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 January 26, 2008


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 or organization)		(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, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):


þ Large accelerated filer		o Accelerated filer		o Non-accelerated filer (Do not check if a smaller reporting company)		o Smaller Reporting Company

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 February 22, 2008 was 376,086,119 shares.

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements regarding future events and our future results. All statements other than statements of historical fact are statements that could be deemed forward-looking statements, including, but not limited to, projections of revenue, margins, expenses, tax provisions, earnings, cash flows, benefit obligations, share repurchases or other financial items; any statements of the plans, strategies and objectives of management for future operations; any statements concerning expected development, performance or market share relating to products or services; any statements regarding future economic conditions or performance; any statements regarding pending investigations, claims or disputes; any statements of expectation or belief; and any statements of assumptions underlying any of the foregoing. Words such as “expects,” “anticipates,” “targets,” “goals,” “projects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “continues,” “may,” variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are based on current expectations, estimates, forecasts, and projections about the industries in which we operate and the beliefs and assumptions of our management. Readers are cautioned that these forward-looking statements are only predictions and are subject to risks, uncertainties, and assumptions that are difficult to predict, including those identified below, under “Part II — Other Information, Item 1A. Risk Factors” and elsewhere herein. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. Further, we undertake no obligation to revise or update any forward-looking statements for any reason.

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

BROCADE COMMUNICATIONS SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
(Unaudited)


	Three Months Ended
	January 26,			January 27,
	2008			2007
Net revenues
Product	$	297,946		$	207,216
Service		49,903			16,940

Total net revenues		347,849			224,156
Cost of revenues
Product		117,777			72,311
Service		33,495			10,479

Total cost of revenues		151,272			82,790

Gross margin
Product		180,169			134,905
Service		16,408			6,461

Gross margin		196,577			141,366
Operating expenses:
Research and development		58,206			42,391
Sales and marketing		63,174			38,587
General and administrative		12,366			7,404
Legal fees associated with indemnification obligations, SEC investigation and other related costs		9,659			5,228
Acquisition and integration costs		—			7,433
Amortization of intangible assets		7,909			910

Total operating expenses		151,314			101,953

Income from operations		45,263			39,413
Interest and other income, net		11,485			7,456
Interest expense		(1,521	)		(4	)
Loss on investments, net		(2,225	)		—

Income before provision for income taxes		53,002			46,865
Income tax provision		33,157			13,547

Net income	$	19,845		$	33,318

Net income per share — basic	$	0.05		$	0.12

Net income per share — diluted	$	0.05		$	0.12

Shares used in per share calculation — basic		383,194			272,855

Shares used in per share calculation — diluted		403,279			285,137

See accompanying notes to condensed consolidated financial statements.

BROCADE COMMUNICATIONS SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value)
(Unaudited)


	January 26,			October 27,
	2008			2007
Assets
Current assets:
Cash and cash equivalents	$	386,590		$	315,755
Short-term investments		267,687			325,846

Total cash, cash equivalents and short-term investments		654,277			641,601
Marketable equity securities		3,785			14,205
Accounts receivable, net of allowances of $6,339 and $6,505 at January 26, 2008 and October 27, 2007, respectively		152,364			175,755
Inventories		15,355			18,017
Prepaid expenses and other current assets		63,892			62,622

Total current assets		889,673			912,200
Long-term investments		124,894			137,524
Property and equipment, net		208,807			204,052
Goodwill		364,650			384,376
Intangible assets, net		253,414			272,652
Other assets		17,357			19,296

Total assets	$	1,858,795		$	1,930,100

Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	78,527		$	108,810
Accrued employee compensation		55,881			76,017
Deferred revenue		97,931			94,533
Current liabilities associated with lease losses		11,834			12,807
Other accrued liabilities		85,043			117,534

Total current liabilities		329,216			409,701
Convertible subordinated debt		168,038			167,498
Non-current liabilities associated with lease losses		24,239			25,742
Non-current liabilities – deferred taxes		22,476			22,781
Non-current deferred revenue		38,652			36,344
Other non-current liabilities		42,875			1,376

Total liabilities		625,496			663,442

Commitments and contingencies (Note 8)
Stockholders’ equity:
Preferred stock, $0.001 par value 5,000 shares authorized, no shares issued and outstanding		—			—
Common stock, $0.001 par value, 800,000 shares authorized:
Issued and outstanding: 377,723 and 387,406 shares at January 26, 2008 and October 27, 2007, respectively		378			387
Additional paid-in capital		1,409,663			1,462,782
Accumulated other comprehensive loss		(4,335	)		(1,180	)
Accumulated deficit		(172,407	)		(195,331	)

Total stockholders’ equity		1,233,299			1,266,658

Total liabilities and stockholders’ equity	$	1,858,795		$	1,930,100

See accompanying notes to condensed consolidated financial statements.

BROCADE COMMUNICATIONS SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)


	Three Months Ended
	January 26,			January 27,
	2008			2007
Cash flows from operating activities:
Net income	$	19,845		$	33,318
Adjustments to reconcile net income to net cash provided by operating activities:
Excess tax benefit from employee stock plans		(3,925	)		(6,314	)
Depreciation and amortization		30,888			8,513
Loss on disposal of property and equipment		629			148
Net losses on investments and marketable equity securities		1,667			—
Provision for doubtful accounts receivable and sales allowances		1,688			127
Non-cash compensation expense		8,472			6,725
Changes in assets and liabilities:
Accounts receivable		21,702			3,862
Inventories		2,662			(958	)
Prepaid expenses and other assets		3,311			(5,091	)
Accounts payable		(30,282	)		(3,171	)
Accrued employee compensation		(16,116	)		(14,757	)
Deferred revenue		5,706			8,325
Other accrued liabilities		35,430			4,050
Liabilities associated with lease losses		(2,476	)		(1,446	)

Net cash provided by operating activities		79,201			33,331

Cash flows from investing activities:
Purchases of short-term investments		(74,919	)		(117,700	)
Purchases of long-term investments		(29,456	)		(52,176	)
Proceeds from maturities and sale of short-term investments		177,301			92,603
Proceeds from maturities and sale of long-term investments		152			3,697
Proceeds from sale of marketable equity securities and equity investments		5,803			—
Purchases of property and equipment		(17,178	)		(13,362	)
Cash paid in connection with acquisitions, net of cash acquired		—			(7,706	)

Net cash provided by (used in) investing activities		61,703			(94,644	)

Cash flows from financing activities:
Proceeds from issuance of common stock, net		7,824			30,507
Common stock repurchase program		(80,012	)		—
Excess tax benefit from employee stock plans		3,925			6,314

Net cash provided by (used in) financing activities		(68,263	)		36,821

Effect of exchange rate fluctuations on cash and cash equivalents		(1,806	)		(69	)

Net increase (decrease) in cash and cash equivalents		70,835			(24,561	)
Cash and cash equivalents, beginning of period		315,755			274,368

Cash and cash equivalents, end of period	$	386,590		$	249,807

See accompanying notes to condensed consolidated financial statements.

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”) is the leading supplier of data center networking solutions that help enterprises connect and manage their information. The Company offers a comprehensive line of data center networking products, software and services that enable businesses to make their data centers more efficient, reliable and adaptable.

Brocade products and services are designed to help information technology (“IT”) organizations manage their data and data center infrastructure assets in an efficient, cost-effective manner. In the first fiscal quarter of 2008, Brocade reorganized the Company into four operating units. The objective of this new organization is to allow us to more effectively focus on growth opportunities, while being able to more rapidly scale and accommodate new business opportunities, including potential future acquisitions. We will be structured along focused lines of business, or operating units, which include the following:

The Data Center Infrastructure (“DCI”) operating unit encompasses the Brocade family of Storage Area Network (“SAN”) business which includes infrastructure products and solutions which includes directors, switches, routers, fabric-based software applications, distance/extension products, as well as management applications and utilities to centralize data management.

The Files (“Files”) operating unit includes the Brocade family of File Area Network (“FAN”) solutions which includes both software and hardware offerings for more effectively managing file data and storage resources.

The Server Edge and Storage (“SES”) operating unit includes our new host bus adapters (“HBAs”) and Intelligent Server Adapter (“ISA”) initiatives as well as our SAN switch modules for bladed servers and embedded switches for blade servers.

The Support, Services and Solution (“S3”) operating unit includes services that assist customers with consulting and support in designing, implementing, deploying and managing data center enterprise solutions as well as post-contract customer support (“PCS”).

Together, Brocade’s products, services and solutions simplify IT infrastructure, increase resource utilization, ensure availability of mission critical applications and serve as a platform for corporate data back up and disaster recovery.

Brocade products and services are marketed, sold and supported worldwide to end-user customers through distribution partners, including original equipment manufacturers (“OEMs”), distributors, systems integrators, value-added resellers and by Brocade directly.

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

Brocade®, the Brocade B-wing logo™, Fabric OS®, File Lifecycle Manager®, My View®, Secure Fabric OS® and StorageX® are registered trademarks 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

Basis of Presentation

The accompanying financial data as of January 26, 2008, and for the three months ended January 26, 2008 and January 27, 2007, has been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The October 27, 2007 Condensed Consolidated Balance Sheet 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 27, 2007.

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 January 26, 2008, results of operations for the three months ended January 26, 2008 and January 27, 2007, and cash flows for the three months ended January 26, 2008 and January 27, 2007 have been made. The results of operations for the three months ended January 26, 2008 are not necessarily indicative of the operating results for the full fiscal year or any future periods.

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 2008 and 2007 are 52-week fiscal years.

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 outstanding and potentially dilutive common shares outstanding during the period that have a dilutive effect on earnings per share. Potentially dilutive common shares result from the assumed exercise of outstanding stock options, assumed vesting of outstanding restricted stock units and assumed issuance of stock under the employee stock purchase plan using the treasury stock method, and the assumed conversion of outstanding convertible debt using the if-converted method.

Income Taxes

The Company adopted the provisions of Financial Accounting Standards Interpretation No. 48, “Accounting for Uncertainty of Income Taxes — an interpretation of FASB Statement No. 109” (“FIN 48”), effective at the beginning of fiscal year 2008. FIN 48 prescribes a recognition threshold and measurement attribute for financial statement disclosure of tax positions taken or expected to be taken on a tax return. Recognition of a tax position is determined when it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes. Upon its adoption of FIN 48, the Company applied the provisions of FIN 48 to all income tax positions. The cumulative effect of applying the provisions of FIN 48 have been reported as an adjustment to the opening balance of retained earnings or other appropriate components of equity or net assets on the Company’s Condensed Consolidated Balance Sheet as of the beginning of fiscal year 2008.

Recent Accounting Pronouncements

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (“GAAP”), expands disclosures about fair value measurements, and applies under other accounting pronouncements that require or permit fair value measurements. SFAS 157 does not require any new fair value measurements. However, the FASB anticipates that for some entities, the application of SFAS 157 will change current practice. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We do not expect the adoption of SFAS 157 will have a material impact on our financial position, results of operations, and cash flows.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115” (“SFAS 159”). Under SFAS 159, a company may choose, at specified election dates, to measure eligible items at fair value and report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. SFAS 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. We are currently assessing the impact that SFAS 159 may have on our financial position, results of operations, and cash flows.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141 (revised 2007), “Business Combinations” (“SFAS 141R”). SFAS 141R changes accounting for acquisitions that close beginning in 2009. More transactions and events will qualify as business combinations and will be accounted for at fair value under the new standard. SFAS 141R promotes greater use of fair values in financial reporting. Some of the changes will introduce more volatility into earnings. SFAS 141R is effective for fiscal years beginning on or after December 15, 2008. We are currently assessing the impact that SFAS 141R may have on our financial position, results of operations, and cash flows.

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160, “Noncontrolling Interests in Consolidated Financial Statements — an amendment of ARB No.51” (“SFAS 160”). SFAS 160 will change the accounting and reporting for minority interests which will be recharacterized as noncontrolling interests and classified as a component of equity. SFAS 160 is effective for fiscal years beginning on or after December 15, 2008, and interim periods within those fiscal years. SFAS 160 requires retroactive adoption of the presentation and disclosure requirements for existing minority interests. We are currently assessing the impact that SFAS 160 may have on our financial position, results of operations, and cash flows.

3. Balance Sheet Details

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


	January 26,			October 27,
	2008			2007
Inventories:
Raw materials	$	2,656		$	11,860
Finished goods		12,699			6,157

Total	$	15,355		$	18,017

Property and equipment, net:
Computer equipment and software	$	105,629		$	102,643
Engineering and other equipment		193,516			182,640
Furniture and fixtures		11,298			11,152
Leasehold improvements		56,558			56,052
Land and building		79,873			79,523

Subtotal		446,874			432,010
Less: Accumulated depreciation and amortization		(238,067	)		(227,958	)

Total	$	208,807		$	204,052

Leasehold improvements as of January 26, 2008 and October 27, 2007, are shown net of estimated asset impairments related to facilities lease losses. See Note 6, “Liabilities Associated with Facilities Lease Losses,” of the Notes to Condensed Consolidated Financial Statements.


	January 26,		October 27,
	2008		2007
Other accrued liabilities:
Income taxes payable	$	15,729	$	46,739
Accrued warranty		5,982		5,923
Inventory purchase commitments		24,132		23,176
Accrued sales programs		9,258		11,245
Other		29,942		30,451

Total	$	85,043	$	117,534

4. 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
January 26, 2008
U.S. government and its agencies and municipal obligations	$	122,929	$	925	$	—		$	123,854
Corporate bonds and notes		262,751		1,953		(1,085	)		263,619
Marketable equity securities		13,420		—		(4,526	)		8,894

Total	$	399,100	$	2,878	$	(5,611	)	$	396,367

Reported as:
Short-term investments and marketable equity securities								$	271,473
Long-term investments									124,894

Total								$	396,367

October 27, 2007
U.S. government and its agencies and municipal obligations	$	168,064	$	175	$	(17	)	$	168,222
Corporate bonds and notes		284,711		702		(524	)		284,889
Marketable equity securities		26,189		—		(1,725	)		24,464

Total	$	478,964	$	877	$	(2,266	)	$	477,575

Reported as:
Short-term investments and marketable equity securities								$	340,051
Long-term investments									137,524

Total								$	477,575

For the three months ended January 26, 2008, losses of $2.2 million were realized on the sale of marketable equity securities. For the three months ended January 27, 2007, no gains were realized on the sale of investments or marketable equity securities. At January 26, 2008 and October 27, 2007, net unrealized holding losses of $2.7 million and $1.4 million, respectively, were included in accumulated other comprehensive income in the accompanying Condensed Consolidated Balance Sheets. Marketable equity securities are held for purposes other than trading. There were no impairment charges on marketable equity securities during the first quarter of fiscal 2008.

