| BROCADE COMMUNICATIONS SYSTEMS INC Item 1A Risk Factors Our future revenue growth depends on our ability to introduce new products and services on a timely basis and achieve market acceptance of these new products and services |
| The market for SANs is characterized by rapidly changing technology and accelerating product introduction cycles |
| Our future success depends upon our ability to address the rapidly changing needs of our customers by developing and supplying high-quality, cost-effective products, product enhancements and services on a timely basis, and by keeping pace with technological developments and emerging industry standards |
| This risk will become more pronounced as the SAN market becomes more competitive and subject to increased demand for new and improved technologies |
| We have recently introduced a significant number of new products, primarily in our SilkWorm product family, which accounts for a substantial portion of our revenues |
| For example, during fiscal year 2005 we introduced the SilkWorm 48000 Director, the SilkWorm 200E entry level fabric switch, four new switch modules for bladed server solutions, and a new release of Fabric Manager software |
| We also launched two new software products, the Tapestry Application Resource Manager solution and the Tapestry Wide Area File Services solution, as well as new service and support offerings |
| In addition, we recently announced our new Tapestry Data Migration Manager solution |
| As of December 31, 2005, two of our three Tapestry offerings, Tapestry Application Resource Manager and Tapestry Data Migration Manager were still in the evaluation stage at various customers and only our Tapestry Wide Area File Services solution was generally available and shipping for revenue |
| We have also begun investing in new service offerings |
| We must achieve widespread market acceptance of our new products and service offerings in order to realize the benefits of our investments |
| The rate of market adoption is also critical |
| The success of our product and service offerings depend on numerous factors, including our ability: • to properly define the new products and services; • to timely develop and introduce the new products and services; • to differentiate our new products and services from our competitors’ offerings; and 10 _________________________________________________________________ [69]Table of Contents • to address the complexities of interoperability of our products with our OEM partners’ server and storage products and our competitors’ products |
| Some factors impacting market acceptance are also outside of our control, including the availability and price of competing products, technologies; product qualification requirements by our OEM partners, which can cause delays in the market acceptance; and the ability of our OEM partners to successfully distribute, support and provide training for our products |
| If we are not able to successfully develop and market new and enhanced products and services, our business and results of operations will be harmed |
| We are currently diversifying our product and service offerings to include software applications and support services, and our operating results will suffer if these initiatives are not successful |
| Starting in the second half of fiscal year 2004, we began making a series of investments in the development and acquisition of new technologies and services, including new switch modules for bladed server solutions, new hardware and software solutions for information technology infrastructure management and new service and support offerings |
| Some of these offerings are focused on new markets that are adjacent or parallel to our traditional market |
| Our strategy is to derive competitive advantage and drive incremental revenue growth through such investments |
| However, we cannot be certain that our new strategic offerings will achieve market acceptance, or that we will benefit fully from the substantial investments we have made and plan to continue to make in them |
| In addition, these investments have caused, and will likely continue to result in, higher operating expenses and if they are not successful, our operating income and operating margin will deteriorate |
| For instance, we have hired a number of additional employees, and plan to continue to add additional personnel and resources, to further develop and market software applications, including three recently introduced solutions, a Tapestry Application Resource Manager solution, a Tapestry Data Migration Manager solution and a Tapestry Wide Area File Services solution, and our service offerings |
| In addition, our acquisition of Therion Software Corporation and our investment in a strategic partnership contributed to the software applications associated with these solutions |
| In addition, because some of these offerings may be different from the areas that we have historically focused on, we may face a number of additional challenges, such as: • successfully identifying market opportunities; • developing new customer relationships; • expanding our relationship with our existing OEM partners and end-users; • managing different sales cycles; • hiring qualified personnel on a timely basis; • establishing effective distribution channels and alternative routes to market; and • estimating the level of customer acceptance and rate of market adoption |
| These new product and service offerings also may contain some features that are currently offered by our OEM partners, which could cause conflicts with partners on whom we rely to bring our current products to customers and thus negatively impact our relationship with such partners |
| In addition, if we are unable to successfully integrate new offerings that we develop, license or otherwise acquire into our existing base of products and services, our business and results of operations may be harmed |
| We are also investing in an expanded service initiative, which may be costly and may not gain market acceptance |
| For instance, we recently announced the availability of new professional services designed to assist customers in designing, installing, operating and supporting shared storage infrastructures |
| Traditionally, we have relied on our OEM partners and third parties to provide such support for end-users of our products and services, and we cannot be sure that this change in our business model will result in anticipated revenues |
| For instance, staffing support centers involves cost and revenue structures that are different from those used in selling hardware and licensing software |
| We also intend to significantly increase headcount to provide these services and staff support centers |
| Revenue will be dependent on our ability to utilize service providers, and if we do not effectively manage 11 _________________________________________________________________ [70]Table of Contents costs relative to revenue, our services initiative will not be successful |
| In addition, bringing the service initiative to market may be competitive with our OEM partners and other distribution channel partners |
| Increased market competition may lead to reduced sales, margins, profits and market share |
| The SAN market is becoming increasingly more competitive as new products, services and technologies are introduced by existing competitors and as new competitors enter the market |
