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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:

     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 o          No þ

      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).     Yes þ          No o

      The aggregate market value of voting and non-voting common equity held by non-affiliates of the Registrant was approximately $1,361,000,000 as of May 1, 2004 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 25, 2004, was 267,862,709 shares.

DOCUMENTS INCORPORATED BY REFERENCE

     Portions of the Registrant’s Proxy Statement for its 2005 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.

BROCADE COMMUNICATIONS SYSTEMS, INC.

INDEX

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PART I

Restatement of Consolidated Financial Statements

      On January 24, 2005, Brocade announced that its Audit Committee completed its previously announced internal review regarding Brocade’s stock option granting process. As a result of the review, Brocade recorded additional stock-based compensation charges and a valuation allowance against deferred tax assets related to previously recorded stock option tax benefits. The foregoing restatement adjustments did not affect our previously reported cash, cash equivalent and short-term investment balances in any of the years affected.

      Brocade has recorded stock-based compensation calculated under the variable method of accounting and associated income tax adjustments. As a result of these charges, Brocade restated the previously filed financial statements for fiscal years ended October 25, 2003 and October 26, 2002, including the corresponding interim periods for fiscal years 2003 and 2002, and the interim periods ended January 24, 2004, May 1, 2004 and July 31, 2004. Brocade also recorded stock-based compensation and associated income tax adjustments to previously announced financial results for the fourth quarter and year ended October 30, 2004. These charges relate solely to matters pertaining to stock options granted prior to August 2003.

      Except as otherwise stated, all financial information contained in this Annual Report on Form 10-K gives effect to this restatement and revision. Information regarding the effect of the restatement on our financial position and results of operations is provided in Note 3 of the Notes to Consolidated Financial Statements. Financial information included in reports on Form 10-K, Form 10-Q and Form 8-K previously filed by Brocade for these periods should not be relied upon and are superseded by the information in this Annual Report on Form 10-K.

      For years prior to 2002, Brocade reduced previously reported net income by approximately $303 million (consisting of a reduction to net income in years 1999 and 2000 of $15 million and $1,018 million, respectively, and an increase to net income in 2001 of $731 million) relating solely to stock-based compensation and associated income tax adjustments.

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;
	•	customer buying patterns;
	•	research and development expenses;
	•	sales and marketing expenses;
	•	general and administrative expenses;
	•	pricing and cost reduction activities;
	•	income tax provision and effective tax rate;
	•	realization of deferred tax assets;
	•	cash flows from employee participation in employee stock programs;
	•	liquidity and sufficiency of existing cash, cash equivalents, and investments for near-term requirements;
	•	purchase commitments;
	•	product development and transitions;
	•	competition and competing technology;
	•	outcomes of pending or threatened litigation; and
	•	financial condition and results of operations as a result of recent accounting pronouncements.

      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,”

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      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. (Brocade or the Company) designs, develops, markets, sells, and supports data storage networking products and services, offering a line of storage networking products and services that enable companies to implement highly available, scalable, manageable, and secure environments for data storage applications. The Brocade SilkWorm® family of storage area networking (SAN) switches is designed to help companies reduce the cost and complexity of managing business information within a data storage environment, ensure high availability of mission critical applications and serve as a platform for corporate disaster recovery. Brocade products are installed around the world at companies, institutions, and other entities ranging from large enterprises to small and medium size businesses. Brocade products and services are marketed, sold, and supported worldwide to end-user customers through distribution partners, including original equipment manufacturers (OEMs), value-added distributors, systems integrators, and value-added resellers.

      We were incorporated in California on August 24, 1995 and re-incorporated in Delaware on May 14, 1999. Our mailing address and executive offices are located at 1745 Technology Drive, San Jose, California 95110. Our telephone number is (408) 333-8000. Our corporate website is www.brocade.com. The Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge on our website when such reports are available on the U.S. Securities and Exchange Commission (SEC) website. The public may read and copy any materials filed by the Company with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC at http://www.sec.gov. The contents of these websites are not incorporated into this filing. Further, the Company’s references to the URLs for these websites are intended to be inactive textual references only.