5. Goodwill and Intangible Assets

The Company’s carrying value of goodwill as of January 26, 2008 consisted of the following (in thousands):


Balance at October 27, 2007	$	384,376
Tax adjustment(1)		(19,726	)

Balance at January 26, 2008	$	364,650


(1)		The goodwill adjustment of $19.7 million was primarily a result of reversing deferred tax assets of acquired companies.

The Company amortizes intangible assets over a useful life ranging from 6 months to 7 years.

Intangible assets as of January 26, 2008 consisted of the following (in thousands):


	Gross				Net
	Carrying		Accumulated		Carrying
	Value		Amortization		Value
Tradename	$	11,373	$	4,029	$	7,344
Core/Developed technology		154,454		46,257		108,197
Customer relationships		167,011		29,225		137,786
Non-compete agreements		371		284		87
Backlog		80		80		—

Total intangible assets	$	333,289	$	79,875	$	253,414

For the three months ended January 26, 2008, total amortization expense related to intangible assets of $11.3 million is included in cost of revenues and $7.9 million is included in operating expenses in the Condensed Consolidated Statement of Income. For the three months ended January 27, 2007, total amortization expense related to intangible assets of $0.9 million is included in operating expenses in the Condensed Consolidated Statement of Income. The following table presents the estimated future amortization of intangible assets (in thousands):


	Future
	Estimated
Fiscal Year	Amortization
2008 (1)	$	48,537
2009		64,600
2010		51,748
2011		41,748
2012		28,393
2013		16,071
2014		2,317

Total	$	253,414


(1)		Reflects the remaining 9 months of fiscal 2008.

6. Liabilities Associated with Facilities Lease Losses

As of January 26, 2008, the Company had recorded $36.1 million in facilities lease loss reserves related to future lease commitments, net of expected sublease income. During the three months ended January 27, 2007, the Company recorded a charge of $0.6 million related to estimated lease losses, net of expected sublease income as a result of the acquisition of Silverback Systems, Inc. During the three months ended April 28, 2007, the Company recorded a purchase accounting adjustment of $26.3 million related to estimated losses, net of expected sublease income, as a result of the acquisition of McDATA Corporation. During the three months ended October 27, 2007, the Company recorded an additional purchase accounting adjustment of $3.6 million to estimated facility lease losses, net of expected sublease income. 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 loss reserve, net of expected sublease income (in thousands), as of January 26, 2008:


	Lease Loss
	Reserve
Reserve balance at October 27, 2007	$	38,549
Cash payments on facilities leases		(2,549	)
Non-cash charges and other adjustments, net		73

Reserve balance at January 26, 2008	$	36,073

Cash payments for facilities leases related to the above noted facilities lease losses will be paid over the respective lease terms through fiscal year 2017.

7. Convertible Subordinated Debt

As of January 26, 2008, convertible subordinated debt includes $172.5 million outstanding 2.25% convertible subordinated notes (the “2.25% Notes”) due February 15, 2010 previously issued by McDATA. In accordance with purchase accounting rules, the 2.25% Notes were adjusted to their aggregate fair value of $166.5 million based on the quoted market closing price as of the acquisition date.

On January 29, 2007, effective upon the consummation of the merger, the Company fully and unconditionally guaranteed and became a co-obligor on the 2.25% Notes with McDATA. The 2.25% Notes were convertible into Class A common stock at a conversion rate of 93.3986 shares per $1,000 principal amount of notes (aggregate of approximately 16.1 million shares) at any time prior to February 15, 2010, subject to adjustments. As of January 26, 2008, the approximate aggregate fair value of the outstanding debt was between $165.8 million and $165.2 million. We estimated the fair value of the outstanding debt by using the high and low prices per $100 of the Company’s 2.25% Notes as of the last day of trading for the first fiscal 2008 quarter, which were $96.1 and $95.8, respectively.

Pursuant to the Merger Agreement, at the effective time of the merger each outstanding share of McDATA’s Class A common stock, $0.01 par value per share, was converted into the right to receive 0.75 shares of Brocade’s common stock, $0.001 par value per share, together with cash in lieu of fractional shares. As a result, an approximate aggregate of 12.1 million shares are subject to conversion at any time prior to February 15, 2010, subject to adjustments. For the three months ended January 26, 2008, 12.1 million shares were dilutive and therefore included in the calculation of diluted net income per share.

Concurrent with the issuance of the 2.25% Notes, McDATA entered into share option transactions using approximately $20.5 million of net proceeds. As part of these share option transactions, McDATA purchased options that cover approximately 12.1 million shares of common stock, at a strike price of $14.28. McDATA also sold options that cover approximately 12.7 million shares of common stock, at a strike price of $20.11. The net cost of the share option transactions was recorded against additional paid-in-capital in accordance with EITF No. 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock” (“EITF 00-19”).

8. Commitments and Contingencies

Operating and Capital Leases

The Company leases certain facilities and certain equipment under various operating and capital lease agreements expiring through January 2017. In connection with its facilities lease agreements, the Company has signed unconditional, irrevocable letters of credit totaling $2.7 million as security for the leases. Future minimum lease payments under all non-cancelable operating leases as of January 26, 2008 were $100.8 million, net of contractual sublease income of $7.2 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 (see Note 6, “Liabilities Associated with Facilities Lease Losses,” of the Notes to Condensed Consolidated Financial Statements).

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, current trends and our expectations regarding future experience. The Company’s accrued liability for estimated future warranty costs is included in other accrued liabilities on the accompanying Condensed Consolidated Balance Sheets. The beginning balance for the three months ended January 26, 2008 reflects $5.8 million in warranty expenses resulting from the McDATA acquisition. The following table summarizes the activity related to the Company’s accrued liability for estimated future warranty costs during the three months ended January 26, 2008 and January 27, 2007 (in thousands):


	Three Months Ended
	January 26,			January 27,
	2008			2007
Beginning balance	$	5,923		$	2,230
Liabilities accrued for warranties issued during the period		1,308			444
Warranty claims paid and uses during the period		(1,065	)		(74	)
Changes in liability for pre-existing warranties during the period		(184	)		(265	)

Ending balance	$	5,982		$	2,335

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 January 26, 2008, 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

The Company has manufacturing agreements with Hon Hai Precision Industry Co. (“Foxconn”), SCI - Sanmina (“Sanmina”) and Flextronics International Ltd. (“Flextronics”) 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, Sanmina and Flextronics depends on the specific product. As of January 26, 2008, the Company’s aggregate commitment to Foxconn, Sanmina and Flextronics for inventory components used in the manufacture of Brocade products was $123.2 million, net of purchase commitment reserves of $24.1 million, which the Company expects to utilize during future normal ongoing operations. The

Company’s purchase orders placed with Foxconn, Sanmina and Flextronics are cancelable, however if cancelled, the agreements require the Company to purchase all inventory components not returnable, usable by, or sold to, other customers of the aforementioned contract manufacturers. The Company’s purchase commitments reserve reflects the Company’s estimate of purchase commitments it does not expect to consume in normal operations.

Income Taxes

In November 2005, the Company was notified by the Internal Revenue Service (“IRS”) that our domestic federal income tax return for the year ended October 25, 2003 was subject to audit. The IRS had issued two Notices of Proposed Adjustment (“NOPAs”) related to the research and development credit which the Company has reached a tentative agreement on October 29, 2007. In the second quarter of fiscal year 2007 we received three NOPAs related to transfer pricing. The Company is currently contesting these three adjustments and we believe we have adequate reserves to cover any potential assessments that may result from the examination. If upon resolution, we sustain adjustments in excess of our provision, an incremental charge to earnings may result in the current period. However, no additional payments will result as the Company has sufficient loss carryforwards to offset the incremental taxable income resulting from the assessment. In the first quarter of fiscal year 2008, the IRS notified the Company that our domestic federal income tax returns for the years ended October 30, 2004 and October 29, 2005 will also be audited. Due to the net operating loss and credit carryforwards, the Company is subject to U.S. federal, state, and local income tax examinations. The Company is generally not subject to non-U.S. income tax examinations for years before 2000.

Legal Proceedings

From time to time, claims are made against Brocade 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 Brocade 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 Brocade’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 Brocade, certain of its officers and directors, and certain of the underwriters for Brocade’s initial public offering of securities. A consolidated amended class action captioned In Re Brocade Communications Systems, Inc. Initial Public Offering Securities Litigation, No. 01 Civ. 6613 was filed on April 19, 2002. The initial complaint generally alleges that various underwriters engaged in improper and undisclosed activities related to the allocation of shares in Brocade’s initial public offering and seeks unspecified damages for claims under the Exchange Act on behalf of a purported class of purchasers of common stock from May 24, 1999 to December 6, 2000. The lawsuit against Brocade is 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).

Also part of these coordinated proceedings are actions against McDATA Corporation, certain of its officers and directors and the underwriters for McDATA’s initial public offering of securities, No. 01 Civ. 6627, and Inrange Technologies Corporation (which was first acquired by CNT and subsequently acquired by McDATA as part of the CNT acquisition), certain of its officers and directors and the underwriters for Inrange’s initial public offering of securities, No. 01 Civ. 10800. The complaints in these actions asserted claims under the Securities Act and Exchange Act. In October 2002, the individual defendants in the Brocade, McDATA and Inrange actions 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 Brocade and some but not all of the claims against McDATA and Inrange. In June 2004, a stipulation of settlement and release of claims against the issuer defendants, including Brocade, McDATA and Inrange, was submitted to the Court for approval. On August 31, 2005, the Court granted preliminary approval of the settlement. In December 2006, the appellate Court overturned the certification of classes in the six test cases that were selected by the underwriter defendants and plaintiffs in the coordinated proceeding. Neither Brocade, McDATA, nor Inrange is a test case. On June 25, 2007, the Court entered an order terminating the proposed settlement based upon a stipulation among the parties to the settlement. Plaintiffs have filed amended master allegations and amended complaints in the six test cases, which the defendants in those cases have moved to dismiss. Plaintiffs have also moved for class certification in the six test cases, which the defendants in those cases have also opposed. It is uncertain whether there will be any revised or future settlement. If the litigation proceeds, the Company believes that it has meritorious defenses to plaintiffs’ claims and intends to defend the action vigorously.

Beginning on or about May 19, 2005, several securities class action complaints were filed against Brocade and certain of its then 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 Brocade’s stock from February 21, 2001 to May 15, 2005. These lawsuits followed and relate to Brocade’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 Brocade’s stock from May 18, 2000 to May 15, 2005. On November 3, 2006, the Court denied Brocade’s motion to dismiss the consolidated complaint and granted certain individual defendants’ motions to dismiss the consolidated complaint with leave to amend. On January 2, 2007, the lead plaintiffs filed an amended consolidated complaint on behalf of purchasers of Brocade’s stock from May 18, 2000 to May 15, 2005. The amended consolidated complaint names the Company and certain of its former officers and directors and alleges, among other things, violations of sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5 promulgated thereunder. The amended consolidated complaint alleges, among other things, that Brocade and the individual defendants made false or misleading public statements regarding Brocade’s business and operations and seeks unspecified monetary damages and other relief against the defendants. On January 29, 2007, Brocade filed its answer to the amended consolidated complaint. On August 7, 2007, a federal jury convicted Brocade’s former Chief Executive Officer, Gregory Reyes, on ten criminal counts related to the Company’s historical stock option practices. On August 27, 2007, the Court denied certain individual defendants’ motion to dismiss the amended consolidated complaint. On October 12, 2007 the Court granted lead plaintiffs’ motion for class certification and certified a class in this action consisting of all persons and entities who purchased or otherwise acquired the securities of Brocade between May 18, 2000 to May 15, 2005, inclusive, and who were damaged thereby. The Court also partially granted plaintiffs’ motion for partial summary judgment against Mr. Reyes, who is a defendant in this action, prohibiting him from re-litigating in this class action the jury’s finding from Mr. Reyes’ criminal case that he knowingly and willfully made material misrepresentations in Brocade’s Annual Report on Form 10-K for 2001, 2002 and 2003. On December 5, 2007, a federal jury convicted Brocade’s former human resources director, Stephanie Jensen, on two criminal counts related to the Company’s historical stock option practices. (Ms. Jensen is not a defendant in the class action.) No trial date has been set for the class action. Brocade believes it is probable that the ultimate resolution of this class action lawsuit will result in a payment to the class in an amount that is material to the Company; however, such amount is not yet reasonably estimable.

Beginning on or about May 24, 2005, several derivative actions were also filed against certain of Brocade’s current and former officers and directors. 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, among other things, that certain of Brocade’s officers and directors breached their fiduciary duties to Brocade by engaging in alleged wrongful conduct including conduct complained of in the securities litigation described above. Brocade is named solely as a nominal defendant against whom the plaintiffs seek no monetary recovery (other than the award of attorneys’ fees). 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 in the District Court for the Northern District of California on October 7, 2005, and Brocade filed a motion to dismiss that action on October 27, 2005. On January 6, 2006, Brocade’s motion was granted and the consolidated complaint in the District Court for the Northern District of California was dismissed with leave to amend. The parties to this action subsequently reached a preliminary settlement, and on February 14, 2007, the Court entered an Order granting preliminary approval of the settlement. On April 27, 2007, the Court refused to grant final approval of the settlement at that time and set a further hearing on the settlement.

