. 17,534 5,117 1,922
Accrued liabilities .............................. 4,578 (362) 1,438
Deferred revenue ................................. 7,407 371 --
Income taxes payable ............................. 10,103 -- --
---------- ---------- ----------
Net cash provided by operating activities .............. 22,739 7,633 3,982
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment .................... (16,419) (3,305) (6,238)
Purchases of available for sale securities ............. (264,052) -- --
Maturities of available for sale securities ............ 35,000 -- --
Sales of available for sale securities ................. 15,802 -- --
---------- ---------- ----------
Net cash used in investing activities .................. (229,669) (3,305) (6,238)
---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of short-term debt - Parent .................... (1,900) -- --
Payment of obligations under capital leases ............ (2,829) (1,522) (1,054)
Proceeds from sale of stock, net of issuance costs...... 379,392 1,980 2
---------- ---------- ----------
Net cash provided by (used in) financing activities .... 374,663 458 (1,052)
---------- ---------- ----------
Net increase (decrease) in cash and cash
equivalents .......................................... 167,733 4,786 (3,308)
Cash and cash equivalents, beginning of period ......... 6,897 2,111 5,419
---------- ---------- ----------
Cash and cash equivalents, end of period ............... 174,630 $ 6,897 $ 2,111
========== ========== ==========
The accompanying notes are an integral part of these
consolidated financial statements.
F-6
53
McDATA CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
-------------------------------
2000 1999 1998
-------- -------- --------
Net income (loss) ..................................... $ 30,764 $ (1,616) $ (5,118)
Other comprehensive income net of tax:
Unrealized gain on investments, net of tax of
$71, $0 and $0, respectively ............... 117 -- --
-------- -------- --------
Comprehensive income (loss) ........................... $ 30,881 $ (1,616) $ (5,118)
======== ======== ========
The accompanying notes are an integral part of these
consolidated financial statements.
F-7
54
McDATA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- OVERVIEW AND BASIS OF PRESENTATION
On October 1, 1997 EMC Corporation (EMC or the Parent) formed McDATA Corporation
(McDATA or the Company) which is incorporated in Delaware. The Company was
formed when EMC transferred cash and net assets to McDATA pursuant to an Asset
Transfer Agreement. In exchange, EMC received 81,000,000 shares of the Company's
Class A common stock. Concurrently, with the Asset Transfer Agreement, minority
shareholders contributed $10,000,000 in cash in exchange for 10,000,000 shares
of the Company's Class B common stock. Each share of the Company's Class A
common stock entitled its holder to one vote, and each share of the Company's
Class B common stock entitles its holder to one-tenth (1/10) of one vote. After
the issuance and sale of the Company's Class A and Class B common stock to EMC
and the minority shareholders, respectively, EMC owned 89% of the Company and
the minority shareholders owned 11% of the Company. As McDATA was under the
control of EMC at the date of formation, there was no change in the accounting
basis of the Company's assets and liabilities in the consolidated financial
statements.
During the periods presented, McDATA was a majority-owned subsidiary of EMC. On
August 9, 2000, the Company completed an initial public offering of 14,375,000
shares of its Class B Common stock (including the exercise of the underwriters'
over-allotment option) and realized proceeds, after calculation of underwriter's
commissions, of approximately $377 million net of offering costs of
approximately $2.7 million. After completion of the offering, McDATA remained a
majority-owned subsidiary of EMC. As of December 31, 2000, EMC owned 81 million
shares of the Company's Class A common stock, or approximately 74% of the
outstanding common stock of the Company. EMC's ownership of the Class A common
stock represented approximately 97% of the combined voting power of the
Company's Class A and B common stock.
On February 7, 2000, EMC distributed its shares in McDATA Class A common stock
to EMC's shareholders of record as of January 24, 2001 (see Note 16).
McDATA designs, develops, manufactures and sells Fibre Channel switching devices
that enable enterprise-wide high performance storage area networks. The Company
sells its products through original equipment manufacturers and resellers,
including EMC Corporation and IBM, as well as systems integrators. The Company
also provides services for EMC's ESCON switch business under a service agreement
with EMC.
The consolidated financial statements include the assets, liabilities, operating
results and cash flows of McDATA and have been prepared using EMC's historical
bases in the assets and liabilities and the historical results of operations of
McDATA. Because McDATA's operations were substantially independent of EMC's
operations during all periods presented in the financial statements, the
Company's management does not believe that there were any corporate expenses
incurred by EMC that should be allocated to the Company. Accordingly, no
intercompany expense allocations have been included in the financial statements.
The consolidated financial statements do include certain allocations of interest
income and expense from participation in EMC's cash management system (see Note
12). The following is a list of the Company's wholly-owned subsidiaries as of
December 31, 2000:
COUNTRY OF
NAME FORMATION DATE OF FORMATION
---- ---------- -----------------
McDATA Technology Systems Ltd (formerly
Ecksberg Nominees Ltd.) Ireland April 4, 1999
McDATA F.S.C Barbados July 28, 1999
McDATA Japan KK Japan October 16, 2000
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the assets, liabilities, results
of operations, cash flows and changes in stockholders' equity of the Company and
its wholly-owned subsidiaries. All material intercompany transactions and
balances have been eliminated.
F-8
55
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
effect the reported amounts of assets, liabilities, revenues and expenses and
disclosure of contingent assets and liabilities. Actual results could differ
from these estimates.