Products and Services

      We offer a line of storage networking products and SAN management operating system that enables companies to network application servers with storage devices through a SAN. Our products and services are designed to help companies reduce the cost and complexity of managing business information within a data storage environment while enabling high levels of availability of mission critical business applications. In addition, our products assist companies in the development and delivery of disaster recovery programs. Our products are generally used in conjunction with application servers and storage subsystems, 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, performance and availability. As a result, companies are able to better utilize information technology (IT) assets, improve productivity of IT personnel, reduce capital and operational expenditures, and more reliably and securely store, manage, and administer business information.

      We believe that as the need for data storage grows, 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 many 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 also believe companies will 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

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      Since our inception, we have been a pioneer and innovator in developing 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 led 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, increase operational efficiencies, and reduce operating expense. 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.

      Our SilkWorm® family of fabric switches, based on the Fibre Channel protocol, are devices that provide bandwidth and high-speed routing of data. They range from low cost entry-level 8-port switches to 128-port enterprise-class director switches and are available in different form-factors including fixed-port services, modular chassis, and embedded blades. Our SilkWorm Director is a highly reliable solution for deploying enterprise-class SANs in mission-critical environments. It supports key applications such as data backup, remote mirroring, and high-availability clustering as well as high-volume transaction processing applications such as ERP and data warehousing. These products have been designed to meet the storage networking needs of end-users in environments ranging from small and medium-size businesses to large enterprises with SAN fabrics that scale to thousands of ports, spread across multiple locations around the world. Our SilkWorm family of switches share a set of advanced fabric services that enable key SAN management functionality that we believe is unique to Brocade.

      Brocade Fabric Operating System (Fabric OS) is the operating system firmware that provides the core infrastructure for deploying SANs. As the foundation for our family of SilkWorm switches, Fabric OS helps ensure the reliable and high-performance data transport that is critical for scalable SAN fabrics interconnecting multiple servers and storage devices. Our SAN management operating system also includes a common set of advanced fabric services that build upon the foundation of Fabric OS and 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. In addition, we offer management tools that enable end-users to manage and administer their SANs. We believe that our Fabric OS provides us with an advantage in the storage networking market, enabling differentiation and increasing licensable features and services.

      We believe that some of the next generation storage management applications will be fabric-based, rather than server or storage array-based. In general, this means that elements of certain storage related applications will reside in the network of Fibre Channel switches, commonly referred to as the “fabric”, rather than in the server or storage array. We believe this will allow for increased centralization of storage management functions and higher performance of storage related applications. We also believe that these fabric-based applications, such as fabric-based routing services, storage volume management, data replication, and data migration, will accelerate the migration of intelligence into the SAN fabric and minimize operational cost and complexity for the end-user. The SilkWorm® Fabric Application Platform (SilkWorm Fabric AP) is an intelligent switching platform designed to host SAN fabric-based storage management applications while integrating with existing Brocade SAN infrastructures. As a result, this new platform can provide a highly scalable solution for managing server and storage environments much more efficiently. Brocade is working closely with its OEM

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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. We have an open approach to SAN management and work with nearly every leading provider of storage and SAN management applications and technologies.

      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.

      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 resources for purposes of providing interoperability among Brocade solutions and the servers, storage, and storage management applications that run in the Brocade environment, as well as 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.

      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.

      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 training services are made available through our own education facilities and through our worldwide training provider network.

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Distribution Model

      Our products are marketed, sold, and supported worldwide through a wide range of distribution partners, including OEM partners, master resellers, which are value-added distributors, and fabric partners, which are 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 training and other value-added services.

      We have OEM or distribution agreements with the majority of the companies that sell the world’s storage systems and subsystems. In addition, we employ a worldwide overlay 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 Corporation (EMC), Fujitsu Siemens, Hitachi Data Systems, Inc., Hewlett-Packard Company (HP), IBM Corporation (IBM), Network Appliance, Inc., Siemens AG, Storage Technology Corp., Sun Microsystems, Inc., and Unisys Corporation. Our primary non-OEM customers include Bell Microproducts, GE Access Distribution, Tokyo Electron Limited, and XIOTech.

      For the years ended October 30, 2004, October 25, 2003 and October 26, 2002, EMC, HP, and IBM each represented greater than ten percent of our total revenues for combined totals of 70 percent, 67 percent, and 62 percent of our total revenues, respectively. 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, or a decrease in the level of sales to, or a change in the ordering pattern of, any one of these customers could have a material adverse impact on our financial condition or results of operations.