| Increased competition in the past has resulted in greater pricing pressure, and reduced sales, margins, profits and market share |
| Moreover, new competitive products could be based on existing technologies or new technologies that may or may not be compatible with our SAN technology |
| Competitive products include, but are not limited to, non-Fibre Channel based emerging products utilizing Gigabit Ethernet, 10 Gigabit Ethernet, InfiniBand, and iSCSI (Internet Small Computer System Interface) |
| Currently, we believe that we principally face competition from providers of Fibre Channel switching products for interconnecting servers and storage |
| These competitors include Cisco Systems, McDATA Corporation (which completed its acquisition of Computer Network Technology Corporation (“CNT”) on June 1, 2005) and QLogic Corporation |
| In addition, our OEM partners, who also have relationships with some of our current competitors, could become new competitors by developing and introducing products competitive with our product offerings, choosing to sell our competitors’ products instead of our products, or offering preferred pricing or promotions on our competitors’ products |
| Competitive pressure will likely intensify as our industry experiences further consolidation in connection with acquisitions by us, our competitors and our OEM partners |
| Some of our competitors have longer operating histories and significantly greater human, financial and capital resources than us |
| Our competitors could adopt more aggressive pricing policies than us |
| We believe that competition based on price may become more aggressive than we have traditionally experienced |
| Our competitors could also devote greater resources to the development, promotion, and sale of their products than we may be able to support and, as a result, be able to respond more quickly to changes in customer or market requirements |
| Our failure to successfully compete in the market would harm our business and financial results |
| Our competitors may also pressure our distribution model of selling products to customers through OEM solution providers by focusing a large number of sales personnel on end-user customers or by entering into strategic partnerships |
| For example, one of our competitors has formed a strategic partnership with a provider of network storage systems, which includes an agreement whereby our competitor resells the storage systems of its partner in exchange for sales by the partner of our competitor’s products |
| Such strategic partnerships, if successful, may influence us to change our traditional distribution model |
| If our assumptions regarding our revenues and margins do not materialize, our future profitability could be adversely affected |
| We incurred a net loss of dlra7dtta2 million in the third quarter of fiscal year 2005 and were not profitable for the full fiscal years 2004 or 2003, and we may not be profitable in the future |
| We make our investment decisions and plan our operating expenses based in part on future revenue projections |
| However, our ability to accurately forecast quarterly and annual revenues is limited, as discussed below in “Our quarterly and annual revenues and operating results may fluctuate in future periods due to a number of factors, which could adversely affect the trading price of our stock |
| ” In addition, we are diversifying our product and service offerings and expanding into other markets that we have not historically focused on, including new and emerging markets |
| As a result, we face greater challenges accurately predicting our revenue and margins with respect to these other markets |
| Developing new offerings will also require significant, upfront, incremental investments that may not result in revenue for an extended period of time, if at all |
| Particularly as we seek to diversify our product and service offerings, we expect to incur significant costs and expenses for product development, sales, marketing and customer services, most of which are fixed in the short-term or incurred in advance of receipt of corresponding revenue |
| As a result, in the short-term, we may not be able to decrease our spending to offset any unexpected shortfall in revenues |
| If our projected revenues and margins do not materialize, our future profitability could be adversely affected |
| 12 _________________________________________________________________ [71]Table of Contents The prices of our products have declined in the past, and we expect the price of our products to continue to decline, which could reduce our revenues, gross margins and profitability |
| The average selling price per port for our products has declined in the past, and we expect it to continue to decline in the future as a result of changes in product mix, competitive pricing pressure, increased sales discounts, new product introductions by us or our competitors, the entrance of new competitors or other factors |
| For example, since the second half of fiscal year 2004, we have introduced and began shipping a number of new products that expand and extend the breadth of our product offerings |
| Several of these new products have lower per unit revenues, gross margin, and profitability characteristics than our traditional products |
| If we are unable to offset any negative impact that changes in product mix, competitive pricing pressures, increased sales discounts, enhanced marketing programs, new product introductions by us or our competitors, or other factors may have on us by increasing the number of ports shipped or reducing product manufacturing cost, our total revenues and gross margins will decline |
| In addition, to maintain our gross margins we must maintain or increase the number of ports shipped, develop and introduce new products and product enhancements, and continue to reduce the manufacturing cost of our products |
| While we have successfully reduced the cost of manufacturing our products in the past, we may not be able to continue to reduce cost of production at historical rates |
| Moreover, most of our expenses are fixed in the short-term or incurred in advance of receipt of corresponding revenue |
| If this occurs, we could incur losses, our operating results and gross margins could be below our expectations and the expectations of investors and stock market analysts, and our stock price could be negatively affected |
| Our failure to successfully manage the transition between our new products and our older products may adversely affect our financial results |
| As we introduce new or enhanced products, we must successfully manage the transition from older products to minimize disruption in customers’ ordering patterns, avoid excessive levels of older product inventories and provide sufficient supplies of new products to meet customer demands |
| When we introduce new or enhanced products, we face numerous risks relating to product transitions, including the inability to accurately forecast demand, and manage different sales and support requirements due to the type or complexity of the new products |
| For example, we recently introduced 4 Gigabit per second (“Gbit”) technology solutions that replace many of our 2 Gbit products |
| During the third quarter of fiscal year 2005, our net revenue was dlra122dtta3 million, down 16 percent from dlra144dtta8 million reported in the second quarter of fiscal year 2005 and 19 percent from dlra150dtta0 million reported in the third quarter of fiscal year 2004 |
