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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-K

Commission file number: 000-25601

Brocade Communications Systems, Inc.

1745 Technology Drive

Securities registered pursuant to Section 12(b) of the Act: None

      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 þ No o

      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 the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference to Part III of this Form 10-K or any amendment to this Form 10-K. o

      Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

      The aggregate market value of voting and non-voting common equity held by non-affiliates of the Registrant was approximately $1,050,000,000 as of December 20, 2002, based upon the closing price on the Nasdaq National Market reported for such date. This calculation does not reflect a determination that certain persons are affiliates of the Registrant for any other purpose. The number of shares outstanding of the Registrant’s Common Stock on December 20, 2002, was 235,434,404 shares.

DOCUMENTS INCORPORATED BY REFERENCE

      Portions of the Registrant’s Proxy Statement for its 2003 Annual Meeting of Stockholders (the “Proxy Statement”), to be filed with the Securities and Exchange Commission, are incorporated by reference into Part III of this Form 10-K.

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BROCADE COMMUNICATIONS SYSTEMS, INC.

FORM 10-K

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PART I

Item 1.     Business

General

      This Annual Report on Form 10-K (Annual Report) contains forward-looking statements. These forward-looking statements include predictions regarding our future:

	•	revenues and profits;
	•	gross margin;
	•	customer concentration;
	•	research and development expenses;
	•	sales and marketing expenses;
	•	general and administrative expenses;
	•	provision for income taxes;
	•	realization of deferred tax assets;
	•	liquidity and sufficiency of existing cash, cash equivalents, and investments for near-term requirements;
	•	purchase commitments;
	•	technology and products;
	•	the outcome of pending or threatened litigation; and
	•	the effect of recent accounting pronouncements on our financial condition and results of operations.

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

      Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth below under the heading “Risk Factors.” All forward-looking statements included in this document are based on information available to us on the date hereof. We assume no obligation to update any forward-looking statements.

      Brocade Communications Systems, Inc. develops, markets, sells, and supports data storage networking products and services. We provide a line of storage networking products that enables companies to implement highly available, scalable, manageable, and secure environments for data storage applications. Companies use our products to connect servers and storage through a storage area network (SAN).

      Our products are installed around the world at companies, institutions, and other entities of all sizes, ranging from large enterprises to small businesses. Our products and services are marketed, sold, and supported worldwide to end-users through our distribution partners, including original equipment manufacturers (OEMs), value-added distributors, systems integrators, and value-added resellers.

      We were incorporated on May 14, 1999, as a Delaware corporation, succeeding operations that began on August 24, 1995. Our mailing address and executive offices are located at 1745 Technology Drive, San Jose California, 95110. Our telephone number is (408) 487-8000. Our corporate Website is www.brocade.com. Information contained on the Website is not a part of this Annual Report.

Products and Services

      Our products and services are designed to help companies reduce the cost and complexity of managing business information within a data storage environment. Our products are generally used in conjunction with application servers, storage subsystems and devices, SAN interconnection components such as host bus adapters, and storage management software applications and tools.

      By networking servers and storage, companies can more easily share and consolidate server and storage resources; centralize and simplify data management; scale and provision storage resources more effectively, and improve application efficiency and performance. As a result, companies can better utilize information

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      We believe that as data storage needs grow, companies will look to further simplify the complexity of storing, managing, and administering their data, while looking to maximize their IT investments and reduce capital expenditures. SANs, which have been installed at some of the world’s leading companies since the mid-1990’s, provide a platform that helps companies optimize their IT assets and support future data growth. We believe companies will also continue to expand the size and scope of their SANs and the number and types of applications that their SANs support. Consequently, components of SAN environments, which are also commonly referred to as SAN fabrics, will become increasingly heterogeneous, and will originate from different server, storage, and application providers.

      Since our inception, we have been a pioneer and innovator in enabling the market for SAN-based solutions, and have grown to be a market leader in storage networking infrastructure. We believe that the future evolution of the storage networking market will be lead by the providers of products that simplify the management of heterogeneous storage environments and maximize end-users’ IT investments on an ongoing basis. We also believe that storage networking infrastructure will evolve to provide increased capabilities that enable new types of storage management applications that simplify storage management and increase operational efficiencies.

      As a result, many of our initiatives and investments are aimed at expanding the capabilities enabled by SANs, increasing end-to-end interoperability, protecting end-user investments in existing and new IT resources, and making it easier for our OEM and application partners to deliver products that manage heterogeneous storage environments.

      We offer a line of intelligent storage networking products and SAN management software that enable companies to network application servers with storage devices through a SAN.

