1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the quarterly period ended April 28, 2001
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 identification no.)
incorporation)
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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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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 [ ]
The number of shares outstanding of the Registrant's Common Stock on May 25,
2001 was 228,041,855 shares.
Page 1 of 20 pages.
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BROCADE COMMUNICATIONS SYSTEMS, INC.
FORM 10-Q
QUARTER ENDED APRIL 28, 2001
INDEX
PAGE
----
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Statements of Operations for the three and six
months ended April 28, 2001 and April 29, 2000 3
Condensed Balance Sheets as of April 28, 2001 and October 28,
2000 4
Condensed Statements of Cash Flows for the six months ended
April 28, 2001 and April 29, 2000 5
Notes to Condensed Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 9
Item 3. Quantitative and Qualitative Disclosures About Market Risks 19
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 19
Item 4. Submission of Matters to a Vote of Security Holders 20
Item 6. Exhibits and Reports on Form 8-K 20
SIGNATURES 20
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
BROCADE COMMUNICATIONS SYSTEMS, INC.
CONDENSED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
------------------------- -------------------------
APRIL 28, APRIL 29, APRIL 28, APRIL 29,
2001 2000 2001 2000
--------- --------- --------- ---------
Net revenues $115,206 $ 62,053 $280,230 $104,793
Cost of revenues 46,073 26,053 112,127 46,137
-------- -------- -------- --------
Gross margin 69,133 36,000 168,103 58,656
-------- -------- -------- --------
Operating expenses:
Research and development 28,391 9,666 54,533 15,694
Sales and marketing 23,202 8,311 47,033 14,558
General and administrative 4,606 2,080 8,986 4,116
Amortization of deferred compensation 280 280 560 560
-------- -------- -------- --------
Total operating expenses 56,479 20,337 111,112 34,928
-------- -------- -------- --------
Income from operations 12,654 15,663 56,991 23,728
Interest and other income, net 4,462 1,193 6,556 2,378
-------- -------- -------- --------
Income before provision for income taxes 17,116 16,856 63,547 26,106
Provision for income taxes 5,135 3,540 19,064 5,482
-------- -------- -------- --------
Net income $ 11,981 $ 13,316 $ 44,483 $ 20,624
======== ======== ======== ========
Net income per share -- Basic $ 0.05 $ 0.06 $ 0.20 $ 0.10
======== ======== ======== ========
Net income per share -- Diluted $ 0.05 $ 0.06 $ 0.18 $ 0.09
======== ======== ======== ========
Shares used in per share calculation -- Basic 219,865 205,982 217,997 204,032
======== ======== ======== ========
Shares used in per share calculation -- Diluted 238,740 241,860 243,298 238,698
======== ======== ======== ========
The accompanying notes are an integral part of these condensed financial statements.
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BROCADE COMMUNICATIONS SYSTEMS, INC.
CONDENSED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PAR VALUE)
APRIL 28, OCTOBER 28,
2001 2000
----------- -----------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 103,099 $ 27,265
Short-term investments 114,046 127,774
--------- ---------
Total cash, cash equivalents and short-term investments 217,145 155,039
Marketable equity securities 1,118 49,251
Accounts receivable, net of allowances for doubtful accounts
of $3,501 and $2,970, respectively 73,060 72,242
Inventories, net 8,370 1,361
Prepaid expenses and other current assets 10,429 5,462
--------- ---------
Total current assets 310,122 283,355
Property and equipment, net 75,056 38,769
Deferred tax assets 205,406 130,250
Non-marketable equity investments and other assets 16,287 2,805
--------- ---------
Total assets $ 606,871 $ 455,179
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 41,190 $ 23,958
Accrued employee compensation 8,474 23,363
Deferred revenue 5,679 2,056
Other accrued liabilities 27,293 14,925
--------- ---------
Total current liabilities 82,636 64,302
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, 800,000 shares authorized:
Issued and outstanding: 226,894 and 222,559 shares at April 28, 2001 and
October 28, 2000, respectively 227 223
Additional paid-in capital 437,865 306,868
Deferred stock compensation (1,760) (2,320)
Accumulated other comprehensive income 1,834 44,520
Accumulated earnings 86,069 41,586
--------- ---------
Total stockholders' equity 524,235 390,877
--------- ---------
Total liabilities and stockholders' equity $ 606,871 $ 455,179
========= =========
The accompanying notes are an integral part of these condensed financial statements.
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BROCADE COMMUNICATIONS SYSTEMS, INC.
CONDENSED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
SIX MONTHS ENDED
---------------------------
APRIL 28, APRIL 29,
2001 2000
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 44,483 $ 20,624
Adjustments to reconcile net income to net cash
provided by operating activities:
Tax benefits from employee stock option transactions 88,097 --
Deferred taxes (75,156) --
Depreciation, amortization and write-offs of property and equipment 6,692 2,740
Gain on sale of marketable equity securities (5,728) --
Write down of non-marketable equity investments 3,500 4,001
Provision for doubtful accounts receivable 619 822
Non-cash compensation expense 560 560
Changes in assets and liabilities:
Accounts receivable (1,437) (18,575)
Inventories (7,009) 504
Prepaid expenses and other current assets (4,967) (298)
Accounts payable 17,232 11,019
Accrued employee compensation (14,889) 4,780
Deferred revenue 3,623 834
Other accrued liabilities 12,368 9,539
--------- ---------
Net cash provided by operating activities 67,988 36,550
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (42,979) (8,139)
Purchases of short-term investments (16,194) (39,394)
Proceeds from maturities of short-term investments 30,369 19,493
Proceeds from sale of marketable equity securities 10,728 --
Purchases of non-marketable equity investments (16,982) (9,000)
--------- ---------
Net cash used in investing activities (35,058) (37,040)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of common stock 42,904 2,813
--------- ---------
Net cash provided by financing activities 42,904 2,813
--------- ---------
Net increase in cash and cash equivalents 75,834 2,323
Cash and cash equivalents, beginning of period 27,265 25,536
--------- ---------
Cash and cash equivalents, end of period $ 103,099 $ 27,859
========= =========
The accompanying notes are an integral part of these condensed financial statements.
