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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
FOR THE FISCAL YEAR ENDED OCTOBER 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER: 000-25601
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BROCADE COMMUNICATIONS SYSTEMS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 77-0409517
(STATE OR OTHER JURISDICTION OF INCORPORATION OR (I.R.S. EMPLOYER IDENTIFICATION NO.)
ORGANIZATION)
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1901 GUADALUPE PARKWAY
SAN JOSE, CA 95131
(408) 542-1500
(ADDRESS, INCLUDING ZIP CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES AND
TELEPHONE NUMBER, INCLUDING AREA CODE)
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: COMMON STOCK, $.001
PAR VALUE
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
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. [ ]
The aggregate market value of voting stock held by non-affiliates of the
Registrant was approximately $8,845,632,997 as of December 30, 1999, 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 30, 1999 was 53,854,691 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for its 2000 Annual Meeting of
Stockholders (the "Proxy Statement"), to be filed with the Securities and
Exchange Commission, are incorporated by reference to Part III of this Form 10-K
Report.
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BROCADE COMMUNICATIONS SYSTEMS, INC.
FORM 10-K
INDEX
PART I
PAGE
--
Item 1. Business.................................................... 2
Item 2. Properties.................................................. 12
Item 3. Legal Proceedings........................................... 12
Item 4. Submission of Matters to a Vote of Security Holders......... 12
PART II
Item 5. Market For Registrant's Common Equity and Related
Stockholder Matters......................................... 15
Item 6. Selected Financial Data..................................... 15
Item 7. Management's Discussion and Analysis of Financial Condition
and Results
of Operations............................................... 18
Item 7A. Quantitative and Qualitative Disclosure About Market Risk... 30
Item 8. Financial Statements and Supplementary Data................. 30
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure.................................... 49
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 49
Item 11. Executive Compensation...................................... 49
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 49
Item 13. Certain Relationships and Related Transactions.............. 49
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 49
SIGNATURES............................................................ 54
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PART I
ITEM 1. BUSINESS
NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report contains forward-looking statements that relate to
future events or future financial performance. In some cases, forward-looking
statements can be identified by terminology such as "may," "will," "should,"
"expects," "plans," "anticipates," "believes," "estimates," "predicts,"
"intend," "potential" or "continue" or the negative of such terms or other
comparable terminology. These statements are only predictions. Although Brocade
believes that the expectations reflected in the forward-looking statements are
reasonable, we cannot guarantee future results, levels of activity, performance
or achievements. Actual results could differ materially from those anticipated
in these forward-looking statements as a result of various factors, including
the risks outlined under "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Risk Factors" and elsewhere in this
Annual Report. All forward-looking statements included in this document are
based on information available to Brocade on the date hereof. Brocade assumes no
obligation to update any such forward-looking statements.
OVERVIEW
Brocade is the leading provider, based on revenue and the number of ports
shipped, of Fibre Channel switching solutions for Storage Area Networks
("SANs"), which apply the benefits of a networked approach to the connection of
computer storage systems and servers. Our family of SilkWorm switches enables
companies to cost-effectively manage growth in their storage capacity
requirements, improve the performance between their servers and storage systems
and increase the size and scope of their SAN, while allowing them to operate
data-intensive applications, such as data backup and restore, and disaster
recovery, on the SAN. We sell our SAN switching solutions through leading
storage systems and server original equipment manufacturers, including Amdhal,
Compaq Computer, CNT, Data General (a division of EMC Corporation), Dell
Computer, IBM, Groupe Bull, McDATA Corporation (a division of EMC Corporation),
NEC, Network Appliance, Sequent Computer Systems, SGI, Fujitsu/Siemens Computer
Systems and StorageTek and through system integrators. These original equipment
manufacturers and system integrators combine our switching solutions with other
system elements and services for companies' data processing centers.
INDUSTRY BACKGROUND
Business-Critical Data Storage Requirements
The last decade has seen an explosion in the volume of business-critical
data that is being captured, processed, stored and manipulated in business
environments. This has fueled an increase in demand for data storage capacity.
Efficient data storage and management is becoming one of the most important
aspects of business-critical decision making. Increased reliance on applications
ranging from business intelligence and decision support, data warehousing and
data mining of large databases, disaster tolerance and recovery, enterprise
software, and imaging and graphics have all contributed to this trend. In
addition, the development of Web-based business operations and e-commerce in
particular, has intensified the demand placed on data centers. Customer
interactions over the Web have increased operational focus on the performance,
scalability, management and flexibility of systems that use business-critical
data. This dependence on data for fundamental business processes by employees,
customers and suppliers has greatly increased the number of input and output
transactions, or I/Os, required of computer storage systems and servers. In
addition, the complexity of enterprise computing and storage is further
compounded by the use of multiple incompatible server operating systems, such as
the proliferation of Windows NT in traditional UNIX environments. As a result,
organizations are being forced to dedicate substantial financial and personnel
resources to manage and maintain the distributed storage capabilities of their
networks.
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Bottleneck In Storage and Server Connections
Despite the increased attention and resources which have been devoted to
data storage requirements, the technical capabilities of data storage systems
have not kept pace with increasing data management demands and with the
advancements in other networking technologies. In the 1980s, the near ubiquity
of PCs, workstations and servers required broader connectivity, resulting in the
development of local and wide area networks to support messaging between
computer systems. The data used by computers and servers connected to local and
wide area networks are typically located on computer storage systems and
servers, which store, process and manipulate data. The adoption of high speed
messaging technologies such as gigabit Ethernet and asynchronous transfer mode,
or ATM, increased local and wide area network transmission speeds by more than
1,000 times during the 1990s. However, storage-to-server data transmission
speeds increased by less than ten times during this period, creating a
bottleneck between the local or wide area network and business-critical storage
systems and servers.
Traditionally, distributed systems have linked a single server with a
limited number of storage systems in close proximity. The Small Computer Systems
Interface, or SCSI, standard was adopted as the I/O interface standard for
storage-to-server and server-to-server connections in the 1980s. SCSI is a
parallel interface that permits throughput of 20 to 40 megabytes per second.
SCSI's throughput limitations have become much more pronounced as local and wide
area network transmission technologies have migrated from Ethernet, which
transfers data at 10 megabits per second, to gigabit Ethernet, which transfers
data at 1,000 megabits per second. In addition, SCSI allows a maximum
transmission distance of only 12 meters and supports just 32 devices on a single
bus. As a result, SCSI does not adequately support the increasing requirements
for speed, scalability and flexibility of today's data-intensive enterprises.
Introduction and Standardization of Fibre Channel
In response to the demand for high-speed and high-performance
storage-to-server and server-to-server connectivity, the Fibre Channel
interconnect protocol, an industry networking standard, was developed in the
early 1990s. The Fibre Channel interconnect standard received American National
Standards Institute, or ANSI, approval in 1994 and has subsequently earned broad
support from industry and independent testing laboratories. Fibre Channel
supports large data block transfers at gigabit speeds and is therefore well
suited for data transfers between storage systems and servers. It also supports
multiple protocols such as SCSI and Internet Protocol, or IP. Furthermore, it
provides transmission reliability with guaranteed delivery and transmission
distances of up to 10 kilometers. Fibre Channel complements and supports
advancements in local and wide area network technologies, such as gigabit
Ethernet and ATM, which are not effective for large block data-intensive
transfers.
Advent of the Storage Area Network
Fibre Channel has enabled the development of a storage area network, or
SAN, to meet the requirements of data centers and other data-intensive,
distributed computing environments. Similar to local and wide area networks, the
SAN applies the distributed computing model to computer storage systems and
servers and takes advantage of the inherent benefits of a networked approach.
These benefits include the decoupling of computer storage systems and servers,
increasing scalability and a higher level of connectivity than currently exists
in the SCSI environment. Additionally, the SAN provides high-speed connectivity
for data-intensive applications across multiple operating systems, including
UNIX and Windows NT. By bringing networking technology into the data processing
center, a SAN also provides increased flexibility, fault tolerance, ease of
management and lower total cost of ownership. The SAN market is expected to grow
substantially as organizations embrace this emerging solution. According to the
Gartner Group, an independent industry research company, more than 70% of shared
storage in networked environments is projected to be reorganized into SANs by
the year 2002. According to Dataquest, an independent research company, the SAN
market is currently growing at a compound annual growth rate of 200%.
The simplest SAN configuration is a loop topology, which is similar to
traditional SCSI-based distributed systems and interconnects multiple nodes over
a shared Fibre Channel networking device, such as a hub. A
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Fibre Channel hub can support up to 126 devices, but the available bandwidth is
shared among all the devices, resulting in signal and performance degradation as
the number of devices in the loop increases. In addition, loop topologies suffer
from limited network management and fault isolation capabilities. For example,
when a single device is added to the loop, it will cause the loop to reset,
resulting in application disruption. The limitations of shared networks have
been addressed in local and wide area network environments by the development of
switching technologies that have yielded advancements in performance,
scalability, flexibility and management at competitive costs. In order for the
SAN model to become more widely adopted in data centers, today's enterprises
must be able to connect any device on the network to any other device on the
network, or any-to-any connectivity, without performance degradation in order to
effectively leverage distributed computer storage systems, servers, workstations
and other resources. Guaranteed reliability and availability are vital to the
storage, processing and manipulation of business-critical data. Networks require
dedicated connections operating at high performance levels to support large data
transfer demands. Finally, data processing centers are characterized by a high
degree of change that must be supported by a flexible network infrastructure.
THE BROCADE SOLUTION
Brocade is the leading provider of Fibre Channel SAN switching solutions.
We combine advanced switching technologies with our Fibre Channel technology
leadership and systems expertise to provide the Brocade Fabric, comprised of
Fibre Channel switches, a proprietary switch operating system, management tools,
management services and ready-to-deploy configurations. Our products provide an
infrastructure backbone that allows our customers to concurrently run multiple
applications across the SAN, reducing congestion of local and wide area
networks. Our Brocade Fabric helps enterprises cost-effectively manage the
growth in storage capacity, improve server-to-storage and server-to-server
performance, and increase the size and scope of their SANs, while enabling
data-intensive applications, such as reliable backup and restore and disaster
recovery. Our solutions have the following key benefits:
Address the input/output bottleneck. Deployment of SANs based on our
Brocade Fabric not only enhances point-to-point bandwidth with Fibre Channel
connections, but helps solve the I/O bottleneck between data storage systems and
servers. Our SilkWorm family of Fibre Channel switches delivers full-duplex 1
gigabit per second performance at every port. In addition, unlike hubs or other
shared devices, our switches are designed to provide any-to-any connectivity and
to maintain 1 gigabit per second performance per port as additional devices are
added to the SAN. Our superior frame-forwarding capability provides end-users
with rapid data retrieval and allows a greater number of user transactions.
