UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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 JULY 31, 2000
-------------------------------------------------

[ ] 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:
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CROSSROADS SYSTEMS, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)

DELAWARE 74-2846643
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(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)

8300 NORTH MOPAC EXPRESSWAY
AUSTIN, TEXAS 78759
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(Address of principal executive offices) (Zip Code)

(512) 928-7000
- --------------------------------------------------------------------------------
(Registrant's telephone number, including area code)

- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Sections 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. [X] Yes [ ] No

As of September 1, 2000, Registrant had outstanding 27,460,039 shares of
common stock, par value $0.001 per share.

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

TABLE OF CONTENTS

Page
----

PART I FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

Condensed Consolidated Balance Sheets as of October 31, 1999 and
July 31, 2000................................................................. 2

Condensed Consolidated Statements of Operations for the three and nine months
ended July 31, 1999 and 2000.................................................. 3

Condensed Consolidated Statements of Cash Flows for the nine months ended
July 31, 1999 and 2000........................................................ 4

Notes to Condensed Consolidated Financial Statements.............................. 5

Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations......................................................... 10

Item 3. Quantitative and Qualitative Disclosures About Market Risk........................ 28

PART II OTHER INFORMATION

Item 1. Legal Proceedings................................................................. 29

Item 2. Changes in Securities............................................................. 30

Item 6. Exhibits and Reports on Form 8-K.................................................. 30

SIGNATURES........................................................................................... 31

INDEX TO EXHIBITS.................................................................................... 32

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE DATA)

ASSETS
OCTOBER 31, JULY 31,
1999 2000
----------- ---------

Current assets:
Cash and cash equivalents ................................................ $ 61,320 $ 56,490
Short-term investments ................................................... 19,500 7,590
Accounts receivable, net ................................................. 3,654 4,866
Inventories .............................................................. 3,278 5,314
Prepaids and other current assets ........................................ 933 2,412
--------- ---------
Total current assets ................................................. 88,685 76,672

Note receivable from related party, net ...................................... 154 150
Property and equipment, net .................................................. 2,273 8,722
Intangibles, net ............................................................. -- 39,282
Other assets ................................................................. 618 756
--------- ---------
Total assets ......................................................... $ 91,730 $ 125,582
========= =========

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ......................................................... $ 3,328 $ 5,542
Accrued expenses ......................................................... 735 1,939
Accrued warranty costs ................................................... 309 332
Deferred revenue ......................................................... 117 640
Current portion of long-term debt ........................................ 1,031 --
--------- ---------
Total current liabilities ............................................ 5,520 8,453
Long-term debt, net of current portion ....................................... 1,325 --
Commitments and contingencies (Note 5 and 8)
Stockholders' equity:
Common stock, $.001 par value, 175,000,000 shares authorized,
26,549,919 and 27,433,972 shares issued and outstanding, respectively 27 27
Additional paid-in capital ............................................... 102,461 183,315
Deferred stock-based compensation ........................................ (3,718) (11,982)
Notes receivable from stockholders ....................................... (463) (246)
Accumulated deficit ...................................................... (13,420) (53,804)
Treasury stock at cost (22,500 and 358,954 shares, respectively) ......... (2) (181)
--------- ---------
Total stockholders' equity ........................................... 84,885 117,129
--------- ---------
Total liabilities and stockholders' equity ........................... $ 91,730 $ 125,582
========= =========

The accompanying notes are an integral part of these
condensed consolidated financial statements.

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
-------------------------------- --------------------------------
1999 2000 1999 2000
------------ ------------ ------------ ------------

Revenue:
Product revenue .................... $ 5,065 $ 4,630 $ 11,728 $ 24,309
Other revenue ...................... 2 149 65 386
------------ ------------ ------------ ------------
Total revenue ................. 5,067 4,779 11,793 24,695
Cost of revenue .......................... 3,159 4,189 7,011 14,578
------------ ------------ ------------ ------------
Gross profit ............................. 1,908 590 4,782 10,117
------------ ------------ ------------ ------------
Operating expenses:
Sales and marketing ................ 1,278 7,270 2,965 12,882
Research and development ........... 1,785 4,187 3,654 9,322
General and administrative ......... 960 4,367 1,898 26,267
Amortization of intangibles ........ -- 3,596 -- 5,212
------------ ------------ ------------ ------------
Total operating expenses ...... 4,023 19,420 8,517 53,683
------------ ------------ ------------ ------------
Loss from operations ..................... (2,115) (18,830) (3,735) (43,566)
Other income, net ........................ 48 1,000 90 3,182
------------ ------------ ------------ ------------
Net loss ................................. (2,067) (17,830) (3,645) (40,384)
Accretion on redeemable convertible
preferred stock .................... (114) -- (247) --
------------ ------------ ------------ ------------
Net loss attributable to common stock .... $ (2,181) $ (17,830) $ (3,892) $ (40,384)
============ ============ ============ ============
Basic and diluted net loss per share ..... $ (0.30) $ (0.67) $ (0.57) $ (1.55)
============ ============ ============ ============
Shares used in computing basic and
diluted net loss per share ......... 7,351,542 26,677,275 6,812,407 26,134,537
============ ============ ============ ============

The accompanying notes are an integral part of these
condensed consolidated financial statements.

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)

NINE MONTHS ENDED JULY 31,
------------------------------
1999 2000
------------ ------------

Cash flows from operating activities:
Net loss .......................................................................... $ (3,645) $ (40,384)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization .................................................. 639 7,107
Stock-based compensation ....................................................... 534 25,408
Loss on disposal of property and equipment ..................................... 12 --
Provision for doubtful accounts receivable ..................................... 45 123
Amortization of note receivable from related party ............................. -- 5
Changes in assets and liabilities:
Accounts receivable .......................................................... (1,780) (898)
Inventories .................................................................. (1,551) (1,644)
Prepaids and other assets .................................................... (477) (1,353)
Accounts payable ............................................................. 2,976 2,194
Accrued expenses ............................................................. 1,053 1,053
Accrued warranty costs ....................................................... -- 23
Deferred revenue and other ................................................... 61 505
------------ ------------
Net cash used in operating activities ..................................... (2,133) (7,861)
------------ ------------
Cash flows from investing activities:
Purchase of property and equipment ................................................ (1,499) (8,266)
Cash acquired, net of payments for acquisition of Polaris ......................... -- 1,013
Purchase of held-to-maturity investments .......................................... -- (7,590)
Maturity of held-to-maturity investments .......................................... 2,239 19,500
Payment of note receivable from related party ..................................... -- 59
Other assets ...................................................................... 14 (138)
------------ ------------
Net cash provided by investing activities ................................. 754 4,578
------------ ------------
Cash flows from financing activities:
Proceeds from issuance of common stock ............................................ 102 962
Proceeds from issuance of preferred stock,
net of issuance costs .......................................................... 5,257 --
Administration of stock plan ...................................................... -- (115)
Borrowings under long-term debt agreements ........................................ 963 --
Purchase of treasury stock ........................................................ -- (2)
Deferred offering costs ........................................................... 202 --
Repayment of long-term indebtedness ............................................... (348) (2,356)
Other ............................................................................. -- (36)
------------ ------------
Net cash provided by (used in) financing activities ....................... 6,176 (1,547)
------------ ------------
Net increase (decrease) in cash and cash equivalents ................................ 4,797 (4,830)
Cash and cash equivalents, beginning of period ...................................... 1,695 61,320
------------ ------------
Cash and cash equivalents, end of period ............................................ $ 6,492 $ 56,490
============ ============
Supplemental disclosure of non-cash investing and
financing activities:
The Company purchased all of the assets of Polaris Communications, Inc. during
fiscal year 2000. In conjunction with the acquisition, assets acquired and
liabilities assumed were as follows:
Fair value of assets acquired .................................................. $ -- $ 46,751
Liabilities assumed ............................................................ -- (171)
Stock issued in connection with the acquisition ................................... -- (44,483)
Options issued in connection with the acquisition ................................. -- (1,890)
------------ ------------
Cash payments for acquisition of Polaris .......................................... $ -- $ 207
============ ============

The accompanying notes are an integral part of these
condensed consolidated financial statements.

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1. BASIS OF PRESENTATION

The accompanying condensed consolidated financial statements include the
accounts of Crossroads Systems, Inc. ("Crossroads" or the "Company") and its
wholly-owned subsidiaries. All intercompany balances and transactions have been
eliminated in consolidation.

The accompanying unaudited interim condensed consolidated financial
statements reflect all adjustments (consisting only of normal recurring entries)
which, in the opinion of our management, are necessary for a fair presentation
of the results for the interim periods presented. 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 the Securities and Exchange Commission's rules and
regulations. These financial statements should be read in conjunction with the
audited financial statements and related notes for the year ended October 31,
1999, included in our Annual Report on Form 10-K.

The results of operations for the three and the nine months ended July 31,
2000 are not necessarily indicative of results that may be expected for any
other interim period or for the full year.

Crossroads completed the acquisition of Polaris Communications, Inc.
("Polaris") during the second quarter of fiscal 2000. This acquisition was
accounted for under the purchase method of accounting.

2. ACQUISITION OF POLARIS

On March 21, 2000, Crossroads consummated its acquisition of Polaris.
Polaris was a leading developer and marketer of S/390 mainframe communication
interfaces and systems delivering increased connectivity and bandwidth options
to enterprise data centers, focusing on high-speed connections between
open-systems and mainframes. The aggregate purchase price of $46.6 million
consisted of the issuance of 428,625 shares of Crossroads common stock valued at
approximately $44.5 million, the issuance of 21,375 options to purchase
Crossroads common stock valued at approximately $1.9 million and $0.2 million of
other direct acquisition costs. The results of operations of Polaris and the
estimated fair value of the assets acquired and liabilities assumed are included
in Crossroads' financial statements from the date of acquisition.

The purchase price was allocated to the assets acquired and liabilities
assumed based on Crossroads' estimates of fair value. The fair value assigned to
intangible assets acquired was based on a valuation prepared by an independent
third-party appraisal company and consists of proven research and development,
the in-place workforce and the installed customer base. The purchase price
exceeded the amounts allocated to tangible and intangible assets acquired less
liabilities assumed by approximately $41.3 million. The assigned values are
being amortized on a straight-line basis.

The Company's allocation of the purchase price and the resulting assigned
values for the net assets acquired as of March 21, 2000 are as follows:

VALUE ASSIGNED AMORTIZABLE
TO NET ASSETS LIFE
BALANCE SHEET CATEGORY ACQUIRED (YEARS)
---------------------- -------- -------

Intangible assets:
Proven research and development $ 1,030 3 - 7
In-place workforce 1,800 4
Customer base 340 15
Goodwill 41,289 3
Other assets, net of liabilities assumed 2,121 --

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

The carrying value of goodwill is reviewed on a quarterly basis for
recoverability based on the undiscounted cash flows of the businesses acquired
over the remaining amortization period. Should the review indicate that goodwill
is not recoverable, the Company's carrying value of the goodwill would be
reduced by the estimated shortfall of the cash flows. In addition, the Company
assesses long-lived assets for impairment under Financial Accounting Standards
Board's ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 121,
"Accounting for the Impairment of Long-Lived Assets to be Disposed Of." Under
those rules, goodwill associated with assets acquired in a purchase business
combination is included in impairment evaluations when events or circumstances
exist that indicate the carrying amount of those assets may not be recoverable.

The following table represents unaudited consolidated pro forma information
as if Crossroads and Polaris had been combined as of the beginning of the
periods presented. The pro forma data is presented for illustrative purposes
only and is not necessarily indicative of the combined financial position or
results of operations of future periods or the results that actually would have
occurred had Crossroads and Polaris been a combined company during the specified
periods. The pro forma combined results include the effects of the purchase
price allocation, amortization of intangible assets, and certain adjustments
required to conform to Crossroads' accounting policies.

