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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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(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 28, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
FOR THE TRANSITION PERIOD FROM __________ TO __________ .
COMMISSION FILE 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 (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
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1745 TECHNOLOGY DRIVE
SAN JOSE, CA 95110
(408) 487-8000
(ADDRESS, INCLUDING ZIP CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES AND
TELEPHONE NUMBER, INCLUDING AREA CODE)
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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 $15,000,000,000 as of December 29, 2000, 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 29, 2000 was 223,937,640 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for its 2001 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
PAGE
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PART I
Item 1. Business.................................................... 1
Item 2. Properties.................................................. 15
Item 3. Legal Proceedings........................................... 16
Item 4. Submission of Matters to a Vote of Security Holders......... 16
PART II
Item 5. Market For Registrant's Common Equity and Related
Stockholder Matters......................................... 17
Item 6. Selected Financial Data..................................... 18
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 20
Item 7A. Quantitative and Qualitative Disclosure About Market Risk... 24
Item 8. Financial Statements and Supplementary Data................. 24
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure.................................... 42
PART III
Item 10. Directors and Executive Officers of the Registrant.......... 42
Item 11. Executive Compensation...................................... 44
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 44
Item 13. Certain Relationships and Related Transactions.............. 44
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 44
SIGNATURES............................................................ 48
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PART I
ITEM 1. BUSINESS
GENERAL
In addition to historical information, this Annual Report on Form 10-K
(Annual Report) contains forward-looking statements such as statements relating
to the timing of new product releases and upgrades to existing products; the
possibility of making additional strategic investments; the effect of pending
legal claims and proceedings on Brocade; anticipated future revenues, gross
margins, research and development expenses, sales and marketing expenses,
general and administrative expenses, and income taxes; Brocade's liquidity and
the sufficiency of existing cash and cash equivalents for near-term
requirements; and the effect of recent accounting pronouncements on Brocade's
financial condition or results of operations. In some cases, forward-looking
statements can be identified by terminology such as "may," "will," "should,"
"expects," "plans," "anticipates," "believes," "estimates," "predicts,"
"intend," "potential," "continue," or the negative of such terms, or other
comparable terminology. These statements are only predictions. Actual results
could differ materially from those anticipated in these forward-looking
statements as a result of various factors, including those set forth below in
this section under the heading "Risk Factors." Risk factors may include but are
not limited to Brocade's ability to effectively manage future expansion;
Brocade's ability to develop new and enhanced products that achieve widespread
market acceptance; and various factors that may cause Brocade's quarterly
revenues and operating results to fluctuate, such as the timing of customer
orders, changes in general and specific economic conditions in the computer,
storage, and networking industries, and announcements and new product
introductions by competitors. 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.
Brocade Communications Systems, Inc. (Brocade) is the world's leading
provider of storage area networking infrastructure solutions. The exponential
growth rate of business information has resulted in a need for data storage
environments that are highly scalable, continuously available, have a low cost
of management, are secure, and can extend beyond the traditional data center
across wide geographic distances. The Brocade family of hardware and software
products provides the networking foundation for storage area networks (SANs),
which bring a networking model to storage environments. Using Brocade Fibre
Channel fabric switches and software, customers can connect servers with
external storage devices through a SAN, creating a highly reliable and scalable
environment for data-intensive storage applications. SANs are a strategic part
of IT infrastructure -- an enterprise networking foundation that will scale to
support exponential data growth and enable companies to unlock the power of one
of their most strategic assets -- their information.
Brocade delivers and enables hardware and software products, education, and
services that allow companies to implement large, heterogeneous, block-data
networks supporting business-critical storage applications. Companies use
Brocade SAN infrastructure to securely and reliably move blocks of data over
distance at high performance, creating a networking platform to simplify the
administration, management, and movement of data. Using Brocade solutions,
companies can more easily keep pace with rapid growth in data storage
requirements, reduce the total cost of ownership of data storage environments,
improve computing network and application efficiency and performance, and
simplify the implementation and management of SANs and SAN-based applications.
Brocade products are sold through Brocade OEM partners, systems
integrators, and resellers. Brocade has OEM partnerships with the companies that
supply the majority of the world's external storage -- these providers of server
and storage systems use Brocade solutions as a networking foundation for their
SAN solutions.
Brocade was incorporated on May 14, 1999 as a Delaware corporation and is
the successor to operations originally begun on August 24, 1995. Brocade's
headquarters are located in San Jose, California. The mailing address for
Brocade's headquarters is 1745 Technology Drive, San Jose, California, 95110,
telephone number: (408) 487-8000. Brocade can also be reached at its Web site at
www.brocade.com.
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STORAGE AREA NETWORKING INFRASTRUCTURE SOLUTIONS
The Brocade family of Fibre Channel fabric switches and software is
designed to bring the benefits of networking to storage
environments -- providing a network-based foundation that can scale from small
departmental SANs to enterprise-wide networks to interconnect many servers,
storage subsystems, and tape devices. Brocade-based SANs can help reduce overall
storage costs by enabling companies to better utilize and manage their server
and storage resources.
Brocade Fibre Channel Fabric Switches
The Brocade family of Fibre Channel fabric switches interconnects servers
and storage subsystems in a SAN, creating a highly reliable and scalable
environment for storage applications. The Brocade Fibre Channel fabric switch
family includes the 8-port SilkWorm 2000, 16-port SilkWorm 2200, 8-port SilkWorm
2400, and 16-port SilkWorm 2800 products. The products are available in multiple
configurations to meet all SAN requirements from entry-level to
midrange/departmental to enterprise.
Brocade products are fully networkable, enabling customers to create a
high-performance SAN "fabric" that is highly reliable and scalable to support
the interconnection of hundreds of server and storage devices. Brocade Fibre
Channel fabric switches are based on the Brocade Fabric Operating System (Fabric
OS(TM)), which is an intelligent distributed operating system for Brocade-based
SANs. All Brocade Fibre Channel fabric switches are forward-and
backward-compatible; are networkable; and are designed to support
business-critical storage applications such as LAN-free backup, storage
consolidation, remote-mirroring, and high-availability configurations.
In fiscal year 2000, Brocade announced the SilkWorm 6400, a 64-port
integrated fabric solution expected to be generally available in the first
quarter of calendar year 2001. Like all Brocade products, the SilkWorm 6400 is
networkable, forward- and backward-compatible, and is based on the Brocade
Fabric OS. The SilkWorm 6400 simplifies the deployment and management of SAN
fabrics. It contains six switch modules that are integrated into a highly
available fabric within a single enclosure.
In fiscal year 2000, Brocade also announced its product roadmap for
extending the benefits of the Brocade networking model for storage to a
networkable core fabric switch offering. In fiscal year 2001, Brocade expects to
announce its 64- and 128-port networkable Core Fabric switches. With these
products, Brocade's product family will range from entry-level to carrier-class
based on a common architecture that utilizes the Brocade distributed fabric
operating system. It is expected that these new products will be designed to be
forward- and backward-compatible with the entire Brocade product line.
Fabric Operating System Software
The Brocade family of Fibre Channel fabric switches is based on the Brocade
Fabric OS. The Fabric OS provides a feature-rich platform for SAN-designed
applications and offers advanced features for proactive SAN management and
monitoring. This enables applications to dynamically discover physical
components in a SAN and monitor SAN fabric resources. Brocade makes the
value-added features of the Fabric OS available to strategic partners through
the Brocade Fabric OS Access Layer (Fabric Access(TM)), the application
programming interface (API) to Fabric OS. In addition, Brocade offers a suite of
optional add-on products, based on Fabric OS, which provide additional
management capabilities for Brocade-based SANs.
MARKET DRIVERS
During the last decade, a multitude of changes in computing technology and
the globalization of business via the Internet have created a tremendous growth
in storage requirements -- requiring many organizations to reassess the way they
view their storage environments. Storage capacity requirements have grown
exponentially, and continuous access to data and the devices on which it is
stored is now a crucial business requirement. As a result, the financial
implications of data center downtime are now extreme and many organizations are
searching for cost-effective ways to ensure high data availability and
reliability and keep pace with increasing data storage requirements.
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To remain successful in such a dynamic marketplace, organizations need
reliable storage systems that can effectively manage and protect critical
business information. These systems must be able to scale quickly to manage
anticipated data growth -- a difficult problem for many traditional storage
approaches. As a result, organizations are now accessing and managing the
ever-increasing amount of enterprise data through SANs. SANs address some of the
most challenging business requirements, including ensuring that all data is
protected and accessible across the enterprise, improving efficiency of IT
resource management, and maximizing system and data availability, among others.
At the center of the SAN fabric are solutions such as Brocade SilkWorm Fibre
Channel fabric switches, which provide the reliable high-performance data
transfer that is critical to efficient SAN operations.
MARKET INITIATIVES
Interoperability and Standards
Brocade continues to invest in making SANs simpler to design, deploy, and
manage, and in enabling end-to-end interoperability for heterogeneous,
multivendor SANs.
- Standards: Brocade is very active in the development of SAN standards.
Brocade is an active participant in the primary standards and industry
groups for SANs, including the National Committee for Information
Technology Standards (NCITS) T11 Technical Committee, the primary
governing body for Fibre Channel-related standards; the Storage
Networking Industry Association (SNIA); the Fibre Channel Industry
Association (FCIA); the Infiniband Trade Association; the FibreAlliance;
and others. Brocade has authored or contributed significantly to many of
the Fibre Channel standards in existence today. Brocade's inter-switch
routing protocol, Fabric Shortest Path First (FSPF), was recently
accepted as the standard for routing data among multi-vendor Fibre
Channel switches.
- Interoperability and testing labs: In fiscal 2000, Brocade invested
extensively in interoperability and testing labs and expects to expand
those investments in the future.
- Fabric Aware(TM) Program: The BROCADE Fabric Aware program is a
comprehensive testing and configuration initiative designed to foster
end-to-end SAN interoperability in a multivendor, heterogeneous
environment. As part of the program, participating companies agree to
specify, test, and jointly support pretested SAN configurations that
include a heterogeneous mix of servers, storage subsystems, Fibre Channel
switches, and other SAN technologies.
- SOLUTIONware(TM) Library: Brocade also offers a library of pretested,
certified SAN configuration guides for popular SAN environment and
application configurations. Each SOLUTIONware guide provides step-by-step
instructions on how to integrate and configure a wide range of devices
with Brocade Fibre Channel fabric switches in a discrete SAN solution for
applications such as LAN-free and server-free backup, server and storage
consolidation, high availability, and disaster tolerance. Brocade works
closely with application, storage and system partners to ensure
interoperability of solutions in these environments. Each certified
Brocade SOLUTIONware configuration has been thoroughly tested and
certified in Brocade and Brocade partner interoperability labs.
SAN-Designed Applications
The Brocade Fabric OS provides an intelligent operating system foundation
that allows strategic application partners to unlock the power resident within
the SAN. In addition, Brocade provides a developer program to enable developers
of storage applications, hardware, and technologies to design and develop their
own solutions to take optimal advantage of the Brocade SAN infrastructure. These
companies are developing SAN-designed applications that take specific advantage
of the underlying Brocade Fabric OS to simplify management of heterogeneous SANs
while providing higher levels of storage application functionality. Brocade
Fabric Access partners include companies such as VERITAS Software and BMC
Software.
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SAN Internetworking
The rapid deployment of heterogeneous SANs on a large scale is creating
demand to internetwork SANs over optical infrastructure through Dense Wave
Division Multiplexing (DWDM) technologies and over IP-based networks. Today,
Brocade-based SANs can be internetworked via DWDM solutions from companies such
as Adva Optical Networking, Cisco Systems, Nortel Networks, and ONI Systems.
This enables the extension of SAN applications such as high-speed remote data
mirroring, wide area data replication, remote backup, digital content
distribution, and storage outsourcing- over distances of up to 100 kilometers.
In addition, SAN technology combined with the ability to move vast amounts of
block data over distance has created a new market for providers of outsourced
and managed applications and services. Using SANs as the storage environment
foundation, storage service providers, second-generation application providers,
application service providers, and Internet service providers, can deliver
service offerings over extended distances without significant performance
degradation.
EDUCATION SERVICES
Brocade has established a worldwide education and training organization to
deliver high-quality, technical training on SAN technologies and implementation
to Brocade partners and their customers. To date, Brocade has trained more than
2,500 SAN technical professionals at its education facilities, providing
hands-on technical training in SAN design, implementation, and operation. In
fiscal 2000, Brocade opened training facilities in Atlanta, Denver, and Munich
to complement its San Jose facilities, and partnered with StorageNetworks to
expand training globally in Europe, the Middle East, and Africa (EMEA), and
North America.
SERVICE AND SUPPORT
To address the demand for comprehensive maintenance programs for SAN
products, Brocade has created a service and support program that leverages the
expertise and hands-on capabilities of all Brocade technical resources. Brocade
offers five levels of maintenance contracts that can be purchased separately
through Brocade's system integrators, resellers, and service providers. The
contracts typically include returns and replacement as well as telephone
support.
SALES MODEL AND MARKETING
Brocade sells and markets its products through OEM partners, systems
integrators, resellers, and service providers. Brocade solutions provide the
networking foundation for SAN environments and are designed to meet entry-level,
midrange, workgroup, enterprise, and carrier-class requirements. SANs are one of
the key foundations of data centers and high-performance application
environments in enterprises where data storage requirements are high and/or
dynamic, and in which data availability and reliability are important business
requirements. Typical storage applications supported by Brocade-based SANs
include LAN-free and server-free backup, disaster recovery, high-speed remote
data mirroring, data replication, centralized data backup, digital content
distribution, systems and storage consolidation, and storage outsourcing. End
customer profiles include enterprise SAN deployments that are internetworked
across optical infrastructure, ATM, and IP-based networks; midrange SAN
deployments that support departmental and workgroup storage and computing
applications; and service providers offering managed and outsourced services
based on SAN.
- Brocade OEM partners include the world's leading providers of servers and
storage. These companies supply the majority of the world's external
storage. OEM partners typically offer Brocade products for sale after
completing extensive product qualification cycles. OEM partners offer
either Brocade-branded or OEM-branded products, which are identical in
functionality.
- Brocade Fabric Integrators are high-end systems integrators located
worldwide who have invested significantly in SAN expertise and are
trained and certified in Brocade product installation and support.
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- Brocade Master Resellers are leading distributors that offer Brocade
entry-level products to Brocade Fabric Resellers. Master Resellers are
non-exclusive relationships and are designed to offer Brocade-based
solutions to entry-level SAN customers needing pre-configured SAN
solutions.
- Brocade Fabric Resellers are typically regionally focused systems
integrators targeting small- to mid-sized businesses. These systems
integrators, once qualified, are authorized to purchase entry-level
Brocade Fibre Channel fabric switches from Master Resellers and sell them
to their end-user SAN customers.
- Brocade service provider partners are part of Brocade's xSPartner program
and offer Brocade-based outsourced storage services such as
storage-on-demand to their end customers.
CUSTOMERS
Brocade's primary customers are OEMs and systems integrators and account
for over 90 percent of Brocades revenue. Currently, Brocade's major OEM
customers include Amdahl, Compaq Computer, Dell Computer, EMC Corporation,
Fujitsu Siemens Computers, Groupe Bull, Hewlett Packard, IBM, StorageTek, Sun
Microsystems, and Unisys. Brocade's major system integrators include Advanced
Digital Information Corporation, Datalink Corporation, Grass Valley Group,
Hitachi Data Systems, Inc., Mount10, Inc., StorageApps, Inc., StorageNetworks,
Tokyo Electron Limited, Worldstor, Inc., and XIOTech Corporation.