Provide SAN scalability. Our modular Fibre Channel switches, supporting
from two to 16 ports per switch, enable incremental growth by interconnecting or
cascading multiple switches for hundreds of connections in a fully meshed
configuration. Our Brocade Fabric enables companies to grow clusters of high
performance servers or provide multiple servers with high bandwidth connections
to multiple storage systems. Additionally, Fibre Channel allows connections up
to 10 kilometers, enabling companies to interconnect separate SAN clusters or
islands into a single SAN.
Enable SAN applications. The Brocade Fabric creates a SAN backbone for
data-intensive applications, enabling organizations to solve complex problems in
data processing centers. Our products allow all departments within an
organization to share data storage resources despite operating within a
computing environment that includes incompatible operating systems sharing
storage resources. The Brocade Fabric allows highly flexible configurations and
supports a wide range of data traffic, including high throughput and low latency
processing. For example, high throughput applications, such as data backup and
restore, and disaster recovery can be performed on the SAN, freeing up valuable
bandwidth on the local and wide area network and eliminating the need for
expensive backup servers. Additionally, companies utilizing the Brocade Fabric
for their e-commerce and other low latency transaction processing applications
can leverage hundreds of computer storage devices and servers.
Support a mission-critical data processing center. We have designed our
solutions to provide high levels of resiliency and availability with maximum up
time for business-critical, data-intensive applications. Our
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switches have auto-configuration and reconfiguration capabilities that
incorporate redundant and alternate data paths for frame forwarding, which
enable our Brocade Fabric to be self-healing. They also support up to eight
parallel links to other switches. As a result, any cable, port, switch or link
failure can be isolated, providing a resilient solution. This increases the
availability and up time of the data processing center.
Enhance SAN management. Our Brocade Fabric Operating System and our
network management tools enable our customers to centrally manage storage
systems and servers handling business-critical data. Our products deliver a rich
set of SAN management information that can be accessed both locally and
remotely. Data-intensive connections in the organization can be centrally
managed to share resources with other points on the network. All of these
factors combine to help organizations reduce the overall costs and increase the
efficiency of their data network.
THE BROCADE STRATEGY
Our objective is to maintain our position as the leading provider of SAN
switching solutions. The key elements of our strategy include the following:
Leverage our SAN switching market leadership. We believe we were the first
company to provide a comprehensive Fibre Channel fabric solution and that we are
the market leader based upon the number of switch ports shipped. We intend to
capitalize on our first mover advantage and in-depth customer and product
knowledge. We believe we are well positioned to anticipate the future
requirements of the SAN marketplace.
Capitalize on leadership in Fibre Channel technologies and standards. We
have been a leader in the development of Fibre Channel technologies and the
implementation of ANSI Fibre Channel standards. Our technology efforts are led
by some of the most widely recognized members of the Fibre Channel industry. In
addition, our technical personnel have substantial expertise in storage, file
system, routing algorithms and network management technologies. We have also
provided major contributions to many of the ANSI Fibre Channel standards that
have been developed to date. We believe that taking a continued proactive role
in this expanding market will enable us to extend our leading market position.
Leverage core architecture. We are leveraging our core switching
expertise, ASIC architectures, Brocade Fabric Operating System and Fibre Channel
technology to expand our family of SilkWorm products to address the expanding
SAN market. We have been focusing on the workgroup, midrange, and enterprise
segments of the SAN market, and intend to leverage our leadership position in
these segments to broaden our reach into other segments of the SAN switch market
as they emerge. We expect that the demand for SAN switching solutions in entry
level applications will increase, particularly as Windows NT-based servers are
increasingly used in data processing centers. We have recently introduced
products designed to address the specific needs of organizations that use
Windows NT-based servers in anticipation of this growth.
Continue to expand network of original equipment manufacturers and system
integrators. We intend to continue to expand our relationships with key
computer storage system and server original equipment manufacturers and system
integrators, both domestically and abroad. Currently, our major original
equipment manufacturer customers include Amdhal, Compaq Computer, CNT, Data
General (a division of EMC Corporation), Dell Computer, IBM, Groupe Bull, McDATA
Corporation (a division of EMC Corporation), NEC, Network Appliance, Sequent
Computer Systems, SGI, Fujitsu/Siemens Computer Systems and StorageTek. These
relationships allow us to leverage the systems and services capabilities of
these industry-leading original equipment manufacturers. We have also recently
entered into relationships with system integrators including Advanced Systems
Group, Inc., Berkshire Computer Products, Inc., Ciprico, Compsat Technology,
Inc., Cranel, dcVAST, DataDirect Networks, Hitachi Data Systems Canada,
Integrated Systems Technologies, Inc., Kanatek Technologies Inc., Kingswell
Computer Company, LSI Logic's MetaStor(R) Storage Solutions, Leitch Technology,
Midrange Computer Solutions, Open Systems Solutions, Inc., PCC, RAID Power,
Rorke, Stonebridge Technologies, StorNet Inc, Sysix Technologies, Tokyo Electron
Ltd., Unique Digital, and XIOtech. We expect that our relationships with leading
system integrators will allow us to penetrate the market opportunities by
leveraging the reach of these distribution channels.
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Develop strategic partnerships. We are building strategic relationships
with Fibre Channel component and device vendors and storage management software
companies. For example, in November 1999, we entered into a strategic
relationship with Veritas Software Corporation to jointly develop technology for
centralized management of SANs. By partnering with these organizations, we
believe we can enhance SAN applications and interoperability, thereby
accelerating the time to market and overall deployment and functionality of our
products.
PRODUCTS
Brocade provides the SilkWorm family of Fibre Channel switches, which
creates a switch interconnect, enabling any-to-any connectivity between storage
devices and servers. SilkWorm switches can be used individually for server
clustering or storage consolidation, or cascaded with other switches to form a
powerful networking infrastructure, the Brocade Fabric. Brocade's software
solutions provide network administrators with tools to manage the switches and
the SAN. Brocade also provides extensive Fabric services, in order to optimize
the Brocade Fabric for an enterprise's particular needs. Moreover, Brocade
SOLUTIONware provides instructions to enterprises on implementing SANs.
SilkWorm Family of Switches
In March 1997, Brocade introduced the Silkworm 1000 family of products,
beginning with a configurable 16-port switch, used to connect servers to storage
devices to create a SAN. In April 1998, Brocade introduced SilkWorm Express, an
eight-port Fibre Channel switch.
In June 1999, Brocade introduced the SilkWorm 2000 product line that
delivers improved reliability, availability, and serviceability. The three
products introduced were the SilkWorm 2800, a 16-port fabric switch, the
SilkWorm 2400, an 8-port fabric switch, and the SilkWorm 2100, an 8-port loop
switch.
In November 1999, we announced the SilkWorm 2000 entry-level product line.
This product line includes the SilkWorm 2010, a managed hub alternative and the
SilkWorm 2040 and 2050.
The SilkWorm family of switches share a common platform designed to provide
the following features and benefits:
- High throughput. Each port delivers a 1-gigabit per second, full-duplex
data rate regardless of network connectivity.
- Hardware-based data path. SilkWorm reduces latency by eliminating
software processing from the path of data frames.
- Management. SilkWorm supports customers' existing management solutions,
such as local and wide area networks, SCSI tools and web tools.
- In-order delivery of data frames. SilkWorm guarantees that frames are
delivered to a destination in the same order as received by the switch
from the originator.
- Cut-through frame routing. Frames are sent without waiting for the
entire frame or for a response back from its destination, thereby
improving bandwidth utilization and minimizing transmission delays.
- Cascading. SilkWorm may be connected to as many other SilkWorm switches
as there are available ports creating in a meshed topology, enabling
hundreds of connections and large SANs.
- Flexible switch buffering. If the destination is busy, data frames are
stored by a SilkWorm switch for only as long as is necessary, thereby
moving data faster through the switch.
- Path selection. SilkWorm identifies failures automatically and
immediately, and reroutes data to alternate paths, creating a highly
resilient network.
- Registered state change notification. SilkWorm automatically detects
changes in configuration and port status to enable quick corrective
action.
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- Quickloop software. Software that emulates a loop environment with the
benefits of switching.
- Translative mode. Software that allows the intermixing of loop and
fabric devices on the same SAN.
- Media independent. SilkWorm enables the SAN to support diverse media,
including fiber optic connections up to 10 kilometers and copper
connections.
- Auto-configuration. SilkWorm enhances scalability by automatically
expanding the SAN as new devices are added or removed without
interrupting the operation of the rest of the network. SilkWorm
seamlessly incorporates more Brocade switches into the network, thereby
increasing aggregate bandwidth as connectivity increases; network
services automatically expand without additional system resources.
Brocade Fabric Operating System
The SilkWorm family of switches is supported by the Brocade Fabric
Operating System. The Brocade Fabric Operating System provides the intelligence
for the Brocade Fabric, provides services for the switch hardware, runs the
value-added Brocade Fabric services such as name service, which is used to
assist discovery of connected devices, monitors the status of the hardware and
fabric and notifies the host operating system as devices are added to or removed
from the Brocade Fabric.
The Brocade Fabric Operating System provides a common platform upon which
system services can be built. The Brocade Fabric Operating System is layered
with well-defined application interfaces, or APIs, that allow third parties,
such as data storage and data backup software vendors, to write applications
that leverage Brocade's Fabric Operating System. By incorporating API
technology, these third party vendors can develop applications, thereby
increasing the capabilities of the overall switch fabric solution.
Fabric Services
Fabric services are product features that increase the functionality of the
SAN. Our current Brocade Fabric Services include zoning and multicasting.
Brocade Zoning is an add-on software product that allows the creation of
multiple logical connectivity groups within a single SAN. By creating a zone,
the SAN provides the network with benefits that would otherwise only be possible
using multiple SANs. Through zoning, systems that have different operating
environments, such as UNIX and Window NT, can be isolated from each other
allowing both operating systems to co-exist on a single SAN. Zoning can be used
to create functional areas in the fabric and designate closed user groups for
greater security and control. Also, zoning facilitates time-sensitive functions,
such as creating a temporary zone used to backup storage devices that are
members of other zones. Brocade Zoning offers dynamic configuration and an
unlimited number of zones. Finally, Brocade Zoning allows devices to be a member
of more than one zone thereby increasing flexibility.