PRO FORMA
NINE MONTHS ENDED
JULY 31,
--------------------------
1999 2000
---------- ----------

Total revenue ............................... $ 13,541 $ 26,737
Net loss .................................... (14,655) (46,031)
Basic and diluted net loss per share ........ $ (2.17) $ (1.76)

3. INVENTORIES

Inventories consist of the following:

OCTOBER 31, JULY 31,
1999 2000
---------- ----------

Raw materials ..................... $ 2,247 $ 3,511
Work in process ................... -- 12
Finished goods .................... 1,031 1,791
---------- ----------
$ 3,278 $ 5,314
========== ==========

During the three-months ended July 31, 2000, Crossroads recorded a $1.3
million write-down of inventory resulting from StorageTek Technology
Corporation's ("StorageTek") shift in demand to our newer products and Compaq
Computer Corporation's ("Compaq") plan to transition out of our 4100/4200 router
solutions and replace them with its own solution.

4. PROPERTY AND EQUIPMENT

Property and equipment consist of the following:

OCTOBER 31, JULY 31,
1999 2000
------------ ------------

Equipment ............................................. $ 3,536 $ 9,722
Furniture and fixtures ................................ 146 1,511
Leasehold improvements ................................ 245 1,189
------------ ------------
3,927 12,422
------------ ------------

Less: accumulated depreciation and amortization ....... (1,654) (3,700)
------------ ------------
$ 2,273 $ 8,722
============ ============

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

5. COMMITMENTS AND CONTINGENCIES

In April 2000, Crossroads relocated its headquarters in accordance with an
agreement to lease approximately 63,548 square feet of general office,
laboratory, and administrative space in Austin, Texas. The term of the lease
agreement is six years, from April 1, 2000 through March 31, 2006, and
represents a lease commitment of $1.7 million per year for the first three years
and $1.8 million per year, thereafter. In conjunction with entering into the
lease agreement, Crossroads signed an unconditional, irrevocable letter of
credit with a bank for $1.0 million.

6. STOCK-BASED COMPENSATION

On March 1, 2000, Crossroads announced that Larry Sanders was named
president and chief operating officer of the Company. He succeeds Jim Moore, who
retired effective March 3, 2000. We recorded approximately $16.5 million of
stock-based compensation in connection with accelerating the vesting of certain
stock options previously granted to Mr. Moore.

In connection with the grant of certain stock options to Mr. Sanders and to
a new member of our board of directors, Paul Zito, we recorded deferred
compensation during March 2000 aggregating approximately $13.6 million. Deferred
compensation represents, for accounting purposes, the difference between the
fair market value of the common stock underlying these options and their
exercise price at the date of grant. The difference has been recorded as
deferred stock-based compensation and is being amortized over the vesting period
of the applicable options. The amortization associated with these options
totaled approximately $2.0 million and $3.3 million during the three and nine
months ended July 31, 2000.

During June 2000, Crossroads recorded approximately $3.8 million of
stock-based compensation in connection with accelerating the vesting of certain
stock options previously granted to our vice president of sales, who departed
effective June 2, 2000.

During the three-months ended July 31, 2000, the Company allocated
stock-based compensation to specific line items within the statement of
operations based on the classification of the employees who received the
benefit. Stock-based compensation for prior periods has been reclassified to
conform to the July 31, 2000 presentation. Stock-based compensation for the
periods indicated was allocated as follows (in thousands):

THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
------------------------- -------------------------
1999 2000 1999 2000
---------- ---------- ---------- ----------

Cost of revenue ........................ $ 30 $ 73 $ 46 $ 242
Sales and marketing .................... 110 3,926 174 4,305
Research and development ............... 74 131 115 444
General and administrative ............. 173 2,154 199 20,417
---------- ---------- ---------- ----------
Total stock-based compensation ...... $ 387 $ 6,284 $ 534 $ 25,408
========== ========== ========== ==========

7. NET LOSS PER SHARE

The Company's net loss per share is calculated in accordance with SFAS No.
128, "Earnings Per Share". This method requires calculation of both earnings per
share and earnings per share, assuming dilution. Earnings per share excludes the
dilutive effect of common stock equivalents such as stock options, while
earnings per share, assuming dilution, includes such dilutive effects. Future
weighted-average shares outstanding calculations will be impacted by the
following factors: (i) the ongoing issuance of common stock associated with
stock option exercises; (ii) the issuance of common shares associated with our
employee stock

9
CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

purchase program; (iii) any fluctuations in our stock price, which could cause
changes in the number of common stock equivalents included in the earnings per
share, assuming dilution computation; and (iv) the issuance of common stock to
effect business combinations should we enter into such transactions.

The Company has excluded all redeemable convertible preferred stock, up
until the date of their conversion, and all outstanding stock options from the
calculation of diluted net loss per share because all such securities are
anti-dilutive for all periods presented. The total number of common stock
equivalents excluded from the calculations of diluted net loss per common share
were 13,980,481 and 4,721,061 for the nine months ended July 31, 1999 and 2000,
respectively.

8. LITIGATION

On March 31, 2000, Crossroads filed a lawsuit against Chaparral Network
Storage, Inc. ("Chaparral") alleging that Chaparral has infringed one of its
patents with some of their router products. The lawsuit was filed in United
States District Court for the Western District of Texas and the Company is
seeking injunctive relief as well as damages. The case has been assigned to a
Federal District Court Judge, who has already conducted a claims construction
hearing and provided an order resolving claim construction issues. The Company
has started the discovery process. Trial is currently scheduled to begin in the
first six months of 2001. Based on management's understanding of Chaparral's
products sold during the alleged infringement period, management believes that a
reasonable value of the Company's claims brought against Chaparral could be
material to the future results of operations, cash flows and financial position
of the Company. Management intends to vigorously prosecute its claims. The
Company believes it should ultimately prevail on this litigation. However, since
the amount of the damages cannot be fully quantified until the discovery process
proceeds further and no assurances can be made as to the final timing and
outcome of any litigation, no gain has been recorded.

On April 14, 2000, Crossroads filed a lawsuit against Pathlight Technology,
Inc. ("Pathlight") alleging that Pathlight has infringed one of its patents with
their SAN Data Gateway Router. The lawsuit was filed in United States District
Court for the Western District of Texas and the Company is seeking injunctive
relief as well as damages. The case has been assigned to a Federal District
Court Judge, who has already conducted a claims construction hearing and
provided an order resolving claim construction issues. The Company has started
the discovery process. Trial is currently scheduled to begin in the first six
months of 2001. Based on management's understanding of Pathlight's products sold
during the alleged infringement period, management believes that a reasonable
value of the Company's claims brought against Pathlight could be material to the
future results of operations, cash flows and financial position of the Company.
Management intends to vigorously prosecute its claims. The Company believes it
should ultimately prevail on this litigation. However, since the amount of the
damages cannot be fully quantified until the discovery process proceeds further
and no assurances can be made as to the final timing and outcome of any
litigation, no gain has been recorded.

On May 19, 2000, Chaparral filed a counter-suit against Crossroads alleging
tortious interference with prospective business relations. The lawsuit was filed
in District Court, Boulder County, Colorado and Chaparral is seeking injunctive
relief as well as damages. Chaparral claims that the Company has made statements
that Chaparral has infringed our patent rights and that these statements are
false and defamatory. Given the overlapping allegations with the patent
litigation, Crossroads answered and moved to transfer the Colorado case to the
United States District Court in Texas, the Austin division. If transferred to
the Austin division, the Company will seek to consolidate the action with the
aforementioned pending patent litigation. The complaints are at an early stage.
Consequently, at this time it is not possible to predict whether the Company
will incur any liability or to estimate its amount, if any.

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Between July 28, 2000 and September 8, 2000 ten class action lawsuits were
filed against Crossroads and certain of its officers and directors in the United
States District Court for the Western District of Texas, Austin Division. The
plaintiffs in the actions purport to represent purchasers of our common stock
during various periods ranging from January 25, 2000 through August 24, 2000.
The complaints allege that the Company and certain of its executives made
misrepresentations and omissions in violation of sections 10(b) and 20(a) of the
Securities Exchange Act of 1934. The complaints seek compensatory damages, costs
and attorney's fees in an unspecified amount. The Company denies any wrongdoing
and intends to defend against the claims vigorously. In particular, we intend to
file a motion to dismiss after the Court consolidates the actions and appoints a
lead plaintiff under the Private Securities Litigation Reform Act of 1995. The
complaints are at an early stage. Consequently, at this time it is not possible
to predict whether the Company will incur any liability or to estimate its
amount, if any.

9. RECENT ACCOUNTING PRONOUNCEMENTS

In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivatives and Hedging Activities", which establishes
accounting and reporting standards for derivative instruments, including
derivative instruments embedded in other contracts, and for hedging activities.
SFAS No. 133, as amended by SFAS No. 137, "Accounting for Derivative Instruments
and Hedging Activities -- Deferral of the Effective Date of FASB Statement No.
133, an amendment of FASB Statement No. 133", is effective for all fiscal
quarters of fiscal years beginning after June 15, 2000. We do not currently
engage or plan to engage in hedging activities or intend to own or plan to
purchase any derivative instruments.

In March 2000, the FASB issued Financial Accounting Standards Board
Interpretation No. 44 ("Interpretation No. 44"), "Accounting for Certain
Transactions Involving Stock Compensation -- an interpretation of APB Opinion
25" which is generally effective July 1, 2000. Interpretation No. 44 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 non-compensatory plan,
(c) the accounting consequence of various modifications to the terms of a
previously fixed stock option or award, and (d) the accounting for an exchange
of stock compensation awards in a business combination. Management does not
anticipate that the adoption of Interpretation No. 44 will have a material
impact on the financial position or the results of operations.

In December 1999, the Securities and Exchange Commission staff released
Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements"
("SAB No. 101"), which provides guidance on the recognition, presentation and
disclosure of revenue in financial statements. SAB No. 101 will be effective for
all fiscal quarters of fiscal years beginning after December 15, 1999. The
Company does not expect the application of SAB No. 101 to have a material impact
on its financial statements.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.

This report contains forward-looking statements, within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934, that involve risks and uncertainties, such as statements
concerning: growth and future operating results; developments in our markets and
strategic focus; new products and product enhancements; potential acquisitions
and the integration of acquired businesses, products and technologies; strategic
relationships; and future economic, business and regulatory conditions. Such
forward-looking statements are generally accompanied by words such as "plan,"
"estimate," "expect," "believe," "should," "would," "could," "anticipate," "may"
or other words that convey uncertainty of future events or outcomes. These
forward-looking statements and other statements made elsewhere in this report
are made in reliance on the Private Securities Litigation Reform Act of 1995.
The section below entitled "Factors That May Affect Future Results" sets forth
certain factors that could cause our actual future results to differ materially
from these statements.

OVERVIEW

We are the leading provider of storage routers for storage area networks,
based on our market share of storage routers shipped. Storage routers are
computer equipment that organizations use to connect servers and storage systems
together in a storage area network, or "SAN". A SAN is a high speed computer
network that facilitates data transfers among servers and storage systems using
high performance data communications that follow the industry-accepted rules and
conventions, which are commonly referred to as computer protocols. By using our
storage routers to serve as the interconnect between SANs and the other devices
in a computer network, organizations are able to more effectively and
efficiently store, manage and ensure the integrity and availability of their
data.