Geographic Information

      Historically, domestic revenues have been between 60 percent and 75 percent of total revenues. For the year ended October 30, 2004, domestic and international revenues were approximately 65 percent and 35 percent of our total revenues, respectively, and for the year ended October 25, 2003, domestic and international revenues were approximately 67 percent and 33 percent of our total revenues, respectively. Revenues are attributed to geographic areas based on the location of the customer to which our products are shipped. International revenues primarily consist of sales to customers in Western Europe and the greater Asia Pacific region. For the years ended October 30, 2004 and October 25, 2003, international revenues have increased primarily as a result of faster growth in the Asia Pacific region. However, certain OEM customers take possession of our products domestically and then distribute these products to their international customers. Because we account for all of those OEM revenues as domestic revenues, we cannot be certain of the extent to which our domestic and international revenue mix is impacted by the practices of our OEM customers.

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. We have made 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 January 27, 2003, we completed our acquisition of Rhapsody, a privately held technology company based in Fremont, California. This acquisition resulted in the

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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 expand the value-added services of our intelligent platform to enable more functionality for end customers, OEM partners, and application partners and to further simplify storage management.

      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.

      Our product development process includes the certification of our products by our OEM partners, which is referred to as the product qualification process. During this process, we support our OEM Partners in the testing of our new products to insure they meet quality and functionality, and inoperability requirements. The process is completed once the OEM Partner has certified the product and announced general availability of that product to their customers. This process generally is completed in a range of two to four months.

      For the years ended October 30, 2004, October 25, 2003, and October 26, 2002, our research and development expenses totaled $149.5 million, $145.7 million, and $113.2 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 competitive 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 providers of Fibre Channel switching products for interconnecting servers and storage, including Cisco Systems Inc. (Cisco), Computer Network Technology Corporation (CNT), QLogic Corporation (QLogic), and McDATA Corporation (McDATA), which recently announced its intention to acquire CNT.

      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 that compete 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. These competitors may have the ability to devote a larger number of sales personnel to focus on the SAN industry, compete with us and potentially change the current distribution model. Our competitors could also adopt more aggressive pricing policies and devote greater resources to the development,

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Manufacturing

      We use two third-party contract manufacturers, Solectron Corporation (Solectron) and Hon Hai Precision Industry Co., Ltd. (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. Although the purchase orders we place with our contract manufacturers are cancelable, we could be required to purchase all unused material not cancelable, returnable or usable by other customers.

      We use Solectron and Foxconn for final turnkey product assembly, but we also maintain key component selection and qualification 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, our contract manufacturers, Solectron and Foxconn, currently purchase, on our behalf, 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, power supplies, 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 rolling forecasts 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. Failure to do so could materially harm our business.

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      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 negotiations and to changes in quantities of products and delivery schedules in order to reflect changes in customers’ requirements and manufacturing availability. In addition, actual shipments depend on the manufacturing capacity of suppliers and the availability of products from such suppliers. As a result of the foregoing factors, we do not believe that backlog at any given time is a meaningful indicator of our ability to achieve any particular level of revenue or financial performance.

Employees

      As of October 30, 2004, we had 1,038 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 Singapore; and offices throughout North America, Europe, and Asia Pacific. 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.

Certain Financial Information

      Financial information relating to foreign and domestic sales and operations for the three years ended October 30, 2004, October 25, 2003, and October 26, 2002, is set forth in Note 13, “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 30, 2004, October 25, 2003, and October 26, 2002, can be found in Item 6 “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

      The market for SANs is characterized by rapidly changing technology and accelerating product introduction cycles. 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 provide sufficient supplies of new products to meet customer demands. We must also achieve widespread market acceptance of the new or enhanced products in order to realize the benefits of our investments in these products. When we introduce new or enhanced products, we face numerous risks relating to product transitions, including the inability to accurately forecast demand, excess inventories of

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	•	product performance, price and total cost of ownership;
	•	product features and functionality;
	•	availability and price of competing products and technologies; and
	•	the ability of our OEM partners to successfully distribute, support and provide training for our products.