Revenue Recognition
The Company generally recognizes revenue from product sales upon shipment
provided that (a) evidence of an arrangement exists (b) delivery has occurred
(c) the price to the customer is fixed or determinable and (d) collectibility
is assured. The Company accrues for warranty costs and sales returns at the time
of shipment based on its experience. In transactions that include multiple
products and/or services, the Company allocates the sales value among each of
the deliverables based on their relative fair values. Service revenue is
recognized over the contractual period or as the services are rendered. Revenue
from the service agreement with EMC (see Note 12) is recorded as earned pursuant
to the terms of the servicing contract.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of
credit risk are cash equivalents, short and long-term investments and accounts
receivable. The Company has a cash investment policy that limits investments to
investment grade instruments and limits the amount of investment with any single
financial institution.
The Company performs ongoing evaluations of its customers' financial condition
and, generally, requires no collateral from its customers. The Company's
customers include EMC as well as original equipment manufacturers, distributors,
systems integrators and end users. The majority of the Company's customers
operate in the computer industry.
During 2000, the Company earned approximately 68% of its total revenue from the
sales of its ED-5000 Enterprise Director. The Company had the following
customers that accounted for greater than 10% of each respective period's
revenue:
YEAR ENDED DECEMBER 31,
------------------------
2000 1999 1998
------ ------ ------
Customer A (Parent)....................... 76% 69% 86%
Customer B................................ 14% 13% --
Customer C................................ -- 11% --
These customers accounted for the following percentages of the Company's gross
accounts receivable, which is comprised of accounts receivable and receivable
from Parent:
DECEMBER 31,
----------------
2000 1999
------ ------
Customer A (Parent)....................... 75% 26%
Customer B................................ 15% 31%
Customer C................................ -- 18%
Cash Equivalents
Cash equivalents are short-term, highly liquid investments that are readily
convertible to cash and have remaining maturities of ninety days or less at date
of purchase.
F-9
56
Investments
The Company's investments consist of marketable debt securities that are
classified as either short-term or long-term based on Management's intent with
regard to holding the securities. As of December 31, 2000, all investments are
classified as "available-for-sale" and recorded at fair value in the
accompanying consolidated balance sheet. Fair values are determined using quoted
market prices.
Statement of Cash Flows Supplemental Information
YEAR ENDED DECEMBER 31,
-------------------------------
2000 1999 1998
-------- -------- --------
Cash flow information:
Interest incurred, expensed and paid ................ $ 525 $ 1,113 $ 309
Income taxes received from (paid to) parent ......... (7,957) 4,302 (202)
Income taxes paid directly to taxing authorities .... 4,763 -- --
Non cash activities:
Capital lease obligations incurred .................. 4,138 1,944 2,323
Transfer of inventory to fixed assets ............... 793 1,357 --
Fair Value of Financial Instruments
The carrying value of financial instruments, including cash equivalents, gross
accounts receivable, accounts payable and accrued liabilities, approximate fair
value due to their short maturities. Based upon borrowing rates currently
available to the Company, with similar terms, the carrying value of the capital
lease obligations approximate their fair value. The fair values of the Company's
investments are disclosed in Note 3.
Impairment of Long-Lived Assets
The Company periodically evaluates the carrying value of long-lived assets when
events and circumstances warrant such a review. The carrying value of a
long-lived asset is considered impaired when the anticipated undiscounted cash
flows from such asset is separately identifiable and is less than its carrying
value. In that event, a loss is recognized to the extent that the carrying value
exceeds the fair value of the long-lived asset. Fair value is determined
primarily using the anticipated cash flows discounted at a rate commensurate
with the risk involved.
Earnings and Loss Per Share
Basic net income or loss per share is computed using the weighted average number
of common shares outstanding during the period. Diluted net income per share is
computed using the weighted average number of common and dilutive common
equivalent shares outstanding during the period. Dilutive common equivalent
shares consist of stock options.
Following is a reconciliation between basic and diluted earnings per share as
of December 31, 2000 (in thousands except per share information):
PER SHARE
INCOME SHARES AMOUNT
-------- -------- ---------
Net income -- basic EPS............... $ 30,764 99,989 $ 0.31
Effect of stock options............... -- 7,964 (0.03)
-------- -------- ---------
Net income -- diluted EPS............. $ 30,764 107,953 $ 0.28
======== ======== =========
Potentially dilutive securities totaling 198,550, 11,940,514 and 11,262,750,
were excluded from the historical diluted income or loss per common share
calculations because of their anti-dilutive effect for 2000, 1999 and 1998,
respectively.
Stock-Based Compensation
The Company accounts for grants of stock options and common stock purchase
rights according to Accounting Principles Board Opinion No. 25, Accounting for
Stock Issues to Employees (APB 25), and related interpretations. Any deferred
stock compensation calculated pursuant to APB 25 is amortized ratably over the
vesting period of the individual options, generally four years.
F-10
57
Advertising
The Company expenses advertising costs as incurred. Advertising expenses for
2000, 1999 and 1998 were approximately $1,449,000, $531,000 and $696,000,
respectively.
Research and Development
Research and development costs are expensed as incurred.
Software Development Costs
The Company capitalizes eligible computer software development costs upon the
establishment of technological feasibility, which it has defined as completion
of designing, coding and testing activities. For all periods presented, the
amount of costs eligible for capitalization, after consideration of factors such
as realizable value, were not material and, accordingly, all software
development costs have been charged to research and development expenses in the
consolidated statements of operations.