Our company was originally formed in 1995 as Infinity Commstor, LLC, a
Texas limited liability company. In 1996, Infinity Commstor was merged into a
newly formed Delaware corporation, which became Crossroads Systems, Inc., with
operations conducted through a wholly-owned Texas corporation subsidiary. Since
mid-1996, our operating activities have related primarily to increasing our
research and development capabilities, designing, developing and marketing our
storage routers, staffing our administrative, marketing and sales organizations
and establishing relationships with other equipment manufacturers, or "OEMs",
and distributors, resellers and system integrators. We began shipping our first
product, the Crossroads 4100 storage router, to OEMs for their evaluation in
July 1997.

On March 21, 2000, we consummated our acquisition of Polaris
Communications, Inc. ("Polaris"). Polaris was a leading developer and marketer
of S/390 mainframe communication interfaces and systems delivering increased
connectivity and bandwidth options to enterprise data centers, focusing on
high-speed connections between open-systems and mainframes. The aggregate
purchase price of $46.6 million consisted of the issuance of 428,625 shares of
our common stock valued at approximately $44.5 million, the issuance of 21,375
options to purchase our common stock valued at approximately $1.9 million and
$200,000 of other direct acquisition costs. The acquisition of Polaris was
accounted for under the purchase method of accounting. Amortization of
intangibles totaled approximately $3.6 million and $5.2 million for the three
and nine months ended July 31, 2000, respectively.

On March 1, 2000, we announced that Larry Sanders was named president and
chief operating officer of the Company. He succeeds Jim Moore, who retired
effective March 3, 2000. We recorded approximately $16.5 million of stock-based
compensation in connection with accelerating the vesting of certain stock
options previously granted to Mr. Moore. In connection with the grant of certain
stock options to Mr. Sanders and to a new member of our board of directors, Paul
Zito, we recorded deferred compensation during March 2000 aggregating
approximately $13.6 million. The amortization associated with these options
totaled approximately $2.0 million and $3.3 million during the three and nine
months ended July 31, 2000. During June 2000, we recorded approximately $3.8
million of stock-based compensation in connection with accelerating the vesting
of certain stock options previously granted to our vice president of sales, who
departed effective June 2, 2000.

During the three months ended July 31, 2000, we recorded a $1.1 million
return resulting from StorageTek's shift in demand to our newer products.
Moreover, Compaq has informed us that it intends to discontinue purchasing our
4100/4200 line of storage router and to internally manufacture their own
solution. As a result, we recorded a $1.3 million write-down of inventory
resulting from StorageTek's shift in demand and Compaq's plan to transition out
of our 4100/4200 router solutions and replace them with its own solution.

In the past we have experienced fluctuation in the timing of orders from
our OEM customers, and we expect to continue to experience these fluctuations in
the future. These fluctuations have resulted from, among other things, OEM
customers placing initial orders for our products for purposes of qualification
and testing. As a result, we may report an increase in sales or a commencement
of sales of a product in a quarter that will not be followed by similar sales in
subsequent quarters as OEMs conduct qualification and testing.

A key element of our growth strategy is to expand our sales channels. To
this end, we have established relationships with a number of distributors,
resellers and system integrators. Although we anticipate that revenue derived
from sales to distributors, resellers and system integrators will increase as a
percentage of our total revenue in future periods, we expect to continue to
experience significant customer concentration in sales to key OEM accounts for
the foreseeable future.

Although we negotiate the prices for our products on an individual basis
with each of our OEM customers, many of our current agreements with our OEM
customers include provisions that require reductions in the sales price for our
products over time. We believe that this practice is common within our industry.
To date, our agreements with OEM customers, including our largest customers,
provide for quarterly reductions in pricing on a product-by-product basis
ranging from 8% to 15% annually, with the actual discount determined according
to the volume potential expected from the customer, the OEM's customer base, the
credibility the OEM may bring to our solution, additional technology the OEM may
help us incorporate with our product and other Crossroads products the OEM
supports. Notwithstanding, the decreases in our average selling prices of our
older products has been offset by higher average selling prices for our newer
products, as well as sales to distributors, resellers and system integrators
where price decreases are not generally required. Nonetheless, we could
experience declines in our average unit selling prices for our products in the
future, especially if our newer products do not receive broad market acceptance
or if our efforts to increase sales to distributors, resellers and system
integrators are not successful. In addition, declines in our average selling
prices may be more pronounced should we encounter significant pricing pressures
from increased competition within the storage router market.

With respect to sales of our products to OEMs, we recognize product revenue
when products are shipped to the OEM. Product sales to distributors, resellers
and system integrators who do not have return rights are recognized at the time
of shipment. To the extent that we sell products to distributors, resellers and
system integrators that have rights of return, we defer revenue and cost of
revenue associated with such sales and recognize these amounts when that
customer sells our products to its customers. At July 31, 2000, our deferred
revenue totaled $640,000. We provide a repair or replace warranty of between 15
and 39 months following the sale of our products, and we provide a reserve for
warranty costs when the related product revenue is recognized.

Through August 1999, we outsourced substantially all of our manufacturing
requirements to XeTel Corporation, a contract manufacturer, and a significant
portion of our cost of revenue historically has consisted of payments to XeTel.
In September 1999, we transitioned the final assembly and test portion of our
manufacturing process from XeTel to an in-house facility. During the transition
period, our manufacturing costs increased, and our gross profit decreased, as we
incurred costs of final assembly and test performed both by our contract
manufacturer and us. In fiscal 2000, we have engaged another contract
manufacturer, Solectron Texas LP, to make our 4x50 family of products. We
believe that this will enable us to reduce our reliance on XeTel. We believe
that bringing final assembly and test operations in-house and the addition of
Solectron as another contract manufacturer have allowed us to reduce our total
manufacturing costs on a per unit basis and provides us with greater flexibility
to respond to changes in customer demand. As the needs of our customers continue
to evolve, we plan to reassess our manufacturing requirements on a periodic
basis and effect appropriate changes to our manufacturing processes.

In connection with the grant of stock options to our employees and
directors, we recorded deferred compensation during fiscal 1998 and 1999
aggregating approximately $5.0 million. In addition, we recorded deferred
compensation during the nine months ended July 31, 2000 aggregating
approximately $13.6 million. Deferred compensation represents, for accounting
purposes, the difference between the deemed fair value of the common stock
underlying these options and their exercise price on the date of grant. The
difference has been recorded as deferred stock-based compensation and is being
amortized over the vesting period of the applicable options, typically four
years. Of the total deferred compensation amount, approximately $6.5 million has
been amortized as of July 31, 2000.

During the three-months ended July 31, 2000, we allocated stock-based
compensation to specific line items within the statement of operations based on
the classification of the employees who received the benefit. Stock-based
compensation for prior periods has been reclassified to conform to the July 31,
2000 presentation.

Stock-based compensation for the periods indicated was allocated as follows
(in thousands):

THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
------------------------- -------------------------
1999 2000 1999 2000
---------- ---------- ---------- ----------

Cost of revenue .......................... $ 30 $ 73 $ 46 $ 242
Sales and marketing ...................... 110 3,926 174 4,305
Research and development ................. 74 131 115 444
General and administrative ............... 173 2,154 199 20,417
---------- ---------- ---------- ----------
Total stock-based compensation ......... $ 387 $ 6,284 $ 534 $ 25,408
========== ========== ========== ==========

We currently expect to amortize the remaining amounts of deferred
compensation as of July 31, 2000 in the periods indicated (in thousands):

AUG. 1, 2000 TO NOVEMBER 1 TO OCTOBER 31,
---------------------------------------------------------
OCT. 31, 2000 2000-2001 2001-2002 2002-2003 2003-2004 TOTAL
------------- ------------ ------------ ------------ ------------ ------------

Cost of revenue ........................ $ 46 $ 122 $ 56 $ 12 $ -- $ 236
Sales and marketing .................... 53 142 66 14 -- 275
Research and development ............... 84 226 101 20 -- 431
General and administrative ............. 2,084 5,516 2,378 943 119 11,040
------------ ------------ ------------ ------------ ------------ ------------
Total stock-based compensation .... $ 2,267 $ 6,006 $ 2,601 $ 989 $ 119 $ 11,982
============ ============ ============ ============ ============ ============

We have incurred significant operating losses in every fiscal quarter and
annual period since November 1, 1995 and our accumulated deficit was $53.8
million at July 31, 2000.

As of July 31, 2000, we had approximately $19.3 million of federal net
operating loss carryforwards. These net operating loss carryforwards begin to
expire in 2011. We have not recognized any benefit from the future use of loss
carryforwards for these periods or for any other periods since inception due to
uncertainties regarding the realization of deferred tax assets based on our
taxable earnings history.

RESULTS OF OPERATIONS

The following table sets forth our consolidated financial data for the
periods indicated expressed as a percentage of our total revenue, net of the
aforementioned allocation of stock-based compensation for all periods presented
- - See Item I. Financial Statements (Unaudited) - Note 6 to Notes to Condensed
Consolidated Financial Statements.

THREE MONTHS ENDED NINE MONTHS ENDED
JULY 31, JULY 31,
--------------------------- ---------------------------
1999 2000 1999 2000
---------- ---------- ---------- ----------

Revenue:
Product revenue ...................... 100.0% 96.9% 99.4% 98.4%
Other revenue ........................ 0.0 3.1 0.6 1.6
---------- ---------- ---------- ----------
Total revenue .................. 100.0 100.0 100.0 100.0
Cost of revenue ............................. 61.7 86.1 59.1 58.1
---------- ---------- ---------- ----------
Gross profit ................................ 38.3 13.9 40.9 41.9
Operating expenses:
Sales and marketing .................. 23.1 70.0 23.7 34.7
Research and development ............. 33.9 84.9 30.0 35.9
General and administrative ........... 15.5 46.3 14.4 23.7
Amortization of intangibles .......... -- 75.2 -- 21.1
Stock-based compensation ............. 7.6 131.5 4.5 102.9
---------- ---------- ---------- ----------
Total operating expenses ....... 80.1 407.9 72.6 218.3
Loss from operations ........................ (41.8) (394.0) (31.7) (176.4)
Other income, net ........................... 1.0 20.9 0.8 12.9
---------- ---------- ---------- ----------
Net loss .................................... (40.8)% (373.1)% (30.9)% (163.5)%
========== ========== ========== ==========

COMPARISON OF THREE MONTHS ENDED JULY 31, 1999 AND 2000

Revenue. Total revenue decreased 5.7% from $5.1 million for the three
months ended July 31, 1999 to $4.8 million for the three months ended July 31,
2000. Without the inclusion of Polaris products and services, total revenue
decreased 27% for the three month period ended July 31, 2000 compared to the
same period in 1999.

Product revenue. Product revenue decreased 8.6% from $5.1 million for the
three months ended July 31, 1999 to $4.6 million for the three months ended July
31, 2000. As a percentage of total revenue, product revenue decreased from 100%
for the three months ended July 31, 1999 to 96.9% for the three months ended
July 31, 2000. During the three months ended July 31, 2000, we recorded a
product return of $1.1 million resulting from a StorageTek's shift in demand to
our newer products. In addition, in July 2000 we issued a "stop-ship" on our
4x50 line and part of our 4100 line as a precautionary measure due to a firmware
interoperability issue with certain SAN configurations. Although we resumed
shipping our affected fibre channel routers soon after, the timing of the
"stop-ship" negatively affected our product revenues for the three months ended
July 31, 2000.

Other revenue. Other revenue includes sales of licenses for a software
developer's kit, consulting fees and fees received from the licensing of other
intellectual property. Other revenue increased 7,234.3% from $2,000 for the
three months ended July 31, 1999 to $149,000 for the three months ended July 31,
2000. The increase for the three months ended July 31, 2000 was due to the
license of a product design and royalties for $139,000 in that period.