      For example, during the second half of fiscal year 2004, we introduced six new SilkWorm products, which are the SilkWorm 24000 Director, the SilkWorm 3250 and SilkWorm 3850 entry level fabric switches, the SilkWorm Multiprotocol Router, a switch module for bladed server solutions, and the SilkWorm 4100 4 Gigabit per second fabric switch. Because we currently derive the majority of our revenues from sales of our SilkWorm product family and we expect that revenue from this product family will continue to account for a substantial portion of our revenues for the foreseeable future, sustained and widespread market acceptance of these products is critical to our future success. If we fail to successfully manage the transition to these new products or if the products do not achieve market acceptance, our business and financial results will be adversely affected. For instance, during the fourth quarter of fiscal year 2001, we recorded charges to cost of revenues of $7.7 million primarily associated with the accrual of purchase commitments for excess inventory components related to a transition of product offerings from 1 to 2 Gigabit per second technology.

      The success of our new products also depends on several factors, including our ability to properly define the new products, timely complete and introduce the new products, differentiate of our new products from the products of our competitors and address the complexities of interoperability of our products with our OEM partners’ server and storage products. If we are not able to successfully develop new products or enter into new market segments, or if we are unable to obtain or maintain requisite third-party interoperability licenses, our business and results of operations will be harmed.

      We recently introduced, and intend to continue to make substantial investments in, our Silkworm Fabric Application Platform product family. The first product in the Silkworm Fabric Application Platform product family that we announced for general availability is the Silkworm Multiprotocol Router. Our success with the Silkworm Multiprotocol Router and the subsequent products in the Silkworm Fabric Application Platform product family will depend on:

	•	the market acceptance of these products by both end-users and our OEM partners;
	•	the availability of complementary applications developed by our OEM partners and other application developers for these products; and
	•	our ability to timely develop and manufacture these products in volumes and with the performance levels and feature sets required by customers

      We cannot be certain that these new products will be successfully developed or achieve market acceptance, or that we will benefit fully from the substantial investments we have made and continue to make in the Silkworm Fabric Application Platform product family. In addition, we cannot be certain that our OEM partners or other application developers will develop applications for these products in a timely manner, if at all, or if applications that are developed will meet end-user requirements. If we are unable to successfully manage any of these aspects of our Silkworm Fabric Application Platform product family introductions, our business and financial results will be adversely affected.

      The SAN market is becoming more competitive and subject to rapid technological change. Increased competition has in the past resulted in greater pricing pressures, and reduced sales, margins, profits and

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      The SAN market is likely to become even more competitive as new products and technologies are introduced by existing competitors and as new competitors enter the market. These new competitive products could be based on existing technologies or new technologies that may or may not be compatible with our SAN technology. Competitive products might include, but are not limited to, non-Fibre Channel based emerging products utilizing Gigabit Ethernet, 10 Gigabit Ethernet, InfiniBand or iSCSI. In addition, our OEM partners, who also have relationships with some of our current competitors, could become new competitors by developing and introducing products competitive with our product offerings, choose to sell our competitors’ products instead of our products, or offer preferred pricing or promotions on our competitors’ products.

      Some of our competitors have longer operating histories and significantly greater human, financial and capital resources than us. These competitors may have the ability to devote a larger number of sales personnel to focus on the SAN industry, compete with us and potentially change the current distribution model. Our competitors could also adopt more aggressive pricing policies and devote greater resources to the development, promotion, and sale of their products than we can. As a result, they may be able to respond more quickly to changes in customer or market requirements. We may not have the financial resources, technical expertise or marketing, manufacturing, distribution and support capabilities to compete successfully against current or future competitors. This could materially harm our business and financial results.

      We depend on recurring purchases from a limited number of large OEM partners for the majority of our revenue. As a result, these large OEM partners have a significant influence on our quarterly and annual financial results. Our agreements with our OEM partners are typically cancelable, non-exclusive, have no minimum purchase requirements and have no specific timing requirements for purchases. For the fiscal year ended October 30, 2004, three customers each represented greater than ten percent of our total revenues for a combined total of 70 percent. We anticipate that our revenues and operating results will continue to depend on sales to a relatively small number of customers. The loss of any one significant customer, or a decrease in the level of sales to any one significant customer, or unsuccessful quarterly negotiation on key terms, conditions or timing of purchase orders placed during a quarter, could seriously harm our business and financial results.