Brocade's revenues are derived primarily from sales of its SilkWorm family
of products. In fiscal 2000, Compaq Computer and EMC Corporation each
contributed over 10 percent of total revenues for a combined total of 49 percent
of total revenues. In fiscal 1999, Compaq Computer, EMC Corporation, and Sequent
Computer Systems each accounted for 10 percent or more of total revenues for a
combined total of 70 percent of total revenues. In fiscal 1998, EMC Corporation
and Sequent Computer Systems each contributed over 10 percent of total revenues
for a combined total of 83 percent. The level of sales to any customer may vary
from quarter to quarter and Brocade expects 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.
ACQUISITIONS AND INVESTMENTS
Brocade's strategy is to facilitate a rapid evolution of the SAN market to
enable customers to deploy large SANs that are internetworked across optical
infrastructures, IP-based networks, or other communications backbones. Brocade
is committed to helping SAN customers optimize server, storage, and application
investments and extend those benefits across the enterprise. Enabling end-to-end
SAN interoperability and reducing the cost of storage management is important in
the evolving market. Brocade's approach to acquisitions and investments is to
help grow the SAN market and facilitate solutions that help SAN end-user
customers get the most out of their server and storage investments. To date,
Brocade has made no acquisitions. Brocade has made minority investments in
companies that deliver solutions that simplify the deployment and management of
SANs; that offer new types of outsourced and managed services, such as
outsourced storage; that are helping to broaden the reach of education,
consulting, and implementation services; and that are investing in new
advancements in SAN technologies.
RESEARCH AND DEVELOPMENT
The industry in which Brocade competes is subject to rapid technological
developments, evolving industry standards, changes in customer requirements, and
new product introductions. As a result, Brocade's success, in part, depends on
its ability to continue to enhance its existing solutions and to develop and
introduce new solutions that improve performance and reduce total cost of
ownership in the storage environment.
Brocade has invested heavily in research and development to support current
and future product development. Brocade continues to enhance and extend its
products to anticipate and meet customer requirements. Brocade continues to
increase the speed and performance of its Fabric switching products, and
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to deliver higher port density and more cost-optimized solutions. Brocade also
continues to expand the capability of the Brocade Fabric OS by investing in
delivering additional functionality of this distributed operating system and new
value-added services and software to simplify the management and deployment of
SANs. Brocade products are designed to support current industry standards and
will continue to support emerging standards that are consistent with its product
strategy. Brocade 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. Brocade intends to
continue to leverage this architecture to develop and introduce additional
products and enhancements in the future.
During fiscal years 2000, 1999, and 1998, Brocade's research and
development expenses totaled $50.5 million, $15.3 million and $14.7 million,
respectively. All expenditures for research and development costs have been
expensed as incurred. Brocade expects to continue to maintain its high level of
investment in research and development and to make strategic investments, and
potentially, acquisitions, as appropriate.
COMPETITION
The current and potential market for SAN solutions and technologies is
continually evolving, and subject to rapid technological change. New SAN
solutions and products are continually being introduced by major server and
storage providers, and existing products will be continually enhanced. Currently
Brocade faces primary competition from other developers of Fibre Channel
interconnection products including McDATA, InRange, Qlogic, Gadzoox Networks,
Inc., and Vixel Corporation.
In addition, as the SAN market evolves, non-Fibre Channel based
interconnection products may become commercially available that interconnect
servers and storage. To the extent that these products provide the ability to
network servers and storage and support high-performance, block-data storage
applications, they may compete with Brocade's current and future products.
Competitive products might include, but are not limited to, non-Fibre Channel
based emerging products based on Gigabit Ethernet, 10 Gigabit Ethernet, and
Infiniband. In addition, networking companies, manufacturers of networking
equipment, or other companies may develop competitive products. Brocade OEM
partners or other customers/partners could also develop and introduce products
competitive with Brocade product offerings. Brocade believes 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 Brocade's current and potential competitors have longer operating
histories, significantly greater resources, and greater brand recognition than
Brocade. As a result, these companies may have greater credibility with existing
and potential Brocade customers and may be able to adopt more aggressive pricing
policies and devote greater resources to the development, promotion, and sale of
their products than Brocade. These advantages could allow them to respond more
quickly than Brocade to new or emerging technologies and changes in customer
requirements. In addition, some of Brocade's current and potential competitors
have already established supplier or joint development relationships with
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 Brocade products with their
products. Such increased competition may result in price reductions, lower gross
margins, and reduction of market share. There can be no assurance that Brocade
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 Brocade will be able to compete
successfully against current or future competitors or that current or future
competitive pressures will not materially harm Brocade's business.
MANUFACTURING
Solectron Corporation, a third-party contract manufacturer, currently
manufactures Brocade's switches. 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 Brocade purchase orders
placed with Solectron are cancelable, the terms of the manufacturing agreement
with Solectron would require Brocade to purchase from Solectron
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all material inventory not returnable or usable for other customers. Although
Brocade uses Solectron for final turnkey product assembly, Brocade maintains key
component expertise internally. Brocade designs and develops the key components
of its products, including Application Specific Integrated Circuits (ASICs) and
software, as well as certain details in the fabrication and enclosure of its
products. In addition, Brocade determines the components that are incorporated
in its products and selects appropriate suppliers of those components.
Although Brocade uses standard parts and components for its products where
possible, it currently purchases several key components used in the manufacture
of its products from single or limited sources. Brocade's principal
single-source components include ASICs and chassis, and its principal
limited-source components include printed circuit boards, power supplies and
gigabit interface converters (GBICs). In addition, Brocade licenses certain
software from Wind River Systems, Inc. that is incorporated into the Brocade
Fabric Operating System. If Brocade is unable to buy these components on a
timely basis, it will not be able to deliver products to customers in a timely
manner. Brocade uses a rolling six-month forecast based on anticipated product
orders to determine component requirements. If Brocade overestimates component
requirements, it may have excess inventory, which would increase costs. If
Brocade underestimates component requirements, it may have inadequate inventory,
which could interrupt manufacturing. In addition, lead times for ordered
materials and components vary significantly and depend on factors such as the
specific supplier, contract terms, and demand for a component at a given time.
Brocade also may experience shortages of certain components from time to time,
which also could delay manufacturing.
PATENTS, INTELLECTUAL PROPERTY, AND LICENSING
Brocade relies on a combination of patents, copyrights, trademarks, trade
secrets, confidentiality agreements, and other contractual restrictions with
employees and third parties to establish and protect its proprietary rights.
Despite these precautions, there can be no assurance that the measures Brocade
undertakes will prevent misappropriation or infringement of Brocade's
proprietary technology or that these measures will preclude competitors from
independently developing products with functionality or features similar to
Brocade's products.
Brocade currently has a utility patent, two design patents, and seven
pending patent applications in the United States with respect to its technology.
It is possible that patents may not be issued for these applications.
Furthermore, Brocade's issued patents may not adequately protect its technology
from infringement or prevent others from claiming that Brocade's technology
infringes on that of third parties. Failure to protect Brocade's intellectual
property could materially harm its business. In addition, Brocade's competitors
may independently develop similar or superior technology. It is possible that
litigation may be necessary in the future to enforce Brocade's intellectual
property rights, to protect its trade secrets, or to determine the validity and
scope of the proprietary rights of others. Litigation could result in
substantial costs and diversion of Brocade resources and could materially harm
its business.
Some of Brocade's products are designed to include software or other
intellectual property licensed from third parties. While it may be necessary in
the future to seek or renew licenses relating to various aspects of Brocade's
products, Brocade believes that such licenses generally could be obtained on
commercially reasonable terms.
Brocade has 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 Brocade in the future, and it is
possible that past or future assertions or prosecutions could harm Brocade's
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 Brocade's products, or require
Brocade 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 Brocade, or at all. For these reasons,
infringement claims could materially harm Brocade's business.
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BACKLOG
Brocade's order backlog at October 28, 2000 was approximately $110 million.
Sales of Brocade 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 fast
delivery schedules. In addition, actual shipments depend on the manufacturing
capacity of suppliers and the availability of products from such suppliers. As a
result of the foregoing factors, Brocade does not believe that backlog at any
given time is a meaningful indicator of future sales.
EMPLOYEES
As of October 28, 2000, Brocade had 606 employees. No employees are
represented by a labor union. Brocade has not experienced any work stoppages and
considers its relations with employees to be good. Employees are currently
located in Brocade's U.S. headquarters in San Jose, California; its European
headquarters in Geneva, Switzerland; and offices throughout North America, the
United Kingdom, Germany, France, Spain, Canada, Japan, Singapore, and Australia.
Competition for technical personnel in the computing industry continues to be
significant. Brocade believes that its success depends in part on its ability to
hire, assimilate, and retain qualified personnel. There is no assurance that
Brocade will continue to be successful at hiring, assimilating, and retaining
employees in the future.
CERTAIN FINANCIAL INFORMATION
Financial information relating to foreign and domestic sales and operations
for the three years ended October 28, 2000, and October 31, 1999 and 1998, is
set forth in Note 8, "Segment Information," of the Notes to Financial Statements
attached hereto. Financial information relating to revenues, income and total
assets for the three years ended October 28, 2000, October 31, 1999 and 1998,
can be found under "Selected Financial Data" and also in Brocade's Financial
Statements attached hereto.
RISK FACTORS
Set forth below and elsewhere in this Annual Report and in other documents
Brocade files with the SEC are risks and uncertainties that could cause actual
results to differ materially from the results contemplated by the
forward-looking statements contained in this Annual Report.
Failure to Manage Expansion Effectively Could Seriously Harm Brocade's
Business, Financial Condition and Prospects
Brocade's ability to successfully implement its business plan, develop and
offer products, and manage expansion in a rapidly evolving market requires a
comprehensive and effective planning and management process. Brocade continues
to increase the scope of its operations domestically and internationally, and
has grown headcount substantially. In addition, Brocade plans to continue to
hire a significant number of employees in the foreseeable future. The growth in
business, headcount, and relationships with customers and other third parties
has placed, and will continue to place, a significant strain on management
systems and resources. Brocade's failure to continue to improve upon its
operational, managerial, and financial controls, reporting systems, and
procedures, and/or Brocade's failure to continue to expand, train, and manage
its work force worldwide, could have a material adverse affect on its business
and financial results.
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Brocade's Quarterly Revenues and Operating Results May Fluctuate in Future
Periods for a Number of Reasons Which Could Adversely Affect the Trading Price
of Its Stock
Brocade's quarterly revenues and operating results may vary significantly
in the future due to a number of factors, any of which may cause its stock price
to fluctuate. The primary factors that may impact the predictability of
quarterly results include the following:
- the timing of customer orders and product implementations, particularly
large orders from and product implementations of our OEM customers;
- changes in general economic conditions and specific economic conditions
in the computer, storage, and networking industries, such as a change in
current business spending levels for information technology products;
- announcements and new product introductions by competitors;
- deferrals of customer orders in anticipation of new products, services or
product enhancements introduced by Brocade or its competitors;
- Brocade's ability to obtain sufficient supplies of sole or limited
sourced components, including ASICs, GBICs, and power supplies;
- increases in prices of components used in the manufacture of Brocade's
products;
- Brocade's ability to attain and maintain production volumes and quality
levels;
- variations in the mix of Brocade's switches sold and the mix of
distribution channels through which they are sold;
Accordingly, the results of any prior periods should not be relied upon as
an indication of future performance. It is likely that in some future period,
Brocade's operating results may be below expectations of public market analysts
or investors. If this occurs, Brocade's stock price may drop.
Brocade's Success Depends on Its Ability to Develop New and Enhanced Products
that Achieve Widespread Market Acceptance
Brocade currently derives substantially all of its revenues from sales of
its SilkWorm family of products. Brocade expects that revenue from this product
family will continue to account for a substantial portion of revenues for the
foreseeable future. Therefore, widespread market acceptance of these products is
critical to Brocade's future success. Some of its products have been only
recently introduced and therefore, the demand and market acceptance of these
products is uncertain. Factors that may affect the market acceptance of
Brocade's products include the performance, price and total cost of ownership of
those products, the availability and price of competing products and
technologies, and the success and development of Brocade's OEMs and system
integrators. Many of these factors are beyond Brocade's control.
Brocade's future success depends upon its ability to address the rapidly
changing needs of its 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.
Brocade expects to launch new products and upgrades to its existing products
during fiscal 2001, including a 64-port and 128-port Fibre Channel core fabric
switch, and 2 Gigabit per second speed support across the SilkWorm product
family. Brocade's future revenue growth will be dependent on the success of
these new products. Brocade has in the past experienced delays in product
development and such delays may occur in the future. In addition, as new or
enhanced products are introduced, Brocade will have to successfully manage the
transition from older products in order to minimize disruption in customers'
ordering patterns, avoid excessive levels of older product inventories, and
ensure that enough supplies of new products can be delivered to meet customers'
demands. Brocade's failure to develop and successfully introduce new products
and product enhancements could adversely affect its business and financial
results.
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Failure to Adequately Anticipate Future End-User Product Needs and Failure to
Forecast End-User Demand Could Negatively Impact the Demand for Brocade's
Products and Reduce Its Revenues
Brocade sells and markets its products through OEM partners, system
integrators, resellers, and service providers. As a result, Brocade's direct
contact with the end-users of its products is often limited. Although Brocade
makes every effort to communicate with, understand, and anticipate the current
and future needs of the end-users of its products, to a large extent Brocade
relies on its OEM partners, system integrators, resellers, and service providers
for visibility into those end-user requirements. Brocade's failure to adequately
assess and anticipate future end-user needs could negatively impact the demand
for its products and reduce its revenues.
Similarly, Brocade has limited ability to forecast the demand for its
products. In preparing sales and demand forecasts, Brocade largely relies on
input from its OEM partners, system integrators, resellers, and service
providers. If Brocade fails to effectively communicate with its customers about
end-user demand or other time sensitive information, sales and demand forecasts
may not reflect the most accurate, up-to-date information. Because Brocade makes
certain business decisions based on its sales and demand forecasts, should these
forecasts not materialize, Brocade's business and financial results could be
negatively impacted.
Brocade Plans to Increase Its International Sales Activities Significantly,
Which Will Subject It to Additional Business Risks
Brocade plans to expand its international sales activities significantly.
Expansion of international operations will involve inherent risks that Brocade
may not be able to control, including:
- supporting multiple languages;
- recruiting sales and technical support personnel with the skills to
support Brocade's 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 Brocade's international revenues and costs has been
denominated in foreign currencies. As a result, an increase in the value of the
U.S. dollar relative to foreign currencies could make Brocade's products more
expensive and thus less competitive in foreign markets. A portion of Brocade's
international revenues may be denominated in foreign currencies in the future,
including the Euro, which will subject Brocade to risks associated with
fluctuations in those foreign currencies. Additionally, Brocade receives
significant tax benefits from sales to its international customers. These
benefits are contingent upon existing tax regulations in both the United States
and in the respective countries in which Brocade's international customers are
located. Future changes in domestic or international tax regulations could
affect the continued realizability of the tax benefits Brocade is currently
receiving and expects to receive from sales to its international customers.
Brocade Depends on OEM Customers and the Loss of Any of Them Could
Significantly Reduce Revenues
Although Brocade's customer base has increased substantially, Brocade still
depends on large, recurring purchases from certain OEM customers. Brocade's
agreements with its OEM customers are typically cancelable, non-exclusive, and
have no minimum purchase requirements. For the year ended October 28,
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2000, sales to two such customers accounted for a combined total of 49 percent
of Brocade's total revenues. Brocade anticipates that its revenues and operating
results will continue to depend on sales to a relatively small number of
customers. Therefore, the loss of any of these customers, or a significant
reduction in sales to these customers, could significantly reduce Brocade's
revenues.
Failure to Expand Distribution Channels and Manage Distribution Relationships
Could Significantly Reduce Brocade's Revenues
Brocade's success will depend on its continuing ability to develop and
manage relationships with significant OEMs, system integrators and resellers, as
well as on the sales efforts and success of these customers. Brocade's OEM
customers may evaluate its 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, marketing, and management efforts on the part of
Brocade, particularly if Brocade's products are being qualified with multiple
customers at the same time. In addition, once Brocade's products have been
qualified, Brocade's customer agreements have no minimum purchase commitments.