Cost of revenue and gross profit. Cost of revenue consists primarily of
contract manufacturing costs, materials costs, manufacturing overhead, warranty
costs and stock-based compensation. Cost of revenue, net of increased
stock-based compensation of $43,000, increased 31.6% from $3.1 million for the
three months ended July 31, 1999 to $4.1 million for the three months ended July
31, 2000. These increases were primarily due to the $1.3 million write-down of
inventory resulting from the aforementioned shift in demand and Compaq's plan to
transition out of our 4100/4200 router solutions and replace them with its own
solution. Gross profit, net of stock-based compensation, decreased 65.8% from
$1.9 million for the three months ended July 31, 1999 to $660,000 for the three
months ended July 31, 2000. Gross profit margin, net of stock-based
compensation, decreased from 38.3% for the three months ended July 31, 1999 to
13.9% for the three months ended July 31, 2000. The decrease was primarily due
to decreased product revenue in that period in addition to the write-down of
inventory and increased stock-based compensation.

Sales and marketing. Sales and marketing expenses consist primarily of
salaries, commissions and other personnel-related costs, travel expenses,
advertising programs, other promotional activities and stock-based compensation.
Sales and marketing expenses, net of increased stock-based compensation of $3.8
million, increased 186.4% from $1.2 million for the three months ended July 31,
1999 to $3.3 million for the three months ended July 31, 2000. This increase in
sales and marketing expenses for the three months ended July 31, 2000 was
primarily due to increased travel and entertainment expenses of approximately
$150,000 and the hiring of additional sales and marketing personnel resulting in
approximately $1.0 million of increased compensation expense. During June 2000,
we recorded approximately $3.8 million of stock-based compensation in connection
with accelerating the vesting of stock options previously granted to our vice
president of sales, who departed effective June 2, 2000. Sales and marketing
personnel totaled 34 at July 31, 1999 and 51 at July 31, 2000. As a percentage
of total revenue, sales and marketing expenses, net of stock-based compensation,
increased from 23.1% for the three months ended July 31, 1999 to 70.0% for the
three months ended July 31, 2000. This increase as a percentage of total revenue
for the three months ended July 31, 2000 was primarily due to lower revenue in
the three months ended July 31, 2000. We anticipate that sales and marketing
expenses will continue to increase in absolute dollars and may fluctuate as a
percentage of total revenue, due to the planned expansion of our sales and
marketing efforts and increased marketing activity that is intended to broaden
awareness of the benefits of our products.

Research and development. Research and development expenses consist
primarily of salaries and other personnel-related costs, product development,
prototyping expenses and stock-based compensation. Research and development
expenses, net of increased stock-based compensation of $57,000, increased 137.1%
from $1.7 million for the three months ended July 31, 1999 to $4.1 million for
the three months ended July 31, 2000. This increase in research and development
expenses was primarily due to the hiring of additional research and development
personnel resulting in approximately $1.1 million of increased compensation
expense, increased consulting expenses of approximately $180,000 and
approximately $250,000 of increased depreciation expense. Research and
development personnel totaled 42 at July 31, 1999 and 79 at July 31, 2000. As a
percentage of total revenue, research and development expenses, net of
stock-based compensation, increased from 33.9% for the three months ended July
31, 1999 to 84.9% for the three months ended July 31, 2000. This increase as a
percentage of total revenue for the three months ended July 31, 2000 was
primarily due to lower revenue in the three months ended July 31, 2000. We
expect that research and development expenses will continue to increase in
absolute dollars and will fluctuate as a percentage of our total revenue, due to
the importance of research and development in developing our technologies and
expanding our product offerings.

General and administrative. General and administrative expenses consist
primarily of salaries and other personnel-related costs, facilities and other
costs of our administrative, executive and information technology departments,
as well as legal and accounting expenses, insurance costs and stock-based
compensation. General and administrative expenses, net of increased stock-based
compensation of $2.0 million, increased 181.1% from $790,000 for the three
months ended July 31, 1999 to $2.2 million for the three months ended July 31,
2000. This increase in general and administrative expenses was primarily due to
increased legal fees of approximately $500,000 and the hiring of administrative
personnel resulting in approximately $500,000 of increased compensation expense
for the three months ended July 31, 2000 which were necessary to manage and
support the growth in our business as a public company. General and
administrative personnel totaled 20 at July 31, 1999 and 38 at July 31, 2000. As
a percentage of total revenue, general and administrative expenses, net of
stock-based compensation, increased from 15.5% for the three months ended July
31, 1999 to 46.3% for the three months ended July 31, 2000. This increase as a
percentage of total revenue for the three months ended July 31, 2000 was
primarily due to lower revenue in the three months ended July 31, 2000. We
anticipate that general and administrative expenses will continue to increase in
absolute dollars for the foreseeable future as we accommodate growth, add
related infrastructure and incur expenses related to being a public company.
However, if our revenue continues to increase, general and administrative
expenses should decrease as a percentage of total revenue.

Other income, net. Other income, net consists primarily of interest income
on short-term investments partially offset by interest expense. Other income,
net was $48,000 and $1.0 million in the three months ended July 31, 1999 and
2000, respectively, representing 1.0% and 20.9% of total revenues, respectively.
The increase in other income, net was primarily due to increased cash, cash
equivalents and short-term investment balances resulting from the proceeds from
our initial public offering in October 1999.

COMPARISON OF NINE MONTHS ENDED JULY 31, 1999 AND 2000

Revenue. Our total revenue increased 109.4% from $11.8 million for the nine
months ended July 31, 1999 to $24.7 million for the nine months ended July 31,
2000. Without the inclusion of Polaris products and services from the date of
acquisition, total revenue increased 95% for the nine-month period ended July
31, 2000 compared to the same period in 1999.

Product revenue. Product revenue increased 107.3% from $11.7 million for
the nine months ended July 31, 1999 to $24.3 million for the nine months ended
July 31, 2000. As a percentage of total revenue, product revenue decreased from
99.4% for the nine months ended July 31, 1999 to 98.4% for the nine months ended
July 31, 2000. The increases in product revenue resulted from increased sales of
our storage router product family through an increased customer base and
increased sales to our significant original equipment manufacturers, customers,
distributors, resellers and system integrators in conjunction with a growing
demand for Storage Area Network routers.

Other revenue. Other revenue includes sales of licenses for a software
developer's kit, consulting fees and fees received from the licensing of other
intellectual property. Other revenue increased 493.4% from $65,000 for the nine
months ended July 31, 1999 to $386,000 for the nine months ended July 31, 2000.
The increase for the nine months ended July 31, 2000 was due to the license of a
product design and royalties for $248,000 in that period.

Cost of revenue and gross profit. Cost of revenue consists primarily of
contract manufacturing costs, materials costs, manufacturing overhead, warranty
costs and stock-based compensation. Cost of revenue, net of increased
stock-based compensation of $196,000, increased 105.8% from $7.0 million for the
nine months ended July 31, 1999 to $14.3 million for the nine months ended July
31, 2000. These increases were primarily due to increases in unit sales volume
and a corresponding increase in costs related to manufacturing. Gross profit,
net of stock-based compensation, increased 114.6% from $4.8 million for the nine
months ended July 31, 1999 to $10.4 million for the nine months ended July 31,
2000. The increase was primarily due to increased product revenue in each of
these periods. Gross profit margin, net of stock-based compensation, increased
from 40.9% for the nine months ended July 31, 1999 to 41.9% for the nine months
ended July 31, 2000. The increase in gross profit resulted from favorable
customer and product mix in addition to the benefits of moving our final
assembly and test to an in-house facility.

Sales and marketing. Sales and marketing expenses consist primarily of
salaries, commissions and other personnel-related costs, travel expenses,
advertising programs, other promotional activities and stock-based compensation.
Sales and marketing expenses, net of increased stock-based compensation of $4.1
million, increased 207.4% from $2.8 million for the nine months ended July 31,
1999 to $8.6 million for the nine months ended July 31, 2000. This increase in
sales and marketing expenses for the nine months ended July 31, 2000 was
primarily due to the hiring of additional sales and marketing personnel
resulting in approximately $2.4 million of increased compensation expense,
including increased commissions commensurate with greater sales. During June
2000, Crossroads recorded approximately $3.8 million of stock-based compensation
in connection with accelerating the vesting of certain stock options previously
granted to our vice president of sales, who departed effective June 2, 2000.
Sales and marketing personnel totaled 34 at July 31, 1999 and 51 at July 31,
2000. As a percentage of total revenue, sales and marketing expenses, net of
stock-based compensation, increased from 23.7% for the nine months ended July
31, 1999 to 34.7% for the nine months ended July 31, 2000. We anticipate that
sales and marketing expenses will continue to increase in absolute dollars and
may fluctuate as a percentage of total revenue, due to the planned expansion of
our sales and marketing efforts and increased marketing activity that is
intended to broaden awareness of the benefits of our products.

development expenses, net of stock-based compensation, increased from 30.0% for
the nine months ended July 31, 1999 to 35.9% for the nine months ended July 31,
2000. We expect that research and development expenses will continue to increase
in absolute dollars and will fluctuate as a percentage of our total revenue, due
to the importance of research and development in developing our technologies and
expanding our product offerings.

General and administrative. General and administrative expenses consist
primarily of salaries and other personnel-related costs, facilities and other
costs of our administrative, executive and information technology departments,
as well as legal and accounting expenses, insurance costs and stock-based
compensation. General and administrative expenses, net of increased stock-based
compensation of $20.2 million, increased 244.6% from $1.7 million for the nine
months ended July 31, 1999 to $5.8 million for the nine months ended July 31,
2000. This increase in general and administrative expenses was primarily due to
the hiring of administrative personnel resulting in approximately $1.6 million
of increased compensation expense for the nine months ended July 31, 2000 which
were necessary to manage and support the growth in our business as a public
company. General and administrative personnel totaled 20 at July 31, 1999 and 38
at July 31, 2000. In addition, we incurred one-time expenses totaling
approximately $1.3 million related to the transition from Mr. Moore to Mr.
Sanders as president and chief operating officer, the relocation of our
corporate headquarters and legal costs associated with patent infringement
lawsuits. During the nine months ended July 31, 2000, we recorded approximately
$17.8 million in stock-based compensation in connection with the transition of
our president and chief operating officer from Mr. Moore to Mr. Sanders
resulting from approximately $16.5 million of stock-based compensation recorded
in connection with accelerating the vesting of certain stock options previously
granted to Mr. Moore and approximately $2.0 million in amortization associated
with Mr. Sanders' options. As a percentage of total revenue, general and
administrative expenses, net of stock-based compensation, increased from 14.4%
for the nine months ended July 31, 1999 to 23.7% for the nine months ended July
31, 2000. We anticipate that general and administrative expenses will continue
to increase in absolute dollars for the foreseeable future as we accommodate
growth, add related infrastructure and incur expenses related to being a public
company. However, if our revenue continues to increase, general and
administrative expenses should decrease as a percentage of total revenue.

Other income, net. Other income, net consists primarily of interest income
on short-term investments partially offset by interest expense. Other income,
net was $90,000 and $3.2 million in the nine months ended July 31, 1999 and
2000, respectively, representing 0.8% and 12.9% of total revenues, respectively.
The increase in other income, net was primarily due to increased cash, cash
equivalents and short-term investment balances resulting from the proceeds from
our initial public offering in October 1999.

