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 JANUARY 31, 2001
------------------------------------

[ ] 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:
--------------------------------------------------------

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

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

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

(512) 349-0300
- --------------------------------------------------------------------------------
(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 March 1, 2001, Registrant had outstanding 27,796,776 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, 2000 and
January 31, 2001.......................................................... 2

Condensed Consolidated Statements of Operations for the three months
ended January 31, 2000 and 2001........................................... 3

Condensed Consolidated Statements of Cash Flows for the three months ended
January 31, 2000 and 2001................................................. 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.................. 26

PART II OTHER INFORMATION

Item 1. Legal Proceedings........................................................... 27

Item 6. Exhibits and Reports on Form 8-K............................................ 28

SIGNATURES ........................................................................... 29

PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS

CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

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

OCTOBER 31, JANUARY 31,
2000 2001
--------- ---------

ASSETS
Current assets:
Cash and cash equivalents ................................................. $ 42,447 $ 46,394
Short-term investments .................................................... 17,591 10,000
--------- ---------
Total cash, cash equivalents and short-term investments ............... 60,038 56,394
Accounts receivable, net of allowance for doubtful accounts
of $231 and $291, respectively ........................................ 5,590 5,108
Inventories, net .......................................................... 3,918 3,872
Prepaids and other current assets ......................................... 2,037 1,872
--------- ---------
Total current assets .................................................. 71,583 67,246

Note receivable from related party, net ....................................... 159 162
Property and equipment, net ................................................... 10,062 10,180
Intangibles, net .............................................................. 35,686 32,088
Other assets .................................................................. 558 562
--------- ---------
Total assets .......................................................... $ 118,048 $ 110,238
========= =========

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable .......................................................... $ 4,852 $ 5,515
Accrued expenses .......................................................... 2,933 2,606
Accrued warranty costs .................................................... 414 434
Deferred revenue .......................................................... 1,097 772
--------- ---------
Total current liabilities ............................................. 9,296 9,327

Commitments and contingencies
Stockholders' equity:
Common stock, $.001 par value, 175,000,000 shares authorized,
27,690,673 and 27,791,502 shares issued and outstanding, respectively .. 28 28
Additional paid-in capital ................................................ 183,390 184,905
Deferred stock-based compensation ......................................... (9,734) (8,345)
Notes receivable from stockholders ........................................ (249) (235)
Accumulated deficit ....................................................... (64,448) (75,188)
Treasury stock at cost (405,961 and 438,006 shares, respectively) ......... (235) (254)
--------- ---------
Total stockholders' equity ............................................ 108,752 100,911
--------- ---------
Total liabilities and stockholders' equity ............................ $ 118,048 $ 110,238
========= =========

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

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CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

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

THREE MONTHS ENDED
JANUARY 31,
-------------------------------
2000 2001
------------ ------------

Revenue:
Product revenue................................................. $ 8,692 $ 9,824

Other revenue .................................................. 101 150
------------ ------------

Total revenue ............................................. 8,793 9,974

Cost of revenue (including stock-based compensation expense
of $86 and $39, respectively) ..................................... 4,724 4,876
------------ ------------

Gross profit ......................................................... 4,069 5,098
------------ ------------
Operating expenses:
Sales and marketing (including stock-based compensation
expense of $192 and $48, respectively ....................... 2,404 4,068

Research and development (including stock-based
compensation expense of $161 and $265, respectively) ......... 2,145 4,302

General and administrative (including stock-based
compensation expense of $249 and $2,222, respectively) ....... 1,566 4,716
Amortization of intangibles .................................... -- 3,596
------------ ------------

Total operating expenses .................................. 6,115 16,682
------------ ------------
Loss from operations ................................................. (2,046) (11,584)

Other income, net .................................................... 1,123 974
------------ ------------

Net loss before cumulative effect of accounting change ............... (923) (10,610)
Cumulative effect of accounting change ............................. -- (130)
------------ ------------
Net loss ............................................................. $ (923) $ (10,740)
============ ============

Basic and diluted net loss per share:
Before cumulative effect of accounting change ................ $ (0.04) $ (0.38)
Cumulative effect of accounting change ....................... -- (0.01)
------------ ------------
Basic and diluted net loss per share .................. $ (0.04) $ (0.39)
============ ============

Pro forma amounts assuming accounting change is applied retroactively:
Net loss .................................................... $ (1,698) $ --
Net loss per share, basic and diluted ....................... $ (0.07) $ --

Shares used in computing basic and diluted net loss per share ........ 25,629,217 27,284,797
============ ============

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

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CROSSROADS SYSTEMS, INC. AND SUBSIDIARIES

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

THREE MONTHS ENDED
JANUARY 31,
-----------------------
2000 2001
-------- --------

Cash flows from operating activities:
Net loss .................................................. $ (923) $(10,740)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization .......................... 412 4,750
Stock-based compensation ............................... 688 2,574
Provision for doubtful accounts receivable ............. 44 44
Provision for excess and obsolete inventory ............ 108 90
Amortization of note receivable from related party ..... 4 --