     Storage Networking Switches

      Our SilkWorm® family of Fibre Channel fabric switches, which are devices that provide bandwidth and high-speed routing of data, ranges from low cost 8-port switches to dual 64-port enterprise-class switches. These products have been designed to meet the storage networking needs of end-users in environments ranging from small businesses to large enterprises with SAN fabrics that scale to thousands of ports that are spread across multiple locations around the world. Our current SilkWorm family of switches share a common application specific integrated circuit (ASIC) that is the basis for our advanced fabric services, which enable key SAN management functionality that we believe is unique to Brocade.

     SAN Management Software

      Our SAN management software includes a common set of advanced fabric services that help improve performance, availability, scalability, and the overall functionality of the network. These fabric services include the ability to proactively monitor the health and performance of the SAN, the ability to aggregate bandwidth between fabric switches to deliver higher performance for storage applications, and the ability to securely control data access in multi-vendor SAN environments. We believe that our software products provide us with an advantage in the storage networking market, enabling differentiation and increasing licensable features and services. In addition, we offer management tools that enable end-users to manage and administer their SANs.

      We have an open approach to SAN management and work with nearly every leading provider of storage and SAN management applications and technologies. Our advanced fabric services are made available to our distribution and application partners through an application programmable interface (API), which enables them to quickly leverage these features in their storage management solutions.

     Intelligent Fabric Application Platforms

      On November 5, 2002, we announced an agreement to acquire Rhapsody Networks, Inc. (Rhapsody), a privately held technology company based in Fremont, California. We believe that the acquisition of Rhapsody

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Industry Initiatives

      We work with industry-leading companies to facilitate the development of standards, technologies, products, and services that focus on the simplification of heterogeneous storage management, and the implementation and management of storage networking environments.

     Industry Standards Development

      Since our inception, we have been a major contributor to the evolution of industry standards ranging from Fibre Channel communication technology to SAN interoperability to storage and SAN management. We contribute to nearly every related industry standards committee, and have authored or co-authored the majority of the Fibre Channel protocol standards in existence today.

     Storage Networking Environment Interoperability

      As SANs have increased in size and comprise more and different types of server, storage, and interconnection devices, the need for interoperability among those devices has similarly increased. We have invested a significant amount of time and resources for purposes of providing interoperability among Brocade solutions and the servers, storage, and storage management applications that run in the Brocade environment, and in driving standards for interoperability among SAN interconnection devices. We also continually certify Brocade solutions in operational storage environments through our own testing programs, our partners’ testing and qualification initiatives, and through certification programs for third party products, such as the Brocade Fabric Aware program, which we offer as a resource to our application and technology partners. Through our testing initiatives, we also certify interoperability configurations of common customer environments, such as remote data backup in a multi-vendor server and storage environment.

     Application Interoperability

      An important aspect of managing storage environments is the management software used to administer, manage, and provision storage resources and data. Our intelligent platform offers advanced fabric services that allow third-party developers of storage software applications to gain additional functionality and simplify the development of their applications. We offer the Brocade Fabric Access API, which is a development interface that helps to simplify the delivery of third-party applications that utilize the intelligence in the Brocade SAN fabric. Our Fabric Access partners are the leaders in storage and SAN management solutions and include companies such as BMC Software, Computer Associates, EMC Corporation (EMC), Hewlett-Packard Company (HP), IBM Tivoli, and VERITAS Software Corporation (Veritas).

     Education and Technical Certification Services

      Our education and training organization delivers high-quality, technical education and training on SAN technology, design, implementation, and management to our partners and their customers. The Brocade SAN Certification Program, our educational service, offers certification on Brocade SANs for IT professionals who have completed certain tests administered by an independent testing organization. This certification program is designed to measure the knowledge and proficiency of IT professionals in SAN solutions and technologies, and to help ensure that our customers receive superior customer service and support. Our education and

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Distribution Model

      Our products are marketed, sold, and supported worldwide through a wide range of distribution partners, including OEM partners, value-added distributors, systems integrators, and value-added resellers.

	•	Our OEM partners are leading storage systems and subsystems providers who offer our products under their own private label or as Brocade branded solutions. Sales through OEM partners comprise the majority of our business.
	•	Other distribution partners include Brocade-authorized value added distributors, systems integrators, and value-added resellers. These partners are authorized by us to market, sell, and support our SilkWorm family of fabric switches and software. Some also sell education and other value-added services.

      We have OEM or distribution agreements with virtually all of the companies that sell the world’s storage systems and subsystems. In addition, we employ a worldwide sales force to assist our distribution partners in marketing Brocade SAN solutions, assessing SAN requirements and designing, implementing, and maintaining Brocade-based SANs.

