e10vq

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended April 29, 2006


o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from to

Commission file number: 000-25601

BROCADE COMMUNICATIONS SYSTEMS, INC.

(Exact name of Registrant as specified in its charter)


Delaware		77-0409517
(State or other jurisdiction of incorporation)		(I.R.S. employer identification no.)

1745 Technology Drive
San Jose, CA 95110
(408) 333-8000
(Address, including zip code, of Registrant’s
principal executive offices and telephone
number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (check one):

Large accelerated filer þ Accelerated filer o Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o No þ

The number of shares outstanding of the Registrant’s Common Stock on May 26, 2006 was 272,473,492 shares.

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

BROCADE COMMUNICATIONS SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)


	Three Months Ended						Six Months Ended
	April 29,			April 30,			April 29,			April 30,
	2006			2005			2006			2005
Net revenues	$	182,742		$	144,753		$	352,824		$	306,331
Cost of revenues (1)		77,598			61,919			146,979			126,325

Gross margin		105,144			82,834			205,845			180,006
Operating expenses:
Research and development (1)		39,561			31,361			77,680			63,035
Sales and marketing (1)		34,313			25,083			65,181			49,908
General and administrative (1)		7,296			5,692			15,097			12,355
Internal review and SEC investigation costs		3,160			1,363			7,189			5,104
Provision for SEC settlement		—			—			7,000			—
Acquisition related amortization of stock compensation		579			24			1,202			131
Acquisition related compensation expense		585			—			585			—
Amortization of intangible assets		518			—			518			—
Facilities lease losses		3,775			—			3,775			—
Restructuring costs		—			(137	)		—			(137	)

Total operating expenses		89,787			63,386			178,227			130,396

Income from operations		15,357			19,448			27,618			49,610
Interest and other income, net		7,206			5,592			14,236			10,782
Interest expense		(1,838	)		(1,826	)		(3,615	)		(4,063	)
Gain on repurchases of convertible subordinated debt		—			2,168			—			2,318

Income before provision for income taxes		20,725			25,382			38,239			58,647
Income tax provision		7,212			4,025			15,066			9,347

Net income	$	13,513		$	21,357		$	23,173		$	49,300


Net income per share – Basic	$	0.05		$	0.08		$	0.09		$	0.18

Net income per share – Diluted	$	0.05		$	0.08		$	0.08		$	0.18

Shares used in per share calculation – Basic		270,564			268,043			269,982			267,131

Shares used in per share calculation – Diluted		274,393			269,823			273,247			270,648


(1)		Amounts for the three and six months ended April 29, 2006 include stock-based compensation expense for stock options and employee stock purchases recognized under SFAS 123R (see Note 2, “Summary of Significant Accounting Policies,” of the Notes to Condensed Consolidated Financial Statements).

See accompanying notes to Condensed Consolidated Financial Statements.

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BROCADE COMMUNICATIONS SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except par value)

(Unaudited)


	April 29,			October 29,
	2006			2005
Assets

Current assets:
Cash and cash equivalents	$	181,009		$	182,001
Short-term investments		277,794			209,865

Total cash, cash equivalents and short-term investments		458,803			391,866
Restricted short-term investments		279,819			277,230
Accounts receivable, net of allowances of $4,299 and $4,942 at April 29, 2006 and October 29, 2005, respectively		76,112			70,104
Inventories		8,223			11,030
Convertible subordinated debt issuance costs		579			1,430
Prepaid expenses and other current assets		21,964			18,478

Total current assets		845,500			770,138

Long-term investments		42,320			95,306
Property and equipment, net		104,861			108,118
Goodwill		41,013			—
Intangible assets, net		17,241			—
Other long-term assets		44,608			8,168

Total assets	$	1,095,543		$	981,730


Liabilities and Stockholders’ Equity

Current liabilities:
Accounts payable	$	34,241		$	23,778
Accrued employee compensation		48,775			37,762
Deferred revenue		55,651			45,488
Current liabilities associated with lease losses		5,120			4,659
Other accrued liabilities		73,611			69,832
Convertible subordinated debt		278,883			278,883

Total current liabilities		496,281			460,402

Non-current liabilities associated with lease losses		13,376			12,481
Other long-term liabilities		32,031			—

Total liabilities		541,688			472,883
Commitments and contingencies (Note 9)

Stockholders’ equity:
Preferred stock, $0.001 par value 5,000 shares authorized, no shares outstanding		—			—
Common stock, $0.001 par value, 800,000 shares authorized:
Issued and outstanding: 275,176 and 269,695 shares at April 29, 2006 and October 29, 2005, respectively		275			270
Additional paid-in capital		873,150			855,563
Deferred stock compensation		—			(3,180	)
Accumulated other comprehensive loss		(2,911	)		(3,974	)
Accumulated deficit		(316,659	)		(339,832	)

Total stockholders’ equity		553,855			508,847

Total liabilities and stockholders’ equity	$	1,095,543		$	981,730

See accompanying notes to Condensed Consolidated Financial Statements.

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BROCADE COMMUNICATIONS SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)


	Six Months Ended
	April 29,			April 30,
	2006			2005
Cash flows from operating activities:
Net income	$	23,173		$	49,300
Adjustments to reconcile net income to net cash provided by operating activities:
Excess tax benefit from employee stock plans		(6,587	)		—
Depreciation and amortization		18,551			24,758
Loss on disposal of property and equipment		200			500
Amortization of debt issuance costs		851			741
Gain on repurchases of convertible subordinated debt		—			(2,318	)
Non-cash compensation expense (benefit)		14,899			(1,641	)
Provision for doubtful accounts receivable and sales returns		744			1,370
Provision for SEC settlement		7,000			—
Non-cash facilities lease loss expense		3,775			—
Changes in operating assets and liabilities:
Accounts receivable		(6,180	)		7,144
Inventories		2,807			(6,263	)
Prepaid expenses and other assets		(2,915	)		2,688
Accounts payable		10,463			(1,173	)
Accrued employee compensation		11,013			(15	)
Deferred revenue		10,163			5,883
Other accrued liabilities and long-term debt		2,156			5,389
Liabilities associated with lease losses		(2,419	)		(2,684	)

Net cash provided by operating activities		87,694			83,679


Cash flows from investing activities:
Purchases of property and equipment		(15,473	)		(11,359	)
Purchases of short-term investments		(138,184	)		(198,705	)
Proceeds from maturities of short-term investments		135,484			364,509
Purchases of long-term investments		(12,568	)		(190,250	)
Purchases of other investments, net		(4,575	)		—
Proceeds from other investments, net		—			252
Proceeds from maturities of long-term investments		—			7,500
Purchases of restricted short-term investments		(3,309	)		—
Proceeds from the maturities of restricted short-term investments		2,909			—
Cash held in escrow in connection with the acquisition of NuView		(32,031	)		—
Cash paid in connection with the acquisition of NuView, net of cash acquired		(27,856	)		—

Net cash used in investing activities		(95,603	)		(28,053	)


Cash flows from financing activities:
Purchases of convertible subordinated debt		—			(70,485	)
Proceeds from issuance of common stock, net		15,162			23,891
Common stock repurchase program		(14,930	)		(7,050	)
Excess tax benefit from employee stock plans		6,587			—

Net cash provided by (used in) financing activities		6,819			(53,644	)


Effect of exchange rate fluctuations on cash and cash equivalents		98			159


Net increase (decrease) in cash and cash equivalents		(992	)		2,141
Cash and cash equivalents, beginning of period		182,001			79,375

Cash and cash equivalents, end of period	$	181,009		$	81,516

See accompanying notes to Condensed Consolidated Financial Statements.

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BROCADE COMMUNICATIONS SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Organization and Operations of Brocade

Brocade Communications Systems, Inc. (“Brocade” or the “Company”) designs, develops, markets, sells, and supports data storage networking products and services, offering a line of storage networking products that enable companies to implement highly available, scalable, manageable, and secure environments for data storage applications. The Brocade SilkWorm® family of storage area networking (“SAN”) products is designed to help companies reduce the cost and complexity of managing business information within a data storage environment. In addition, the Brocade Tapestry™ family of application infrastructure solutions extends the ability to proactively manage and optimize application and information resources across the enterprise. Brocade products and services are marketed, sold, and supported worldwide to end-user customers primarily through distribution partners, including original equipment manufacturers (“OEMs”), value-added distributors, systems integrators, and value-added resellers.

Brocade was reincorporated on May 14, 1999 as a Delaware corporation, succeeding operations that began in California on August 24, 1995. The Company’s headquarters are located in San Jose, California.

Brocade, the Brocade B weave logo, Fabric OS, File Lifecycle Manager, My View, Secure Fabric OS, SilkWorm, and StorageX are registered trademarks and Tapestry is a trademark of Brocade Communications Systems, Inc., in the United States and/or in other countries. All other brands, products, or service names identified are or may be trademarks or service marks of, and are used to identify, products or services of their respective owners.

2. Summary of Significant Accounting Policies

Fiscal Year

The Company’s fiscal year is the 52 or 53 weeks ending on the last Saturday in October. As is customary for companies that use the 52/53-week convention, every fifth year contains a 53-week year. Both fiscal years 2006 and 2005 are 52-week fiscal years.

Basis of Presentation

The accompanying financial data as of April 29, 2006, and for the three and six months ended April 29, 2006 and April 30, 2005, has been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and accompanying note disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The Condensed Consolidated Balance Sheet dated as of October 29, 2005 was derived from audited consolidated financial statements, but does not include all disclosures required by U.S. generally accepted accounting principles. These Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended October 29, 2005.

In the opinion of management, all adjustments (which include only normal recurring adjustments, except as otherwise indicated) necessary to present a fair statement of financial position as of April 29, 2006, results of operations for the three and six months ended April 29, 2006 and April 30, 2005, and cash flows for the six months ended April 29, 2006 and April 30, 2005 have been made. The results of operations for the three and six months ended April 29, 2006 are not necessarily indicative of the operating results for the full fiscal year or any future periods.

Reclassifications

Certain reclassifications have been made to prior year balances in order to conform to the current year presentation.

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Cash and Cash Equivalents

The Company considers all highly liquid investments with an original or remaining maturity of three months or less at the date of purchase to be cash equivalents.

Investments

Investment securities with original or remaining maturities of more than three months but less than one year are considered short-term investments. Investment securities with original or remaining maturities of one year or more are considered long-term investments. Short-term and long-term investments consist of auction rate securities, debt securities issued by United States government agencies, municipal government obligations, and corporate bonds and notes. The Company classifies its auction rate securities as short-term investments.

Short-term and long-term investments are maintained at three major financial institutions, are classified as available-for-sale, and are recorded in the accompanying Condensed Consolidated Balance Sheets at fair value. Fair value is determined using quoted market prices for those securities. Unrealized holding gains and losses are included as a separate component of accumulated other comprehensive income in the accompanying Condensed Consolidated Balance Sheets, net of any related tax effect. Realized gains and losses are calculated based on the specific identification method and are included in interest and other income, net, in the Condensed Consolidated Statements of Operations.

Restricted short-term investments consist of debt securities issued by the United States government. These investments are maintained at one major financial institution, and are recorded on the accompanying Consolidated Balance Sheets at fair value.

The Company recognizes an impairment charge when the declines in the fair values of its investments below the cost basis are judged to be other-than-temporary. The Company considers various factors in determining whether to recognize an impairment charge, including the length of time and extent to which the fair value has been less than the Company’s cost basis, the financial condition and near-term prospects of the investee, and the Company’s intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value.

From time to time the Company makes equity investments in non-publicly traded companies. These investments are included in other assets in the accompanying Condensed Consolidated Balance Sheets, and are generally accounted for under the cost method as the Company does not have the ability to exercise significant influence over the respective companies’ operating and financial policies. The Company monitors its investments for impairment on a quarterly basis and makes appropriate reductions in carrying values when such impairments are determined to be other-than-temporary. Impairment charges are included in interest and other income, net in the Condensed Consolidated Statements of Operations. Factors used in determining an impairment include, but are not limited to, the current business environment, including competition and uncertainty of financial condition; going concern considerations such as the rate at which the investee company utilizes cash and the investee company’s ability to obtain additional private financing to fulfill its stated business plan; the need for changes to the investee company’s existing business model due to changing business environments and its ability to successfully implement necessary changes; and comparable valuations. If an investment is determined to be impaired, a determination is made as to whether such impairment is other-than-temporary. As of April 29, 2006 and October 29, 2005, the carrying values of the Company’s equity investments in non-publicly traded companies were $8.3 million and $3.8 million, respectively.

Goodwill and Intangible Assets

The Company accounts for goodwill in accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, (“SFAS 142”). SFAS 142 requires that goodwill be capitalized at cost and tested annually for impairment. The Company evaluates goodwill on an annual basis during its second fiscal quarter, or whenever events and changes in circumstances indicate that the carrying amount of an asset may not be recoverable. An impairment loss is recognized to the extent that the carrying amount exceeds the assets implied fair value. Events which might indicate impairment include, but are not limited to, strategic decisions made in response to economic and competitive conditions, the impact of economic environment on the Company’s customer base, material negative changes in relationships with significant customers, and/or a significant decline in the Company’s stock price for a sustained period. No goodwill impairment was recorded for the periods presented.

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Intangible assets other than goodwill are amortized over their useful lives, unless these lives are determined to be indefinite. Intangible assets are carried at cost less accumulated amortization. Amortization is computed over the estimated useful life of the respective asset. Intangible assets are reviewed for impairment in accordance with Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, (“SFAS 144”). The Company performs impairment tests for long-lived assets on an annual basis or whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. Examples of such events or circumstances include significant underperformance relative to historical or projected future operating results, significant changes in the manner of use of acquired assets or the strategy for its business, significant negative industry or economic trends, and/or a significant decline in the Company’s stock price for a sustained period. Impairments are recognized based on the difference between the fair value of the asset and its carrying value, and fair value is generally measured based on discounted cash flow analyses. No intangible asset impairment was recorded for the periods presented.

Concentrations

Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash, cash equivalents, restricted short-term investments, short-term and long-term investments, and accounts receivable. Cash, cash equivalents, restricted short-term investments, and short-term and long-term investments are primarily maintained at six major financial institutions in the United States. Deposits held with banks may be redeemed upon demand and may exceed the amount of insurance provided on such deposits. The Company principally invests in United States government and United States government agency debt securities and corporate bonds and notes, and limits the amount of credit exposure to any one entity.