      In addition, some of our OEM partners purchase our products for their inventories in anticipation of customer demand. These OEM partners make decisions to purchase inventory based on a variety of factors, including their expectations of end customer demand, which may be affected by seasonality and their internal supply management objectives. Others require that we maintain inventories of our products in hubs adjacent to their manufacturing facilities and purchase our products only as necessary to fulfill immediate customer demand. If more of our OEM partners transition into a hub model, form partnerships, alliances or agreements with other companies that diverts business away from us, or otherwise change their business practices, their ordering patterns may become less predictable. Consequently, changes in ordering pattern may affect both the timing and volatility of our reported revenues. The timing of sales to our OEM partners, and consequently the timing and volatility of our reported revenues, may be further affected by the product introduction schedules of our OEM partners. Our OEM partners may delay or postpone their product orders in order to coordinate receipt of our products with their product introduction schedules. We also may be exposed to higher risks of obsolete or excess inventories.

      Our OEM partners 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 engineering 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

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      The average selling price per port for our products has declined in the past, and we expect it to continue to decline in the future as a result of changes in product mix, competitive pricing pressures, increased sales discounts, marketing programs, new product introductions by us or our competitors, the entrance of new competitors or other factors. For example, during the second half of fiscal year 2004, we introduced and began shipping several new products that expand and extend the breadth of our product offerings. Several of these new products have different revenues, gross margin, and profitability characteristics than our traditional products. It will take some time for us to be able to determine the impact that these new products will have on our total revenues, gross margins and overall profitability. If we are unable to offset any negative impact that changes in product mix, competitive pricing pressures, increased sales discounts, enhanced marketing programs, new product introductions by us or our competitors, or other factors may have on us by increasing the number of ports shipped or reducing product manufacturing cost, our total revenues and gross margins will decline.

      In addition, to maintain our gross margins we must maintain or increase the number of ports shipped, develop and introduce new products and product enhancements, and continue to reduce the manufacturing cost of our products. While we have successfully reduced the cost of manufacturing our products, we may not be able to continue to reduce cost of production at historical rates. If we fail to effectively respond to declines in average selling price per port, our gross margins will further decline. 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, our operating results and gross margins would be below our expectations and the expectations of investors and stock market analysts, and our stock price would be negatively affected.

      Our future success depends upon our ability to address the rapidly changing needs of our customers by developing and manufacturing high-quality, cost-effective products and product enhancements on a timely basis, and by keeping pace with technological developments and emerging industry standards. This risk could become more pronounced as the SAN market becomes more competitive and subject to increased demand for new and improved technologies. In the past, we experienced delays in product development, and such delays could occur in the future. If we are required to develop new technologies and introduce new products more rapidly than in the past, or if we have to manage shorter product cycles and transitions, our business and financial results may be harmed.

      We expect to launch new products and product enhancements during the next year that will further expand the market opportunity for our products. We also expect our future revenue growth to be dependent on the success of our current line of products and our ability to rapidly develop and introduce new products and new product enhancements. If we are unable to timely introduce our new products, our business and financial results will be adversely affected.

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      We have invested significant resources developing products that are dependent on the adoption rate of new technologies. For example, in the fourth quarter of fiscal year 2004, we announced the future availability of 4 Gigabit switch technology. The success of these products will depend upon the rate that our OEM partners and end users adopt this new technology. If these products are not adopted or are adopted more slowly by our customers than we planned, our business could be harmed. In addition, our ability to sell 4 Gigabit products is partially dependent upon the availability of components, such as HBAs and SFPs. If sufficient supply of the required components is not available, our business could be harmed.

      We currently depend on two third-party contract manufacturers, Solectron and Foxconn, to manufacture our products. Each of our products is produced by one of the two contract manufacturers. If production is disrupted at one of these manufacturers’ facilities, our ability to produce a particular product could be terminated for an indefinite period of time. Qualifying a new contract manufacturer and commencing volume production is a lengthy and expensive process. If we are required or choose to change contract manufacturers and we encounter production, administrative or logistical obstacles during the transition, we may lose revenue and injure our customer relationships. In addition, if we fail to effectively manage the production of our products through Solectron and Foxconn, or if Solectron or Foxconn experience delays, disruptions, capacity constraints, component parts shortages 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.