LIQUIDITY AND CAPITAL RESOURCES

Our principal sources of liquidity at July 31, 2000 consisted of $56.5
million in cash and cash equivalents, $7.6 million in short-term investments and
our bank credit facility. The credit facility, as amended and restated in
September 1999, includes a revolving line of credit providing borrowings up to
the lesser of (a) $2.5 million or (b) 80% of eligible accounts receivable plus
25% of eligible inventories; and an equipment loan agreement providing for
financing of up to $1.9 million. Borrowings under the revolving line of credit
bear interest at the bank's prime rate, which was 9.5% at July 31, 2000, and are
secured by our accounts receivable and inventories. Term loan financing
available to us under the equipment loan agreement bears interest at the bank's
prime rate plus 0.5%, is secured by the related capital equipment and is payable
through June 30, 2003. The line of credit and the equipment loan agreement
expire in August 2000. The line of credit and equipment loan agreement contain
provisions that prohibit the payment of cash dividends and require the
maintenance of specified levels of tangible net worth and certain financial
performance covenants measured on a monthly basis. In February 2000, we entered
into a $1.0 million letter of credit in connection with the lease requirements
of our new facility.

As of July 31, 2000, there were no borrowings outstanding under the
revolving line of credit and no term loans outstanding.

Our bank credit facility requires that we comply with the following
financial covenants:

o a quick ratio of at least 1.50-to-1.00 ("quick ratio" being defined as
the ratio of our consolidated, unrestricted cash; cash equivalents;
net billed accounts receivable; and investments with maturities of
fewer than twelve months to our current liabilities);

o a debt-to-tangible net worth ratio of not more than 1.00-to-1.00; and

o a liquidity coverage-to-debt service ratio of not less than
1.50-to-1.00 ("liquidity coverage" being defined as cash plus 80% of
accounts receivable eligible for borrowings).

Additionally, the credit facility requires that we operate at a profit in each
fiscal quarter; however, we are allowed a loss which may not exceed $2.9 million
in each of the fiscal quarters ending October 31, 1999, January 31, 2000 and
April 30, 2000; $2.3 million in the fiscal quarter ending July 31, 2000; and
$1.5 million in the fiscal quarter ending October 31, 2000. Although we are in
violation of this financial covenant as of July 31, 2000, we have received a
waiver from our bank dated August 24, 2000.

Cash utilized by operating activities was $2.1 million for the nine months
ended July 31, 1999 as compared to $7.9 million for the nine months ended July
31, 2000. The increases in net cash utilized reflected increased losses from
operations and working capital required to fund the expansion of our operations.

Cash provided by investing activities was $0.8 million for the nine months
ended July 31, 1999 as compared to $4.6 million for the nine months ended July
31, 2000. The increases in net cash provided reflected the maturity of
held-to-maturity investments, net of purchases, of $11.9 million, and cash
acquired from business acquisitions, net of cash payments, of $1.0 million.
Capital expenditures were $1.5 million and $8.3 million for the nine months
ended July 31, 1999 and 2000, respectively. These expenditures reflect our
investments in computer equipment and software, test equipment, software
development tools and leasehold improvements, all of which were required to
support our business expansion. We anticipate additional capital expenditures
through fiscal 2000 of at least $1.9 million to fund our purchase of a new
enterprise resource planning system; leasehold improvements; costs associated
with the transition to an in-house facility of the final assembly and test
portions of our manufacturing process, including modification to our facilities
and test and other manufacturing equipment; and equipment and software to
support our projected growth in personnel.

Cash provided by financing activities was $6.2 million for the nine months
ended July 31, 1999 as compared to cash utilized by financing activities of $1.5
million for the nine months ended July 31, 2000. The increase in cash utilized
reflected the payment of our existing debt of $2.4 million in December 1999 in
addition to $5.3 million in proceeds from issuance of preferred stock during the
nine months ended July 31, 1999. We have funded our operations to date primarily
through sales of preferred stock and our initial public offering, resulting in
aggregate gross proceeds to us of $98.2 million, product sales and, to a lesser
extent, bank debt.

We believe the net proceeds we received from our initial public offering,
together with our existing cash balances, the net proceeds from the sale of our
Series E preferred stock in August 1999 and our credit facilities, will be
sufficient to meet our capital requirements through at least the next 12 months.
However, we could be required, or could elect, to seek additional funding prior
to that time. Our future capital requirements will depend on many factors,
including the rate of revenue growth, the timing and extent of spending to
support product development efforts and expansion of sales and marketing
activities, the timing of introductions of new products and enhancements to
existing products, and market acceptance of our products. On March 21, 2000, we
consummated our acquisition of Polaris Communications, Inc. and we may enter
into additional acquisitions or strategic arrangements in the future which also
could require us to seek additional equity or debt financing. We cannot assure
you that additional equity or debt financing, if required, will be available to
us on acceptable terms, or at all.

RECENT ACCOUNTING PRONOUNCEMENTS

In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivatives and Hedging Activities", which establishes
accounting and reporting standards for derivative instruments, including
derivative instruments embedded in other contracts, and for hedging activities.
SFAS No. 133, as amended by SFAS No. 137, "Accounting for Derivative Instruments
and Hedging Activities - Deferral of the Effective Date of FASB Statement No.
133, an amendment of FASB Statement No. 133", is effective for all fiscal
quarters of fiscal years beginning after June 15, 2000. We do not currently
engage or plan to engage in hedging activities or intend to own or plan to
purchase any derivative instruments.

In March 2000, the FASB issued Financial Accounting Standards Board
Interpretation No. 44 ("Interpretation No. 44"), "Accounting for Certain
Transactions Involving Stock Compensation -- an interpretation of APB Opinion
25" which is generally effective July 1, 2000. Interpretation No. 44 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 non-compensatory plan,
(c) the accounting consequence of various modifications to the terms of a
previously fixed stock option or award, and (d) the accounting for an exchange
of stock compensation awards in a business combination. We do not anticipate
that the adoption of Interpretation No. 44 will have a material impact on our
financial position or the results of operations.

In December 1999, the Securities and Exchange Commission staff released
Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements"
("SAB No. 101"), which provides guidance on the recognition, presentation and
disclosure of revenue in financial statements. SAB No. 101 will be effective for
all fiscal quarters of fiscal years beginning after December 15, 1999. We do not
expect the application of SAB No. 101 to have a material impact on our financial
statements.

FACTORS THAT MAY AFFECT FUTURE RESULTS

Numerous factors may affect our business and future operating results.
These factors include, but are not limited to the potential for significant
losses to continue; our ability to accurately forecast our revenues;
fluctuations in revenue and operating results; class action securities
litigation; overall market performance; limited product lines; limited number of
OEM customers; competition; delays in research and development; inventory risks;
the inability to expand our distribution channels; the loss of our primary
contract manufacturers; risks of delay or poor execution from a variety of
sources; inventory risks; limited resources; pricing; dependence upon key
personnel; international operations; product liability claims; the inability to
protect our intellectual property; potential future acquisitions; concentration
of ownership; and volatility of stock price. The discussion below addresses some
of these factors. For a more thorough discussion of these and other factors that
may affect our business and future results, see the discussion under the caption
"Additional Factors That May Affect Future Results" in our Annual Report on Form
10-K dated January 31, 2000.

WE HAVE INCURRED SIGNIFICANT LOSSES, WE EXPECT FUTURE LOSSES, AND WE MAY NEVER
BECOME PROFITABLE.

We have incurred significant losses in every fiscal quarter since fiscal
1996 and expect to continue to incur losses in the future. As of July 31, 2000,
we had an accumulated deficit of $53.8 million. We cannot be certain that we
will be able to sustain growth rates that we will need to realize sufficient
revenue to achieve profitability. We also expect to incur significant sales and
marketing, research and development and general and administrative expenses and,
as a result, we expect to continue to incur losses. Moreover, even if we do
achieve profitability, we may not be able to sustain or increase profitability.

DUE TO OUR LIMITED OPERATING HISTORY AND THE UNCERTAIN DEVELOPMENT OF THE
STORAGE AREA NETWORK MARKET, WE MAY HAVE DIFFICULTY ACCURATELY PREDICTING
REVENUE FOR FUTURE PERIODS AND APPROPRIATELY BUDGETING FOR EXPENSES.

We have generated product revenue for approximately three years and, thus,
we have only a short history from which to predict future revenue. This limited
operating experience, combined with the rapidly evolving nature of the storage
area network market in which we sell our products and other factors which are
beyond our control, reduces our ability to accurately forecast our quarterly and
annual revenue. However, we use our forecasted revenue to establish our expense
budget. Most of our expenses are fixed in the short term or incurred in advance
of anticipated revenue. As a result, we may not be able to decrease our expenses
in a timely manner to offset any shortfall of revenue. We are currently
expanding our staffing and increasing our expense levels in anticipation of
future revenue growth. If our revenue does not increase as anticipated,
significant losses could result due to our higher expense levels.

WE HAVE EXPERIENCED AND EXPECT TO CONTINUE TO EXPERIENCE SIGNIFICANT
PERIOD-TO-PERIOD FLUCTUATIONS IN OUR REVENUE AND OPERATING RESULTS, WHICH MAY
RESULT IN VOLATILITY IN OUR STOCK PRICE.

We have experienced and expect to continue to experience significant
period-to-period fluctuations in our revenue and operating results due to a
number of factors, and any such variations and factors may cause our stock price
to fluctuate. Accordingly, you should not rely on the results of any past
quarterly or annual periods as an indication of our future performance.

It is likely that in some future period our operating results will be below
the expectations of public market analysts or investors. If this occurs, our
stock price may drop, perhaps significantly.

A number of factors may particularly contribute to fluctuations in our
revenue and operating results, including:

o the timing of orders from, and product integration by, our customers,
particularly our OEMs, and the tendency of these customers to change
their order requirements frequently with little or no advance notice
to us;

o the rate of adoption of storage area networks as an alternative to
existing data storage and management systems;

o the ongoing need for storage routing products in storage area network
architectures;

o deferrals of customer orders in anticipation of new products, services
or product enhancements from us or our competitors or from other
providers of storage area network products; and

o the rate at which new markets emerge for products we are currently
developing.

In addition, potential and existing OEM customers often place initial
orders for our products for purposes of qualification and testing. As a result,
we may report an increase in sales or a commencement of sales of a product in a
quarter that will not be followed by similar sales in subsequent quarters as
OEMs conduct qualification and testing. This order pattern has in the past and
could in the future lead to fluctuations in quarterly revenue and gross profits.

AN ADVERSE DECISION IN THE VARIOUS CLASS ACTION LAWSUITS FILED AGAINST US MAY
HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS AND FINANCIAL PERFORMANCE.

We were named as the defendant in ten class action lawsuits filed between
July 28, 2000 and September 8, 2000. The plaintiffs in the actions purport to
represent purchasers of our common stock during various periods ranging from
January 25, 2000 through August 24, 2000. The complaints allege that certain of
our executives made misrepresentations and omissions in violation of sections
10(b) and 20(a) of the Securities Exchange Act of 1934. The complaints seek
compensatory damages, costs and attorney's fees in an unspecified amount. We
deny any wrongdoing and intend to defend against the claims vigorously. In
particular, we intend to file a motion to dismiss after the Court consolidates
the actions and appoints a lead plaintiff under the Private Securities
Litigation Reform Act of 1995. An adverse judgment may have a material adverse
effect on our business and financial performance. See Item 1. Financial
Statements (Unaudited) - Note 8 to Notes to Condensed Consolidated Financial
Statements.

OUR BUSINESS IS DEPENDENT ON THE STORAGE AREA NETWORK MARKET WHICH IS NEW AND
UNPREDICTABLE, AND IF THIS MARKET DOES NOT DEVELOP AND EXPAND AS WE ANTICIPATE,
OUR BUSINESS WILL SUFFER.