A majority of the Company’s trade receivable balance is derived from sales to OEM partners in the computer storage and server industry. As of April 29, 2006, two customers accounted for 38 percent and 19 percent, respectively, of total accounts receivable. As of October 29, 2005, three customers accounted for 37 percent, 18 percent, and 10 percent, respectively, of total accounts receivable. The Company performs ongoing credit evaluations of its customers and generally does not require collateral on accounts receivable balances. The Company has established reserves for credit losses, sales returns, and other allowances. While the Company has not experienced material credit losses in any of the periods presented, there can be no assurance that the Company will not experience material credit losses in the future.

For the three months ended April 29, 2006 and April 30, 2005, three customers each represented ten percent or more of the Company’s total revenues for combined totals of 70 percent and 73 percent of total revenues, respectively. For the six months ended April 29, 2006 and April 30, 2005, three customers each represented ten percent or more of the Company’s total revenues for combined totals of 71 percent and 72 percent of total revenues, respectively. The level of sales to any one of these customers may vary, and the loss of, or a decrease in the level of sales to, any one of these customers would likely cause seriously harm to the Company’s financial condition and results of operations.

The Company currently relies on single and limited supply sources for several key components used in the manufacture of its products. Additionally, the Company relies on one contract manufacturer for the production of its products. The inability of any single and limited source suppliers or the inability of the contract manufacturer to fulfill supply and production requirements, respectively, could have a material adverse effect on the Company’s future operating results.

The Company’s business is concentrated in the SAN industry, which is highly competitive and from time to time has been impacted by unfavorable economic conditions and reduced information technology (“IT”) spending rates. The Company’s future success depends, in part, upon the buying patterns of customers in the SAN industry, their response to current and future IT investment trends, and the continued demand by such customers for the Company’s products. The Company’s future success, in part, also depends upon its ability to enhance its existing products and to develop and introduce, on a timely basis, new cost-effective products and features that keep pace with technological developments and emerging industry standards.

Revenue Recognition

Product revenue. Product revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collection is probable. However, for newly introduced products, many of the Company’s large OEM customers require a product qualification period during which the Company’s products are tested and approved by the OEM customer for sale to their customers. Revenue recognition, and related cost, is deferred for shipments to new OEM customers and for shipments of newly introduced products to existing OEM customers until satisfactory evidence of completion of the product qualification has been received from the OEM customer. Revenue from sales to the Company’s master reseller customers is recognized in the same period in which the product is actually sold by the master reseller (sell-through).

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The Company reduces revenue for estimated sales returns, sales programs, and other allowances at the time of shipment. Sales returns, sales programs, and other allowances are estimated based upon historical experience, current trends, and the Company’s expectations regarding future experience. In addition, the Company maintains allowances for doubtful accounts, which are also accounted for as a reduction in revenue. The allowance for doubtful accounts is estimated based upon analysis of accounts receivable, historical collection patterns, customer concentrations, customer creditworthiness, current economic trends, and changes in customer payment terms and practices.

Service revenue. Service revenue consists of training, warranty, and maintenance arrangements, including post-contract customer support (“PCS”) and other professional services. PCS services are offered under renewable, annual fee-based contracts or as part of multiple element arrangements and typically include upgrades and enhancements to the Company’s software operating system and telephone support. Service revenue, including revenue allocated to PCS elements, is deferred and recognized ratably over the contractual period. Service contracts are typically one to three years in length. Professional services are offered under fee-based contracts or as part of multiple element arrangements. Professional service revenue is recognized as delivery of the underlying service occurs. Training revenue is recognized upon completion of the training. Service and training revenue were not material in any of the periods presented.

Multiple-element arrangements. The Company’s multiple-element product offerings include computer hardware and software products, and support services. The Company also sells certain software products and support services separately. The Company’s software products are essential to the functionality of its hardware products and are, therefore, accounted for in accordance with Statement of Position 97-2, Software Revenue Recognition (“SOP 97-2”), as amended. The Company allocates revenue to each element based upon vendor-specific objective evidence (“VSOE”) of the fair value of the element or, if VSOE is not available, by application of the residual method. VSOE of the fair value for an element is based upon the price charged when the element is sold separately. Revenue allocated to each element is then recognized when the basic revenue recognition criteria are met for each element.

Warranty Expense. The Company provides warranties on its products ranging from one to three years. Estimated future warranty costs are accrued at the time of shipment and charged to cost of revenues based upon historical experience.

Stock-Based Compensation

Effective October 30, 2005 the Company began recording compensation expense associated with stock-based awards and other forms of equity compensation in accordance with Statement of Financial Accounting Standards No. 123-R, Share-Based Payment, (“SFAS 123R”) as interpreted by SEC Staff Accounting Bulletin No. 107. The Company adopted the modified prospective transition method provided for under SFAS 123R, and consequently has not retroactively adjusted results from prior periods. Under this transition method, compensation cost associated with stock-based awards recognized for the six months ended April 29, 2006 now includes: (1) quarterly amortization related to the remaining unvested portion of stock-based awards granted prior to October 30, 2005, based on the grant date fair value estimated in accordance with the original provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, (“SFAS 123”); and (2) quarterly amortization related to stock-based awards granted subsequent to October 30, 2005, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R. In addition, the Company records expense over the offering period and vesting term in connection with (1) shares issued under its employee stock purchase plan and (2) stock options and restricted stock awards. The compensation expense for stock-based awards includes an estimate for forfeitures and is recognized over the expected term of the award under an accelerated vesting method.

Prior to October 30, 2005, the Company accounted for stock-based awards using the intrinsic value method of accounting in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”), whereby the difference between the exercise price and the fair market value on the date of grant is recognized as compensation expense. Under the intrinsic value method of accounting, no compensation expense was recognized in the Company’s Condensed Consolidated Statements of Operations when the exercise price of the Company’s employee stock option grant equals the market price of the underlying common stock on the date of grant, and the measurement date of the option grant is certain. The measurement date is certain when the date of grant is fixed and determinable. Prior to October 30, 2005, when the measurement date was not certain, the Company recorded stock-based compensation expense using variable accounting under APB 25. From May 1999 through July 2003, the Company granted 98.8 million options that were subject to variable accounting under APB 25 because the measurement date of the options granted was not certain. Effective October 30, 2005, if the measurement date is not certain, the Company records stock-based compensation expense under SFAS 123R. Under SFAS 123R, the Company remeasures the intrinsic value of the options at the end of each reporting period until the

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options are exercised, cancelled or expire unexercised. As of April 29, 2006, 3.0 million options with a weighted average exercise price of $13.28 and a weighted average remaining life of 5.5 years remain outstanding and continue to be remeasured at the intrinsic value. Compensation expense in any given period is calculated as the difference between total earned compensation at the end of the period, less total earned compensation at the beginning of the period. Compensation earned is calculated under an accelerated vesting method.

Employee Stock Plans

The Company has several stock-based compensation plans (the “Plans”) that are described in the Company’s Annual Report on Form 10-K for the fiscal year ended October 29, 2005. The Company, under the various equity plans, grants stock options for shares of common stock to employees and directors. In accordance with the Plans, incentive stock options may not be granted at less than 100 percent of the estimated fair market value of the common stock, and incentive stock options granted to a person owning more than 10 percent of the combined voting power of all classes of stock of the Company must be issued at 110 percent of the fair market value of the stock on the date of grant. Nonstatutory stock options may be granted at any price. The Plans provide that the options shall be exercisable over a period not to exceed seven years. The majority of options granted under the Plans vest over a period of four years. Certain options granted under the Plans vest over shorter or longer periods. At April 29, 2006, an aggregate of 129.1 million shares were authorized for future issuance under the Plans, which includes Stock Options, Employee Stock Purchase Plan, and Restricted Stock Awards. A total of 88.2 million shares of common stock were available for grant under the Plans as of April 29, 2006. Awards that expire, or are cancelled without delivery of shares, generally become available for issuance under the Plans.

Stock Options

When the measurement date is certain, the fair value of each option grant is estimated on the date of grant using the Black-Scholes valuation model and the assumptions noted in the following table. The expected term of stock options is based on the midpoint of the historical exercise behavior and uniform exercise behavior. The expected volatility is based on an equal weighted average of implied volatilities from traded options of the Company’s stock and historical volatility of the Company’s stock. The risk-free interest rate is based on the implied yield on a U.S. Treasury zero-coupon issue with a remaining term equal to the expected term of the option. The dividend yield reflects that Brocade has not paid any cash dividends since inception and does not anticipate paying cash dividends in the foreseeable future.


	Three Months Ended						Six Months Ended
	April 29,			April 30,			April 29,			April 30,
Stock Options	2006			2005			2006			2005
Expected dividend yield		0.0	%		0.0	%		0.0	%		0.0	%

Risk-free interest rate		5.0 – 5.3	%		3.4 – 3.9	%		4.8 – 5.0	%		3.2 – 3.8	%
Expected volatility		48.5	%		47.6	%		50.7	%		47.4	%
Expected term (in years)		3.3			2.8			3.3			2.8

The Company recorded $3.5 million and $7.9 million of compensation expense related to stock options for the three and six months ended April 29, 2006, respectively, in accordance with SFAS 123R. A summary of stock option activity under the Plans for the three and six months ended April 29, 2006 is presented as follows:


						Weighted
						Average
				Weighted		Remaining
				Average		Contractual		Aggregate
	Shares			Exercise		Term		Intrinsic Value
	(in thousands)			Price		(Years)		(in thousands)
Outstanding, October 29, 2005		45,179		$	6.59
Granted		1,165		$	4.19
Exercised		(204	)	$	0.68
Forfeited or Expired		(3,209	)	$	6.14

Outstanding, January 29, 2006		42,931		$	6.57

Granted		2,025		$	5.52
Exercised		(2,061	)	$	5.50
Forfeited or Expired		(1,965	)	$	6.09

Outstanding, April 29, 2006		40,390		$	6.60		6.1	$	29,797

Ending Vested and Expected to Vest		38,826		$	6.68		6.5	$	27,500

Exercisable and Vested, April 29, 2006		24,989		$	7.54		6.2	$	12,642

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The weighted-average fair value of employee stock options granted during the three months ended April 29, 2006 and April 30, 2005 were $2.15 and $2.07, respectively. The total intrinsic value of stock options exercised for the three months ended April 29, 2006 and April 30, 2005 was $1.5 million and $2.6 million, respectively. The weighted-average fair value of employee stock options granted during the six months ended April 29, 2006 and April 30, 2005 were $1.98 and $2.09, respectively. The total intrinsic value of stock options exercised for the six months ended April 29, 2006 and April 30, 2005 was $2.3 million and $7.2 million, respectively.

As of April 29, 2006, there was $17.0 million of total unrecognized compensation costs related to stock options. These costs are expected to be recognized over a weighted average period of 3.7 years.

Employee Stock Purchase Plan

Under Brocade’s Employee Stock Purchase Plan, eligible employees can participate and purchase shares semi-annually through payroll deductions at the lower of 85% of the fair market value of the stock at the commencement or end of the offering period. The Purchase Plan permits eligible employees to purchase common stock through payroll deductions for up to 15% of qualified compensation. The Company accounts for the Employee Stock Purchase Plan as a compensatory plan and recorded compensation expense of $1.1 million and $2.0 million, respectively for the three and six months ended April 29, 2006 in accordance with SFAS 123R.

The fair value of the purchase right of the Employee Stock Purchase Plan shares were estimated at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions:


	Three Months Ended						Six Months Ended
	April 29,			April 30,			April 29,			April 30,
Employee Stock Purchase Plan	2006			2005			2006			2005
Expected dividend yield		0.0	%		0.0	%		0.0	%		0.0	%
Risk-free interest rate		3.4 – 4.4	%		2.0 – 2.5	%		3.4 – 4.4	%		2.0 – 2.5	%
Expected volatility		44.3	%		50.3	%		44.3	%		50.3	%
Expected term (in years)		0.5			0.5			0.5			0.5

As of April 29, 2006, there was $0.4 million of total unrecognized compensation costs related to employee stock purchases. These costs are expected to be recognized over a weighted average period of 0.1 years.

Information as Reported in the Financial Statements

Total stock-based compensation expense of $8.0 million and $14.9 million included in the Company’s Condensed Consolidated Statement of Operations for the three and six months ended April 29, 2006 is comprised of the following (in thousands):


	Three Months		Six Months
	Ended		Ended
	April 29,		April 29,
	2006		2006
Restricted stock awards	$	1,032	$	1,791
Options remeasured at their intrinsic value		1,787		2,049
Acquisition related amortization of stock compensation		579		1,203
Incremental expense related to the adoption of SFAS 123R		4,563		9,856

Total	$	7,961	$	14,899

- 11 -

The table below sets out the $4.6 million and $9.9 million of incremental stock-based compensation expense for stock options and employee stock purchases recognized under the provisions of SFAS 123R (in thousands, except per share data) for the three and six months ended April 29, 2006, respectively:


	Three Months			Six Months
	Ended			Ended
	April 29,			April 29,
	2006			2006
Stock-based compensation expense for stock options and employee stock purchases included in operations:
Cost of revenues	$	(1,278	)	$	(2,925	)
Research and development		(1,551	)		(3,285	)
Sales and marketing		(1,141	)		(2,400	)
General and administrative		(593	)		(1,246	)

Total		(4,563	)		(9,856	)
Tax benefit		122			153

Net decrease in net income	$	(4,441	)	$	(9,703	)


Effect on:
Net income per share- Basic	$	(0.02	)	$	(0.04	)
Net income per share- Diluted	$	(0.02	)	$	(0.04	)

Prior to our adoption of SFAS 123R, benefits of tax deductions in excess of recognized compensation costs were reported as operating cash flows. SFAS 123R requires that they be recorded as a financing cash inflow rather than as a reduction of taxes paid. For both the three and six months ended April 29, 2006, excess tax benefit generated from option exercises was $6.6 million. While our estimate of fair value and the associated charge to earnings materially affects our results of operations, it has no impact on our cash position.

Information Calculated as if Fair Value Method Had Applied to All Awards

The table below sets out the pro forma amounts of net income and net income per share (in thousands, except per share data) that would have resulted for the three and six months ended April 30, 2005, if Brocade accounted for its employee stock plans under the fair value recognition provisions of SFAS 123:


	Three Months			Six Months
	Ended			Ended
	April 30,			April 30,
	2005			2005
Net income – as reported	$	21,357		$	49,300
Deduct: Stock-based compensation benefit included in reported net income, net of tax		(706	)		(1,641	)
Deduct: Stock-based compensation expense determined under the fair value based method, net of tax		(4,903	)		(9,539	)

Pro forma net income	$	15,748		$	38,120

Basic net income per share:
As reported	$	0.08		$	0.18
Pro forma	$	0.06		$	0.14
Diluted net income per share:
As reported	$	0.08		$	0.18
Pro forma	$	0.06		$	0.14

- 12 -

Restricted Stock Awards

For the three months ended April 29, 2006 and April 30, 2005 Brocade did not issue restricted stock awards. For the six months ended April 29, 2006 and April 30, 2005, Brocade issued restricted stock awards of 1.9 million shares and 0.02 million shares, respectively, to certain eligible employees at a purchase price of $0.001 and $0.01 per share, respectively. These restricted shares are not transferable until fully vested and are subject to repurchase for all unvested shares upon termination. The fair value of each award is based on the Company’s closing stock price on the date of grant. Compensation expense computed under the fair value method for stock awards issued is amortized over the awards’ vesting period and was $1.0 million and $0.3 million, respectively, for the three months ended April 29, 2006 and April 30, 2005, and $1.8 million and $0.6 million, respectively, for the six months ended April 29, 2006 and April 30, 2005.