Changes in assets and liabilities:
Accounts receivable .................................. (2,939) 438
Inventories .......................................... 391 (44)
Prepaids and other current assets .................... (382) 165
Accounts payable ..................................... (618) 663
Accrued expenses ..................................... 394 (327)
Accrued warranty costs ............................... 99 20

Deferred revenue and other ........................... 48 (325)
Other ................................................ -- (6)
-------- --------
Net cash used in operating activities ............. (2,674) (2,698)
-------- --------
Cash flows from investing activities:
Purchase of property and equipment ........................ (1,714) (1,270)
Purchase of held-to-maturity investments .................. (7,591) --
Maturity of held-to-maturity investments .................. 13,000 7,591
Payment of note receivable from related party ............. -- 17
Other assets .............................................. 139 (4)
-------- --------
Net cash provided by investing activities ......... 3,834 6,334
-------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock .................... 43 330
Costs associated with initial public offering ............. (40) --
Purchase of treasury stock ................................ -- (19)
Repayment of long-term indebtedness ....................... (2,356) --
Other ..................................................... (45) --
-------- --------
Net cash provided by (used in) financing activities (2,408) 311
-------- --------
Net increase (decrease) in cash and cash equivalents ........ (1,248) 3,947
Cash and cash equivalents, beginning of period .............. 61,320 42,447
-------- --------
Cash and cash equivalents, end of period .................... $ 60,072 $ 46,394
======== ========

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

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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. Headquartered in Austin, Texas, Crossroads, a
Delaware corporation, is the leading provider of enterprise data center routing
solutions for open system storage area networks ("SANs") including S/390
connections. Crossroads sells its products and services primarily to leading
storage system and server original equipment manufacturers, distributors,
resellers, system integrators and storage service providers. The Company is
organized and operates as one business segment. 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, 2000, included in our Annual Report on Form 10-K.

The results of operations for the three months ended January 31, 2001 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 (Note 2).

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. Amortization of intangibles totaled
approximately $0 and $3.6 million for the three months ended January 31, 2000
and 2001, respectively.

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:

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7

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

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

Intangible assets:
Proven research and development ...... $ 1,030 5 - 7
In-place workforce ................... 1,800 4
Customer base ........................ 340 15
Goodwill ............................. 41,324 3
--------
44,494
Less: accumulated amortization ....... (12,406)
--------
Intangible assets, net at
January 31, 2001 ....................... $ 32,088
========
Other assets, net of liabilities assumed $ 2,121
========

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
THREE MONTHS ENDED
JANUARY 31,
-----------------------
2000 2001
-------- --------

Total revenue .... $ 9,732 $ 9,974
Net loss ......... (4,577) (10,740)
Net loss per share $ (0.18) $ (0.39)

3. INVENTORIES

Inventories are stated at the lower of cost or market. Cost is determined
using the first-in, first-out method. Provisions, when required, are made to
reduce excess and obsolete inventories to their estimated net realizable values.

Inventories consist of the following:

OCTOBER 31, JANUARY 31,
2000 2001
----------- -----------

Raw materials ......................................... $ 4,154 $ 4,432
Work-in-process ....................................... 183 --
Finished goods ........................................ 1,670 1,619
------- -------
6,007 6,051
Less: Allowance for excess and obsolete inventory (2,089) (2,179)
======= =======
$ 3,918 $ 3,872
======= =======

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

4. PROPERTY AND EQUIPMENT

Property and equipment consist of the following:

OCTOBER 31, JANUARY 31,
2000 2001
---------- ----------

Equipment ........................ $ 12,013 $ 13,267
Furniture and fixtures ........... 1,911 1,927
Leasehold improvements ........... 916 916
-------- --------
14,840 16,110
-------- --------
Less: accumulated depreciation and
amortization ..................... (4,778) (5,930)
-------- --------
$ 10,062 $ 10,180
======== ========

5. LINE OF CREDIT

In January 2001, the Company extended its existing line of credit with
its bank. The committed revolving line is an advance of up to $3 million with a
borrowing base of 80% of eligible accounts receivable. The line of credit
matures on February 1, 2002.

6. COMMITMENTS AND CONTINGENCIES

Legal Proceedings

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. Trial is
currently scheduled to begin in the second half of 2001. Management intends to
vigorously prosecute its claims. However, no assurance can be given as to the
outcome of this action. The Company believes it should ultimately prevail on
this litigation.

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. Trial is currently
scheduled to begin in the first half of 2001. Management intends to vigorously
prosecute its claims. However, no assurance can be given as to the outcome of
this action. The Company believes it should ultimately prevail on this
litigation. In January 2001, Advanced Digital Information Corporation, a
customer and shareholder of Crossroads, announced that it had entered into a
definitive agreement to acquire Pathlight.