Internal-Use Software Development Costs
Costs of developing and implementing software for internal use, which meet
certain criteria, were capitalized and are being amortized over the expected
useful life of the software of between two and five years. The Company
capitalized approximately $3,239,000, $401,000 and $1,913,000 during 2000, 1999
and 1998, respectively. Amortization expense totaled $1,090,000, $424,000 and $0
during 2000, 1999 and 1998, respectively.
Reclassifications
Certain prior year amounts have been reclassified to conform with the 2000
presentation.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities." SFAS 133 is effective for all fiscal quarters of all
fiscal years beginning after June 15, 2000. The Company adopted SFAS 133 on
January 1, 1999. To date, the Company has not entered into any derivative
instruments, so the adoption has had no effect on the financial position or
results of operations of the Company.
In December 1999, the Securities and Exchange Commission (the "Commission")
issued Staff Accounting Bulletin No. 101, Revenue Recognition in Financial
Statements, as amended. SAB 101 summarizes certain of the Commission's views in
applying generally accepted accounting principles to revenue recognition in
financial statements. The Company has applied the provisions of SAB 101 and the
related interpretive guidance in the consolidated financial statements. The
adoption of SAB 101 did not have a material impact on the Company's financial
condition or results of operations.
In March 2000, the Financial Accounting Standards Board issued FASB
Interpretation No. 44, Accounting for Certain Transactions Involving Stock
Compensation - an interpretation of APB Opinion No. 25, ("FIN 44"). FIN 44
clarifies the application of APB Opinion No. 25 and among other issues clarifies
the following: the definition of an employee for purposes of applying APB
Opinion No. 25, the criteria for determining whether a plan qualifies as a
noncompensatory plan, the accounting consequences of various modifications to
the terms of previously fixed stock options or awards, and the accounting for an
exchange of stock compensation awards in a business combination. FIN 44 was
effective as of July 1, 2000, but certain conclusions in FIN 44 cover specific
events that occurred after either December 15, 1998 or January 12, 2000. The
adoption of FIN 44 did not have a material impact on the Company's financial
condition or results of operations.
F-11
58
NOTE 3 -- INVESTMENTS
Investments consisted of the following available for sale securities as of
December 31, 2000 (in thousands):
UNREALIZED UNREALIZED
AMORTIZED HOLDING HOLDING FAIR
COST GAINS LOSSES VALUES
---------- ---------- ---------- ---------
Debt securities:
U.S. Government agency............... $ 71,242 $ 34 $ 1 $ 71,275
State and local government........... 142,008 158 3 142,163
---------- ---------- ---------- ---------
$ 213,250 $ 192 $ 4 $ 213,438
========== ========== ========== =========
Amortized cost is determined based on specific identification. Realized gains on
sales of securities were $2,000 in 2000. There were no realized losses on sales
of securities in 2000.
As of December 31, 2000, the contractual maturities of these securities were as
follows (in thousands):
AMORTIZED FAIR
COST VALUES
--------- ----------
Less than 1 year..................... $ 190,980 $ 191,060
Greater than 1 year.................. 22,270 22,378
--------- ----------
$ 213,250 $ 213,438
========= ==========
NOTE 4 -- INVENTORIES
Inventories, which include material, labor and factory overhead, are stated at
the lower of cost (first-in, first-out method) or market. The Company evaluates
the need for reserves associated with obsolete, slow-moving and nonsalable
inventory by reviewing net realizable values on a quarterly basis. The Company's
inventories do not include materials purchased and held by the Company's
component subcontractors, as this inventory is not owned by the Company. The
components of inventory were as follows (in thousands):
DECEMBER 31,
-----------------------
2000 1999
--------- --------
Raw materials........................ $ 19,058 $ 6,450
Work-in-progress..................... 872 1,081
Finished goods....................... 7,490 1,485
--------- --------
27,420 9,016
Less reserves........................ (4,315) (2,064)
--------- --------
$ 23,105 $ 6,952
========= ========
NOTE 5 -- PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. For financial reporting purposes,
depreciation is recorded principally on a straight-line method over the
estimated useful lives of the asset as follows:
Equipment and furniture.............. 3-5 years
Computer software.................... 2-5 years
Capital lease equipment.............. The shorter of the useful life of 3-5 years or
lease term
Leasehold improvements............... The shorter of the useful life of 3-5 years or
lease term
F-12
59
Accelerated depreciation methods are generally used for income tax purposes.
Expenditures that substantially extend the useful life of an asset are
capitalized. Ordinary repair and maintenance expenditures are expensed as
incurred. When assets are retired or disposed of, the cost and accumulated
depreciation thereon are removed from the accounts and the related gains or
losses are included in the statement of operations.
Property and equipment consisted of the following (in thousands):
DECEMBER 31,
----------------------
2000 1999
--------- ----------
Equipment and furniture........................................ $ 36,298 $ 24,225
Computer software.............................................. 8,079 5,992
Leasehold improvements......................................... 3,298 1,748
Construction in progress....................................... 4,852 65
--------- ---------
52,527 32,030
Less accumulated depreciation and amortization................. (25,633) (18,230)
--------- ----------
$ 26,894 $ 13,800
========= ==========
Depreciation expense was $8,256,000, $5,300,000 and $3,773,000 in 2000, 1999 and
1998 respectively. Equipment and furniture at December 31, 2000 and 1999
includes assets under capitalized leases of $9,469,000 and $5,896,000,
respectively, with related accumulated amortization of $5,342,000 and
$3,168,000, respectively.