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BROCADE COMMUNICATIONS SYSTEMS, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(unaudited)
1. ORGANIZATION AND OPERATIONS OF BROCADE
Brocade Communications Systems, Inc. (Brocade or the Company) 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. The Company's
headquarters are located in San Jose, California.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying financial data as of April 28, 2001, and for the three
and six-month periods ended April 28, 2001 and April 29, 2000, has been prepared
by the Company, without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission (SEC). Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations. The October 28, 2000 condensed balance
sheet was derived from audited financial statements, but does not include all
disclosures required by generally accepted accounting principles. These
financial statements should be read in conjunction with the financial statements
and notes thereto included in the Company's Annual Report on Form 10-K for the
fiscal year ended October 28, 2000.
In the opinion of management, all adjustments (which include only normal
recurring adjustments) necessary to present a fair statement of financial
position as of April 28, 2001, results of operations for the three and six-month
periods ended April 28, 2001 and April 29, 2000, and cash flows for the
six-month periods ended April 28, 2001 and April 29, 2000, have been made. The
results of operations for the three and six-month periods ended April 28, 2001
are not necessarily indicative of the operating results for the full fiscal year
or any future periods.
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. The Company'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 the Company has met
its support obligations. Revenue from sales to resellers is recognized upon
reported sell-thru. Warranty costs, sales returns, and other allowances are
accrued based on experience at the time of shipment.
Computation of Net Income per Share
Basic net income per share is computed using the weighted-average number
of common shares outstanding during the period, less shares subject to
repurchase. Diluted net income per share is computed using the weighted-average
number of common shares and dilutive common-equivalent shares outstanding during
the period. Dilutive common-equivalent shares result from the assumed exercise
of outstanding stock options that have a dilutive effect when applying the
treasure stock method.
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 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 the quarters ended
April 28, 2001, and April 29, 2000, the Company recognized
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impairments totaling $3.5 million and $3.0 million, respectively, related to
other than temporary declines in the carrying value of the Company's
non-marketable equity investments that have been accounted for under the cost
method.
Stock Splits
On November 29, 2000, the Board of Directors of Brocade approved a
two-for-one stock split of the Company's Common Stock. The stock began trading
on a split-adjusted basis on December 22, 2000. 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 split.
Comprehensive Income
The components of comprehensive income (loss), net of tax, are as follows
(in thousands):
THREE MONTHS ENDED SIX MONTHS ENDED
------------------------ ------------------------
APRIL 28, APRIL 29, APRIL 28, APRIL 29,
2001 2000 2001 2000
--------- --------- --------- ---------
Net income $ 11,981 $ 13,316 $ 44,483 $ 20,624
-------- -------- -------- --------
Other comprehensive income (loss):
Change in net unrealized gains on marketable equity
securities and short-term investments (17,828) (5) (29,880) (95)
Reclassification adjustment for net unrealized gains
previously included in net income 4,010 -- 4,010 --
-------- -------- -------- --------
Total comprehensive income (loss) $ (1,837) $ 13,311 $ 18,613 $ 20,529
======== ======== ======== ========
Interest and Other Income, net
Interest and other income for the quarter ended April 28, 2001, and for
the six-month period ended April 28, 2001, includes gains of $5.7 million from
the sale of marketable equity securities and write-downs of $3.5 million related
to other than temporary declines in the carrying value of the Company's
non-marketable equity investments.
Derivatives
In the first quarter of fiscal 2001, the Company adopted Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities," as amended by SFAS 137, "Accounting for Derivative
Instruments and Hedging Activities -- Deferral of the Effective Date of FASB
Statement No. 133," and SFAS 138, "Accounting for Certain Derivative Instruments
and Certain Hedging Activities" (referred to hereafter as SFAS 133). SFAS 133,
as amended, establishes accounting and reporting standards for derivative
instruments and hedging activities. SFAS 133, as amended, requires that an
entity recognize all derivatives as either assets or liabilities on the balance
sheet and measure those instruments at fair value. The accounting for changes in
the fair value of a derivative depends on the intended use of the derivative and
the resulting designation. The adoption of SFAS 133 did not have a material
impact on the Company's operations or financial position. As of April 28, 2001,
the Company did not hold any derivative instruments.
Reclassifications
Certain information reported in the prior year has been reclassified to
conform to the current year presentation.
Recent Accounting Pronouncements
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
the Company's financial position or results of operations. The Company is
required to adopt SAB 101 in the fourth quarter of fiscal 2001.
3. BALANCE SHEET DETAIL
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Inventories, net consisted of the following (in thousands):
APRIL 28, OCTOBER 28,
2001 2000
--------- -----------
Raw materials $ 1,924 $ 352
Work-in-process -- 2
Finished goods 6,446 1,007
-------- --------
Total $ 8,370 $ 1,361
======== ========
Prepaid expenses and other current assets consisted of the following (in
thousands):
APRIL 28, OCTOBER 28,
2001 2000
--------- -----------
Employee and other receivables $ 6,376 $ 2,902
Prepaid expenses, deposits, and other 4,053 2,560
-------- --------
Total $ 10,429 $ 5,462
======== ========
Property and equipment, net consisted of the following (in thousands):
APRIL 28, OCTOBER 28,
2001 2000
--------- -----------
Computers and equipment $ 75,142 $ 37,449
Furniture and fixtures 2,774 2,006
Leasehold improvements 12,721 8,517
-------- --------
90,637 47,972
Less: accumulated depreciation and
amortization (15,581) (9,203)
-------- --------
Total $ 75,056 $ 38,769
======== ========
Other accrued liabilities consisted of the following (in thousands):
APRIL 28, OCTOBER 28,
2001 2000
--------- -----------
Accrued warranty $ 4,815 $ 4,815
Purchase commitments 5,983 1,572
Income taxes payable 8,279 2,290
Other 8,216 6,248
-------- --------
Total $ 27,293 $ 14,925
======== ========
4. COMMITMENTS AND CONTINGENCIES
The Company has a manufacturing agreement with Solectron Corporation under
which the Company 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 the Company's customers. Although the
Company's purchase orders placed with Solectron are cancelable, the terms of the
agreement would require the Company to purchase from Solectron all material
inventory not returnable or usable by other Solectron customers. At April 28,
2001, the Company's commitment to Solectron for such material was approximately
$69.2 million, which the Company expects to utilize during future normal ongoing
operations. The Company has established reserves for portions of such material
that it believes may not be realizable during future normal ongoing operations.