| We believe that the transition from 2 Gbit products to 4 Gbit products was a significant factor contributing to the drop in our revenue in the third quarter of fiscal year 2005 |
| We also recorded a dlra3dtta4 million and dlra1dtta8 million write-down during the third and fourth quarters of fiscal year 2005, respectively, for excess and obsolete inventory due largely to the faster than expected product transition |
| We depend on OEM partners for a majority of our revenues, and the loss of any of these OEM partners or a decrease in their purchases could significantly reduce our revenues and negatively affect our financial results |
| We depend on recurring purchases from a limited number of large OEM partners for the majority of our revenue |
| As a result, these large OEM partners have a significant influence on our quarterly and annual financial results |
| Our agreements with our OEM partners are typically cancelable, non-exclusive, have no minimum purchase requirements and have no specific timing requirements for purchases |
| For the year ended October 29, 2005, three customers each represented ten percent or more of our total revenues for a combined total of 71 percent |
| We anticipate that our revenues and operating results will continue to depend on sales to a relatively small number of customers |
| The loss of any one significant customer, or a decrease in the level of sales to any one significant customer, or unsuccessful quarterly negotiation on key terms, conditions or timing of purchase orders placed during a quarter, could seriously harm our business and financial results |
| In addition, some of our OEM partners purchase our products for their inventories in anticipation of customer demand |
| These OEM partners make decisions to purchase inventory based on a variety of factors, including their product qualification cycles and their expectations of end customer demand, which may be affected by seasonality 13 _________________________________________________________________ [72]Table of Contents and their internal supply management objectives |
| Others require that we maintain inventories of our products in hubs adjacent to their manufacturing facilities and purchase our products only as necessary to fulfill immediate customer demand |
| If more of our OEM partners transition to a hub model, form partnerships, alliances or agreements with other companies that divert business away from us; or otherwise change their business practices, their ordering patterns may become less predictable |
| Consequently, changes in ordering patterns may affect both the timing and volatility of our reported revenues |
| The timing of sales to our OEM partners, and consequently the timing and volatility of our reported revenues, may be further affected by the product introduction schedules of our OEM partners |
| We also may be exposed to higher risks of obsolete or excess inventories |
| For example, during the third and fourth quarters of fiscal year 2005, we recorded write-downs for excess and obsolete inventory of dlra3dtta4 million and dlra1dtta8 million, respectively, due to the faster than expected transition from our 2 Gbit products to our 4 Gbit products |
| Our OEM partners evaluate and qualify our products for a limited time period before they begin to market and sell them |
| Assisting these distribution partners through the evaluation process requires significant sales, marketing and engineering management efforts on our part, particularly if our products are being qualified with multiple distribution partners at the same time |
| In addition, once our products have been qualified, our customer agreements have no minimum purchase commitments |
| We may not be able to effectively maintain or expand our distribution channels, manage distribution relationships successfully, or market our products through distribution partners |
| We must continually assess, anticipate and respond to the needs of our distribution partners and their customers, and ensure that our products integrate with their solutions |
| Our failure to successfully manage our distribution relationships or the failure of our distribution partners to sell our products could reduce our revenues significantly |
| In addition, our ability to respond to the needs of our distribution partners in the future may depend on third parties producing complementary products and applications for our products |
| If we fail to respond successfully to the needs of these groups, our business and financial results could be harmed |
| Our quarterly and annual revenues and operating results may fluctuate in future periods due to a number of factors, which could adversely affect the trading price of our stock |
| Our quarterly and annual revenues and operating results may vary significantly in the future due to a number of factors, any of which may cause our stock price to fluctuate |
| Factors that may affect the predictability of our annual and quarterly results include, but are not limited to, the following: • announcements, introductions, and transitions of new products by us and our competitors or our OEM partners; • the timing of customer orders, product qualifications, and product introductions of our OEM partners; • seasonal fluctuations; • changes, disruptions or downturns in general economic conditions, particularly in the information technology industry; • declines in average selling price per port for our products as a result of competitive pricing pressures or new product introductions by us or our competitors; • the emergence of new competitors in the SAN market; • deferrals of customer orders in anticipation of new products, services, or product enhancements introduced by us or our competitors; • our ability to timely produce products that comply with new environmental restrictions or related requirements of our OEM customers; • our ability to obtain sufficient supplies of sole- or limited-sourced components, including application-specific integrated circuits (or ASICs), microprocessors, certain connectors, certain logic chips, and programmable logic devices; • increases in prices of components used in the manufacture of our products; 14 _________________________________________________________________ [73]Table of Contents • our ability to attain and maintain production volumes and quality levels; • variations in the mix of our products sold and the mix of distribution channels through which they are sold; • pending or threatened litigation; • stock-based compensation expense that is affected by our stock price; • new legislation and regulatory developments; and • other risk factors detailed in this section entitled “Risk Factors |
| ” Accordingly, the results of any prior periods should not be relied upon as an indication of future performance |
| We cannot assure you that in some future quarter our revenues or operating results will not be below our projections or the expectations of stock market analysts or investors, which could cause our stock price to decline |
| If we lose key personnel or are unable to hire additional qualified personnel, our business may be harmed |
| Our success depends to a significant degree upon the continued contributions of key management, engineering, sales and other personnel, many of whom would be difficult to replace |