      We provide product forecasts to our contract manufacturers and place purchase orders with them in advance of the scheduled delivery of products to our customers. In preparing sales and demand forecasts, we rely largely on input from our distribution partners. Therefore, if our distribution partners are unable to accurately forecast demand, or if 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. If these forecasts are inaccurate we may be unable to obtain from our contract manufacturers adequate manufacturing capacity to meet customers’ delivery requirements, or we may accumulate excess inventories. Furthermore, we may not be able to identify forecast discrepancies until late in our fiscal quarter. Consequently, we may not be able to make adjustments to our business model. If we are unable to obtain adequate manufacturing capacity from our contract manufacturers, if we accumulate excess inventories, or if we are unable to make necessary adjustments to our business model, our business and financial results may be negatively affected. In addition, although the purchase orders placed with our contract manufacturers are cancelable, in certain circumstances we could be required to purchase certain unused material not returnable, usable by, or sold to other customers if we cancel any of our orders. This purchase commitment exposure is particularly high in periods of product transition, such as the introduction of our 3250 and 3850 switch products, which were introduced in the third quarter of fiscal year 2004. If we are required to purchase unused material from our contract manufacturers, we would incur unanticipated expenses and our business and financial results could be negatively affected.

      As part of our business strategy, we may seek to transition a greater portion of our product manufacturing to third parties that are located overseas. This kind of transition would expose us to certain inherent risks, including unexpected changes in regulatory requirements and tariffs, delays related to the acquisition of product components and distribution of our products, and potentially adverse tax consequences, all of which could harm our business. If we are not successful in our strategy to further transition our manufacturing to overseas markets, or if we are not successful in the implementation of this overseas manufacturing, our ability to manufacture and sell our products could be substantially impaired.

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      In January 2005, on management’s recommendation, our Board of Directors, in consultation with KPMG LLP, our independent auditors, and our advisors, concluded that our financial statements for the fiscal years ended 2002, 2003 and the nine months ended July 31, 2004, and the interim periods contained therein, should no longer be relied upon because of an error in such financial statements as addressed in Accounting Principles Board Opinion No. 20. We restated those financial statements, which appear elsewhere in this Annual Report on Form 10-K. As a result, the SEC may choose to begin an investigation or we may be the subject to litigation, which could require significant human and financial resources which could otherwise be devoted to the operation of our business. If we are subject to an SEC investigation or litigation, we could be required to pay damages or penalties or have other remedies imposed upon us. In addition, we could become the target of costly securities litigation related to other matters in the future. Any SEC investigation or litigation could adversely affect our business, results of operations, financial position and cash flows.

      Our success depends to a significant degree upon the continued contributions of key management, engineering, sales and other personnel, many of whom would be difficult to replace. Our compensation packages include equity-based incentives. Therefore, our compensation packages could be adversely affected if our stock price does not increase.

      We believe our future success will also depend, in large part, upon our ability to attract and retain highly skilled managerial, engineering, sales and other personnel, and on the ability of management to operate effectively, both individually and as a group. We have experienced difficulty in hiring qualified ASIC, software, system and test, sales, marketing, key management and customer support personnel. In addition, our recent reductions in force could potentially make attracting and retaining qualified employees more difficult 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 affect 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 or that there will be inappropriate disclosure of confidential or proprietary information. We may receive such claims in the future as we seek to hire additional qualified personnel. Such claims could result in material litigation. As a result, we could incur substantial costs in defending against these claims, regardless of their merits.

      Our quarterly and annual 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. Factors that may affect the predictability of our annual and quarterly results include, but are not limited to, the following:

	•	changes, disruptions or downturns in general economic conditions, particularly in the information technology industry;
	•	the timing of customer orders, product qualifications, and product introductions of our OEM partners;
	•	announcements, introductions, and transitions of new products by us and our competitors or our OEM partners;
	•	declines in average selling price per port for our products as a result of competitive pricing pressures or new product introductions by us or our competitors;
	•	the emergence of new competitors in the SAN market;
	•	deferrals of customer orders in anticipation of new products, services, or product enhancements introduced by us or our competitors;

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

      Accordingly, the results of any prior periods should not be relied upon as an indication of future performance. It is possible that in some future quarter our revenues or operating results will not meet our projections or the expectations of stock market analysts or investors, and our stock price will decline.