Independently of Solectron, the Company purchases several key components
used in the manufacture of its products. At April 28, 2001, the Company had
non-cancelable purchase commitments for various components totaling
approximately $20.2 million, which the Company expects to utilize during future
normal ongoing operations. The Company has established reserves for portions of
such components that it believes may not be realizable during future normal
ongoing operations.
5. NET INCOME PER SHARE
The following table presents the calculation of basic and diluted net
income per common share (in thousands, except per share data):
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THREE MONTHS ENDED SIX MONTHS ENDED
------------------------ ------------------------
APRIL 28, APRIL 29, APRIL 28, APRIL 29,
2001 2000 2001 2000
--------- --------- --------- ---------
Net income $ 11,981 $ 13,316 $ 44,483 $ 20,624
--------- --------- --------- ---------
Basic and diluted net income per share:
Weighted average shares of common stock outstanding 226,216 217,514 224,975 216,320
Less: Weighted average shares subject to repurchase (6,351) (11,532) (6,978) (12,288)
--------- --------- --------- ---------
Weighted average shares used in computing basic net
income per share 219,865 205,982 217,997 204,032
Dilutive effect of common share equivalents 18,875 35,878 25,301 34,666
--------- --------- --------- ---------
Weighted average shares used in computing diluted
net income per share 238,740 241,860 243,298 238,698
========= ========= ========= =========
Basic net income per share $ 0.05 $ 0.06 $ 0.20 $ 0.10
========= ========= ========= =========
Diluted net income per share $ 0.05 $ 0.06 $ 0.18 $ 0.09
========= ========= ========= =========
6. SEGMENT INFORMATION
The Company is organized and operates as one operating segment; the
design, development, manufacturing, marketing and selling of switching solutions
for SANs. The Company'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 the Company 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 and international revenues were
approximately 72 percent and 28 percent of total revenues, respectively, for
both the quarter ended April 28, 2001, and the first six months of fiscal 2001.
Domestic and international revenues were approximately 82 percent and 18
percent, respectively, for the quarter ended April 29, 2000, and 81 percent and
19 percent, respectively, for the first six months of fiscal 2000. Domestic
revenues include sales to certain OEM customers who then distribute to their
international customers. To date, service revenues have not been significant.
Identifiable assets located in foreign countries were not material at April 28,
2001, and October 28, 2000.
7. COMMON STOCK
In February 2001, the Board of Directors approved an increase of 23
million shares of Common Stock reserved for issuance under the Company's 1999
Nonstatutory Stock Option Plan (NSO Plan). In April 2001, the Company granted
employees stock options to purchase approximately 20.3 million shares of the
Company's Common Stock.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This report contains forward-looking statements. These forward-looking
statements include predictions regarding our future:
- revenues;
- customer concentration;
- gross margins;
- research and development expenses;
- sales and marketing expenses;
- general and administrative expenses;
- realizability of deferred tax assets;
- liquidity and sufficiency of existing cash and cash equivalents for
near-term requirements; and
- the effect of recent accounting pronouncements on our financial
condition or results of operations.
You can identify these and other forward-looking statements by the use of
words such as "may," "will," "should," "expects," "plans," "anticipates,"
"believes," "estimates," "predicts," "intend," "potential," "continue," or the
negative of such terms, or other comparable terminology. Forward-looking
statements also include the assumptions underlying or relating to any of the
foregoing statements.
Actual results could differ materially from those anticipated in these
forward-looking statements as a result of various factors, including those set
forth below under the heading "Risk Factors." The following information should
be read in conjunction with the condensed interim financial statements and notes
thereto included in Item 1 of this
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Quarterly Report and with Management's Discussion and Analysis of Financial
Condition and Results of Operations contained in our Annual Report on Form 10-K
filed with the Securities and Exchange Commission on January 26, 2001.
All forward-looking statements included in this document are based on
information available to us on the date hereof. We assume no obligation to
update any forward-looking statements.
RESULTS OF OPERATIONS
The following table sets forth certain financial data for the periods
indicated as a percentage of total net revenues:
THREE MONTHS ENDED SIX MONTHS ENDED
--------------------- ---------------------
APRIL 28, APRIL 29, APRIL 28, APRIL 29,
2001 2000 2001 2000
--------- --------- --------- ---------
Net revenues 100.0% 100.0% 100.0% 100.0%
Cost of revenues 40.0 42.0 40.0 44.0
----- ----- ----- -----
Gross margin 60.0 58.0 60.0 56.0
----- ----- ----- -----
Operating expenses:
Research and development 24.6 15.6 19.5 15.0
Sales and marketing 20.1 13.4 16.8 13.9
General and administrative 4.0 3.4 3.2 3.9
Amortization of deferred
compensation 0.3 0.4 0.2 0.6
----- ----- ----- -----
Total operating expenses 49.0 32.8 39.7 33.4
----- ----- ----- -----
Income from operations 11.0 25.2 20.3 22.6
Interest and other income, net 3.9 1.9 2.4 2.3
----- ----- ----- -----
Income before provision for
income taxes 14.9 27.1 22.7 24.9
Provision for income taxes 4.5 5.7 6.8 5.2
----- ----- ----- -----
Net income 10.4% 21.4% 15.9% 19.7%
===== ===== ===== =====
Revenues. Our revenues are derived primarily from sales of our SilkWorm
family of products. Net revenues for the quarter ended April 28, 2001 increased
to $115.2 million, an increase of 86 percent compared with revenues of $62.1
million for the quarter ended April 29, 2000. Net revenues for the first six
months of fiscal 2001 increased to $280.2 million, an increase of 167 percent
compared with revenues of $104.8 million for the first six months of fiscal
2000. The increases reflect increased demand for SAN switching products and are
the result of increased unit sales to several significant OEMs and system
integrator customers, and to an expanding customer base.