Brocade cannot provide assurance that it will be able to maintain or expand its
distribution channels, manage distribution relationships successfully or that
its customers will market its products effectively. Brocade's failure to manage
successfully its distribution relationships or the failure of its customers to
sell its products would reduce Brocade's revenues.
The Loss of Solectron Corporation, Brocade's Sole Manufacturer, or the Failure
to Forecast Accurately Demand for Brocade's Products or Manage Successfully
Brocade's Relationship With Solectron, Would Negatively Impact Brocade's
Ability to Manufacture and Sell Its Products
Brocade depends on Solectron, a third party manufacturer for numerous
companies, to manufacture all of its products at Solectron's Milpitas,
California facilities. If Brocade should fail to effectively manage its
relationship with Solectron, or if Solectron experiences delays, disruptions,
capacity constraints or quality control problems in its manufacturing
operations, Brocade's ability to ship products to its customers could be delayed
and its competitive position and reputation could be harmed. Qualifying a new
contract manufacturer and commencing volume production is expensive and time
consuming. If Brocade is required or chooses to change contract manufacturers,
it may lose revenue and damage its customer relationships.
Brocade has entered into a manufacturing agreement with Solectron under
which Brocade provides to Solectron a twelve-month product forecast and places
purchase orders with Solectron sixty calendar days in advance of the scheduled
delivery of products to Brocade customers. Although Brocade purchase orders
placed with Solectron are cancelable, the terms of the agreement would require
Brocade to purchase from Solectron all material inventory not returnable or
usable by other Solectron customers. Accordingly, if Brocade inaccurately
forecasts demand for its products, Brocade may be unable to obtain adequate
manufacturing capacity from Solectron to meet customers' delivery requirements
or Brocade may accumulate excess inventories.
Recently, California has been experiencing a shortage of electric power
supply that has resulted in intermittent loss of power in the form of rolling
blackouts. While Solectron has not experienced any power failures to date that
have prevented their ability to manufacture Brocade's products, the continuance
of blackouts may affect Solectron's ability to manufacture Brocade's products
and meet scheduled delivery needs.
Brocade Is Dependent on Sole Source and Limited Source Suppliers for Certain
Key Components Including ASICs and Power Supplies
With the current demand for electronic products, component shortages are
possible and the predictability of the availability of such components is
limited. Brocade currently purchases several key components from single or
limited sources. Brocade purchases ASICs and chassis from a single source, and
printed circuit boards, power supplies and GBICs from limited sources. In
addition, Brocade licenses certain software that is incorporated into the
Brocade Fabric Operating System from Wind River Systems, Inc. If Brocade is
unable
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to buy these components on a timely basis, it will not be able to deliver
product to customers in a timely manner. Brocade uses a rolling six-month
forecast based on anticipated product orders to determine component
requirements. If component requirements are overestimated, Brocade may have
excess inventory, which would increase costs. If component requirements are
underestimated, Brocade may have inadequate inventory, which could interrupt the
manufacturing process. In addition, lead times for materials and components vary
significantly and depend on factors such as the specific supplier, contract
terms, and demand for a component at a given time. Brocade also may experience
shortages of certain components from time to time, which also could delay
manufacturing.
Increased Market Competition May Lead to Reduced Sales of Brocade's Products,
Reduced Profits and Reduced Market Share
The markets for Brocade's 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 Brocade products to achieve or maintain market
acceptance. Brocade products face competition from multiple sources and we may
not be able to compete successfully against current and future competitors.
Furthermore, as the SAN market evolves, non-Fibre Channel based products may
become available to interconnect servers and storage. To the extent that these
products provide the ability to network servers and storage and support
high-performance, block-data storage applications, they may compete with current
and future Brocade products. These products may include, but are not limited to,
non-Fibre Channel based emerging products based on Gigabit Ethernet, 10-Gigabit
Ethernet, and Infiniband.
The Prices of Brocade's Products May Decline Which Would Reduce Revenues and
Gross Margins
To date Brocade has not experienced material reductions in its average unit
selling prices, except for planned price reductions relating to the
introductions of new product. The average unit prices of Brocade's products may
decrease in the future in response to changes in product mix, competitive
pricing pressures, increased sales discounts, new product introductions by
Brocade or Brocade's competitors, or other factors. If Brocade is unable to
offset these factors by increasing sales volumes, revenues will decline. In
addition, to maintain its gross margins, Brocade must develop and introduce new
products and product enhancements, and must continue to reduce the manufacturing
cost of its products.
Undetected Software or Hardware Errors Could Increase Brocade's Costs and
Reduce Revenues
Networking products frequently contain undetected software or hardware
errors when first introduced or as new versions are released. Brocade products
are complex and errors may be found from time to time in its new or enhanced
products. In addition, Brocade's 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 Brocade to incur significant
warranty and repair costs, divert the attention of engineering personnel from
Brocade product development efforts and cause significant customer relations
problems. Moreover, the occurrence of hardware and software errors, whether
caused by Brocade or another vendor's SAN products, could delay or prevent the
development of the SAN market.
Brocade May Not be Able to Maintain Profitability
Although Brocade has been profitable since the third quarter of fiscal
1999, Brocade cannot be certain that it will be able to maintain profitability
in the future. Brocade expects to incur significant costs and expenses for
product development, sales and marketing, customer support, facilities
expansion, and expansion of our corporate infrastructure. Brocade makes such
investment decisions based upon anticipated revenues and margins. Failure of
these anticipated revenues and margins to materialize could impact Brocade's
ability to remain profitable. As a result, Brocade will need to grow its
revenues and realize expected margins to maintain profitability.
In addition, Brocade has a limited operating history. Therefore, it is
difficult to forecast future operating results based on historical results.
Brocade plans its operating expenses based in part on future revenue
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projections. Brocade's ability to accurately forecast quarterly revenue is
limited for the reasons discussed above in "Brocade's Quarterly Revenues and
Operating Results May Fluctuate in Future Periods for a Number of Reasons Which
Could Adversely Affect the Trading Price of Its Stock." Moreover, most of
Brocade's expenses are fixed in the short-term or incurred in advance of receipt
of corresponding revenue. As a result, Brocade may not be able to decrease its
spending to offset any unexpected shortfall in revenues. If this were to occur,
Brocade could incur losses and its operating results would be below its
expectations and those of investors and market analysts.
If Brocade Loses Key Personnel or is Unable to Hire Additional Qualified
Personnel, Brocade May Not Continue to Be Successful
Brocade's success depends to a significant degree upon the continued
contributions of key management, engineering, and sales and marketing personnel,
many of whom would be difficult to replace. Brocade does not have employment
contracts with, or key person life insurance on, any of its key personnel.
Brocade also believes that its success depends to a significant extent on the
ability of management to operate effectively, both individually and as a group.
Brocade believes its future success will also depend in large part upon its
ability to attract and retain highly skilled managerial, engineering, sales and
marketing, finance, and operations personnel. Competition for these personnel is
intense, especially in the San Francisco Bay Area. In particular, Brocade has
experienced difficulty in hiring qualified ASIC, software, system and test, and
customer support engineers and there can be no assurance that future efforts
will be successful in attracting and retaining these individuals. The loss of
the services of any of Brocade's 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 Brocade's ability to sell
its products. In addition, companies in Brocade's industry whose employees
accept positions with competitors frequently claim that their competitors have
engaged in unfair hiring practices. Brocade cannot provide assurance that such
claims will not be received in the future as Brocade seeks to hire qualified
personnel, or that such claims will not result in material litigation. Brocade
could incur substantial costs in defending against these claims, regardless of
their merits.
Brocade May be Unable to Protect Its Intellectual Property Which Would
Negatively Affect Its Ability to Compete
Brocade relies on a combination of patent, copyright, trademark, and trade
secret laws and restrictions on disclosure to protect its intellectual property
rights. Brocade also enters into confidentiality or license agreements with its
employees, consultants, and corporate partners, and controls access to and
distribution of its software, documentation, and other proprietary information.
Despite Brocade's efforts to protect its proprietary rights, unauthorized
parties may attempt to copy or otherwise obtain and use Brocade products or
technology. Monitoring unauthorized use of Brocade's products is difficult and
Brocade cannot be certain that the steps it takes to prevent unauthorized use of
its technology, particularly in foreign countries where the laws may not protect
proprietary rights as fully as in the United States, will be effective.
Others May Bring Infringement Claims Against Brocade 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. Brocade has previously
been the subject of a lawsuit alleging infringement of intellectual property
rights. Although this dispute was resolved and the lawsuit dismissed, and
Brocade is not currently involved in any other intellectual property litigation,
Brocade may be a party to litigation in the future to protect its intellectual
property or as a result of an alleged infringement of others' intellectual
property. These claims and any resulting lawsuit could subject Brocade to
significant liability for damages and invalidation of proprietary rights. These
lawsuits, regardless of their success, would likely be time-consuming
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and expensive to resolve and would divert management time and attention. Any
potential intellectual property litigation also could force Brocade to do one or
more of the following:
- stop selling, incorporating or using products or services that use the
challenged intellectual property;
- obtain from the owner of the infringed intellectual property 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 Brocade is forced to take any of the foregoing actions, Brocade may be
unable to manufacture, use, sell, import and/or export its products, which would
reduce revenues.
Brocade May Engage in Future Acquisitions That Dilute Its Stockholders and
Cause Brocade to Incur Debt or Assume Contingent Liabilities
As part of its strategy, Brocade expects to review opportunities to buy
other businesses or technologies that would complement its current products,
expand the breadth of its markets or enhance its technical capabilities, or that
may otherwise offer growth opportunities. While Brocade has no current
agreements or negotiations underway, Brocade may buy businesses, products or
technologies in the future. In the event of any future purchases, Brocade could:
- issue stock that would dilute Brocade's 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 Brocade's core business;
- adverse effects on existing business relationships with suppliers and
customers;
- risks associated with entering markets in which Brocade has no or limited
prior experience; and
- potential loss of key employees of acquired organizations.
Brocade cannot provide assurance that it will be able to successfully
integrate any businesses, products, technologies or personnel that it might
acquire in the future.
Brocade's Products Must Comply With Evolving Industry Standards and Government
Regulations
Industry standards for SAN products are continuing to emerge, evolve, and
achieve acceptance. To remain competitive, Brocade 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. Brocade's products comprise only a part of the entire SAN and Brocade
depends on the companies that provide other components of the SAN, many of whom
are significantly larger than Brocade, 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 Brocade's products. In addition, in
the United States, Brocade's products must comply with various regulations and
standards defined by the Federal Communications Commission and Underwriters
Laboratories. Internationally, products that Brocade develops 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 Brocade's business.
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Provisions in Brocade's Charter Documents, Customer Agreements and Delaware
Law Could Prevent or Delay a Change in Control of Brocade and May Reduce the
Market Price of Brocade's Common Stock
Provisions of Brocade's certificate of incorporation and bylaws may
discourage, delay or prevent a merger or acquisition that a stockholder may
consider favorable. These provisions include:
- authorizing the issuance of preferred stock without stockholder approval;
- providing for a classified board of directors with staggered, three-year
terms;
- prohibiting cumulative voting in the election of directors;
- requiring super-majority voting to effect certain amendments to Brocade's
certificate of incorporation and bylaws;
- limiting the persons who may call special meetings of stockholders; and
- prohibiting stockholder actions by written consent.
Certain provisions of Delaware law also may discourage, delay or prevent
someone from acquiring or merging with Brocade. Further, Brocade's agreements
with certain of its customers require Brocade to give prior notice of a change
of control of Brocade and grant certain manufacturing rights following the
change of control.
Brocade Expects to Experience Volatility in Its Stock Price Which Could
Negatively Affect Your Investment
The market price of Brocade's common stock may fluctuate significantly in
response to the following factors, some of which are beyond Brocade's control:
- actual or anticipated fluctuations in Brocade's operating results;
- changes in financial estimates by securities analysts;
- changes in market valuations of other technology companies;
- announcements by Brocade or Brocade's competitors of significant
technical innovations, contracts, acquisitions, strategic partnerships,
joint ventures or capital commitments;
- losses of major OEM customers;
- additions or departures of key personnel; and
- sales of common stock in the future.
In addition, the stock market has experienced extreme volatility that often
has been unrelated to the performance of particular companies. These market
fluctuations may cause Brocade's stock price to fall regardless of performance.
Brocade's Business May be Harmed by Class Action Litigation Due to Stock Price
Volatility
In the past, securities class action litigation often has been brought
against a company following periods of volatility in the market price of its
securities. Brocade may in the future be the target of similar litigation.
Securities litigation could result in substantial costs and divert management's
attention and resources.
ITEM 2. PROPERTIES
Brocade's principal administrative, sales and marketing, education,
customer support, and research and development facilities are located in
approximately 495,000 square feet of leased office space in San Jose,
California. Of this amount, approximately 300,000 square feet is currently
occupied by Brocade. The remaining 195,000 square feet of office space is
currently under construction and Brocade intends to occupy this additional space
in December 2001. The leases on these facilities will expire beginning August
2010. In addition to the San Jose facility, Brocade also leases sales and
marketing offices in various locations
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throughout the world. Brocade believes that its existing facilities are adequate
for its present needs. However, should Brocade require additional space, Brocade
believes that it will be able to secure such space on commercially reasonable
terms without undue operational disruption.
ITEM 3. LEGAL PROCEEDINGS
Brocade is subject to various legal proceedings, claims, and litigation
that arise in the normal course of business. While the outcome of these matters
is currently not determinable, management does not expect these matters will
have a material adverse effect on the financial position, results of operations
or cash flows of Brocade.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of fiscal 2000.
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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 its initial public offering on May 24, 1999. Prior to
this time, there was no public market for the stock. See "Item 6. Selected
Financial Data" for the high and low closing sales prices per share of Brocade's
common stock as reported on the Nasdaq National Market, for the periods
indicated.
Brocade currently expects to retain future earnings, if any, for use in the
operation and expansion of its business and does not anticipate paying any cash
dividends in the foreseeable future. According to records of Brocade's transfer
agent, at October 28, 2000, there were approximately 480 stockholders of record
of Brocade's common stock.
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ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data should be read in conjunction with
Brocade's 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 28, 2000, the balance sheet data as of October 28, 2000, and
October 31, 1999, are derived from, and qualified by reference to, the audited
financial statements appearing elsewhere in this Annual Report. The statement of
operations data for the years ended October 31, 1997 and 1996, and the balance
sheet data as of October 31, 1998, 1997 and 1996, are derived from audited
financial statements not included herein. All references to earnings per share
and the number of common shares have been retroactively restated to reflect
three two-for-one stock splits, effected on December 3, 1999, March 15, 2000,
and December 22, 2000.
Note: Brocade changed its fiscal year end to the last Saturday in October,
beginning with the fiscal year ended October 28, 2000. This change did not have
a material impact on Brocade's financial statements.