      In the past, unfavorable or uncertain economic conditions and reduced global IT spending rates have adversely affected our operating results and have led to a decline in our growth rates. We are unable to predict changes in general economic conditions and when IT spending rates will be affected. Furthermore, even if IT spending rates are positively affected, we cannot be certain that the market for SAN solutions will be positively impacted. If there are future reductions in either domestic or international IT spending rates, or if IT spending rates do not improve, 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 continues to be adversely affected by weak or uncertain economic conditions, and because larger businesses are focusing on more efficiently using their existing IT infrastructure rather than making new equipment purchases. If weakened IT spending levels persist, and new products improve our customers’ ability to utilize their existing storage infrastructure, the demand for SAN products may decline. If this occurs, our business and financial results will be harmed.

      Many of our OEM partners experience seasonality and uneven sales patterns in their businesses. For example, some of our partners close a disproportionate percentage of their sales transactions in the last month, weeks and days of each fiscal quarter; and other partners experience spikes in sales during the fourth calendar quarter of each year. Because the majority of our sales are derived from OEM partners, if they experience seasonality, we are likely to experience similar seasonality. In addition, we have experienced quarters where uneven sales patterns of our OEM partners have resulted in a significant portion of our revenue occurring in the last month of our fiscal quarter. This exposes us to additional inventory risk as we have to order products in anticipation of expected future orders. It is difficult for us to evaluate the degree to which the seasonality and uneven sales patterns of our OEM partners or other customers may affect our business in the future because the historical growth of our business may have lessened the effect of this seasonality and uneven sales patterns on our business in the past.

      We purchase certain key components used in the manufacture of our products from single or limited sources. We purchase application specific integrated circuits (ASICs) from a single source, and we purchase microprocessors, certain connectors, logic chips, power supplies and programmable logic devices from limited sources. We also license certain third-party software that is incorporated into our operating system software and other software products. If we are unable to timely purchase or license these components or experience

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      We use rolling forecasts 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. If we overestimate or underestimate our component requirements, or if we experience shortages, our business and financial results 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. During fiscal year 2003 and the second quarter of fiscal year 2004, we completed programs to restructure certain business operations that included workforce reductions and structural cost reductions. If we do not properly manage these cost and headcount reductions, our ability to generate revenue and to produce and sell products could be harmed.

      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, enterprise-wide management information and reporting systems, and procedures, and our failure to continue to train and manage our workforce worldwide, could seriously harm our business and financial results.

      In the past we have vacated certain unused facilities and made various assumptions in recording facilities lease loss reserves, including the time period over which the facilities are expected to be vacant, expected sublease terms, expected sublease rates, anticipated future operating expenses, and expected future use of the facilities. Our estimates involve a number of risks and uncertainties, some of which are beyond our control, including future real estate market conditions and our ability to successfully enter into subleases or lease termination agreements with terms as favorable as those assumed when arriving at our estimates. If actual results differ significantly from our estimates, we may be required to take additional charge and our financial results could be harmed.

      We completed our acquisition of Rhapsody on January 27, 2003. As part of our business 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. If we buy other businesses, products or technologies in the future, we could:

	•	incur significant unplanned expenses and personnel costs;
	•	issue stock, or assume stock option plans that would dilute our current stockholders’ percentage ownership;
	•	use cash, which may result in a reduction of our liquidity;
	•	incur debt; or
	•	assume liabilities.

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      These purchases also involve numerous risks, including:

	•	problems integrating the purchased operations, technologies, personnel or products;
	•	unanticipated costs, litigation and other contingent liabilities;
	•	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;
	•	unconsummated transactions; and
	•	potential loss of our key employees or the key employees of an acquired organizations.

      We may not be able to successfully integrate any businesses, products, technologies or personnel that we might acquire, or to realize expected benefits of acquisitions that we may undertake in the future. If this occurs, our business and financial results may be adversely affected.