Fibre Channel-based storage area networks, or SANs, were first deployed in
1997. As a result, the market for SANs and related storage router products has
only recently begun to develop and is rapidly evolving. Because this market is
new, it is difficult to predict its potential size or future growth rate. Our
products are used exclusively in SANs and, therefore, our business is dependent
on the SAN market. Accordingly, the widespread adoption of SANs for use in
organizations' computing systems is critical to our future success. Most of the
organizations that potentially may purchase our products from our customers have
invested substantial resources in their existing computing and data storage
systems and, as a result, may be reluctant or slow to adopt a new approach like
SANs. SANs are often implemented in connection with the deployment of new
storage systems and servers. Therefore, our future success is also substantially
dependent on the market for new storage systems and servers. Furthermore, the
ability of the different components used in a SAN to function effectively, or
interoperate, with each other when placed in a computing system has not yet been
achieved on a widespread basis. Until greater interoperability is achieved,
customers may be reluctant to deploy SANs. Our success in generating revenue in
the emerging SAN market will depend on, among other things, our ability to:

o educate potential OEM customers, distributors, resellers, system
integrators and end-user organizations about the benefits of SANs and
storage router technology, including, in particular, the ability to
use storage routers with SANs to improve system backup and recovery
processes;

o maintain and enhance our relationships with OEM customers,
distributors, resellers, system integrators and end-user
organizations;

o predict and base our products on standards which ultimately become
industry standards; and

o achieve interoperability between our products and other SAN components
from diverse vendors.

WE HAVE LIMITED PRODUCT OFFERINGS AND OUR SUCCESS DEPENDS ON OUR ABILITY TO
DEVELOP IN A TIMELY MANNER NEW AND ENHANCED PRODUCTS THAT ACHIEVE MARKET
ACCEPTANCE.

We currently have only three principal products within our storage router
product family that we sell in commercial quantities. In particular, sales of
our 4100 and 4200 products have accounted for the vast majority of our product
revenue to date. To reduce our dependence on these products, we must
successfully develop and introduce to market new products and product
enhancements in a timely manner. On September 1, 2000, we began notifying our
customers that our 4100 product was at its "end of life". Customers who
purchased the 4100 product are migrating to our next generation of products that
we refer to as the 4x50 product line. Even if we are able to develop and
commercially introduce new products and enhancements, these new products or
enhancements may not achieve market acceptance which could reduce our revenue.

Factors that may affect the market acceptance of our products, some of
which are beyond our control, include the following:

o growth of, and changing requirements of customers within, the SAN and
storage router markets;

o performance, quality, price and total cost of ownership of our
products;

o availability, performance, quality and price of competing products and
technologies;

o our customer service and support capabilities and responsiveness; and

o successful development of our relationships with existing and
potential OEM, distributor, reseller and system integrator customers.

WE DEPEND ON A LIMITED NUMBER OF OEM CUSTOMERS FOR THE VAST MAJORITY OF OUR
REVENUE, AND THE LOSS OF OR SIGNIFICANT REDUCTION IN ORDERS FROM ANY KEY OEM
CUSTOMER WOULD SIGNIFICANTLY REDUCE OUR REVENUE.

In fiscal 1998, 1999 and the nine months ended July 31, 2000, approximately
90%, 85% and 71% of our revenue, respectively, was derived from six OEM
customers. Furthermore, during fiscal 1998, our four largest customers -- ADIC,
Compaq, Hewlett-Packard and StorageTek -- accounted for 25%, 20%, 16% and 14% of
our total revenue, respectively. In fiscal 1999, revenue from Compaq and
StorageTek represented 36% and 36% of our total revenue, respectively. During
the nine month period ended July 31, 2000, Compaq and StorageTek represented 33%
and 27% of our total revenue, respectively. During the three months ended July
31, 2000, we recorded a $1.1 million return resulting from StorageTek's shift in
demand to our newer products. Moreover, Compaq has informed us that it intends
to discontinue purchasing our 4100/4200 line of storage routers and to
internally manufacture their own solution. If the level of StorageTek's
purchases fails to return to previous levels and if we are unable to replace the
revenue lost due to Compaq's transition away from our 4100/4200 line of routers,
our results of operations and future prospects will suffer.

We rely on OEMs as a primary distribution channel as they are able to sell
our products to a large number of end-user organizations, which enables us to
achieve broad market penetration, with limited sales, marketing and customer
service and support resources from us. Our operating results in the foreseeable
future will continue to depend on sales to a relatively small number of OEM
customers. Therefore, the loss of any of our key OEM customers, or a significant
reduction in sales to any one of them, would significantly reduce our revenue.

OUR OEM CUSTOMERS REQUIRE OUR PRODUCTS TO UNDERGO A LENGTHY AND EXPENSIVE
QUALIFICATION PROCESS WHICH DOES NOT ASSURE PRODUCT SALES.

Prior to offering our products for sale, our OEM customers require that
each of our products undergo an extensive qualification process, which involves
interoperability testing of our product in the OEM's system as well as rigorous
reliability testing. This qualification process may continue for a year or
longer. However, qualification of a product by an OEM does not assure any sales
of the product to the OEM. Despite this uncertainty, we devote substantial
resources, including sales, marketing and management efforts, toward qualifying
our products with OEMs in anticipation of sales to them. If we are unsuccessful
or delayed in qualifying any products with an OEM,

such failure or delay would preclude or delay sales of that product to the OEM,
which may impede our ability to grow our business.

DEMAND FOR OUR PRODUCTS DEPENDS SIGNIFICANTLY UPON THE NEED TO INTERCONNECT
SCSI-BASED TAPE STORAGE SYSTEMS WITH FIBRE CHANNEL SANS, AND WE EXPECT TO FACE
COMPETITION FROM MANUFACTURERS OF TAPE STORAGE SYSTEMS THAT INCORPORATE FIBRE
CHANNEL INTERFACES INTO THEIR PRODUCTS.

In traditional computer networks, system backup is accomplished by
transferring data from applications and databases over the servers used in the
network to tape drives or other media where the data is safely stored. Tape
storage devices generally rely on a SCSI connection to interface with the
network in receiving and transmitting data. Our routers enable these SCSI-based
storage devices to interface with the Fibre Channel-based components of the SAN.
Because our routers allow communication between SCSI storage devices and a Fibre
Channel SAN, organizations are able to effect their backup processes over the
SAN rather than through the computer network, enabling the servers of the
network to remain available for other computing purposes. We currently derive
the majority of our revenue from sales of storage routers that are used to
connect SCSI-based tape storage systems with SANs. The introduction of tape
storage systems that incorporate Fibre Channel interfaces would enable tape
storage devices to communicate directly with SANs, without using storage
routers. We are aware that a number of manufacturers of storage systems,
including several of our current customers, are developing tape storage systems
with embedded Fibre Channel interfaces, with products expected to be introduced
to market in the near future. If these or other manufacturers are successful in
introducing Fibre Channel-based storage systems, demand for our storage router
products would be materially reduced and our revenue would decline.

OUR RESEARCH AND DEVELOPMENT EFFORTS ARE FOCUSED ON UTILIZING EMERGING
TECHNOLOGIES AND STANDARDS AND ANY DELAY OR ABANDONMENT OF EFFORTS TO DEVELOP
THESE TECHNOLOGIES OR STANDARDS BY INDUSTRY PARTICIPANTS, OR FAILURE OF THESE
TECHNOLOGIES OR STANDARDS TO ACHIEVE MARKET ACCEPTANCE, COULD COMPROMISE OUR
COMPETITIVE POSITION.

Our products are intended to complement other SAN products to improve the
performance of computer networks by addressing the input/output bottlenecks that
have emerged between the storage systems and the servers within a computing
system. We have devoted and expect to continue to devote significant resources
to developing products based on emerging technologies and standards that reduce
input/output bottlenecks. A number of large companies in the computer hardware
and software industries are actively involved in the development of new
technologies and standards that are expected to be incorporated in our new
products. Should any of these companies delay or abandon their efforts to
develop commercially available products based on these new technologies and
standards, our research and development efforts with respect to such
technologies and standards likely would have no appreciable value. In addition,
if we do not correctly anticipate new technologies and standards, or if our
products based on these new technologies and standards fail to achieve market
acceptance, our competitors may be better able to address market demand than
would we. Furthermore, if markets for these new technologies and standards
develop later than we anticipate, or do not develop at all, demand for our
products that are currently in development would suffer, resulting in less
revenue for these products than we currently anticipate.

WE ARE SUBJECT TO INCREASED INVENTORY RISKS AND COSTS BECAUSE WE MANUFACTURE
PRODUCTS IN ADVANCE OF BINDING COMMITMENTS FROM OUR CUSTOMERS TO PURCHASE OUR
PRODUCTS.

In order to assure availability of our products for some of our largest OEM
customers, we manufacture products in advance of purchase orders from these
customers based on forecasts provided by them. However, these forecasts do not
represent binding purchase commitments and we do not recognize revenue for such
products until the product is shipped to the OEM. As a result, we incur
inventory and manufacturing costs in advance of anticipated revenue. Because
demand for our products may not materialize, this product delivery method
subjects us to increased risks of high inventory carrying costs and increased
obsolescence and may increase our operating costs.

FAILURE TO EXPAND OUR DISTRIBUTION CHANNELS AND MANAGE OUR DISTRIBUTION
RELATIONSHIPS COULD IMPEDE OUR FUTURE GROWTH.

The future growth of our business will depend in part on our ability to
expand our existing relationships with distributors, resellers and system
integrators, develop additional channels for the distribution and sale of our

products and manage these relationships. As part of our growth strategy, we
intend to expand our relationships with distributors, resellers and system
integrators. The inability to successfully execute this strategy could impede
our future growth.

THE LOSS OF OUR PRIMARY CONTRACT MANUFACTURERS, OR THE FAILURE TO FORECAST
DEMAND ACCURATELY FOR OUR PRODUCTS OR TO MANAGE OUR RELATIONSHIP WITH OUR
PRIMARY CONTRACT MANUFACTURERS SUCCESSFULLY, WOULD NEGATIVELY IMPACT OUR ABILITY
TO MANUFACTURE AND SELL OUR PRODUCTS.

Prior to August 1999, we have relied on a third-party manufacturer, XeTel,
to manufacture substantially all of our products on a purchase order basis. We
do not have a long-term supply contract with XeTel and, therefore, XeTel is not
obligated to manufacture products for us for any specific period, or in any
specific quantity, except as may be provided in a particular purchase order. In
August 1999, we engaged another contract manufacturer, Solectron, to make our
4x50 family of products. We believe that this will enable us to reduce our
reliance on XeTel. We generally place orders for products with XeTel and
Solectron approximately four months prior to the anticipated delivery date, with
order volumes based on forecasts of demand from our customers. Accordingly, if
we inaccurately forecast demand for our products, we may be unable to obtain
adequate manufacturing capacity from XeTel or Solectron to meet our customers'
delivery requirements, or we may accumulate excess inventories. We have on
occasion in the past been unable to adequately respond to unexpected increases
in customer purchase orders, and therefore were unable to benefit from this
incremental demand. XeTel and Solectron have not provided assurances to us that
adequate capacity will be available to us within the time required to meet
additional demand for our products.

OUR PLANS TO INTRODUCE NEW PRODUCTS AND PRODUCT ENHANCEMENTS TO MARKET REQUIRES
COORDINATION ACROSS OUR SUPPLIERS AND MANUFACTURERS, WHICH EXPOSES US TO RISKS
OF DELAY OR POOR EXECUTION FROM A VARIETY OF SOURCES.