Customers

      Our major OEM customers include Dell Computer Corporation, EMC, Fujitsu Siemens Computers, Hitachi Data Systems, Inc., HP, IBM Corporation (IBM), Network Appliance, StorageTek, Sun Microsystems, Inc., and Unisys Corporation. Our primary non-OEM customers include Bell Microproducts, GE Access, Tokyo Electron Limited, and XIOTech.

      For the year ended October 26, 2002, EMC, HP, and IBM each represented greater than ten percent of our total revenues. For the year ended October 27, 2001, Compaq Computer Corporation (Compaq), EMC, and IBM each represented greater than ten percent of our total revenues. For the year ended October 28, 2000, Compaq and EMC, each represented greater than ten percent of our total revenues. The level of sales to any OEM customer may vary from quarter to quarter, and we expect that significant customer concentration will continue for the foreseeable future. The loss of any one of these customers, or a decrease in the level of sales to any one of these customers, could have a material adverse impact on our financial condition or results of operations.

Acquisitions and Investments

      Our acquisition and investment strategy is focused on facilitating the evolution and expansion of the SAN market and enabling companies to further simplify storage management. In the past, we have made minority equity investments in companies that develop technology or provide services that are complementary to or broaden the markets for our products and further our business objectives. On November 5, 2002, we announced an agreement to acquire Rhapsody, a privately held technology company based in Fremont, California that provides an intelligent fabric application platform. The Rhapsody acquisition is expected to close in January 2003.

Research and Development

      The industry in which we compete is subject to rapid technological developments, evolving industry standards, changes in customer requirements, and new product introductions. As a result, our success depends, in part, on our ability to continue to enhance our existing solutions and to develop and introduce new solutions that improve performance and reduce the total cost of ownership in the storage environment. We have invested significantly in product research and development. We continue to enhance and extend our products, and to increase the speed, performance, and port-density of our switching platform. We also continue to

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      Our products are designed to support current industry standards and will continue to support emerging standards that are consistent with our product strategy. Our products have been designed around a common platform architecture, which facilitates the product design, development, and testing cycle, and reduces the time to market for new products and features. We intend to continue to leverage this common architecture to develop and introduce additional hardware and software products and enhancements in the future.

      For the years ended October 26, 2002, October 27, 2001, and October 28, 2000, our research and development expenses totaled $132.2 million, $110.7 million, and $50.5 million, respectively. All expenditures for research and development costs have been expensed as incurred. We expect to continue to maintain our high level of investment in research and development.

Competition

      The current and potential market for SAN solutions and technologies is continuously evolving and subject to rapid technological change. Major storage systems and server providers are continually introducing new SAN-oriented solutions and products, and enhancing existing SAN-oriented solutions and products. We believe our primary competition is from developers of Fibre Channel switching or interconnection products, including Cisco Systems Inc. (Cisco), INRANGE Technologies Corporation (INRANGE), McDATA Corporation (McDATA), and QLogic Corporation (QLogic).

      As the SAN market evolves, additional technologies may become available for interconnecting servers and storage. To the extent that these products provide the ability to network servers and storage and support high-performance, block-data storage applications, they may compete with our current and future products. Competitive products might include, but are not limited to, non-Fibre Channel based emerging products based on Gigabit Ethernet, 10 Gigabit Ethernet, or InfiniBand. In addition, networking companies, manufacturers of networking equipment, or other companies may develop competitive products. Our OEM partners or other partners could also 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, price, size and extent of installed base, ability to meet delivery schedules, customer service, technical support, and distribution channels.

      Some of our competitors have longer operating histories and significantly greater human and financial resources than us. As a result, these competitors could adopt more aggressive pricing policies and devote greater resources to the development, promotion, and sale of their products than us. These advantages could allow them to respond more quickly to changes in customer or market requirements. In addition, some of our competitors have established supplier or joint development relationships with current or potential customers of ours. These competitors may be able to leverage their existing relationships to discourage these customers from purchasing additional products from us. These competitors may also be able to persuade our customers to replace our products with their products. Increased competition may result in reduced product prices, lower gross margins, reduced profitability, and reduced market share. We may not have the financial resources, technical expertise or marketing, manufacturing, distribution, and support capabilities to compete successfully in the future. There can also be no assurance that we will be able to compete successfully against current or future competitors or that current or future competitive pressures will not materially harm our business.

Manufacturing

      We use two third-party contract manufacturers, Solectron Corporation (Solectron) and Foxconn Electronics (Foxconn), to manufacture our products. Solectron and Foxconn invoice us based on prices and payment terms mutually agreed upon and set forth in purchase orders we issue to them. The pricing takes into account component costs, manufacturing costs, and margin requirements. Although the purchase orders we place with our contract manufacturers are cancelable, we could be required to purchase all unused material not returnable or usable by other customers.