| We believe our future success will also depend, in large part, upon our ability to attract and retain highly skilled managerial, engineering, sales and other personnel, and on the ability of management to operate effectively, both individually and as a group, in geographically disparate locations |
| We have experienced difficulty in hiring qualified personnel in areas such as application specific integrated circuits, software, system and test, sales, marketing, service, key management and customer support |
| In addition, our past reductions in force could potentially make attracting and retaining qualified employees more difficult in the future |
| Our ability to hire qualified personnel may also be negatively impacted by our recent internal reviews and financial statement restatements, related investigations by the SEC and Department of Justice (“DOJ”), and current level of our stock price |
| The loss of the services of any of our key employees, the inability to attract or retain qualified personnel in the future, or delays in hiring required personnel, particularly engineers and sales personnel, could delay the development and introduction of, and negatively affect our ability to sell our products |
| In addition, companies in the computer storage and server industry whose employees accept positions with competitors may claim that their competitors have engaged in unfair hiring practices or that there will be inappropriate disclosure of confidential or proprietary information |
| We may be subject to such claims in the future as we seek to hire additional qualified personnel |
| Such claims could result in material litigation |
| As a result, we could incur substantial costs in defending against these claims, regardless of their merits, and be subject to additional restrictions if any such litigation is resolved against us |
| The loss of our third-party contract manufacturer would adversely affect our ability to manufacture and sell our products |
| The loss of our third-party contract manufacturer could significantly impact our ability to produce our products for an indefinite period of time |
| Qualifying a new contract manufacturer and commencing volume production is a lengthy and expensive process |
| If we are required to change our contract manufacturer, if we fail to effectively manage our contract manufacturer, or if our contract manufacturer experiences delays, disruptions, capacity constraints, component parts shortages or quality control problems in its manufacturing operations, shipment of our products to our customers could be delayed resulting in loss of revenues and our competitive position and relationship with customers could be harmed |
| The failure to accurately forecast demand for our products or the failure to successfully manage the production of our products could negatively affect the supply of key components for our products and our ability to manufacture and sell our products |
| We provide product forecasts to our contract manufacturer and place purchase orders with it in advance of the scheduled delivery of products to our customers |
| Moreover, in preparing sales and demand forecasts, we rely largely on input from our distribution partners |
| Therefore, if we or our distribution partners are unable to accurately forecast demand, or if we fail to effectively communicate with our distribution partners about end-user demand or other 15 _________________________________________________________________ [74]Table of Contents time-sensitive information, sales and demand forecasts may not reflect the most accurate, up-to-date information |
| If these forecasts are inaccurate, we may be unable to obtain adequate manufacturing capacity from our contract manufacturer to meet customers’ delivery requirements, or we may accumulate excess inventories |
| Furthermore, we may not be able to identify forecast discrepancies until late in our fiscal quarter |
| Consequently, we may not be able to make adjustments to our business model |
| If we are unable to obtain adequate manufacturing capacity from our contract manufacturer, if we accumulate excess inventories, or if we are unable to make necessary adjustments to our business model, revenue may be delayed or even lost to our competitors, and our business and financial results may be harmed |
| In addition, although the purchase orders placed with our contract manufacturer are cancelable, in certain circumstances we could be required to purchase certain unused material not returnable, usable by, or sold to other customers if we cancel any of our orders |
| This purchase commitment exposure is particularly high in periods of new product introductions and product transitions |
| If we are required to purchase unused material from our contract manufacturer, we would incur unanticipated expenses and our business and financial results could be negatively affected |
| Our business is subject to cyclical fluctuations and uneven sales patterns |
| Many of our OEM partners experience uneven sales patterns in their businesses due to the cyclical nature of information technology spending |
| For example, some of our partners close a disproportionate percentage of their sales transactions in the last month, weeks and days of each fiscal quarter, and other partners experience spikes in sales during the fourth calendar quarter of each year |
| Because the majority of our sales are derived from a small number of OEM partners, when they experience seasonality, we experience similar seasonality |
| For instance, we were exposed to significant seasonality in the second fiscal quarter of fiscal year 2005 in part due to weaker spending in the enterprise product line during the first calendar quarter of 2005 |
| In addition, we have experienced quarters where uneven sales patterns of our OEM partners have resulted in a significant portion of our revenue occurring in the last month of our fiscal quarter |
| This exposes us to additional inventory risk as we have to order products in anticipation of expected future orders and additional sales risk if we are unable to fulfill unanticipated demand |
| We are not able to predict the degree to which the seasonality and uneven sales patterns of our OEM partners or other customers will affect our business in the future particularly as we release new products |
| We are dependent on sole source and limited source suppliers for certain key components |
| We purchase certain key components used in the manufacture of our products from single or limited sources |
| We purchase ASICs from a single source, and we purchase microprocessors, certain connectors, logic chips, power supplies and programmable logic devices from limited sources |
| We also license certain third-party software that is incorporated into our operating system software and other software products |
| If we are unable to timely obtain these and other components or experience significant component defects, we may not be able to deliver our products to our customers in a timely manner |
| We use rolling forecasts based on anticipated product orders to determine component requirements |
| If we overestimate component requirements, we may have excess inventory, which would increase our costs |
| If we underestimate component requirements, we may have inadequate inventory, which could interrupt the manufacturing process and result in lost or delayed revenue |
| In addition, lead times for components vary significantly and depend on factors such as the specific supplier, contract terms, and demand for a component at a given time |