The derivative actions pending in the Superior Court in Santa Clara County were also consolidated. The derivative plaintiffs filed a consolidated complaint on September 19, 2005. Brocade filed a motion in the state derivative action to stay that action in deference to the substantially identical consolidated derivative action pending in the District Court for the Northern District of California, and on November 15, 2005, the state Court stayed the action. In October 2006, the Court partially lifted the stay and granted plaintiffs leave to file an amended complaint. On November 13, 2006, plaintiffs filed an amended complaint, and Brocade filed a demurrer to the action on March 9, 2007 and, on September 4, 2007, a motion to dismiss due to plaintiffs’ lack of standing. On February 22, 2008, Brocade’s Board of Directors appointed a Special Litigation Committee of the Board to, among other things, evaluate and resolve the claims asserted in the federal and state derivative actions.

On October 23, 2007, a class action complaint was filed against Brocade and certain of its former officers and current and former directors. This action was filed in the California Superior Court in Santa Clara County on behalf of individuals who owned Brocade stock between February 21, 2001 and May 16, 2005. The complaint generally alleges that Brocade and the individual defendants breached the duty of disclosure by failing to disclose alleged wrongful conduct including conduct complained of in the securities litigation described above and seeks unspecified monetary damages and other relief against the defendants. On November 26, 2007, this action was removed from state court to the United States District Court for the Northern District of California. On November 28, 2007, Brocade filed a motion seeking to have this action deemed “related” to the consolidated federal securities class action described above. On December 3, 2007, Brocade filed a motion to dismiss the action in its entirety on the ground that it is preempted by the Securities Litigation Uniform Standards Act of 1998.

No liabilities have been accrued in Brocade’s Consolidated Financial Statements associated with these matters as the amounts are not both probable and reasonably estimable.

9. Derivative Accounting Policies

In the normal course of business, the Company is exposed to fluctuations in interest rates and the exchange rates associated with foreign currencies. The derivatives entered into by the Company qualify for, and are designated as, fair value hedges and foreign-currency cash flow hedges as per the definitions in Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities”, as amended and interpreted, incorporating FASB Statements No. 137, 138 and 149 (“SFAS 133”).

The derivatives are recognized on the consolidated balance sheets at their respective fair values. Unrealized gain positions are recorded as other current assets. Unrealized loss positions are recorded as other liabilities or other non-current liabilities. Changes in fair values of outstanding cash flow hedges that are highly effective as per the definition in SFAS 133 are recorded in other comprehensive income, until earnings are affected by the variability of cash flows of the underlying hedged transaction. In most cases amounts recorded in other comprehensive income will be released to earnings at maturity of the related derivative. The recognition of effective hedge results offsets the gains or losses on the underlying exposure. Cash flows from derivative transactions are classified according to the nature of the risk being hedged.

The Company formally documents all relationships between hedging instruments and hedged items, as well as the risk-management objective and strategy for undertaking hedge transactions. This documentation includes linking all derivatives either to specific assets and liabilities on the balance sheet or specific firm commitments or forecasted transactions. The Company also formally assesses both at the hedge’s inception and on an ongoing basis, whether the derivatives that are used in hedging transactions have been highly effective in offsetting changes in the cash flows of hedged items and whether those derivatives may be expected to remain highly effective in future periods. When it is determined that a derivative is not, or has ceased to be, highly effective as a hedge, the Company discontinues hedge accounting prospectively, as discussed below.

The Company discontinues hedge accounting prospectively when (1) the derivative is no longer highly effective in offsetting changes in the cash flows of a hedged item (including hedged items such as firm commitments or forecasted transactions); (2) the derivative expires or is sold, terminated, or exercised; (3) it is no longer probable that the forecasted transaction will occur; or (4) management determines that designating the derivative as a hedging instrument is no longer appropriate.

When the Company discontinues hedge accounting but it continues to be probable that the forecasted transaction will occur in the originally expected period, the gain or loss on the derivative remains in accumulated other comprehensive income and is reclassified into earnings when the forecasted transaction affects earnings. However, if it is no longer probable that a forecasted transaction will occur by the end of the originally specified time period or within an additional two-month period of time thereafter, the gains and losses that were accumulated in other comprehensive income will be recognized immediately in earnings. In all situations in which hedge accounting is discontinued and the derivative remains outstanding, the Company will carry the derivative at its fair value on the consolidated balance sheets until maturity, recognizing future changes in the fair value in current-period earnings. Any hedge ineffectiveness is recorded in current-period earnings in other expense (income), net. Effectiveness is assessed based on the comparison of current forward rates to the rates established on the Company’s hedges.

As of January 26, 2008, a gain of $1.0 million, net, which represented effective hedges of net investments, was reported as a component of accumulated other comprehensive income/(loss) within unrealized translation adjustment. Hedge ineffectiveness, which is reported in the Condensed Consolidated Statements of Income, was not significant.

10. Comprehensive Income

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


	Three Months Ended
	January 26,			January 27,
	2008			2007
Net income	$	19,845		$	33,318
Other comprehensive income:
Change in net unrealized gains (losses) on marketable equity securities, cash flow hedges and investments		(1,345	)		(43	)
Cumulative translation adjustments		(1,809	)		(526	)

Total comprehensive income	$	16,691		$	32,749

11. Employee Stock Plans

The Company has several stock-based compensation plans that are described in the Company’s Annual Report on Form 10-K for the fiscal year ended October 27, 2007, as well as several stock-based compensation plans assumed in connection with the acquisition of McDATA Corporation and filed on Form S-8 with the Securities and Exchange Commission on January 30, 2007 (collectively, the “Plans”). The Company, under the various equity plans, grants stock options for shares of the Company’s common stock to its employees and directors. The Company also grants restricted stock and restricted stock units under the Plans. 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. Under the Plans, options or restricted stock typically have a maximum term of seven or ten 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 January 26, 2008, an aggregate of 123.3 million shares were authorized for future issuance under the Plans, which includes stock options, shares issued pursuant to the Employee Stock Purchase Plan, and restricted stock units and other awards. A total of 75.5 million shares of common stock were available for grant under the Plans as of January 26, 2008. 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 historical 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
	January 26,			January 27,
Stock Options	2008			2007
Expected dividend yield		0.0	%		0.0	%
Risk-free interest rate		3.1 — 4.1	%		4.5 — 4.9	%
Expected volatility		44.2	%		48.1	%
Expected term (in years)		4.0			3.3

The Company recorded $5.2 million and $4.2 million of compensation expense related to stock options for the quarters ended January 26, 2008 and January 27, 2007, respectively, in accordance with Statement of Financial Accounting Standards No. 123-R, “Share-Based Payment” (“SFAS 123R”). A summary of stock option activity under the Plans for the three months ended January 26, 2008 and January 27, 2007 is presented as follows:


						Weighted Average
						Remaining
	Shares			Weighted Average		Contractual Term		Aggregate Intrinsic
	(in thousands)			Exercise Price		(Years)		Value ($000)
Outstanding, October 27, 2007		43,197		$	8.20
Granted		2,212		$	7.15
Exercised		(621	)	$	5.33
Forfeited or expired		(663	)	$	12.02

Outstanding, January 26, 2008		44,125		$	8.17		4.68	$	21,115

Ending vested and expected to vest		40,483		$	8.27		4.58	$	19,367

Exercisable and vested, January 26, 2008		28,045		$	8.73		4.01	$	14,437


						Weighted Average
						Remaining
	Shares			Weighted Average		Contractual Term		Aggregate Intrinsic
	(in thousands)			Exercise Price		(Years)		Value ($000)
Outstanding, October 28, 2006		39,954		$	6.35
Granted		2,180		$	9.14
Exercised		(4,249	)	$	5.58
Forfeited or expired		(546	)	$	5.28

Outstanding, January 27, 2007		37,339		$	6.62		5.5	$	89,937

Ending vested and expected to vest		35,220		$	6.64		5.5	$	85,067

Exercisable and vested, January 27, 2007		21,720		$	7.11		5.3	$	50,923

The weighted-average grant date fair value of employee stock options granted during the three months ended January 26, 2008 and January 27, 2007 was $7.15 and $3.42, respectively. The total intrinsic value of stock options exercised for the three months ended January 26, 2008 and January 27, 2007 was $1.6 million and $14.5 million, respectively.

As of January 26, 2008, there was $21.3 million of unrecognized compensation expense related to stock options. The expenses are expected to be recognized over a weighted-average period of 1.4 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 Employee Stock 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 $1.3 million and $1.2 million for the three months ended January 26, 2008 and January 27, 2007, respectively, in accordance with SFAS 123R.

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


	Three Months Ended
	January 26,			January 27,
Employee Stock Purchase Plan	2008			2007
Expected dividend yield		0.0	%		0.0	%
Risk-free interest rate		3.3 — 5.0	%		5.1 — 5.2	%
Expected volatility		44.8	%		53.5	%
Contractual term (in years)		0.5			0.5

As of January 26, 2008, there was $2.1 million of unrecognized compensation expense related to employee stock purchases. The expenses are expected to be recognized over a weighted-average period of 0.3 years.

Restricted Stock Awards

No restricted stock awards were issued for the three months ended January 26, 2008. For the three months ended January 27, 2007, Brocade issued 0.1 million restricted stock awards to certain eligible employees at a purchase price of $0.00 per share. 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. In addition, as part of its acquisition of McDATA, the Company became the administrator of retention compensation plans for certain employees. The plans provide the employees restricted stock that vests generally over a two year service period under certain conditions, subject to full acceleration of vesting upon termination without cause and execution of a release in favor of the Company. Compensation expense computed under the fair value method for stock awards issued is being amortized under a graded vesting method over the awards’ vesting period and was $0.1 million and $2.6 million, respectively, for the three months ended January 26, 2008 and January 27, 2007.

The weighted-average fair value of the restricted stock awards granted during the three months ended January 26, 2008 and January 27, 2007 was zero and $8.98, respectively. The total fair value of stock awards vested for the three months ended January 26, 2008 and January 27, 2007 was $13.7 million and zero, respectively.

At January 26, 2008, unrecognized costs related to restricted stock awards totaled approximately $18.7 thousand. These costs are expected to be recognized over a weighted-average period of 0.6 years. A summary of the nonvested restricted stock awards for the three months ended January 26, 2008 and January 27, 2007 is presented as follows:


	Shares			Weighted Average
	(in thousands)			Grant-Date Fair Value
Nonvested, October 27, 2007		2,130		$	3.75
Granted		—		$	—
Vested		(1,820	)	$	4.38
Forfeited		(6	)	$	0.01

Nonvested, January 26, 2008		304		$	0.12

Expected to vest, January 26, 2008		274		$	0.12


	Shares			Weighted Average
	(in thousands)			Grant-Date Fair Value
Nonvested, October 28, 2006		1,848		$	4.44
Granted		130		$	8.98
Vested		(3	)	$	7.05
Forfeited		—		$	—

Nonvested, January 27, 2007		1,975		$	4.73

Expected to vest, January 27, 2007		1,650		$	4.73

Restricted Stock Units

During the three months ended January 26, 2008 and January 27, 2007, Brocade issued 1.0 million and 0.3 million restricted stock units, respectively. Typically, vesting of restricted stock units occurs over two to three years and is subject to the employee’s continuing service to Brocade. The compensation expense of $3.2 million and $0.1 million for the three months ended January 26, 2008 and January 27, 2007, respectively, related to these awards was determined using the fair market value of Brocade’s common stock on the date of the grant and is recognized under a graded vesting method over the vesting period.

A summary of the changes in restricted stock units outstanding under Brocade’s equity-based compensation plans during the three months ended January 26, 2008 and January 27, 2007 is presented as follows:


				Weighted
				Average
	Shares			Grant-Date
	(in thousands)			Fair Value
Nonvested, October 27, 2007		2,719		$	8.29
Granted		1,029		$	7.00
Vested		—		$	—
Forfeited		(43	)	$	8.25

Nonvested, January 26, 2008		3,705		$	7.93

Nonvested expected to vest at January 26, 2008		2,980		$	7.93


			Weighted
			Average
	Shares		Grant-Date
	(in thousands)		Fair Value
Nonvested, October 28, 2006		—	$	—
Granted		346	$	9.19
Vested		—	$	—
Forfeited		—	$	—

Nonvested, January 27, 2007		346	$	9.19

Nonvested expected to vest at January 27, 2007		266	$	9.19

The aggregate intrinsic value of restricted stock units outstanding at January 26, 2008 was $23.5 million.

On July 30, 2007, the Compensation Committee approved a long-term, performance-based equity incentive plan under the Company’s 1999 Stock Plan for the Company’s executive officers and other selected Company employees. The long-term incentive plan provides for the issuance of performance-based restricted stock units, which represent a contingent right to receive one share of the Company’s common stock. The restricted stock units are subject to the Company’s performance compared to the NASDAQ-100 Index over an initial 27-month performance period. The plan participants must also remain a service provider to the Company during the performance period.

Under the principal terms of the plan, executive officers and other plan participants would be entitled to receive restricted stock units representing up to an aggregate of 2.0% of the amount the Company’s market capitalization growth rate exceeds the growth rate of the NASDAQ-100 Index (the “Total Plan Pool”) for the performance period from August 1, 2007 to October 31, 2009, subject to certain adjustments.

As of January 26, 2008, Brocade had $23.3 million of total unrecognized compensation expense, net of estimated forfeitures, related to restricted stock unit grants, which is expected to be recognized over a weighted-average period of 1.71 years.

12. Segment Information

FASB Statement No. 131, “Disclosures about Segments of an Enterprise and Related Information” (“SFAS 131”), establishes standards for reporting information about operating segments. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker (“CODM”), or decision-making group, in deciding how to allocate resources and in assessing performance. The chief operating decision maker is the Chief Executive Officer (“CEO”).