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      We use Solectron and Foxconn for final turnkey product assembly, but we also maintain key component expertise internally. We design and develop the key components of our products, including ASICs and operating system and other software, as well as certain details in the fabrication and enclosure of our products. In addition, we determine the components that are incorporated into our products and we select appropriate suppliers of those components.

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

Patents, Intellectual Property, and Licensing

      We rely on a combination of patents, copyrights, trademarks, trade secrets, confidentiality agreements, and other contractual restrictions with employees and third parties to establish and protect our proprietary rights. Despite these precautions, the measures we undertake may not prevent misappropriation or infringement of our proprietary technology. These measures may not preclude competitors from independently developing products with functionality or features similar to our products.

      We maintain a program to identify and obtain patent protection for our inventions. It is possible that we will not receive patents for every application we file. Furthermore, our issued patents may not adequately protect our technology from infringement or prevent others from claiming that our products infringe the patents of those third parties. Our failure to protect our intellectual property could materially harm our business. In addition, our competitors may independently develop similar or superior technology, duplicate our products, or design around our patents. 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 resources and could materially harm our business.

      Some of our products are designed to include software or other intellectual property licensed from third parties. While it may be necessary in the future to seek or renew licenses relating to various aspects of our products, we believe that such licenses generally could be obtained on commercially reasonable terms.

      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 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 or licensing arrangements, if required, may require us to license back our technology or may not be available on terms acceptable to us, or at all. For these reasons, infringement claims could materially harm our business.

Backlog

      Our business is characterized by short lead-time orders and fast delivery schedules. Sales of our products are generally made pursuant to contracts and purchase orders that are cancelable without significant penalties. These commitments are subject to price renegotiations and to changes in quantities of products and delivery

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Employees

      As of October 26, 2002, we had 1,332 employees. No employees are represented by a labor union. We have not experienced any work stoppages and consider our relations with employees to be good. Employees are currently located in our United States headquarters in San Jose, California; our European headquarters in Geneva, Switzerland; our Asia Pacific headquarters in Hong Kong; and offices in North America, Australia, Canada, Denmark, France, Germany, Italy, Japan, Korea, the Netherlands, the People’s Republic of China, Singapore, Spain, Taiwan, and the United Kingdom. Competition for technical personnel in the computing industry continues to be significant. We believe that our success depends in part on our ability to hire, assimilate, and retain qualified personnel. We cannot assure you that we will continue to be successful at hiring, assimilating, and retaining employees in the future. On November 21, 2002, we announced a restructuring program that included a workforce reduction. Accordingly, we reduced our workforce by approximately 12 percent (see Note 14, “Subsequent Events,” of the Notes to Consolidated Financial Statements).

Executive Officers of the Registrant

      The following table sets forth certain information regarding our executive officers as of December 31, 2002:

      Gregory L. Reyes has served as our Chairman of the Board of Directors and Chief Executive Officer since May 2001. From July 1998 to May 2001, Mr. Reyes served as our President and Chief Executive Officer and was a member of our Board of Directors. Before joining Brocade, from January 1995 to June 1998, Mr. Reyes was President and Chief Executive Officer of Wireless Access, Inc., a wireless data communications products company. From January 1995 to November 1997, Mr. Reyes served as Chairman of the Board of Directors of Wireless Access. From January 1991 to January 1995, Mr. Reyes served as Divisional Vice President and general manager of Norand Data Systems, a developer of wireless data networks and hand-held terminals. Mr. Reyes also serves on the Board of Directors and Compensation Committee of Verisign, Inc., an Internet infrastructure company. Mr. Reyes received a B.S. in Economics and Business Administration from Saint Mary’s College in Moraga, California.

      Michael J. Byrd has served as our President and Chief Operating Officer since May 2001. In November 2002, Mr. Byrd announced his intention to retire at the end of the first quarter of fiscal 2003. Mr. Byrd joined Brocade in April 1999 and served as our Vice President, Finance and Chief Financial Officer from April 1999 to May 2001. From February 1994 to April 1999, Mr. Byrd served as Vice President, Finance and Chief Financial Officer of Maxim Integrated Products, Inc., a designer, developer and manufacturer of linear and mixed-signal integrated circuits. From 1982 to 1994, Mr. Byrd held various positions at Ernst & Young LLP, most recently as Partner. Mr. Byrd received a B.S. in Business Administration from California Polytechnic State University in San Luis Obispo, California.