| We also may experience shortages of certain components from time to time, which also could delay the manufacturing and sales processes |
| If we overestimate or underestimate our component requirements, or if we experience shortages, our business and financial results could be harmed |
| We have been named as a party to several class action and derivative action lawsuits arising from our recent internal reviews and related restatements of our financial statements, and we may be named in additional litigation, all of which could require significant management time and attention and result in significant legal expenses and may result in an unfavorable outcome which could have a material adverse effect on our business, financial condition, results of operations and cash flows |
| We are subject to a number of lawsuits arising from our recent internal reviews and the related restatements of our financial statements that have been filed, some purportedly on behalf of a class of our stockholders, against us 16 _________________________________________________________________ [75]Table of Contents and certain of our executive officers claiming violations of securities laws and others purportedly on behalf of Brocade against certain of our executive officers and board members, and we may become the subject of additional private or government actions |
| The expense of defending such litigation may be significant |
| The amount of time to resolve these lawsuits is unpredictable and defending ourselves may divert management’s attention from the day-to-day operations of our business, which could adversely affect our business, results of operations and cash flows |
| In addition, an unfavorable outcome in such litigation could have a material adverse effect on our business, results of operations and cash flows |
| As a result of our recent internal reviews and related restatements, we are subject to investigation by the SEC and DOJ, which may not be resolved favorably and has required, and may continue to require, a significant amount of management time and attention and accounting and legal resources, which could adversely affect our business, results of operations and cash flows |
| The SEC and the DOJ are currently conducting an investigation of the Company |
| We have been responding to, and continue to respond to, inquiries from the SEC and DOJ The period of time necessary to resolve the SEC and DOJ investigation is uncertain, and these matters could require significant management and financial resources which could otherwise be devoted to the operation of our business |
| If we are subject to an adverse finding resulting from the SEC and DOJ investigation, we could be required to pay damages or penalties or have other remedies imposed upon us |
| The recent restatements of our financial results, the ongoing SEC and DOJ investigations and any negative outcome that may occur from these investigations could impact our relationships with customers and our ability to generate revenue |
| In addition, considerable legal and accounting expenses related to these matters have been incurred to date and significant expenditures may continue to be incurred in the future |
| The SEC and DOJ investigation could adversely affect our business, results of operations, financial position and cash flows |
| We may engage in future acquisitions and strategic investments that dilute the ownership percentage of our stockholders and require the use of cash, incur debt or assume contingent liabilities |
| As part of our business strategy, we expect to continue to review opportunities to buy or invest in other businesses or technologies that we believe would complement our current products, expand the breadth of our markets or enhance our technical capabilities, or that may otherwise offer growth opportunities |
| If we buy or invest in other businesses, products or technologies in the future, we could: • incur significant unplanned expenses and personnel costs; • issue stock, or assume stock option plans that would dilute our current stockholders’ percentage ownership; • use cash, which may result in a reduction of our liquidity; • incur debt; • assume liabilities; and • spend resources on unconsummated transactions |
| In addition, we are not currently eligible to file short-form registration statements on Form S-3 |
| Although registration statement on other forms are available, it could increase the cost of future acquisitions involving the issuance of stock until such time that we regain eligibility on Form S-3 |
| We may not realize the anticipated benefits of past or future acquisitions and strategic investments, and integration of acquisitions may disrupt our business and management |
| We have in the past and may in the future acquire or make strategic investments in additional companies, products or technologies |
| Most recently, we completed the acquisition of Therion Software Corporation and a strategic investment in Tacit Networks in May 2005 |
| We may not realize the anticipated benefits of these or any other acquisitions or strategic investments, which involve numerous risks, including: • problems integrating the purchased operations, technologies, personnel or products over geographically disparate locations, including San Jose, California; Redmond, Washington; and India; 17 _________________________________________________________________ [76]Table of Contents • unanticipated costs, litigation and other contingent liabilities; • diversion of management’s attention from our core business; • adverse effects on existing business relationships with suppliers and customers; • risks associated with entering into markets in which we have no, or limited, prior experience; • incurrence of significant exit charges if products acquired in business combinations are unsuccessful; • incurrence of acquisition-related costs or amortization costs for acquired intangible assets that could impact our operating results; • inability to retain key customers, distributors, vendors and other business partners of the acquired business; and • potential loss of our key employees or the key employees of an acquired organization |
| If we are not be able to successfully integrate businesses, products, technologies or personnel that we acquire, or to realize expected benefits of our acquisitions or strategic investments, our business and financial results may be adversely affected |
| Our revenues will be affected by changes in domestic and international information technology spending and overall demand for storage area network solutions |
| In the past, unfavorable or uncertain economic conditions and reduced global information technology spending rates have adversely affected our operating results |
| We are unable to predict changes in general economic conditions and when information technology spending rates will be affected |
| If there are future reductions in either domestic or international information technology spending rates, or if information technology spending rates do not improve, our revenues, operating results and financial condition may be adversely affected |
| Even if information technology spending rates increase, we cannot be certain that the market for SAN solutions will be positively impacted |
| Our storage networking products are sold as part of storage systems and subsystems |
| As a result, the demand for our storage networking products has historically been affected by changes in storage requirements associated with growth related to new applications and an increase in transaction levels |