We plan to introduce new products and product enhancements, which will
require that we coordinate our efforts with those of our component suppliers and
our contract manufacturers to rapidly achieve volume production. If we should
fail to effectively manage our relationships with our component suppliers and
our contract manufacturers, or if any of our suppliers or our manufacturers
experience delays, disruptions, capacity constraints or quality control problems
in their 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 component supplier or contract manufacturer and commencing
volume production can be expensive and time consuming. If we are required to
change or choose to change suppliers, we may lose revenue and damage our
customer relationships.

WE HAVE RECENTLY TRANSITIONED THE FINAL ASSEMBLY AND TEST PORTION OF OUR
MANUFACTURING PROCESS TO AN IN-HOUSE FACILITY, WHICH HAS INCREASED OUR FIXED
COSTS AND EXPOSED US TO INCREASED INVENTORY RISKS.

In September 1999, we transitioned our final assembly and product test
operations in-house. XeTel previously performed these activities for us.
Although we have personnel with prior experience in managing assembly and test
operations, we had not previously assembled our products, and we may encounter
difficulties and delays in establishing, maintaining or expanding our internal
assembly and test capabilities. If demand for our products does not support the
effective utilization of these employees and additional facilities and
equipment, we may not realize any benefit from replacing our contract
manufacturer with internal final assembly and testing. Furthermore, internal
final assembly and test operations requires us to manage and maintain the
components used in our products at our facilities. A significant portion of this
inventory will be useful only in the final assembly of our products. Any
decrease in demand for our products could result in a substantial part of this
inventory becoming excess, obsolete or otherwise unusable. If our internal final
assembly and test operations are underused or mismanaged, we may incur
significant costs that could adversely affect our operating results.

WE DEPEND ON SOLE SOURCE AND LIMITED SOURCE SUPPLIERS FOR CERTAIN KEY
COMPONENTS, AND IF WE ARE UNABLE TO BUY THESE COMPONENTS ON A TIMELY BASIS, OUR
DELAYED ABILITY TO DELIVER OUR PRODUCTS TO OUR CUSTOMERS MAY RESULT IN REDUCED
REVENUE AND LOST SALES.

We currently purchase Fibre Channel application specific integrated
circuits and other key components for our products from sole or limited sources.
To date, most of our component purchases have been made in relatively small
volumes. As a result, if our suppliers receive excess demand for their products,
we likely will receive a low priority for order fulfillment as large volume
customers will use our suppliers' available capacity. If we are delayed in

acquiring components for our products, the manufacture and shipment of our
products will also be delayed, which will reduce our revenues and may result in
lost sales. We generally use a rolling six-month forecast of our future product
sales to determine our component requirements. Lead times for ordering materials
and components vary significantly and depend on factors such as specific
supplier requirements, contract terms and current market demand for such
components. If we overestimate our component requirements, we may have excess
inventory which would increase our costs. If we underestimate our component
requirements, we may have inadequate inventory which would delay our
manufacturing and render us unable to deliver products to customers on a
scheduled delivery date. We also may experience shortages of certain components
from time to time, which also could delay our manufacturing. Manufacturing
delays could negatively impact our ability to sell our products and damage our
customer relationships.

COMPETITION WITHIN OUR MARKETS MAY REDUCE SALES OF OUR PRODUCTS AND REDUCE OUR
MARKET SHARE.

The market for SAN products generally, and storage routers in particular,
is increasingly competitive. We anticipate that the market for our products will
continually evolve and will be subject to rapid technological change. We
currently face competition from ATTO, Chaparral, Pathlight and, to some extent,
Computer Network Technologies. In addition, our OEM customers could develop
products or technologies internally that would replace their need for our
products and would become a source of competition. We expect to face competition
in the future from storage system industry suppliers, including manufacturers
and vendors of other SAN products or entire SAN systems, as well as innovative
start-up companies. For example, manufacturers of Fibre Channel hubs or switches
could seek to include router functionality within their SAN products which would
obviate the need for our storage routers. As the market for SAN products grows,
we also may face competition from traditional networking companies and other
manufacturers of networking products. These networking companies may enter the
storage router market by introducing their own products or by entering into
strategic relationships with or acquiring other existing SAN product providers.
In the past quarter, Compaq informed us of its intent to manufacture its own
routers, rather than act as an OEM for our 4100 and 4200 lines of routers. This
could introduce additional competition in our markets, especially if Compaq or
another one of our OEMs begins to manufacture our higher end storage routers.
Moreover, we are currently in litigation with Chaparral and Pathlight in which
we have alleged their infringement of certain proprietary rights. If we are not
successful in this litigation, our competitive position may be harmed.

WE ARE A RELATIVELY SMALL COMPANY WITH LIMITED RESOURCES COMPARED TO SOME OF OUR
CURRENT AND POTENTIAL COMPETITORS.

Some of our current and potential competitors have longer operating
histories, significantly greater resources, broader name recognition and a
larger installed base of customers than we have. As a result, these competitors
may have greater credibility with our existing and potential customers. They
also may be able to adopt more aggressive pricing policies and devote greater
resources to the development, promotion and sale of their products than we can
to ours, which would allow them to respond more quickly than us to new or
emerging technologies or changes in customer requirements. In addition, some of
our current and potential competitors have already established supplier or joint
development relationships with decision makers at our current or potential
customers. These competitors may be able to leverage their existing
relationships to discourage these customers from purchasing products from us or
to persuade them to replace our products with their products. Increased
competition could decrease our prices, reduce our sales, lower our margins, or
decrease our market share. These and other competitive pressures may prevent us
from competing successfully against current or future competitors, and may
materially harm our business.

WE HAVE LICENSED OUR 4200 STORAGE ROUTER TECHNOLOGY TO A STOCKHOLDER THAT IS
ALSO A KEY CUSTOMER, WHICH MAY ENABLE THIS CUSTOMER TO COMPETE WITH US.

We have licensed our 4200 storage router technology to Hewlett-Packard.
Hewlett-Packard is a stockholder of our company and a key customer. While
Hewlett-Packard has not introduced to market any products competitive to ours
that use the licensed technology, it could potentially do so in the future.
Because Hewlett-Packard has vastly greater resources and distribution
capabilities than Crossroads, it could establish market acceptance in a
relatively short time frame for any competitive products that it may introduce,
which, in turn, would reduce demand for our products from Hewlett-Packard and
could reduce demand for our products from other customers.

WE EXPECT UNIT PRICES OF OUR PRODUCTS TO DECREASE OVER TIME, AND IF WE CANNOT
INCREASE OUR SALES VOLUMES OUR REVENUE WILL DECLINE.

Many of our agreements with OEM customers provide for decreases in the
price of our products over time. In addition, we anticipate that, as products in
the SAN market become standardized and more widely available, we may need to
reduce the average unit selling price of our products in the future to respond
to competitive pricing pressures or new product introductions by our
competitors. If we are unable to offset the anticipated decrease in our average
selling prices by increasing our sales volume, our revenue will decline.

OUR PRODUCTS ARE COMPLEX AND MAY CONTAIN UNDETECTED SOFTWARE OR HARDWARE ERRORS
WHICH COULD LEAD TO AN INCREASE IN OUR COSTS OR A REDUCTION IN OUR REVENUE.

Networking products such as ours frequently contain undetected software or
hardware errors when first introduced or as new versions are released. Our
products are complex and errors have been found in the past and may be found
from time to time in the future. For example in July, 2000, we issued a
"stop-ship" on our 4x50 line and part of our 4200 line due to a firmware
interoperability issue, which negatively affected our product revenues for the
three months ended July 31, 2000. In addition, our products include components
from a number of third-party vendors. We rely on the quality testing of these
vendors to ensure the adequate operation of their products. Because our products
are manufactured with a number of components supplied by various third-party
sources, should problems occur in the operation or performance of our products,
it may be difficult to identify the source. In addition, our products are
deployed within SANs from a variety of vendors. Therefore, the occurrence of
hardware and software errors, whether caused by our or another vendor's SAN
products, could adversely affect sales of our products. Furthermore, defects may
not be discovered until our products are already deployed in the SAN. These
errors also could cause us to incur significant warranty, diagnostic and repair
costs, divert the attention of our engineering personnel from our product
development efforts and cause significant customer relations and business
reputation problems.

WE DEPEND ON OUR KEY PERSONNEL TO MANAGE OUR BUSINESS EFFECTIVELY IN A RAPIDLY
CHANGING MARKET, AND IF WE ARE UNABLE TO RETAIN OUR CURRENT PERSONNEL AND HIRE
ADDITIONAL PERSONNEL, OUR ABILITY TO SELL OUR PRODUCTS COULD BE HARMED.

We believe our future success will depend in large part upon our ability to
attract and retain highly skilled managerial, engineering and sales and
marketing personnel. In particular, we believe that our future success is highly
dependent on Brian R. Smith, our co-founder, chief executive officer and
chairman of the board, to provide continuity in the execution of our growth
plans. We do not have employment contracts with any of our key personnel with
the exception of Larry Sanders, our president and chief operating officer. We
have experienced difficulty in hiring engineers with appropriate qualifications
in networking, routing and storage technologies and we may not be successful in
attracting and retaining sufficient levels of such engineers to support our
anticipated growth. The loss of the services of any of our key employees, the
inability to attract or retain qualified personnel in the future or delays in
hiring required personnel, particularly engineers and sales personnel, could
delay the development and introduction of, and negatively impact our ability to
sell, our products.

TO MANAGE OUR GROWTH AND EXPANSION, WE RELOCATED TO NEW FACILITIES AND PLAN TO
UPGRADE AND IMPLEMENT OUR ENTERPRISE RESOURCE PLANNING SYSTEM, WHICH MAY DISRUPT
OUR BUSINESS.

Our rapid growth in personnel and operations has placed, and will continue
to place, a significant strain on our management and operational resources,
including our physical facilities and enterprise resource planning system. We
plan to continue to aggressively expand our operations to pursue existing and
potential market opportunities. We relocated our headquarters facility to a
larger facility. In addition, we have selected and are currently implementing a
new enterprise resource planning system in order to integrate manufacturing,
resource planning and financial accounting. We expect these changes to be
disruptive, time-consuming and expensive processes. If we are unsuccessful or
experience delays in effecting these changes, our ability to effectively manage
our operations may be compromised.

WE PLAN TO INCREASE OUR INTERNATIONAL SALES ACTIVITIES SIGNIFICANTLY, WHICH WILL
SUBJECT US TO ADDITIONAL BUSINESS RISKS.

To date, a significant portion of our products that are purchased by OEMs
are shipped to their end-user customers in international markets. We intend to
open sales offices in international markets to focus on expanding our
international sales activities in Europe and the Pacific Rim region. Our planned
international sales growth will be limited if we are unable to expand our
international sales channel relationships, hire additional personnel and develop
relationships with international distributors, resellers, system integrators and
service providers. We may not be able to maintain or increase international
market demand for our products. Our international sales activities are subject
to a number of risks, including:

o increased complexity and costs of managing international operations;

o protectionist laws and business practices that favor local competition
in some countries;

o multiple, conflicting and changing laws, regulations and tax schemes;

o longer sales cycles;

o greater difficulty in accounts receivable collection and longer
collection periods; and

o political and economic instability.

To date, all of our sales to international customers have been denominated
in U.S. dollars. As a result, an increase in the value of the U.S. dollar
relative to foreign currencies could make our products more expensive for our
customers to purchase, thus rendering them less competitive.

WE MAY BE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY, WHICH WOULD NEGATIVELY
AFFECT OUR ABILITY TO COMPETE.