Domestic and international revenues were approximately 72 percent and 28
percent of total revenues, respectively, for both the quarter ended April 28,
2001, and the first six months of fiscal 2001. Domestic and international
revenues were approximately 82 percent and 18 percent, respectively, for the
quarter ended April 29, 2000, and 81 percent and 19 percent, respectively, for
the first six months of fiscal 2000. International revenues primarily consisted
of sales to countries in Western Europe and Asia. Domestic revenues also include
sales to certain OEM customers who then distribute to their international
customers.
A significant portion of our revenues is concentrated among a relatively
small number of customers. The level of sales to any single customer may vary
and the loss of any one significant customer, or a decrease in the level of
sales to any one significant customer, could have a material adverse impact on
our financial condition and results of operations. We expect that a significant
portion of our future revenues will continue to come from sales of products to a
relatively small number of customers.
Recent economic uncertainty has resulted in a general reduction in
information technology (IT) spending, including storage area networking. This
reduction in IT spending has lead to a decline in our growth rates compared to
historical trends, specifically a 30 percent decline in revenues for the quarter
ended April 28, 2001, compared with the quarter ended January 27, 2001. We
currently expect revenues for the next three months to remain consistent with
revenues reported for the quarter ended April 28, 2001. Our revenues are
principally derived from sales to North American customers where the reduction
in IT spending has, to date, been the most profound. We are unable to predict
when the spending rates for IT will return to historical rates, if at all, or
the impact these reductions may have on IT spending rates in international
markets.
Gross margin. Gross margin increased to 60.0 percent of net revenues for
both the quarter ended April 28, 2001, and the first six months of fiscal 2001,
compared with 58.0 percent and 56.0 percent for the quarter ended April 28,
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2000, and the first six months of fiscal 2000, respectively. 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 of higher margin products. We expect gross margins for the
next three months to remain relatively consistent with those reported for the
first six months of fiscal 2001.
Research and development expenses. Research and development (R&D) expenses
increased to $28.4 million for the quarter ended April 28, 2001, compared with
$9.7 million for the quarter ended April 29, 2000. R&D expenses for the first
six months of fiscal 2001 increased to $54.5 million, compared with $15.7
million for the first six months of fiscal 2000. R&D 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 our products;
and IT and facilities expenses. The increased expenses reflect our belief that
continued investment in research and development is a critical factor in
maintaining our competitive position. We currently anticipate that R&D expenses
for the next three months will remain relatively consistent in absolute dollars
with the quarter ended April 28, 2001. We expect to increase R&D expenses when
and if revenue growth resumes.
Sales and marketing expenses. Sales and marketing expenses increased to
$23.2 million for the quarter ended April 28, 2001, compared with $8.3 million
for the quarter ended April 29, 2000. Sales and marketing expenses for the first
six months of fiscal 2001 increased to $47.0 million, compared with $14.6
million for the first six months of fiscal 2000. Sales and marketing 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 expenses. The increases were primarily due to
the hiring of additional sales and marketing personnel and increased direct
selling expenses associated with increased revenues. We believe that continued
investment in sales and marketing is critical to the success of our strategy to
expand relationships with our OEM customers, to expand our presence in the
system integration channel, and to maintain our leadership position in the SAN
market. In addition, we are currently expanding international sales activities
to various countries in Europe, the Middle East, Africa, and the Asia Pacific
region. We currently anticipate that sales and marketing expenses for the next
three months will remain relatively consistent in absolute dollars with the
quarter ended April 28, 2001. We expect to increase sales and marketing expenses
when and if revenue growth resumes.
General and administrative expenses. General and administrative (G&A)
expenses increased to $4.6 million for the quarter ended April 28, 2001,
compared with $2.1 million for the quarter ended April 29, 2000. G&A expenses
for the first six months of fiscal 2001 increased to $9.0 million, compared with
$4.1 million for the first six months of fiscal 2000. G&A 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 facilities expenses. The increases
were primarily due to additional headcount and other expenses necessary to
manage and support increased levels of business activity. We currently
anticipate that G&A expenses for the next three months will remain relatively
consistent in absolute dollars with the quarter ended April 28, 2001. We expect
to increase G&A expenses when and if revenue growth resumes.
Amortization of deferred compensation. We recorded amortization of
deferred compensation of $0.3 million for each of the quarters ended April 28,
2001, and April 29, 2000. For the first six months of each of fiscal 2001 and
fiscal 2000, we recorded amortization of deferred compensation of $0.6 million.
At April 28, 2001, unamortized deferred stock compensation was approximately
$1.8 million.
Interest and other income, net. Net interest and other income increased to
$4.5 million for the quarter ended April 28, 2001, compared with $1.2 million
for the quarter ended April 29, 2000. Net interest and other income for the
first six months of fiscal 2001 increased to $6.6 million, compared with $2.4
million for the first six months of fiscal 2000. Net interest and other income
for the quarter ended April 28, 2001, and for the first six months of fiscal
2001, includes net gains of $2.2 million from the sale of marketable equity
securities and write-downs of non-marketable equity investments. The remaining
increases were primarily the result of additional investment income on increased
cash and short-term investment balances.
Provision for income taxes. Our effective tax rate was 30 percent for the
quarter ended April 28, 2001, and for the first six months of fiscal 2001. Our
effective tax rate was 21 percent for the quarter ended April 29, 2000 and for
the first six months of fiscal 2000. Our ability to maintain our 30 percent tax
rate requires that international revenues and earnings be achieved as planned.
To the extent that international revenues and earnings differ from plan, a
factor largely influenced by the buying behavior of our OEM customers, or
unfavorable changes in tax laws and regulations occur, our tax rate could
change.
LIQUIDITY AND CAPITAL RESOURCES
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Cash, cash equivalents, and short-term investments were $217.1 million at
April 28, 2001, an increase of $62.1 million from October 28, 2000. For the
first six months of fiscal 2001, we generated $68.0 million in cash from
operating activities, primarily from net income and increases in accounts
payable and other accrued liabilities, partially offset by a decrease in accrued
employee compensation. Cash from operations also resulted from income tax
benefits related to employee stock option transactions partially offset by an
increase in deferred tax assets. At April 28, 2001, we had $205.4 million in
deferred tax assets, which we believe will be realizable through profitable
operations in future periods.