| Although in the past we have experienced historical growth in our business as enterprise-class customers have adopted SAN technology, demand for SAN products in the enterprise-class sector continues to be adversely affected by weak or uncertain economic conditions, and because larger businesses are focusing on using their existing information technology infrastructure more efficiently rather than making new equipment purchases |
| If information technology spending levels are restricted, and new products improve our customers’ ability to utilize their existing storage infrastructure, the demand for SAN products may decline |
| Our business is subject to increasingly complex corporate governance, public disclosure, accounting, and tax requirements that has increased both our costs and the risk of noncompliance |
| We are subject to rules and regulations of federal and state government as well as the stock exchange on which our common stock is listed |
| These entities, including the Public Company Accounting Oversight Board, the SEC, the Internal Revenue Service and NASDAQ, have issued a significant number of new and increasingly complex requirements and regulations over the course of the last several years and continue to develop additional regulations and requirements in response to laws enacted by Congress, most notably the Sarbanes-Oxley Act of 2002 |
| Our efforts to comply with these requirements have resulted in, and are likely to continue to result in, increased expenses and a diversion of management time and attention from revenue-generating activities to compliance activities |
| We are subject to periodic audits or other reviews by such governmental agencies |
| For example, in November 2005, we were notified by the Internal Revenue Service that our domestic federal income tax return for the year ended October 25, 2003 was subject to audit |
| The SEC also periodically reviews our public company filings |
| Any such examination or review frequently requires management’s time and diversion of internal resources and, in the 18 _________________________________________________________________ [77]Table of Contents event of an unfavorable outcome, may result in additional liabilities or adjustments to our historical financial results |
| Recent changes in accounting rules, including the expensing of stock options granted to our employees, could have a material impact on our reported business and financial results |
| The US generally accepted accounting principles are subject to interpretation by the Financial Accounting Standards Board, or FASB, the American Institute of Certified Public Accountants, the PCAOB, the SEC, and various bodies formed to promulgate and interpret appropriate accounting principles |
| A change in these principles or interpretations could have a significant effect on our reported financial results |
| We currently record any compensation expense associated with stock option grants to employees using the intrinsic value method in accordance with Accounting Principles Board Opinion Nodtta 25 |
| On December 15, 2004, the FASB issued SFAS 123R, Share-Based Payment, which will require us to measure compensation expense for employee stock options using the fair value method beginning the first quarter of fiscal year 2006, which is the quarter ended January 28, 2006 |
| SFAS 123R applies to all outstanding stock options that are not vested at the effective date and grants of new stock options made subsequent to the effective date |
| As a result of SFAS 123R, we will record higher levels of stock based compensation due to differences between the valuation methods of SFAS 123R and APB 25 |
| Our future operating expenses may be adversely affected by changes in our stock price |
| A portion of our outstanding stock options are subject to variable accounting |
| Under variable accounting, we are required to remeasure the value of the options, and the corresponding compensation expense, at the end of each reporting period until the option is exercised, cancelled or expires unexercised |
| As a result, the stock-based compensation expense we recognize in any given period can vary substantially due to changes in the market value of our common stock |
| Volatility associated with stock price movements has resulted in compensation benefits when our stock price has declined and compensation expense when our stock price has increased |
| For example, the market value of our common stock at the end of the first, second, third and fourth quarters of fiscal year 2005 were dlra5dtta99, dlra4dtta35, dlra4dtta48 and dlra3dtta60 per share, respectively |
| Accordingly, we recorded compensation benefit in the fourth quarter of fiscal year 2005 of approximately dlra0dtta2 million |
| We are unable to predict the future market value of our common stock and therefore are unable to predict the compensation expense or benefit that we will record in future periods |
| International political instability and concerns about other international crises may increase our cost of doing business and disrupt our business |
| International political instability may halt or hinder our ability to do business and may increase our costs |
| Various events, including the occurrence or threat of terrorist attacks, increased national security measures in the United States and other countries, and military action and armed conflicts, can suddenly increase international tensions |
| Increases in energy prices will also impact our costs and could harm our operating results |
| In addition, concerns about other international crises, such as the spread of severe acute respiratory syndrome (“SARS”), avian influenza, or bird flu, and West Nile viruses, may have an adverse effect on the world economy and could adversely affect our business operations or the operations of our OEM partners, contract manufacturer and suppliers |
| This political instability and concerns about other international crises may, for example: • negatively affect the reliability and cost of transportation; • negatively affect the desire and ability of our employees and customers to travel; • disrupt the production capabilities of our OEM partners, contract manufacturers and suppliers; • adversely affect our ability to obtain adequate insurance at reasonable rates; and • require us to take extra security precautions for our operations |
| Furthermore, to the extent that air or sea transportation is delayed or disrupted, the operations of our contract manufacturers and suppliers may be disrupted, particularly if shipments of components and raw materials are delayed |
| 19 _________________________________________________________________ [78]Table of Contents We have extensive international operations, which subjects us to additional business risks |
| A significant portion of our sales occur in international jurisdictions and our contract manufacturer has significant operations in China |
| We also plan to continue to expand our international operations and sales activities |