FISCAL YEAR ENDED
-------------------------------------------------------------------
OCTOBER 28, OCTOBER 31, OCTOBER 31, OCTOBER 31, OCTOBER 31,
2000 1999 1998 1997 1996
----------- ----------- ----------- ----------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF OPERATIONS DATA:
Net revenues $329,045 $ 68,692 $ 24,246 $ 8,482 $ --
Cost of revenues 137,456 33,497 15,759 6,682 --
-------- -------- -------- -------- -------
Gross margin 191,589 35,195 8,487 1,800 --
-------- -------- -------- -------- -------
Operating expenses:
Research and development 50,505 15,267 14,744 7,666 3,091
Sales and marketing 46,524 13,288 5,154 2,112 152
General and administrative 10,506 3,849 3,813 1,464 575
Amortization of deferred compensation 1,120 1,937 7 -- --
-------- -------- -------- -------- -------
Total operating expenses 108,655 34,341 23,718 11,242 3,818
-------- -------- -------- -------- -------
Income (loss) from operations 82,934 854 (15,231) (9,442) (3,818)
Interest income (expense), net 5,382 1,737 120 (177) (116)
-------- -------- -------- -------- -------
Income (loss) before provision for income
taxes 88,316 2,591 (15,111) (9,619) (3,934)
Provision for income taxes 20,385 106 -- -- --
-------- -------- -------- -------- -------
Net income (loss) $ 67,931 $ 2,485 $(15,111) $ (9,619) $(3,934)
======== ======== ======== ======== =======
Net income (loss) per share -- Basic $ 0.33 $ 0.02 $ (0.56) $ (0.60) $ (1.19)
======== ======== ======== ======== =======
Net income (loss) per share -- Diluted $ 0.28 $ 0.01 $ (0.56) $ (0.60) $ (1.19)
======== ======== ======== ======== =======
Shares used in per share
calculation -- Basic 207,454 104,376 27,200 15,976 3,312
======== ======== ======== ======== =======
Shares used in per share calculation --
Diluted 242,504 204,584 27,200 15,976 3,312
======== ======== ======== ======== =======
BALANCE SHEET DATA:
Cash, cash equivalents and short-term
investments $155,039 $ 89,305 $ 10,420 $ 18,472 $ 700
Working capital 219,053 79,253 5,276 15,334 104
Total assets 455,179 117,280 21,301 26,100 2,605
Long-term portion of debt and capital
lease obligations -- -- 2,209 1,954 874
Redeemable convertible preferred stock -- -- 35,261 30,359 4,613
Total stockholders' equity (deficit) 390,877 84,206 (27,355) (13,458) (3,957)
18
21
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
---------- ---------- ---------- -----------
(IN THOUSANDS, EXCEPT PER SHARE AND STOCK PRICE DATA)
QUARTERLY DATA:
FISCAL YEAR ENDED OCTOBER 28, 2000
Net revenues $42,740 $62,053 $92,138 $132,114
Gross margin 22,656 36,000 53,979 78,954
Income from operations 8,065 15,663 24,044 35,162
Net income $ 7,308 $13,316 $20,077 $ 27,230
Per share amounts:
Basic $ 0.04 $ 0.06 $ 0.10 $ 0.13
Diluted $ 0.03 $ 0.06 $ 0.08 $ 0.11
Shares used in computing per share amounts:
Basic 202,080 205,982 209,208 212,546
Diluted 235,536 241,860 244,424 248,194
Stock prices:
High $ 44.25 $ 89.66 $104.84 $ 133.31
Low $ 30.25 $ 40.50 $ 47.50 $ 81.97
FISCAL 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 $ (0.05) $ (0.02) $ 0.01 $ 0.02
Diluted $ (0.05) $ (0.02) $ 0.01 $ 0.02
Shares used in computing per share amounts:
Basic 34,792 41,320 142,688 198,688
Diluted 34,792 41,320 220,056 233,128
Stock prices:
High N/A N/A $ 16.13 $ 35.63
Low N/A N/A $ 5.66 $ 12.27
19
22
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Note: Brocade changed its fiscal year end to the last Saturday in October,
beginning with the fiscal year ended October 28, 2000. This change did not have
a material impact on Brocade's financial statements.
RESULTS OF OPERATIONS
The following table sets forth certain financial data for the periods
indicated as a percentage of total net revenues:
FISCAL YEAR ENDED
-----------------------------------------
OCTOBER 28, OCTOBER 31, OCTOBER 31,
2000 1999 1998
----------- ----------- -----------
Net revenues 100.0% 100.0% 100.0%
Cost of revenues 41.8 48.8 65.0
----- ----- -----
Gross margin 58.2 51.2 35.0
----- ----- -----
Operating expenses:
Research and development 15.4 22.2 60.8
Sales and marketing 14.1 19.4 21.3
General and administrative 3.2 5.6 15.7
Amortization of deferred compensation 0.3 2.8 *
----- ----- -----
Total operating expenses 33.0 50.0 97.8
----- ----- -----
Income (loss) from operations 25.2 1.2 (62.8)
Interest income, net 1.6 2.5 0.5
----- ----- -----
Income (loss) before provision for income taxes 26.8 3.7 (62.3)
Provision for income taxes 6.2 0.1 --
----- ----- -----
Net income (loss) 20.6% 3.6% (62.3)%
===== ===== =====
- ---------------
* Not meaningful
Revenues. Brocade's revenues are derived primarily from sales of its
SilkWorm family of products. For the year ended October 28, 2000, net revenues
increased to $329.0 million, an increase of 379 percent compared with fiscal
1999 revenues of $68.7 million. Fiscal 1999 net revenues represented a 183
percent increase over fiscal 1998 net revenues of $24.2 million. The increases
in net revenues reflect growing demand for SAN switching products and are the
result of increased unit sales to an expanding customer base along with
increased sales to several significant OEMs and system integrator customers. The
increase in net revenues from fiscal 1999 to fiscal 2000 was primarily due to
increased sales of our SilkWorm 2000 family of products introduced in June 1999.
The increase in net revenues from fiscal 1998 to fiscal 1999 was primarily due
to increased sales of Brocade's SilkWorm 1000 family of products introduced in
March 1997.
During the first quarter of fiscal 2000 Brocade began shipping a second
generation of its SilkWorm family of products. Brocade priced these second
generation products approximately 15 percent to 20 percent below the prices of
its first generation products. Except for the planned price reduction noted
above, Brocade has not experienced any material price erosion. The prices of
Brocade's products could decline in future periods for any number of reasons
including competitive pricing pressures, increased sales discounts, new product
introductions by Brocade or Brocade's competitors, or other factors. A future
reduction in the prices of Brocade's products could have a material impact on
Brocade's results of operations and financial position.
Domestic and international revenues accounted for approximately 78 percent
and 22 percent of total revenues, respectively, for the year ended October 28,
2000. International revenues primarily consisted of sales to countries in
Western Europe and Asia. Domestic revenues include sales to certain OEM
customers who then distribute to their international customers. For the years
ended October 31, 1999 and 1998, substantially all revenues were domestic.
20
23
A significant portion of Brocade's revenues is concentrated among a
relatively small number of customers. In fiscal 2000 two customers accounted for
a combined total of 49 percent of total revenues. In fiscal years 1999 and 1998,
three and two customers accounted for combined totals of 70 percent and 83
percent of total revenues, respectively. The level of sales to any single
customer may vary and the loss of any one of these customers, or a decrease in
the level of sales to any one of these customers, could have a material adverse
impact on Brocade's financial condition and results of operations. Brocade
expects that a significant portion of its future revenues will continue to come
from sales of products to a relatively small number of customers.
Product revenue is generally recognized when persuasive evidence of an
arrangement exists, delivery has occurred, fee is fixed or determinable, and
collectibility is probable. Brocade's only post-sales obligations are limited to
product warranties. Revenue recognition is deferred for shipments to new
customers where significant support services are required to successfully launch
the customer's product. These revenues are recognized when the customer has
successfully integrated and launched its products and Brocade has met its
support obligations. Warranty costs, sales returns, and other allowances are
accrued based on experience at the time of shipment. Deferred revenues at
October 28, 2000, and October 31, 1999, were approximately $2.1 million and $7.7
million, respectively. Brocade expects deferred revenue at October 28, 2000,
will be recognized as revenue in the first and second quarters of fiscal 2001.
Gross margin. Gross margin increased to 58.2 percent of net revenues in
fiscal 2000, compared with 51.2 percent in fiscal 1999, and 35.0 percent in
fiscal 1998. The increases were primarily due to lower component and
manufacturing costs, the allocation of fixed manufacturing costs over a greater
revenue base, and an increase in the percentage of sales to higher margin
customers. Fiscal 1998 gross margin was adversely affected by the write-off of
obsolete inventory and certain other inventory and equipment related to a change
in contract manufacturers. Brocade expects fiscal 2001 margins to be relatively
consistent with fiscal 2000 margins.
Research and development expenses. Research and development expenses
increased to $50.5 million in fiscal 2000. In fiscal 1999 and 1998, research and
development expenses were $15.3 million and $14.7 million, respectively. These
expenses consist primarily of salaries and related personnel expenses, fees paid
to consultants and outside service providers, nonrecurring engineering charges,
prototyping expenses related to the design, development, testing and
enhancements of Brocade's products, and IT and facilities costs. The increased
expenses reflect Brocade's belief that continued investment in research and
development is a critical factor in maintaining its competitive position. As
such, Brocade will continue to aggressively invest in the development of new
products and continue to enhance its existing products. Brocade currently
anticipates that research and development expenses will continue to increase in
absolute dollars, but will remain relatively constant as a percentage of total
revenues.
Sales and marketing expenses. Sales and marketing expenses increased to
$46.5 million in fiscal 2000. In fiscal years 1999 and 1998, sales and marketing
expenses were $13.3 million and $5.2 million, respectively. These expenses
consist primarily of salaries, commissions and related expenses for personnel
engaged in marketing and sales, costs associated with promotional and travel
expenses, and IT and facilities costs. The increases were primarily due to the
hiring of additional sales and marketing personnel and increased direct selling
expenses associated with increased revenues, principally commissions. Brocade
believes that continued investment in sales and marketing is critical to the
success of its strategy to expand relationships with leading OEMs, to expand its
presence in the system integration channel, and to maintaining its leadership
position in the SAN market. In addition, Brocade is currently expanding
international sales activities to various Europe, Middle East, Africa, and Asia
Pacific countries. As such, Brocade currently anticipates sales and marketing
expenses for fiscal 2001 will continue to increase in absolute dollars, but will
remain relatively constant as a percentage of total revenues.
General and administrative expenses. General and administrative expenses
increased to $10.5 million in fiscal 2000. General and administrative expenses
were $3.8 million in both fiscal years 1999 and 1998. These expenses consist
primarily of salaries and related expenses for executives, finance, human
resources, and investor relations, as well as recruiting expenses, professional
fees, other corporate expenses, and IT and
21
24
facilities costs. The increases were primarily due to additional headcount and
other expenses necessary to manage and support increased levels of business
activity. Brocade currently anticipates general and administrative expenses for
fiscal 2001 will continue to increase in absolute dollars, but will decrease
modestly as a percentage of total revenues.
Amortization of deferred compensation. During fiscal years 1999 and 1998,
Brocade recorded deferred compensation of $5.1 million and $307,000,
respectively, in connection with certain stock option grants. No deferred
compensation was recorded in fiscal 2000. Deferred compensation is amortized
over the vesting periods of the applicable options and resulted in amortization
expense of $1.1 million, $1.9 million, and $7,000 in fiscal years 2000, 1999,
and 1998, respectively. At October 28, 2000, unamortized deferred stock
compensation was approximately $2.3 million.
Interest income, net. Net interest income increased to $5.4 million in
fiscal 2000. In fiscal years 1999 and 1998, net interest income was $1.7 million
and $120,000, respectively. The increases were primarily the result of
additional investment income on increased investment balances resulting from the
proceeds of Brocade's initial public offering and cash generated from
operations.
Provision for income taxes. Brocade's effective tax rate for fiscal 2000
was 23.1 percent compared with 4.0 percent for fiscal 1999. As of October 28,
2000, Brocade had federal net operating loss carryforwards of approximately
$275.2 million and state net operating loss carryforwards of approximately $75.4
million available to offset future taxable income. Such net operating loss
carryforwards expire at various dates beginning in fiscal 2003. Brocade
currently expects an effective tax rate of approximately 32 percent for fiscal
2001.
LIQUIDITY AND CAPITAL RESOURCES
Cash, cash equivalents, and short-term investments were $155.0 million at
October 28, 2000, an increase of $65.7 million over the prior year amount of
$89.3 million. The increase was primarily the result of $113.9 million in cash
generated from operating and financing activities partially offset by $40.7
million invested in capital equipment and a net $7.8 million invested in
minority equity investments.
During fiscal 2000 Brocade generated $69.7 million in cash from operating
activities. Net cash generated from operations primarily resulted from net
income and increases in accounts payable and accrued employee compensation,
partially offset by an increase in accounts receivable. These increases resulted
from the significant increase in business activity experienced in fiscal 2000.
Days sales outstanding in receivables for the fourth quarter of fiscal 2000
decreased to 50 days compared with 52 days for the fourth quarter of fiscal
1999. Cash generated from operations also increased as a result of income tax
benefits related to employee stock option transactions. These benefits were
partially offset by an increase in deferred tax assets. At October 28, 2000,
Brocade had $130.3 million in deferred tax assets, which it believes will be
realizable through profitable operations in future periods.
Net cash used in investing activities totaled $112.2 million for the year
ended October 28, 2000. Net cash used in investing activities resulted primarily
from net purchases of short-term investments of $63.7 million, $40.7 million
invested in capital equipment, and a net $7.8 million invested in minority
equity investments.
Net cash provided by financing activities totaled $44.3 million for the
year ended October 28, 2000. Net cash provided by financing activities resulted
mainly from $39.0 million in proceeds from the issuance of common stock related
to participation in employee stock plans and $5.7 million in payments received
from loans to stockholders.
Brocade has entered into a manufacturing agreement with Solectron
Corporation under which Brocade provides to Solectron a twelve-month product
forecast and places purchase orders with Solectron sixty calendar days in
advance of the scheduled delivery of products to Brocade customers. Although
Brocade purchase orders placed with Solectron are cancelable, the terms of the
agreement would require Brocade to purchase from Solectron all material
inventory not returnable or usable by other Solectron customers. At October 28,
2000, Brocade's commitment to Solectron for such material inventory was
approximately $22.2 million, which Brocade expects to utilize during future
normal ongoing operations.
22
25
Brocade purchases several key components used in the manufacture of its
products. At October 28, 2000, Brocade had non-cancelable purchase commitments
for various such components totaling approximately $16.4 million, which Brocade
expects to utilize during future normal ongoing operations.
During fiscal 2000, Brocade entered into various agreements to lease its
headquarters facilities in San Jose, California. In connection with these lease
agreements, and subsequent amendments, Brocade has signed unconditional,
irrevocable letters of credit for $8.3 million as security for the leases (see
Note 4 to the Financial Statements).
In December 2000, Brocade entered into an agreement to lease approximately
195,000 additional square feet of office, laboratory, and administrative space
in San Jose, California. The lease expires November 30, 2013, and represents a
commitment of approximately $11.6 million per year to Brocade. Brocade intends
to occupy the space in December 2001 and sub-lease any excess space, if
possible, to offset the rental expense. In connection with this lease agreement,
Brocade signed an unconditional, irrevocable letter of credit for $10.4 million
as security for the lease.
Brocade believes that its existing cash, cash equivalents, short-term
investments, and cash expected to be generated from future operations will be
sufficient to meet capital requirements at least through the next 12 months,
although Brocade could be required, or could elect, to seek additional funding
prior to that time. Brocade's future capital requirements will depend on many
factors, including the rate of revenue growth, the timing and extent of spending
to support product development efforts and the expansion of sales and marketing,
the timing of introductions of new products and enhancements to existing
products, and market acceptance of its products. There can be no assurances that
additional equity or debt financing, if required, will be available on
acceptable terms or at all.
RECENT ACCOUNTING PRONOUNCEMENTS
In March 2000, the Financial Accounting Standards Board issued Financial
Accounting Standards Board Interpretation No. 44, "Accounting for Certain
Transactions Involving Stock Compensation -- an interpretation of APB Opinion
25," (Interpretation 44). Interpretation 44 was effective beginning in July 2000
and clarifies the application of APB Opinion 25 for certain matters,
specifically (a) the definition of an employee for purposes of applying APB
Opinion 25, (b) the criteria for determining whether a plan qualifies as a
noncompensatory plan, (c) the accounting consequence of various modifications to
the terms of a previously fixed stock option award, and (d) the accounting for
an exchange of stock compensation awards in a business combination. The adoption
of Interpretation 44 did not have a material impact on Brocade's financial
condition or results of operations.