The weighted-average fair value of the restricted stock awards granted and vested in both the three months ended April 29, 2006 and April 30, 2005 was zero. The weighted-average fair value of the restricted stock awards granted in the six months ended April 29, 2006 and April 30, 2005 was $4.43 and $7.06, respectively. The total fair value of stock awards vested for both the six months ended April 29, 2006 and April 30, 2005 was zero.

At April 29, 2006, unrecognized costs related to restricted stock awards totaled approximately $6.4 million. These costs are expected to be recognized over a weighted average period of 1.6 years. A summary of the nonvested shares for the three and six months ended April 29, 2006 is presented as follows:


				Weighted
				Average
	Shares			Grant-Date
	(in thousand)			Fair Value
Nonvested, October 29, 2005		13		$	7.05
Granted		1,923		$	4.43
Vested		(3	)	$	7.05
Forfeited		—			—

Nonvested, January 29, 2006		1,933		$	4.44
Granted		—			—
Vested		(3	)	$	7.05
Forfeited		(20	)	$	4.43

Nonvested, April 29, 2006		1,910		$	4.44

Computation of Net Income per Share

Basic net income per share is computed using the weighted-average number of common shares outstanding during the period, less shares subject to repurchase. Diluted net income per share is computed using the weighted-average number of common shares and dilutive potential common shares outstanding during the period. Dilutive potential common shares result from the assumed exercise of outstanding stock options, by application of the treasury stock method, that have a dilutive effect on earnings per share, and from the assumed conversion of outstanding convertible debt if it has a dilutive effect on earnings per share.

Comprehensive Income

The components of comprehensive income, net of tax, are as follows (in thousands):


	Three Months Ended					Six Months Ended
	April 29,		April 30,			April 29,		April 30,
	2006		2005			2006		2005
Net income	$	13,513	$	21,357		$	23,173	$	49,300
Other comprehensive income (loss):
Change in net unrealized gains (losses) on marketable equity securities and investments		488		(4,372	)		965		(6,671	)
Cumulative translation adjustments		104		(21	)		98		159

Total comprehensive income	$	14,105	$	16,964		$	24,236	$	42,788

- 13 -

Acquisitions

On March 6, 2006, the Company completed its acquisition of NuView, Inc. (“NuView”), a privately held software developer based in Houston, Texas. The acquisition expands the Company’s product offerings to include software solutions that extend the benefits of shared storage architectures to file data environments.

The results of operations of NuView are included in the accompanying Condensed Consolidated Statement of Operations from the date of the acquisition. The Company does not consider the acquisition of NuView to be material to its results of operations, and therefore is not presenting pro forma statements of operations for the three and six months ended April 29, 2006 and April 30, 2005, respectively.

Purchase Price. The total purchase price was $60.5 million, consisting of $59.9 million cash consideration for all outstanding capital stock and vested options and direct acquisition costs of $0.6 million. Of the $59.9 million cash consideration, $32.0 million is being held in escrow for a period of 15 months from the transaction date and will be released subject to certain indemnification obligations and other contingencies. As of April 29, 2006 the $32.0 million escrow fund was recorded as a long-term liability in the accompanying Condensed Consolidated Balance Sheets.

In connection with this acquisition, the Company allocated the total purchase consideration to the net assets and liabilities acquired, including identifiable intangible assets, based on their respective fair values at the acquisition date, resulting in goodwill of approximately $41.0 million. The following table summarizes the allocation of the purchase price to the fair value of the assets and liabilities acquired (in thousands):


Assets acquired
Cash	$	130
Accounts receivable		1,947
Identifiable intangible assets
Tradename		932
Core/Developed technology		7,896
Customer relationships		8,931
Goodwill		41,013
Other assets		114

Total assets acquired		60,963
Liabilities assumed
Accounts payable and accrued liabilities		230
Deferred revenue		220

Total liabilities acquired		450

Net assets acquired	$	60,513

Additionally, for the three months ended April 29, 2006, the Company recorded acquisition related compensation expense of $0.6 million. No other acquisition related compensation expense related has been recorded in the Condensed Consolidated Financial Statements for the periods presented.

Goodwill and Intangible Assets. Goodwill, representing the excess of the purchase price over the fair value of tangible and identifiable intangible assets acquired, will not be amortized and is not deductible for tax purposes. All Intangible assets will be amortized over an estimated useful life of 5 years.

Goodwill and Intangible Assets

The Company’s carrying value of goodwill as of April 29, 2006 consisted of the following (in thousands):


Balance at October 29, 2005	$	—
NuView acquisition		41,013

Balance at April 29, 2006	$	41,013

- 14 -

The Company amortizes intangible assets over a useful life of 5 years. Intangible assets as of April 29, 2006 consisted of the following (in thousands):


					Net
	Gross Carrying		Accumulated		Carrying
	Value		Amortization		Value
Tradename	$	932	$	27	$	905
Core/Developed technology		7,896		230		7,666
Customer relationships		8,931		261		8,670

Total intangible assets	$	17,759	$	518	$	17,241

The Company had no intangible assets as of October 29, 2005. For both the three and six months ended April 29, 2006, total amortization expense related to intangible assets of $0.5 million is included in operating expenses in the Condensed Consolidated Statement of Operations. The following table presents the estimated future amortization of intangible assets (in thousands):


Six months ending October 28, 2006	$	1,776
Fiscal Years:
2007		3,552
2008		3,552
2009		3,552
2010		3,552
2011		1,257

Total	$	17,241

Balance Sheet Details

The following tables provide details of selected balance sheet items (in thousands):


	April 29,			October 29,
	2006			2005
Inventories:
Raw materials	$	406		$	1,517
Finished goods		7,817			9,513

Total	$	8,223		$	11,030


Property and equipment, net:
Computer equipment and software	$	70,790		$	68,294
Engineering and other equipment		134,292			123,811
Furniture and fixtures		4,256			4,136
Leasehold improvements		43,227			41,696
Land and building		30,000			30,000

Subtotal		282,565			267,937
Less: Accumulated depreciation and amortization		(177,704	)		(159,819	)

Total	$	104,861		$	108,118


	April 29,		October 29,
	2006		2005
Other accrued liabilities:
Income taxes payable	$	34,695	$	36,923
Accrued warranty		2,290		1,746
Inventory purchase commitments		4,068		6,634
Other		32,558		24,529

Total	$	73,611	$	69,832

- 15 -

Leasehold improvements as of April 29, 2006 and October 29, 2005, are shown net of estimated asset impairments related to facilities lease losses (see Note 7).

Investments and Equity Securities

The following tables summarize the Company’s investments and equity securities (in thousands):


			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
April 29, 2006
U.S. government and its agencies and municipal obligations	$	407,019	$	—	$	(2,101	)	$	404,918
Corporate bonds and notes		196,139		11		(1,135	)		195,015

Total	$	603,158	$	11	$	(3,236	)	$	599,933


Reported as:
Short-term investments								$	277,794
Restricted short-term investments									279,819
Long-term investments									42,320

Total								$	599,933


October 29, 2005
U.S. government and its agencies and municipal obligations	$	413,574	$	—	$	(2,629	)	$	410,945
Corporate bonds and notes		173,021		11		(1,576	)		171,456
Equity securities		34		2		—			36

Total	$	586,629	$	13	$	(4,205	)	$	582,437


Reported as:
Short-term investments								$	209,865
Restricted short-term investments									277,230
Other current assets									36
Long-term investments									95,306

Total								$	582,437

For both the three months ended April 29, 2006 and April 30, 2005, no gains were realized on the sale of investments or marketable equity securities. As of April 29, 2006 and October 29, 2005, net unrealized holding losses of $3.2 million and $4.2 million, respectively, were included in accumulated other comprehensive income in the accompanying Condensed Consolidated Balance Sheets.

The following table summarizes the maturities of the Company’s investments in debt securities issued by United States government and its agencies, municipal government obligations, and corporate bonds and notes as of April 29, 2006 (in thousands):


	Amortized		Fair
	Cost		Value
Less than one year	$	560,027	$	557,613
Due in 1 – 2 years		41,652		40,876
Due in 2 – 3 years		1,479		1,444

Total	$	603,158	$	599,933

Liabilities Associated with Facilities Lease Losses

During the three months ended October 27, 2001, the Company recorded a charge of $39.8 million related to estimated facilities lease losses, net of expected sublease income, and a charge of $5.7 million in connection with the estimated impairment of certain related leasehold improvements. These charges represented the low-end of the then estimated range of $39.8 million to $63.0 million.

- 16 -

During the three months ended July 27, 2002, the Company completed a transaction to sublease a portion of these vacant facilities. Accordingly, based on then current market data, the Company revised certain estimates and assumptions, including those related to estimated sublease rates, estimated time to sublease the facilities, expected future operating costs, and expected future use of the facilities.

In November 2003 the Company purchased a previously leased building. In addition, the Company consolidated its engineering organization and development, test and interoperability laboratories into the purchased facilities and vacated other existing leased facilities. As a result, the Company recorded adjustments to the previously recorded facilities lease loss reserve, deferred rent and leasehold improvement impairments, and recorded additional reserves in connection with the facilities consolidation.

During the three months ended April 29, 2006, the Company recorded a charge of $3.8 million related to estimated facilities lease losses, net of expected sublease income. This charge represents an estimate based on current market data. As a result, the Company revised certain estimates and assumptions, including those related to estimated sublease rates, estimated time to sublease the facilities, expected future operating costs, and expected future use of the facilities. The Company reevaluates its estimates and assumptions on a quarterly basis and makes adjustments to the reserve balance if necessary.

The following table summarizes the activity related to the facilities lease losses reserve, net of expected sublease income (in thousands), as of April 29, 2006:


	Lease Loss
	Reserve
Reserve balances at October 29, 2005	$	17,140
Cash payments on facilities leases		(2,338	)
Non-cash charges		(81	)
Additional reserve booked based on current market data		3,775

Reserve balance at April 29, 2006	$	18,496

Cash payments for facilities leases related to the above noted facilities lease losses will be paid over the respective lease terms through fiscal year 2010.

Convertible Subordinated Debt

On December 21, 2001, and January 10, 2002, the Company sold, in private placements pursuant to Section 4(2) of the Securities Act of 1933, as amended, an aggregate of $550 million in principal amount, two percent convertible subordinated notes due January 2007 (the notes or convertible subordinated debt). The initial purchasers purchased the notes from the Company at a discount of 2.25 percent of the aggregate principal amount. Under the original term of the Notes, holders of the notes may, in whole or in part, convert the notes into shares of the Company’s common stock at a conversion rate of 22.8571 shares per $1,000 principal amount of notes (approximately 6.4 million shares may be issued upon conversion based on outstanding debt of $278.9 million as of April 29, 2006) at any time prior to maturity on January 1, 2007, subject to earlier redemption. Additionally, under the original term of the Notes, at any time on or after January 5, 2005, the Company was entitled to redeem the notes in whole or in part at the following prices expressed as a percentage of the principal amount:


Redemption Period	Price
Beginning on January 5, 2005 and ending on December 31, 2005		100.80	%
Beginning on January 1, 2006 and ending on December 31, 2006		100.40	%
On January 1, 2007 and thereafter		100.00	%

On August 23, 2005, in accordance with the terms of the indenture agreement dated December 21, 2001 with respect to the Convertible Subordinated Debt, the Company elected to deposit securities with the trustee of the Notes (the “Trustee”), which fully collateralized the outstanding notes, and to discharge the indenture agreement. Pursuant to this election, the Company provided an irrevocable letter of instruction to the Trustee to issue a notice of redemption on June 26, 2006 and to redeem the Notes on August 22, 2006 (the “Redemption Date”). Over the course of the next year, the Trustee, using the securities deposited with them, will pay to the noteholders (1) all the interest scheduled to become due per the original note prior to the Redemption Date, and (2) all the principal and remaining interest, plus a call premium of 0.4% of the face value

- 17 -

of the Notes, on the Redemption Date. As of April 29, 2006, the Company had an aggregate of $279.8 million in interest-bearing U.S. government securities with the Trustee. The securities will remain on the Company’s balance sheet as restricted short-term investments until the Redemption Date.

The Company is required to pay interest on January 1 and July 1 of each year, beginning July 1, 2002. Under the original term of the notes, debt issuance costs of $12.4 million are being amortized over the term of the notes and will accelerate upon early redemption or conversion of the notes. As of April 29, 2006, the remaining balance of unamortized debt issuance costs was $0.6 million and is being amortized through the redemption date of August 22, 2006. The net proceeds of the convertible subordinated debt remain available for general corporate purposes, including working capital and capital expenditures.

During the three and six months ended April 29, 2006, the Company did not repurchase any of its convertible subordinated debt. To date, the Company has repurchased a total of $271.1 million in face value of its convertible subordinated notes. As of April 29, 2006, the remaining balance outstanding of the convertible subordinated debt was $278.9 million.

The notes are not listed on any securities exchange or included in any automated quotation system; however, the notes are eligible for trading on the Portal^SM Market. On April 28, 2006, the average bid and ask price on the Portal Market of the notes was 99.13, resulting in an aggregate fair value of approximately $276.5 million.

Commitments and Contingencies

Leases

The Company leases its facilities and certain equipment under various operating lease agreements expiring through August 2010. In connection with its facilities lease agreements, the Company has signed unconditional, irrevocable letters of credit totaling $8.3 million as security for the leases. Future minimum lease payments under all non-cancelable operating leases as of April 29, 2006 were $64.6 million. In addition to base rent, many of the facilities lease agreements require that the Company pay a proportional share of the respective facilities’ operating expenses.

As of April 29, 2006, the Company had recorded $18.5 million in facilities lease loss reserves related to future lease commitments, net of expected sublease income (see Note 7).