During the three months ended January 26, 2008, the Company changed its internal reporting structure such that operations are managed and reported in four operating units, of which two are individually reportable segments: Data Center Infrastructure (“DCI”), Service, Support, Solutions (“S3”); and two are combined into one reportable segment: Other. These segments are organized principally by product category. Prior to the three months ended January 26, 2008, the Company managed and reported its operations in two operating segments, each of which was a reportable segment: Product and Service.

The types of products and services from which each reportable segment derives its revenues are as follows:

•

DCI includes a majority of our storage area network products and software;

	•		S3 includes break/fix maintenance, extended warranty, installation, consulting, network management, related software maintenance and support revenue, and telecommunications services; and

	•		Other includes embedded blades, HBA products, and files products.

Prior to the Merger with McDATA during the second quarter of fiscal year 2007, the Company had one reporting segment. Prior period segment results have been conformed to the new measurements of segment financial reporting. As of January 26, 2008, the Company was in the process of developing a methodology to allocate goodwill to the reporting units.

Financial decisions and the allocation of resources are based on the information from the Company’s management reporting system. At this point in time, the Company does not track all of its assets by operating segments. Consequently, it is not practical to show assets by operating segments.

Summarized financial information by operating segment for the three months ended January 26, 2008 and January 27, 2007, based on the internal management system is as follows (in thousands):


	Three Months Ended
	January 26,		January 27,
	2008		2007
Revenues
DCI	$	265,170	$	184,842
S3		49,903		16,940
Other		32,776		22,374

Total revenues		347,849		224,156

Cost of revenues
DCI		106,598		64,076
S3		33,495		10,479
Other		11,179		8,235

Total cost of revenues		151,272		82,790
Gross margin
DCI		158,572		120,766
S3		16,408		6,461
Other		21,597		14,139

Total gross margin	$	196,577	$	141,366

13. 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
	January 26,			January 27,
	2008			2007
Basic net income per share
Net income	$	19,845		$	33,318
Weighted-average shares of common stock outstanding		383,485			275,177
Less: Weighted-average shares of common stock subject to repurchase		(291	)		(2,322	)

Weighted-average shares used in computing basic net income per share		383,194			272,855
Basic net income per share	$	0.05		$	0.12

Diluted net income per share
Net income	$	19,845		$	33,318
Interest on convertible subordinated debt, net of income tax effect		569			—

Net income, as adjusted		20,414			33,318
Weighted-average shares used in computing basic net income per share		383,194			272,855
Dilutive potential common shares		20,085			12,282

Weighted-average shares used in computing diluted net income per share		403,279			285,137

Diluted net income per share	$	0.05		$	0.12

For the three months ended January 26, 2008 and January 27, 2007, potential common shares in the form of stock options to purchase 15.8 million and 3.3 million weighted-average shares of common stock, respectively, were antidilutive and, therefore, not included in the computation of diluted earnings per share.

14. Income Taxes

In June 2006, the Financial Accounting Standards Board issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109” (“FIN 48”), which clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS 109. FIN 48 prescribes a recognition threshold and measurement attribute for financial statement disclosure of tax positions taken or expected to be taken on a tax return. Recognition of a tax position is determined when it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes. A tax position that meets the more-likely-than-not recognition threshold is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement with a taxing authority.

We adopted FIN 48 effective at the beginning of fiscal year 2008. As a result, the cumulative effect of applying FIN 48 was a $3.1 million increase to retained earnings at the beginning of fiscal year 2008. Historically, we have classified unrecognized tax benefits as current income taxes payable. Under FIN 48, we now classify unrecognized tax benefits as long-term income taxes payable except to the extent we anticipate cash payment within the next year. The amount of unrecognized tax benefits at the beginning of fiscal year 2008 was $90.4 million including interest and penalties of $2.6 million, and is reported in long-term income taxes payable and as a reduction in deferred tax assets. Of this amount, $56.9 million relates to unrecognized tax benefits that, if recognized, would affect our effective tax rate.

Upon adoption of FIN 48, the Company adopted an accounting policy to classify interest and penalties related to unrecognized tax benefits as a component of income tax expense. The amount of interest and penalties accrued as of the beginning of fiscal year 2008 was $2.6 million.

We are required to file income tax returns in the U.S. federal jurisdiction, various state and local jurisdictions, and many foreign jurisdictions. A number of years may elapse before an uncertain tax position is audited and ultimately resolved. While it is often difficult to predict the final outcome or the exact timing of resolution for any particular uncertain tax position, we believe that the amounts of unrecognized tax benefits we have accrued reflect our best estimate. We adjust these amounts, as well as the related interest and penalties, as facts and circumstances change. Upon resolution of an uncertain tax position, we record an adjustment to income taxes in the same period.

In November 2005, we were notified by the IRS that our domestic federal income tax return for the year ended October 25, 2003 was subject to audit. The IRS had issued two NOPAs related to the research and development credit which the Company has reached a tentative agreement on October 29, 2007. In the second quarter of fiscal year 2007 we received three NOPAs related to transfer pricing. The Company is currently contesting these three adjustments and we believe we have adequate reserves to cover any potential assessments that may result from the examination. If upon resolution, we sustain adjustments in excess of our provision, an incremental charge to earnings may result in the current period. However, no additional payments will result as we have sufficient loss carryforwards to offset the incremental taxable income resulting from the assessment. In the first quarter of fiscal year 2008, the IRS notified the Company that our domestic federal income tax returns for the years ended October 30, 2004 and October 29, 2005 will also be audited. Due to the net operating loss and credit carryforwards, the Company is subject to U.S. federal, state, and local income tax examinations. The Company is generally not subject to non-U.S. income tax examinations for years before 2000.

Based on the outcome of the ongoing IRS audit as discussed above and when statutes of limitations expire for specific taxing jurisdictions, no material changes to uncertain tax benefits are expected in the next twelve months.

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

You should read the following discussion and analysis in conjunction with the condensed consolidated financial statements and notes thereto included in Item 1 of this Quarterly Report and with Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report filed on Form 10-K with the Securities and Exchange Commission on December 21, 2007.

Results of Operations

The following table sets forth certain financial data for the periods indicated as a percentage of total net revenues except for cost of revenues and gross margin which are indicated as a percentage of the respective segment net revenues:


	Three Months Ended
	January 26,			January 27,
	2008			2007
Net revenues
DCI		76.2	%		82.5	%
S3		14.4			7.5
Other		9.4			10.0

Total net revenues		100.0			100.0
Cost of revenues
DCI		40.2			34.7
S3		67.1			61.9
Other		34.1			36.8

Total cost of revenues		43.5			36.9
Gross margin
DCI		59.8			65.3
S3		32.9			38.1
Other		65.9			63.2

Total gross margin		56.5			63.1

Operating expenses:
Research and development		16.7			18.9
Sales and marketing		18.2			17.2
General and administrative		3.5			3.3
Legal fees associated with indemnification obligations, SEC investigation and other related costs		2.8			2.4
Acquisition and integration costs		—			3.3
Amortization of intangible assets		2.3			0.4

Total operating expenses		43.5			45.5

Income from operations		13.0			17.6
Interest and other income, net		3.3			3.3
Interest expense		(0.5	)		(0.0	)
Loss on sale of investments		(0.6	)		—

Income before provision for income taxes		15.2			20.9
Income tax provision		9.5			6.0

Net income		5.7	%		14.9	%

Revenues. Our revenues are derived primarily from sales of our family of SAN products and our service and support offerings related to those products. Our fabric switches and directors, which range in size from 8 ports to 896 ports, connect our customers’ servers and storage devices creating a SAN.

Our total net revenues for the three months ended January 26, 2008 and January 27, 2007 were as follows (in thousands):


	Three Months Ended
	January 26,		% of Net			January 27,		% of Net			Increase/		%
	2008		Revenue			2007		Revenue			(Decrease)		Change
DCI	$	265,170		76.2	%	$	184,842		82.5	%	$	80,328		43.5	%
S3		49,903		14.4	%		16,940		7.5	%		32,963		194.6	%
Other		32,776		9.4	%		22,374		10.0	%		10,402		46.5	%

Total net revenues	$	347,849		100.0	%	$	224,156		100.0	%	$	123,693		55.2	%

The increase in net revenues for the three months ended January 26, 2008 as compared with net revenues for the three months ended January 27, 2007 reflects growth in sales of DCI product and S3 offerings and other products. The increase in DCI revenues for the period reflected a 47.5 percent increase in the number of ports shipped, due to our acquisition of McDATA in January 2007, partially offset by a 2.8 percent decline in average selling price per port. The increase in S3 revenues is a result of the McDATA acquisition as well as the continued expansion of our installed base. Other revenues increased due to a 29.1% increase in the number of ports shipped as a result of our continued growth in the embedded switch market as well as a 13.5% increase in average selling price per port.

For both the three months ended January 26, 2008 and January 27, 2007, the declines in average selling prices are the result of a continuing competitive pricing environment and change in product mix. We believe the increase in the number of ports shipped reflects higher demand for our products due in part to expansion of our installed base as a result of the McDATA acquisition as well as higher market demand as end-users continue to consolidate storage and servers infrastructures using SANs, expand SANs to support more applications, and deploy SANs in new environments.

Going forward, we 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 also expect that average selling prices per port will likely decline at rates consistent with historical rates, unless they are adversely affected by accelerated pricing pressures, new product introductions by us or our competitors, or other factors that may be beyond our control. Historically, Brocade’s first and fourth fiscal quarters are seasonally stronger quarters than its second and third fiscal quarters.

Our total net revenues by geographical area for the three months ended January 26, 2008 and January 27, 2007 were as follows (in thousands):


	Three Months Ended
	January 26,		% of Net			January 27,		% of Net			Increase/		%
	2008		Revenue			2007		Revenue			(Decrease)		Change
Domestic	$	217,028		62.4	%	$	133,183		59.4	%	$	83,845		63.0	%
International		130,821		37.6	%		90,973		40.6	%		39,848		43.8	%

Total net revenues	$	347,849		100.0	%	$	224,156		100.0	%	$	123,693		55.2	%

Historically, domestic revenues have accounted for between 59 percent and 75 percent of total revenues. International revenues primarily consist of sales to customers in Western Europe and the greater Asia Pacific region. For the three months ended January 26, 2008 as compared to the three months ended January 27, 2007, international revenues decreased as a percentage of total revenue primarily as a result of lower direct product shipments in international regions. Revenues are attributed to geographic areas based on where our products are shipped. 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, but we believe international revenue is a larger percent of our total revenue than the attributed revenues may indicate.

A significant portion of our revenue is concentrated among a relatively small number of OEM customers. For the three months ended January 26, 2008, three customers each represented ten percent or more of our total revenues for a combined total of 66 percent of our total revenues. For the three months ended January 27, 2007, the same three customers each represented ten percent or more of

our total revenues for combined total of 72 percent of our total revenues. 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 could seriously harm our financial condition and results of operations.

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 January 26, 2008, four customers each accounted for 20 percent, 17 percent, 12 percent and 11 percent of total accounts receivable. As of October 27, 2007, three customers each accounted for 21 percent, 17 percent and 13 percent 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 allowances, 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.

Cost of Goods Sold. Cost of goods sold consists of product costs, which typically vary with volume and manufacturing operations costs, which do not change directly with volume.

Cost of goods sold for the three months ended January 26, 2008 and January 27, 2007 were as follows (in thousands):


	Three Months Ended
	January 26,		% of Net			January 27,		% of Net			Increase/		% Points
	2008		Revenue			2007		Revenue			(Decrease)		Change
DCI	$	106,598		40.2	%	$	64,076		34.7	%	$	42,522		5.5	%
S3		33,495		67.1	%		10,479		61.9	%		23,016		5.2	%
Other		11,179		34.1	%		8,235		36.8	%		2,944		(2.7	)%

Total cost of goods sold	$	151,272		43.5	%	$	82,790		36.9	%	$	68,482		6.6	%

Gross margin for the three months ended January 26, 2008 was 56.5 percent, a decrease of 6.6 percentage points from 63.1 percent for the three months ended January 27, 2007. For the three months ended January 26, 2008, DCI product costs relative to net revenues increased by 5.5 percent as compared to the three months ended January 27, 2007. This is primarily the result of $11.3 million in intangibles amortization included in DCI product costs for the three months ended January 26, 2008 compared with no intangibles amortization included in product costs for the three months ended January 27, 2007 period, as well as an increase in manufacturing costs due to increased headcount resulting from the McDATA acquisition. During the three months ended January 26, 2008, DCI product costs aside from amortization and manufacturing costs were relatively unchanged, as declines in average selling price were matched by declines in product costs, in part due to an increase in the volume of shipments. S3 operations costs increased by 5.3 percent relative to net revenues primarily due to increased headcount and outside services, as the S3 organization was expanded as a result of the McDATA acquisition. Other product costs decreased by 2.7 percent relative to net revenues primarily due to a favorable sales product mix partially offset by a slight increase in manufacturing costs.

Gross margin is primarily affected by average selling price per port, number of ports shipped and cost of goods sold. As described above, we expect that average selling prices per port for our products will continue to decline at rates consistent with historical rates, unless they are further affected by accelerated pricing pressures, 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 our product and manufacturing operations cost reductions. However, the average selling price per port could decline at a faster pace than we anticipate. If this dynamic occurs, we may not be able to reduce our costs fast enough to prevent a decline in our gross margins. In addition, we must continue to increase the 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 near 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 would likely be adversely affected if we fail to successfully manage the introductions of these new products. However, we currently anticipate that fluctuations in cost of goods sold related expenses will be consistent with fluctuations in revenue.

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.

Research and development expenses for the three months ended January 26, 2008 and January 27, 2007 were as follows (in thousands):


January 26,	% of Net			January 27,		% of Net			Increase/		%
2008	Revenue			2007		Revenue			(Decrease)		Change
$58,206		16.7	%	$	42,391		18.9	%	$	15,815		37.3	%

For the three months ended January 26, 2008, R&D expenses increased by $15.8 million, or 37.3 percent, to $58.2 million, compared with $42.4 million, for the three months ended January 27, 2007. This increase is primarily due to a $6.0 million increase in salaries and headcount related costs as a result of the McDATA and Silverback acquisitions, $3.4 million in additional outside service related expenses related to product development, $1.7 million in additional depreciation and a $4.6 million increase in expenses related to IT and facilities, partially offset by a $1.1 million increase in charges to manufacturing due to more products being transitioned from the development phase into the sustaining phase. R&D expenses fell 2.2 percentage points as a percent of total net revenue in the three months ended January 26, 2008 compared with the three months ended January 27, 2007.