Net cash used in investing activities totaled $35.1 million for the first
six months of fiscal 2001. Net cash used in investing activities was primarily
the result of $43.0 million invested in property and equipment and $17.0 million
invested in non-marketable equity investments, partially offset by net
maturities of short-term investments of $14.2 million and proceeds from the sale
of marketable equity securities of $10.7 million.
Net cash provided by financing activities totaled $42.9 million for the
first six months of fiscal 2001 and was primarily the result of proceeds from
the issuance of Common Stock related to employee participation in employee stock
plans.
We have a manufacturing agreement with Solectron Corporation under which
we provide to Solectron a twelve-month product forecast and place purchase
orders with Solectron sixty calendar days in advance of the scheduled delivery
of products to our customers. Although our purchase orders placed with Solectron
are cancelable, the terms of the agreement would require us to purchase from
Solectron all material inventory not returnable or usable by other Solectron
customers. At April 28, 2001, our commitment to Solectron for such material was
approximately $69.2 million, which we expect to utilize during future normal
ongoing operations. We have established reserves for portions of such material
that we believe may not be realizable during future normal ongoing operations.
Independently of Solectron, we purchase several key components used in the
manufacture of our products. At April 28, 2001, we had non-cancelable purchase
commitments for various components totaling approximately $20.2 million, which
we expect to utilize during future normal ongoing operations. We have
established reserves for portions of such components that we believe may not be
realizable during future normal ongoing operations.
Commitments to Solectron and other vendors are based on our current
forecasts of revenue. To the extent that such forecasts are not achieved, our
commitments and associated reserve levels may change.
We believe that our 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 we could be required, or could elect, to seek additional funding prior
to that time. Our future capital requirements will depend on many factors,
including the rate of revenue growth, the timing and extent of spending to
support product development efforts and the expansion of sales and marketing,
the timing of introductions of new products and enhancements to existing
products, and market acceptance of our products. There can be no assurances that
additional equity or debt financing, if required, will be available on
acceptable terms or at all.
RECENT ACCOUNTING PRONOUNCEMENTS
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
our financial position or results of operations. We are required to adopt SAB
101 in the fourth quarter of fiscal 2001.
RISK FACTORS
Set forth below are some of the risks and uncertainties that could affect
our results of operations and the market price of our Common Stock.
OUR QUARTERLY REVENUES AND OPERATING RESULTS MAY FLUCTUATE IN FUTURE PERIODS FOR
A NUMBER OF REASONS WHICH COULD ADVERSELY AFFECT THE TRADING PRICE OF OUR STOCK
Our quarterly revenues and operating results may vary significantly in the
future due to a number of factors, any of which may cause our stock price to
fluctuate. The primary factors that may impact the predictability of quarterly
results include the following:
- changes in general economic conditions and specific economic conditions
in the computer, storage, and networking industries. In particular,
recent economic uncertainty has resulted in a general reduction in
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information technology (IT) spending. This reduction in IT spending has
lead to a decline in our growth rates compared to historical trends;
- the timing of customer orders and product implementations, particularly
large orders from and product implementations of our OEM customers;
- announcements and new product introductions by competitors;
- deferrals of customer orders in anticipation of new products, services
or product enhancements introduced by us or our competitors;
- our ability to obtain sufficient supplies of sole or limited sourced
components, including ASICs, GBICs, and power supplies;
- increases in prices of components used in the manufacture of our
products;
- our ability to attain and maintain production volumes and quality
levels; and
- variations in the mix of our 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. To the extent that our operating results
are below expectations of market analysts or investors our stock price may
decline.
OUR REVENUES MAY BE IMPACTED BY CHANGES IN INFORMATION TECHNOLOGY SPENDING
LEVELS
Recent economic uncertainty has resulted in a general reduction in IT
spending. This reduction in IT spending has lead to a decline in our growth
rates compared to historical trends. Our revenues are principally derived from
sales to North American customers where the reduction in IT spending has, to
date, been the most profound. We are unable to predict when the spending rates
for IT will return to historical levels, if at all, or the impact these
reductions may have on IT spending rates in international markets. Should there
be further reductions in either domestic or international IT spending rates, or
should IT spending rates not return to historical levels, our revenues may be
adversely affected.
FAILURE TO MANAGE EXPANSION EFFECTIVELY COULD SERIOUSLY HARM OUR BUSINESS,
FINANCIAL CONDITION AND PROSPECTS
Our ability to successfully implement our business plan, develop and offer
products, and manage expansion in a rapidly evolving market requires a
comprehensive and effective planning and management process. We continue to
increase the scope of our operations domestically and internationally, and have
grown headcount substantially. In addition, we plan to continue to hire
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. Our
failure to continue to improve upon our operational, managerial, and financial
controls, reporting systems, and procedures, and/or our failure to continue to
expand, train, and manage our work force worldwide, could have a material
adverse affect on our business and financial results.
OUR SUCCESS DEPENDS ON OUR ABILITY TO DEVELOP NEW AND ENHANCED PRODUCTS THAT
ACHIEVE WIDESPREAD MARKET ACCEPTANCE
We currently derive substantially all of our revenues from sales of our
SilkWorm family of products. We expect that revenue from this product family
will continue to account for a substantial portion of revenues for the
foreseeable future. Therefore, widespread market acceptance of these products is
critical to our future success. Some of our products have been only recently
introduced and, therefore, the demand and market acceptance of these products is
uncertain. Factors that may affect the market acceptance of our products include
the performance, price and total cost of ownership of those products; the
availability and price of competing products and technologies; and the success
and development of our OEMs and system integrators. Many of these factors are
beyond our control.
Our future success depends upon our ability to address the rapidly
changing needs of our customers by developing and introducing high-quality,
cost-effective products, product enhancements and services on a timely basis and
by keeping pace with technological developments and emerging industry standards.
We expect to launch new products and upgrades to our existing products during
the next year and our future revenue growth will be dependent on the success of
these new products. We have 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, we 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. Our failure to develop and successfully introduce new products and
product enhancements could adversely affect our business and financial results.
Our failure to manage the transition to newer
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products could result in an increase in inventory levels and/or a decline in
revenues.