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 the Company's patent rights and that these
statements are false and defamatory. Given the overlapping allegations with the
patent litigation, the case was transferred to the Austin division, and
consolidated 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.

The Company and several of its officers and directors were named as
defendants in several class action lawsuits filed in the United States District
Court for the Western District of Texas. 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 Court consolidated the actions and
appointed a lead plaintiff under the Private Securities Litigation Reform Act of
1995. The amended consolidated complaint was filed February 2001 and the Company
intends to file

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9

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

a motion to dismiss. The plaintiffs are seeking unspecified amounts of
compensatory damages, interests and costs, including legal fees. The Company
denies the allegations in the complaint and intends to defend itself vigorously.

The class action lawsuit is still at an early stage. Consequently, it is not
possible at this time to predict whether the Company will incur any liability or
to estimate the damages, or the range of damages, if any, that the Company might
incur in connection with this lawsuit. The inability of the Company to prevail
in this action could have a material adverse effect on the Company's future
business, financial condition and results of operations.

Other

If the Company reduces or cancels production orders with its third party
contract manufacturer, the Company may be required to reimburse its contract
manufacturer for materials purchased on its behalf.

7. STOCK-BASED COMPENSATION

In connection with the grant of certain stock options to our employees and
directors, the Company recorded deferred compensation aggregating $19.6 million
in 1998, 1999, 2000, and the three months ended January 31, 2001, representing
the difference between the deemed fair value of the common stock underlying
these options and their exercise price at the date of grant. Such amount is
presented as a reduction of stockholders' equity and is being amortized over the
vesting period of the applicable individuals, generally four years. Deferred
compensation expense is decreased in the period of forfeiture for any accrued
but unvested compensation arising from the early termination of an option
holder's services. Of the total deferred compensation amount, approximately
$11.3 million has been amortized as of January 31, 2001.

The Company allocates 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 the periods indicated was allocated as follows
(in thousands):

THREE MONTHS ENDED
JANUARY 31,
------------------
2000 2001
------ ------

Cost of revenue ...................... $ 86 $ 39
Sales and marketing .................. 192 48
Research and development ............. 161 265
General and administrative ........... 249 2,222
------ ------
Total stock-based compensation...... $ 688 $2,574
====== ======

We currently expect to amortize the remaining amounts of deferred
stock-based compensation as of January 31, 2001 in the periods indicated (in
thousands):

YEAR ENDED OCTOBER 31,
------------------------------------------------------
2001 2002 2003 2004 TOTAL
------ ------ ------ ------ ------

Cost of revenue ................... $ 83 $ 56 $ 11 $ -- $ 150
Sales and marketing ............... 108 81 14 -- 203
Research and development .......... 149 98 20 -- 267
General and administrative ........ 4,076 2,541 1,011 97 7,725
------ ------ ------ ------ ------
Total stock-based compensation $4,416 $2,776 $1,056 $ 97 $8,345
====== ====== ====== ====== ======

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

8. NET LOSS PER SHARE

In accordance with SFAS No. 128, "Earnings Per Share," ("SFAS No. 128")
basic earnings per share is computed by dividing income available to common
stockholders by the weighted average number of common shares outstanding for the
period, less shares subject to repurchase. Diluted earnings per share is
computed by giving effect to all dilutive potential common shares that were
outstanding during the period. Basic 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 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 outstanding stock options from the calculation
of diluted net loss per share because all such securities are antidilutive for
all periods presented. The total number of common stock equivalents excluded
from the calculations of diluted net loss per common share were 2,301,130 and
5,029,341 for the three months ended January 31, 2000 and 2001, respectively.

9. RECENT ACCOUNTING PRONOUNCEMENTS

In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivatives and
Hedging Activities," (SFAS No. 133) 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. The Company does 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 Interpretation No. 44, "Accounting for
Certain Transactions Involving Stock Compensation - an interpretation of APB
Opinion 25," ("Interpretation No. 44") 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. The adoption of Interpretation No. 44 did not 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. Effective November 1, 2000, the Company adopted SAB 101. The adoption
of SAB 101 resulted in a change in method of revenue recognition for certain
product shipments due to the specified shipping terms for these products. The
cumulative effect of this accounting change was $130,000, which has been
included in net loss for the three months ended January 31, 2001. Prior period
financial statements have not been restated to apply SAB 101 retroactively,
however, the pro forma amounts included in the Condensed Consolidated Statements
of Operations reflect the net loss and net loss per share assuming the Company
had retroactively applied SAB 101 to all periods presented.

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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.

OVERVIEW

We are the leading provider of enterprise data center routing solutions
for open system 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. Specifically, when used in
storage area networks our storage routers decrease congestion in the transfer of
data within a network, reduce the time required to back up data, improve
utilization of storage resources, and preserve and enhance existing server and
storage system investments.