We currently anticipate that R&D expenses, as a percent of revenue, for the three months ended April 26, 2008, will be relatively consistent with the three months ended January 26, 2008, but will increase in absolute dollar terms.

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.

Sales and marketing expenses for the three months ended January 26, 2008 and January 27, 2007 were as follows (in thousands):


January 26,	% of Net			January 27,		% of Net			Increase/		%
2008	Revenue			2007		Revenue			(Decrease)		Change
$63,174		18.2	%	$	38,587		17.2	%	$	24,587		63.7	%

For the three months ended January 26, 2008 as compared to the three months ended January 27, 2007, sales and marketing expenses increased by $24.6 million, or 63.7 percent, to $63.2 million, compared with $38.6 million for the three months ended January 27, 2007. This increase is primarily due to the McDATA acquisition and included a $12.2 million increase in salaries and headcount related expenses, a $6.7 million increase in outside services and conferences, and a $4.1 million increase in expenses related to IT and facilities. Sales and marketing expenses increased 1.0 percentage points as a percent of total revenue in the three months ended January 26, 2008 compared with the three months ended January 27, 2007.

We currently anticipate that sales and marketing expenses, as a percent of revenue and in absolute dollars for the three months ended April 26, 2008, will increase as compared with the three months ended January 26, 2008.

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.

General and administrative expenses for the three months ended January 26, 2008 and January 27, 2007 were as follows (in thousands):


January 26,	% of Net			January 27,		% of Net			Increase/		%
2008	Revenue			2007		Revenue			(Decrease)		Change
$12,366		3.5	%	$	7,404		3.3	%	$	4,962		67.0	%

G&A expenses for the three months ended January 26, 2008 as compared to the three months ended January 27, 2007 increased by $5.0 million, or 67.0 percent. The increase in G&A is primarily due to the McDATA acquisition which resulted in a $3.4 million increase in salaries and headcount related expenses and a $5.1 million increase in outside services, as well as a $0.6 million increase in stock-based compensation expense, partially offset by an increase in legal and HR expenses of $4.1 million which is allocated to other

functional groups. G&A expenses as a percent of total net revenue was relatively unchanged in the three months ended January 26, 2008 as compared with the three months ended January 27, 2007.

We currently anticipate that G&A expenses, as a percent of revenue, for the three months ending April 26, 2008, will be consistent with the three months ended January 26, 2008.

Legal fees associated with indemnification obligations, SEC investigation and other related costs. These expenses consist of professional legal and accounting service fees for various matters, including applicable indemnification obligations, defense of the Company in legal proceedings, the completed internal reviews and the SEC and Department of Justice (“DOJ”) joint investigations regarding historical stock option granting practices. Pursuant to the Company’s charter documents and indemnification agreements, the Company has certain indemnification obligations to its directors, officers, and certain former directors and officers. Pursuant to such obligations, the Company incurred expenses related to amounts paid to certain former directors, officers and/or employees of the Company who have been either convicted in criminal proceedings and/or are subject to ongoing SEC and civil actions in connection with Brocade’s historical stock option grant practices.

Legal fees associated with indemnification obligations, SEC investigation and other related costs for the three months ended January 26, 2008 and January 27, 2007 were as follows (in thousands):


January 26,	% of Net			January 27,		% of Net			Increase/		%
2008	Revenue			2007		Revenue			(Decrease)		Change
$9,659		2.8	%	$	5,228		2.4	%	$	4,431		84.8	%

The increase of $4.4 million in legal fees for the three months ended January 26, 2008 as compared to the three months ended January 27, 2007 is primarily due to an increase in legal indemnification expenses.

Acquisition and integration costs. Acquisition and integration costs for the three months ended January 26, 2008 and January 27, 2007 were as follows (in thousands):


January 26,	% of Net			January 27,		% of Net			Increase/			%
2008	Revenue			2007		Revenue			(Decrease)			Change
$ —		—	%	$	7,433		3.3	%	$	(7,433	)		(100.0	)%

In connection with our acquisition of McDATA, we recorded acquisition and integration costs of $7.4 million during the three months ended January 27, 2007, which consisted primarily of costs incurred for consulting services and other professional fees.

Amortization of intangible assets. Amortization of intangible assets for the three months ended January 26, 2008 and January 27, 2007 was as follows (in thousands):


January 26,	% of Net			January 27,		% of Net			Increase/		%
2008	Revenue			2007		Revenue			(Decrease)		Change
$7,909		2.3	%	$	910		0.4	%	$	6,999		769.1	%

During the three months ended January 26, 2008, we recorded amortization of intangible assets related to the acquisitions of McDATA, Silverback and NuView. The increase in amortization of intangible assets for the three months ended January 26, 2008 as compared to the three months ended January 27, 2007 is primarily due to the McDATA acquisition which was completed at the beginning of our second fiscal quarter of 2007. We account for intangible assets in accordance with Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“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 5, “Goodwill and Intangible Assets,” of the Notes to Condensed Consolidated Financial Statements).

Interest and other income, net. Interest and other income, net, for the three months ended January 26, 2008 and January 27, 2007 were as follows (in thousands):


January 26,	% of Net			January 27,		% of Net			Increase/		%
2008	Revenue			2007		Revenue			(Decrease)		Change
$11,485		3.3	%	$	7,456		3.3	%	$	4,029		54.0	%

For the three months ended January 26, 2008 as compared to the three months ended January 27, 2007, the increase in interest and other income was primarily related to an increased average cash, cash equivalents, marketable equity securities and long-term investment balances as a result of the McDATA acquisition.

Interest expense. Interest expense primarily represents the interest cost associated with our convertible subordinated debt (see Note 7, “Convertible Subordinated Debt,” of the Notes to Condensed Consolidated Financial Statements).

Interest expense for the three months ended January 26, 2008 and January 27, 2007 was as follows (in thousands):


January 26,	% of Net			January 27,			% of Net			Increase/		%
2008	Revenue			2007			Revenue			(Decrease)		Change
$(1,521)		(0.5	%)	$	(4	)		(0	)%	$	1,517		37,931.1	%

The increase in interest expense for the three months ended January 26, 2008 as compared to the three months ended January 27, 2007 was primarily the result of the debt assumed from the McDATA acquisition.

As of January 26, 2008 and January 27, 2007, the carrying value of the outstanding balance of our convertible subordinated debt was $168.0 million and zero, respectively.

(Loss) on investments, net. (Loss) on investments, net, for the three months ended January 26, 2008 and January 27, 2007 was as follows (in thousands):


January 26,	% of Net			January 27,		% of Net			Increase/		%
2008	Revenue			2007		Revenue			(Decrease)		Change
$(2,225)		(0.6	)%	$	—		—	%	$	2,225		100.0	%

The increase in loss of investments for the three months ended January 26, 2008 as compared to the three months ended January 27, 2007 was $2.2 million. The increase was due to $1.8 million losses on the sale of our equity investments in publicly traded companies and $0.4 million losses on the disposition of portfolio investments at amounts below the carrying value. The carrying value of our equity investments in non-publicly traded companies at January 26, 2008 was $5.0 million. As of January 27, 2007, we had net unrealized holding gains (losses) of $(1.2) million associated with our remaining investment portfolio. The carrying value of our equity investments in non-publicly traded companies at January 27, 2007 was $0.8 million.

Provision for income taxes. Provision for income taxes for the three months ended January 26, 2008 and January 27, 2007 was as follows (in thousands):


January 26,	% of Net			January 27,		% of Net			Increase/		%
2008	Revenue			2007		Revenue			(Decrease)		Change
$33,157		9.5	%	$	13,547		6.0	%	$	19,610		144.8	%

For the three months ended January 26, 2008, our income tax provision was 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. To the extent utilization of net operating losses, credit carryforwards, or acquired deductible temporary differences are attributable to the operations of McDATA prior to the acquisition, the resulting tax benefit is recorded to goodwill. 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.

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. FASB Statement 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.

The realization of deferred tax assets is based on several factors, including the Company’s past earnings and the scheduling of deferred tax liabilities and projected income from operating activities. In assessing the realizability of deferred taxes assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. We do not believe it is more likely than not that the Company’s deferred tax assets are realizable. As of January 26, 2008, we had a 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 operating results.

SFAS 109 requires that deferred tax assets are to be reduced by a valuation allowance if the weight of available evidence indicates that it is more-likely-than-not that some portion of the deferred tax assets will not be realized. We achieved profitability in the prior fiscal year and the first three months of the current fiscal year. We continue to evaluate the future realization of our deferred tax assets based on expectations of future taxable income. Depending on our continued ability to achieve these levels of profitability, we may have sufficient evidence in future quarters of fiscal year 2008 to conclude that realization of additional deferred tax assets is more-likely-than-not and thus realize a tax benefit in such period from a reduction of our deferred tax asset valuation allowance.

In November 2005, we were notified by the Internal Revenue Service (“IRS”) that our domestic federal income tax return for the year ended October 25, 2003 was subject to audit. The IRS had issued two Notices of Proposed Adjustment (“NOPAs”) related to the research and development credit which the Company has reached a tentative agreement on October 29, 2007. In the second quarter of fiscal year 2007 we received three NOPAs related to transfer pricing. The Company is currently contesting these three adjustments and we believe we have adequate reserves to cover any potential assessments that may result from the examination. If upon resolution, we sustain adjustments in excess of our provision, an incremental charge to earnings may result in the current period. However, no additional payments will result as we have sufficient loss carryforwards to offset the incremental taxable income resulting from the assessment. In the first quarter of fiscal year 2008, the IRS notified the Company that our domestic federal income tax returns for the years ended October 30, 2004 and October 29, 2005 will also be audited. Due to the net operating loss and credit carryforwards, the Company is subject to U.S. federal, state, and local income tax examinations. The Company is generally not subject to non-U.S. income tax examinations for years before 2000.

We adopted FIN 48 effective at the beginning of fiscal year 2008. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of an income tax position taken or expected to be taken on a tax return. Under FIN 48, recognition of a tax position is determined when it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes. A tax position that meets the more-likely-than-not recognition threshold is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement with a taxing authority.

The calculation of tax liabilities involves significant judgment in estimating the impact of uncertainties in the application of complex tax laws. Although FIN 48, which we adopted at the beginning of fiscal year 2008, provides further clarification on the accounting for uncertainty in income taxes recognized in the financial statements, the new threshold and measurement attribute prescribed by the FASB will continue to require significant judgment by management. Resolution of these uncertainties in a manner inconsistent with our expectations could have a material impact on our results of operations.

Stock compensation expense. Stock compensation expense for the three months ended January 26, 2008 and January 27, 2007 was as follows (in thousands):


January 26,	% of Net			January 27,		% of Net			Increase/		%
2008	Revenue			2007		Revenue			(Decrease)		Change
$8,473		2.4	%	$	6,725		3.0	%	$	1,748		26.0	%

Stock compensation expense was included in the following statements of income line items for the three months ended January 26, 2008 and January 27, 2007 as follows (in thousands):


	Three Months Ended		Three Months Ended
	January 26, 2008		January 27, 2007
Cost of goods sold	$	2,492	$	1,778
Research and development		2,624		2,438
Sales and marketing		1,986		1,707
General and administrative		1,371		802

Total stock compensation	$	8,473	$	6,725

Included in the amounts presented above is stock compensation arising from certain stock option grants that are remeasured at the end of each reporting period until the options are exercised, cancelled or expire unexercised. Stock-based compensation benefit for these options was $1.7 million and $44 thousand for the three months ended January 26, 2008 and January 27, 2007, respectively. The stock compensation expense associated with remeasuring awards at their intrinsic value each reporting period may vary significantly as a result of future changes in the market value of our common stock until those options are either exercised or expire unexercised. The change in stock-based compensation for these awards during the three months ended January 26, 2008 as compared to the three months ended January 27, 2007 is due to the change in market values of our common stock during the reported periods as well as exercise behaviors of the holders of these options.

Liquidity and Capital Resources


	January 26,			October 27,			Increase/
	2008			2007			(Decrease)
	(in thousands)
Cash and cash equivalents	$	386,590		$	315,755		$	70,835
Short-term investments		267,687			325,846			(58,159	)
Marketable equity securities		3,785			14,205			(10,420	)
Long-term investments		124,894			137,524			(12,630	)

Total	$	782,956		$	793,330		$	(10,374	)

Percentage of total assets		42	%		41	%

Cash and cash equivalents as of January 26, 2008 increased $70.8 million over the balance as of October 27, 2007. For the three months ended January 26, 2008, we generated $79.2 million in cash from operating activities, which significantly exceeded net income for the three months ended January 26, 2008, as a result of net income adjusted for non-cash items related to depreciation and amortization, and other accrued liabilities primarily due to deferred tax liability as well as a relatively high level of collections, offset by payments for accounts payable and accrued employee compensation during the period. Days sales outstanding in receivables for the three months ended January 26, 2008 was 40 days, compared with 38 days for the three months ended January 27, 2007.

Net cash provided by investing activities for the three months ended January 26, 2008 totaled $61.7 million and was primarily the result of $177.3 million in proceeds resulting from maturities and sales of short-term investments, offset by purchases of short-term and long-term investments for a total of $104.4 million and purchases of property and equipment of $17.2 million.

Net cash used in financing activities for the three months ended January 26, 2008 totaled $68.3 million. Net cash used in financing activities was primarily the result of common stock repurchases of $80.0 million, slightly offset by proceeds from the issuance of common stock, net, of $7.8 million.

Net proceeds from the issuance of common stock in connection with 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 in connection with employee participation in employee stock programs will vary.