In December 1999, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements," (SAB
101), which provides guidance on the recognition, presentation, and disclosure
of revenue in financial statements filed with the SEC. SAB 101 outlines the
basic criteria that must be met to recognize revenue and provides guidance for
disclosures related to revenue recognition policies. Management does not expect
the adoption of SAB 101 to have a material impact on Brocade's financial
position or results of operations.
In September 1999, the Financial Accounting Standards Board issued Emerging
Issues Task Force Topic No. D-83, "Accounting for Payroll Taxes Associated with
Stock Option Exercises" (EITF D-83). EITF D-83 requires that payroll taxes paid
on the difference between the exercise price and the fair value of stock
acquired in association with an employee's stock options be recorded as
operating expenses. For the year ended October 28, 2000, Brocade expensed $2.1
million in payroll taxes on stock option exercises.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and hedging Activities," (SFAS 133), 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.
23
26
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Brocade is exposed to market risk related to changes in interest rates and
equity security prices.
INTEREST RATE RISK
Brocade's exposure to market risk due to changes in the general level of
U.S. interest rates relates primarily to its cash equivalents and short-term
investments portfolio. The primary objective of Brocade's investment activities
is the preservation of principal while maximizing investment income and
minimizing risk. As such, short-term investments consist of U.S. Treasury and
Federal Agency debt securities with original maturity dates between three months
and one year. Due to the nature of its short-term investments, Brocade believes
that market risk due to changes in interest rates is not material.
The following table (in thousands) presents Brocade's cash equivalents and
short-term investments subject to interest rate risk and their related weighted
average interest rates at October 28, 2000. Carrying value approximates fair
value.
AVERAGE
AMOUNT INTEREST RATE
-------- -------------
Cash and cash equivalents $ 27,265 4.99%
Short-term investments 127,774 6.18%
--------
Total $155,039 5.97%
========
EQUITY SECURITY PRICE RISK
Brocade's exposure to market risk due to equity security price fluctuations
primarily relates to investments in marketable equity securities. These
investments are generally in companies in the volatile high-technology sector
and Brocade does not attempt to reduce or eliminate the market exposure on these
securities. A 20 percent adverse change in equity prices would result in a
decrease of approximately $9.9 million in the fair value of marketable equity
securities at October 28, 2000.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
BROCADE COMMUNICATIONS SYSTEMS, INC.
INDEX TO FINANCIAL STATEMENTS
PAGE
----
Report of Independent Public Accountants.................... 25
Statements of Operations.................................... 26
Balance Sheets.............................................. 27
Statements of Stockholders' Equity.......................... 28
Statements of Cash Flows.................................... 29
Notes to Financial Statements............................... 30
24
27
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders
of Brocade Communications Systems, Inc.:
We have audited the accompanying balance sheets of Brocade Communications
Systems, Inc. (a Delaware corporation) as of October 28, 2000 and October 31,
1999 and the related statements of operations, stockholders' equity and cash
flows for each of the three years ended October 28, 2000, and October 31, 1999
and 1998. These financial statements and the schedule referred to below are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Brocade Communications
Systems, Inc. as of October 28, 2000 and October 31, 1999 and the results of its
operations and its cash flows for each of the three years ended October 28,
2000, and October 31, 1999 and 1998, in conformity with generally accepted
accounting principles.
Our audit was made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedule listed in Item 14(a)(2) is
presented for purposes of complying with the Securities and Exchange Commissions
rules and are not part of the basic financial statements. This schedule has been
subjected to the auditing procedures applied in the audit of the basic financial
statements and, in our opinion, fairly states in all material respects the
financial data required to be set forth therein in relation to the basic
financial statements taken as a whole.
ARTHUR ANDERSEN LLP
San Jose, California
November 16, 2000
25
28
BROCADE COMMUNICATIONS SYSTEMS, INC.
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
FISCAL YEAR ENDED
-----------------------------------------
OCTOBER 28, OCTOBER 31, OCTOBER 31,
2000 1999 1998
----------- ----------- -----------
Net revenues $329,045 $ 68,692 $ 24,246
Cost of revenues 137,456 33,497 15,759
-------- -------- --------
Gross margin 191,589 35,195 8,487
-------- -------- --------
Operating expenses:
Research and development 50,505 15,267 14,744
Sales and marketing 46,524 13,288 5,154
General and administrative 10,506 3,849 3,813
Amortization of deferred compensation 1,120 1,937 7
-------- -------- --------
Total operating expenses 108,655 34,341 23,718
-------- -------- --------
Income (loss) from operations 82,934 854 (15,231)
Interest income, net 5,382 1,737 120
-------- -------- --------
Income (loss) before provision for income taxes 88,316 2,591 (15,111)
Provision for income taxes 20,385 106 --
-------- -------- --------
Net income (loss) $ 67,931 $ 2,485 $(15,111)
======== ======== ========
Net income (loss) per share -- Basic $ 0.33 $ 0.02 $ (0.56)
======== ======== ========
Net income (loss) per share -- Diluted $ 0.28 $ 0.01 $ (0.56)
======== ======== ========
Shares used in per share calculation -- Basic 207,454 104,376 27,200
======== ======== ========
Shares used in per share calculation -- Diluted 242,504 204,584 27,200
======== ======== ========
The accompanying notes are an integral part of these financial statements.
26
29
BROCADE COMMUNICATIONS SYSTEMS, INC.
BALANCE SHEETS
(IN THOUSANDS, EXCEPT PAR VALUE)
ASSETS
OCTOBER 28, OCTOBER 31,
2000 1999
----------- -----------
Current assets:
Cash and cash equivalents $ 27,265 $ 25,536
Short-term investments 127,774 63,769
-------- --------
Total cash, cash equivalents and short-term
investments 155,039 89,305
Marketable equity securities 49,251 --
Accounts receivable, net of allowances for doubtful
accounts of $2,970 and $2,447, respectively 72,242 17,139
Inventories, net 1,361 3,686
Prepaid expenses and other current assets 5,462 2,197
-------- --------
Total current assets 283,355 112,327
Property and equipment, net 38,769 4,947
Deferred tax assets 130,250 --
Other assets 2,805 6
-------- --------
Total assets $455,179 $117,280
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 23,958 $ 10,664
Accrued employee compensation 23,363 4,414
Deferred revenue 2,056 7,688
Other accrued liabilities 14,883 9,830
Current portion of capital lease obligations 42 478
-------- --------
Total current liabilities 64,302 33,074
Commitments and contingencies (Note 4)
Stockholders' equity:
Preferred stock, $0.001 par value 5,000 shares authorized,
no shares outstanding -- --
Common stock, $0.001 par value, 400,000 shares authorized:
Issued and outstanding: 222,559 and 214,080 shares at
October 28, 2000 and October 31, 1999, respectively 223 214
Additional paid-in capital 306,868 119,486
Deferred stock compensation (2,320) (3,440)
Notes receivable from stockholders -- (5,660)
Accumulated other comprehensive income (loss) 44,520 (49)
Accumulated earnings (deficit) 41,586 (26,345)
-------- --------
Total stockholders' equity 390,877 84,206
-------- --------
Total liabilities and stockholders' equity $455,179 $117,280
======== ========
The accompanying notes are an integral part of these financial statements.
27
30
BROCADE COMMUNICATIONS SYSTEMS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
REDEEMABLE CONVERTIBLE COMMON WARRANTS
PREFERRED STOCK STOCK ADDITIONAL FOR DEFERRED
---------------------------- ---------------- PAID-IN COMMON STOCK
SHARES AMOUNT WARRANTS SHARES AMOUNT CAPITAL STOCK COMPENSATION
------ -------- -------- ------- ------ ---------- -------- ------------
Balances at October 31, 1997 8,370 $ 30,359 $ 648 39,304 $ 39 $ 385 $ -- $ (88)
Exercise of options -- -- -- 1,608 2 53 -- --
Compensation charges -- -- -- -- -- 1,067 -- 88
Deferred compensation -- -- -- -- -- 307 -- (307)
Amortization of deferred
compensation -- -- -- -- -- -- -- 7
Issuance of Series D Redeemable
convertible preferred stock, net
of issuance costs of $98 865 4,902 -- -- -- -- -- --
Issuance of stock for notes
receivable from stockholders -- -- -- 1,800 2 373 -- --
Stock in exchange for services -- -- -- 144 -- 41 -- --
Repurchase of common stock -- -- -- (1,296) (1) (43) -- --
Net loss -- -- -- -- -- -- -- --
------ -------- ----- ------- ---- -------- ----- -------
Balances at October 31, 1998 9,235 35,261 648 41,560 42 2,183 -- (300)
Issuance of Series D Redeemable
convertible preferred Stock, net 299 2,322 (326) -- -- -- -- --
Conversion of Redeemable Convertible
preferred Stock to common stock (9,534) (37,583) (322) 117,000 117 37,466 322 --
Issuance of common stock -- -- -- 35,680 35 67,999 -- --
Issuance of stock for notes
receivable from stockholders -- -- -- 18,816 19 6,393 -- --
Repayments on notes receivable from
stockholders -- -- -- -- -- -- -- --
Exercise of warrants for common
stock -- -- -- 2,272 2 380 (322) --
Compensation charges -- -- -- -- -- 80 -- --
Deferred compensation -- -- -- -- -- 5,077 -- (5,077)
Amortization of deferred
compensation -- -- -- -- -- -- -- 1,937
Repurchase of common stock -- -- -- (1,248) (1) (92) -- --
Unrealized loss on marketable equity
securities -- -- -- -- -- -- -- --
Net income -- -- -- -- -- -- -- --
------ -------- ----- ------- ---- -------- ----- -------
Balances at October 31, 1999 -- -- -- 214,080 214 119,486 -- (3,440)
Issuance of common stock -- -- -- 8,479 9 39,026 -- --
Repayments on notes receivable from
stockholders -- -- -- -- -- -- -- --
Tax benefits of employee stock
transactions -- -- -- -- -- 148,356 -- --
Amortization of deferred
compensation -- -- -- -- -- -- -- 1,120
Unrealized gain on marketable equity
securities -- -- -- -- -- -- -- --
Net income -- -- -- -- -- -- -- --
------ -------- ----- ------- ---- -------- ----- -------
Balances at October 28, 2000 -- $ -- $ -- 222,559 $223 $306,868 $ -- $(2,320)
====== ======== ===== ======= ==== ======== ===== =======
ACCUMULATED
NOTES OTHER TOTAL
RECEIVABLE COMPREHENSIVE ACCUMULATED STOCKHOLDERS' COMPREHENSIVE
FROM INCOME EARNINGS EQUITY INCOME
STOCKHOLDERS (LOSS) (DEFICIT) (DEFICIT) (LOSS)
------------ ------------- ----------- ------------- -------------
Balances at October 31, 1997 $ (75) $ -- $(13,719) $(13,458) $ --
Exercise of options -- -- -- 55 --
Compensation charges -- -- -- 1,155 --
Deferred compensation -- -- -- -- --
Amortization of deferred
compensation -- -- -- 7 --
Issuance of Series D Redeemable
convertible preferred stock, net
of issuance costs of $98 -- -- -- -- --
Issuance of stock for notes
receivable from stockholders (375) -- -- -- --
Stock in exchange for services -- -- -- 41 --
Repurchase of common stock -- -- -- (44) --
Net loss -- -- (15,111) (15,111) (15,111)
------- ------- -------- -------- --------
Balances at October 31, 1998 (450) -- (28,830) (27,355) (15,111)
========
Issuance of Series D Redeemable
convertible preferred Stock, net -- -- -- -- --
Conversion of Redeemable Convertible
preferred Stock to common stock -- -- -- 37,905 --
Issuance of common stock -- -- -- 68,034 --
Issuance of stock for notes
receivable from stockholders (6,412) -- -- -- --
Repayments on notes receivable from
stockholders 1,202 -- -- 1,202 --
Exercise of warrants for common
stock -- -- -- 60 --
Compensation charges -- -- -- 80 --
Deferred compensation -- -- -- -- --
Amortization of deferred
compensation -- -- -- 1,937 --
Repurchase of common stock -- -- -- (93) --
Unrealized loss on marketable equity
securities -- (49) (49) (49)
Net income -- -- 2,485 2,485 2,485
------- ------- -------- -------- --------
Balances at October 31, 1999 (5,660) (49) (26,345) 84,206 2,436
========
Issuance of common stock -- -- -- 39,035 --
Repayments on notes receivable from
stockholders 5,660 -- -- 5,660 --
Tax benefits of employee stock
transactions -- -- -- 148,356 --
Amortization of deferred
compensation -- -- -- 1,120 --
Unrealized gain on marketable equity
securities -- 44,569 -- 44,569 44,569
Net income -- -- 67,931 67,931 67,931
------- ------- -------- -------- --------
Balances at October 28, 2000 $ -- $44,520 $ 41,586 $390,877 $$112,500
======= ======= ======== ======== ========
The accompanying notes are an integral part of these financial statements.
28
31
BROCADE COMMUNICATIONS SYSTEMS, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FISCAL YEAR ENDED
-----------------------------------------
OCTOBER 28, OCTOBER 31, OCTOBER 31,
2000 1999 1998
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 67,931 $ 2,485 $(15,111)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Tax benefits from employee stock option transactions 148,356 -- --
Deferred taxes (130,250) -- --
Depreciation, amortization and write-offs of property
and equipment 6,876 3,693 2,374
Provision for doubtful accounts receivable 829 536 185
Noncash compensation expense 1,120 2,017 1,202
Changes in assets and liabilities:
Accounts receivable (55,932) (14,245) (969)
Inventories 2,325 (1,942) (1,273)
Prepaid expenses and other assets (3,265) (1,819) 205
Accounts payable 13,294 7,417 (45)
Accrued employee compensation 18,949 3,786 154
Other accrued liabilities 5,053 7,397 1,682
Deferred revenue (5,632) 7,145 9
--------- -------- --------
Net cash provided by (used in) operating activities 69,654 16,470 (11,587)
--------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (40,698) (3,317) (3,775)
Purchases of short-term investments (90,306) (75,769) --
Proceeds from disposition of short-term investments 26,619 12,000 15,920
Other investing activities (7,799) -- --
--------- -------- --------
Net cash (used in) provided by investing activities (112,184) (67,086) 12,145
--------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of redeemable convertible preferred
stock and warrants -- 1,996 4,902
Proceeds from issuance of common stock 39,035 67,952 12
Payments received from loans to stockholders 5,660 1,202 --
Line of credit borrowings -- -- 1,672
Line of credit repayments -- (1,672) (500)
Payments on capital lease obligations (436) (784) (677)
Proceeds from notes payable -- 247 2,594
Repayments of notes payable -- (3,209) (693)
--------- -------- --------
Net cash provided by financing activities 44,259 65,732 7,310
--------- -------- --------
Net increase in cash and cash equivalents 1,729 15,116 7,868
Cash and cash equivalents, beginning of period 25,536 10,420 2,552
--------- -------- --------
Cash and cash equivalents, end of period $ 27,265 $ 25,536 $ 10,420
========= ======== ========
Supplemental disclosure of cash flow information:
Cash paid for interest $ 475 $ 359 $ 557
========= ======== ========
Cash paid for income taxes $ 26 $ -- $ --
========= ======== ========
Conversion of redeemable convertible preferred stock upon
initial public offering $ -- $ 37,905 $ --
========= ======== ========
Issuance of stock for notes receivable from stockholders $ -- $ 6,412 $ 375
========= ======== ========
The accompanying notes are an integral part of these financial statements.