| Expansion of international operations will involve inherent risks that we may not be able to control, including: • supporting multiple languages; • recruiting sales and technical support personnel with the skills to design, manufacture, sell, and support our products; • increased complexity and costs of managing international operations; • increased exposure to foreign currency exchange rate fluctuations; • commercial laws and business practices that favor local competition; • multiple, potentially conflicting, and changing governmental laws, regulations and practices, including differing export, import, tax, labor, anti-bribery and employment laws; • longer sales cycles and manufacturing lead times; • difficulties in collecting accounts receivable; • reduced or limited protection of intellectual property rights; • managing a development team in geographically disparate locations, including China and India; • more complicated logistics and distribution arrangements; and • political and economic instability |
| To date, no material amount of our international revenues and costs of revenues have been denominated in foreign currencies |
| As a result, an increase in the value of the United States dollar relative to foreign currencies could make our products more expensive and, thus, not competitively priced in foreign markets |
| Additionally, a decrease in the value of the United States dollar relative to foreign currencies could increase our operating costs in foreign locations |
| In the future, a larger portion of our international revenues may be denominated in foreign currencies, which will subject us to additional risks associated with fluctuations in those foreign currencies |
| We currently do not have hedging program in place to offset our foreign currency risk |
| Undetected software or hardware errors could increase our costs, reduce our revenues and delay market acceptance of our products |
| Networking products frequently contain undetected software or hardware errors, or “bugs,” when first introduced or as new versions are released |
| Our products are becoming increasingly complex and, particularly as we continue to expand our product portfolio to include software-centric products, including software licensed from third parties, errors may be found from time to time in our products |
| Some types of errors also may not be detected until the product is installed in a heavy production or user environment |
| In addition, our products are often combined with other products, including software, from other vendors |
| As a result, when problems occur, it may be difficult to identify the source of the problem |
| These problems may cause us to incur significant warranty and repair costs, divert the attention of engineering personnel from product development efforts and cause significant customer relations problems |
| Moreover, the occurrence of hardware and software errors, whether caused by another vendor’s SAN products or ours, could delay market acceptance of our new products |
| We rely on licenses from third parties and the loss or inability to obtain any such license could harm our business |
| Many of our products are designed to include software or other intellectual property licensed from third parties |
| While it may be necessary in the future to seek or renew licenses relating to various aspects of our products, we believe, based upon past experience and standard industry practice, that such licenses generally could be obtained on commercially reasonable terms |
| Nonetheless, there can be no assurance that the necessary licenses 20 _________________________________________________________________ [79]Table of Contents would be available on acceptable terms, if at all |
| Our inability to obtain certain licenses or other rights on favorable terms could have a material adverse effect on our business, operating results and financial condition |
| If we fail to carefully manage the use of “open source” software in our products, we may be required to license key portions of our products on a royalty free basis or expose key parts of source code |
| Certain of our products or technologies acquired, licensed or developed by us may incorporate so-called “open source” software |
| Open source software is typically licensed for use at no initial charge, but certain open source software licenses impose on the licensee of the applicable open source software certain requirements to license or make available to others both the open source software as well as the software that relates to, or interacts with, the open source software |
| Our ability to commercialize products or technologies incorporating open source software or otherwise fully realize the anticipated benefits of any such acquisition may be restricted as a result of using such open source software |
| We may be unable to protect our intellectual property, which could negatively affect our ability to compete |
| We rely on a combination of patent, copyright, trademark, and trade secret laws, confidentiality agreements, and other contractual restrictions on disclosure to protect our intellectual property rights |
| We also enter into confidentiality or license agreements with our employees, consultants, and corporate partners, and control access to and distribution of our technology, software, documentation, and other confidential information |
| These measures may not preclude the disclosure of our confidential or propriety information, or prevent competitors from independently developing products with functionality or features similar to our products |
| Despite efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology |
| Monitoring unauthorized use of our products is difficult, and we cannot be certain that the steps we take to prevent unauthorized use of our technology, particularly in foreign countries where the laws may not protect proprietary rights as fully as in the United States, will be effective |
| Third-parties may bring infringement claims against us, which could be time-consuming and expensive to defend |
| In recent years, there has been significant litigation in the United States involving patents and other intellectual property rights |
| We have in the past been involved in intellectual property-related disputes, including lawsuits with Vixel Corporation, Raytheon Company and McData Corporation, and we may be involved in such disputes in the future, to protect our intellectual property or as a result of an alleged infringement of the intellectual property of others |
| We also may be subject to indemnification obligations with respect to infringement of third party intellectual property rights pursuant to our agreements with customers |
| These claims and any resulting lawsuit could subject us to significant liability for damages and invalidation of proprietary rights |
| Any such lawsuits, even if ultimately resolved in our favor, would likely be time-consuming and expensive to resolve and would divert management’s time and attention |
| Any potential intellectual property dispute also could force us to do one or more of the following: • stop selling, incorporating or using products or services that use the challenged intellectual property; • obtain from the owner of the infringed intellectual property a license to the relevant intellectual property, which may require us to license our intellectual property to such owner, or may not be available on reasonable terms or at all; and • redesign those products or services that use technology that is the subject of an infringement claim |
| If we are forced to take any of the foregoing actions, our business and results of operations could be materially harmed |
| Our failure, or the failure of our customers, to comply with evolving industry standards and government regulations could harm our business |