The minimum future lease payments under capital leases as of December 31, 2000
are as follows (in thousands):
2001............................................................ $2,749
2002............................................................ 1,628
2003............................................................ 271
------
4,648
Less amount representing interest............................... (578)
------
Present value of minimum lease payments (including
$2,446 classified as current)................................. $4,070
======
NOTE 6 -- PREPAID EXPENSES AND OTHER ASSETS
Prepaid expenses and other current assets consisted of the following (in
thousands):
DECEMBER 31,
-----------------
2000 1999
------- -------
Prepaid technology license fees................................. $ -- $ 1,702
Other........................................................... 3,467 1,413
------- -------
$ 3,467 $ 3,115
======= =======
Other assets consisted of the following (in thousands):
DECEMBER 31,
-----------------
2000 1999
------- -------
Intangible assets and goodwill.................................. $ 2,408 $ 2,408
Other........................................................... 1,263 485
------- -------
3,671 2,893
Less accumulated amortization................................... (1,865) (1,432)
------- -------
$ 1,806 $ 1,461
======= =======
The identifiable intangible assets and goodwill are being amortized on a
straight-line method over five years.
F-13
60
NOTE 7 -- ACCRUED LIABILITIES
Accrued liabilities consisted of the following (in thousands):
DECEMBER 31,
-----------------
2000 1999
------- -------
Wages and employee benefits........................ $ 6,425 $ 2,104
Warranty reserves.................................. 956 986
Other taxes........................................ 1,011 612
Other accrued liabilities.......................... 666 778
------- -------
$ 9,058 $ 4,480
======= =======
NOTE 8 -- NOTE PAYABLE TO PARENT COMPANY
On October 1, 1997, the Company entered into an unsecured term note with its
Parent in the amount of $1,900,000. The note required quarterly payments of
interest in arrears, with principle to be paid in 2007 or upon the consummation
of a sale of all or part of the Company, including an initial public offering.
On August 9, 2000, the Company consummated an initial public offering and
proceeds from the offering were used to payoff the note. The note was classified
as a current liability as of December 31, 1999 in anticipation of the initial
public offering. The note bore simple interest at the prime rate. Interest
expense incurred and paid to the Parent for 2000, 1999 and 1998 totaled
$109,000, $154,000 and $161,000, respectively.
NOTE 9 -- STOCKHOLDERS' EQUITY
The Company has both Class A and Class B common stock. Holders of Class A and
Class B common stock have voting rights equal to one vote and one-tenth vote,
respectively, for each share held. Holders of Class A and Class B common stock
share equal rights as to dividends.
On May 23, 2000 the Board of Directors approved a 2-for-1 stock split of the
Company's Class A and B common stock. All share and per share amounts have been
adjusted for all periods presented to give retroactive effect to this stock
split. The Board of Directors also authorized, after giving effect to the stock
split, an increase in the authorized shares of the Company's Class A common
stock to 250,000,000 shares and an increase in the Class B common stock to
200,000,000 shares. In addition, the Board of Directors authorized 25,000,000
shares of undesignated preferred stock. All of these transactions were
consummated on or about July 12, 2000.
No dividends attributable to common stock were declared or paid during 2000,
1999 or 1998.
NOTE 10 -- EMPLOYEE BENEFIT PLANS AND STOCK OPTIONS
Defined Contribution Plan
The Company has a defined contribution plan (the McDATA Retirement Savings Plan)
that covers eligible employees. The Company matches 50% of an employee's
contribution up to 6% of annual eligible compensation, subject to restrictions
of such plans. Such Company contributions are made in cash, and amounted to
$769,000, $550,000 and $393,000 in 2000, 1999 and 1998, respectively.
Profit Sharing Plan
Effective October 1, 1997, the Board of Directors authorized a profit sharing
plan whereby the Company contributes a portion of each year's profits to a
profit sharing pool. The profit sharing amount is determined annually by the
Board of Directors and is distributed to employees approximately 50% in cash and
approximately 50% on the employees' behalf as contributions to the McDATA
Retirement Savings Plan. The Company recorded an expense related to this plan of
$1,946,000, $0 and $0 for 2000, 1999 and 1998, respectively.
F-14
61
Stock Option Plan
The 1997 Stock Option Plan (the Plan), adopted on October 1, 1997, provides for
the grant of either incentive or nonstatutory options to employees for the
purchase of Class B common stock. The Company has reserved 19,000,000 shares for
issuance under the Plan. Options under the Plan become exercisable over a
four-year period with one-fourth exercisable on each annual anniversary of grant
date and expire ten years from the date of grant.
The following summarizes option transactions for the period from December 31,
1997 to December 31, 2000:
WEIGHTED- WEIGHTED-
SHARES AVERAGE AVERAGE
COVERED EXERCISE OPTIONS EXERCISE
BY OPTIONS PRICE EXERCISABLE PRICE
------------- --------- ----------- ---------
Outstanding at December 31, 1997.............. 8,799,000 $ 1.00 -- $ --
Granted....................................... 2,725,600 1.06
Exercised..................................... (2,000) 1.00
Forfeited or expired.......................... (259,850) 1.00
-------------
Outstanding at December 31, 1998.............. 11,262,750 1.02 2,173,938 1.00
Granted....................................... 3,646,700 2.29
Exercised..................................... (1,978,936) 1.00
Forfeited or expired.......................... (990,000) 1.10
-------------
Outstanding at December 31, 1999.............. 11,940,514 1.40 2,584,690 1.02
Granted....................................... 3,882,375 21.53
Exercised..................................... (2,551,753) 1.09
Forfeited or expired.......................... (1,380,000) 6.80
-------------
Outstanding at December 31, 2000.............. 11,891,136 7.41 3,264,855 1.30
=============
As of December 31, 2000, there were 2,576,175 options available for grant under
the Plan.