FAILURE TO ADEQUATELY ANTICIPATE FUTURE END-USER PRODUCT NEEDS AND FAILURE TO
FORECAST END-USER DEMAND COULD NEGATIVELY IMPACT THE DEMAND FOR OUR PRODUCTS AND
REDUCE OUR REVENUES
We sell and market our products through OEM partners, system integrators,
and resellers. As a result, direct contact with the end-users of our products is
often limited. Although we make every effort to communicate with, understand,
and anticipate the current and future needs of the end-users of our products, to
a large extent we rely on our OEM partners, system integrators, resellers, and
service providers for visibility into those end-user requirements. Our failure
to adequately assess and anticipate future end-user needs could negatively
impact the demand for our products and reduce our revenues.
Similarly, we have limited ability to forecast the demand for our
products. In preparing sales and demand forecasts, we largely rely on input from
our OEM partners, system integrators, resellers, and service providers. If we
fail to effectively communicate with our 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 we make certain business
decisions based on our sales and demand forecasts, should these forecasts not
materialize, our business and financial results could be negatively impacted.
WE HAVE PLANS TO INCREASE OUR INTERNATIONAL SALES ACTIVITIES SIGNIFICANTLY,
WHICH WILL SUBJECT US TO ADDITIONAL BUSINESS RISKS
We plan to expand our international sales activities significantly.
Expansion of international operations will involve inherent risks that we may
not be able to control, including:
- supporting multiple languages;
- recruiting sales and technical support personnel with the skills to
support our products;
- increased complexity and costs of managing international operations;
- protectionist laws and business practices that favor local competition;
- dependence on local vendors;
- multiple, conflicting, and changing governmental laws and regulations;
- longer sales cycles;
- difficulties in collecting accounts receivable;
- reduced or limited protections of intellectual property rights; and
- political and economic instability.
To date, none of our international revenues and costs have been
denominated in foreign currencies. As a result, an increase in the value of the
U.S. dollar relative to foreign currencies could make our products more
expensive and thus less competitive in foreign markets. A portion of our
international revenues may be denominated in foreign currencies in the future,
including the Euro, which will subject us to risks associated with fluctuations
in those foreign currencies. Additionally, we receive 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 our international customers are located. Future changes in
domestic or international tax regulations could affect the continued
realizability of the tax benefits we are currently receiving and expect to
receive from sales to our international customers.
WE DEPEND ON OEM CUSTOMERS AND THE LOSS OF ANY OF THEM COULD SIGNIFICANTLY
REDUCE REVENUES
Although our customer base has increased substantially, we still depend on
large, recurring purchases from certain OEM customers. Our agreements with our
OEM customers are typically cancelable, non-exclusive, and have no minimum
purchase requirements. As such a significant portion of our revenues are
concentrated among a relatively small number of customers. We anticipate that
our revenues and operating results will continue to depend
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on sales to a relatively small number of customers. Therefore, the loss of any
one significant customer, or a decrease in the level of sales to any one
significant customer, could have a material adverse impact on our financial
condition and results of operations.
FAILURE TO EXPAND DISTRIBUTION CHANNELS AND MANAGE DISTRIBUTION RELATIONSHIPS
COULD SIGNIFICANTLY REDUCE OUR REVENUES
Our success will depend on our 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. Our OEM customers may
evaluate our products for up to a year before they begin to market and sell them
and assisting these customers through the evaluation process may require
significant sales, marketing, and management efforts on our part, particularly
if our products are being qualified with multiple customers at the same time. In
addition, once our products have been qualified, our customer agreements have no
minimum purchase commitments. We cannot provide assurance that we will be able
to maintain or expand our distribution channels, manage distribution
relationships successfully or that our customers will market our products
effectively. Our failure to successfully manage our distribution relationships
or the failure of our customers to sell our products could reduce our revenues.
THE LOSS OF SOLECTRON CORPORATION, OUR SOLE MANUFACTURER, OR THE FAILURE TO
ACCURATELY FORECAST DEMAND FOR OUR PRODUCTS OR SUCCESSFULLY MANAGE OUR
RELATIONSHIP WITH SOLECTRON, COULD NEGATIVELY IMPACT OUR ABILITY TO MANUFACTURE
AND SELL OUR PRODUCTS
We depend on Solectron, a third party manufacturer for numerous companies,
to manufacture all of our products at Solectron's California facilities. If we
should fail to effectively manage our relationship with Solectron, or if
Solectron experiences delays, disruptions, capacity constraints or quality
control problems in its manufacturing operations, our ability to ship products
to our customers could be delayed and our competitive position and reputation
could be harmed. Qualifying a new contract manufacturer and commencing volume
production is expensive and time consuming. If we are required or choose to
change contract manufacturers, we may lose revenue and damage our customer
relationships.
We have entered into a manufacturing agreement with Solectron under which
we provide to Solectron a twelve-month product forecast and place purchase
orders with Solectron sixty calendar days in advance of the scheduled delivery
of products to our customers. Although our purchase orders placed with Solectron
are cancelable, the terms of the agreement would require us to purchase from
Solectron all material inventory not returnable or usable by other Solectron
customers. Accordingly, if we inaccurately forecast demand for our products, we
may be unable to obtain adequate manufacturing capacity from Solectron to meet
customers' delivery requirements or we 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 our products, the continuance of
blackouts may affect Solectron's ability to manufacture our products and meet
our scheduled delivery needs.
WE ARE DEPENDENT ON SOLE SOURCE AND LIMITED SOURCE SUPPLIERS FOR CERTAIN KEY
COMPONENTS INCLUDING ASICS AND POWER SUPPLIES
We currently purchase several key components from single or limited
sources. We purchase ASICs, certain logic chips, and chassis from a single
source, and printed circuit boards, power supplies and GBICs from limited
sources. In addition, we license certain software that is incorporated into the
Brocade Fabric Operating System from Wind River Systems, Inc. If we are unable
to buy these components on a timely basis, we will not be able to deliver
product to our customers in a timely manner. We use a rolling six-month forecast
based on anticipated product orders to determine component requirements. If
component requirements are overestimated, we may have excess inventory, which
would increase costs. If component requirements are underestimated, we 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. We 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 OUR PRODUCTS, REDUCED
PROFITS AND REDUCED MARKET SHARE
The markets for our SAN switching products are competitive, and are likely
to become even more competitive. Increased competition could result in pricing
pressures, reduced sales, reduced margins, reduced profits, reduced
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market share or the failure of our products to achieve or maintain market
acceptance. Our 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 our
current and future 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 OUR PRODUCTS MAY DECLINE WHICH WOULD REDUCE REVENUES AND GROSS
MARGINS
To date we have not experienced material reductions in our average unit
selling prices, except for planned price reductions of older generation products
relating to the introduction of new products. The average unit prices of our
products may decrease in the future in response to changes in product mix,
competitive pricing pressures, increased sales discounts, new product
introductions by us or our competitors, or other factors. If we are unable to
offset these factors by increasing sales volumes, revenues will decline. In
addition, to maintain our gross margins, we must develop and introduce new
products and product enhancements, and must continue to reduce the manufacturing
cost of our products.