29
32
BROCADE COMMUNICATIONS SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
1. ORGANIZATION AND OPERATIONS OF BROCADE
Brocade Communications Systems, Inc. (Brocade) is the world's leading
provider of storage area networking infrastructure solutions. The Brocade family
of hardware and software products provides the networking foundation for storage
area networks (SANs) and allows customers to connect servers with external
storage devices through a SAN, creating a highly reliable and scalable
environment for data-intensive storage applications. Brocade products are sold
through OEM partners, system integrators, and resellers.
Brocade was incorporated on May 14, 1999 as a Delaware corporation and is
the successor to operations originally begun on August 24, 1995. Brocade's
headquarters are located in San Jose, California.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Fiscal Year
Brocade changed its fiscal year end to the last Saturday in October,
beginning with the fiscal year ended October 28, 2000. This change did not have
a material impact on Brocade's financial statements.
Cash, Cash Equivalents and Short-term Investments
All highly liquid investment securities with original maturities of three
months or less are considered cash equivalents, while investment securities with
original maturities of more than three months but less than one year are
considered short-term investments. Brocade's short-term investments consist of
U.S. Treasuries and Federal Agency debt securities with original maturity dates
between three months and one year. All cash equivalents and short-term
investments are classified as available-for-sale. Unrealized holding gains and
losses are included in Accumulated Other Comprehensive Income (Loss) in the
accompanying balance sheets, net of any related tax effect. Realized gains and
losses are included in interest income in the statement of operations and the
cost of securities sold is based on the specific identification method.
Marketable Equity Securities and Other Investments
Marketable equity securities consist of equity holdings in public companies
and are classified as available-for-sale when there are no restrictions on
Brocade's ability to immediately liquidate such securities. The fair value of
marketable equity securities is determined using quoted market prices for those
securities. Unrealized holding gains and losses are included in Accumulated
Other Comprehensive Income (Loss) in the accompanying balance sheets, net of any
related tax effect. Realized gains and losses are calculated based on the
specific identification method and are included in interest income in the
statement of operations.
Brocade also has certain other minority equity holdings in non-public
companies. These investments are included in Other Assets and are carried at
cost. Brocade monitors these investments for impairment and makes appropriate
reductions in carrying values when necessary.
Inventories, net
Inventories are stated at the lower of cost or market, using the first in,
first out method. Inventory costs include material, labor and overhead. Deferred
charges represent the product costs associated with product shipments that are
recorded in deferred revenue. Inventories consisted of the following and are
shown net of reserves for excess and obsolete inventory (in thousands):
OCTOBER 28, OCTOBER 31,
2000 1999
----------- -----------
Raw materials $ 352 $ 878
Work-in-process 2 173
Finished goods, including deferred charges 1,007 2,635
------ ------
$1,361 $3,686
====== ======
30
33
BROCADE COMMUNICATIONS SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Property and Equipment
Property and equipment are stated at cost. Depreciation is computed using
the straight-line method over the estimated useful lives of the assets,
generally three to four years. Leasehold improvements are amortized using the
straight-line method over the shorter of the assets useful lives or the
remaining term of the lease. Property and equipment consisted of the following
(in thousands):
OCTOBER 28, OCTOBER 31,
2000 1999
----------- -----------
Computers and equipment $37,449 $10,530
Furniture and fixtures 2,006 711
Leasehold improvements 8,517 --
Less: Accumulated depreciation and amortization (9,203) (6,294)
------- -------
$38,769 $ 4,947
======= =======
Included in property and equipment at October 28, 2000, are assets acquired
under capital lease obligations with a total cost and related accumulated
amortization of approximately $2.6 million each.
Accrued Employee Compensation
Accrued employee compensation consists of accrued wages, commissions,
bonuses, payroll taxes, vacation payable, payroll deductions for the employee
stock purchase plan and other employee benefit payroll deductions.
Other Accrued Liabilities
Other accrued liabilities consisted of the following (in thousands):
OCTOBER 28, OCTOBER 31,
2000 1999
----------- -----------
Accrued warranty $ 4,815 $1,856
Purchase commitments reserve 1,572 3,629
Other 8,496 4,345
------- ------
$14,883 $9,830
======= ======
Concentrations
Financial instruments that potentially subject Brocade to concentrations of
credit risk consist primarily of cash equivalents, short-term investments and
accounts receivable. Brocade invests only in high credit quality, short-term
debt instruments and limits the amount of credit exposure to any one entity. A
majority of Brocade's trade receivable balance is derived from sales to original
equipment manufacturers in the computer storage and server industry. At October
28, 2000, and October 31, 1999, approximately 70 percent and 74 percent of
accounts receivable were concentrated with five and four customers,
respectively. Brocade performs on going credit evaluations of its customers and
generally does not require collateral on accounts receivable. Brocade has
established reserves for credit losses and product sales returns.
In fiscal 2000, two customers accounted for a combined total of 49 percent
of total revenues. In fiscal years 1999 and 1998, three and two customers
accounted for combined totals of 70 percent and 83 percent of total revenues,
respectively. The level of sales to any single customer may vary and the loss of
any one of these customers, or a decrease in the level of sales to any one of
these customers, could have a material adverse impact on Brocade's financial
condition or results of operations.
31
34
BROCADE COMMUNICATIONS SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Brocade currently relies on single and limited supply sources for several
key components used in the manufacture of its products. Additionally, Brocade
relies on a single third party manufacturer for the production of its products.
The inability of Brocade's single and limited source suppliers or the inability
of the third party manufacturer to fulfill supply and production requirements,
respectively, could negatively impact future results.
Brocade's business is concentrated in the storage area networking industry.
Accordingly, Brocade's future success depends upon the buying patterns of such
customers and the continued demand by such customers for Brocade's products.
Brocade's continued success will depend upon its ability to enhance its existing
products and to develop and introduce, on a timely basis, new products and
features that keep pace with technological developments and emerging industry
standards.
Revenue Recognition
Product revenue is generally recognized when persuasive evidence of an
arrangement exists, delivery has occurred, fee is fixed or determinable, and
collectibility is probable. Brocade's only post-sales obligations are limited to
product warranties. Revenue recognition is deferred for shipments to new
customers where significant support services are required to successfully launch
the customer's product. These revenues are recognized when the customer has
successfully integrated and launched its products and Brocade has met its
support obligations. Warranty costs, sales returns, and other allowances are
accrued based on experience at the time of shipment. Deferred revenues at
October 28, 2000, and October 31, 1999, were approximately $2.1 million and $7.7
million, respectively.
Warranty Expense
Brocade provides for estimated expenses for warranty obligations as revenue
is recognized to the extent not covered by its third-party contract
manufacturer.
Research and Development
Costs to develop Brocade's products are expensed as incurred in accordance
with Statement of Financial Accounting Standards No. 2, "Accounting for Research
and Development Costs." Costs related to internally developed software and
software purchased for internal use are capitalized in accordance with Statement
of Position 98-1, "Accounting for Costs of Computer Software Developed or
Obtained for Internal Use." During fiscal 2000, Brocade implemented an
enterprise-wide, integrated business information system. At October 28, 2000,
approximately $10.6 million in capitalized costs related to this system were
included in property and equipment. These costs will be depreciated over a term
of seven years.
Software Development Costs
In accordance with Statement of Financial Accounting Standards (SFAS) No.
86, "Accounting for the Costs of Computer Software to be Sold, Leased, or
Otherwise Marketed," Brocade capitalizes eligible computer software development
costs upon the establishment of technological feasibility, which it has defined
as completion of designing, coding and testing activities. For the years ended
October 28, 2000, and October 31, 1999 and 1998, the amount of costs eligible
for capitalization, after consideration of factors such as realizable value,
were not material and, accordingly, all software development costs have been
charged to research and development expense in the accompanying statements of
operations for all periods presented.
Impairment of Long-lived Assets
Long-lived assets to be held and used are reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of such
assets may not be recoverable. Measurement of an
32
35
BROCADE COMMUNICATIONS SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
impairment loss for long-lived assets is based on the fair value of the asset
and is reported at the lower of carrying amount or fair value less any costs to
sell. During fiscal 2000, Brocade recognized impairments totaling $6.5 million
related to minority equity holdings in non-public companies which Brocade has
accounted for under the cost method.
Income Taxes
Income tax expense is based on pre-tax financial accounting income.
Deferred tax assets and liabilities are recognized for the expected tax
consequences of temporary differences between the tax bases of assets and
liabilities and their reported amounts.
Computation of Basic and Diluted Net Income (Loss) Per Share
Basic and diluted net income (loss) per common share are presented in
conformity with Statement of Financial Accounting Standards No. 128, "Earnings
Per Share," (SFAS 128), for all periods presented. Pursuant to Securities and
Exchange Commission Staff Accounting Bulletin No. 98, common stock and
convertible preferred stock issued or granted for nominal consideration prior to
the anticipated effective date of an initial public offering must be included in
the calculation of basic and diluted net income (loss) per common share as if
such stock had been outstanding for all periods presented. To date, Brocade has
not had any issuances or grants for nominal consideration.
In accordance with SFAS 128, basic net income (loss) per common share has
been computed using the weighted average number of shares of common stock
outstanding during the period, less shares subject to repurchase. Diluted net
income (loss) per share is computed on the basis of the weighted average number
of common shares and common equivalent shares outstanding during the period.
Common equivalent shares result from the assumed exercise of outstanding stock
options that have a dilutive effect when applying the treasury stock method. For
the year ended October 31, 1998, Brocade excluded 156,050,504 shares from the
calculation of diluted net loss per common share. These shares, which consisted
of all convertible preferred stock, warrants for convertible preferred stock,
outstanding stock options and shares subject to repurchase, were excluded
because all such securities were antidilutive.
The following table presents the calculation of basic and diluted net
income (loss) per common share (in thousands, except per share data).
FISCAL YEAR ENDED
-----------------------------------------
OCTOBER 28, OCTOBER 31, OCTOBER 31,
2000 1999 1998
----------- ----------- -----------
Net income (loss) $ 67,931 $ 2,485 $(15,111)
======== ======== ========
Basic and diluted net income (loss) per share:
Weighted average shares of common stock outstanding 218,368 121,056 41,392
Less: Weighted average shares subject to repurchase (10,914) (16,680) (14,192)
-------- -------- --------
Weighted average shares used in computing basic net income
(loss) per share 207,454 104,376 27,200
Dilutive effect of common share equivalents 35,050 100,208 --
-------- -------- --------
Weighted average shares used in computing diluted net
income (loss) per share 242,504 204,584 27,200
======== ======== ========
Basic net income (loss) per share $ 0.33 $ 0.02 $ (0.56)
======== ======== ========
Diluted net income (loss) per share $ 0.28 $ 0.01 $ (0.56)
======== ======== ========
33
36
BROCADE COMMUNICATIONS SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
Stock-Based Compensation
Brocade accounts for its stock option plans and its Employee Stock Purchase
Plan in accordance with the provisions of Accounting Principles Board Opinion
25, "Accounting for Stock Issued to Employees," (APB 25) whereby the difference
between the exercise price and the fair value at the date of grant is recognized
as compensation expense. In 1995, the Financial Accounting Standards Board
issued Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation," (SFAS 123), which established a fair value based
method of accounting for stock-based plans. Companies that elect to account for
stock-based compensation plans in accordance with APB 25 are required to
disclose the pro forma net income (loss) that would have resulted from the use
of the fair value based method. Accordingly, pro forma disclosures required
under SFAS 123 are included in Note 5.
Stock Splits
On November 8, 1999, January 21, 2000, and November 29, 2000, Brocade's
board of directors approved two-for-one splits of Brocade's Common Stock. The
stock began trading on a split-adjusted basis on December 3, 1999, March 15,
2000, and December 22, 2000, respectively. All references in the accompanying
financial statements and notes thereto to earnings per share and the number of
common shares have been retroactively restated to reflect the common stock
splits.
Comprehensive Income (Loss)
Brocade's comprehensive income (loss) is comprised of net income (loss) and
unrealized holding gains (losses) on marketable equity securities and short-term
investments. Comprehensive income (loss) is reflected in the statement of
stockholders' equity. Net unrealized holding gains on marketable equity
securities and short-term investments were $44.6 million for the year ended
October 28, 2000. Accordingly, total comprehensive income for the year ended
October 28, 2000, was $112.5 million. Unrealized holding gains (losses) for all
other periods presented are not material and accordingly, comprehensive income
(loss) for all such periods approximates net income (loss).
Use of Estimates in Preparation of Financial Statements
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Such estimates relate to the useful lives of fixed assets,
allowances for doubtful accounts and product returns, inventory and warranty
reserves, accrued liabilities and other reserves. Actual results could differ
materially from those estimates.
Reclassifications
Certain information reported in previous years has been reclassified to
conform to the current year presentation.
Recent Accounting Pronouncements
In March 2000, the Financial Accounting Standards Board issued Financial
Accounting Standards Board Interpretation No. 44, "Accounting for Certain
Transactions Involving Stock Compensation -- an interpretation of APB Opinion
25," (Interpretation 44). Interpretation 44 was effective beginning in July 2000
and clarifies the application of APB Opinion 25 for certain matters,
specifically (a) the definition of an employee for purposes of applying APB
Opinion 25, (b) the criteria for determining whether a plan qualifies as a
noncompensatory plan, (c) the accounting consequence of various modifications to
the terms of a previously
34
37
BROCADE COMMUNICATIONS SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
fixed stock option award, and (d) the accounting for an exchange of stock
compensation awards in a business combination. The adoption of Interpretation 44
did not have a material impact on Brocade's financial position or results of
operations.
In December 1999, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements," (SAB
101), which provides guidance on the recognition, presentation, and disclosure
of revenue in financial statements filed with the SEC. SAB 101 outlines the
basic criteria that must be met to recognize revenue and provides guidance for
disclosures related to revenue recognition policies. Management does not expect
the adoption of SAB 101 to have a material impact on Brocade's financial
position or results of operations.
In September 1999, the Financial Accounting Standards Board issued Emerging
Issues Task Force Topic No. D-83, "Accounting for Payroll Taxes Associated with
Stock Option Exercises" (EITF D-83). EITF D-83 requires that payroll taxes paid
on the difference between the exercise price and the fair value of stock
acquired in association with an employee's stock options be recorded as
operating expenses. For the year ended October 28, 2000, Brocade expensed $2.1
million in payroll taxes on stock option exercises.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and hedging Activities," (SFAS 133), 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.
3. FAIR VALUE OF FINANCIAL INSTRUMENTS
The cost and estimated fair value of Brocade's short-term investments,
marketable equity securities, and other investments were as follows (in
thousands):
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
-------- ---------- ---------- --------
OCTOBER 28, 2000
Short-term investments
U.S. government obligations $127,456 $ 355 $37 $127,774
Marketable equity securities 5,000 44,251 -- 49,251
Other investments 2,805 -- -- 2,805
-------- ------- --- --------
Total $135,261 $44,606 $37 $179,830
======== ======= === ========
OCTOBER 31, 1999
Short-term investments
U.S. government obligations $ 63,818 $ -- $49 $ 63,769
======== ======= === ========
No gains or losses were realized on the sale of short-term investments or
marketable equity securities during fiscal 2000 or fiscal 1999. Net unrealized
holding gains of $44.6 million for fiscal 2000, and net unrealized holding
losses of $49,000 for fiscal 1999, were included in Accumulated Other
Comprehensive Income (Loss) in the accompanying balances sheets for the years
ended October 28, 2000, and October 31, 1999, respectively.
4. COMMITMENTS AND CONTINGENCIES
Brocade leases its facilities under various operating lease agreements
expiring through August 2010. In connection with these agreements Brocade has
signed unconditional, irrevocable letters of credit for $8.3 million as security
for the leases. In addition to base rent, many of the operating lease agreements
require that Brocade pay a proportional share of the respective facilities'
operating expenses. Rent expense for the
35
38
BROCADE COMMUNICATIONS SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
years ended October 28, 2000, and October 31, 1999 and 1998, was $4.1 million,
$1.3 million, and $0.8 million, respectively.