We have manufacturing agreements with Foxconn, Sanmina and Flextronics 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, Sanmina and Flextronics depends on the specific product. As of January 26, 2008, our aggregate commitment for inventory components used in the manufacture of Brocade products was $123.2 million, net of purchase commitment reserves of $24.1 million, as reflected in the Condensed Consolidated Balance Sheet, which we expect to utilize during future normal ongoing operations. Although the purchase orders we place with Foxconn, Sanmina and Flextronics are cancelable, the terms of the agreements require us to purchase all inventory components not returnable or usable by, or sold to, other customers of the aforementioned contract manufacturers. Our purchase commitments reserve reflects our estimate of purchase commitments we do not expect to consume in normal operations within the next twelve months, in accordance with our policy.

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 January 26, 2008 (in thousands):


				Less than						More than
	Total			1 Year		1—3 Years		3—5 Years		5 Years
Contractual Obligations:
Non-cancelable operating leases(1)		107,955	(1)		24,538		39,975		16,003		27,439
Capital leases		709			657		52		—		—
Purchase commitments, gross(2)		123,195	(2)		123,195		—		—		—

Total contractual obligations	$	231,859		$	148,390	$	40,027	$	16,003	$	27,439

Other Commitments:
Standby letters of credit	$	2,693		$	n/a	$	n/a	$	n/a	$	n/a

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

Unrecognized tax benefits and related accrued interest (3)	$	90,409	(3)	$	n/a	$	n/a	$	n/a	$	n/a


(1)		Amount excludes contractual sublease income of $7.2 million, which consists of $2.9 million to be received in less than 1 year and $4.3 million to be received in 1 to 3 years.

(2)		Amount reflects total gross purchase commitments under our manufacturing agreements with third party contract manufacturers. Of this amount, we have accrued $24.1 million for estimated purchase commitments that we do not expect to consume in normal operations within the next twelve months, in accordance with our policy.

(3)		As a result of the adoption of FIN 48, we reclassified unrecognized tax benefits to long-term income taxes payable. As of January 26, 2008, we had a liability for unrecognized tax benefits and an accrual for the payment of related interest totaling $90.4 million, none of which is expected to be paid within one year. We are unable to make a reasonably reliable estimate when cash settlement with a taxing authority will occur.

Share Repurchase Program. On January 29, 2007, the Company announced the authorization of $200 million for stock repurchases, which is in addition to the $52.7 million remaining under the previously announced $100 million stock repurchase program approved by our Board of Directors on August 2004. In addition, the Company announced on November 29, 2007 that an additional $500 million had been authorized for repurchase of the Company’s common stock. The purchases may be made, from time to time, in the open market or by privately negotiated transactions and will be funded from available working capital. The Company has also entered into a written plan for the automatic repurchase of its securities in accordance with Section 10b5-1 of the Securities Exchange Act of 1934 as part of its share repurchase program. 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. For the three months ended January 26, 2008, we have repurchased 11.1 million shares for an aggregate purchase price of $80.0 million. As such, approximately $502.5 million remains available for future repurchases under this program.

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 allowances, bad debts, excess inventory and purchase commitments, investments, warranty obligations, stock-based compensation, restructuring costs, lease losses, income taxes, and contingencies and litigation. We base our estimates on historical experience 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.

The following reflects significant changes in our critical accounting policies during the three months ended January 26, 2008 as compared to the critical accounting policies disclosed in Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the fiscal year ended October 27, 2007.

Accounting for uncertain tax benefits. The calculation of tax liabilities involves significant judgment in estimating the impact of uncertainties in the application of complex tax laws. We adopted FIN 48 effective at the beginning of fiscal year 2008. FIN 48 prescribes a recognition threshold and measurement attribute for financial statement disclosure of tax positions taken or expected to be taken on a tax return. Recognition of a tax position is determined when it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes. A tax position that meets the more-likely-than-not recognition threshold is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement with a taxing authority. Although FIN 48 provides further clarification on the accounting for uncertainty in income taxes recognized in the financial statements, the new threshold and measurement attribute prescribed by the FASB will continue to require significant judgment by management. Resolution of these uncertainties in a manner inconsistent with our expectations could have a material impact on our results of operations.

Recent Accounting Pronouncements

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We are exposed to market risk related to changes in interest rates, foreign currency fluctuations 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, and short-term and long-term investments are primarily maintained at five major financial institutions in the United States. As of January 26, 2008, we held an immaterial amount of cash flow 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 January 26, 2008 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						January 26,		Increase of X Basis Points
Issuer	(150 BPS)		(100 BPS)		(50 BPS)		2008		50 BPS		100 BPS		150 BPS
U.S. government agencies and municipal obligations	$	111,450	$	111,368	$	111,289	$	123,854	$	123,563	$	123,274	$	122,985
Corporate bonds and notes	$	260,788	$	260,248	$	259,718	$	263,618	$	261,696	$	260,766	$	259,845

Total	$	372,238	$	371,616	$	371,007	$	387,472	$	385,259	$	384,040	$	382,830

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 investments and long-term investments subject to interest rate risk and their related weighted-average interest rates as of January 26, 2008. Carrying value approximates fair value.


			Weighted
			Average
	Amount		Interest Rate
Cash and cash equivalents	$	386,590		2.73	%
Short-term investments		267,687		5.74	%
Marketable equity securities		3,785		4.56	%
Long-term investments		124,894		4.81	%

Total	$	782,956		4.10	%

Our convertible subordinated debt is subject to a fixed interest rate and the notes are based on a fixed conversion ratio into common stock. As of January 26, 2008, the approximate aggregate fair value of the outstanding debt was between $165.8 and $165.2. We estimated the fair value of the outstanding debt by using the high and low prices per $100 of the Company’s 2.25% Notes as of the last day of trading for the first fiscal 2008 quarter, which were $96.1 and $95.8, respectively.

Our common stock is quoted on the NASDAQ Global Select Market under the symbol “BRCD.” On January 25, 2008, the last reported sale price of our common stock on the NASDAQ Global Market was $6.35 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, 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 first quarter of fiscal year 2008 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 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

to May 15, 2005, inclusive, and who were damaged thereby. The Court also partially granted plaintiffs’ motion for partial summary judgment against Mr. Reyes, who is a defendant in this action, prohibiting him from re-litigating in this class action the jury’s finding from Mr. Reyes’ criminal case that he knowingly and willfully made material misrepresentations in Brocade’s Annual Report on Form 10-K for 2001, 2002 and 2003. On December 5, 2007, a federal jury convicted Brocade’s former human resources director, Stephanie Jensen, on two criminal counts related to the Company’s historical stock option practices. (Ms. Jensen is not a defendant in the class action.) No trial date has been set for the class action. Brocade believes it is probable that the ultimate resolution of this class action lawsuit will result in a payment to the class in an amount that is material to the Company; however, such amount is not yet reasonably estimable.

No liabilities have been accrued in Brocade’s Consolidated Financial Statements associated with these matters as the amounts are not both probable and reasonably estimable.

Item 1A. Risk Factors

Brocade’s future revenue growth depends on its ability to introduce new products and services on a timely basis and achieve market acceptance of these new products and services.

The market for data center networking solutions is characterized by rapidly changing technology and accelerating product introduction cycles. Brocade’s future success depends largely upon its ability to address the rapidly changing needs of its 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 data center networking markets become more competitive and as demand for new and improved technologies increases.

Brocade has introduced a significant number of new products in recent history, including products across its family of SAN infrastructure solutions, which accounts for a substantial portion of Brocade’s revenues. For example, in the fourth quarter of fiscal year 2007 Brocade announced its new Data Center Fabric architecture and plans to provide a wide range of new solutions,

technologies and partnerships over the following six months, including new product offerings based on 8 Gigabit per second, or Gbit, technology solutions. Other recent product introductions in the SAN infrastructure market include the Brocade DCX^TM Backbone, the first in a new class of high-performance data center networking products designed to address the demanding requirements of the evolving data center, and the Brocade 5000, Brocade’s first midrange switch that supports native interoperability for seamless connectivity with McDATA’s classic products.

Brocade must achieve widespread market acceptance of Brocade’s new products and service offerings in order to realize the benefits of Brocade’s investments. The rate of market adoption is also critical. The success of Brocade’s product and service offerings depends on numerous factors, including its ability to:

	•		properly define the new products and services;

	•		timely develop and introduce the new products and services;

	•		differentiate Brocade’s new products and services from its competitors’ technology and product offerings;

	•		address the complexities of interoperability of Brocade’s products with its OEM partners’ server and storage products and its competitors’ products; and

	•		maintain product quality and reliability.

Various factors impacting market acceptance are outside of Brocade’s control, including the availability and price of competing products and alternative technologies; the cost of certain product subcomponents, which could reduce Brocade’s gross margins; product qualification requirements by Brocade’s OEM partners, which can cause delays in the market acceptance; and the ability of its OEM partners to successfully distribute, support and provide training for its products. If Brocade is not able to successfully develop and market new and enhanced products and services on a timely basis, its business and results of operations will be harmed.

Brocade is currently expanding its product and service offerings in new and adjacent markets and Brocade’s operating results will suffer if these initiatives are not successful.

Brocade has made a series of investments and plans to continue to invest, in offerings focused on new markets that are adjacent or related to Brocade’s traditional market, including new and emerging markets. For instance, Brocade has recently made a series of introductions in the emerging FAN market with several enhancements to existing products in its family of file data management solutions which includes Brocade StorageX and Brocade File Lifecycle Manager (“FLM”). Brocade has also recently announced new HBA product offerings in the Server Connectivity market. In addition, Brocade has added multiple new professional service offerings to its solution portfolio.

Part of Brocade’s growth strategy is to derive competitive advantage and drive incremental revenue growth through such investments. As a result, Brocade believes these new markets could substantially increase its total available market opportunities. However, Brocade cannot be certain that it has accurately identified and estimated these market opportunities. Moreover, Brocade cannot assure you that its new strategic offerings will achieve market acceptance, or that Brocade will realize the full benefits from the substantial investments it has made and plans to continue to make in them. Brocade may also have only limited experience in these new markets given that such markets are adjacent or parallel to Brocade’s core market. As a result, Brocade may not be able to successfully penetrate or realize anticipated revenue from these new potential market opportunities. Brocade also faces greater challenges in accurately forecasting its revenue and margins with respect to these market opportunities.

Developing new offerings also requires significant upfront investments that may not result in revenue for an extended period of time, if at all. Particularly as Brocade seeks to diversify its product and service offerings, Brocade expects 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. In addition, these investments have caused and will likely continue to result in, higher operating expenses and if they are not successful, Brocade’s operating income and operating margin will deteriorate. These new offerings may also involve cost and revenue structures that are different from those experienced in Brocade’s historical business, which could negatively impact Brocade’s operating results.

Because these new offerings may address different market needs than those it has historically addressed, Brocade may face a number of additional challenges, such as:

•

developing new customer relationships both with new and existing customers;

	•		expanding Brocade’s relationships with its existing OEM partners and end-users;

	•		managing different sales cycles;

	•		hiring qualified personnel with appropriate skill sets on a timely basis; and

	•		establishing effective distribution channels and alternative routes to market.

Brocade’s new product and service offerings also may contain some features that are currently offered by Brocade’s OEM partners, which could cause conflicts with partners on whom Brocade relies to bring its current products to customers and thus negatively impact Brocade’s relationship with such partners.

Increased market competition may lead to reduced sales, margins, profits and market share.

The data center networking markets continue to be very competitive as new products, services and technologies are introduced by existing competitors and as new competitors enter these markets. Increased competition in the past has resulted in greater pricing pressure and reduced sales, margins, profits and market share. For example, Brocade expects to experience increased competition in future periods as other companies gain broader market acceptance with recently released 4 Gbit products that are intended to compete with Brocade’s 4 Gbit products. Moreover, new competitive products could be based on existing technologies or new technologies that may or may not be compatible with Brocade’s storage network technology and new data center architecture. While new technologies such as Fibre Channel over Ethernet (“FCoE”) and non-Fibre Channel based emerging products utilizing Gigabit Ethernet, 10 Gigabit Ethernet, InfiniBand, or Internet Small Computer System Interface (“iSCSI”), represent future opportunities for further establishing or expanding Brocade’s market presence, they also could be disruptive to Brocade’s business if Brocade is not able to develop products that compete effectively.

In addition to competing technology solutions, Brocade faces significant competition from providers of Fibre Channel switching products for interconnecting servers and storage. These principle competitors include Cisco Systems and QLogic Corporation. Brocade also faces other competitors in markets adjacent to the SAN market, such as Cisco and F5 Networks in the FAN market and QLogic and Emulex in the Server Connectivity market. In addition, Brocade’s OEM partners, who also have relationships with some of Brocade’s current competitors, could become new competitors by developing and introducing products that compete with Brocade’s product offerings, by choosing to sell Brocade’s competitors’ products instead of Brocade’s products, or by offering preferred pricing or promotions on Brocade’s competitors’ products. Competitive pressure will likely intensify as Brocade’s industry experiences further consolidation in connection with acquisitions by Brocade, its competitors and its OEM partners.

Some of Brocade’s competitors have longer operating histories and significantly greater human, financial and capital resources than Brocade does. Particularly as Brocade enters new adjacent markets, Brocade may face competitors with well-established market share and customer relationships. Brocade’s competitors could adopt more aggressive pricing policies than Brocade. Brocade believes that competition based on price may become more aggressive than it has traditionally experienced. Brocade’s competitors could also devote greater resources to the development, promotion and sale of their products than Brocade may be able to support and, as a result, be able to respond more quickly to changes in customer or market requirements. Brocade’s failure to successfully compete in the market would harm Brocade’s business and financial results.

Brocade’s competitors may also put pressure on Brocade’s 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 Brocade’s competitors has formed a strategic partnership with a provider of network storage systems, which includes an agreement whereby Brocade’s competitor resells the storage systems of its partner in exchange for sales by the partner of Brocade’s competitor’s products. Such strategic partnerships, if successful, may influence Brocade to change Brocade’s traditional distribution model.