Our mission is to become the company customers trust to link business
with information regardless of technology or location. Our objective is to
maintain our position as the leading provider of storage routers and to leverage
this position to become the leading provider of I/O routing solutions. The key
elements of our strategy include providing products compatible with existing
technologies to ensure connectivity for our customers, delivering products that
are on the cutting edge of technology, expanding field sales force with coverage
of key regional and OEMs accounts, expanding distribution channels, emphasizing
quality through our Crossroads Quality Management (CQM) Program and ensuring
broad interoperability with CV-SAN testing and verification program with leading
software vendors.

We have developed or acquired extensive expertise in several different
input-output (I/O) and networking protocols, including small computer system
interface (SCSI), Fibre Channel, Enterprise Systems Connection (ESCON),
Asynchronous Transfer Mode (ATM), Ethernet, Transmission Control
Protocol/Internet Protocol (TCP/IP) and InfiniBand. We have applied this
expertise in these protocols to develop solutions for leading server and storage
system providers such as ACAL, ADIC, ATL, Bell Micro, Compaq, Cranel, Datalink ,
Dell, Fujitsu-Siemens, Groupe Bull, Hewlett-Packard, Hitachi Data Systems, IBM,
McDATA, SANrise, StorageTek, Sun Microsystems, Tech Data and Unisys.

We expanded our product line with the launch of our 4x50 storage
router, our third generation product line. The 4x50 line enables companies to
realize the benefits of managing their mission critical data using applications
such as LAN-free and server-free backup. The 4x50 provides the broadest array of
connectivity options for the departmental workgroup through the enterprise
customer.

In March 2000, we consummated our acquisition of Polaris
Communications, Inc. Polaris was a leading developer and marketer of System 390,
or 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. This technology
provides us with access to the S/390 market, where approximately 70 percent of
the world's data resides.

To date, we have sold our products primarily to original equipment
manufacturers, or OEMs, of servers and storage systems. These computer equipment
manufacturers sell our storage routers to end-user organizations for use in
their storage area networks. We also sell our storage routers through companies
that distribute, resell or integrate

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our storage routers as part of a complete SAN solution. Recently, we have also
begun to establish relationships to sell our products through storage service
providers, or SSPs, an important new class of service providers which provide
storage-related services to customers within Internet data centers and large
metropolitan areas. A few OEM customers historically have accounted for a
substantial portion of our revenue. During fiscal 1998, our four largest
customers - ADIC, Compaq, Hewlett-Packard and StorageTek - respectively
accounted for 25%, 20%, 16% and 14% of our total revenue. During fiscal 1999,
2000 and the three months ended January 31, 2001, sales to Compaq and StorageTek
respectively accounted for 36% and 36%, 33% and 21%, and 3% and 15% of our total
revenue. This decrease in sales to Compaq and StorageTek during the three months
ended January 31, 2001 was more than offset by significantly higher revenue
through our expanded OEM revenue base including a new OEM relationship with Sun
Microsystems under which medium to large businesses are given more bandwidth for
data movement between Sun servers and S/390 class mainframes, where more than
half of the world's data is stored and managed. This broadened revenue base was
also evidenced by volume from our top eight customers representing 75% of our
total revenue, four of which individually accounted for 10% or more of our
revenue, during the three months ended January 31, 2001.

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, storage service providers and system integrators. Our worldwide
distribution channel accounted for approximately 4%, 10%, and 10% of our total
sales during the fiscal years 1999, 2000, and the three months ended January 31,
2001, respectively. Although we anticipate that revenue derived from sales to
distributors, resellers and system integrators and through SSPs 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.

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. During July 2000, we recorded a $1.1 million return
resulting from StorageTek's shift in demand to our newer products. Moreover,
Compaq informed us that it intends to discontinue purchasing our 4100/4200 line
of storage routers and has begun to internally manufacture its 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. Other
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.

With respect to sales of our products to OEMs, we recognize product
revenue when products are shipped and risk of loss has passed 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 the related cost of revenue associated with such
sales and recognize these amounts when that customer sells our products to its
customers. At January 31, 2001, our deferred revenue totaled $772,000. 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. During fiscal 2000, we engaged another contract manufacturer,
Solectron, to supply the printed circuit board for our 4x50 family of products.
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, 1999, 2000, and
three months ended January 31, 2001 aggregating approximately $19.6 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 $11.3 million has been amortized as of
January 31, 2001.

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During the three months ended January 31, 2001, 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 January 31, 2001 presentation.