UNDETECTED SOFTWARE OR HARDWARE ERRORS COULD INCREASE OUR COSTS AND REDUCE
REVENUES
Networking products frequently contain undetected software or hardware
errors when first introduced or as new versions are released. Our products are
complex and errors may be found from time to time in our new or enhanced
products. In addition, our products are combined with products from other
vendors. As a result, when problems occur, it may be difficult to identify the
source of the problem. These problems may cause us to incur significant warranty
and repair costs, divert the attention of engineering personnel from product
development efforts and cause significant customer relations problems. Moreover,
the occurrence of hardware and software errors, whether caused by us or another
vendor's SAN products, could delay or prevent the development of the SAN market.
WE MAY NOT BE ABLE TO MAINTAIN PROFITABILITY
Although we have been profitable since the third quarter of fiscal 1999,
we cannot be certain that we will be able to maintain profitability in the
future. We expect to incur significant costs and expenses for product
development, sales and marketing, customer support, facilities expansion, and
expansion of corporate infrastructure. We make such investment decisions based
upon anticipated revenues and margins. Failure of these anticipated revenues and
margins to materialize could impact our ability to remain profitable. As a
result, we will need to grow our revenues and realize expected margins to
maintain profitability.
In addition, we have a limited operating history. Therefore, it is
difficult to forecast future operating results based on historical results. We
plan our operating expenses based in part on future revenue projections. Our
ability to accurately forecast quarterly revenue is limited for the reasons
discussed above in "Our Quarterly Revenues and Operating Results May Fluctuate
in Future Periods for a Number of Reasons Which Could Adversely Affect the
Trading Price of Our Stock." Moreover, most of our expenses are fixed in the
short-term or incurred in advance of receipt of corresponding revenue. As a
result, we may not be able to decrease our spending to offset any unexpected
shortfall in revenues. If this were to occur, we could incur losses and our
operating results would be below our expectations and those of investors and
market analysts.
IF WE LOSE KEY PERSONNEL OR ARE UNABLE TO HIRE ADDITIONAL QUALIFIED PERSONNEL,
WE MAY NOT CONTINUE TO BE SUCCESSFUL
Our success depends to a significant degree upon the continued
contributions of key management, engineering, and sales and marketing personnel,
many of whom would be difficult to replace. We do not have employment contracts
with, or key person life insurance on, any of our key personnel. We also believe
that our success depends to a significant extent on the ability of management to
operate effectively, both individually and as a group.
We believe our future success will also depend in large part upon our
ability to attract and retain highly skilled managerial, engineering, sales and
marketing, finance, and operations personnel. Competition for these personnel is
intense, especially in the San Francisco Bay Area. In particular, we have
experienced difficulty in hiring qualified ASIC, software, system and test, and
customer support engineers and there can be no assurance that future efforts
will be successful in attracting and retaining these individuals. The loss of
the services of any of our key employees, the inability to attract or retain
qualified personnel in the future, or delays in hiring required personnel,
particularly engineers and sales personnel, could delay the development and
introduction of and negatively impact our ability to
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sell our products. In addition, companies in the computer storage and server
industry whose employees accept positions with competitors frequently claim that
their competitors have engaged in unfair hiring practices. We cannot provide
assurance that such claims will not be received in the future as we seek to hire
qualified personnel, or that such claims will not result in material litigation.
We could incur substantial costs in defending against these claims, regardless
of their merits.
WE MAY BE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY WHICH WOULD NEGATIVELY
AFFECT OUR ABILITY TO COMPETE
We rely on a combination of patent, copyright, trademark, and trade secret
laws and restrictions on disclosure to protect our intellectual property rights.
We also enter into confidentiality or license agreements with our employees,
consultants, and corporate partners, and control access to and distribution of
our software, documentation, and other proprietary information. Despite efforts
to protect our proprietary rights, unauthorized parties may attempt to copy or
otherwise obtain and use our products or technology. Monitoring unauthorized use
of our products is difficult and we cannot be certain that the steps we take to
prevent unauthorized use of our technology, particularly in foreign countries
where the laws may not protect proprietary rights as fully as in the United
States, will be effective.
OTHERS MAY BRING INFRINGEMENT CLAIMS AGAINST US WHICH COULD BE TIME-CONSUMING
AND EXPENSIVE TO DEFEND
In recent years, there has been significant litigation in the United
States involving patents and other intellectual property rights. We have
previously been the subject of a lawsuit alleging infringement of intellectual
property rights. Although this dispute was resolved and the lawsuit dismissed,
and we are not currently involved in any other intellectual property litigation,
we may be a party to litigation in the future to protect our intellectual
property or as a result of an alleged infringement of others' intellectual
property. These claims and any resulting lawsuit could subject us to significant
liability for damages and invalidation of proprietary rights. These lawsuits,
regardless of their success, would likely be time-consuming and expensive to
resolve and would divert management time and attention. Any potential
intellectual property litigation also could force us to do one or more of the
following:
- stop selling, incorporating or using 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 we are forced to take any of the foregoing actions, we may be unable to
manufacture, use, sell, import and/or export our products, which would reduce
revenues.
WE MAY ENGAGE IN FUTURE ACQUISITIONS THAT DILUTE OUR STOCKHOLDERS AND CAUSE US
TO INCUR DEBT OR ASSUME CONTINGENT LIABILITIES
As part of our strategy, we expect to review opportunities to buy other
businesses or technologies that would complement our current products, expand
the breadth of our markets or enhance our technical capabilities, or that may
otherwise offer growth opportunities. While we have no current agreements or
negotiations underway, we may buy businesses, products or technologies in the
future. In the event of any future purchases, we could:
- issue stock that would dilute our current stockholders' percentage
ownership;
- incur debt; or
- assume liabilities.