Brocade Multicasting enables up to 32 groups of devices to replicate data
in a one-to-one method or in a one-to-many method. By accomplishing this
replication through hardware, Brocade is able to maintain high throughput.
SOLUTIONware
Brocade's SOLUTIONware is a set of application notes that facilitates the
implementation of SAN solutions incorporating products and applications from
multiple vendors, including Brocade. These applications notes include specific
details including equipment requirements, software specifics, detailed
installation instructions and tested application software. This enables original
equipment manufacturers and system integrators to replicate high performance
solutions. We have delivered over 15 SOLUTIONware application notes covering
Brocade Tape Backup and Restore, storage consolidation and business continuance
applications for heterogeneous environments.
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Management Tools
Brocade Web Tools is an add-on software product that helps to remotely
manage a SAN of our SilkWorm family of switches via the Internet or intranet.
The information technology administrator can log onto a switch from a host with
a java-based Web browser. From that switch, the administrator can monitor the
status and performance of any switch in the SAN.
SALES AND MARKETING
Our sales and marketing strategy is focused on an indirect sales model
executed through original equipment manufacturers and system integrators. Our
distribution channels are supported by a sales and marketing organization
comprised of managers, sales representatives and technical and administrative
support personnel. Our marketing effort is focused on developing strategic
partnerships and relationships with industry analysts, providing customer sales
support, managing new product planning and supporting industry standard
initiatives.
Original equipment manufacturers. We have established key relationships
with storage systems and server original equipment manufacturers. Each original
equipment manufacturer provides installation, service and technical support to
its customers while we focus on high-level back-up support. In addition to
maintaining and enhancing our relationships with our existing original equipment
manufacturer customers, we intend to pursue relationships with additional
original equipment manufacturers that may offer products or distribution
channels that complement ours. We believe that these relationships allow us to
leverage the systems and services capabilities of our original equipment
manufacturers.
System integrators. We continue to develop our system integrator program
and have established several relationships within this channel. Revenues from
this channel have grown in excess of 10% in the fourth quarter of fiscal 1999
and we believe revenues from this channel may continue to increase significantly
in the future. Each system integrator provides installation, service and
technical support to its customers, while we focus on integration and technical
back-up support. We intend to continue to develop relationships with system
integrators who may offer products or distribution channels that complement
ours.
We have entered into relationships with international distributors and
integrators and plan to expand our international sales activities significantly.
In fiscal 2000, we intend to focus on expanding our international sales
activities in Western Europe and Japan.
CUSTOMERS
Our primary customers are original equipment manufacturers and system
integrators. Currently, our major original equipment manufacturer customers
include Amdhal, Compaq Computer, CNT, Data General (a division of EMC
Corporation), Dell Computer, IBM, Groupe Bull, McDATA Corporation (a division of
EMC Corporation), NEC, Network Appliance, Sequent Computer Systems, SGI,
Fujitsu/Siemens Computer Systems and StorageTek. Our major system integrators
including Advanced Systems Group, Inc., Berkshire Computer Products, Inc.,
Ciprico, Compsat Technology, Inc., Cranel, dcVAST, DataDirect Networks, Hitachi
Data Systems Canada, Integrated Systems Technologies, Inc., Kanatek Technologies
Inc., Kingswell Computer Company, LSI Logic's MetaStor(R) Storage Solutions,
Leitch Technology, Midrange Computer Solutions, Open Systems Solutions, Inc.,
PCC, RAID Power, Rorke, Stonebridge Technologies, StorNet Inc, Sysix
Technologies, Tokyo Electron Ltd., Unique Digital, and XIOtech.
Our revenue is derived primarily from sales of our SilkWorm family of
products. In fiscal 1997, McData and Sequent each contributed over 10% of our
total revenues for a combined total of 94% of total revenues. In fiscal 1998,
these same two customers each contributed over 10% of total revenues for a
combined total of 83% of total revenues. In fiscal 1999, Compaq, Data General,
McData, and Sequent each accounted for 10% or more of total revenues for a
combined total of 70%. The level of sales to any customer may vary from quarter
to quarter. However, 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 Brocade's financial condition or results of
operations.
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CUSTOMER SERVICE AND SUPPORT
Our customer service and support organization provides technical support to
our original equipment manufacturers and system integrators, enabling them to
provide technical support to their end-users. We prepare our original equipment
manufacturer and system integrator customers for product launch through a
comprehensive training program. In addition, we employ systems engineers for
pre- and post-sales support and technical support engineers for field support.
Our original equipment manufacturers and system integrator customers provide
primary technical support.
We have developed an extensive training course for our original equipment
manufacturer and system integrator customers. The curriculum includes Fibre
Channel architecture, SAN implementation and Brocade product training.
MANUFACTURING
We currently use a third-party contract manufacturer, Solectron, to
manufacture our products. Solectron invoices Brocade based on prices and payment
terms agreed to by both parties and set forth in purchase orders issued by
Brocade. The pricing takes into account component costs, Solectron's
manufacturing costs and margin requirements. Although we use Solectron for final
turnkey product assembly, we maintain key component expertise internally. We
design and develop the key components of our products, including ASICs and
software, as well as certain details in the fabrication and enclosure of our
products. In addition, we determine the components that are incorporated in our
products and select the appropriate suppliers of the 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 or limited sources. Our principal single source
components include ASICs, power supplies and chassis, and our principal limited
source components include printed circuit boards and GBICs. In addition, we
license certain software from Wind River Systems, Inc. that is incorporated into
our Brocade Fabric Operating System.
TECHNOLOGY
Fibre Channel
Fibre Channel is an industry-standard, open protocol for server-to-storage
and server-to-server connectivity and data-intensive transfers. Fibre Channel
combines the high-speed I/O capabilities of a channel technology with the
increased functionality of a networking technology to seamlessly connect and
transfer data from one device to another.
Fibre Channel was designed for storage systems and is well suited for SANs.
It offers a single network for both server clustering and shared storage. It
accommodates both high throughput and low latency dependent traffic required for
large block data transfers and inter-processor communication messages. We
believe the following characteristics of Fibre Channel make it more suitable for
data-intensive and storage related applications than either gigabit Ethernet or
ATM, two widely used networking protocols:
- Fibre Channel has an industry standard interconnect rate of 1 gigabit per
second per port that is expected to increase to 2 gigabits per second in
2000 as compared to gigabit Ethernet's, 1 gigabit per second and ATM's
622 megabits per second speeds;
- Fibre Channel is designed to transmit large packets of information and is
therefore well-suited for data-intensive applications as compared to
gigabit Ethernet and ATM, which use smaller packets and are designed for
smaller but more frequent data transfers;
- Fibre Channel relies more on hardware than software during data transfers
and therefore, is better suited to handle the higher speeds and low
latency required during data transfers;
- In addition to supporting networking protocols including IP, Fibre
Channel also supports I/O storage protocols like SCSI;
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- Unlike gigabit Ethernet and ATM, which can lose or drop packets due to
congestion, Fibre Channel manages packet flow to ensure delivery; and
- Fibre Channel relieves each port from the responsibility of station
management and instead delegates that responsibility to the interconnect
device. Therefore, each Fibre Channel port only has to manage a single
point-to-point connection between itself and an interconnect device.
SilkWorm Architecture
Brocade is focused on implementing Fibre Channel standards in the Brocade
Fabric. We utilize a layered architecture to provide a high performance,
flexible, and extensible solution. This architecture is comprised of media
interfaces, a switching platform, the Brocade Fabric Operating System and
value-added services.
- Media interfaces. Media interfaces comprise the lowest layer of our
architecture. Fibre Channel standards specify numerous media interfaces.
The SilkWorm architecture supports removable gigabit copper interfaces up
to 13 meters, short wavelength laser interfaces up to 500 meters and long
wavelength laser interfaces up to 10 kilometers. Removable media
interfaces provide flexible product configurations and simple product
maintenance.
- Switching platform. Our SilkWorm products are based on a central memory
time multiplexed switching architecture. The architecture is implemented
through the use of highly integrated ASICs. The use of ASIC technology is
required to provide the high bandwidth and low latency necessary for
Fibre Channel switching to cater to both high throughput and low latency
data transfer. The switching architecture is non-blocking and utilizes
cut through routing techniques to achieve low latency. The data path of
the architecture is completely implemented in hardware and the CPU and
operating system are not in the data path.
- Brocade Fabric Operating System. The architecture of the Brocade Fabric
Operating System is highly structured, modular, hardware independent and
layered with well-defined interfaces. This extensible architecture is
easy to maintain and upgrade with new features. The base operating system
is a UNIX-like realtime operating system with extensive libraries and
services. The layers of the Brocade Fabric Operating System include
hardware drivers, a board level support package, a Fibre Channel layer,
services and application program interfaces.
- Value added services. Value-added services comprise the top layer of our
architecture. Brocade value-added services include Brocade Zoning, and
multicasting. The Brocade value-added services run on top of the Brocade
Fabric Operating System through well-defined application program
interfaces.
RESEARCH AND DEVELOPMENT
We believe that our future success depends on our ability to continue to
enhance our existing products and to develop new products that maintain
technological competitiveness. We focus our product development activities on
solving the needs of SAN users. We work closely with our original equipment
manufacturers and system integrators to monitor changes in the market place. We
design our products around current industry standards and will continue to
support emerging standards that are consistent with our product strategy. During
fiscal 1997, 1998 and 1999 our research and development expenses were $7.7
million, $14.7 million and $15.3 million, respectively.
Our products have been designed around a core system architecture, which
facilitates a relatively short product design and development cycle and reduces
the time to market for new products and features. We intend to continue to
leverage our architecture to develop and introduce additional products and
enhancements in the future.
COMPETITION
Although the competitive environment in the Fibre Channel switching market
has yet to develop fully, we anticipate that the current and potential market
for our products will be highly competitive, continually
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evolving and subject to rapid technological change. New SAN products are being
introduced by major server and storage providers, and existing products will be
continually enhanced. We currently face competition from other manufacturers of
SAN switches, including Ancor Communications, Inc. We also face competition from
manufacturers of hubs, including Gadzoox Networks, Inc. and Vixel Corporation.