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

THREE MONTHS ENDED
JANUARY 31,
------------------
2000 2001
------ ------

We currently expect to amortize the remaining amounts of deferred
stock-based compensation as of January 31, 2001 in the periods indicated (in
thousands):

YEAR ENDED OCTOBER 31,
------------------------------------------------------
2001 2002 2003 2004 TOTAL
------ ------ ------ ------ ------

We currently have six patents issued, one allowed and 14 patent
applications pending in the United States Patent and Trademark Office with
respect to our technology. We have 14 pending international patent applications
(one in Australia, four in Canada, three in the European Patent Office, two in
Hong Kong, and four in Japan). We also have patents pending under the Patent
Cooperation Treaty with the intent of filing in additional countries. However,
none of our patents, including patents that may be issued in the future, may
adequately protect our technology from infringement or prevent others from
claiming that our technology infringes that of third parties. Failure to
adequately protect our intellectual property could materially harm our business.
In addition, our competitors may independently develop similar or superior
technology

We have incurred significant operating losses in every fiscal quarter
and annual period since November 1, 1995 and our accumulated deficit was $75.2
million at January 31, 2001.

As of January 31, 2001, we had approximately $44.7 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.

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 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.

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RESULTS OF OPERATIONS

The following table sets forth our consolidated financial data for the
periods indicated expressed as a percentage of our total revenue, including the
aforementioned allocation of stock-based compensation for all periods presented.
See Item I. Financial Statements (Unaudited) - Note 7 to Notes to Condensed
Consolidated Financial Statements.

THREE MONTHS ENDED
JANUARY 31,
------------------
2000 2001
----- -----

Revenue:
Product revenue .................. 98.8% 98.5%
Other revenue .................... 1.2 1.5
----- -----
Total revenue ................. 100.0 100.0
Cost of revenue .................... 53.8 48.9
----- -----
Gross profit ....................... 46.2 51.1
Operating expenses:
Sales and marketing .............. 27.3 40.8
Research and development ......... 24.4 43.1
General and administrative ....... 17.8 47.3
Amortization of intangibles ...... -- 36.1
----- -----
Total operating expenses ...... 69.5 167.3
----- -----
Loss from operations ............... (23.3) (116.2)
Other income, net .................. 12.8 9.8
----- -----
Net loss before cumulative effect of
accounting change ................ (10.5) (106.4)
Cumulative effect of accounting
change ........................... -- (1.3)
----- -----
Net loss ........................... (10.5)% (107.7)%
===== =====

COMPARISON OF THREE MONTHS ENDED JANUARY 31, 2000 AND 2001

Revenue. Total revenue increased 13.4% from $8.8 million for the three
months ended January 31, 2000 to $10.0 million for the three months ended
January 31, 2001. Without the inclusion of Polaris products and services, total
revenue decreased 10.0% for the three months ended January 31, 2001 compared to
the same period in 2000.

Product revenue. Product revenue increased 13.0% from $8.7 million for the
three months ended January 31, 2000 to $9.8 million for the three months ended
January 31, 2001. As a percentage of total revenue, product revenue decreased
from 98.8% for the three months ended January 31, 2000 to 98.5% for the three
months ended January 31, 2001. The increase in product revenue resulted from
increased sales of our storage router product family through an increased
customer base and increased sales to our significant OEMs, customers,
distributors, resellers and system integrators in conjunction with a growing
demand for storage routers. This broadened revenue base was also evidenced by
volume from our top eight customers representing 75.0% of our total revenue,
four of which individually accounted for 10.0% or more of our revenue. In the
past twelve months, we deployed our sales team throughout the United States and
Europe tripling our U.S. field sales and support offices and opened offices in
the United Kingdom and Germany. This field sales force is strategically located
near key accounts to provide better service and drive demand creation through
joint sales calls with our partners. In addition, we launched our third
generation technology, the Crossroads 4x50 line of high-performance intelligent
routers that enable companies to realize the benefits of managing their mission
critical data using applications such as server-free backup and LAN-free backup
while protecting the investments made in their current enterprise systems. Our
4x50 line accounted for approximately 4.3% and 49.9% of our product revenue
during the three months ended January 31, 2000 and 2001, respectively.

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 47.9% from $101,000 for the three
months ended January 31, 2000 to $150,000 for the three months ended January 31,
2001. The increase for the three months ended January 31, 2001 was due to the
license of a product design and royalties for $110,000 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 stock-based
compensation of $86,000 and $39,000 during the three months ended January 31,
2000 and 2001, respectively, increased 4.3% from $4.6 million for the three
months ended January 31, 2000 to $4.8 million for the three months ended January
31, 2001. Gross profit, net of stock-based compensation, increased 23.6% from
$4.2 million for the

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three months ended January 31, 2000 to $5.1 for the three months ended January
31, 2001. Gross profit margin, net of stock-based compensation, increased from
47.3% for the three months ended January 31, 2000 to 51.5% for the three months
ended January 31, 2001. The increase was primarily due to higher margin OEM
product sales, a better product mix and significantly improved revenue linearity
during the quarter.