Product Warranties

The Company provides warranties on its products ranging from one to three years. Estimated future warranty costs are accrued at the time of shipment and charged to cost of revenues based upon historical experience. The Company’s accrued liability for estimated future warranty costs is included in other accrued liabilities in the accompanying Condensed Consolidated Balance Sheets. The following table summarizes the activity related to the Company’s accrued liability for estimated future warranty costs during the six months ended April 29, 2006 and April 30, 2005 (in thousands), respectively:


	April 29,			April 30,
	2006			2005
Beginning balance	$	1,746		$	4,669
Liabilities accrued for warranties issued during the period		930			553
Warranty claims paid during the period		(251	)		(317	)
Changes in liability for pre-existing warranties during the period		(135	)		(3,125	)

Ending balance	$	2,290		$	1,780

In addition, the Company has standard indemnification clauses contained within its various customer contracts. As such, the Company indemnifies the parties to whom it sells its products with respect to the Company’s product infringing upon any patents, trademarks, copyrights, or trade secrets, as well as against bodily injury or damage to real or tangible personal property caused by a defective Company product. As of April 29, 2006, there have been no known events or circumstances that have resulted in a customer contract related indemnification liability to the Company.

Manufacturing and Purchase Commitments

- 18 -

The Company has a manufacturing agreement with Hon Hai Precision Industry Co. (“Foxconn”) under which the Company provides twelve-month product forecasts and places purchase orders in advance of the scheduled delivery of products to the Company’s customers. The required lead-time for placing orders with Foxconn depends on the specific product. As of April 29, 2006, the Company’s aggregate commitment to Foxconn for inventory components used in the manufacture of Brocade products was $73.4 million, net of purchase commitment reserves of $4.1 million, which the Company expects to utilize during future normal ongoing operations. The Company’s purchase orders placed with Foxconn are cancelable; however, if cancelled the agreement with Foxconn requires the Company to purchase from Foxconn all inventory components not returnable, usable by, or sold to, other customers of Foxconn. The Company’s purchase commitments reserve reflects the Company’s estimate of purchase commitments it does not expect to consume in normal operations.

Legal Proceedings

From time to time, claims are made against the Company in the ordinary course of its business, which could result in litigation. Claims and associated litigation are subject to inherent uncertainties and unfavorable outcomes could occur, such as monetary damages, fines, penalties or injunctions prohibiting the Company from selling one or more products or engaging in other activities. The occurrence of an unfavorable outcome in any specific period could have a material adverse affect on the Company’s results of operations for that period or future periods.

On July 20, 2001, the first of a number of putative class actions for violations of the federal securities laws was filed in the United States District Court for the Southern District of New York against the Company, certain of its officers and directors, and certain of the underwriters for the Company’s initial public offering of securities. A consolidated amended class action captioned In Re Brocade Communications Systems, Inc. Initial Public Offering Securities Litigation was filed on April 19, 2002. The complaint generally alleges that various underwriters engaged in improper and undisclosed activities related to the allocation of shares in the Company’s initial public offering and seeks unspecified damages on behalf of a purported class of purchasers of common stock from May 24, 1999 to December 6, 2000. The lawsuit against the Company is being coordinated for pretrial proceedings with a number of other pending litigations challenging underwriter practices in over 300 cases as In Re Initial Public Offering Securities Litigation, 21 MC 92(SAS). In October 2002, the individual defendants were dismissed without prejudice from the action, pursuant to a tolling agreement. On February 19, 2003, the Court issued an Opinion and Order dismissing all of the plaintiffs’ claims against the Company. In June 2004, a stipulation of settlement for the claims against the issuer defendants, including the Company, was submitted to the Court for approval. On August 31, 2005, the Court granted preliminary approval of the settlement. On April 24, 2006, the Court held a fairness hearing in connection with the motion for final approval of the settlement. The Court did not issue a ruling on the motion for final approval at the fairness hearing. The settlement remains subject to a number of conditions, including final approval by the Court.

On May 16, 2005, we announced that the Securities and Exchange Commission (SEC) and the Department of Justice (DOJ) are conducting an investigation regarding the Company’s historical stock option granting processes. We have been cooperating with the SEC and DOJ. During the first quarter of fiscal year 2006, we began active settlement discussions with the Staff of the SEC’s Division of Enforcement (the “Staff”) regarding our financial restatements related to stock option accounting. As a result of these discussions, for the three months ended January 28, 2006 we recorded $7.0 million provision for an estimated settlement expense. The $7.0 million estimated settlement expense is based on an offer of settlement that the Company made to the Staff and for which the Staff has noted it intends on recommending to the SEC’s Commissioners. The offer of settlement is contingent upon final approval by the SEC’s Commissioners.

Beginning on or about May 19, 2005, several securities class action complaints were filed against the Company and certain of its current and former officers. These actions were filed in the United States District Court for the Northern District of California on behalf of purchasers of the Company’s stock from February 2001 to May 2005. These lawsuits followed the Company’s restatement of certain financial results due to stock-based compensation accounting issues. On January 12, 2006, the Court appointed a lead plaintiff and lead counsel. On April 14, 2006, the lead plaintiff filed a consolidated complaint on behalf of purchasers of the Company’s stock from May 2000 to May 2005. The consolidated complaint alleges, among other things, violations of sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. The consolidated complaint generally alleges that the Company and the individual defendants made false or misleading public statements regarding the Company’s business and operations and seeks unspecified monetary damages and other relief against the defendants. These lawsuits followed the Company’s restatement of certain financial results due to stock-based compensation accounting issues.

Beginning on or about May 24, 2005, several derivative actions were also filed against certain of the Company’s current and former directors and officers. These actions were filed in the United States District Court for the Northern District of California and in the California Superior Court in Santa Clara County. The complaints allege that certain of the Company’s officers and directors breached their fiduciary duties to the Company by engaging in alleged wrongful conduct including conduct complained of in the securities litigation described above. The Company is named solely as a nominal defendant against whom the plaintiffs seek no recovery. The derivative actions pending in the District Court for the Northern District of California were consolidated and the Court created a Lead Counsel structure. The derivative plaintiffs filed a consolidated complaint on October 7, 2005 and the Company filed a motion to dismiss that action on October 27, 2005. On January 6, 2006, Brocade’s motion was granted and the consolidated complaint was dismissed with leave to amend. The derivative actions pending in the Superior Court in Santa Clara County were consolidated. The derivative plaintiffs filed a consolidated complaint on September 19, 2005. The Company filed a motion to stay that action in deference to the substantially identical consolidated derivative action pending in the District Court, and on November 15, 2005, the Court stayed the action. The parties to this action subsequently reached preliminary settlement, which they plan to submit to the Court for approval.

- 19 -

No amounts have been recorded in the accompanying Condensed Consolidated Financial Statements associated with these matters.

10.

Segment Information

The Company is organized and operates as one operating segment: the design, development, marketing and selling of infrastructure for SANs. The Company’s Chief Executive Officer is the Company’s Chief Operating Decision Maker (“CODM”), as defined by SFAS 131, Disclosures about Segments of an Enterprise and Related Information. The CODM allocates resources and assesses the performance of the Company based on revenues and overall profitability.

Revenues are attributed to geographic areas based on the location of the customer to which products are shipped. Domestic revenues include sales to certain OEM customers who take possession of Brocade products domestically and then distribute these products to their international customers. The percent of revenue derived from domestic and international customers for the three and six months ended April 29, 2006 and April 30, 2005, is as follows:


	Three Months Ended						Six Months Ended
	April 29,			April 30,			April 29,			April 30,
	2006			2005			2006			2005
Revenues by geography:
Domestic		63	%		67	%		63	%		66	%
International		37	%		33	%		37	%		34	%

Total		100	%		100	%		100	%		100	%

The total number of customers representing ten percent or more of total revenues and the percent of revenue derived from these customers for the three and six months ended April 29, 2006 and April 30, 2005, is as follows:


	Three Months Ended						Six Months Ended
	April 29,			April 30,			April 29,			April 30,
	2006			2005			2006			2005
# of customers representing ten percent or more of total revenues		3			3			3			3
Revenue from customers representing ten percent or more of total revenues		70	%		73	%		71	%		72	%

To date, service revenue has not exceeded 10 percent of total revenues. Identifiable assets located in foreign countries were not material as of April 29, 2006 and October 29, 2005.

11.

Net Income per Share

The following table presents the calculation of basic and diluted net income per common share (in thousands, except per share amounts):


	Three Months Ended						Six Months Ended
	April 29,			April 30,			April 29,			April 30,
	2006			2005			2006			2005
Net income	$	13,513		$	21,357		$	23,173		$	49,300

Basic and diluted net income per share:
Weighted-average shares of common stock outstanding		272,474			268,133			271,905			267,262
Less: Weighted-average shares of common stock subject to repurchase		(1,910	)		(90	)		(1,923	)		(131	)

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	Three Months Ended				Six Months Ended
	April 29,		April 30,		April 29,		April 30,
	2006		2005		2006		2005
Weighted-average shares used in computing basic net income per share		270,564		268,043		269,982		267,131
Dilutive effect of common share equivalents		3,829		1,780		3,265		3,517

Weighted-average shares used in computing diluted net income per share		274,393		269,823		273,247		270,648

Basic net income per share	$	0.05	$	0.08	$	0.09	$	0.18

Diluted net income per share	$	0.05	$	0.08	$	0.08	$	0.18

For the three and six months ended April 29, 2006, potential common shares in the form of stock options to purchase 30.0 million and 36.3 million weighted-average shares of common stock, respectively, were antidilutive and, therefore, not included in the computation of diluted earnings per share. For the three and six months ended April 30, 2005, potential common shares in the form of stock options to purchase 30.0 million and 16.5 million weighted-average shares of common stock, respectively, were antidilutive and, therefore, not included in the computation of diluted earnings per share. For both the three and six months ended April 29, 2006, potential common shares resulting from the potential conversion, on a weighted average basis, of the Company’s convertible subordinated debt of 6.4 million common shares were antidilutive and therefore not included in the computation of diluted earnings per share. For the three and six months ended April 30, 2005, potential common shares resulting from the potential conversion, on a weighted average basis, of the Company’s convertible subordinated debt of 6.4 million and 7.2 million common shares, respectively, were antidilutive and therefore not included in the computation of diluted earnings per share.

12.

Subsequent Events

On May 12^th, 2006 the Company filed a tender offer that is intended to address recent changes to tax laws that could have unfavorable personal tax consequences for some of Brocade’s employees who received certain stock options that were or may have been granted at a discount from fair market value at the time of grant. The Tender Offer provides affected employees with the opportunity to amend or cancel their affected options to remedy the unfavorable personal tax consequences of the tax law change.

Specifically, the Company is offering to amend certain discounted options granted after August 14, 2003 to increase the option grant price to the fair market value on the date of grant, and to give the employee a cash payment for the difference in option grant price between the amended option and the original discounted price. For certain options granted prior to August 14, 2003 that may have been granted at a discount, the Company is offering to cancel the options in exchange for a cash payment based on the Black-Scholes value of the option. The tender offer is expected to close on June 12, 2006.

At this time, the Company expects that the financial impact of the tender offer will include a one-time expense of approximately $1.0 million to $2.0 million in the third quarter of fiscal 2006, or approximately zero ($0.00) to one cent ($0.01) in earnings per share. The Company expects cash payments to employees to be approximately $3.5 million to $4.5 million.

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

Results of Operations

The following table sets forth certain financial data for the periods indicated as a percentage of total net revenues:


	Three Months Ended						Six Months Ended
	April 29,			April 30,			April 29,			April 30,
	2006			2005			2006			2005
Net revenues		100.0	%		100.0	%		100.0	%		100.0	%
Cost of revenues		42.5			42.8			41.7			41.2

Gross margin		57.5			57.2			58.3			58.8

Operating expenses:
Research and development		21.6			21.7			22.0			20.6
Sales and marketing		18.8			17.3			18.5			16.3
General and administrative		4.0			3.9			4.3			4.0

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	Three Months Ended						Six Months Ended
	April 29,			April 30,			April 29,			April 30,
	2006			2005			2006			2005
Internal review and SEC investigation costs		1.7			0.9			2.0			1.7
Provision for SEC settlement		—			—			2.0			—
Acquisition related amortization of stock compensation		0.3			0.1			0.3			0.0
Acquisition related compensation expense		0.3			—			0.2			—
Amortization of intangible assets		0.3			—			0.1			—
Facilities lease loss		2.1			—			1.1			—
Restructuring costs		—			(0.1	)		—			(0.0	)
Total operating expenses		49.1			43.8			50.5			42.6

Income from operations		8.4			13.4			7.8			16.2
Interest and other income, net		3.9			3.9			4.0			3.5
Interest expense		(1.0	)		(1.3	)		(1.0	)		(1.3	)
Gain on repurchases of convertible subordinated debt		—			1.5			0.0			0.8

Income before provision for income taxes		11.3			17.5			10.8			19.2
Income tax provision		3.9			2.8			4.3			3.1

Net income		7.4	%		14.7	%		6.6	%		16.1	%

Revenues. Our revenues are derived primarily from sales of our SilkWorm family of products. Our SilkWorm products, which range in size from 8 ports to 256 ports, connect servers and storage devices creating a SAN. Net revenues for the three months ended April 29, 2006 were $182.7 million, an increase of 26 percent compared with net revenues of $144.8 million for the three months ended April 30, 2005. The increase in net revenues for the period reflected a 45 percent increase in the number of ports shipped, and an increase in software and service revenue, partially offset by a 12 percent decline in average selling price per port. Net revenues for the six months ended April 29, 2006 were $352.8 million, an increase of fifteen percent compared with net revenues of $306.3 million for the six months ended April 30, 2005. This increase in net revenues for the period reflects a 31 percent increase in the number of ports shipped, and an increase in software and service revenue, partially offset by a 15 percent decline in average selling price per port. We believe the increase in the number of ports shipped in the first half of 2006 reflects growth in the overall market for SAN switching products such as ours, as end-users continue to consolidate storage and servers infrastructures using SANs, expand SANs to support more applications, and deploy SANs in new environments. We also believe our 2006 first half performance was favorably impacted by accelerated demand for 4 Gigabit per port second products, which Brocade was among the first to introduce to the market and of which we have been, to date, the sole supplier at the high end of the switching product range.

Declines in average selling prices in the second quarter and first half of 2006 compared with thee same periods of 2005 are the result of a continuing competitive pricing environment. However, over the last two quarters, declines in average selling price per port have been lower than in the immediately preceding quarters due to a more favorable competitive environment than is typically the case. Going forward, we expect that the decline in average selling price per port to be consistent with the rates we experienced in fiscal year 2005, unless they are further affected by a stronger or weaker than anticipated competitive environment, new product introductions by us or our competitors, or other factors that may be beyond our control. We also expect the number of ports shipped to fluctuate depending on the demand for our existing and recently introduced products as well as the timing of product transitions by our OEM customers. We expect quarterly fluctuations in revenue to be consistent with historic seasonal trends.