In addition, as the market for SAN products grows, we may face competition from
traditional networking companies and other manufacturers of networking equipment
who may enter the SAN market with their own switching products. It is also
possible that customers could develop and introduce products competitive with
our product offerings. We believe the competitive factors in this market segment
include product performance and features, product reliability, price, ability to
meet delivery schedules, customer service and technical support.
Some of our current and potential competitors have longer operating
histories, significantly greater resources and name recognition, and a larger
installed base of customers than we have. As a result, these competitors may
have greater credibility with our existing and potential customers. They also
may be able to adopt more aggressive pricing policies and devote greater
resources to the development, promotion and sale of their products than we can
to ours, which would allow them to respond more quickly than we can to new or
emerging technologies and changes in customer requirements. In addition, some of
our current and potential competitors have already established supplier or joint
development relationships with divisions of our current or potential customers.
These competitors may be able to leverage their existing relationships to
discourage these customers from purchasing additional Brocade products or
persuade them to replace our products with their products. Such increased
competition may result in price reductions, lower gross margins and loss of our
market share. There can be no assurance that we will 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 competitive pressures will not materially harm our business.
INTELLECTUAL PROPERTY
We rely on a combination of patents, copyrights, trademarks, and trade
secrets, as well as confidentiality agreements and other contractual
restrictions with employees and third parties, to establish and protect our
proprietary rights. Despite these precautions, there can be no assurance that
the measures we undertake will be adequate to protect our proprietary
technology, or that they will preclude competitors from independently developing
products with functionality or features similar to our products. There can be no
assurance that the precautions we take will prevent misappropriation or
infringement of our technology. We currently have 2 design patents and 8 pending
patent applications in the United States, 5 utility applications and 3
provisional applications, with respect to our technology. However, it is
possible that patents may not be issued for these applications. Our issued
patents may not adequately protect our technology from infringement or prevent
others from claiming that our technology infringes that of third parties.
Failure to protect our intellectual property could materially harm our business.
In addition, our competitors may independently develop similar or superior
technology. It is possible that litigation may be necessary in the future to
enforce our intellectual property rights, to protect our trade secrets or to
determine the validity and scope of the proprietary rights of others. Litigation
could result in substantial costs and diversion of our resources and could
materially harm our business.
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 not be available on terms
acceptable to us, or at all. For these reasons, infringement claims could
materially harm our business.
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BACKLOG
Brocade's order backlog as of October 30, 1999 was approximately $44
million. Sales of Brocade's products are generally made pursuant to standard
purchase orders that are cancelable without significant penalties. In addition,
purchase orders are subject to price renegotiations and to changes in quantities
of products and delivery schedules in order to reflect changes in customers'
requirements and manufacturing availability. As a result, a portion of backlog
at any given time may never be realized by Brocade. Brocade's business is
characterized by short lead time orders and quick delivery schedules. In
addition, Brocade's actual shipments depend on the manufacturing capacity of
Brocade's suppliers and the availability of products from such suppliers. As a
result of the foregoing factors, Brocade does not believe that backlog at any
given time is a meaningful indicator of future sales.
EMPLOYEES
As of October 30, 1999, we had 182 full-time employees. None of our
employees are represented by a labor union. We have not experienced any work
stoppages and consider our relations with our employees to be good.
ITEM 2. PROPERTIES
Our principal administrative, sales and marketing, education, customer
support and research and development facilities are located in a single office
building in San Jose, California. We currently occupy approximately 35,000
square feet of office space in the San Jose facility under the terms of a lease
that expires in November 2000. We also lease office space for sales and
marketing in Nashua, New Hampshire.
In December 1999, Brocade entered into an agreement to lease approximately
210,000 square feet of office, laboratory, and administrative space in San Jose,
California for its corporate headquarters. The term of the lease agreement is
September 1, 2000 through August 31, 2010, and represents a lease commitment of
$6.2 million per year to Brocade. Brocade intends to occupy the space in
September 2000 and sub-lease any excess space.
ITEM 3. LEGAL PROCEEDINGS
Brocade's former contract manufacturer filed a suit against Brocade,
alleging that Brocade is liable for breaching certain contracts with the
contract manufacturer. The suit claimed damages in excess of $3.0 million plus
interest, an unspecified amount of consequential and incidental damages, costs
and attorneys' fees. Brocade filed a cross complaint against the contract
manufacturer for various credits Brocade claimed on its account with the
contract manufacturer. The suit was settled in December 1999. The settlement of
this litigation did not have a material impact on Brocade's financial
statements.
Brocade is subject to various claims that arise in the normal course of
business. In the opinion of management, the ultimate disposition of these claims
will not have a material adverse effect on the financial position of Brocade.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable
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EXECUTIVE OFFICERS AND DIRECTORS
The following table sets forth certain information regarding our executive
officers and directors as of December 30, 1999:
NAME AGE POSITION
- ---- --- --------
Gregory L. Reyes................ 37 President, Chief Executive Officer and Director
Paul R. Bonderson, Jr. ......... 47 Vice President, Engineering
Michael J. Byrd................. 39 Vice President, Finance and Chief Financial
Officer
Kumar Malavalli................. 56 Vice President, Technology
Victor M. Rinkle................ 46 Vice President, Operations
Charles W. Smith................ 38 Vice President, Worldwide Sales
Peter J. Tarrant................ 39 Vice President, Marketing and Business Development
Jean Zorzy...................... 47 Vice President, Program Management
Seth D. Neiman(1)............... 45 Chairman of the Board
Neal Dempsey(1)(2).............. 58 Director
Mark Leslie(2).................. 53 Director
Larry W. Sonsini................ 58 Director
- ---------------
(1) Member of audit committee.
(2) Member of compensation committee.
Gregory L. Reyes has served as our President and Chief Executive Officer
and a member of our board of directors since July 1998. From January 1995 to
November 1997, Mr. Reyes served as Chairman of the board of directors, and from
January 1995 to June 1998, served as President and Chief Executive Officer of
Wireless Access, Inc., a wireless data communications products company. From
January 1991 to January 1995, Mr. Reyes served as Divisional Vice President and
general manager of Norand Data Systems, a data collection company. Mr. Reyes
also serves as a director of Proxim, Inc., a wireless networking company. Mr.
Reyes received a B.S. in Economics and Business Administration from Saint Mary's
College in Moraga, California.
Paul R. Bonderson, Jr. co-founded Brocade in August 1995 and has served as
Vice President, Engineering since August 1995. From March 1986 to August 1995,
Mr. Bonderson held several engineering positions at Sun Microsystems, Inc., most
recently as Director of Engineering. Mr. Bonderson received a B.S. in Electrical
Engineering from California Polytechnic State University, San Luis Obispo.
Michael J. Byrd joined Brocade in April 1999 and became our Vice President,
Finance and Chief Financial Officer effective May 3, 1999. 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, most recently as Partner. Mr.
Byrd received a B.S. in Business Administration from California Polytechnic
State University, San Luis Obispo.
Kumar Malavalli co-founded Brocade in August 1995 and has served as our
Vice President, Technology since October 1995. From July 1993 to October 1995,
Mr. Malavalli served as Manager of Architecture and Standards in the Canadian
Network Operation at Hewlett-Packard Company. Mr. Malavalli was a member of the
industry team that originated the Fibre Channel architecture, has helped guide
the technology through the industry standards committees and currently chairs
the ANSI T11 Technical Committee, which oversees all standards related to the
development of Fibre Channel. From 1993 to 1999, Mr. Malavalli was the chairman
of the Fibre Channel Association Technical Committee. Mr. Malavalli received
both a B.S. in Physics and Mathematics and a B.S. in Electrical Engineering from
the University of Mysore, India.
Victor M. Rinkle has served as our Vice President, Operations since January
1998. From April 1989 to December 1997, Mr. Rinkle held several managerial
positions at Apple Computer, Inc., most recently as Vice
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President, Global Supply Base Management. Mr. Rinkle received a B.B.A. in
Marketing and Production Logistics from the University of Houston.
Charles W. Smith has served as our Vice President, Worldwide Sales since
February 1997. From June 1996 to February 1997, Mr. Smith served as Director,
Corporate Account Sales at IBM. From July 1990 to February 1996, Mr. Smith held
various senior sales management positions at Conner Peripherals, Inc., a storage
solutions company, most recently as Vice President, US Sales, Western Region.
Mr. Smith received an A.S. in Aeronautics and Business from the College of San
Mateo and a B.S. in Business Management from San Jose State University.
Peter J. Tarrant has served as our Vice President, Marketing and Business
Development since December 1997. From October 1994 to December 1997, Mr. Tarrant
served as Vice President, Product Management and Vice President, Business
Development at Bay Networks, Inc., a computer networking company. From April
1990 to October 1994, Mr. Tarrant held several product management positions at
SynOptics, a predecessor of Bay Networks, Inc. most recently as Director,
Product Management. Mr. Tarrant received a B.Sc. in Electronic Engineering from
the University of Southampton, United Kingdom.
Jean E. Zorzy has served as our Vice President, Program Management since
May 1999. From February 1998 to May 1999, Ms. Zorzy served as our Director of
Supplier Management. From July 1986 to February 1998, Ms. Zorzy held several
positions at Apple Computer, most recently as Director, External Operations. Ms.
Zorzy received a B.A. in Psychology from American University in Washington, D.C.
and an M.B.A. from San Jose State University.
Seth D. Neiman has served as Chairman of the board of directors of Brocade
since August 1995. Mr. Neiman formerly served as our Chief Executive Officer
from August 1995 to June 1996. Since August 1994, Mr. Neiman has held various
positions at Crosspoint Venture Partners, a venture capital firm, and has been a
partner of Crosspoint since January 1996. From September 1991 to July 1994, Mr.
Neiman was Vice President of Engineering at Coactive Networks, a local area
networks company. Mr. Neiman also serves on the boards of directors and
compensation committees of numerous private companies. Mr. Neiman received a
B.A. in Philosophy from Ohio State University.
Neal Dempsey has served as a director of Brocade since December 1996. Since
May 1989, Mr. Dempsey has been a General Partner of Bay Partners, a venture
capital firm. Mr. Dempsey also serves on the boards of directors and
compensation committees of numerous private companies. Mr. Dempsey received a
B.A. in Business from the University of Washington.
Mark Leslie has served as a director of Brocade since January 1999. Mr.