The status of total stock options outstanding and exercisable at December 31,
2000 was as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------- --------------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
EXERCISE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
PRICES OF SHARES LIFE (YEARS) PRICE OF SHARES PRICE
------------- ----------- ------------ --------- ---------- --------
$1.00 4,791,326 6.8 $ 1.00 2,395,826 $1.00
$1.13 - $2.75 3,824,935 8.4 2.15 869,029 2.13
$11.54-$13.75 2,060,900 9.2 12.35 -- --
$28.00-$47.25 891,875 9.6 28.65 -- --
$56.81-$93.36 322,100 9.9 74.77 -- --
----------- ----------
Total 11,891,136 8.0 7.41 3,264,855 $1.30
=========== ==========
The Company applies APB 25 and related interpretations in accounting for its
stock-based compensation plan. During 2000 and 1999, in connection with the
grant of certain stock options to employees, the Company recorded deferred
stock-based compensation, net of forfeitures, of $8,971,000 and $27,139,000,
respectively, representing the difference between the exercise price and the
deemed fair market value of the Company's common stock on the dates these stock
options were granted.
F-15
62
Deferred compensation is included as a reduction of stockholders' equity and is
being amortized on a straight-line basis over the vesting periods of the related
options, which is generally four years. During 2000 and 1999, the Company
recorded amortization of $8,366,000 and $2,894,000, respectively (of which
$1,907,000 and $709,000 is included in the cost of product and service revenue
for 2000 and 1999, respectively).
All stock option grants under the Plan since August 2000 have been granted at an
exercise price equal to the fair market value of the Company's stock.
The fair value of each option granted during 2000, 1999 and 1998 is estimated on
the date of grant using the Black-Scholes option pricing model with the
following weighted average assumptions:
YEARS ENDED DECEMBER 31,
-----------------------------------
2000 1999 1998
---------- ---------- ---------
Dividend yield................................ 0% 0% 0%
Expected volatility........................... 90% 0% 0%
Risk-free interest rate....................... 6.3% 5.5% 5.4%
Expected life in years........................ 4.0 4.0 4.0
Using these assumptions, the weighted average fair values of options granted
were:
YEARS ENDED DECEMBER 31,
-------------------------------------
2000 1999 1998
---------- ---------- -----------
Options granted with an exercise price
below fair market value................. $12.71 $ 7.96 --
Options granted with an exercise price
equal to fair market value.............. $27.53 -- $ 0.21
The Company has adopted the disclosure provisions of Statement of Financial
Accounting Standards No. 123, Accounting for Stock-Based Compensation. The pro
forma impact on the company's net income (loss) and net income (loss) per share
as reported for the years ended December 31 pursuant to SFAS 123 to reflect the
fair value method of accounting for stock-based compensation plans would have
been as follows (in thousands, except per share amounts):
YEARS ENDED DECEMBER 31,
---------------------------------
2000 1999 1998
-------- --------- ---------
Net income (loss):
As reported........................... $ 30,764 $ (1,616) $ (5,118)
Pro forma............................. $ 27,323 $ (2,006) $ (5,473)
Basic net income (loss) per share:
As reported........................... $ 0.31 $ (0.02) $ (0.06)
Pro forma............................. $ 0.27 $ (0.02) $ (0.06)
Diluted net income (loss) per share:
As reported........................... $ 0.28 $ (0.02) $ (0.06)
Pro forma............................. $ 0.25 $ (0.02) $ (0.06)
NOTE 11 -- INCOME TAXES
Historically, the Company has been included in a consolidated Federal and
Colorado income tax return with EMC. As a result of its initial public offering
on August 9, 2000, the Company is no longer eligible to be included in EMC's
consolidated tax returns and will consequently file a separate income tax return
for the tax period which began immediately following the offering.
When the Company was included in EMC's consolidated tax returns, the Company
recorded income taxes based on the pro rata method. The pro rata method assumes
the allocation of income taxes based on McDATA's parent
F-16
63
company's consolidated tax position. The pro rata method of allocating income
taxes is consistently used for all members of the consolidated group. Pursuant
to a tax sharing agreement entered into with EMC, the Company was compensated by
EMC for the use of its United States net operating losses during 1999 and 1998
at 35%, and its tax credits, including research and development credits,
utilized by the Parent.
Had the Company's tax provision been calculated as if the Company were a
separate, independent United States taxpayer, the income tax provision would not
have materially changed.