Historically, domestic revenues have been between 60 percent and 75 percent of total revenues. Domestic and international revenues were approximately 63 percent and 37 percent of our total revenues, respectively, for the three months ended April 29, 2006, compared to 67 percent and 33 percent of total revenues, respectively, for the three months ended April 30, 2005. For the six months ended April 29, 2006, domestic and international revenues were approximately 63 percent and 37 percent of total revenues, respectively, compared to 66 percent and 34 percent of total revenues, respectively, for the six months ended April 30, 2005. Revenues are attributed to geographic areas based on the location of the customer to which our products are shipped. International revenues primarily consist of sales to customers in Western Europe and the greater Asia Pacific region and have increased primarily as a result of faster growth in sales in Western Europe relative to North America. However, certain OEM customers take possession of our products domestically and then distribute these products to their international customers. Because we account for all of those OEM revenues as domestic revenues, we cannot be certain of the extent to which our domestic and international revenue mix is impacted by the practices of our OEM customers.

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A significant portion of our revenue is concentrated among a relatively small number of OEM customers. For the three months ended April 29, 2006 and April 30, 2005, three customers each represented ten percent or more of our total revenues for combined totals of 70 percent and 73 percent of total revenues, respectively. For the six months ended April 29, 2006 and April 30, 2005, three customers each represented ten percent or more of our total revenues for combined totals of 71 percent and 72 percent of total revenues, respectively. We expect that a significant portion of our future revenues will continue to come from sales of products to a relatively small number of OEM customers. Therefore, the loss of, or a decrease in the level of sales to, or a change in the ordering pattern of, any one of these customers would likely cause seriously harm to our financial condition and results of operations.

Gross margin. Gross margin for the three months ended April 29, 2006 was 57.5 percent, an increase of 0.3 percent from 57.2 percent for the three months ended April 30, 2005. Gross margin for the six months ended April 29, 2006 was 58.3 percent, a decrease of 0.5 percent from 58.8 percent for the six months ended April 30, 2005. Cost of goods sold consists of product costs, which are variable, and manufacturing operations costs and service operations, which are generally fixed. For the three months ended April 29, 2006, product costs relative to net revenues decreased by 1.7 percent as compared to the three months ended April 30, 2005 due to the transition from 2 Gbit products to new 4 Gbit products and a favorable mix of products shipped. Manufacturing operation costs and service operation costs increased by 2.5 percent relative to net revenues primarily due to an increase in headcount and higher sustaining engineering charges as products transitioned into sustaining engineering from development. In addition, stock-based compensation expense for the three months ended April 29, 2006 increased by 1.1 percent relative to net revenues primarily as a result of our adoption of Statement of Financial Accounting Standards No. 123-R, Share-Based Payment, (“SFAS 123R”). For the six months ended April 29, 2006, product costs relative to net revenues decreased by 2.1 percent as compared to the six months ended April 30, 2005 due to the transition from 2 Gbit products to new 4 Gbit products and a favorable mix of products shipped. Manufacturing operation costs and service operation costs increased by 3.6 percent relative to net revenues primarily due to an increase in headcount, growth of our services business, and higher sustaining engineering charges as products transitioned into sustaining engineering from development. In addition, stock-based compensation expense in the six months ended April 29, 2006 increased by 1.0 percent relative to net revenues primarily as a result of our adoption of SFAS 123R.

Gross margin is primarily affected by average selling price per port, number of ports shipped, and cost of goods sold. Over the last two quarters, declines in average selling price per port have been lower than in the immediately preceding quarters, due to a more favorable competitive environment than is typically the case. Going forward, we expect that the decline in average selling price per port for our products to be consistent with the rates we experienced in fiscal year 2005, unless they are further affected by a stronger or weaker than anticipated competitive environment, new product introductions by us or our competitors, or other factors that may be beyond our control. We believe that we have the ability to partially mitigate the effect of declines in average selling price per port on gross margins through product and manufacturing operations cost reductions. However, the average selling price per port could decline at a faster pace than we anticipate. If this occurs, we may not be able to reduce our costs quickly enough to prevent a decline in our gross margins. In addition, we must also maintain or increase current volume of ports shipped to maintain our current gross margins. If we are unable to offset future reductions of average selling price per port with reductions in product and manufacturing operations costs, or if as a result of future reductions in average selling price per port our revenues do not grow, our gross margins would be negatively affected.

We recently introduced several new products and expect to introduce additional new products in the future. As new or enhanced products are introduced, we must successfully manage the transition from older products in order 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. Our gross margins may be adversely affected if we fail to successfully manage the introductions of these new products.

Research and development expenses. Research and development (“R&D”) expenses consist primarily of salaries and related expenses for personnel engaged in engineering and R&D activities; fees paid to consultants and outside service providers; nonrecurring engineering charges; prototyping expenses related to the design, development, testing and enhancement of our products; depreciation related to engineering and test equipment; and IT and facilities expenses.

For the three months ended April 29, 2006, R&D expenses increased by $8.2 million, or 26 percent, to $39.6 million, compared with $31.4 million for the three months ended April 30, 2005. This increase is primarily due to a $5.0 million increase in salaries and headcount related expenses resulting from continuing investment in our Tapestry line of products and from the acquisitions of NuView and Therion Software Corporation (“Therion”), as well as a $3.1 million increase in stock-based compensation expense primarily attributable to our adoption of SFAS 123R.

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For the six months ended April 29, 2006, R&D expenses increased by $14.6 million, or 23 percent, to $77.7 million, compared with $63.0 million for the six months ended April 30, 2005. This increase is primarily due to an increase of $8.7 million in salaries and headcount related expenses resulting from continuing investment in our Tapestry line of products and from the acquisitions of NuView and Therion, as well as a $5.8 million increase in stock-based compensation expense primarily attributable to our adoption of SFAS 123R.

Excluding any stock-based compensation expenses related to stock awards remeasured at their intrinsic value, which will vary depending on the changes in the market value of our common stock, we currently anticipate that R&D expenses for the three months ending July 29, 2006 will increase in absolute dollars as a result of increased headcount.

Sales and marketing expenses. Sales and marketing expenses consist primarily of salaries, commissions and related expenses for personnel engaged in marketing and sales; costs associated with promotional and travel expenses; and IT and facilities expenses.

For the three months ended April 29, 2006, sales and marketing expenses increased by $9.2 million, or 37 percent, to $34.3 million, compared with $25.1 million for the three months ended April 30, 2005. This increase is primarily due to a $4.0 million increase in salaries and headcount related expenses, including higher commissions expenses due to higher revenues, a $3.1 million increase in sales and marketing program expenses primarily related to our Tapestry line of products, and a $1.9 million increase in stock-based compensation expense primarily attributable to our adoption of SFAS 123R.

For the six months ended April 29, 2006, sales and marketing expenses increased by $15.3 million, or 31 percent, to $65.2 million, compared with $49.9 million for the six months ended April 30, 2005. This increase is primarily due to a $6.7 million increase in salaries and headcount related expenses, including higher commissions expenses due to higher revenues, a $4.8 million increase in sales and marketing program expenses primarily related to our Tapestry line of products, and a $3.7 million increase in stock-based compensation expense primarily attributable to our adoption of SFAS 123R.

Excluding any stock-based compensation expenses related to stock awards remeasured at their intrinsic value, which will vary depending on the changes in the market value of our common stock, we currently anticipate that sales and marketing expenses for the three months ended July 29, 2006 will increase in absolute dollars as a result of increased headcount.

General and administrative expenses. General and administrative (G&A) expenses consist primarily of salaries and related expenses for corporate executives, finance, human resources and investor relations, as well as recruiting expenses, professional fees, corporate legal expenses, other corporate expenses, and IT and facilities expenses.

G&A expenses for the three months ended April 29, 2006 increased by $1.6 million, or 28 percent, to $7.3 million, compared with $5.7 million for the three months ended April 30, 2005. The increase in G&A is primarily due to a $0.9 million increase in stock based compensation primarily attributable to our adoption of SFAS 123R and a $0.7 million increase in salaries and headcount related expenses to support ongoing initiatives.

G&A expenses for the six months ended April 29, 2006 increased by $2.7 million, or 22 percent, to $15.1 million, compared with $12.4 million for the six months ended April 30, 2005. The increase in G&A is primarily due to a $1.9 million increase in stock based compensation primarily attributable to our adoption of SFAS 123R and a $1.0 million increase in salaries and headcount related expenses to support ongoing initiatives.

Excluding any stock-based compensation expenses related to stock awards remeasured at their intrinsic value, which will vary depending on the changes in the market value of our common stock, we currently anticipate that G&A expenses for the three months ending July 29, 2006 to remain flat in absolute dollars.

Internal review and SEC investigation costs. On January 24, 2005, we announced that our Audit Committee completed an internal review regarding historical stock option granting practices. Following the January 2005 Audit Committee internal review, on May 16, 2005, we announced that additional information had come to our attention that indicated that certain guidelines regarding stock option granting practices were not followed and our Audit Committee had commenced an internal review of our stock option accounting focusing on leaves of absence and transition and advisory roles. This Audit Committee review was completed in November 2005. We are currently undergoing an SEC and Department of Justice (“DOJ”) joint investigation regarding our historical stock option granting practices. As a result, for the three months ended April 29, 2006, and April 30, 2005, we recorded $3.2 million and $1.4 million, respectively, for professional service fees related to the completed internal reviews and ongoing SEC investigation. For the six months ended April 29, 2006, and April 30, 2005 we recorded $7.2 million and $5.1 million, respectively, for professional service fees related to the completed internal reviews and ongoing SEC investigation.

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Provision for SEC settlement. During the first quarter of fiscal year 2006, we began active settlement discussions with the Staff of the SEC’s Division of Enforcement (the “Staff”) regarding our financial restatements related to stock option accounting. As a result of these discussions, for the three and six months ended April 29, 2006 we recorded $0 million and $7 million provision, respectively, for an estimated settlement expense. The $7.0 million estimated settlement expense is based on an offer of settlement that the Company made to the Staff and for which the Staff intends on recommending to the SEC’s Commissioners. The offer of settlement is contingent upon final approval by the SEC’s Commissioners. No other provision amounts have been recorded in the Condensed Consolidated Financial Statements for the periods presented.

Stock compensation expense. Total stock-based compensation expense for the three months ended April 29, 2006 was $8.0 million. Of this amount, $2.3 million was included in cost of sales, $2.5 million in research and development, $1.8 million in sales and marketing, $0.8 million in general and administrative expenses, and $0.6 million in acquisition related amortization of stock compensation. Total stock-based compensation expense (benefit) for the three months ended April 30, 2005 was $(0.9) million. Of this amount, $(0.3) million was included in cost of sales, $(0.4) million in research and development, $(0.1) million in sales and marketing, and $(0.1) million in general and administrative expenses. Total stock-based compensation expense for the six months ended April 29, 2006 was $14.9 million. Of this amount, $4.1 million was included in cost of sales, $4.5 million in research and development, $3.4 million in sales and marketing, $1.7 million in general and administrative expenses, and $1.2 million in acquisition related amortization of stock compensation. Total stock-based compensation expense (benefit) for the six months ended April 30, 2005 was $(1.8) million. Of this amount, of $(0.5) million was included in cost of sales, $(0.8) million in research and development, $(0.3) million in sales and marketing, $(0.3) million in general and administrative expenses, and $0.1 million in acquisition related amortization of stock compensation. Total stock-based compensation benefit for the three and six months ended April 30, 2005 excludes certain stock-based awards which were previously reported as proforma compensation expense under APB 25 (see Note 2, “Summary of Significant Accounting Policies,” of the Notes to Condensed Consolidated Financial Statements).

Effective October 30, 2005, we began recording compensation expense associated with stock-based awards and other forms of equity compensation in accordance with SFAS 123R. Under the fair value recognition provisions of SFAS 123R, stock-based compensation expense is measured at the grant date based on the fair value of the award and is recognized as expense over the vesting period. Determining the fair value of stock-based awards and other forms of equity compensation at the grant date requires judgment, including estimating our stock price volatility and employee stock option exercise behaviors. If actual results differ significantly from these estimates, stock-based compensation expense and our results of operations could be materially impacted. For the three and six months ended April 29, 2006, stock-based compensation expense for stock options and employee stock purchases of $4.6 million and $9.9 million, respectively, is included in cost of sales, research and development, sales and marketing, or general and administrative expenses by employee.

We have stock-based compensation arising from stock option grants remeasured at their intrinsic value and subject to change in measurement date. For the three months ended April 29, 2006, total compensation expense of $1.8 million resulting from stock option grants remeasured at their intrinsic value was included in cost of sales, research and development, sales and marketing, or general and administrative expenses by employee. For the three months ended April 30, 2005, total compensation expense (benefit) of $(1.5) million resulting from stock option grants remeasured at their intrinsic value and subject to change in measurement date are included in cost of sales, research and development, sales and marketing, or general and administrative expenses, by employee. For the six months ended April 29, 2006, total compensation expense of $2.0 million resulting from stock option grants remeasured at their intrinsic value was included in cost of sales, research and development, sales and marketing, or general and administrative expenses by employee. For the six months ended April 30, 2005, total compensation expense (benefit) of $(2.8) million resulting from stock option grants remeasured at their intrinsic value and subject to change in measurement date are included in cost of sales, research and development, sales and marketing, or general and administrative expenses, by employee. Accordingly, amortization of stock-based compensation does not include the compensation expense arising from these awards. The stock-based compensation expense associated with remeasuring awards at their intrinsic value each reporting period will vary significantly as a result of future changes in the market value of our common stock. The change in stock-based compensation related to awards remeasured at their intrinsic value during the three and six months ended April 29, 2006 as compared to the three and six months ended April 30, 2005 is due to a change in market values of our common stock during the reported periods.

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In addition to the stock-based compensation expense recorded for stock-based awards, for the three months ended April 29, 2006 and April 30, 2005, we recorded $0.6 million and $0 million, respectively, in acquisition related amortization of stock compensation. For the six months ended April 29, 2006 and April 30, 2005, acquisition related amortization of stock compensation was $1.2 million and $0.1 million, respectively. The amortized stock-based compensation expense represents the fair value of unvested restricted common stock and assumed stock options, and is being amortized over the respective remaining service periods on a straight-line basis. As of April 29, 2006, the remaining unamortized balance of acquisition related stock-based compensation was approximately $0.9 million.

Acquisition related compensation expense. During the three months ended April 29, 2006, we recorded acquisition related compensation expense of $0.6 million related to the acquisition of NuView (see Note 3: “Acquisitions,” of the Notes to Condensed Consolidated Financial Statements). No other acquisition related compensation expense has been recorded in the Condensed Consolidated Financial Statements for the periods presented.