Leslie has served as the Chief Executive Officer and a member of the board of
directors of VERITAS Software Corporation, a storage management software
company, since February 1990. Mr. Leslie also serves on the board of directors
of Versant Object Technology, as well as on the board of directors of a private
company. Mr. Leslie received a B.A. in Physics and Mathematics from New York
University.
Larry W. Sonsini has served as a director of Brocade since January 1999.
Mr. Sonsini has been a partner of the law firm of Wilson Sonsini Goodrich &
Rosati, P.C., since 1973 and is currently the Chairman of the Executive
Committee of the firm. Mr. Sonsini serves on numerous advisory boards and
committees, including the SEC's Advisory Committee on Capital Formation and
Regulatory Processes, the ABA Committee on Federal Regulation of Securities and
the Legal Advisory Committee to the Board of Governors, New York Stock Exchange.
Mr. Sonsini serves on the boards of directors of Novell, Inc., Lattice
Semiconductor Corporation and Pixar Animation Studios, as well as on the boards
of directors of several private companies. Mr. Sonsini received an A.B. from the
University of California, Berkeley and an L.L.B. from Boalt Hall School of Law,
University of California, Berkeley.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Brocade's common stock has been quoted on the Nasdaq National Market under
the symbol "BRCD" since our initial public offering on May 24, 1999. Prior to
this time, there was no public market for our stock. See "Item 6. -- Selected
Financial Data" for the high and low closing sales prices per share of our
common stock as reported on the Nasdaq National Market, for the periods
indicated.
We currently expect to retain future earnings, if any, for use in the
operation and expansion of our business and do not anticipate paying any cash
dividends in the foreseeable future. At October 30, 1999, there were
approximately 292 stockholders of record of Brocade's common stock.
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with
our financial statements and related notes, "Management's Discussion and
Analysis of Financial Condition and Results of Operations," and other financial
information appearing elsewhere in this Annual Report. The statement of
operations data set forth below for each of the years in the three-year period
ended October 31, 1999 and the balance sheet data as of October 31, 1998 and
1999 are derived from, and qualified by reference to, our audited financial
statements appearing elsewhere in this Annual Report. The statement of
operations data for the period from inception on August 24, 1995 to October 31,
1995 and for the year ended October 31, 1996 and the balance sheet data as of
October 31, 1995, 1996 and 1997 are derived from audited financial statements
not included herein.
YEAR ENDED OCTOBER 31,
----------------------------------------------
1995 1996 1997 1998 1999
----- ------- ------- -------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Net revenues........................................... $ -- $ -- $ 8,482 $ 24,246 $68,692
Cost of revenues....................................... -- -- 6,682 15,759 33,497
----- ------- ------- -------- -------
Gross margin......................................... -- -- 1,800 8,487 35,195
----- ------- ------- -------- -------
Operating expenses:
Research and development............................. 124 3,091 7,666 14,744 15,267
Sales and marketing.................................. -- 152 2,112 5,154 13,288
General and administrative........................... 52 575 1,464 3,813 3,849
Amortization of deferred compensation................ -- -- -- 7 1,937
----- ------- ------- -------- -------
Total operating expenses........................... 176 3,818 11,242 23,718 34,341
Income (loss) from operations.......................... (176) (3,818) (9,442) (15,231) 854
Interest income (expense), net......................... 10 (116) (177) 120 1,737
----- ------- ------- -------- -------
Income (loss) before provision for income taxes........ (166) (3,934) (9,619) (15,111) 2,591
Provision for income taxes............................. -- -- -- -- 106
----- ------- ------- -------- -------
Net income (loss)...................................... $(166) $(3,934) $(9,619) $(15,111) $ 2,485
===== ======= ======= ======== =======
Basic net income (loss) per share...................... $ -- $ (4.75) $ (2.41) $ (2.22) $ 0.10
===== ======= ======= ======== =======
Diluted net income (loss) per share.................... $ -- $ (4.75) $ (2.41) $ (2.22) $ 0.05
===== ======= ======= ======== =======
Shares used in computing basic net income (loss) per
share................................................ -- 828 3,994 6,800 26,094
===== ======= ======= ======== =======
Shares used in computing diluted net income (loss) per
share................................................ -- 828 3,994 6,800 51,146
===== ======= ======= ======== =======
Pro forma basic net income (loss) per share
(unaudited).......................................... $ (0.42) $ 0.06
======== =======
Pro forma diluted net income (loss) per share
(unaudited).......................................... $ (0.42) $ 0.05
======== =======
Shares used in computing pro forma basic net income
(loss) per share (unaudited)......................... 35,830 43,074
======== =======
Shares used in computing pro forma diluted net income
(loss) per share (unaudited)......................... 35,830 51,146
======== =======
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AS OF OCTOBER 31,
-----------------------------------------------------
1995 1996 1997 1998 1999
------ ------- -------- -------- --------
(IN THOUSANDS)
BALANCE SHEET DATA:
Cash, cash equivalents and short-term
investments................................. $1,168 $ 700 $ 18,472 $ 10,420 $ 89,305
Working capital............................. 922 104 15,334 5,276 79,295
Total assets................................ 1,549 2,605 26,100 21,301 117,280
Long-term portion of debt and capital lease
obligations............................... -- 874 1,954 2,209 42
Redeemable convertible preferred stock...... 1,411 4,613 30,359 35,261 --
Total stockholders' equity (deficit)........ (166) (3,957) (13,458) (27,355) 84,206
Note: all references to earnings per share and the number of common shares have
been retroactively restated to reflect a two-for-one stock split, effected on
December 3, 1999.
Note: Brocade changed its fiscal year end to the last Saturday in October
beginning with the fiscal year ended October 30, 1999. For presentation
purposes, our fiscal year end is referred to as October 31, 1999. This change
did not have a material impact on Brocade's financial statements.
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
QUARTERLY DATA:
YEAR ENDED OCTOBER 31, 1998
Net revenues........................................ $ 7,850 $ 6,420 $ 4,569 $ 5,407
Gross margin........................................ 3,153 2,748 218 2,368
Loss from operations................................ (1,398) (2,635) (8,221) (2,977)
Net loss............................................ $(1,355) $(2,515) $(8,107) $(3,134)
Per share amounts:
Basic............................................. $ (0.26) $ (0.40) $ (1.23) $ (0.43)
Diluted........................................... $ (0.26) $ (0.40) $ (1.23) $ (0.43)
Shares used in computing per share amounts:
Basic............................................. 5,140 6,284 6,616 7,284
Diluted........................................... 5,140 6,284 6,616 7,284
Stock prices:
High.............................................. N/A N/A N/A N/A
Low............................................... N/A N/A N/A N/A
YEAR ENDED OCTOBER 31, 1999
Net revenues........................................ $ 8,007 $10,540 $20,051 $30,094
Gross margin........................................ 4,686 5,103 10,130 15,276
Income (loss) from operations....................... (1,846) (877) 1,011 2,566
Net income (loss)................................... (1,839) (848) 1,611 3,561
Per share amounts:
Basic............................................. $ (0.21) $ (0.08) $ 0.05 $ 0.07
Diluted........................................... $ (0.21) $ (0.08) $ 0.03 $ 0.06
Shares used in computing per share amounts:
Basic............................................. 8,698 10,330 35,672 49,672
Diluted........................................... 8,698 10,330 55,014 58,282
Stock prices:
High.............................................. N/A N/A $ 64.50 $142.50
Low............................................... N/A N/A $ 22.63 49.09
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the selected
financial data in Item 6 of this Annual Report and Brocade's financial
statements and notes thereto in Item 8 of this annual report.
NOTE REGARDING FORWARD-LOOKING STATEMENTS
This discussion contains forward-looking statements that relate to future
events or our future financial performance. In some cases, you can identify
forward-looking statements by terminology such as "may," "will," "should,"
"expects," "plans," "anticipates," "believes," "estimates," "predicts,"
"intend," "potential" or "continue" or the negative of such terms or other
comparable terminology. These statements are only predictions. Although we
believe that the expectations reflected in the forward-looking statements are
reasonable, we cannot guarantee future results, levels of activity, performance
or achievements. Our actual results could differ materially from those
anticipated in these forward-looking statements as a result of various factors,
including the risks outlined under "Risk Factors" and elsewhere in this annual
report. All forward-looking statements included in this document are based on
information available to Brocade on the date hereof. Brocade assumes no
obligation to update any such forward-looking statements.
OVERVIEW
Brocade is a leading provider of switching solutions for Storage Area
Networks ("SANs"). We sell our SAN switching solutions through leading storage
systems and server original equipment manufacturers, including Amdhal, Compaq
Computer, CNT, Data General (a division of EMC Corporation), Dell Computer, IBM,
Groupe Bull, McDATA Corporation (a division of EMC Corporation), NEC, Network
Appliance, Sequent Computer Systems, SGI, Fujitsu/Siemens Computer Systems and
StorageTek and through system integrators. These original equipment
manufacturers and our system integrator customers combine our switching
solutions with other system elements and services for enterprise data centers.
Our revenue is derived primarily from sales of our SilkWorm family of
products. In fiscal 1997, McData and Sequent each contributed over 10% of our
total revenues for a combined total of 94% of total revenues. In fiscal 1998,
these same two customers each contributed over 10% of total revenues for a
combined total of 83% of total revenues. In fiscal 1999, Compaq, Data General,
McData, and Sequent each accounted for 10% or more of total revenues for a
combined total of 70%. The level of sales to any customer may vary from quarter
to quarter. However, 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 Brocade's financial condition or results of
operations.
As noted above, we currently sell a large percentage of our products
through several major original equipment manufacturers. The initial evaluation
and product qualification cycle with original equipment manufacturers typically
takes six to twelve months and includes technical evaluation, integration,
testing, product launch planning and execution. Our sales strategy also includes
recruiting system integrators with a Fortune 500 data center presence and the
technical resources to design, implement and support SANs. To date,
substantially all of our sales have been in the United States. However, we have
launched sales and marketing efforts in Western Europe and Japan.