Brocade’s revenues will be affected by changes in domestic and international information technology spending and overall demand for data center solutions.

In the past, unfavorable or uncertain economic conditions and reduced global information technology spending rates have adversely affected Brocade’s operating results. For example, in the latter half of fiscal 2007 the SAN market experienced cautious enterprise spending in North America. Brocade is 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, Brocade’s revenues, operating results and financial condition may be adversely affected.

Even if information technology spending rates increase, Brocade cannot be certain that the market for storage network and data center networking solutions will be positively impacted. Brocade’s storage networking products are sold as part of storage systems and subsystems. As a result, the demand for Brocade’s 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 Brocade has experienced growth as enterprise-class customers have adopted storage area network technology, demand for data center products in the enterprise-class sector could be adversely affected if the overall economy weakens or experiences greater uncertainty, or if larger businesses were to decide to limit new equipment purchases. If information technology spending levels are restricted and new products improve Brocade’s customers’ ability to utilize their existing data center infrastructure, the demand for data center solutions may decline. If this occurs, Brocade’s business and financial results will be harmed.

Brocade depends on OEM partners for a substantial portion of Brocade’s revenues and the loss of any of these OEM partners or a decrease in their purchases could significantly reduce Brocade’s revenues and negatively affect Brocade’s financial results.

Brocade depends on recurring purchases from a limited number of large OEM partners for a substantial portion of its revenue. As a result, these large OEM partners have a significant influence on Brocade’s quarterly and annual financial results. For fiscal years 2007, 2006 and 2005, the same three customers each represented ten percent or more of Brocade’s total revenues for a combined total of 68%, 73% and 71%, respectively. Brocade’s agreements with its OEM partners are typically cancelable, non-exclusive, have no minimum purchase requirements and have no specific timing requirements for purchases. Brocade’s OEM partners could also elect to reduce, or rebalance, the amount they purchase from Brocade and increase the amount purchased from Brocade’s competitors. Brocade anticipates that its revenues and operating results will continue to depend on sales to a relatively small number of OEM partners. The loss of any one significant OEM partner, or a decrease in the level of sales to any one significant OEM partner, or unsuccessful quarterly negotiation on key terms, conditions or timing of purchase orders placed during a quarter, would likely cause serious harm to Brocade’s business and financial results.

In addition, some of Brocade’s OEM partners purchase Brocade’s 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 Brocade maintain inventories of Brocade’s products in hubs adjacent to their manufacturing facilities and purchase Brocade’s products only as necessary to fulfill immediate customer demand. If more of Brocade’s OEM partners transition to a hub model, form partnerships, alliances or agreements with other companies that divert business away from Brocade; 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 Brocade’s reported revenues. The timing of sales to Brocade’s OEM partners and consequently the timing and volatility of Brocade’s reported revenues, may be further affected by the product introduction schedules of Brocade’s OEM partners.

Brocade’s OEM partners evaluate and qualify Brocade’s products for a limited time period before they begin to market and sell them. Assisting Brocade’s OEM partners through the evaluation process requires significant sales, marketing and engineering management efforts on Brocade’s part, particularly if Brocade’s products are being qualified with multiple distribution partners at the same time. In addition, once Brocade’s products have been qualified, its customer agreements have no minimum purchase commitments. Brocade may not be able to effectively maintain or expand its distribution channels, manage distribution relationships successfully, or market its products through distribution partners. Brocade must continually assess, anticipate and respond to the needs of its distribution partners and their customers and ensure that its products integrate with their solutions. Brocade’s failure to successfully manage its distribution relationships or the failure of its distribution partners to sell Brocade’s products could reduce Brocade’s revenues significantly. In addition, Brocade’s ability to respond to the needs of its distribution partners in the future may depend on third parties producing complementary products and applications for Brocade’s products. If Brocade fails to respond successfully to the needs of these groups, its business and financial results could be harmed.

Brocade’s failure to successfully manage the transition between its new products and its older products may adversely affect Brocade’s financial results.

As Brocade introduces new or enhanced products, Brocade 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. For example, Brocade’s introduction of 4 Gigabit per second, or Gbit, technology solutions that replaced many of Brocade’s 2 Gbit products contributed to a quarterly drop in revenue in the third quarter of fiscal year 2005 and write-downs of $3.4 million and $1.8 million for excess and obsolete inventory during the third and fourth quarters of fiscal year 2005, respectively. When Brocade introduces new or enhanced products, such as new products based on the recently introduced 8 Gbit technology, Brocade faces numerous risks relating to product transitions, including the inability to accurately forecast demand, address new or higher product cost structures and manage different sales and support requirements due to the type or complexity of the new products. In addition, any customer uncertainty regarding the timeline for rolling out new products or Brocade’s plans for future support of existing products, may negatively impact customer purchase decisions.

Failure to manage expansion effectively could seriously harm our business, financial condition and prospects.

We continue to increase the scope of our operations domestically and internationally as a result of our expanded product and service offerings and acquisitions of other companies or businesses. In November 2007, we announced that we reorganized our management structure to provide more dedicated focus on the Company’s growth opportunities, as well as allow the Company to more easily accommodate and assimilate future acquisitions and new business initiatives. The new structure is organized around four distinct business units, each with its own general manager. Our ability to successfully implement our business plan, develop and offer products and manage expansion in a rapidly evolving market requires a comprehensive and effective planning and management process. Moreover, our growth in business and relationships with customers and other third parties has placed and will continue to place, a significant strain on management systems, employees, resources, intercompany communications and coordination, and can lead to increased costs. Failure to maintain and to continue to improve upon our operational, managerial and financial controls, reporting systems, processes and procedures and/or our failure to continue to expand, train and manage our work force worldwide, or control increased costs of our efforts to manage expansion could seriously harm our business and financial results.

The failure to accurately forecast demand for Brocade’s products or the failure to successfully manage the production of Brocade’s products could negatively affect the supply of key components for Brocade’s products and Brocade’s ability to manufacture and sell Brocade’s products.

Brocade provides product forecasts to its contract manufacturers and places purchase orders with them in advance of the scheduled delivery of products to Brocade’s customers. Moreover, in preparing sales and demand forecasts, Brocade relies largely on input from its OEM partners. Therefore, if Brocade or its OEM partners are unable to accurately forecast demand, or if Brocade fails to effectively communicate with its 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, Brocade may be unable to obtain adequate manufacturing capacity from its contract manufacturers to meet customers’ delivery requirements, or Brocade may accumulate excess inventories. Furthermore, Brocade may not be able to identify forecast discrepancies until late in its fiscal quarter. Consequently, Brocade may not be able to make adjustments to its business model. If Brocade is unable to obtain adequate manufacturing capacity from its contract manufacturers, if Brocade accumulates excess inventories, or if Brocade is unable to make necessary adjustments to Brocade’s business model, revenue may be delayed or even lost to Brocade’s competitors and Brocade’s business and financial results may be harmed. In addition, Brocade may experience higher fixed costs as it expands its contract manufacturer capabilities and be less able to react quickly if demand suddenly decreases.

Brocade’s ability to accurately forecast demand also may become increasingly more difficult as Brocade enters new or adjacent markets, begins phasing out certain products, or in the event of acquisitions of other companies or businesses. Forecasting demand for new or adjacent markets, particularly where the markets are not yet well-established, can be highly speculative and uncertain. For products that are nearing end of life or being replaced by new versions, it may be difficult to forecast how quickly to ramp down production on the older products and ramp up production on the new products. Acquired companies or businesses may offer less visibility into demand than Brocade typically has experienced, may cause customer uncertainty regarding purchasing decisions and may use different measures to evaluate demand that are less familiar to Brocade and thus more difficult to accurately predict.

In addition, although the purchase orders placed with Brocade’s contract manufacturer are cancelable, in certain circumstances Brocade could be required to purchase certain unused material not returnable, usable by, or sold to other customers if Brocade cancels

any of Brocade’s orders. This purchase commitment exposure is particularly high in periods of new product introductions and product transitions. If Brocade is required to purchase unused material from Brocade’s contract manufacturer, Brocade would incur unanticipated expenses and Brocade’s business and financial results could be negatively affected.

The prices of Brocade’s products have declined in the past and Brocade expects the price of Brocade’s products to continue to decline, which could reduce Brocade’s revenues, gross margins and profitability.

The average selling price for Brocade’s products has declined in the past and Brocade expects 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 Brocade or Brocade’s competitors, the entrance of new competitors or other factors. For example, while the pricing environment for the past several quarters has been more favorable than historical levels, price declines may increase as competitors ramp up product releases that compete with Brocade’s 4 Gbit products. If Brocade is unable to offset any negative impact that changes in product mix, competitive pricing pressures, increased sales discounts, enhanced marketing programs, new product introductions by Brocade or Brocade’s competitors, or other factors may have on it by increasing the volume of products shipped or reducing product manufacturing cost, Brocade’s total revenues and gross margins will be negatively impacted.

In addition, to maintain Brocade’s gross margins Brocade must maintain or increase the number of products shipped, develop and introduce new products and product enhancements and continue to reduce the manufacturing cost of Brocade’s products. While Brocade has successfully reduced the cost of manufacturing Brocade’s products in the past, Brocade may not be able to continue to reduce cost of production at historical rates. Moreover, most of Brocade’s expenses are fixed in the short-term or incurred in advance of receipt of corresponding revenue. As a result, Brocade may not be able to decrease its spending quickly enough or in sufficient amounts to offset any unexpected shortfall in revenues. If this occurs, Brocade could incur losses, Brocade’s operating results and gross margins could be below expectations.

Brocade is dependent on sole source and limited source suppliers for certain key components, the loss of which may significantly impact results of operations.

Brocade purchases certain key components used in the manufacture of its products from single or limited sources. Brocade purchases specific ASICs from a single source and Brocade purchases microprocessors, certain connectors, small form-factor pluggable transceivers (“SFP’s”), logic chips, power supplies and programmable logic devices from limited sources. Brocade also licenses certain third-party software that is incorporated into Brocade’s operating system software and other software products. If Brocade is unable to obtain these and other components when required or Brocade experiences significant component defects, Brocade may not be able to deliver Brocade’s products to Brocade’s customers in a timely manner. As a result, Brocade’s business and financial results could be harmed.

In addition, the loss of any of Brocade’s major third party contract manufacturers could significantly impact Brocade’s ability to produce its products for an indefinite period of time. Qualifying a new contract manufacturer and commencing volume production is a lengthy and expensive process. If Brocade is required to change its contract manufacturer or if its contract manufacturer experiences delays, disruptions, capacity constraints, component parts shortages or quality control problems in its manufacturing operations, shipment of Brocade’s products to Brocade’s customers could be delayed resulting in loss of revenues and Brocade’s competitive position and relationship with customers could be harmed.

Brocade has been named as a party to several class action and derivative action lawsuits arising from Brocade’s internal reviews and related restatements of Brocade’s financial statements during 2005, and Brocade may be named in additional litigation, all of which could require significant management time and attention and result in significant additional legal expenses as well as result in an unfavorable resolution which would likely have a material adverse effect on Brocade’s business, financial condition, results of operations and cash flows.

Brocade is subject to a number of lawsuits arising from Brocade’s internal reviews and the related restatements of Brocade’s financial statements in 2005, some filed on behalf of a class of Brocade’s stockholders, against Brocade and certain of its current and former officers and directors claiming violations of securities laws and others purportedly filed on behalf of Brocade against certain of Brocade’s current and former officers and directors, and Brocade may become the subject of additional private actions. The expense of defending and resolving such litigation is significant. The amount of time to resolve these lawsuits is unpredictable and defending Brocade may divert management’s attention from the day-to-day operations of Brocade’s business, which could adversely affect Brocade’s business. In addition, Brocade believes that it is probable that any settlement between the parties in the consolidated class action pending in federal court or unfavorable resolution of such litigation will result in a payment to the class in an amount that will

have a material adverse effect on Brocade’s business, results of operations and/or cash flows. Brocade believes it is probable that the ultimate resolution of the consolidated class action lawsuit will result in a payment to the class in an amount that is material to the Company; however, such amount is not yet reasonably estimable. Finally, Brocade has certain indemnification obligations to certain officers, directors and employees that are also named in these actions for, among other things, the advancement of certain legal expenses.

Certain former employees of Brocade are subject to ongoing actions by the SEC, the Department of Justice (“DOJ”) and others, which have required, and may continue to require, a significant amount of legal expense pursuant to indemnification obligations of Brocade, which could adversely affect Brocade’s results of operations and cash flows.

Although the Company reached a settlement with the SEC regarding the previously-disclosed SEC investigation of the Company’s historical stock option granting practices in May 2007, the SEC, DOJ and various other third parties are continuing to investigate and pursue actions against certain former executive officers of Brocade. While those actions are targeted against certain former executive officers and not Brocade, Brocade has certain indemnification obligations to such former officers for, among other things, the advancement of legal expenses incurred in connection with such actions, which have required, and may continue to require, a significant amount of expense to Brocade. Whether Brocade may be entitled to recoup all or a portion of the expenses advanced by Brocade on behalf of such former officers or recover for any losses resulting from certain actions of such former officers is complex and can be affected by, among other things, various state laws, the interpretation of indemnification agreements and the collectability of any such amounts.

Brocade may not realize the anticipated benefits of past or future acquisitions and strategic investments and integration of acquired companies or technologies may negatively impact Brocade’s business.