Amortization of intangible assets. During the three months ended April 29, 2006, we recorded amortization of intangible assets of $0.5 million related to the acquisition of NuView. We account for intangible assets in accordance with SFAS 142. Intangible assets are recorded based on estimates of fair value at the time of the acquisition and identifiable intangible assets are amortized on a straight line basis over their estimated useful lives (see Note 4: “Goodwill and Identifiable Intangible Assets,” of the Notes to Condensed Consolidated Financial Statements). No other amortization of intangible asset expenses have been recorded in the Condensed Consolidated Financial Statements for the periods presented.

Facilities lease losses. During the three months ended April 29, 2006, we recorded a charge of $3.8 million related to estimated facilities lease losses, net of expected sublease income. This charge represents an estimate based on current market data (see Note 7, “Liabilities Associated with Facilities Lease Losses,” of the Notes to Condensed Consolidated Financial Statements). No other facilities lease loss expenses have been recorded in the Condensed Consolidated Financial Statements for the periods presented.

Restructuring costs. During the three months ended April 30, 2005, we recorded a reduction of $0.1 million to restructuring costs related to recovery of previously recorded restructuring costs. This reduction relates to a restructuring plan we implemented in fiscal year 2004 which was designed to optimize our business model to drive improved profitability through reduction of headcount as well as certain structural changes in the business. The reduction was primarily attributable to actual payments which were lower than the estimated amount. No other restructuring costs or benefits have been recorded in the Condensed Consolidated Financial Statements for the periods presented.

Interest and other income, net. Interest and other income, net increased to $7.2 million for the three months ended April 29, 2006, compared with $5.6 million for the three months ended April 30, 2005, and $14.2 million and $10.8 million for the six months ended April 29, 2006 and April 30, 2005, respectively. The increase for the three and six months ended April 29, 2006 was primarily due to higher average rates of return due to investment mix and an increase in interest rates, as well as an increase in cash invested.

Interest expense. Interest expense was $1.8 million for the three months ended April 29, 2006 and April 30, 2005, and $3.6 million and $4.1 million for the six months ended April 29, 2006 and April 30, 2005, respectively. Interest expense primarily represents the interest cost associated with our convertible subordinated debt. The decrease in interest expense for the six months ended April 29, 2006 compared to April 30, 2005 was primarily the result of the repurchases of our convertible subordinated debt in the first six months of fiscal year 2005, resulting in a lower debt outstanding. As of April 29, 2006 and April 30, 2005, the outstanding balance of our convertible subordinated debt was $278.9 million and $278.9 million, respectively (see Note 8, “Convertible Subordinated Debt,” of the Notes to Condensed Consolidated Financial Statements).

Gain on repurchases of convertible subordinated debt. During the three months ended April 30, 2005, we repurchased $69.2 million in face value of our convertible subordinated debt on the open market. For the three months ended April 30, 2005, we paid an average of $0.96 on each dollar of face value for an aggregate purchase price of $66.5 million, which resulted in a pre-tax gain of $2.2 million. We did not repurchase any of our convertible subordinated debt during the three months ended April 29, 2006.

During the six months ended April 30, 2005, we repurchased $73.4 million in face value of our convertible subordinated debt on the open market. For the six months ended April 30, 2005 we paid an average of $0.96 on each dollar of face value for an aggregate purchase price of $70.5 million, which resulted in a pre-tax gain of $2.3 million. We did not repurchase any of our convertible subordinated debt during the six months ended April 29, 2006.

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Provision for income taxes. Estimates and judgments are required in the calculation of certain tax liabilities and in the determination of the recoverability of certain of the deferred tax assets, which arise from variable stock option expenses, net operating losses, tax carryforwards and temporary differences between the tax and financial statement recognition of revenue and expense. SFAS No. 109, Accounting for Income Taxes (“SFAS 109”), also requires that the deferred tax assets be reduced by a valuation allowance, if based on the weight of available evidence, it is more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods.

In evaluating our ability to recover our deferred tax assets, in full or in part, we consider all available positive and negative evidence including our past operating results, the existence of cumulative losses in the most recent fiscal years and our forecast of future taxable income on a jurisdiction by jurisdiction basis. In determining future taxable income, we are responsible for assumptions utilized including the amount of state and federal pre-tax operating income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgments about the forecasts of future taxable income and are consistent with the plans and estimates we are using to manage the underlying businesses. Cumulative losses incurred in the last seven fiscal years represented sufficient negative evidence to require a full valuation allowance. As of April 29, 2006, we had a full valuation allowance against the deferred tax assets, which we intend to maintain until sufficient positive evidence exists to support reversal of the valuation allowance. Future reversals or increases to our valuation allowance could have a significant impact on our future earnings.

In addition, the calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations in a multitude of jurisdictions. We recognize potential liabilities for anticipated tax audit issues in the U.S. and other tax jurisdictions based on our estimate of whether, and the extent to which, additional taxes will be due. If events occur and the payment of these amounts ultimately proves to be unnecessary, the reversal of the liabilities would result in tax benefits being recognized in the period when we determine the liabilities are no longer necessary. If our estimate of tax liabilities proves to be less than the ultimate assessment, a further charge to expense would result.

For the three months ended April 29, 2006, we have recorded an income tax provision of $7.2 million, compared to an income tax provision of $4.0 million for the three months ended April 30, 2005. For the six months ended April 29, 2006, we recorded an income tax provision of $15.1 million, compared to an income tax provision of $9.3 million for the six months ended April 30, 2005. For the three months ended April 29, 2006, our income tax provision is based on both domestic and international operations. We expect to continue to record an income tax provision for our international and domestic operations in the future. Since we have a full valuation allowance against deferred tax assets which result from U.S. operations, U.S. income tax expense or benefits are offset by releasing or increasing, respectively, the valuation allowance. Our U.S. federal income tax liability is reduced by the utilization of net operating loss and credit carryforwards from prior years such that only alternative minimum tax results. To the extent these carryforwards are fully utilized against future earnings, our US federal effective tax rate is expected to increase. To the extent that international revenues and earnings differ from those historically achieved, a factor largely influenced by the buying behavior of our OEM partners, or unfavorable changes in tax laws and regulations occur, our income tax provision could change.

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 IRS Audit is ongoing and we believe our reserves are adequate to cover any potential assessments that may result from the examination.

In April 2006, we were notified by the Franchise Tax Board (“FTB”) that our California income tax returns for the years ended October 25, 2003 and October 30, 2004 were subject to audit. The FTB Audit is ongoing and we believe our reserves are adequate to cover any potential assessments that may result from the examination.

Liquidity and Capital Resources

Cash, cash equivalents, restricted short-term investments, and short-term and long-term investments were $780.9 million as of April 29, 2006. For the six months ended April 29, 2006, we generated $87.7 million in cash from operating activities. Cash from operations significantly exceeded net income for the three months ended April 29, 2006 due to non-cash items, primarily related to depreciation and amortization, non-cash compensation expense, non-cash facilities lease loss expense and the provision for SEC settlement, offset by an increase in accounts receivable. Days sales outstanding in receivables for the six months ended April 29, 2006 was 39 days, compared with 52 days for the six months ended April 30, 2005.

Net cash used in investing activities for the six months ended April 29, 2006 totaled $95.6 million and was the result of $59.9 million in cash paid in connection with the NuView acquisition, $158.6 million used for purchases of short-term, restricted short-term, long-term investments, and other non-marketable minority equity investments, and $15.5 million invested in capital equipment, offset by $138.4 million in net proceeds from sales and maturities of short-term and short-term restricted investments.

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Net cash provided by financing activities for the six months ended April 29, 2006 totaled $6.8 million. Net cash provided by financing activities was primarily the result of $15.2 million in proceeds from the issuance of common stock and $6.6 million of excess tax benefit from employee stock plans, offset by $14.9 million in common stock repurchases under the Company’s share repurchase program.

Net proceeds from the issuance of common stock related to employee participation in employee stock programs have historically been a significant component of our liquidity. The extent to which our employees participate in these programs generally increases or decreases based upon changes in the market price of our common stock. As a result, our cash flow resulting from the issuance of common stock related to employee participation in employee stock programs will vary. As a result of our voluntary stock options exchange program, which was completed in July 2003, we do not expect to generate significant cash flow from the issuance of common stock related to the employee participation in employee stock programs during fiscal year 2006 unless our future common stock price exceeds $6.54 per share, which is the exercise price of the stock options granted under the exchange program.

Manufacturing and Purchase Commitments. We have a manufacturing agreement with Foxconn under which we provide twelve-month product forecasts and place purchase orders in advance of the scheduled delivery of products to our customers. The required lead-time for placing orders with Foxconn depends on the specific product. As of April 29, 2006, our aggregate commitment to Foxconn for inventory components used in the manufacture of Brocade products was $73.4 million, net of purchase commitment reserves of $4.1 million, which we expect to utilize during future normal ongoing operations. Although the purchase orders we place with Foxconn are cancelable, the terms of the agreement requires us to purchase from Foxconn all inventory components not returnable or usable by, or sold to, other customers of Foxconn. Our purchase commitments reserve reflects our estimate of purchase commitments we do not expect to consume in normal operations.

Convertible Subordinated Debt. On December 21, 2001, and January 10, 2002, we sold an aggregate of $550 million in principal amount of two percent convertible subordinated notes due January 2007 (the “Notes” or “Convertible Subordinated Debt”) (see Note 8, “Convertible Subordinated Debt,” of the Notes to Condensed Consolidated Financial Statements). Holders of the Notes may, in whole or in part, convert the Notes into shares of our common stock at a conversion rate of 22.8571 shares per $1,000 principal amount of notes (approximately 6.4 million shares may be issued upon conversion based on outstanding debt of $278.9 million as of April 29, 2006) at any time prior to maturity on January 1, 2007, subject to earlier redemption. Under the original term of the Notes, at any time on or after January 5, 2005, we were entitled to redeem the notes in whole or in part at the following prices expressed as a percentage of the principal amount:


Redemption Period	Price
Beginning on January 5, 2005 and ending on December 31, 2005		100.80	%
Beginning on January 1, 2006 and ending on December 31, 2006		100.40	%
On January 1, 2007		100.00	%

We are required to pay interest on January 1 and July 1 of each year, beginning July 1, 2002. Debt issuance costs are being amortized over the term of the notes. The amortization of debt issuance costs will accelerate upon the redemption of the notes. The net proceeds remain available for general corporate purposes, including working capital and capital expenditures.

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During the three and six months ended April 29, 2006, we did not purchase any of our Convertible Subordinated Debt on the open market. For the three months ended April 30, 2005, we purchased $69.2 million in face value of our Convertible Subordinated Debt on the open market and paid an average of $0.96 on each dollar of face value for an aggregate purchase price of $66.5 million, which resulted in a pre-tax gain of $2.2 million. During the six months ended April 30, 2005, we repurchased $73.4 million in face value of our Convertible Subordinated Debt, which resulted in a pre-tax gain of $2.3 million for the six months ended April 30, 2005. To date, the Company has repurchased a total of $271.1 million in face value of its convertible subordinated notes. As of April 29, 2006, the remaining balance outstanding of the convertible subordinated debt was $278.9 million.

Other Contractual Obligations. On November 18, 2003, we purchased a previously leased building located near our San Jose headquarters, and issued a $1.0 million guarantee as part of the purchase agreements.

The following table summarizes our contractual obligations (including interest expense) and commitments as of April 29, 2006 (in thousands):


				Less than						More than
	Total			1 Year		1-3 Years		3-5 Years		5 Years
Contractual Obligations:
Convertible subordinated notes, including interest	$	279,819		$	279,819	$	—	$	—	$	—
Non-cancelable operating leases		64,582			16,161		29,497		18,924		—
Purchase commitments, gross		73,410	(1)		73,410		—		—		—

Total contractual obligations	$	417,811		$	369,390	$	29,497	$	18,924	$	—

Other Commitments:
Standby letters of credit	$	8,343		$	n/a	$	n/a	$	n/a	$	n/a

Guarantee	$	1,015		$	n/a	$	n/a	$	n/a	$	n/a


(1)		Amount reflects total gross purchase commitments under our manufacturing agreement with a third party contract manufacturer. Of this amount, we have reserved $4.1 million for estimated purchase commitments that we do not expect to consume in normal operations.

Share Repurchase Program. In August 2004, our board of directors approved a share repurchase program for up to $100.0 million of our common stock. The purchases may be made, from time to time, in the open market and will be funded from available working capital. The number of shares to be purchased and the timing of purchases will be based on the level of our cash balances, general business and market conditions, and other factors, including alternative investment opportunities. To date, we have repurchased 3.7 million shares and $78.0 million remains available for future repurchases under this program.

Other. Under the terms of a certain licensing agreement, we may be required to pay up to $3.7 million of prepaid license fees if certain milestones are met.

We believe that our existing cash, cash equivalents, short-term and long-term investments, and cash expected to be generated from future operations will be sufficient to meet our capital requirements at least through the next 12 months, although we may elect to seek additional funding prior to that time, if available. Our future capital requirements will depend on many factors, including our rate of revenue growth, the timing and extent of spending to support our product development efforts and the expansion of our sales and marketing programs, the timing of introductions of new products and enhancements to our existing products, and market acceptance of our products.

Critical Accounting Policies

Our discussion and analysis of financial condition and results of operations is based upon our Condensed Consolidated Financial Statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these Condensed Consolidated Financial Statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We evaluate, on an on-going basis, our estimates and judgments, including those related to sales returns, bad debts, excess inventory and purchase commitments, investments, warranty obligations, restructuring costs, lease losses, goodwill and identified intangible assets, income taxes, and contingencies and litigation. We base our estimates on historical experience

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and assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

The methods, estimates, and judgments we use in applying our most critical accounting policies have a significant impact on the results that we report in our Condensed Consolidated Financial Statements. The SEC considers an entity’s most critical accounting policies to be those policies that are both most important to the portrayal of a company’s financial condition and results of operations, and those that require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about matters that are inherently uncertain at the time of estimation. We believe the following critical accounting policies, among others, require significant judgments and estimates used in the preparation of our Condensed Consolidated Financial Statements:

	•		Revenue recognition, and allowances for sales returns, sales programs, and doubtful accounts;

	•		Stock-based compensation;

	•		Inventory and purchase commitment reserves;

	•		Restructuring charges and lease loss reserves;

	•		Goodwill and intangible assets;

	•		Litigation costs; and

	•		Accounting for income taxes.