Revenue is recognized when products are shipped to customers, unless at the
time of shipment product returns cannot be estimated or significant support
services are required to successfully launch the customer's products. As of
October 31, 1999, several of our customers were implementing SAN solutions,
including our product, for their end-users for the first time. In addition,
several customers were implementing our new SilkWorm 2000 family of products for
the first time. Given the recent adoption of the SAN model and Brocade's
solution and because substantial Brocade services are required to support the
customer's product launches, the revenue related to shipments to these customers
has been deferred pending successful customer product launches. The deferred
revenue will be recognized on a customer-by-customer basis as each customer
successfully completes its product launch. Similarly, revenue is deferred for
new products that have not
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completed the beta test phase. As of October 31, 1999, $7.7 million of revenue
was deferred and consisted principally of revenue associated with shipments of
our new SilkWorm 2000 family of products made in the fourth quarter of fiscal
1999. It is expected that this deferred revenue will be recognized in the first
and second quarters of fiscal year 2000 as customers begin volume shipments of
these solutions that incorporate the Brocade SilkWorm 2000 family of products.
We believe that, as the SAN market matures, this revenue deferral method for new
customers may not be necessary.
Between fiscal 1998 and fiscal 1999 our average unit-selling price
decreased. We expect continued declines in our average unit selling price due to
anticipated increases in per customer sales volume, the impact of competitive
pricing pressures and new product introductions. However, in the near future, we
do not anticipate that our gross margins will be affected by declines in average
unit selling prices due to anticipated product cost reductions.
In July 1998, we outsourced our manufacturing and the majority of our
supply chain management operations. Accordingly, a significant portion of our
cost of revenues consists of payments to our contract manufacturer, Solectron
Corporation. We conduct quality assurance, manufacturing engineering,
documentation control and repairs at our facility in San Jose, California.
Research and development expenses consist primarily of salaries and related
personnel expenses, fees paid to consultants and outside service providers,
prototyping expenses related to the design, development, testing and
enhancements of our ASICs and software and the costs of computer support
services. We believe that continued investment in research and development is
critical to our strategic product and cost-reduction objectives. As a result, we
expect these expenses to increase in absolute dollars in the future.
Selling and marketing expenses consist primarily of salaries, commissions
and related expenses for personnel engaged in marketing, sales and customer
engineering support functions, as well as costs associated with promotional and
travel expenses. We believe that continued investment in sales and marketing is
critical to the success of our strategy to expand our relationships with leading
original equipment manufacturers, to expand our presence in the system
integration channel, and to maintaining our leadership position in the SAN
market. As a result, we expect these expenses to increase in absolute dollars in
the future.
General and administrative expenses consist primarily of salaries and
related expenses for executive, finance and human resources personnel,
recruiting expenses, professional fees and other corporate expenses. We expect
general and administrative expenses to increase in absolute dollars as we add
personnel and incur additional costs related to the growth of our business.
In connection with the grant of certain stock options to employees, we
recorded deferred compensation of $307,000 and $5.1 million during fiscal 1998
and 1999, respectively, representing the difference between the deemed value of
our common stock for accounting purposes and the option exercise price of these
options at the date of grant. Deferred compensation is presented as a reduction
of stockholders' equity and amortized ratably over the vesting period of the
applicable options. We amortized $1.9 million of deferred compensation during
the year ended October 31, 1999. We will expense the balance ratably over the
remainder of the vesting period of the options. See note 7 to our financial
statements.
As of October 31, 1999, we had operating loss carryforwards of
approximately $44.0 million for federal income tax purposes and $14.7 million
for state tax purposes. The federal net operating loss carryforwards expire on
various dates between 2010 and 2019, and the state net operating loss
carryforwards will begin to expire in 2003. We have provided a full valuation
allowance against our deferred tax assets, consisting primarily of net operating
loss carryforwards, because of the uncertainty regarding their realization.
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RESULTS OF OPERATIONS
The following table sets forth certain financial data for the periods
indicated as a percentage of total revenues.
YEAR ENDED OCTOBER 31,
-----------------------
1997 1998 1999
----- ----- -----
Net revenues................................................ 100% 100% 100%
Cost of revenues............................................ 79 65 49
---- --- ---
Gross margin.............................................. 21 35 51
---- --- ---
Operating expenses:
Research and development.................................. 90 61 22
Sales and marketing....................................... 25 21 19
General and administrative................................ 17 16 6
Amortization of deferred compensation..................... -- -- 3
---- --- ---
Total operating expenses............................... 132 98 50
---- --- ---
Income (loss) from operations............................... (111) (63) 1
Interest income (expense), net.............................. (2) 1 3
---- --- ---
Income (loss) before provision for income taxes............. (113) (62) 4
---- --- ---
Provision for income taxes.................................. -- -- --
---- --- ---
Net income (loss)........................................... (113)% (62)% 4%
==== === ===
Revenues. We shipped our first commercial product in the second quarter of
fiscal 1997, generating revenues of $8.5 million for the year ended October 31,
1997. Net revenues increased by 185% to $24.2 million in fiscal 1998 and by 183%
to $68.7 million in fiscal 1999. The increase in net revenues from fiscal 1997
to fiscal 1998 reflects an increase in sales to a significant original equipment
manufacturer customer and the introduction of the SilkWorm Express product. The
increase in net revenues from fiscal 1998 to fiscal 1999 was due to increased
unit shipments of our SilkWorm 1000 family of products to an increasing customer
base, an increase in sales to several significant original equipment
manufacturer customers and increased sales in the system integrator channel. Net
revenues for the year ended October 31, 1999 exclude $7.7 million in deferred
revenue associated with shipments to new customers and shipments of our new
SilkWorm 2000 family of products. In fiscal 1999, revenues from four customers
accounted for 70% of total net revenues. The level of sales to any customer may
vary from quarter to quarter; however, we expect that significant customer
concentration will continue for the foreseeable future.
Gross margin. Gross margin increased from $1.8 million or 21.3% of net
revenues in fiscal 1997, to $8.5 million or 35.0% in fiscal 1998, and to $35.2
million or 51.2% in fiscal 1999. The increase from fiscal 1997 to fiscal 1998
was due to lower component and manufacturing costs, and the allocation of fixed
manufacturing costs over a greater revenue base. In addition, beginning in
fiscal 1998, gross margins increased as a result of the decision to outsource
all manufacturing activities during the year. The increase in gross margin from
fiscal 1998 to fiscal 1999 was due to lower component and manufacturing costs
and the allocation of fixed manufacturing costs over a greater revenue base. In
addition, for fiscal 1998, gross margin was adversely affected by the write-off
of obsolete inventory and the write-off of certain inventory and equipment
related to a change in contract manufacturers.
Research and development expenses. Research and development expenses
increased from $7.7 million in fiscal 1997, to $14.7 million in fiscal 1998 and
to $15.3 million in fiscal 1999. These increases reflect significant research
and development efforts required to bring the SilkWorm family of products to the
marketplace. The increase in fiscal 1998 expenses also reflects restructuring
costs associated with the cancellation of new product development and simulation
projects.
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Sales and marketing expenses. Sales and marketing expenses increased from
$2.1 million in fiscal 1997, to $5.2 million in fiscal 1998, and to $13.3
million in fiscal 1999. The increases reflect the hiring of additional sales and
marketing personnel and increased direct selling expenses associated with
increased revenues.
General and administrative expenses. General and administrative expenses
increased from $1.5 million for fiscal 1997, to $3.8 million for fiscal 1998 and
fiscal 1999. The increase from fiscal 1997 to fiscal 1998 was primarily due to
increased staffing and associated expenses necessary to manage and support our
increased scale of operations. Fiscal 1998 expenses were also affected by costs
related to a business restructuring which totaled $1.2 million, primarily
related to the termination of employees. Fiscal 1999 expenses reflect costs
associated with increased staffing and other expenses necessary to manage and
support our increased scale of operations.
Amortization of deferred compensation. During fiscal 1998 and 1999 we
recorded deferred compensation of $307,000 and $5.1 million, respectively, in
connection with stock option grants. Deferred compensation is amortized over
vesting periods of the applicable options, resulting in amortization expense of
$7,000 and $1.9 million in fiscal 1998 and 1999, respectively.
Interest income, net. Net interest income increased from $120,000 in
fiscal year 1998 to $1.7 million in fiscal 1999 due to interest earned on the
funds associated with the closing of our initial public offering in May 1999.
LIQUIDITY AND CAPITAL RESOURCES
We have funded our operations to date primarily through the sale of
preferred stock, capital equipment lease lines, bank debt and, in May 1999, we
raised $66.0 million in our initial public offering. Our principal sources of
liquidity as of October 31, 1999 consisted of $89.3 million in cash, cash
equivalents and short-term investments.
During fiscal 1997, cash used in operating activities was $7.3 million
compared to $11.6 million in fiscal 1998. In fiscal 1999, we generated $16.5
million in cash from operations. The increase in cash used in operations in
fiscal 1998 reflects the increased working capital required to fund expanding
operations and increases in inventories and accounts receivable. The cash
provided by operating activities in fiscal 1999 reflects net income of $2.5
million in fiscal 1999 compared to a net loss of $15.1 million in fiscal 1998,
plus favorable changes in the balances of operating assets and liabilities.
Net cash provided by investing activities for fiscal 1998 was $12.1 million
compared to net cash used in investing activities of $19.3 million for fiscal
1997. The period to period change was due mainly to sales of short-term
investments during fiscal 1998. Net cash used in investing activities for fiscal
1999 was $67.1 million compared to net cash provided by investing activities of
$12.1 million for fiscal 1998. The period to period change was due mainly to the
purchases of short-term investments during fiscal 1999.
Net cash provided by financing activities was $28.5 million, $7.3 million
and $65.7 million for fiscal 1997, 1998 and 1999, respectively. The primary
source of cash generated from financing for fiscal 1997 related to the issuance
of redeemable convertible preferred stock and warrants. For fiscal 1998, the
primary source of cash generation from financing related to the issuance of
redeemable convertible preferred stock and warrants, proceeds from the issuance
of notes payable, and borrowings under a credit facility. During fiscal 1999,
the primary source of cash generation from financing activities was the sale of
common stock in our initial public offering.
We believe that our existing cash, cash equivalents and short-term
investment balances and cash flow expected to be generated from future
operations, will be sufficient to meet our capital requirements at least through
the next 12 months, although we could be required, or could elect, to seek
additional funding prior to that time. Our future capital requirements will
depend on many factors, including the rate of revenue growth, the timing and
extent of spending to support product development efforts and expansion of sales
and marketing, the timing of introductions of new products and enhancements to
existing products, and market acceptance of our products. There can be no
assurances that additional equity or debt financing, if required, will be
available on acceptable terms or at all.