      Antonio Canova has served as our Vice President, Finance and Chief Financial Officer since May 2001. Mr. Canova joined Brocade in November 2000 as our Vice President, Finance. From April 2000 to November

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      Jack Cuthbert has served as our Vice President, OEM Sales since August 2002. From November 2001 to August 2002, Mr. Cuthbert served as our Vice President, Worldwide Sales. From November 2000 to November 2001, Mr. Cuthbert served as our Vice President, Worldwide Sales, Marketing and Support, and from April 2000 to November 2000, he served as our Vice President, Worldwide Marketing. Mr. Cuthbert was Vice President North American Sales from October 1999 to April 2000, and was Director, Channel Sales from June 1998 to October 1999. From November 1996 to June 1998, Mr. Cuthbert served as Vice President, North American Sales at Macromedia, Inc., an Internet software development company. From July 1986 to July 1996, Mr. Cuthbert held various positions at SGI, a producer of visual computing systems, most recently Director, North American Channels. Mr. Cuthbert received a B.Sc. in Physics from the University of Waterloo in Canada and a M.S. in Engineering Physics from McMaster University in Canada.

Certain Financial Information

      Financial information relating to foreign and domestic sales and operations for the three years ended October 26, 2002, October 27, 2001 and October 28, 2000, is set forth in Note 10, “Segment Information,” of the Notes to Consolidated Financial Statements attached hereto. Financial information relating to revenues, income and total assets for the three years ended October 26, 2002, October 27, 2001 and October 28, 2000, can be found under “Selected Financial Data” and also in our Consolidated Financial Statements attached hereto.

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

Risk Factors

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

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

	•	changes in general economic conditions and specific economic conditions in the computer, storage, and networking industries. In particular, continuing economic uncertainty has resulted in a general reduction in IT spending. This reduction in IT spending has lead to a decline in our growth rates compared to historical trends;
	•	the timing of customer orders and product implementations, particularly large orders from and product implementations of our OEM partners;
	•	disruptions or downturns in general economic activity resulting from terrorist activity and armed conflict;
	•	announcements, introductions, and transitions of new products by us and our competitors;
	•	the ability of new competitors to enter the market and effectively compete against us;
	•	deferrals of customer orders in anticipation of new products, services, or product enhancements introduced by us or our competitors;
	•	our ability to obtain sufficient supplies of sole or limited sourced components, including ASICs, microprocessors, certain connectors, certain logic chips, and programmable logic devices;
	•	increases in prices of components used in the manufacture of our products;
	•	our ability to attain and maintain production volumes and quality levels;

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	•	variations in the mix of our products sold and the mix of distribution channels through which they are sold;
	•	litigation; and
	•	legislation or regulatory developments.

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

      In recent quarters, unfavorable economic conditions and reduced global IT spending rates have adversely affected our operating results and led to a decline in our growth rates compared to historical trends. We are unable to predict when IT spending rates will return to historical levels, if at all. If there are further reductions in either domestic or international IT spending rates, or if IT spending rates do not return to historical levels, our revenues, operating results and financial condition may be adversely affected.

      Our storage networking products are sold as part of storage systems and subsystems. As a result, the demand for our storage networking products has historically been affected by changes in storage requirements associated with growth related to new applications and an increase in transaction levels. Although in the past we have experienced historical growth in our business as enterprise-class customers have adopted SAN technology, demand for SAN products in the enterprise-class sector is being adversely impacted as a result of the weakened economy and because larger businesses have begun to focus on more efficiently using their existing IT infrastructure rather than making new equipment purchases. Increases in a customer’s ability to utilize existing storage infrastructure and the continued weakened economy may cause a decline in the demand for SAN products. This may harm our financial condition and results of operations.

      The market for our SAN solutions and technologies is competitive and is likely to become even more competitive as a result of recently introduced products by existing and new competitors. Currently, we believe that we face competition primarily from developers of Fibre Channel switching or interconnection products, including Cisco, INRANGE, McDATA, and QLogic. 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.

      The current and potential market for SAN solutions and technologies is continuously evolving and subject to rapid technological change. Major server and storage providers are continually introducing new SAN-oriented solutions and products and enhancing existing SAN-oriented solutions and products. As the SAN market evolves, additional technologies may become available for interconnecting servers and storage. In addition, networking companies, manufacturers of networking equipment, or other companies may develop competitive products. Furthermore, our OEM partners or other partners could also 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, price, size and extent of installed base, ability to meet delivery schedules, customer service, technical support, and distribution channels.

      Some of our competitors have longer operating histories and significantly greater human and financial resources than us. As a result, these competitors could adopt more aggressive pricing policies and devote greater resources to the development, promotion, and sale of their products than us. These advantages could allow them to respond more quickly to changes in customer or market requirements. In addition, some of our competitors have established supplier or joint development relationships with current or potential customers of ours. These competitors may be able to leverage their existing relationships to discourage these customers from purchasing additional products from us. These competitors may also be able to persuade our customers to replace our products with their products. Increased competition may result in reduced product prices, lower gross margins, and reduced market share. We may not have the financial resources, technical expertise or

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      Although our customer base has increased, we still depend on large, recurring purchases from a limited number of large OEM partners. Our agreements with our OEM partners are typically cancelable, non-exclusive, and have no minimum purchase requirements. For the fiscal year ended October 26, 2002, three customers each represented greater than ten percent of our total revenues for a combined total of 62 percent of our total revenues. During fiscal year 2002, two of our significant OEM partners, HP and Compaq, merged. We are unable to predict the impact this merger may have on our business. While to date the impact of this merger has not been material, this merger may result in a decrease or a disruption in our sales to the combined company.