Future minimum lease payments under all noncancelable operating leases at
October 28, 2000 were as follows (in thousands):
OPERATING
FISCAL YEAR ENDED OCTOBER, LEASES
-------------------------- ---------
2001 $ 12,555
2002 12,672
2003 12,981
2004 13,314
2005 13,658
Thereafter 62,201
--------
Total minimum lease payments $127,381
========
Brocade also leases various computers, office equipment and furniture under
long-term lease agreements that are classified as capital leases. The leases
expire through January 2001 and require a final buyout payment at the end of the
lease term. At October 28, 2000, the total minimum lease payments under capital
leases were $42,000.
Brocade has entered into a manufacturing agreement with Solectron
Corporation under which Brocade provides to Solectron a twelve-month product
forecast and places purchase orders with Solectron sixty calendar days in
advance of the scheduled delivery of products to Brocade customers. Although
Brocade purchase orders placed with Solectron are cancelable, the terms of the
agreement would require Brocade to purchase from Solectron all material
inventory not returnable or usable by other Solectron customers. At October 28,
2000, Brocade's commitment to Solectron for such material inventory was
approximately $22.2 million.
Brocade purchases several key components used in the manufacture of its
products. At October 28, 2000, Brocade had non-cancelable purchase commitments
for various such components totaling approximately $16.4 million.
Brocade is subject to various legal proceedings, claims and litigation that
arise in the normal course of business. While the outcome of these matters is
currently not determinable, management does not expect these matters will have a
material adverse effect on the financial position, results of operations or cash
flows of Brocade.
5. COMMON STOCK
Deferred Compensation
In connection with the grant of certain stock options to employees during
the years ended October 31, 1999 and 1998, Brocade recorded deferred
compensation of approximately $5.1 million and $307,000, respectively,
representing the difference between the deemed value of the common stock for
accounting purposes and the option exercise price of such options at the date of
grant. Such amounts are presented as reductions of stockholders' equity and
amortized ratably over the vesting period of the applicable options.
Approximately $1.1 million, $1.9 million, and $7,000 were expensed during the
years ended October 28, 2000, October 31, 1999 and 1998, respectively. Deferred
compensation expense is decreased in the period of forfeiture for any accrued
but unvested compensation arising from the early termination of an option
holder's services. No compensation expense related to any other periods
presented has been recorded.
36
39
BROCADE COMMUNICATIONS SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
1999 Employee Stock Purchase Plan
In March 1999, the Board of Directors approved the adoption of Brocade's
1999 Employee Stock Purchase Plan (the "Purchase Plan"), and Brocade's
shareholders approved the Purchase Plan in April 1999. The Purchase Plan permits
eligible employees to purchase shares of Brocade's common stock through payroll
deductions at 85 percent of the fair market value at certain plan-defined dates.
The maximum number of shares of Brocade's common stock available for sale under
the Purchase Plan is 1,600,000 shares, plus an annual increase to be added on
the first day of Brocade's fiscal year, equal to the lesser of 20,000,000
shares, or 2.5 percent of the outstanding shares of common stock at such date.
Accordingly, on October 29, 2000, 5,563,966 additional shares were made
available for sale under the Purchase Plan. During fiscal 2000, 603,658 shares
were issued under the Purchase Plan. No shares were issued during fiscal 1999.
At October 28, 2000, 6,560,308 shares were available for future issuance under
the Purchase Plan.
1999 Stock Plan
In March 1999, the Board of Directors approved Brocade's 1999 Stock Plan
(the "1999 Plan") and Brocade's shareholders approved the 1999 Plan in April
1999. The 1999 Plan provides for the grant of incentive stock options and/or
nonstatutory stock options to employees. Per the terms of the 1999 Plan, the
maximum number of shares of Brocade's common stock available for sale under the
1999 Plan is 60,856,000 shares, plus an annual increase to be added on the first
day of Brocade's fiscal year, equal to the lesser of 40,000,000 shares, or 5
percent of the outstanding shares of common stock at such date. Accordingly, on
October 29, 2000, 11,127,934 additional shares were made available for sale
under the 1999 Plan. At October 28, 2000, Brocade had reserved 36,660,404 shares
of authorized but unissued shares of common stock for future issuance under the
1999 Plan. Of this amount, 25,246,514 shares were outstanding and 11,413,890
shares were available for future grants.
1999 Director Option Plan
In March 1999, the Board of Directors approved the 1999 Director Option
Plan (the "Director Plan") and Brocade's shareholders approved the Director Plan
in April 1999. The Director Plan provides for the grant of common stock to
non-employee directors. At October 28, 2000, Brocade had reserved 1,600,000
shares of authorized but unissued shares of common stock for future issuance
under the Director Plan. Of this amount, 160,000 shares were outstanding and
1,440,000 shares were available for future grants.
1999 Nonstatutory Stock Option Plan
In September 1999, the Board of Directors approved Brocade's 1999
Nonstatutory Stock Option Plan (the "NSO Plan"). The NSO Plan provides for the
grant of nonstatutory stock options to employees and consultants. A total of
28,400,000 shares of common stock have been reserved for issuance under the NSO
Plan. At October 28, 2000, Brocade had reserved 27,851,396 shares of authorized
but unissued shares of common stock for future issuance under the NSO Plan. Of
this amount, 19,464,192 shares were outstanding and 8,387,204 shares were
available for future grants.
Stock Options
Brocade, under the various stock option plans (the "Plans") discussed
above, grants stock options for shares of common stock to employees, directors
and consultants. In accordance with the Plans, the stated exercise price shall
not be less than 85 percent of the estimated fair market value of common stock
on the date of grant. Incentive Stock Options (ISOs) may not be granted at less
than 100 percent of the estimated fair market value of the common stock and
stock options granted to a person owning more than 10 percent of the combined
voting power of all classes of stock of Brocade must be issued at 110 percent of
the fair market value of the stock on the date of grant. The Plans provide that
the options shall be exercisable over a period not to
37
40
BROCADE COMMUNICATIONS SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
exceed ten years and generally vest over a period of four years. At October 28,
2000, Brocade had reserved 66,111,800 shares of authorized but unissued shares
of common stock for future issuance under all of the Plans. Of this amount,
44,870,706 shares were outstanding and 21,241,094 shares were available for
future grants.
The following table summarizes stock option plan activity under all of the
Plans:
FISCAL YEAR ENDED FISCAL YEAR ENDED FISCAL YEAR ENDED
OCTOBER 28, 2000 OCTOBER 31, 1999 OCTOBER 31, 1998
--------------------------- ---------------------------- ---------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE SHARES EXERCISE PRICE
---------- -------------- ----------- -------------- ---------- --------------
Outstanding at beginning of year 23,462,448 $ 4.70 28,183,312 $0.23 8,441,336 $0.04
Granted 30,755,320 $47.78 21,424,096 $5.22 25,239,296 $0.28
Exercised (7,872,862) $ 4.60 (24,605,472) $0.32 (3,404,560) $0.13
Cancelled (1,474,200) $32.30 (1,539,488) $0.24 (2,092,760) $0.13
---------- ----------- ----------
Outstanding at end of year 44,870,706 $33.24 23,462,448 $4.70 28,183,312 $0.23
========== =========== ==========
Exercisable at end of year 3,417,698 $ 7.50 1,799,016 $0.22 3,726,456 $0.19
The following table summarizes information about stock options outstanding
and exercisable at October 28, 2000:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- ---------------------------------------------------------- --------------------
WEIGHTED WEIGHTED
OCTOBER 28, 2000 AVERAGE WEIGHTED AVERAGE
RANGE OF EXERCISE REMAINING AVERAGE EXERCISE
PRICES NUMBER YEARS EXERCISE PRICE NUMBER PRICE
- ----------------- ---------- --------- -------------- --------- --------
$ 0.03 - $ 0.63 9,117,466 7.69 $ 0.34 2,194,990 $ 0.29
$ 0.88 - $ 30.72 9,204,554 8.80 $16.71 988,738 $16.77
$32.13 - $ 40.00 10,212,648 9.11 $34.07 211,060 $32.15
$40.02 - $ 55.50 9,130,608 9.39 $45.20 5,336 $44.42
$58.38 - $105.19 7,205,430 9.63 $79.63 17,574 $72.94
- ---------------- ---------- ---- ------ --------- ------
$ 0.03 - $105.19 44,870,706 8.90 $33.24 3,417,698 $ 7.50
================ ========== ==== ====== ========= ======
At October 28, 2000, 8,894,988 shares issued upon exercise of stock options
with a weighted-average exercise price of $0.36 per share were subject to
repurchase by Brocade.
SFAS 123 requires disclosure of pro forma information regarding option
grants made to employees based on specified valuation techniques that produce
estimated compensation expense. Had compensation expense been determined under
the provisions of SFAS 123, net income (loss) would have decreased or increased,
respectively, to the following pro forma amounts, (in thousands except per share
data):
FISCAL YEAR ENDED
-----------------------------------------
OCTOBER 28, OCTOBER 31, OCTOBER 31,
2000 1999 1998
----------- ----------- -----------
Net income (loss) as reported $ 67,931 $ 2,485 $(15,111)
Net income (loss) Pro Forma $(172,331) $(1,933) $(15,522)
Basic earnings (loss) per share
As reported $ 0.33 $ 0.02 $ (0.56)
Pro Forma $ (0.83) $ (0.02) $ (0.57)
Diluted earnings (loss) per share
As reported $ 0.28 $ 0.01 $ (0.56)
Pro Forma $ (0.83) $ (0.02) $ (0.57)
38
41
BROCADE COMMUNICATIONS SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions for each respective fiscal year ended:
EMPLOYEE STOCK OPTION PLANS EMPLOYEE STOCK PURCHASE PLANS
--------------------------------------- ---------------------------------------
OCTOBER 28, OCTOBER 31, OCTOBER 31, OCTOBER 28, OCTOBER 31, OCTOBER 31,
2000 1999 1998 2000 1999 1998
----------- ----------- ----------- ----------- ----------- -----------
Expected dividend yield 0.0% 0.0% 0.0% 0.0% * *
Risk-free interest rate 5.4 - 5.9% 5.0 - 5.3% 5.6 - 5.9% 6.0% * *
Expected volatility 93.4% 60.0% 0.0001% 80.3% * *
Expected life from vest date (in
years) 0.5 0.5 0.5 0.5 * *
- ---------------
* Not applicable
The Black-Scholes option-pricing model was developed for use in estimating
the fair value of traded options that have no vesting restrictions and are fully
transferable. In addition, option-pricing models require the input of highly
subjective assumptions, including the expected stock price volatility. Because
Brocade's employee stock options have characteristics significantly different
from those of traded options, and because changes in the subjective input
assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of Brocade's options. Based upon the above
assumptions, the weighted-average fair value of employee stock options granted
during fiscal years 2000, 1999, and 1998, were $30.82, $2.42, and $0.04 per
share, respectively.
6. INCOME TAXES
Brocade accounts for income taxes pursuant to Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes," (SFAS 109). The
provision for (benefit from) income taxes consisted of the following (in
thousands):
FISCAL YEAR ENDED
OCTOBER 28, OCTOBER 31,
2000 1999
----------- -----------
Federal:
Current $27,458 $ 393
Deferred (8,684) (323)
------- -------
18,774 70
------- -------
State:
Current 8,098 1,516
Deferred (6,487) (1,480)
------- -------
1,611 36
------- -------
Total provision for income taxes $20,385 $ 106
======= =======
39
42
BROCADE COMMUNICATIONS SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
The difference between the U.S. Federal statutory rate and Brocade's income
tax provision for financial statement purposes consisted of the following:
FISCAL YEAR ENDED
OCTOBER 28, OCTOBER 31,
2000 1999
----------- -----------
Provision for income taxes at statutory rate 35.0% 35.0%
State taxes, net of federal benefit 6.2 5.7
Losses for which no tax benefit recognized -- (73.8)
Stock compensation not deductible for tax 0.4 31.7
NOL and credit carryforwards (6.9) --
Release of valuation allowance (10.8) --
Other (0.8) 5.4
----- -----
Provision for income taxes 23.1% 4.0%
===== =====
The components of net deferred tax assets are as follows (in thousands):
OCTOBER 28, OCTOBER 31,
2000 1999
----------- -----------
Net operating loss carryforwards $107,166 $ 16,300
Tax credit carryforwards 7,914 2,000
Capitalized startup costs 390 200
Reserves and accruals 10,274 7,900
Capitalized research expenditures 4,506 1,400
-------- --------
Total deferred tax assets 130,250 27,800
Less: Valuation allowance -- (27,800)
-------- --------
Net deferred tax assets $130,250 $ --
======== ========
As of October 28, 2000, Brocade had federal net operating loss
carryforwards of approximately $275.2 million and state net operating loss
carryforwards of approximately $75.4 million. The federal net operating loss and
other tax credit carryforwards expire on various dates between 2010 through
2029. The state net operating loss carryforwards will expire beginning in 2003.
Under current tax law, net operating loss and credit carryforwards available to
offset future income in any given year may be limited upon the occurrence of
certain events, including significant changes in ownership interests.
Brocade's income taxes payable for federal, state, and foreign purposes
have been reduced and the deferred tax assets increased by the tax benefits
associated with employee stock options. The benefits were credited directly to
stockholders' equity and amounted to $148.4 million for fiscal 2000. Benefits
reducing taxes payable amounted to $33.3 million and benefits increasing gross
deferred tax assets amounted to $115.1 million in fiscal 2000.
7. RELATED PARTY TRANSACTIONS
During fiscal years 1999 and 1998, Brocade sold 4.7 million and 450,000
shares, respectively, of its common stock to officers and a director of Brocade
in consideration for full recourse promissory notes in the aggregate amount of
$6.8 million. Should the officers terminate employment, the shares are subject
to a right of repurchase by Brocade that lapses over a four-year period. At
October 28, 2000, all such promissory notes had been repaid in full and there
were no outstanding balances.
During fiscal 2000, total revenues to companies in which Brocade holds
minority investments were approximately $13.1 million, and outstanding accounts
receivable balances were approximately $2.7 million at
40
43
BROCADE COMMUNICATIONS SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
October 28, 2000. Sales transactions with such companies were no more favorable
than those with unrelated parties.
8. SEGMENT INFORMATION
Brocade is organized and operates as one operating segment; the design,
development, manufacturing, marketing and selling of Fiber Channel switching
solutions for SANs. Brocade's Chief Executive Officer is the Chief Operating
Decision Maker (CODM), as defined by SFAS 131. The CODM allocates resources and
assesses the performance of Brocade based on revenues and overall profitability.
Revenues are attributed to geographic areas based on the location of the
customer to which product is shipped. Domestic revenues include sales to certain
OEM customers who then distribute to their international customers. To date,
service revenues have not been significant.
In fiscal 2000, two customers accounted for 31 percent and 18 percent of
total revenues, respectively. In fiscal 1999, three customers accounted for 34
percent, 26 percent, and 10 percent of total revenues, respectively, and in
fiscal 1998, two customers accounted for 72 percent and 11 percent,
respectively. The level of sales to any customer may vary from quarter to
quarter and Brocade expects 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.
During fiscal 2000 Brocade expanded its international sales activities.
Geographic information for the year ended October 28, 2000 is presented below
(in thousands). For the years ended October 31, 1999, and 1998, international
revenues were not material. Identifiable assets located in foreign countries
were not material at October 28, 2000, and October 31, 1999, and 1998.