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In December 1999, Brocade entered into an agreement to lease approximately
210,000 square feet of office, laboratory, and administrative space in San Jose,
California. The term of the lease agreement is September 1, 2000 through August
31, 2010, and represents a lease commitment of $6.2 million per year to Brocade.
Brocade intends to occupy the space in September 2000 and sub-lease any excess
space. In conjunction with entering into the lease agreement, Brocade signed an
unconditional, irrevocable letter of credit for $6.2 million as security for the
lease. In connection with our occupation of this building, Brocade intends to
make significant tenant improvement. Brocade intends to finance these tenant
improvements and the lease commitment with internally generated funds.
YEAR 2000 COMPLIANCE
Impact of the year 2000 computer problem. The year 2000 computer problem
refers to the potential for system and processing failures of date-related data
as a result of computer-controlled systems using two digits rather than four to
define the applicable year. For example, computer programs that have
time-sensitive software may recognize a date represented as "00" as the year
1900 rather than the year 2000. This could result in a system failure or
miscalculations causing disruptions of operations, including among other things,
a temporary inability to process transactions, send invoices, or engage in
similar normal business activities.
To date, we have not experienced any year 2000 issues with any of our
internal systems or our products, and we do not expect to experience any in the
future. To date, we have not experienced any year 2000 issues related to any of
our key third party suppliers and customers nor do we expect to experience any
in the future. Costs associated with remediating our internal systems were not
material.
RECENT ACCOUNTING PRONOUNCEMENTS
In December 1998, the AICPA issued Statement of Position 98-9,
"Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain
Transactions," ("SOP 98-9"). SOP 98-9 amends SOP 97-2 and SOP 98-4 by extending
the deferral of the application of certain provisions of SOP 97-2 amended by SOP
98-4 through fiscal years beginning on or before March 15, 1999. All other
provisions of SOP 98-9 are effective for transactions entered into in fiscal
years beginning after March 15, 1999. Brocade has not had significant software
sales to date and management does not expect the adoption of SOP 98-9 to have a
significant effect on the financial condition or results of operations.
In June 1998, the Financial Accounting Standards Board issued Statement No.
133, "Accounting for Derivative Instruments and hedging Activities" ("SFAS 133")
which provides a comprehensive and consistent standard for the recognition and
measurement of derivatives and hedging activities. The statement is effective
for fiscal years commencing after June 15, 2000. Brocade does not believe that
SFAS 133 will have a material impact on earnings or financial condition.
RISK FACTORS
WE HAVE AN ACCUMULATED DEFICIT OF $26.3 MILLION AND MAY NOT MAINTAIN
PROFITABILITY
We have incurred significant losses since our inception. As a result, as of
October 31, 1999, we had an accumulated deficit of $26.3 million. Although our
revenues have grown in recent quarters, and we achieved profitability in our
third and fourth quarters of fiscal 1999, we cannot be certain that we will be
able to sustain these growth rates or that we will realize sufficient revenues
to maintain profitability. We expect to incur significant product development,
sales and marketing and administrative expenses and, as a result, we will need
to generate significant revenues to achieve and maintain profitability.
In addition, we have a limited operating history. Therefore, we cannot
forecast future operating results based on our historical results. We plan our
operating expenses based in part on future revenue projections. Our ability to
accurately forecast our quarterly revenue is limited for the reasons discussed
below in "-- We Expect Our Quarterly Revenues and Operating Results to Fluctuate
for a Number of Reasons Which Could Cause Our Stock Price to Fluctuate."
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
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offset any unexpected shortfall in our revenues. If this were to occur, we would
expect to incur significant losses.
WE EXPECT OUR QUARTERLY REVENUES AND OPERATING RESULTS TO FLUCTUATE FOR A NUMBER
OF REASONS WHICH COULD CAUSE OUR STOCK PRICE TO FLUCTUATE
Our quarterly revenues and operating results have varied significantly in
the past and are likely to 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 affect us include the following:
- fluctuations in demand for our SilkWorm family of products and services;
- the timing of customer orders and product implementations, particularly
large orders from and product implementations of our original equipment
manufacturer customers;
- our ability to develop, introduce, ship and support new products and
product enhancements;
- announcements and new product introductions by our competitors;
- the expected decline in the prices at which we can sell our SilkWorm
family of products to our customers;
- our ability to obtain sufficient supplies of sole or limited sourced
components, including application specific integrated circuits, or ASICs,
gigabit interface converters, or GBICs, and power supplies, for our
SilkWorm family of products;
- increases in the prices of the components we purchase;
- our ability to attain and maintain production volumes and quality levels
for our SilkWorm family of products;
- the mix of our SilkWorm and SilkWorm Express switches sold and the mix of
distribution channels through which they are sold;
- increased expenses, particularly in connection with our strategy to
continue to expand our relationships with key original equipment
manufacturers and system integrators;
- widespread adoption of SANs as an alternative to existing data storage
and management systems;
- decisions by end-users to reallocate their information resources to other
purposes, including year 2000 preparedness; and
- deferrals of customer orders in anticipation of new products, services or
product enhancements introduced by us or our competitors.
Accordingly, you should not rely on the results of any past periods as an
indication of our future performance. It is likely that in some future period,
our operating results may be below expectations of public market analysts or
investors. If this occurs, our stock price may drop.
OUR SUCCESS IS DEPENDENT UPON THE DEVELOPMENT OF THE EMERGING MARKET FOR SANS
AND SAN SWITCHING PRODUCTS
Our SilkWorm family of Fibre Channel switching products is used exclusively
in storage area networks, or SANs. Accordingly, widespread adoption of SANs as
an integral part of data-intensive enterprise computing environments is critical
to our future success. In addition, our success depends upon market acceptance
of our SAN switching solutions as an alternative to the use of hubs or other
interconnect devices in SANs. The markets for SANs and SAN switching products
have only recently begun to develop and are rapidly evolving. Because these
markets are new, it is difficult to predict their potential size or future
growth rate. In addition, SANs are often implemented in connection with
deployment of new storage systems and servers and we are therefore dependent to
some extent on this market. Potential end-user customers who have invested
substantial resources in their existing data storage and management systems may
be reluctant or slow
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to adopt a new approach, like SANs. Our success in generating revenue in these
emerging markets will depend, among other things, on our ability to educate
potential original equipment manufacturers and system integrator customers, as
well as potential end-users, about the benefits of SANs and SAN switching
technology and our ability to maintain and enhance our relationships with
leading original equipment manufacturers and system integrators. In addition,
our products are designed to conform to the Fibre Channel interconnect protocol
and certain other industry standards. Some of these standards may not be widely
adopted, and competing standards may emerge that will be preferred by original
equipment manufacturers or end-users.
WE CURRENTLY ONLY OFFER OUR SILKWORM PRODUCT FAMILY AND MUST DEVELOP NEW AND
ENHANCED PRODUCTS THAT ACHIEVE WIDESPREAD MARKET ACCEPTANCE
We currently derive substantially all of our revenues from sales of our
SilkWorm family of products. We expect that revenue from this product family
will continue to account for a substantial portion of our revenues for the
foreseeable future. Therefore, widespread market acceptance of these products is
critical to our future success. Some of our products have been only recently
introduced and therefore, the demand and market acceptance of our products is
uncertain. Factors that may affect the market acceptance of our products include
market acceptance of SAN switching products, the performance, price and total
cost of ownership of our products, the availability and price of competing
products and technologies, and the success and development of our original
equipment manufacturers and system integrators. 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, product enhancements and services on a timely basis and
by keeping pace with technological developments and emerging industry standards.
We have new product launches and upgrades to our existing products planned for
fiscal year 2000. Our future revenue growth will be dependent on the success of
these new product launches. We have in the past experienced delays in product
development and such delays may occur in the future. In addition, as we
introduce new or enhanced products, we will have to manage successfully the
transition from older products in order to minimize disruption in our customers'
ordering patterns, avoid excessive levels of older product inventories and
ensure that enough supplies of new products can be delivered to meet our
customers' demands. Our failure to develop and introduce successfully new
products and product enhancements, which are not broadly accepted, would reduce
our revenues.
WE DEPEND ON A FEW KEY ORIGINAL EQUIPMENT MANUFACTURER CUSTOMERS AND THE LOSS OF
ANY OF THEM COULD SIGNIFICANTLY REDUCE OUR REVENUES
We depend on a few key original equipment manufacturer customers. For
example, in the year ended October 31, 1999, sales to four customers accounted
for 70% of our total revenues. We anticipate that our operating results will
continue to depend on sales to a relatively small number of original equipment
manufacturers. Therefore, the loss of any of our key original equipment
manufacturers, or a significant reduction in sales to these original equipment
manufacturers could significantly reduce our revenues.
FAILURE TO EXPAND OUR DISTRIBUTION CHANNELS AND MANAGE OUR DISTRIBUTION
RELATIONSHIPS COULD SIGNIFICANTLY REDUCE OUR REVENUES
Our success will depend on our continuing ability to develop and manage
relationships with significant original equipment manufacturers and system
integrators, as well as on the sales efforts and success of these customers. Our
customers may evaluate our products for up to a year before they begin to market
and sell them and assisting these customers through the evaluation process may
require significant sales and marketing and management efforts on our part,
particularly if we have to qualify our products with multiple customers at the
same time. In addition, once our products have been qualified, our agreements
with our customers have no minimum purchase commitments. We cannot assure you
that we will be able to expand our distribution channels, manage our
distribution relationships successfully or that our customers will market our
products effectively. Our failure to manage successfully our distribution
relationships or the failure of our customers to sell our products could reduce
our revenues.
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THE LOSS OF SOLECTRON CORPORATION, OUR SOLE MANUFACTURER, OR THE FAILURE TO
FORECAST ACCURATELY DEMAND FOR OUR PRODUCTS OR MANAGE SUCCESSFULLY OUR
RELATIONSHIP WITH SOLECTRON, WOULD NEGATIVELY IMPACT OUR ABILITY TO MANUFACTURE
AND SELL OUR PRODUCTS
Solectron, a third party manufacturer for numerous companies, manufactures
all of our products at its Milpitas, California facility on a purchase order
basis. We have entered into a three-year manufacturing agreement with Solectron
under which we provide to Solectron a twelve-month product forecast and place
purchase orders with Solectron sixty calendar days in advance of the scheduled
delivery of products to our customers. Accordingly, if we inaccurately forecast
demand for our products, we may be unable to obtain adequate manufacturing
capacity from Solectron to meet our customers' delivery requirements or we may
accumulate excess inventories.