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 stock-based compensation of $192,000 and
$48,000 during the three months ended January 31, 2000 and 2001, respectively,
increased 81.8% from $2.2 million for the three months ended January 31, 2000 to
$4.0 million for the three months ended January 31, 2001. This increase in sales
and marketing expenses for the three months ended January 31, 2001 was primarily
due to increased travel and entertainment expenses of approximately $100,000,
increased tradeshow related expenses of approximately $90,000, increased
depreciation of approximately $100,000 and the hiring of additional sales and
marketing personnel resulting in approximately $900,000 of increased
compensation expense, including increased commissions commensurate with greater
sales. Sales and marketing personnel totaled 48 at January 31, 2000 and 64 at
January 31, 2001. As a percentage of total revenue, sales and marketing expenses
increased from 27.3% for the three months ended January 31, 2000 to 40.8% for
the three months ended January 31, 2001. 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 $161,000 and $265,000
during the three months ended January 31, 2000 and 2001, respectively, increased
103.4% from $2.0 million for the three months ended January 31, 2000 to $4.0
million for the three months ended January 31, 2001. This increase in research
and development expenses was primarily due to the hiring of additional research
and development personnel resulting in approximately $700,000 of increased
compensation expense, increased prototyping costs of approximately $250,000
related to the ongoing development of an expanded product line, increased
consulting expenses of approximately $100,000 and approximately $170,000 of
increased depreciation expense. Research and development personnel totaled 60 at
January 31, 2000 and 70 at January 31, 2001. As a percentage of total revenue,
research and development expenses increased from 24.4% for the three months
ended January 31, 2000 to 43.1% for the three months ended January 31, 2001. 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 $249,000 and $2.2 million during the three months ended January
31, 2000 and 2001, respectively, increased 89.4% from $1.3 million for the three
months ended January 31, 2000 to $2.5 million for the three months ended January
31, 2001. This increase in general and administrative expenses was primarily due
to increased legal costs associated with patent infringement lawsuits of
approximately $600,000 and the hiring of administrative personnel resulting in
approximately $360,000 of increased compensation expense for the three months
ended January 31, 2001 which were necessary to manage and support the growth in
our business as a public company. General and administrative personnel totaled
30 at January 31, 2000 and 37 at January 31, 2001. As a percentage of total
revenue, general and administrative expenses increased from 17.8% for the three
months ended January 31, 2000 to 47.3% for the three months ended January 31,
2001. 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 $1.1 million and $974,000 in the three months ended January 31, 2000 and
2001, respectively, representing 12.8% and 9.8% of total revenue respectively.
The decrease in other income, net was primarily due to decreased cash, cash
equivalents and short-term investment balances.

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LIQUIDITY AND CAPITAL RESOURCES

Our principal sources of liquidity at January 31, 2001 consisted of $46.4
million in cash and cash equivalents and $10.0 million in short-term
investments. At January 31, 2000, we had a bank credit facility, which 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. 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 January 2001, the Company extended its existing line of credit with a
bank. The committed revolving line is an advance of up to $3.0 million with a
borrowing base of 80% of eligible accounts receivable. The line of credit
matures on February 1, 2002. As of January 31, 2001, there were no borrowings
outstanding under the revolving line of credit and no term loans outstanding.

In February 2000, we entered into a $1.0 million letter of credit in
connection with the lease requirements of our new facility.

Cash utilized by operating activities was $2.7 million for the three months
ended January 31, 2000 as compared to $2.7 million for the three months ended
January 31, 2001. The net cash utilized remained consistent with the comparable
period despite an increase in net losses of approximately $9.8 million due to
increased working capital of $3.6 million required to fund the expansion of our
operations and increased non-cash items such as depreciation, amortization and
stock based compensation of approximately $6.2 million.

Cash provided by investing activities was $3.8 million for the three months
ended January 31, 2000 as compared to $6.3 million for the three months ended
January 31, 2001. The increase in net cash provided reflected the maturity of
held-to-maturity investments, net of purchases, of $7.6 million during the three
months ended January 31, 2001 compared to $5.4 million during the three months
ended January 31, 2000 in addition to capital expenditures during the period.
Capital expenditures were $1.7 million and $1.3 million for the three months
ended January 31, 2000 and 2001, 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 2001 of at least $6.7 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 utilized by financing activities was $2.4 million for the three months
ended January 31, 2000 as compared to cash provided by financing activities of
$311,000 for the three months ended January 31, 2001. The increase in cash
provided by financing activities reflected the payment of our existing debt of
$2.4 million during the three months ended January 31, 2000 in addition to an
increase of approximately $290,000 in proceeds from issuance of common stock
during the three months ended January 31, 2001. 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 (which amount
includes the $12.0 million of proceeds received from the private placement of
our Series E preferred stock in August 1999), product sales and, to a lesser
extent, bank debt (equipment loan).

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.