      In addition, the financial strength of some of our competitors could allow them to market their products aggressively and to target our OEM partners with special incentives. We anticipate that our revenues and operating results will continue to depend on sales to a relatively small number of customers. Therefore, the loss of any one significant customer, or a decrease in the level of sales to any one significant customer, could seriously harm our financial condition and results of operations.

      The average unit prices and gross margins of some of our products have declined and may continue to decline in the future in response to changes in product mix, competitive pricing pressures, increased sales discounts, new product introductions by us or our competitors, or other factors. If we are unable to offset these factors by increasing sales volumes and, in particular, increasing the percent of software sales, our total revenues may decline. In addition, to maintain our gross margins we must maintain or increase current shipment volumes, develop and introduce new products and product enhancements, and we must continue to reduce the manufacturing cost of our products. Failure to reduce the manufacturing cost of our products in response to declines in unit selling prices would result in a further decline in our gross margins. Moreover, most of our expenses are fixed in the short-term or incurred in advance of receipt of corresponding revenue. As a result, we may not be able to decrease our spending to offset any unexpected shortfall in revenues. If this occurs, we could incur losses, and our operating results and gross margins may be below our expectations and those of investors and stock market analysts.

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

      Our future success depends upon our ability to address the rapidly changing needs of our customers by developing and introducing high-quality, cost-effective products and product enhancements on a timely basis, and by keeping pace with technological developments and emerging industry standards. In the second quarter of fiscal 2002, we introduced the SilkWorm 12000 Core Fabric Switch targeted at expanding our existing

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      As new or enhanced products are introduced, we must successfully manage the transition from older products in order to minimize disruption in customers’ ordering patterns, avoid excessive levels of older product inventories, and ensure that sufficient supplies of new products can be delivered to meet customer demands. For example, during the fourth quarter of fiscal 2002, we introduced the SilkWorm 3900 Enterprise Fabric Switch, a new enterprise-class, 32-port fabric switch that we expect will meet customer needs in both the mid-range and enterprise end-user markets. Because the SilkWorm 3900 Enterprise Fabric Switch is designed for customers in multiple market segments, it could potentially adversely impact sales of our existing mid-range products and result in an overall decline in product revenues. Our failure to manage the transition to newer products in the future or to develop and successfully introduce new products and product enhancements could adversely affect our business and financial results. When we introduce new products and product enhancements, we face risks relating to product transitions, including risks relating to forecasting demand, as well as possible product and software defects and a potentially different sales and support environment due to the complexity of these new systems. If any of the foregoing occurs, our business could be seriously harmed.

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

      Our ability to successfully implement our business plan, develop and offer products, and manage our business in a rapidly evolving market requires a comprehensive and effective planning and management process. We continue to change the scope of our operations domestically and internationally, including managing our headcount appropriately. In addition, the expected acquisition of Rhapsody and its integration into Brocade could present additional management challenges. Changes in our business, headcount, organizational structure and relationships with customers and other third parties has placed, and will continue to place, a significant strain on management systems and resources. Our failure to continue to improve upon our operational, managerial, and financial controls, reporting systems, and procedures, and our failure to continue to train and manage our work force worldwide, could seriously harm our business and financial results.

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      We market and sell our products through distribution partners, including OEM partners, value-added distributors, system integrators, and value-added resellers. Therefore, we must continually assess, anticipate, and respond to the needs of these distribution partners and ensure that our products integrate with their solutions. We must also continually assess, anticipate, and respond to the needs of our distribution partners’ customers, who are the end-users of our products. If we fail to respond to the needs of these groups, our business and operating results could be harmed.

      Because of our indirect distribution model, our contact with the actual end-users of our products is limited. Although we make every effort to communicate with, understand, and anticipate the current and future needs of the end-users of our products, to a large extent we rely on our distribution partners for visibility into those end-user requirements. Our failure to adequately assess and anticipate future end-user needs could negatively impact the demand for our products and reduce our revenues.