We plan to regularly introduce new products and product enhancements, which
will require that we coordinate our efforts with those of our suppliers and
Solectron to rapidly achieve volume production. While we have not, to date,
experienced supply problems with Solectron, we have experienced delays in
product deliveries from one of our former contract manufacturers. If we should
fail to effectively manage our relationships with our suppliers and Solectron,
or if Solectron experiences delays, disruptions, capacity constraints or quality
control problems in its manufacturing operations, our ability to ship products
to our customers could be delayed and our competitive position and reputation
could be harmed. Qualifying a new contract manufacturer and commencing volume
production is expensive and time consuming. If we are required or choose to
change contract manufacturers, we may lose revenue and damage our customer
relationships.
WE ARE DEPENDENT ON SOLE SOURCE AND LIMITED SOURCE SUPPLIERS FOR CERTAIN KEY
COMPONENTS INCLUDING ASICS AND POWER SUPPLIES
We currently purchase several key components from single or limited
sources. We purchase ASICs and power supplies from single sources, and printed
circuit boards and GBICs from limited sources. In addition, we license certain
software that is incorporated into our Brocade Fabric Operating System from Wind
River Systems, Inc. If we are unable to buy these components on a timely basis,
we will not be able to manufacture our products. We use a rolling six-month
forecast based on anticipated product orders to determine our component
requirements. If we overestimate our component requirements, we may have excess
inventory, which would increase our costs. If we underestimate our component
requirements, we may have inadequate inventory, which could interrupt our
manufacturing. In addition, lead times for materials and components we order
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 our
manufacturing.
THE COMPETITION IN OUR MARKETS MAY LEAD TO REDUCED SALES OF OUR PRODUCTS,
REDUCED PROFITS AND REDUCED MARKET SHARE
The markets for our SAN switching products are competitive, and are likely
to become even more competitive. Increased competition could result in pricing
pressures, reduced sales, reduced margins, reduced profits, reduced market share
or the failure of our products to achieve or maintain market acceptance. Our
products face competition from multiple sources. Some of our competitors and
potential competitors have longer operating histories, greater name recognition,
access to larger customer bases, or substantially greater resources than we
have. As a result, they may be able to respond more quickly than we can to new
or changing opportunities, technologies, standards or customer requirements. For
all of the foregoing reasons, we may not be able to compete successfully against
our current and future competitors.
THE PRICES OF OUR PRODUCTS ARE DECLINING WHICH COULD REDUCE OUR REVENUES AND
GROSS MARGINS
The average unit price of our products continued to decrease in fiscal
1999. We anticipate that the average unit price of our products may continue to
decrease in the future in response to changes in product mix, competitive
pricing pressures, increased sales discounts, new product introductions by us or
our
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competitors or other factors. If we are unable to offset these factors by
increasing our sales volumes, our revenues will decline. In addition, to
maintain our gross margins, we must develop and introduce new products and
product enhancements, and we must continue to reduce the manufacturing cost of
our products.
UNDETECTED SOFTWARE OR HARDWARE ERRORS COULD INCREASE OUR COSTS AND REDUCE OUR
REVENUES
Networking products frequently contain undetected software or hardware
errors when first introduced or as new versions are released. Our products are
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 our engineering personnel from our
product development efforts and cause significant customer relations problems.
Moreover, the occurrence of hardware and software errors, whether caused by our
or another vendor's SAN products, could delay or prevent the development of the
SAN market.
IF WE LOSE KEY PERSONNEL OR ARE UNABLE TO HIRE ADDITIONAL QUALIFIED PERSONNEL,
WE MAY NOT BE SUCCESSFUL
Our success depends to a significant degree upon the continued
contributions of our key management, engineering and sales and marketing
personnel, many of whom would be difficult to replace. In particular, we believe
that our future success is highly dependent on Gregory L. Reyes, our President
and Chief Executive Officer, Kumar Malavalli, our Vice President, Technology and
Paul R. Bonderson, Jr., our Vice President, Engineering. We do not have
employment contracts with, or key person life insurance on, any of our key
personnel. We also believe that our success depends to a significant extent on
the ability of our management to operate effectively, both individually and as a
group. In April 1999, we hired a new Chief Financial Officer, and certain other
members of our management team, including Mr. Reyes, have only recently joined
us.
We believe our future success will also depend in large part upon our
ability to attract and retain highly skilled managerial, engineering, sales and
marketing, and finance and operations personnel. Competition for these personnel
is intense, especially in the San Francisco Bay Area. In particular, we have
experienced difficulty in hiring qualified ASIC, software, system and test, and
customer support engineers and there can be no assurance that we will be
successful in attracting and retaining these individuals. 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 our industry whose employees accept positions with
competitors frequently claim that their competitors have engaged in unfair
hiring practices. We cannot assure you that we will not receive such claims in
the future as we seek to hire qualified personnel or that such claims will not
result in material litigation. We could incur substantial costs in defending
ourselves against these claims, regardless of their merits.
WE MUST CONTINUE TO IMPROVE OUR OPERATIONAL SYSTEMS AND CONTROLS TO MANAGE
FUTURE GROWTH
We plan to continue to expand our operations significantly to pursue
existing and potential market opportunities. This growth places a significant
demand on our management and our operational resources. In order to manage
growth effectively, we must implement and improve our operational systems,
procedures and controls on a timely basis.
WE PLAN TO INCREASE OUR INTERNATIONAL SALES ACTIVITIES SIGNIFICANTLY, WHICH WILL
SUBJECT US TO ADDITIONAL BUSINESS RISKS
We plan to expand our international sales activities significantly. In
fiscal 2000, we intend to focus on expanding our international sales activities
in Western Europe and Japan. Our international sales growth in these countries
will be limited if we are unable to establish relationships with international
distributors, establish additional foreign operations, expand international
sales channel management, hire additional personnel and develop relationships
with international service providers. Even if we are able to successfully
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expand international operations, we cannot be certain that we will be able to
maintain or increase international market demand for our products. Our
international operations, including our sales activities in Western Europe and
Japan, are subject to a number of risks, 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;
- protectionist laws and business practices that favor local competition;
- dependence on local vendors;
- multiple, conflicting and changing governmental laws and regulations;
- 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 have been denominated
in foreign currencies. As a result, an increase in the value of the U.S. dollar
relative to foreign currencies could make our products more expensive and thus
less competitive in foreign markets. A portion of our international revenues may
be denominated in foreign currencies in the future, including the Euro, which
will subject us to risks associated with fluctuations in those foreign
currencies.
WE MAY BE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY WHICH WOULD NEGATIVELY
AFFECT OUR ABILITY TO COMPETE
We rely on a combination of patent, copyright, trademark and trade secret
laws and 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 software, documentation and other proprietary information. Despite our
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 have taken will prevent unauthorized use of our technology,
particularly in foreign countries where the laws may not protect our proprietary
rights as fully as in the United States. See "Business -- Intellectual
Property."
OTHERS MAY BRING INFRINGEMENT CLAIMS AGAINST US WHICH COULD BE TIME-CONSUMING
AND EXPENSIVE TO DEFEND
In recent years, there has been significant litigation in the United States
involving patents and other intellectual property rights. We were previously the
subject of a lawsuit alleging infringement of intellectual property rights.
Although this dispute was resolved and the lawsuit dismissed, and we are not
currently involved in any other intellectual property litigation, 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 could subject us to significant liability for damages
and invalidation of our proprietary rights. These lawsuits, regardless of their
success, would likely be time-consuming and expensive to resolve and would
divert management time and attention. Any potential intellectual property
litigation also could force us to do one or more of the following:
- stop selling, incorporating or using our products or services that use
the challenged intellectual property;
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- obtain from the owner of the infringed intellectual property right a
license to make, use, sell, import and/or export the relevant technology,
which license may not be available on reasonable terms, or at all; and
- redesign those products or services that use such technology.
If we are forced to take any of the foregoing actions, we may be unable to
manufacture, use, sell, import and/or export our products, which would reduce
our revenues.
WE MAY ENGAGE IN FUTURE ACQUISITIONS THAT DILUTE OUR STOCKHOLDERS AND CAUSE US
TO INCUR DEBT OR ASSUME CONTINGENT LIABILITIES
As part of our strategy, we expect to review opportunities to buy other
businesses or technologies that would complement our current products, expand
the breadth of our markets or enhance our technical capabilities, or that may
otherwise offer growth opportunities. While we have no current agreements or
negotiations underway, we may buy businesses, products or technologies in the
future. In the event of any future purchases, we could:
- issue stock that would dilute our current stockholders' percentage
ownership;
- incur debt; or
- assume liabilities.
These purchases also involve numerous risks, including:
- problems combining the purchased operations, technologies 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 markets in which we have no or limited
prior experience; and
- potential loss of key employees of purchased organizations.
We cannot assure you that we will be able to successfully integrate any
businesses, products, technologies or personnel that we might purchase in the
future.
YEAR 2000 COMPLIANCE
Impact of the year 2000 computer problem. The year 2000 computer problem
refers to the potential for system and processing failures of date-related data
as a result of computer-controlled systems using two digits rather than four to
define the applicable year. For example, computer programs that have
time-sensitive software may recognize a date represented as "00" as the year
1900 rather than the year 2000. This could result in a system failure or
miscalculations causing disruptions of operations, including among other things,
a temporary inability to process transactions, send invoices, or engage in
similar normal business activities.
To date, we have not experienced any year 2000 issues with any of our
internal systems or our products, and we do not expect to experience any in the
future. To date, we have not experienced any year 2000 issues related to any of
our key third party suppliers and customers nor do we expect to experience any
in the future. Costs associated with remediating our internal systems were not
material.
OUR PRODUCTS MUST COMPLY WITH EVOLVING INDUSTRY STANDARDS AND GOVERNMENT
REGULATIONS
The market for SAN products is characterized by the need to support
industry standards as they 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 utilize the
same standards in order to operate together. Our products comprise only a part
of the entire SAN and we depend on
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the companies that provide other components of the SAN, many of whom are
significantly larger than we are, 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 must comply with various regulations and standards
defined by the Federal Communications Commission and Underwriters Laboratories.
Internationally, products that we develop will also be required to comply with
standards established by authorities in various countries. Failure to comply
with existing or evolving industry standards or to obtain timely domestic or
foreign regulatory approvals or certificates could materially harm our business.
PROVISIONS IN OUR