Income tax expense (benefit) consisted of the following (in thousands):
YEARS ENDED DECEMBER 31,
--------------------------------
2000 1999 1998
-------- -------- --------
Current:
Federal .................. $ 26,035 $ 508 $ (3,918)
State .................... 1,934 7 (217)
-------- -------- --------
27,969 515 (4,135)
Deferred:
Federal .................. (6,511) (676) 956
State .................... (567) (25) 55
-------- -------- --------
(7,078) (701) 1,011
-------- -------- --------
Total expense (benefit) .... $ 20,891 $ (186) $ (3,124)
======== ======== ========
The total income tax expense (benefit) differs from the amount computed using
the federal income tax rate of 35% for the following reasons (in thousands):
YEARS ENDED DECEMBER 31,
--------------------------------
2000 1999 1998
-------- -------- --------
Federal income tax expense (benefit) at
statutory rate .......................... $ 18,079 $ (631) $ (2,885)
Research and development credit ............ (100) (300) (100)
State taxes, net of federal benefit ........ 1,343 (23) (107)
Stock-based compensation ................... 1,926 778 --
Foreign sales corporation .................. (1,218) (151) --
Other ...................................... 861 141 (32)
-------- -------- --------
Income tax expense (benefit) ............... $ 20,891 $ (186) $ (3,124)
======== ======== ========
Deferred income taxes reflect the tax effect of temporary differences between
the amount of assets and liabilities for financial reporting purposes and income
tax purposes. The tax effects of each type of temporary difference that give
rise to significant portions of the net deferred tax assets are as follows (in
thousands):
DECEMBER 31,
-------------------
2000 1999
-------- --------
Current deferred tax assets:
Inventory reserves and costs ................... $ 2,492 $ 1,329
Revenue recognition ............................ 4,067 --
Warranty reserves .............................. 360 358
Reserves related to employee benefits .......... 877 597
Stock-based compensation ....................... 1,354 273
Other .......................................... 82 58
-------- --------
9,232 2,615
Noncurrent deferred tax assets (liabilities):
Difference between book and tax depreciation ... 186 (275)
-------- --------
Total deferred tax asset, net .................... $ 9,418 $ 2,340
======== ========
Under the terms of the tax sharing agreement between the Company and EMC, the
Company is obligated to indemnify EMC for any taxes arising out of the failure
of such distribution to be tax free if that failure results from, among other
things, (i) any act or omission by the Company that would cause such
distribution to fail to qualify as a
F-17
64
tax free distribution under the Internal Revenue Code of 1986, as amended; (ii)
any act or omission by the Company that is inconsistent with any representation
made to the Internal Revenue Service in connection with the request for a
private letter ruling regarding the tax-free nature of the distribution; (iii)
any acquisition by a third party of the Company's stock or assets; or (iv) any
issuance by the Company of stock or any change in ownership of the Company's
stock. If the distribution of the Company's Class A common stock fails to
qualify as a tax-free distribution, EMC would incur tax liability as if the
Company's Class A common stock that was distributed by EMC had been sold by EMC
for its fair market value in a taxable transaction. In the event that the
Company is required to indemnify EMC because the distribution of the Company's
Class A common stock fails to qualify as a tax-free distribution, the Company's
liability could exceed 35% of the value of the Company's Class A common stock
distributed by EMC as determined on the date of the distribution.
Although the Company is no longer a member of EMC's consolidated tax group, the
tax sharing agreement between the Company and EMC continues to affect the
Company in two principal ways. First, if a taxing authority effects a change to
the EMC consolidated return, the Company is required to reimburse EMC for the
tax of any Company-related unfavorable adjustment. Conversely, the Company is
entitled to any refund for any Company-related favorable adjustment. Second, the
Company is required to remit to EMC any tax savings generated by the tax
deductions, if any, related to the issuance or sale of EMC stock upon the
exercise of options held by Company employees.
NOTE 12 -- TRANSACTIONS WITH PARENT
McDATA, as EMC's majority-owned subsidiary, has engaged in several related-party
transactions with EMC and its subsidiaries. These included benefiting from a
service agreement to provide services for the Parent's ESCON switch business,
making direct sales of Fibre Channel products to the Parent, participating in
the Parent's cash management system and filing as a member of the Parent's
consolidated tax return (see Note 11). The terms of these arrangements, which
were negotiated in the context of a parent-subsidiary relationship, may be more
or less favorable to us than if they had been negotiated with unaffiliated third
parties.
Under the terms of the service agreement with the Parent, the Company provides
management, manufacturing, research, development, sales, support and
administrative services with respect to specified customers of the Parent. The
amount of such service fee is subject to annual revision based on the review and
concurrence of both parties. Such service fee revenue totaled $14,497,000,
$17,337,000 and $25,674,000 for 2000, 1999 and 1998, respectively. Additionally,
the Company provided $2,824,000 and $349,000 of consulting services to the
Parent for 2000 and 1999, respectively. No such services were provided to the
Parent in 1998.
Pursuant to a five-year OEM supply and license agreement executed in 2000, the
Company sells Fibre Channel products to the Parent. Such sales comprised 69%,
51% and 15% of Company revenue in 2000, 1999 and 1998, respectively. The
agreement has no minimum purchase commitments and has customary termination
rights.
Until September 2000, the Company participated in EMC's cash management program,
in which it deposited excess operating funds with EMC for short-term investment
when funds in excess of operating requirements were available or borrowed funds
from EMC during periods of operating cash needs. Such funds were repaid on
demand and earned simple interest, calculated monthly. Interest income and
interest (expense) includes $102,000, $(740,000) and $312,000 earned (paid) from
participation in EMC's cash management program during 2000, 1999 and 1998,
respectively.
Certain directors and executive officers of the Company own EMC common stock and
options to purchase EMC common stock. One of the Company's directors as of
December 31, 2000 was an employee of EMC. This director resigned from his
position on the Company's Board of Directors effective upon the distribution of
the McDATA Class A common stock.
F-18
65
NOTE 13 -- COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company had various operating leases in effect at December 31, 2000 for
certain buildings, office space and machinery and equipment. Future minimum
lease payments under non-cancelable operating leases with terms of one year or
more are as follows at December 31, 2000 (in thousands):
2001................................................... $ 4,850
2002................................................... 5,151
2003................................................... 4,030
2004................................................... 1,907
2005 and thereafter.................................... 2,560
----------
$18,498
==========
Rent expense in 2000, 1999 and 1998 totaled approximately $3,424,000, $2,218,000
and $2,115,000, respectively.