| Industry standards for SAN products are continuing to evolve and achieve acceptance |
| To remain competitive, we must continue to introduce new products and product enhancements that meet these industry standards |
| All components of the SAN must interoperate together |
| Industry standards are in place to specify guidelines for 21 _________________________________________________________________ [80]Table of Contents interoperability and communication based on standard specifications |
| Our products encompass only a part of the entire SAN solution utilized by the end-user, and we depend on the companies that provide other components of the SAN solution, many of whom are significantly larger than we are, to support the industry standards as they evolve |
| The failure of these providers to support these industry standards could adversely affect the market acceptance of our products |
| In addition, in the United States, our products comply with various regulations and standards defined by the Federal Communications Commission and Underwriters Laboratories |
| Internationally, products that we develop will be required to comply with standards established by authorities in various countries |
| Failure to comply with existing or evolving industry standards or to obtain timely domestic or foreign regulatory approvals or certificates could materially harm our business |
| We are subject to environmental regulations that could have a material adverse effect on our business |
| We are subject to various environmental and other regulations governing product safety, materials usage, packaging and other environmental impacts in the various countries where our products are sold |
| For example, many of our products are subject to laws and regulations that restrict the use of mercury, hexavalent chromium, cadmium and other substances, and require producers of electrical and electronic equipment to assume responsibility for collecting, treating, recycling and disposing of our products when they have reached the end of their useful life |
| In Europe, substance restrictions will apply to products sold after July 1, 2006, and one or more of our OEM partners may require compliance with these or more stringent requirements by an earlier date |
| In addition, recycling, labeling, financing and related requirements have already begun to apply to products we sell in Europe |
| Where necessary, we are redesigning our products to ensure that they comply with these requirements as well as related requirements imposed by our OEM customers |
| We are also working with our suppliers to provide us with compliant materials, parts and components |
| If our products do not comply with the European substance restrictions, we could become subject to fines, civil or criminal sanctions, and contract damage claims |
| In addition, we could be prohibited from shipping non-compliant products into the EU, and required to recall and replace any products already shipped, if such products were found to be non-compliant, which would disrupt our ability to ship products and result in reduced revenue, increased obsolete or excess inventories and harm to our business and customer relationships |
| Our suppliers may also fail to provide us with compliant materials, parts and components, which could impact our ability to timely produce compliant products and may disrupt our business |
| Various other countries and states in the United States have issued, or are in the process of issuing, other environmental regulations that may impose additional restrictions or obligations and require further changes to our products |
| Business interruptions could adversely affect our business |
| Our operations and the operations of our suppliers, contract manufacturer and customers are vulnerable to interruption by fire, earthquake, hurricanes, power loss, telecommunications failure and other events beyond our control |
| For example, a substantial portion of our facilities, including our corporate headquarters, is located near major earthquake faults |
| In the event of a major earthquake, we could experience business interruptions, destruction of facilities and loss of life |
| We do not carry earthquake insurance and have not set aside funds or reserves to cover such potential earthquake-related losses |
| In addition, our contract manufacturer has a major facility located in an area that is subject to hurricanes |
| In the event that a material business interruption occurs that affects us or our suppliers, contract manufacturer or customers, shipments could be delayed and our business and financial results could be harmed |
| Provisions in our charter documents, customer agreements, Delaware law, and our stockholder rights plan could prevent or delay a change in control of Brocade, which could hinder stockholders’ ability to receive a premium for our stock |
| Provisions of our certificate of incorporation and bylaws may discourage, delay or prevent a merger or acquisition that a stockholder may consider favorable |
| These provisions include: • authorizing the issuance of preferred stock without stockholder approval; • providing for a classified board of directors with staggered, three-year terms; 22 _________________________________________________________________ [81]Table of Contents • prohibiting cumulative voting in the election of directors; • limiting the persons who may call special meetings of stockholders; • prohibiting stockholder actions by written consent; and • requiring super-majority voting to effect amendments to the foregoing provisions of our certificate of incorporation and bylaws |
| Certain provisions of Delaware law also may discourage, delay, or prevent someone from acquiring or merging with us, and our agreements with certain of our customers require that we give prior notice of a change of control and grant certain manufacturing rights following a change of control |
| In addition, we currently have in place a stockholder rights plan |
| Our various anti-takeover provisions could prevent or delay a change in control of Brocade, which could hinder stockholders’ ability to receive a premium for our stock |
| We expect to experience volatility in our stock price, which could negatively affect stockholders’ investments |
| The market price of our common stock has experienced significant volatility in the past and will likely continue to fluctuate significantly in response to the following factors, some of which are beyond our control: • macroeconomic conditions; • actual or anticipated fluctuations in our operating results; • changes in financial estimates and ratings by securities analysts; • changes in market valuations of other technology companies; • announcements of financial results by us or other technology companies; • announcements by us, our competitors, customers, or similar businesses of significant technical innovations, contracts, acquisitions, strategic partnerships, joint ventures or capital commitments; • losses of major OEM partners; • additions or departures of key personnel; • sales by us of common stock or convertible securities; • incurring additional debt; and • other risk factors detailed in this section |
| In addition, the stock market has experienced extreme volatility that often has been unrelated to the performance of particular companies |
| These market fluctuations may cause our stock price to fall regardless of how the business performs |