FISCAL YEAR ENDED
OCTOBER 28, 2000
NET REVENUES
-----------------
North America (principally the United States) $257,690
EMEA 69,217
Asia Pacific 2,138
--------
Total $329,045
========
9. SUBSEQUENT EVENTS (UNAUDITED)
In December 2000, Brocade entered into an agreement to lease approximately
195,000 additional square feet of office, laboratory, and administrative space
in San Jose, California. The lease expires November 30, 2013, and represents an
additional commitment of approximately $11.6 million per year to Brocade.
Brocade intends to occupy the space in December 2001 and sub-lease any excess
space, if possible, to offset the rental expense. In connection with this lease
agreement, Brocade signed an unconditional, irrevocable letter of credit for
$10.4 million as security for the lease.
Subsequent to October 28, 2000, the fair market value of Brocade's
marketable equity securities declined. At January 24, 2001, the fair market
value of Brocade's marketable equity securities was approximately $29.2 million.
41
44
ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
PART III
Certain information required by Part III is incorporated by reference from
Brocade's definitive Proxy Statement to be filed with the Securities and
Exchange Commission in connection with the solicitation of proxies for Brocade's
2001 Annual Meeting of Stockholders to be held on April 4, 2001 (the "Proxy
Statement").
ITEM 10.DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Item 405 of Regulation S-K calls for disclosure of any known late filing or
failure by an insider to file a report required by Section 16 of the Exchange
Act. This disclosure is contained in the section entitled "Section 16(a)
Beneficial Ownership Reporting Compliance" in the Proxy Statement and is
incorporated by reference, herein.
EXECUTIVE OFFICERS AND DIRECTORS
The following table sets forth certain information regarding our executive
officers and directors as of December 31, 2000:
NAME AGE POSITION
---- --- --------
Gregory L. Reyes 38 President, Chief Executive Officer and Director
Paul R. Bonderson, Jr. 48 Vice President, Engineering
Michael J. Byrd 40 Vice President and Chief Financial Officer
Victor M. Rinkle 48 Vice President, Operations
Charles W. Smith 39 Vice President, OEM Sales
David A. Smith 44 Vice President, Service, Support and SAN Integration
Jack Cuthbert 46 Vice President, Worldwide Sales, Marketing and Support
Seth D. Neiman(1) 46 Chairman of the Board
Neal Dempsey(1)(2) 59 Director
Mark Leslie(2) 56 Director
Larry W. Sonsini 59 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
42
45
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.
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 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, OEM Sales since November
2000, and 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.
David A. Smith has served as our Vice President, Service, Support and SAN
Integration since January 2000. From 1991 to January 2000, Mr. Smith held
various positions at BMC Software, Inc., a provider of enterprise software
solutions for applications and network management, most recently Vice President,
Worldwide Support Services.
Jack Cuthbert has served as our Vice President, Worldwide Sales, Marketing
and Support since November 2000, and Vice President, Worldwide Marketing since
April 2000. He was Vice President North American Sales from October 1999 to
April 2000, and was Director, Channel Sales from June 1998 to October 1999. From
November 1996 to June 1998, Mr. Cuthbert served as Vice President, North
American Sales at Macromedia, Inc., an Internet software development company.
From July 1986 to July 1996, Mr. Cuthbert held various positions at SGI, a
producer of visual computing systems, most recently Director, North American
Channels. Mr. Cuthbert received a B.Sc. in Physics from the University of
Waterloo in Canada and a M.S. in Engineering Physics from McMaster University in
Canada.
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 currently serves as the Chairman of the board of directors of VERITAS
Software Corporation, a storage management software company. From February 1990
to November 2000, Mr. Leslie served as Chief Executive Officer and a member of
the board of directors of VERITAS Software Corporation. Mr. Leslie also serves
on the board of directors and audit and compensation committees of Keynote
Systems, Inc., as well as on the boards of directors of several private
companies. 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 and Chief Executive
Officer of the firm. Mr. Sonsini serves on the boards of directors of Commerce
One, Inc., Echelon Corporation, Lattice Semiconductor Corporation, LSI Logic,
Inc., Novell, Inc., Pixar, and Tibco Software, Inc. as well as on the boards of
directors of several private companies. Mr. Sonsini received an A.B.
43
46
from the University of California, Berkeley and an L.L.B. from Boalt Hall School
of Law, University of California, Berkeley.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this section is incorporated by reference from
the information in the section entitled "Executive Compensation and Other
Matters" in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this section is incorporated by reference from
the information in the section entitled "Security Ownership of Certain
Beneficial Owners and Management" in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this section is incorporated by reference from
the information in the section entitled "Certain Relationships and Related
Transactions" in the Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this Form 10-K
(1) FINANCIAL STATEMENTS:
Reference is made to the Index to Financial Statements of Brocade
Communications Systems, Inc. under Item 8 in Part II of this Form 10-K.
(2) FINANCIAL STATEMENT SCHEDULES:
The following financial statement schedule of Brocade Communications
Systems, Inc. for the years ended October 28, 2000, October 31, 1999,
and October 31, 1998, is filed as part of this Annual Report and should
be read in conjunction with the Financial Statements of Brocade
Communications Systems, Inc.
Schedule II -- Valuation and Qualifying
Accounts Page 47
(3) EXHIBITS:
The exhibits listed below are required by Item 601 of Regulation S-K.
Each management contract or compensatory plan or arrangement required
to be filed as an exhibit to this Form 10-K has been identified.
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
3.1 Amended and Restated Certificate of Incorporation.
3.2(1) Bylaws of the Registrant.
4.1(1) Form of Registrant's Common Stock certificate.
10.1(1) Form of Indemnification Agreement entered into between
Brocade and each of its directors and executive officers.
10.2(1)* 1995 Equity Incentive Plan and forms of agreements
thereunder.
10.3(1)* 1998 Equity Incentive Plan and forms of agreements
thereunder.
10.4(1)* 1998 Executive Equity Incentive Plan and forms of agreements
thereunder.
10.5(2)* 1999 Director Option Plan and form of agreement thereunder.
10.6(3)* 1999 Employee Stock Purchase Plan.
10.7(3)* 1999 Stock Plan and forms of agreements thereunder.
10.8(3)* 1999 Nonstatutory Stock Option Plan and forms of agreements
thereunder.
44
47
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
10.9(1) Sublease between Symmetricom, Inc. and Brocade dated May 6,
1997.
10.10(1) Master Equipment Lease Agreement between Venture Lending &
Leasing, Inc. and Brocade dated September 5, 1996.
10.11(1)# Master Purchase Agreement between Dell Products L.P. and
Brocade dated November 1, 1998.
10.12(1)# Purchase Agreement between Sequent Computer Systems, Inc.
and Brocade.
10.13(1)# Supplement No. 1 to Purchase Agreement between Sequent
Computer Systems, Inc. and Brocade dated September 26, 1997.
10.14(1)# OEM Agreement between Storage Technology Corporation and
Brocade dated May 1, 1998.
10.15(1)# Acknowledgement between Wind River Systems, Inc. and Brocade
dated April 22, 1999.
10.16(1)* Confidential Agreement and General Release of Claims between
Bruce J. Bergman, The Bergman Family Trust and Brocade dated
September 23, 1998.
10.17(1)* Letter Agreement with Michael J. Byrd dated April 5, 1999.
10.18(1)# OEM and License Agreement between McDATA Corporation and
Brocade dated April 27, 1999.
10.19(4)# Volume Pricing Agreement between Data General Corporation
and Brocade dated October 1, 1998.
10.20(4)# Manufacturing Agreement between Solectron California
Corporation and Brocade dated July 30, 1999.
10.21(4) Master Lease Agreement between Spieker Properties and
Brocade dated December 17, 1999.
10.22 First Amendment to Lease between Spieker Properties and
Brocade dated February 16, 2000.
10.23 Second Amendment to Lease between Spieker Properties and
Brocade dated August 11, 2000.
10.24(5) Credit Agreement between Comerica Bank-California and
Brocade dated January 5, 2000.
10.25 First Amendment to Credit Agreement between Comerica
Bank-California and Brocade dated March 21, 2000.
10.26 Second Amendment to Credit Agreement between Comerica
Bank-California and Brocade dated September 20, 2000.
10.27 Master Lease Agreement between Spieker Properties and
Brocade dated July 26, 2000.
10.28# Purchase Agreement between Compaq Computer Corporation and
Brocade dated February 1, 2000.
10.29# Purchase Agreement between EMC Corporation and Brocade dated
January 25, 2000.
10.30* Promissory Note between David A. Smith and Brocade dated
April 27, 2000.
23.1 Consent of Arthur Andersen LLP, Independent Public
Accountants.
24.1 Power of attorney (see signature page).
45
48
- ---------------
* Indicates management contract or compensatory plan or arrangement required
to be filed as an exhibit pursuant to Item 14(c) of Form 10-K.
# Confidential treatment requested as to certain portions, which portions are
omitted and filed separately with the Securities and Exchange Commission.
(1) Incorporated by reference from Brocade's Registration Statement on Form S-1
(Reg. No. 333-74711), as amended.
(2) Incorporated by reference from Brocade's Registration Statement on Form S-8
(Reg. No. 333-85187) filed on August 13, 1999.
(3) Incorporated by reference from Brocade's Registration Statement on Form S-8
(Reg. No. 333-95653) filed on January 28, 2000.
(4) Incorporated by reference from Brocade's Annual Report on Form 10-K for the
fiscal year ended October 31, 1999, as amended.
(5) Incorporated by reference from Brocade's Quarterly Report on Form 10-Q for
the fiscal quarter ended January 29, 2000.
(b) REPORTS ON FORM 8-K
None.
46
49
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED OCTOBER 28, 2000, OCTOBER 31, 1999 AND 1998
(IN THOUSANDS)
ADDITIONS
BALANCE AT CHARGED TO BALANCE AT
BEGINNING OF COSTS AND END OF
DESCRIPTION PERIOD EXPENSES DEDUCTIONS PERIOD
----------- ------------ ---------- ---------- ----------
Allowance for doubtful accounts:
2000 $ 818 $ 829 $(294) $1,353
1999 278 596 (56) 818
1998 100 178 -- 278
Sales returns and allowances:
2000 $1,629 $ 268 $(280) $1,617
1999 7 1,622 -- 1,629
1998 -- 7 -- 7
47
50
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized on January 26, 2001.
Brocade Communications Systems, Inc.
By: /s/ GREGORY L. REYES
------------------------------------
Gregory L. Reyes
President, Chief Executive Officer,
and Director
January 26, 2001
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints Gregory L. Reyes and Michael J. Bird, and
each of them, his true and lawful attorneys-in-fact, each with full power of
substitution, for him in any and all capacities, to sign any amendments to this
report on Form 10-K and to file the same, with exhibits thereto and other
documents in connection therewith, with the Securities and Exchange Commission,
hereby ratifying and confirming all that each of said attorneys-in-fact or their
substitute or substitutes may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the date indicated:
SIGNATURE TITLE DATE
--------- ----- ----
/s/ GREGORY L. REYES President, Chief Executive January 26, 2001
- --------------------------------------------------- Officer, and Director (Principal
Gregory L. Reyes Executive Officer)
/s/ MICHAEL J. BYRD Vice President and Chief January 26, 2001
- --------------------------------------------------- Financial Officer (Principal
Michael J. Byrd Financial and Accounting
Officer)
/s/ SETH D. NEIMAN Chairman of the Board January 26, 2001
- ---------------------------------------------------
Seth D. Neiman
/s/ NEAL DEMPSEY Director January 26, 2001
- ---------------------------------------------------
Neal Dempsey
/s/ MARK LESLIE Director January 26, 2001
- ---------------------------------------------------
Mark Leslie
/s/ LARRY W. SONSINI Director January 26, 2001
- ---------------------------------------------------
Larry W. Sonsini
48
51
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
3.1 Amended and Restated Certificate of Incorporation.
3.2(1) Bylaws of the Registrant.
4.1(1) Form of Registrant's Common Stock certificate.
10.1(1) Form of Indemnification Agreement entered into between
Brocade and each of its directors and executive officers.
10.2(1)* 1995 Equity Incentive Plan and forms of agreements
thereunder.
10.3(1)* 1998 Equity Incentive Plan and forms of agreements
thereunder.
10.4(1)* 1998 Executive Equity Incentive Plan and forms of agreements
thereunder.
10.5(2)* 1999 Director Option Plan and form of agreement thereunder.
10.6(3)* 1999 Employee Stock Purchase Plan.
10.7(3)* 1999 Stock Plan and forms of agreements thereunder.
10.8(3)* 1999 Nonstatutory Stock Option Plan and forms of agreements
thereunder.
10.9(1) Sublease between Symmetricom, Inc. and Brocade dated May 6,
1997.
10.10(1) Master Equipment Lease Agreement between Venture Lending &
Leasing, Inc. and Brocade dated September 5, 1996.
10.11(1)# Master Purchase Agreement between Dell Products L.P. and
Brocade dated November 1, 1998.
10.12(1)# Purchase Agreement between Sequent Computer Systems, Inc.
and Brocade.
10.13(1)# Supplement No. 1 to Purchase Agreement between Sequent
Computer Systems, Inc. and Brocade dated September 26, 1997.
10.14(1)# OEM Agreement between Storage Technology Corporation and
Brocade dated May 1, 1998.
10.15(1)# Acknowledgement between Wind River Systems, Inc. and Brocade
dated April 22, 1999.
10.16(1)* Confidential Agreement and General Release of Claims between
Bruce J. Bergman, The Bergman Family Trust and Brocade dated
September 23, 1998.
10.17(1)* Letter Agreement with Michael J. Byrd dated April 5, 1999.
10.18(1)# OEM and License Agreement between McDATA Corporation and
Brocade dated April 27, 1999.
10.19(4)# Volume Pricing Agreement between Data General Corporation
and Brocade dated October 1, 1998.
10.20(4)# Manufacturing Agreement between Solectron California
Corporation and Brocade dated July 30, 1999.
10.21(4) Master Lease Agreement between Spieker Properties and
Brocade dated December 17, 1999.
10.22 First Amendment to Lease between Spieker Properties and
Brocade dated February 16, 2000.
10.23 Second Amendment to Lease between Spieker Properties and
Brocade dated August 11, 2000.
10.24(5) Credit Agreement between Comerica Bank-California and
Brocade dated January 5, 2000.
10.25 First Amendment to Credit Agreement between Comerica
Bank-California and Brocade dated March 21, 2000.
10.26 Second Amendment to Credit Agreement between Comerica
Bank-California and Brocade dated September 20, 2000.
10.27 Master Lease Agreement between Spieker Properties and
Brocade dated July 26, 2000.
52
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
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10.28# Purchase Agreement between Compaq Computer Corporation and
Brocade dated February 1, 2000.
10.29# Purchase Agreement between EMC Corporation and Brocade dated
January 25, 2000.
10.30* Promissory Note between David A. Smith and Brocade dated
April 27, 2000.
23.1 Consent of Arthur Andersen LLP, Independent Public
Accountants.
24.1 Power of attorney (see signature page).
- ---------------
* Indicates management contract or compensatory plan or arrangement required
to be filed as an exhibit pursuant to Item 14(c) of Form 10-K.
# Confidential treatment requested as to certain portions, which portions are
omitted and filed separately with the Securities and Exchange Commission.
(1) Incorporated by reference from Brocade's Registration Statement on Form S-1
(Reg. No. 333-74711), as amended.
(2) Incorporated by reference from Brocade's Registration Statement on Form S-8
(Reg. No. 333-85187) filed on August 13, 1999.
(3) Incorporated by reference from Brocade's Registration Statement on Form S-8
(Reg. No. 333-95653) filed on January 28, 2000.
(4) Incorporated by reference from Brocade's Annual Report on Form 10-K for the
fiscal year ended October 31, 1999, as amended.
(5) Incorporated by reference from Brocade's Quarterly Report on Form 10-Q for
the fiscal quarter ended January 29, 2000.