Contingencies
From time to time, the Company is subject to claims arising in the ordinary
course of business. In the opinion of management, no such matter, individually
or in the aggregate, exists which is expected to have a material effect on the
Company's consolidated results of operations, financial position or cash flows.
The Company has contracted with SCI Systems, Inc. (SCI) for the manufacture of
printed circuit boards and box build assembly for specific Fibre Channel
directors and switches. The agreement with SCI requires the Company to submit
purchasing forecasts, place orders and reschedule orders for products as
necessary. At December 31, 2000, SCI had on hand materials purchased on behalf
of McDATA valued at approximately $33,205,000. In addition, SCI has purchase
commitments outstanding related to materials that it had also ordered on
McDATA's behalf. The Company may be liable for materials that SCI purchases on
McDATA's behalf if the Company's actual requirements do not meet or exceed its
forecasts and those materials cannot be redirected to other uses by SCI.
Management does not expect this commitment to have a material adverse effect on
the Company's business, results of operations, financial position or cash flows.
The agreement renews monthly and both parties have customary termination rights.
The Company has various commitments for sales, purchases and employee benefit
plans in the ordinary course of business. In the aggregate, such commitments do
not differ significantly from current market prices or anticipated usage
requirements.
NOTE 14 -- SEGMENT INFORMATION
The Company has one reporting segment relating to the manufacturing and
marketing of computer-based hardware systems. The Company's operations are
conducted in the United States with sales offices in Germany, Japan and the
United Kingdom and a research and development facility in Canada, none of which
are individually significant to the Company's overall operations. The Company
has not incurred any foreign currency translation adjustments as all of its
sales are settled in U.S. dollars. In addition, all of its subsidiaries' books
are maintained in U.S. dollars.
F-19
66
Certain information related to the Company's operations by geographic area is
presented below (in thousands). The Company's revenues are attributed to the
geographic areas according to the location of the customers. Long-lived assets
include property and equipment and other non-current assets.
LONG-LIVED
NET SALES ASSETS
---------- ----------
2000
United States................................................. $ 171,888 $ 27,347
Foreign countries............................................. 76,798 1,353
---------- ---------
Total............................................... $ 248,686 $ 28,700
========== =========
1999
United States................................................. $ 80,055 $ 13,755
Foreign countries............................................. 15,208 1,506
---------- ---------
Total............................................... $ 95,263 $ 15,261
========== =========
1998
United States................................................. $ 34,463 $ 13,126
Foreign countries............................................. 2,085 2,414
---------- ---------
Total............................................... $ 36,548 $ 15,540
========== =========
Included in the United States long-lived assets balances at December 31, 2000,
1999 and 1998 are intangible assets totaling $0, $95,000 and $1,828,000,
respectively. Included in the foreign countries long-lived assets balances as of
December 31, 2000, 1999 and 1998 are intangible assets totaling $542,000,
$897,000 and $1,330,000, respectively.
Included in the net sales to foreign countries is $58,836,000, $8,924,000 and
$1,419,000 of net sales to Ireland for 2000, 1999 and 1998, respectively.
NOTE 15 -- SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
The following summarizes selected financial information for each of the two
years in the period ended December 31, 2000 (in thousands except share data):
Q1 Q2 Q3 Q4
-------- ------- -------- -------
2000
Total revenue............................... $ 47,134 $ 56,461 $ 66,760 $78,331
Gross profit................................ 24,524 28,807 35,661 40,151
Net income.................................. 4,848 4,707 8,958 12,251
Basic net income per share.................. 0.05 0.05 0.09 0.11
Diluted net income per share................ $ 0.05 $ 0.05 $ 0.08 $ 0.10
1999
Total revenue............................... $ 13,163 $ 21,027 $ 22,661 $38,412
Gross profit................................ 7,067 10,818 10,443 16,655
Net income (loss)........................... (1,995) (52) (1,587) 2,018
Basic net income (loss) per share........... (0.02) 0.00 (0.02) 0.02
Diluted net income (loss) per share......... $ (0.02) $ 0.00 $ (0.02) $ 0.02
NOTE 16 -- SUBSEQUENT EVENTS
On February 7, 2001, EMC distributed all of its shares of Class A stock in the
Company to EMC's stockholders of record as of January 24, 2001. EMC has received
a ruling from the Internal Revenue Service that the distribution to EMC
stockholders will be tax free for U.S. federal income tax purposes. The Company
currently believes that the distribution of its Class A common stock by EMC will
be tax free.
F-20
67
On February 9, 2001, the Company entered into a lease for an approximately
167,000 square foot multi-story office and engineering building to be
constructed on a 109 acre parcel of land located in Broomfield, Colorado.
Construction of the building is anticipated to commence in the first half of
2001 and is scheduled to be complete no later than February 2003. The initial
term of the lease is for 78 months, with an option to renew the lease for
additional 12 month terms, subject to certain conditions. The Company, at its
option, may purchase the facility during or at the end of the term of the lease
at approximately the amount expended by the lessor to acquire the land and
construct the building (approximately $60 million). If the Company does not
renew the lease, exercise the purchase option by the end of the lease, or
arrange for the sale of the property to a third-party, the Company has
guaranteed a residual value of the facility as a percentage of the original
costs (approximately 85% of such original costs). As part of the lease, the
Company has agreed to restrict up to $60 million (plus 5 percent) of its
investment securities as collateral for specified obligations under the lease.