These purchases also involve numerous risks, including:
- problems combining the purchased operations, technologies or products;
- unanticipated costs;
- diversion of management's attention from our core business;
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- adverse effects on existing business relationships with suppliers and
customers;
- risks associated with entering markets in which we have no or limited
prior experience; and
- potential loss of key employees of acquired organizations.
We cannot provide assurance that we will be able to successfully integrate
any businesses, products, technologies or personnel that we might acquire in the
future.
OUR 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 we must continue to introduce new
products and product enhancements that meet these industry standards. All
components of the SAN must utilize the same standards in order to operate
together. Our products comprise only a part of the entire SAN and we depend on
the companies that provide other components of the SAN, many of whom are
significantly larger than us, to support the industry standards as they evolve.
The failure of these providers to support these industry standards could
adversely affect the market acceptance of our products.
In addition, in the United States, our products must comply with various
regulations and standards defined by the Federal Communications Commission and
Underwriters Laboratories. Internationally, products that we develop will also
be required to comply with standards established by authorities in various
countries. Failure to comply with existing or evolving industry standards or to
obtain timely domestic or foreign regulatory approvals or certificates could
materially harm our business.
PROVISIONS IN OUR CHARTER DOCUMENTS, CUSTOMER AGREEMENTS AND DELAWARE LAW COULD
PREVENT OR DELAY A CHANGE IN CONTROL AND MAY REDUCE THE MARKET PRICE OF OUR
COMMON STOCK
Provisions of our certificate of incorporation and bylaws may discourage,
delay or prevent a merger or acquisition that a stockholder may consider
favorable. These provisions include:
- authorizing the issuance of preferred stock without stockholder
approval;
- providing for a classified board of directors with staggered,
three-year terms;
- prohibiting cumulative voting in the election of directors;
- limiting the persons who may call special meetings of stockholders
- prohibiting stockholder actions by written consent; and
- requiring super-majority voting to effect amendments to the foregoing
provisions of our certificate of incorporation and bylaws;
Certain provisions of Delaware law also may discourage, delay or prevent
someone from acquiring or merging with us. Further, our agreements with certain
of our customers require that we give prior notice of a change of control and
grant certain manufacturing rights following the change of control.
WE EXPECT TO EXPERIENCE VOLATILITY IN OUR STOCK PRICE WHICH COULD NEGATIVELY
AFFECT YOUR INVESTMENT.
The market price of our Common Stock has experienced significant
volatility in the past and may continue to fluctuate significantly in response
to the following factors, some of which are beyond our control:
- actual or anticipated fluctuations in our operating results;
- changes in financial estimates by securities analysts;
- changes in market valuations of other technology companies;
- announcements by us or our competitors of significant technical
innovations, contracts, acquisitions, strategic partnerships, joint
ventures or capital commitments;
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- 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 our stock price to fall regardless of performance.
OUR 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. We may, in the future, be the target of similar litigation.
Securities litigation could result in substantial costs and divert management's
attention and resources.
BUSINESS INTERRUPTIONS COULD ADVERSELY AFFECT OUR BUSINESS
Our operations are vulnerable to interruption by fire, earthquake, power
loss, telecommunications failure and other events beyond our control. A
substantial portion of our facilities, including our corporate headquarters, is
located near major earthquake faults and we neither carry earthquake insurance
nor self-insure for earthquake-related losses. Our facilities in the State of
California are currently subject to rolling electrical blackouts resulting from
shortages of available electrical power. Should these blackouts continue or
increase in severity, they could disrupt the operations of our affected
facilities. Although we carry business interruption insurance to mitigate the
impact of potential business interruptions, should a business interruption
occur, our business could be seriously harmed.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS
We are exposed to market risk related to changes in interest rates and
equity security prices.
INTEREST RATE RISK
Our exposure to market risk due to changes in the general level of U.S.
interest rates relates primarily to our cash equivalents and short-term
investments portfolio. The primary objective of our 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 our short-term investments, we believe that market
risk due to changes in interest rates is not material.
The following table (in thousands) presents our cash equivalents and
short-term investments subject to interest rate risk and their related weighted
average interest rates at April 28, 2001. Carrying value approximates fair
value.
AVERAGE
AMOUNT INTEREST RATE
-------- -------------
Cash and cash equivalents $103,099 3.66%
Short-term investments 114,046 5.40%
--------
Total $217,145 4.57%
========
EQUITY SECURITY PRICE RISK
Our 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 we do 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 $0.2 million in the fair value of marketable equity
securities at April 28, 2001.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Our Annual Meeting of Stockholders was held on April 4, 2001 in San Jose,
California. Of the 225,912,876 shares outstanding as of the record date,
184,719,405 were present or represented by proxy at the meeting. The results of
the voting on the matters submitted to the stockholders are as follows:
1. To elect two (2) Class II Directors to serve until the 2004 Annual
Meeting of Stockholders or until their successors are duly elected
and qualified.
NAME VOTES FOR VOTES WITHHELD
---------------- ----------- --------------
Neal Dempsey 184,226,071 493,334
Larry W. Sonsini 183,976,660 742,745
2. To ratify the appointment of Arthur Andersen, LLP as independent
auditors of Brocade for the fiscal year ending October 27, 2001.
Votes for: 170,550,924
Votes against: 14,129,541
Votes abstaining: 38,940
3. To amend the Company's Certificate of Incorporation to increase the
authorized number of shares of Common Stock from 400,000,000 shares
to 800,000,000 shares.
Votes for: 173,322,063
Votes against: 11,201,264
Votes abstaining: 196,078
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS.
None.
(b) REPORTS ON FORM 8-K.
None.
Items 2, 3, and 5 are not applicable and have been omitted.
SIGNATURES
Pursuant to the requirements 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.
Brocade Communications Systems, Inc.
Date: June 12, 2001 By: /s/ ANTONIO CANOVA
----------------------------------
Antonio Canova
Vice President, Finance and
Chief Financial Officer
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