      We did not attain profitability for the full fiscal years 2004 or 2003, and we may not be able to attain profitability in the future. We make our investment decisions and plan our operating expenses based in part on future revenue projections. However, our ability to accurately forecast quarterly and annual revenues is limited, as discussed above in “Our quarterly and annual revenues and operating results may fluctuate in future periods due to a number of factors, which could adversely affect the trading price of our stock.” If our projected revenues and margins do not materialize, our future profitability could be adversely affected. Moreover, we expect to incur significant costs and expenses for product development, sales, marketing and customer support, most of which 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.

      We also make operating and investment decisions based on our anticipated future expansion, which may have an adverse effect on our earnings in the short term. For example, in fiscal year 2004, we purchased a 194,000 square foot building located near our San Jose headquarters. Our building purchase has adversely affected our earnings per share for our fiscal year 2004 as we recorded a $75.6 million charge related to lease termination, facilities consolidation and other associated costs (see Note 6, “Liabilities Associated with Facilities Lease Losses,” of the Notes to Consolidated Financial Statements).

      During fiscal year 2003 and the second quarter of fiscal year 2004, we completed programs to restructure certain business operations that included workforce reductions and the impairment of certain assets no longer being used as a result of the restructuring programs. 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. We may not be able to achieve our planned reduction in spending related to these restructuring programs if we incur unforeseen expenses in future quarters or if we are unable 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. If we are unable to achieve our planned reduction in spending or if our current reductions in spending are insufficient, we may be required to undertake additional restructuring activities that may involve our personnel, real estate, fixed assets, marketing programs and research and development programs.

      FASB’s recent change to mandate the expensing of stock options, would require us to record charges to earnings for employee stock option grants and will adversely affect our financial results. In addition, the FASB requires certain valuation models to estimate the fair value of employee stock options. These models, including the Black-Scholes option-pricing model, use varying methods, inputs and assumptions selected across companies. If another party asserts that the fair value of our employee stock options are misstated, securities

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      A portion of our outstanding stock options are subject to variable accounting under Accounting Principles Board Opinion No. 25. Under variable accounting we are required to remeasure the value of the options, and the corresponding compensation expense, at the end of each reporting period until the option is exercised, cancelled, or expires unexercised. As a result, the stock-based compensation recognized in any given period can vary substantially due to changes in the market value of our common stock. In order to illustrate the volatility associated with stock price movements we offer the following example. If the market value of our common stock at the end of the first quarter of fiscal year 2005 is $7, we will record additional compensation expense in that quarter of approximately $0.5 million. If, however the market value of our common stock at the end of the first quarter of fiscal year 2005 is $9, the compensation expense recorded will increase to $4.0 million. We are unable to predict the future market value of our common stock and therefore are unable to predict the compensation expense that we will record in future periods.

      International political instability, evidenced by the occurrence and threat of terrorist attacks, enhanced national security measures and military action and armed conflicts, may halt or hinder our ability to do business and may increase our costs. In addition, concerns about other international crises, such as the spread of the SARS and West Nile viruses, may have an adverse effect upon the world economy and could adversely affect our business operations or the operations of our OEM partners, contract manufacturers and suppliers. This political instability and concerns about other international crises may, for example:

	•	negatively affect the reliability and cost of transportation;
	•	negatively affect the desire and ability of our employees and customers to travel;
	•	disrupt the production capabilities of our OEM partners, contract manufacturers and suppliers;
	•	adversely affect our ability to obtain adequate insurance at reasonable rates; and
	•	require us to take extra security precautions for our operations.

      Furthermore, 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.

      We plan to continue to expand our international operations and 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 design, manufacture, sell, and support our products;
	•	increased complexity and costs of managing international operations;
	•	increased exposure to foreign currency exchange rate fluctuations;
	•	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 and manufacturing lead times;
	•	difficulties in collecting accounts receivable;
	•	reduced or limited protections of intellectual property rights;

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	•	more complicated logistics and distribution arrangements; and
	•	political and economic instability.

      To date, no material amount of our international revenues and costs of revenues have 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, not competitively priced in foreign markets. Additionally, a decrease in the value of the United States dollar relative to foreign currencies could increase our operating costs in foreign locations. In the future, a larger 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.