Our products rely on our proprietary technology, and we expect that future
technological advancements made by us will be critical to sustain market
acceptance of our products. Therefore, we believe that the protection of our
intellectual property rights is and will continue to be important to the success
of our business. 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 business partners, and control access to and
distribution of our software, documentation and other proprietary information.
Despite these efforts, unauthorized parties may attempt to copy or otherwise
obtain and use our products or technology. Monitoring unauthorized use of our
products is difficult, and we cannot be certain that the steps we have taken
will prevent unauthorized use of our technology, particularly in foreign
countries where applicable laws may not protect our proprietary rights as fully
as in the United States.

OUR EFFORTS TO PROTECT OUR INTELLECTUAL PROPERTY MAY CAUSE US TO BECOME INVOLVED
IN COSTLY AND LENGTHY LITIGATION WHICH COULD SERIOUSLY HARM OUR BUSINESS.

In recent years, there has been significant litigation in the United States
involving patents, trademarks and other intellectual property rights. For
example, we are currently involved in patent infringement litigation with
Chaparral Network Storage, Inc. and Pathlight Technology, Inc. (See "Legal
Proceedings" below). Legal proceedings could subject us to significant liability
for damages or invalidate our intellectual property rights. Any litigation,
regardless of its outcome, would likely be time consuming and expensive to
resolve and would divert management's time and attention. Any potential
intellectual property litigation also could force us to take specific actions,
including:

o cease selling our products that use the challenged intellectual
property;

o obtain from the owner of the infringed intellectual property right a
license to sell or use the relevant technology or trademark, which
license may not be available on reasonable terms, or at all; or

o redesign those products that use infringing intellectual property or
cease to use an infringing trademark.

ANY ACQUISITIONS WE MAKE COULD DISRUPT OUR BUSINESS AND HARM OUR FINANCIAL
CONDITION.

As part of our growth strategy, we intend to review opportunities to
acquire other businesses or technologies that would complement our current
products, expand the breadth of our markets or enhance our technical
capabilities. For example, on March 21, 2000, we consummated our acquisition of
Polaris Communications, Inc. Acquisitions entail a number of risks that could
materially and adversely affect our business and operating results, including:

o problems integrating the acquired operations, technologies or products
with our existing business and products;

o diversion of management's time and attention from our core business;

o difficulties in retaining business relationships with suppliers and
customers of the acquired company;

o risks associated with entering markets in which we lack prior
experience; and

o potential loss of key employees of the acquired company.

OUR PRODUCTS MUST CONFORM TO INDUSTRY STANDARDS IN ORDER TO BE ACCEPTED BY
CUSTOMERS IN OUR MARKET.

Our products comprise only a part of a SAN. All components of a SAN must
uniformly comply with the same industry standards in order to operate
efficiently together. We depend on companies that provide other components of
the SAN to support prevailing industry standards. Many of these companies are
significantly larger and more influential in effecting industry standards than
we are. Some industry standards may not be widely adopted or implemented
uniformly, and competing standards may emerge that may be preferred by OEM
customers or end users. If larger companies do not support the same industry
standards that we do, or if competing standards emerge, our products may not
achieve market acceptance which would adversely affect our business.

INSIDERS WILL CONTINUE TO HAVE SUBSTANTIAL CONTROL OVER OUR COMPANY AND COULD
DELAY OR PREVENT A CHANGE IN CORPORATE CONTROL.

Our executive officers and directors beneficially own approximately 16.0%
of the total voting power of our company. As a result, these stockholders will
be able to exert significant control over all matters requiring stockholder
approval, including the election of directors and approval of significant
corporate transactions. This concentration of voting power could delay or
prevent an acquisition of our company on terms which other stockholders may
desire.

PROVISIONS IN OUR CHARTER DOCUMENTS AND DELAWARE LAW COULD PREVENT, DELAY OR
IMPEDE A CHANGE IN CONTROL OF US AND MAY REDUCE THE MARKET PRICE OF OUR COMMON
STOCK.

Provisions of our certificate of incorporation and bylaws could have the
effect of discouraging, delaying or preventing a merger or acquisition that a
stockholder may consider favorable. We also are subject to the anti-takeover
laws of the State of Delaware which may discourage, delay or prevent someone
from acquiring or merging with us, which may adversely affect the market price
of our common stock.

OUR STOCK PRICE MAY BE VOLATILE.

The market price of our common stock has been volatile in the past and may
be volatile in the future. The market price of our common stock may be
significantly affected by the following factors:

o actual or anticipated fluctuations in our operating results;

o changes in financial estimates by securities analysts or our failure
to perform in line with such estimates;

o changes in market valuations of other technology companies,
particularly those that sell products used in SANs;

o announcements by us or our competitors of significant technical
innovations, acquisitions, strategic partnerships, joint ventures or
capital commitments;

o introduction of technologies or product enhancements that reduce the
need for storage routers;

o the loss of one or more key OEM customers; and

o departures of key personnel.

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 our performance.

THE RECENT ISSUANCE BY THE SEC OF AN ACCOUNTING BULLETIN RELATED TO REVENUE
RECOGNITION, SAB 101, MAY HAVE A MATERIAL ADVERSE IMPACT ON OUR FINANCIAL
PERFORMANCE

In December 1999, the SEC issued Staff Accounting Bulletin No. 101, Revenue
Recognition in Financial Statements, referred to as SAB 101. SAB 101 summarizes
the SEC staff's views in applying generally accepted accounting principles to
revenue recognition in financial statements. In addition to other uncertain
risks related to SAB 101, it is possible that SAB 101 will result in increased
fluctuations in our quarterly operating results and increase the likelihood that
we may fail to meet the expectations of securities analysts for any period. We
are currently in the process of evaluating SAB 101 and what effect it may have
on our financial statements. As of this date, we have not determined whether SAB
101 will have a material impact on our financial position or results of
operations; however, we believe that it may require a portion of our fiscal year
2001 revenues to be deferred. In the event that the implementation of SAB 101
requires us to report a change in accounting principles related to our revenue
recognition policy, we would be required to report such change no later than the
quarter ending January 31, 2001. We are also considering potential changes to
the terms of our sales agreements for equipment sales that could mitigate the
impact of SAB 101. While SAB 101 would not affect the fundamental aspects of our
operations as measured by product shipments and cash flows, implementation of
SAB 101 could have a material adverse effect on our reported results of
operations for fiscal year 2001. The application of SAB No. 101 is not expected
to have a material impact on the financial statements of the Company.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Information concerning market risk is contained on Page 33 of our 1999
Annual Report on Form 10-K and is incorporated herein by reference to the annual
report.

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

On March 31, 2000, we filed a lawsuit against Chaparral Network Storage,
Inc. ("Chaparral") alleging that Chaparral has infringed one of our patents with
some of their router products. The lawsuit was filed in United States District
Court for the Western District of Texas and we are seeking injunctive relief as
well as damages. The case has been assigned to a Federal District Court Judge,
who has already conducted a claims construction hearing and provided an order
resolving claim construction issues. We have started the discovery process.
Trial is currently scheduled to begin in the first six months of 2001. Based on
our understanding of Chaparral's products sold during the alleged infringement
period, we believe that a reasonable value of our claims brought against
Chaparral could be material to our future results of operations, cash flows and
financial position. We intend to vigorously prosecute our claims. We believe we
should ultimately prevail on this litigation. However, since the amount of the
damages cannot be fully quantified until the discovery process proceeds further
and no assurances can be made as to the final timing and outcome of any
litigation, no gain has been recorded.

On April 14, 2000, we filed a lawsuit against Pathlight Technology, Inc.
("Pathlight") alleging that Pathlight has infringed one of our patents with
their SAN Data Gateway Router. The lawsuit was filed in United States District
Court for the Western District of Texas and we are seeking injunctive relief as
well as damages. The case has been assigned to a Federal District Court Judge,
who has already conducted a claims construction hearing and provided an order
resolving claim construction issues. We have started the discovery process.
Trial is currently scheduled to begin in the first six months of 2001. Based on
our understanding of Pathlight's products sold during the alleged infringement
period, we believe that a reasonable value of our claims brought against
Pathlight could be material to our future results of operations, cash flows and
financial position. We intend to vigorously prosecute our claims. We believe we
should ultimately prevail on this litigation. However, since the amount of the
damages cannot be fully quantified until the discovery process proceeds further
and no assurances can be made as to the final timing and outcome of any
litigation, no gain has been recorded.

On May 19, 2000, Chaparral filed a counter-suit against us alleging
tortious interference with prospective business relations. The lawsuit was filed
in District Court, Boulder County, Colorado and Chaparral is seeking injunctive
relief as well as damages. Chaparral claims that we have made statements that
Chaparral has infringed our patent rights and that these statements are false
and defamatory. Given the overlapping allegations with the patent litigation, we
answered and moved to transfer the Colorado case to the United States District
Court in Texas, the Austin division. If transferred to the Austin division, we
will seek to consolidate the action with the aforementioned pending patent
litigation. The complaints are at an early stage. Consequently, at this time it
is not possible to predict whether we will incur any liability or to estimate
its amount, if any.

Between July 28, 2000 and September 8, 2000 ten class action lawsuits were
filed against us and certain of our officers and directors in the United States
District Court for the Western District of Texas, Austin Division. The
plaintiffs in the actions purport to represent purchasers of our common stock
during various periods ranging from January 25, 2000 through August 24, 2000.
The complaints allege that the Company and certain of our executives made
misrepresentations and omissions in violation of sections 10(b) and 20(a) of the
Securities Exchange Act of 1934. The complaints seek compensatory damages, costs
and attorney's fees for the purported class members in an unspecified amount. We
deny any wrongdoing and intend to defend against the claims vigorously. In
particular, we intend to file a motion to dismiss after the Court consolidates
the actions and appoints a lead plaintiff under the Private Securities
Litigation Reform Act of 1995. The complaints are at an early stage.
Consequently, at this time it is not possible to predict whether we will incur
any liability or to estimate its amount, if any.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.

From May through July 31, 2000, we issued approximately 95,938 shares of
our common stock to employees pursuant to exercises of stock options (with
exercise prices ranging from $0.10 to $1.333 per share) under our stock plans.
These issuances were deemed exempt from registration under Section 5 of the
Securities Act of 1933 in reliance upon Rule 701 thereunder. In addition, the
recipients of securities in each such transaction represented their intentions
to acquire the securities for investment only and not with a view to, or for
sale in connection with, any distribution thereof and appropriate restrictive
transfer legends were affixed to the share certificates issued in each such
transaction.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.

(a) Exhibit Index

Exhibit Number Description

27.1 Financial Data Schedule (EDGAR Version Only)

(b) Reports on Form 8-K

During the three months ended July 31, 2000, we filed the following Current
Report on Form 8-K:

o We filed an Amended Current Report on Form 8-K/A dated March 21, 2000
(Item 7) filing the financial statements of Polaris Communications,
Inc. for the years ended December 31, 1997, 1998 and 1999 and the
unaudited pro forma consolidated financial statements for Crossroads.

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.

CROSSROADS SYSTEMS, INC.

Sept. 14, 2000 /s/ Brian R. Smith
-------------- ------------------
(Date) Brian R. Smith
Chairman of the Board and Chief Executive Officer
(Principal executive officer)

Sept. 14, 2000 /s/ Reagan Y. Sakai
-------------- -------------------
(Date) Reagan Y. Sakai
Chief Financial Officer
(Principal financial and accounting officer)

INDEX TO EXHIBITS

EXHIBIT
NUMBER DESCRIPTION
- ------ -----------

27.1 Financial Data Schedule