In addition, the lease agreement requires that the Company maintain compliance
with certain affirmative and negative covenants, representations and warranties,
including certain defined financial covenants.
F-21
68
S-1
MCDATA CORPORATION
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
BALANCE CHARGED TO BALANCE
BEGINNING COSTS AND AT END
OF PERIOD EXPENSES DEDUCTIONS OF PERIOD
---------- ---------- ---------- ----------
Year ended December 31, 1998
Allowance for doubtful accounts............................. $ 48 $ 18 $ (1) $ 65
Inventory reserves.......................................... 3,129 1,326 (3,815) 640
Warranty reserve............................................ 826 905 (246) 1,485
Year ended December 31, 1999
Allowance for doubtful accounts............................. $ 65 $ 30 $ -- $ 95
Inventory reserves.......................................... 640 1,907 (483) 2,064
Warranty reserve............................................ 1,485 12 (511) 986
Year ended December 31, 2000
Allowance for doubtful accounts............................. $ 95 $ 248 $ (59) $ 284
Inventory reserves.......................................... 2,064 2,541 (290) 4,315
Warranty reserve............................................ 986 707 (737) 956
S-1
69
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
- ------- -----------
(3.1) Amended and Restated Certificate of Incorporation of the
Company
(3.2) Amended and Restated By-laws of the Company
(4.1) Form of Company's Class B Common Stock Certificates
(4.1.1) Form of Company's Class A Common Stock Certificates
(4.2) Investors' Rights Agreement dated as of October 1, 1997 by and
among the Company, EMC Corporation, McDATA Holdings
Corporation and Certain Investors
(4.3) Amendment No. 1 to the Investors' Rights Agreement dated May
23, 2000 by and among the Company, McDATA Holdings Corporation
and certain Investors
(10.1) Asset Transfer Agreement dated as of October 1, 1997 by and
among the Company, EMC Corporation, and McDATA Holdings
Corporation
(10.2) Investors' Rights Agreement dated as of October 1, 1997 by and
among the Company, EMC Corporation, McDATA Holdings
Corporation and certain Investors (see Exhibit 4.2)
(10.3) Amendment No. 1 to the Investors' Rights Agreement dated May
23, 2000 by and among the Company, McDATA Holdings Corporation
and certain Investors (see Exhibit 4.3)
10.3.1 Termination of Investors' Rights Agreement, dated as of
January 24, 2001, by and among the Company, McDATA Holdings
Corporation and Certain Investors.
(10.4) Services Agreement dated as of October 1, 1997 by and among
EMC Corporation, McDATA Holdings Corporation and the Company
(10.5) Letter Agreement dated April 19, 1999 by and between the
Company and McDATA Holdings Corporation
(10.6) Technology Rights Agreement dated as of October 1, 1997 by and
among the Company, EMC Corporation and McDATA Holdings
Corporation
(10.7) Amended and Restated Tax Sharing Agreement dated as of May 31,
2000 by and among EMC Corporation, McDATA Holdings Corporation
and the Company
(10.8) Form of Master Transaction Agreement entered into by and among
the Company and EMC Corporation dated May 31, 2000
(10.9) Form of Indemnification and Insurance Matters Agreement
entered into by and among the Company and EMC Corporation
dated May 31, 2000
(10.10) Master Confidential Disclosure and License Agreement dated as
of May 31, 2000 by and among the Company and EMC Corporation
(10.11)+ Reseller Agreement dated as of February 22, 2000 by and
between International Business Machines Corporation and the
Company
(10.12) Amendment Number One to the Resale Agreement dated June 30,
2000 by and between International Business Machines
Corporation and the Company
(10.13)+ OEM Purchase and License Agreement dated as of May 19, 2000 by
and between EMC Corporation and the Company
(10.14)+ Development Agreement dated as of May 19, 2000 by and between
EMC Corporation and the Company
(10.15)+ Manufacturing Agreement dated as of June 17, 1992 by and
between SCI Systems, Inc. and the Company
(10.16)+ OEM and License Agreement dated as of April 27, 1999 by and
between Brocade Communication Systems, Inc. and the Company
(10.17) Lease dated September 12, 1997 by and between the Company and
WHLNF Real Estate Limited Partnership
(10.18) Lease dated November 2, 1999 by and between the Company and
the Mills Family LLC
(10.19) Lease dated May 28, 1997 by and between the Company and
1211486 Ontario Limited
[10.19.1] Lease dated October 6, 2000, by and between the Company and
Amber Drive I, LLC
10.19.2 Lease dated February 9, 2001 by and between the Company and
Deutsche Bank
10.19.3 Participation Agreement dated February 9, 2001 by and between
the Company and Deutsche Bank
(10.20)* Form of Severance Agreement
(10.21)* 1997 Stock Option Plan
(10.22)* Form of Stock Option Agreement for 1997 Stock Option Plan
(10.23)* Description of the Company's Management Bonus Program
21 Subsidiaries of Company
70
23 Consent of PricewaterhouseCoopers LLP
24 Power of Attorney
- ----------
( ) Exhibits previously filed in the Company's Registration Statement on Form
S-1, SEC File No. 333-38106, declared effective on August 8, 2000.
[ ] Exhibits previously filed in the Company's Quarterly Report on Form 10-Q for
the fiscal quarter ended September 30, 2000.
+ Portions of these Exhibits have been omitted and filed separately with the
Securities and Exchange Commission pursuant to an order for confidential
treatment.
* Executive compensation plans and arrangements.