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

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

	•	supporting multiple languages;
	•	recruiting sales and technical support personnel with the skills to support our products;
	•	increased complexity and costs of managing international operations;
	•	commercial laws and business practices that favor local competition;
	•	multiple, potentially conflicting, and changing governmental laws and regulations, including differing labor and employment laws;
	•	longer sales cycles;
	•	difficulties in collecting accounts receivable;
	•	reduced or limited protections of intellectual property rights; and
	•	political and economic instability.

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

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

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      Some of our large customers experience seasonality in their businesses. While to date our operating results have not varied seasonally, as our business and products become more mature it is possible that we could begin to experience seasonality similar to that experienced by our large customers. It is difficult for us to evaluate the degree to which the seasonality of our large customers may affect our business in the future because the overall growth of our business may have lessened the impact of this customer seasonality on our business in the past.

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

      We currently depend on two third-party contract manufacturers, Solectron and Foxconn, to manufacture our products. If we should fail to effectively manage the production of our products through Solectron and Foxconn, or if Solectron or Foxconn experience delays, disruptions, capacity constraints, or quality control problems in their manufacturing operations, shipment of our products to our customers could be delayed and our competitive position and reputation could be harmed. Qualifying a new contract manufacturer and commencing volume production is a lengthy and expensive process and if we are required or choose to change contract manufacturers, we may lose revenue and damage our customer relationships.

      We provide to our contract manufacturers product forecasts and place purchase orders with our contract manufacturers in advance of the scheduled delivery of products to our customers. Although our purchase orders placed with our contract manufacturers are cancelable, we could be required to purchase all unused material not returnable or usable by other customers. Accordingly, if we inaccurately forecast demand for our products, we may be unable to obtain adequate manufacturing capacity from our contract manufacturers to meet customers’ delivery requirements, or we may accumulate excess inventories.

      We currently purchase several key components used in the manufacture of our products from single or limited sources. We purchase ASICs from a single source, and we purchase microprocessors, certain connectors, certain logic chips, and programmable logic devices from limited sources. In addition, we license certain third-party software that is incorporated into our Fabric Operating System and other software products. If we are unable to buy or license these components on a timely basis, we may not be able to deliver our products to our customers in a timely manner. We use a rolling six-month forecast based on anticipated product orders to determine component requirements. If we overestimate component requirements, we may have excess inventory, which would increase our costs. If we underestimate component requirements, we may have inadequate inventory, which could interrupt the manufacturing process and result in lost or deferred revenue. In addition, lead times for components vary significantly and depend on factors such as the specific

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

      In fiscal year 2003, we do not expect to maintain profitability at historical levels, and may not be able to maintain profitability at all in the future. We expect to incur significant costs and expenses for product development, sales and marketing, customer support, and expansion of corporate infrastructure. We make investment decisions based upon anticipated revenues and margins. If these anticipated revenues and margins do not materialize, our future profitability could be adversely affected.

      We recently announced an agreement to acquire Rhapsody. If the Rhapsody acquisition is completed, we expect this acquisition will adversely affect our earnings per share at least through our fiscal year 2004.

      We recently announced a restructuring program that included a workforce reduction, consolidation of excess facilities, and the restructuring of certain business functions. As part of this restructuring program, we reduced our workforce, including certain officers, by approximately 12 percent. Our planned reduction in spending related to this restructuring program is subject to risks and uncertainties, including the difficulty of achieving anticipated cost reductions due to unforeseen expenses we may incur in future quarters and an inability to reduce expenses without jeopardizing further development, marketing, and sales of our products. Additionally, it is possible that these reductions in spending may not be sufficient to achieve their intended goals. Because we cannot predict our revenue with certainty, additional restructuring activity may be necessary to reduce our expenses.

      We recently announced that our Board of Directors approved a voluntary stock option exchange program for employees. Under the stock option exchange program, employees were offered the opportunity to exchange 67.3 million outstanding stock options with exercise prices equal to or greater than $12.00 per share for new stock options that will be granted at an exchange ratio determined by the date the exchanged stock options were granted. In accordance with this program, on January 9, 2003, we cancelled 58.1 million of our outstanding stock options. We expect to grant 29.6 million new options to purchase shares of our common stock on July 10, 2003, the first business day that is six months and one day after the cancellation of the exchanged options. The new stock options represent approximately 12.6 percent of the total shares of our common stock outstanding as of December 20, 2002, and could have a dilutive impact on our future earnings per share to the extent that the market price of our common stock exceeds the exercise price of the new stock options to be granted on July 10, 2003.