Revenue recognition, and allowances for sales returns, sales programs, and doubtful accounts. Product revenue is generally recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collection is probable. However, for newly introduced products, many of our large OEM customers require a product qualification period during which our products are tested and approved by the OEM customer for sale to their customers. Revenue recognition, and related cost, is deferred for shipments to new OEM customers and for shipments of newly introduced products to existing OEM customers until satisfactory evidence of completion of the product qualification has been received from the OEM customer. In addition, revenue from sales to our master reseller customers is recognized in the same period in which the product is sold by the master reseller (sell-through).

We reduce revenue for estimated sales returns, sales programs, and other allowances at the time of shipment. Sales returns, sales programs, and other allowances are estimated based on historical experience, current trends, and our expectations regarding future experience. Reductions to revenue associated with sales returns, sales programs, and other allowances include consideration of historical sales levels, the timing and magnitude of historical sales returns, claims under sales programs, and other allowances, and a projection of this experience into the future. In addition, we maintain allowances for doubtful accounts, which are also accounted for as a reduction in revenue, for estimated losses resulting from the inability of our customers to make required payments. We analyze accounts receivable, historical collection patterns, customer concentrations, customer creditworthiness, current economic trends, changes in customer payment terms and practices, and customer communication when evaluating the adequacy of the allowance for doubtful accounts. If actual sales returns, sales programs, and other allowances exceed our estimate, or if the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances and charges may be required.

Service revenue consists of training, warranty, and maintenance arrangements, including post-contract customer support (“PCS”) and other professional services. PCS services are offered under renewable, annual fee-based contracts or as part of multiple element arrangements and typically include upgrades and enhancements to our software operating system software, and telephone support. Service revenue, including revenue allocated to PCS elements, is deferred and recognized ratably over the contractual period. Service contracts are typically one to three years in length. Professional services are offered under fee based contracts or as part of multiple element arrangements. Professional service revenue is recognized as delivery of the underlying service occurs. Training revenue is recognized upon completion of the training.

Our multiple-element product offerings include computer hardware and software products, and support services. We also sell certain software products and support services separately. Our software products are essential to the functionality of our hardware products and are, therefore, accounted for in accordance with Statement of Position 97-2, Software Revenue

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Recognition (“SOP 97-2”), as amended. We allocate revenue to each element based upon vendor-specific objective evidence (“VSOE”) of the fair value of the element or, if VSOE is not available, by application of the residual method. VSOE of the fair value for an element is based upon the price charged when the element is sold separately. Revenue allocated to each element is then recognized when the basic revenue recognition criteria are met for each element. Changes in the allocation of revenue to each element in a multiple element arrangement may affect the timing of revenue recognition.

Stock-Based Compensation. Effective October 30, 2005 we began recording compensation expense associated with stock-based awards and other forms of equity compensation in accordance with SFAS 123R. We adopted the modified prospective transition method provided for under SFAS 123R, and consequently have not retroactively adjusted results from prior periods. Under this transition method, compensation cost associated with stock-based awards recognized in the first quarter of fiscal year 2006 now includes 1) quarterly amortization related to the remaining unvested portion of stock-based awards granted prior to October 30, 2005, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123; and 2) quarterly amortization related to stock-based awards granted subsequent to October 30, 2005, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R. In addition, we record expense over the offering period and vesting term in connection with 1) shares issued under our employee stock purchase plan and 2) stock options and restricted stock awards. The compensation expense for stock-based awards includes an estimate for forfeitures and is recognized over the expected term of the award under an accelerated vesting method.

Prior to October 30, 2005, we accounted for stock-based awards using the intrinsic value method of accounting in accordance with APB 25, whereby the difference between the exercise price and the fair market value on the date of grant is recognized as compensation expense. Under the intrinsic value method of accounting, no compensation expense was recognized in our Condensed Consolidated Statements of Operations when the exercise price of our employee stock option grant equals the market price of the underlying common stock on the date of grant, and the measurement date of the option grant is certain. The measurement date is certain when the date of grant is fixed and determinable. Prior to October 30, 2005 when the measurement date was not certain, we recorded stock-based compensation expense using variable accounting under APB 25. Effective October 30 2005, for awards where the measurement date is not certain, we record stock-based compensation expense under SFAS 123R. Under SFAS 123R, we remeasure the intrinsic value of the options at the end of each reporting period until the options are exercised, cancelled or expire unexercised.

Inventory and purchase commitment reserves. We write down inventory and record purchase commitment reserves for estimated excess and obsolete inventory equal to the difference between the cost of inventory and the estimated fair value based upon forecast of future product demand, product transition cycles, and market conditions. Although we strive to ensure the accuracy of our forecasts of future product demand, any significant unanticipated changes in demand or technological developments could have a significant impact on the value of our inventory and commitments, and our reported results. If actual market conditions are less favorable than those projected, additional inventory write-downs, purchase commitment reserves, and charges against earnings might be required.

Restructuring charges and lease loss reserves. We monitor and regularly evaluate our organizational structure and associated operating expenses. Depending on events and circumstances, we may decide to take additional actions to reduce future operating costs as our business requirements evolve. In determining restructuring charges, we analyze our future operating requirements, including the required headcount by business functions and facility space requirements. Our restructuring costs, and any resulting accruals, involve significant estimates made by management using the best information available at the time the estimates are made, some of which may be provided by third parties. In recording severance reserves, we accrue a liability when the following conditions have been met: employees’ rights to receive compensation is attributable to employees’ services already rendered; the obligation relates to rights that vest or accumulate; payment of the compensation is probable; and the amount can be reasonably estimated. In recording facilities lease loss reserves, we make various assumptions, including the time period over which the facilities are expected to be vacant, expected sublease terms, expected sublease rates, anticipated future operating expenses, and expected future use of the facilities. Our estimates involve a number of risks and uncertainties, some of which are beyond our control, including future real estate market conditions and our ability to successfully enter into subleases or lease termination agreements with terms as favorable as those assumed when arriving at our estimates. We regularly evaluate a number of factors to determine the appropriateness and reasonableness of our restructuring and lease loss accruals including the various assumptions noted above. If actual results differ significantly from our estimates, we may be required to adjust our restructuring and lease loss accruals in the future.

Goodwill and intangible assets. We assess the impairment of goodwill and other identifiable intangibles annually or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Some factors we consider important which could trigger an impairment review include significant underperformance relative to historical or

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projected future operating results, significant changes in the manner of use of acquired assets or the strategy for its business, and significant negative industry or economic trends. If we determine that the carrying value of goodwill and other identified intangibles may not be recoverable based upon the existence of one or more of the above indicators of impairment, we would typically measure any impairment based on a projected discounted cash flow method using a discount rate determined by us to be commensurate with the risk inherent in our current business model.

We plan to conduct impairment tests annually during our second fiscal quarter, unless impairment indicators exist sooner. Screening for and assessing whether impairment indicators exist or if events or changes in circumstances have occurred, including market conditions, operating fundamentals, competition, and general economic conditions, requires significant judgment. Additionally, changes in the high-technology industry occur frequently and quickly. Therefore, there can be no assurance that a charge to operations will not occur as a result of future intangible impairment tests.

Litigation costs. We are subject to the possibility of legal actions arising in the ordinary course of business. We regularly monitor the status of pending legal actions to evaluate both the magnitude and likelihood of any potential loss. We accrue for these potential losses when it is probable that a liability has been incurred and the amount of loss, or possible range of loss, can be reasonably estimated. Where there is a range of loss, we record the minimum estimated liability unless there is a better point of estimate within that range. If actual results differ significantly from our estimates, we may be required to adjust our accruals in the future.

Accounting for income taxes. The determination of our tax provision is subject to judgments and estimates due to operations in multiple tax jurisdictions inside and outside the United States. Sales to our international customers are principally taxed at rates that are lower than the United States statutory rates. The ability to maintain our current effective tax rate is contingent upon existing tax laws in both the United States and in the respective countries in which our international subsidiaries are located. Future changes in domestic or international tax laws could affect the continued realization of the tax benefits we are currently receiving and expect to receive from international sales. In addition, an increase in the percentage of our total revenue from international customers or in the mix of international revenue among particular tax jurisdictions could change our overall effective tax rate. Also, our current effective tax rate assumes that United States income taxes are not provided for undistributed earnings of certain non-United States subsidiaries. These earnings could become subject to United States federal and state income taxes and foreign withholding taxes, as applicable, should they be either deemed or actually remitted from our international subsidiaries to the United States.

The carrying value of our net deferred tax assets is subject to a full valuation allowance. At some point in the future, we may have sufficient United States taxable income to release the valuation allowance and accrue United States tax. We evaluate the expected realization of our deferred tax assets and assess the need for valuation allowances quarterly.

Item 3. Quantitative and Qualitative Disclosures About Market Risks

We are exposed to market risk related to changes in interest rates and equity security prices.

Interest Rate Risk

Our exposure to market risk due to changes in the general level of United States interest rates relates primarily to our cash equivalents and short-term and long-term investment portfolios. Our cash, cash equivalents, restricted short-term, and short-term and long-term investments are primarily maintained at six major financial institutions in the United States. As of April 29, 2006, we did not hold any derivative instruments. The primary objective of our investment activities is the preservation of principal while maximizing investment income and minimizing risk.

The following table presents the hypothetical changes in fair values of our investments as of April 29, 2006 that are sensitive to changes in interest rates (in thousands):


	Valuation of Securities						Fair Value		Valuation of Securities
	Given an Interest Rate						As of		Given an Interest Rate
	Decrease of X Basis Points						April 29,		Increase of X Basis Points
Issuer	(150 BPS)		(100 BPS)		(50 BPS)		2006		50 BPS		100 BPS		150 BPS
U.S. government agencies and municipal obligations	$	411,144	$	408,763	$	406,561	$	404,918	$	402,558	$	400,728	$	399,002
Corporate bonds and notes	$	196,638	$	196,293	$	195,865	$	195,015	$	194,982	$	194,541	$	194,102

Total	$	607,782	$	605,056	$	602,426	$	599,933	$	597,540	$	595,269	$	593,104

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These instruments are not leveraged and are classified as available-for-sale. The modeling technique used measures the change in fair values arising from selected potential changes in interest rates. Market changes reflect immediate hypothetical parallel shifts in the yield curve of plus or minus 50 basis points (BPS), 100 BPS, and 150 BPS, which are representative of the historical movements in the Federal Funds Rate.

The following table (in thousands) presents our cash equivalents, short-term, restricted short-term, and long-term investments subject to interest rate risk and their related weighted average interest rates as of April 29, 2006. Carrying value approximates fair value.


			Weighted
			Average
	Amount		Interest Rate
Cash and cash equivalents	$	181,009		4.2	%
Restricted short-term investments		279,819		3.8	%
Short-term investments		277,794		3.7	%
Long-term investments		42,320		3.5	%

Total	$	780,942		3.9	%

Our convertible subordinated debt is subject to a fixed interest rate and the notes are based on a fixed conversion ratio into common stock. Therefore, we are not exposed to changes in interest rates related to our long-term debt instruments. The notes are not listed on any securities exchange or included in any automated quotation system; however, the notes are eligible for trading on the Portal^SM Market. On April 28, 2006, the average bid and ask price on the Portal Market of our convertible subordinated notes due 2007 was 99.13, resulting in an aggregate fair value of approximately $276.5 million. Our common stock is quoted on the Nasdaq National Market under the symbol “BRCD.” On April 28, 2006, the last reported sale price of our common stock on the Nasdaq National Market was $6.16 per share.

Item 4. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures. Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this Quarterly Report on Form 10-Q (the “Evaluation Date”).

The purpose of this evaluation is to determine if, as of the Evaluation Date, our disclosure controls and procedures were operating effectively such that the information relating to Brocade, required to be disclosed in our Securities and Exchange Commission (“SEC”) reports (i) was recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) was accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the Evaluation Date, our disclosure controls and procedures were operating effectively.

(b) Changes in Internal Control Over Financial Reporting.

There were no changes in our internal controls over financial reporting during the second quarter of fiscal 2006 that materially affected or are reasonably likely to materially affect our internal control over financial reporting.

Limitations on the Effectiveness of Disclosure Controls and Procedures.

Our management, including our Chief Executive Officer and Chief Financial Officer, do not expect that our disclosure controls and procedures or internal control over financial reporting will prevent all errors and all fraud. A control system no matter how well designed and implemented, can provide only reasonable, not absolute, assurance that the control system’s

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objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues within a company are detected. The inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistakes. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the controls. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and may not be detected.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

On July 20, 2001, the first of a number of putative class actions for violations of the federal securities laws was filed in the United States District Court for the Southern District of New York against the Company, certain of its officers and directors, and certain of the underwriters for the Company’s initial public offering of securities. A consolidated amended class action captioned In Re Brocade Communications Systems, Inc. Initial Public Offering Securities Litigation was filed on April 19, 2002. The complaint generally alleges that various underwriters engaged in improper and undisclosed activities related to the allocation of shares in the Company’s initial public offering and seeks unspecified damages on behalf of a purported class of purchasers of common stock from May 24, 1999 to December 6, 2000. The lawsuit against the Company is being coordinated for pretrial proceedings with a number of other pending litigations challenging underwriter practices in over 300 cases as In Re Initial Public Offering Securities Litigation, 21 MC 92(SAS). In October 2002, the individual defendants were dismissed without prejudice from the action, pursuant to a tolling agreement. On February 19, 2003, the Court issued an Opinion and Order dismissing all of the plaintiffs’ claims against the Company. In June 2004, a stipulation of settlement for the claims against the issuer defendants, including the Company, was submitted to the Court for approval. On August 31, 2005, the Court granted preliminary approval of the settlement. On April 24, 2006 the Court held a fairness hearing in connection with the motion for final approval of the settlement. The Court did not issue a ruling on the motion for final approval at the fairness hearing. The settlement remains subject to a number of conditions, including final approval by the Court.

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No amounts have been recorded in the accompanying Condensed Consolidated Financial Statements associated with these matters.

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 as 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 recently launched three new software products, the Tapestry Application Resource Manager solution, the Tapestry Data Migration Manager, and the Tapestry Wide Area File Services solution, as well as new service and support 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

	•		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 professional 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 professional 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. As a result, we believe these new markets could substantially increase our total available market opportunities. However, we cannot be certain that we have accurately identified and estimated these market opportunities. Moreover, we cannot assure you 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. As a result, we may not be able to successfully penetrate or realize anticipated revenue from these new potential market opportunities. 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.

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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 our recently introduced Tapestry solutions and our service offerings. In addition, our recent acquisition of NuView, Inc. and our strategic partnership with Packeteer, Inc. and Tacit Networks, Inc. (recently acquired by Packeteer) contributed to the software applications associated with these solutions. In addition, because some of our new offerings may address different market needs than those we have historically addressed, we may face a number of additional challenges, such as:

	•		successfully identifying market opportunities;

	•		developing new customer relationships;

	•		expanding our relationships 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.