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RECENT ACCOUNTING PRONOUNCEMENTS

In June 1998, the Financial Accounting Standards Board, or FASB, issued,
Statement of Financial Accounting Standards, or 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 FASB Interpretation No. 44 "Accounting for
Certain Transactions Involving Stock Compensation - an interpretation of APB
Opinion 25" ("Interpretation No. 44"), 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. The adoption of Interpretation No. 44 did not 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. Effective November 1, 2000, we
adopted SAB 101. The adoption of SAB 101 resulted in a change in method of
revenue recognition for certain product shipments due to the specified shipping
terms for these periods. The cumulative effect of this accounting change was
$130,000, which has been included in net loss for the three months ended January
31, 2001. Prior period financial statements have not been restated to apply SAB
101 retroactively, however, the pro forma amounts included in the Condensed
Consolidated Statements of Operations reflect the net loss and net loss per
share assuming the Company had retroactively applied SAB 101 to all periods
presented.

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FACTORS THAT MAY AFFECT FUTURE RESULTS

In addition to the other information in this Form 10-Q, the following factors
should be considered in evaluating Crossroads and our business. These factors
include, but are not limited to the potential for significant losses to
continue; our inability to accurately predict revenue and budget for expenses
for future periods; fluctuations in revenue and operating results; class action
securities litigation; overall market performance; limited product lines;
limited number of OEM customers; lengthy OEM product qualification process;
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; final
assembly and test process; inventory risks; limited resources; pricing;
dependence upon key personnel; international operations; product liability
claims; the inability to protect our intellectual property rights, including any
adverse outcome in our pending patent litigation with certain of our
competitors; potential future acquisitions; concentration of ownership;
volatility of stock price; and the impact on our results or operations due to
changes in accounting standards, including the implementation of SAB 101 with
respect to revenue recognition. The discussion below addresses some of these
factors. Additional risks and uncertainties that we are unaware of or that we
currently deem immaterial also may become important factors that affect us.

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 January 31,
2001, we had an accumulated deficit of $75.2 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 four 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 that 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;

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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 the 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 and several of our officers and directors were named as defendants in
several class action lawsuits filed in the United States District Court for the
Western District of Texas. 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 Court consolidated the actions and appointed a
lead plaintiff under the Private Securities Litigation Reform Act of 1995. We
deny the allegations in the complaints and intend to defend against them
vigorously. We intend to file a motion to dismiss the consolidated amended
complaint once it has been filed. The litigation is at an early stage and it is
not possible at this time to predict whether we will incur any liability or to
estimate the damages, or the range of damages, that we might incur in connection
with such actions. An adverse judgment may have a material adverse effect on our
business and financial performance. See Item 1. Financial Statements (Unaudited)
- - Note 6 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.
Substantially all of 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, storage service providers 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, storage system providers
and end-user organizations;

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

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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. Sales of our 4x50 product accounted for
approximately 4% and 50% of our product revenue during the three months ended
January 31, 2000 and 2001, respectively. 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, system integrator and storage
system provider customers.

WE DEPEND ON A LIMITED NUMBER OF CUSTOMERS FOR THE VAST MAJORITY OF OUR REVENUE.
THE LOSS OF OR SIGNIFICANT REDUCTION IN ORDERS FROM ANY KEY CUSTOMERS WOULD
SIGNIFICANTLY REDUCE OUR REVENUE, AND THE FAILURE TO REPLACE REVENUE FROM
COMPAQ, WOULD SUBSTANTIALLY HARM OUR FUTURE RESULTS OF OPERATIONS.

In fiscal 1998, 1999, 2000, and the three months ended January 31, 2001,
approximately 90%, 85%, 77%, and 46% of our revenue, respectively, was derived
from six 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. In fiscal
2000, Compaq and StorageTek represented 33% and 21% of our total revenue,
respectively. During the three months ended January 31, 2001, Compaq and
StorageTek represented 3% and 15% of our total revenue, respectively. During
fiscal 2000, we recorded a $1.1 million return resulting from StorageTek's shift
in demand to our newer products. Moreover, Compaq informed us that it intends to
discontinue purchasing our 4100/4200 line of storage routers and to internally
manufacture its 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.

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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 an 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

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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, system
integrators and storage service providers, 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, system integrators and storage system providers. 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 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 our contract
manufacturers 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 our contract manufacturers 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. Our contract manufacturers 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 REQUIRE
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.

TRANSITIONING THE FINAL ASSEMBLY AND TEST PORTION OF OUR MANUFACTURING PROCESS
TO AN IN-HOUSE FACILITY 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. If demand for our products does not support the effective
utilization of our manufacturing employees and additional facilities and
equipment, we may not realize any benefit from replacing these services
previously outsourced to a contract manufacturer with internal final assembly
and testing. Furthermore, internal final assembly and test operations require 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.

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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 revenue 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 Adva-SAN Ltd., ATTO, Chaparral Network Storage,
Computer Network Technologies and Pathlight Technology. During fiscal 2000,
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. In addition, other OEM
customers could develop products or technologies internally, or by entering into
strategic relationships with or acquiring other existing SAN product providers
that would replace their need for our products and would become a source of
competition. We expect to face competition in the future from OEMs, including
our customers and potential customers, LAN router manufacturers, storage system
industry suppliers, including manufacturers and vendors of other SAN products or
entire SAN systems, and 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. 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.