      These actions involve numerous risks, including unanticipated costs, diversion of management’s attention from our core business and adverse effects on existing business relationships with suppliers, customers, and employees. In addition, it is difficult to forecast future operating results based on historical results. We plan our operating expenses based in part on future revenue projections. Our ability to accurately forecast quarterly revenue is limited for the reasons discussed above in “Our quarterly revenues and operating results may fluctuate in future periods for a number of reasons, which could adversely affect the trading price of our stock.” Moreover, most of our expenses are fixed in the short-term or incurred in advance of receipt of corresponding revenue. As a result, we may not be able to decrease our spending to offset any unexpected

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

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

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

      We rely on a combination of patent, copyright, trademark, and trade secret laws, confidentiality agreements, and other contractual restrictions on disclosure to protect our intellectual property rights. We also enter into confidentiality or license agreements with our employees, consultants, and corporate partners, and control access to and distribution of our technology, software, documentation, and other confidential information. These measures may not preclude competitors from independently developing products with functionality or features similar to our products. Despite efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology. Monitoring unauthorized use of our products is difficult, and we cannot be certain that the steps we take to prevent unauthorized use of our technology, particularly in foreign countries where the laws may not protect proprietary rights as fully as in the United States, will be effective.

      In recent years, there has been significant litigation in the United States involving patents and other intellectual property rights. On February 14, 2002, a suit captioned McDATA Corp. v. Brocade Communications Systems, Inc. was filed against Brocade in the United States District Court for the District of Colorado. The complaint alleged that the Brocade SilkWorm 3800 Enterprise Fabric Switch and Brocade SilkWorm 12000 Core Fabric Switch infringe United States Patent No. 6,233,236, entitled “Method and Apparatus for Measuring Traffic Within a Switch.” The complaint seeks unspecified compensatory and exemplary damages and to permanently enjoin Brocade from infringing the patent in the future. On March 4, 2002, McDATA filed an amended complaint, in which it additionally alleged that the Brocade SilkWorm 3200 Entry Fabric Switch infringed this patent. In connection with this suit, on March 4, 2002, McDATA filed a motion for a preliminary injunction against Brocade with regard to the patent. A hearing on the motion for preliminary injunction was held on July 15, 2002. On December 5, 2002, the Court issued its decision denying McDATA’s request for a preliminary injunction. On December 23, 2002, McDATA filed a demand for arbitration to move this matter from the United States District Court for the District of Colorado to arbitration. We believe that

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

	•	stop selling, incorporating or using products or services that use the challenged intellectual property;
	•	obtain from the owner of the infringed intellectual property a license to the relevant intellectual property, which may require us to license our intellectual property to such owner, or may not be available on reasonable terms or at all; and
	•	redesign those products or services that use technology that is the subject of an infringement claim. If we are forced to take any of the foregoing actions, we may be unable to manufacture, use, sell, import and export our products, which would reduce our revenues.

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

	•	issue stock that would dilute our current stockholders’ percentage ownership;
	•	use cash, which may result in a reduction of our liquidity;
	•	incur debt; or
	•	assume liabilities.

      These purchases also involve numerous risks, including:

	•	problems combining the purchased operations, technologies, personnel or products;
	•	unanticipated costs;
	•	diversion of management’s attention from our core business;
	•	adverse effects on existing business relationships with suppliers and customers;
	•	risks associated with entering into markets in which we have no, or limited, prior experience; and
	•	potential loss of key employees of acquired organizations.

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

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

      In addition, in the United States, our products comply with various regulations and standards defined by the Federal Communications Commission and Underwriters Laboratories. Internationally, products that we

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

	•	authorizing the issuance of preferred stock without stockholder approval;
	•	providing for a classified board of directors with staggered, three-year terms;
	•	prohibiting cumulative voting in the election of directors;
	•	limiting the persons who may call special meetings of stockholders;
	•	prohibiting stockholder actions by written consent; and
	•	requiring super-majority voting to effect amendments to the foregoing provisions of our certificate of incorporation and bylaws.

      Furthermore, the full impact of recent corporate governance legislation and regulations on our operations is uncertain at this time, but these laws and regulations could potentially result in changes to our charter documents or other agreements that affect our ability to enter into a merger or acquisition transaction.

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

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

	•	macroeconomic conditions;
	•	actual or anticipated fluctuations in our operating results;
	•	changes in financial estimates and ratings by securities analysts;
	•	changes in market valuations of other technology companies;
	•	announcements of financial results by us or other technology companies;
	•	announcements by us, our competitors, customers, or similar businesses of significant technical innovations, contracts, acquisitions, strategic partnerships, joint ventures or capital commitments;
	•	losses of major OEM partners;
	•	additions or departures of key personnel;
	•	sales by us of common stock or convertible securities; and
	•	incurring additional debt.

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

      In the past, securities class action litigation often has been brought against a company following periods of volatility in the market price of its securities. We are currently in litigation regarding alleged nondisclosure of improprieties in the distribution of shares in our initial public offering by our underwriters, including undisclosed fees and commissions received by the underwriters and alleged laddering arrangements. We

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