Our business and operations are also experiencing rapid change as we diversify our product and service offerings. If we fail to effectively manage these changes and implement necessary organizational changes, our business and operating results could be harmed and we may have to incur significant expenditures to address the additional operational and control requirements from these changes.

Our 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.

With respect to the investments we are making in an expanded service initiative, these investments may be costly and may not result in 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 primarily relied on our OEM partners and third parties to provide some of this 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. In addition, 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 costs relative to revenue, our services initiative will not be successful. Further, 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. For example, we expect to experience increased competition in future periods as other companies release 4 Gbit products that are intended to compete with our 4 Gbit products. 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

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developing and introducing products that compete with our product offerings, by choosing to sell our competitors’ products instead of our products, or by 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 we do. 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 put pressure on 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 $7.2 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. 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 in 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.

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 revenue per port and gross margin 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. As a result, we may not be able to decrease our spending quickly enough or in sufficient amounts to offset any unexpected shortfall in revenues. 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.

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.

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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 first and second quarters of fiscal 2006, three customers each represented ten percent or more of our total revenues for a combined total of 72 percent and 70 percent, respectively. 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, would likely cause seriously harm to 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 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 $3.4 million and $1.8 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;

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	•		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;

	•		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.

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 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.

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.

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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 specific ASICs from a single source, and we purchase microprocessors, certain connectors, small form-factor pluggable transceivers (“SFP’s”), 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 obtain these and other components when required or we experience significant component defects, we may not be able to deliver our products to our customers in a timely manner. As a result, our business and financial results could be harmed.

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.

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 typically experience similar seasonality. Historically, revenues in our second fiscal quarter are lower compared with a seasonally stronger first fiscal quarter due to a typically slower growth period for most of our major OEM partners. 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 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, some purportedly filed on behalf of a class of our stockholders, against us and certain of our executive officers claiming violations of securities laws and others purportedly filed 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 internal reviews and related restatements, we are subject to investigations by the SEC and DOJ, which may not be resolved favorably and have 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 investigations of the Company. The period of time necessary to resolve the SEC and DOJ investigations 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

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SEC and DOJ investigation, we could be required to pay damages or penalties or have other remedies imposed upon us. During the three months ended January 28, 2006 we began active settlement discussions with the Staff of the SEC’s Division of Enforcement (the “Staff’’). As a result of these discussions, for the three months ended January 28, 2006 we recorded $7.0 million provision for an estimated settlement expense. The $7.0 million estimated settlement expense is based on an offer of settlement that the Company made to the Staff and for which the Staff intends on recommending to the SEC’s Commissioners. The offer of settlement is contingent upon final approval by the SEC’s Commissioners. 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 investigations 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 would require us to use 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 NuView, Inc., Therion Software Corporation and a strategic investment in Tacit Networks in May 2005 (recently acquired by Packeteer, Inc.). 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; Houston, Texas; Redmond, Washington; and India;

	•		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 limited, or no prior experience;

	•		failure to successfully manage additional remote locations, including the additional infrastructure and resources necessary to support and integrate such locations;

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	•		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;

	•		potential write-down of goodwill and/or acquired intangible assets, which are subject to impairment testing on a regular basis, and could significantly 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.

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. For example, in Europe substance restrictions will apply to products sold after July 1, 2006, and certain of our OEM partners require compliance with these or more stringent requirements prior to such date. In some cases we redesigned our products to comply with these substance restrictions as well as related requirements imposed by our OEM customers. In addition, recycling, labeling, financing and related requirements have already begun to apply to products we sell in Europe. We are also coordinating with our suppliers to provide us with compliant materials, parts and components. Despite our efforts to ensure that our products comply with new and emerging requirements, we cannot provide absolute assurance that our products will, in all cases comply with such requirements. If our products do not comply with the European substance restrictions or other applicable environmental laws, 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 one or more jurisdictions, and required to recall and replace any non-compliant products already shipped, 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 despite our requirement to them to provide compliant materials, parts and components, which could impact our ability to timely produce compliant products and, accordingly could disrupt our business. In addition, 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.

Our business and operations are experiencing rapid change as we diversify our product and service offerings. If we fail to effectively manage these changes, our business and operating results could be harmed and we may have to incur significant expenditures to address the additional operational and control requirements of these changes.

We have experienced, and continue to experience, rapid growth in our headcount and operations, which has placed, and may continue to place, increased demands on our management, operational and financial infrastructure. If we do not effectively manage our growth, the quality of our products and services could suffer, which could negatively affect our brand and operating results. Our expansion and growth in international markets heightens these risks as a result of the particular challenges of supporting a rapidly growing business in an environment of multiple languages, cultures, customs, legal systems, alternative dispute systems, regulatory systems and commercial infrastructures. To effectively manage this growth, we will need to continue to improve our operational, financial and management controls and our reporting systems and procedures. These systems enhancements and improvements will require significant capital expenditures and allocation of valuable management resources. If the improvements are not implemented successfully, our ability to manage our growth will be impaired and we may have to make significant additional expenditures to address these issues, which could harm our financial position.

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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 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.

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. If this occurs, our business and financial results will be harmed.

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. Additionally, in May 2006, the Franchise Tax Board notified us that our California income tax returns for the years ended October 25, 2003 and October 30, 2004 are 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 event of an unfavorable outcome, may result in additional liabilities or adjustments to our historical financial results.

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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 U.S. 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.

On December 15, 2004, the FASB issued SFAS 123R, Share-Based Payment, which requires 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 recorded higher levels of stock based compensation due to differences between the valuation methods of SFAS 123R and APB 25. In prior periods, we recorded any compensation expense associated with stock option grants to employees using the intrinsic value method in accordance with Accounting Principles Board Opinion No. 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 third and fourth quarters of fiscal year 2005 and the first quarter of 2006 was $4.48, $3.60 and $4.62 per share, respectively. Accordingly, we recorded compensation expense (benefit) in the fourth quarter of fiscal year 2005 and the first quarter of fiscal year 2006 of approximately $(0.2) million and $0.3 million, respectively. 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.

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 $122.3 million, down 16 percent from $144.8 million reported in the second quarter of fiscal year 2005 and 19 percent from $150.0 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 $3.4 million and $1.8 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.

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:

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	•		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.

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

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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 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 pay royalty or license fees, or to license our intellectual property to such owner, and which may not be available on commercially reasonable terms or at all; and

	•		redesign those products or services that use technology that is the subject of an infringement claim.

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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 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.

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;

	•		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:

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	•		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;

	•		comments made by third-party market observers that may impact investment decisions of investors;

	•		losses of major OEM partners;

	•		additions or departures of key personnel;

	•		adverse finding resulting from the SEC and DOJ investigation or related litigation;

	•		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.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

The following table summarizes stock repurchase activity of our common stock for the three months ended April 29, 2006 (in thousands excluding per share data):


					Total Number		Approximate
					of Shares		Dollar Value of
					Purchased as		Shares that May
	Total Number				Part of Publicly		Yet Be Purchased
	of Shares		Average Price		Announced		Under the
	Purchased (1)		Paid Per Share		Program		Program (2)
January 29, 2006 – February 25, 2006		22	$	0.25		—	$	92,950

February 26, 2006 – March 25, 2006		—	$	5.82		2,309	$	79,506

March 26, 2006 – April 29, 2006		—	$	6.38		233	$	78,020


Total		22	$	0.25		2,542	$	78,020


(1)		The total number of shares repurchased include those shares of Brocade common stock that employees deliver back to Brocade to satisfy tax-withholding obligations at the settlement of restricted stock exercises, and upon the termination of an employee, the forfeiture of either restricted shares or unvested common stock as a result of early exercises. As of April 29, 2006, approximately 1,909,728 million shares are subject to repurchase by Brocade.

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(2)		In August 2004, our board of directors approved a share repurchase program for up to $100.0 million of our common stock. The purchases may be made, from time to time, in the open market and will be funded from available working capital. The number of shares to be purchased and the timing of purchases will be based on the level of our cash balances, general business and market conditions, and other factors, including alternative investment opportunities. As of April 29, 2006, we have purchased 3,692,300 shares at an average price of $5.95 per share, and under this program $78.0 million remains available for future repurchases.

Item 4. Submission of Matters to a Vote of Security Holders

Our Annual Meeting of Stockholders was held on April 17, 2006 in San Jose, California. Of the 273,158,241 shares outstanding as of the record date, 245,529,006 shares (approximately 90%) were present or represented by proxy at the meeting. The results of the voting on the matters submitted to the stockholders are as follows:

1. To elect two Class I Directors to serve until the 2009 Annual Meeting of Stockholders or until their successors are duly elected and qualified.


Name	Votes For		Votes Withheld
David House		209,299,019		36,229,987
L. William Krause		216,294,564		29,234,442

In addition, the terms of office of the following directors continued after the 2006 meeting:

Neal Dempsey
Michael Klayko
Robert Walker
Sanjay Vaswani

2. To ratify the appointment of KPMG LLP as independent auditors of Brocade for the fiscal year ending October 29, 2006.


Votes For	Votes Against	Votes Abstaining	Broker Non-Vote
233,766,762	11,620,667	141,577	-0-

3. To consider a stockholder proposal submitted by CalPERS regarding supermajority voting requirements.


Votes For	Votes Against	Votes Abstaining	Broker Non-Vote
146,622,556	13,433,574	1,841,781	83,631,095

Item 6. Exhibits


	Exhibit
	Number		Description of Document
	3.1		Amended and Restated Certificate of Incorporation (incorporated by reference to Exhibit 3.1 from Brocade’s Annual Report on Form 10-K for the fiscal year ended October 27, 2001).

	3.2		Amended and Restated Bylaws, effective as of April 18, 2006 (incorporated by reference to Exhibit 99.1 from Registrant’s Form 8-K as filed on April 19, 2006).

	3.3		Certificate of Designation of Rights, Preferences and Privileges of Series A Participating Preferred Stock of Brocade Communications Systems, Inc. (incorporated by reference to Exhibit 4.1 from Brocade’s Registration Statement on Form 8-A filed on February 11, 2002)

	4.1		Form of Registrant’s Common Stock certificate (incorporated by reference to Exhibit 4.1 from Brocade’s Registration Statement on Form S-1 (Reg. No. 333-74711), as amended)

	4.2		Preferred Stock Rights Agreement dated as of February 7, 2002 between Brocade and Wells Fargo Bank MN, N.A. (incorporated by reference to Exhibit 4.1 from Brocade’s Registration Statement on Form 8-A filed on February 11, 2002)

	4.3		Form of Convertible Debenture (incorporated by reference to Exhibit 4.3 from Brocade’s Quarterly Report on Form 10-Q for the fiscal quarter ended January 26, 2002)

	10.1+/**		Fourth Amendment to the OEM Purchase Agreement dated December 16, 2002 by and between Hewlett-Packard Company and Registrant, effective as of January 20, 2006.

	10.2+/**		Amendment No. 12 to the OEM Purchase Agreement dated January 25, 2000 (effective as of January 31, 2006) by and among Registrant, Brocade Communications Switzerland SarL, and EMC Corporation.

	10.3+/**		Amendment #25 to SOW #1 between IBM and Registrant, effective April 14, 2006.

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Exhibit Index


Exhibit
Number		Description of Document
3.1		Amended and Restated Certificate of Incorporation (incorporated by reference to Exhibit 3.1 from Brocade’s Annual Report on Form 10-K for the fiscal year ended October 27, 2001).

3.2		Amended and Restated Bylaws, effective as of April 18, 2006 (incorporated by reference to Exhibit 99.1 from Registrant’s Form 8-K as filed on April 19, 2006).

3.3		Certificate of Designation of Rights, Preferences and Privileges of Series A Participating Preferred Stock of Brocade Communications Systems, Inc. (incorporated by reference to Exhibit 4.1 from Brocade’s Registration Statement on Form 8-A filed on February 11, 2002)

4.1		Form of Registrant’s Common Stock certificate (incorporated by reference to Exhibit 4.1 from Brocade’s Registration Statement on Form S-1 (Reg. No. 333-74711), as amended)

4.2		Preferred Stock Rights Agreement dated as of February 7, 2002 between Brocade and Wells Fargo Bank MN, N.A. (incorporated by reference to Exhibit 4.1 from Brocade’s Registration Statement on Form 8-A filed on February 11, 2002)

4.3		Form of Convertible Debenture (incorporated by reference to Exhibit 4.3 from Brocade’s Quarterly Report on Form 10-Q for the fiscal quarter ended January 26, 2002)

10.1+/**		Fourth Amendment to the OEM Purchase Agreement dated December 16, 2002 by and between Hewlett-Packard Company and Registrant, effective as of January 20, 2006.

10.2+/**		Amendment No. 12 to the OEM Purchase Agreement dated January 25, 2000 (effective as of January 31, 2006) by and among Registrant, Brocade Communications Switzerland SarL, and EMC Corporation.

10.3+/**		Amendment #25 to SOW #1 between IBM and Registrant, effective April 14, 2006.

10.4+/**		Amendment #4 to Goods Agreement between IBM and Registrant dated March 30, 2006

31.1**		Rule 13a-14(a)/15d-14(a) Certification by the Chief Executive Officer.

31.2**		Rule 13a-14(a)/15d-14(a) Certification by the Chief Financial Officer.

32.1**		Certification by the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


+		Confidential treatment requested as to certain portions, which portions were omitted and filed separately with the Securities and Exchange Commission

**		Filed herewith


	Page
PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

Condensed Consolidated Statements of Operations for the Three and Six Months Ended April 29, 2006 and April 30, 2005		3

Condensed Consolidated Balance Sheets as of April 29, 2006 and October 29, 2005		4

Condensed Consolidated Statements of Cash Flows for the Six Months Ended April 29, 2006 and April 30, 2005		5

Notes to Condensed Consolidated Financial Statements		6

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		21

Item 3. Quantitative and Qualitative Disclosures About Market Risks		32

Item 4. Controls and Procedures		33

PART II — OTHER INFORMATION

Item 1. Legal Proceedings		34

Item 1A. Risk Factors		35

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		48

Item 4. Submission of Matters to a Vote of Security Holders		49

Item 6. Exhibits		49

SIGNATURES		51
EXHIBIT 10.1
EXHIBIT 10.2
EXHIBIT 10.3
EXHIBIT 10.4
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1


	BROCADE COMMUNICATIONS SYSTEMS, INC.
Date: June 7, 2006	By:	/s/ Richard Deranleau
		Richard Deranleau
		Chief Financial Officer