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WE HAVE LICENSED OUR 4200 AND 4X50 STORAGE ROUTER TECHNOLOGY TO A KEY CUSTOMER,
WHICH MAY ENABLE THIS CUSTOMER TO COMPETE WITH US.

We have licensed our 4200 and 4x50 storage router technology to
Hewlett-Packard. Hewlett-Packard currently manufactures the 4200 product under
its name and pays us a royalty. Hewlett-Packard has vastly greater resources and
distribution capabilities than we do, and therefore, 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.

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 generally have 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.

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

Networking products such as ours may 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 voluntarily
issued a "stop-ship" on our 4x50 line and part of our 4200 line due to firmware
issues, which negatively affected our product revenue for the fiscal year ended
October 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, and Larry Sanders, our president and chief operating
officer, 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
Mr. Sanders. 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

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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.

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

We have opened 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
continue to develop relationships with international distributors, resellers,
system integrators and storage 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 rules;

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. 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
against us 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

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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, in March 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.

As of January 31, 2001, our executive officers and directors beneficially
own approximately 31.4% 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 us 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;

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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. Effective November 1, 2000, we
adopted SAB 101. While SAB 101 will not affect the fundamental aspects of our
operations as measured by product shipments and cash flows, implementation of
SAB 101 will affect our reported results of operations. 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. The adoption of SAB 101 resulted in a change in method
of revenue recognition for certain product shipments due to the specified
shipping terms for these periods. The cumulative effect of this accounting
change was $130,000, which has been included in net income for the three months
ended January 31, 2001. Prior period financial statements have not been restated
to apply SAB 101 retroactively, however, the pro forma amounts included in the
Condensed Consolidated Statements of Operations reflect the net loss and net
loss per share assuming we had retroactively applied SAB 101 to all periods
presented. We are also considering potential changes to the terms of our sales
agreements for equipment sales that could mitigate the impact of SAB 101.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Information concerning market risk is contained on Page 31 of our 2000
Annual Report on Form 10-K and is incorporated herein by reference to the annual
report.

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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., or 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. Trial is currently
scheduled to begin in the second half of 2001. We intend to vigorously prosecute
our claims. However, no assurance can be given as to the outcome of this action.
We believe we should ultimately prevail on this litigation.

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. Trial is currently scheduled to begin in
the first half of 2001. We intend to vigorously prosecute our claims. However,
no assurance can be given as to the outcome of this action. We believe we should
ultimately prevail on this litigation. In January 2001, Advanced Digital
Information Corporation, a customer and shareholder of Crossroads, announced
that it had entered into a definitive agreement to acquire Pathlight.

On May 19, 2000, Chaparral filed a counter-suit against us alleging tortuous
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,
the case was transferred to the Austin division, and consolidated 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.

We and several of our officers and directors were named as defendants in
several class action lawsuits filed in the United States District Court for the
Western District of Texas. 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 Court consolidated the actions and appointed a
lead plaintiff under the Private Securities Litigation Reform Act of 1995. The
amended consolidated complaint was filed February 2001 and we intend to file a
motion to dismiss. The plaintiffs are seeking unspecified amounts of
compensatory damages, interests and costs, including legal fees. We deny the
allegations in the complaint and intend to defend ourselves vigorously.

The class action lawsuit is still at an early stage. Consequently, it is not
possible at this time to predict whether we will incur any liability or to
estimate the damages, or the range of damages, if any, that we might incur in
connection with this lawsuit. Our inability to prevail in this action could have
a material adverse effect on our future business, financial condition and
results of operations.

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29

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

(a) Exhibit Index

Exhibit Number Description
-------------- -----------

10.15 Loan Modification Agreement dated December 31, 2000
by and between Crossroads and Silicon Valley Bank.

(b) Reports on Form 8-K

Crossroads did not file any current reports on Form 8-K during the three
months ended January 31, 2001.

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30

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.

By: /s/ Reagan Y. Sakai
-----------------------------------------
Reagan Y. Sakai
Vice-President, Chief Financial Officer
Secretary and Treasurer

March 16, 2001 /s/ Brian R. Smith
-------------- ----------------------------------------------
(Date) Brian R. Smith
Chairman of the Board and Chief Executive Officer
(Principal Executive Officer)

March 16, 2001 /s/ Reagan Y. Sakai
-------------- ----------------------------------------------
(Date) Reagan Y. Sakai
Chief Financial Officer
(Principal Financial and Accounting Officer)

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31

INDEX TO EXHIBITS

Exhibit Number Description
-------------- -----------

10.15 Loan Modification Agreement dated December 31, 2000 by
and between Crossroads and Silicon Valley Bank