Brocade has in the past acquired, or made strategic investments, in other companies, products or technologies and Brocade expects to make additional acquisitions and strategic investments in the future. Examples of recent acquisitions include McDATA Corporation in January 2007 and NuView, Inc. in March 2006. Brocade may not realize the anticipated benefits of these or any other acquisitions or strategic investments, which involve numerous risks, including:

	•		difficulties in successfully integrating the acquired businesses;

	•		revenue attrition in excess of anticipated levels if existing customers alter or reduce their historical buying patterns;

	•		unanticipated costs, litigation and other contingent liabilities;

	•		diversion of management’s attention from Brocade’s daily operations and business;

	•		adverse effects on existing business relationships with suppliers and customers;

	•		risks associated with entering into markets in which Brocade has limited, or no prior, experience;

	•		potential loss of key employees;

	•		inability to retain key customers, distributors, vendors and other business partners of the acquired business;

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

	•		assumption of debt and contingent liabilities;

	•		additional costs such as increased costs of manufacturing and service costs; costs associated with excess or obsolete inventory; costs of employee redeployment; relocation and retention, including salary increases or bonuses; accelerated amortization of deferred equity compensation and severance payments; reorganization or closure of facilities; and taxes; advisor and professional fees and termination of contracts that provide redundant or conflicting services;

	•		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 Brocade’s 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 Brocade’s operating results; and

	•		dilution of the percentage of Brocade’s stockholders to the extent equity is used as consideration or option plans are assumed.

If Brocade is not able to successfully integrate businesses, products, technologies or personnel that Brocade acquires, or to realize expected benefits of Brocade’s acquisitions or strategic investments, Brocade’s business and financial results would be adversely affected.

Brocade’s business is subject to cyclical fluctuations and uneven sales patterns, which makes predicting results of operations difficult.

Many of Brocade’s OEM partners experience uneven sales patterns in their businesses due to the cyclical nature of information technology spending. For example, some of Brocade’s 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 Brocade’s sales are derived from a small number of OEM partners, when they experience seasonality, Brocade typically experiences similar seasonality. Historically, Brocade’s first and fourth fiscal quarters are seasonally stronger quarters than its second and third fiscal quarters. In addition, Brocade has experienced quarters where uneven sales patterns of Brocade’s OEM partners have resulted in a significant portion of Brocade’s revenue occurring in the last month of Brocade’s fiscal quarter. This exposes Brocade to additional inventory risk as it has to order products in anticipation of expected future orders and additional sales risk if Brocade is unable to fulfill unanticipated demand. Brocade is not able to predict the degree to which the seasonality and uneven sales patterns of Brocade’s OEM partners or other customers will affect Brocade’s business in the future particularly as Brocade releases new products.

Brocade’s 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 Brocade’s stock.

Brocade’s quarterly and annual revenues and operating results may vary significantly in the future due to a number of factors, any of which may cause Brocade’s stock price to fluctuate. Factors that may affect the predictability of Brocade’s annual and quarterly results include, but are not limited to, the following:

	•		announcements, introductions and transitions of new products by Brocade and its competitors or its OEM partners;

	•		the timing of customer orders, product qualifications and product introductions of Brocade’s OEM partners;

	•		seasonal fluctuations;

	•		long and complex sales cycles;

	•		changes, disruptions or downturns in general economic conditions, particularly in the information technology industry;

	•		declines in average selling prices for Brocade’s products as a result of competitive pricing pressures or new product introductions by Brocade or its competitors;

	•		the emergence of new competitors and new technologies in the storage network and data management markets;

	•		deferrals of customer orders in anticipation of new products, services, or product enhancements introduced by Brocade or its competitors;

	•		Brocade’s ability to timely produce products that comply with new environmental restrictions or related requirements of its OEM customers;

	•		Brocade’s ability to obtain sufficient supplies of sole- or limited-sourced components, including ASICs, microprocessors, certain connectors, certain logic chips and programmable logic devices;

	•		increases in prices of components used in the manufacture of Brocade’s products;

	•		Brocade’s ability to attain and maintain production volumes and quality levels;

	•		variations in the mix of Brocade’s products sold and the mix of distribution channels and geographies through which they are sold;

	•		pending or threatened litigation;

	•		stock-based compensation expense that is affected by Brocade’s stock price;

	•		new legislation and regulatory developments; and

	•		other risk factors detailed in this section.

Accordingly, the results of any prior periods should not be relied upon as an indication of future performance. Brocade cannot assure you that in some future quarter Brocade’s revenues or operating results will not be below Brocade’s projections or the expectations of stock market analysts or investors, which could cause Brocade’s stock price to decline.

Undetected software or hardware errors could increase Brocade’s costs, reduce Brocade’s revenues and delay market acceptance of Brocade’s products.

Networking products frequently contain undetected software or hardware errors, or bugs, when first introduced or as new versions are released. Brocade’s products are becoming increasingly complex and, particularly as Brocade continues to expand Brocade’s product portfolio to include software-centric products, including software licensed from third parties, errors may be found from time to time in Brocade’s products. In addition, through its acquisitions, Brocade has assumed, and may in the future assume, products previously developed by an acquired company that may not have been through the same product development, testing and quality control processes typically used for products developed internally by Brocade that have known or undetected errors. Some types of errors also may not be detected until the product is installed in a heavy production or user environment. In addition, Brocade’s 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 Brocade 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 storage network and data management products or Brocade’s, could delay market acceptance of Brocade’s new products.

If Brocade loses key personnel or is unable to hire additional qualified personnel, Brocade’s business may be harmed.

Brocade’s 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. Brocade believes its future success will also depend, in large part, upon Brocade’s 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. There are only a limited number of qualified personnel in the applicable market and competition for such employees is fierce. Brocade has 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, Brocade’s past reductions in force could potentially make attracting and retaining qualified employees more difficult in the future. Brocade’s ability to hire qualified personnel may also be negatively impacted by Brocade’s lawsuits relating to its historical stock option granting practices and related media coverage, as well as Brocade’s fluctuating stock price. Brocade’s ability to retain qualified personnel may also be affected by future acquisitions, which can cause uncertainty and loss of key personnel. The loss of the services of any of Brocade’s 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 Brocade’s ability to sell its products or services.

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. Brocade may be subject to such claims in the future as Brocade seeks to hire additional qualified personnel. Such claims could result in material litigation. As a result, Brocade 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 Brocade.

Brocade is subject to environmental regulations that could have a material adverse effect on Brocade’s business.

Brocade is subject to various environmental and other regulations governing product safety, materials usage, packaging and other environmental impacts in the various countries where Brocade’s products are sold. For example, many of Brocade’s products are subject to laws and regulations that restrict the use of lead, 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 Brocade’s products when they have reached the end of their useful life. For example, in Europe, substance restrictions apply to products sold, and certain of Brocade’s OEM partners require compliance with these or more stringent requirements. In addition, recycling, labeling, financing and related requirements apply to products Brocade sells in Europe. China has also enacted similar legislation. Despite Brocade’s efforts to ensure that Brocade’s products comply with new and emerging requirements, Brocade cannot provide absolute assurance that its products will, in all cases, comply with such requirements. If Brocade’s products do not comply with the substance restrictions under local environmental laws, Brocade could become subject to fines, civil or criminal sanctions and contract damage claims. In addition, Brocade 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 Brocade’s ability to ship products and result in reduced revenue, increased obsolete or excess inventories and harm to Brocade’s business and customer relationships. Brocade’s suppliers may also fail to provide it with compliant materials, parts and components despite Brocade’s requirement to them to provide compliant materials, parts and components, which could impact Brocade’s ability to timely produce compliant products and, accordingly could disrupt Brocade’s business.

Brocade’s future operating expenses may be adversely affected by changes in Brocade’s stock price.

A portion of Brocade’s outstanding stock options and restricted stock units are subject to variable accounting. Under variable accounting, Brocade is required to re-measure the value of certain options and other equity awards, and the corresponding compensation expense, at the end of each reporting period until the option is exercised, cancelled or expires unexercised, or the RSU vests or is cancelled. As a result, the stock-based compensation expense Brocade recognizes in any given period can vary substantially due to changes in the market value of Brocade’s common stock. Volatility associated with stock price movements has resulted in compensation benefits when Brocade’s stock price has declined and compensation expense when Brocade’s stock price has increased. For example, the market value of Brocade’s common stock at the end of the third and fourth quarters of fiscal year 2006 and the first quarter of 2007 was $6.17, $8.43 and $8.30 per share, respectively. Accordingly, Brocade recorded compensation expense (benefit) in the fourth quarter of fiscal year 2006 and the first quarter of fiscal year 2007 of approximately $2.0 million and $(0.1) million, respectively. Brocade is unable to predict the future market value of Brocade’s common stock and therefore is unable to predict the compensation expense or benefit that Brocade will record in future periods.

Brocade has extensive international operations, which subjects it to additional business risks.

A significant portion of Brocade’s sales occur in international jurisdictions and Brocade’s contract manufacturer has significant operations in China. Brocade also plans to continue to expand its international operations and sales activities, including establishing a new limited manufacturing facility in Eastern Europe in 2008. Expansion of international operations will involve inherent risks that Brocade 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 Brocade’s 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; and

	•		more complicated logistics and distribution arrangements.

In addition, international political instability may halt or hinder Brocade’s ability to do business and may increase Brocade’s 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. In addition, concerns about other international crises, such as potential pandemics, may have an adverse effect on the world economy and could adversely affect Brocade’s business operations or the operations of Brocade’s OEM partners, contract manufacturer and suppliers.

To date, no material amount of Brocade’s 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 Brocade’s 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 Brocade’s operating costs in foreign locations. In the future, a larger portion of Brocade’s international revenues may be denominated in foreign currencies, which will subject Brocade to additional risks associated with fluctuations in those foreign currencies.

Brocade relies on licenses from third parties and the loss or inability to obtain any such license could harm Brocade’s business.

Many of Brocade’s 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 Brocade’s products, Brocade believes that, based upon past experience and standard industry practice, 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. Brocade’s inability to obtain certain licenses or other rights on favorable terms could have a material adverse effect on Brocade’s business, operating results and financial condition. In addition, if Brocade fails to carefully manage the use of “open source” software in Brocade’s products, Brocade may be required to license key portions of Brocade’s products on a royalty free basis or expose key parts of source code.

Third-parties may bring infringement claims against Brocade, 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. Brocade has in the past been involved in intellectual property-related disputes, including lawsuits with Vixel Corporation and Raytheon Company and Brocade may be involved in such disputes in the future, to protect Brocade’s intellectual property or as a result of an alleged infringement of the intellectual property of others. Brocade may also inherit intellectual property-related disputes from acquisitions of other companies, products or technologies made by Brocade. Brocade also may be subject to indemnification obligations with respect to infringement of third party intellectual property rights pursuant to Brocade’s agreements with OEM partners or customers. These claims and any resulting lawsuit could subject Brocade to significant liability for damages and invalidation of proprietary rights. Any such lawsuits, even if ultimately resolved in Brocade’s 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 Brocade 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 Brocade to pay royalty or license fees, or to license Brocade’s 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.

If Brocade is forced to take any of the foregoing actions, Brocade’s business and results of operations could be materially harmed.

Business interruptions could adversely affect Brocade’s business.

Brocade’s operations and the operations of its suppliers, contract manufacturer and customers are vulnerable to interruption by fire, earthquake, hurricanes, power loss, telecommunications failure and other events beyond Brocade’s control. For example, a substantial portion of Brocade’s facilities, including its corporate headquarters, is located near major earthquake faults. In the event of a major earthquake, Brocade could experience business interruptions, destruction of facilities and loss of life. Brocade does not carry earthquake insurance and has not set aside funds or reserves to cover such potential earthquake-related losses. In addition, Brocade’s 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 Brocade or its suppliers, contract manufacturer or customers, shipments could be delayed and Brocade’s business and financial results could be harmed.

Brocade’s business is subject to increasingly complex corporate governance, public disclosure, accounting and tax requirements that have increased both its costs and the risk of noncompliance.

Brocade is subject to rules and regulations of federal and state government as well as the stock exchange on which Brocade’s common stock is listed. These entities, including the Public Company Accounting Oversight Board, (“PCAOB”), 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. Brocade’s 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.

Brocade is subject to periodic audits or other reviews by such governmental agencies. For example, in November 2005, Brocade was notified by the Internal Revenue Service that Brocade’s 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 Brocade that its California income tax returns for the years ended October 25, 2003 and October 30, 2004 are subject to audit. The SEC also periodically reviews Brocade’s 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 Brocade’s historical financial results.

Provisions in Brocade’s charter documents, customer agreements and Delaware law could prevent or delay a change in control of Brocade, which could hinder stockholders’ ability to receive a premium for Brocade’s stock.

Provisions of Brocade’s certificate of incorporation and bylaws may discourage, delay or prevent a merger or mergers 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 Brocade’s certificate of incorporation and bylaws.

Certain provisions of Delaware law also may discourage, delay, or prevent someone from acquiring or merging with Brocade and Brocade’s agreements with certain of Brocade’s customers require that Brocade give prior notice of a change of control and grant certain manufacturing rights following a change of control. Brocade’s various anti-takeover provisions could prevent or delay a change in control of Brocade, which could hinder stockholders’ ability to receive a premium for Brocade’s stock.

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

The following table summarizes stock repurchase activity for the three months ended January 26, 2008 (in thousands, except per share amounts):


							Approximate Dollar
					Total Number of		Value of Shares
	Total Number of				Shares Purchased as		that May Yet Be
	Shares Purchased		Average Price Paid		Part of Publicly		Purchased Under the
	(1)		Per Share		Announced Program (2)		Program (2)
October 28, 2007 — November 24, 2007		529	$	8.55		1,792	$	567,142
November 25, 2007 — December 22, 2007		2	$	7.35		3,455	$	541,761
December 23, 2007 — January 26, 2008		1	$	6.66		5,900	$	502,458

Total		532	$	7.18		11,147	$	502,458


(1)		The total number of shares repurchased includes those shares of Brocade common stock that employees deliver back to Brocade to satisfy tax-withholding obligations at the settlement of restricted stock exercises or upon termination of the employee, and the forfeiture of restricted awards.

(2)		On January 29, 2007, the Company announced the authorization of $200 million for stock repurchases, which is in addition to the $52.7 million remaining under the previously announced $100 million stock repurchase program approved by our Board of Directors in August 2004. In addition, the Company announced on November 29, 2007 that an additional $500 million had been authorized for repurchase of the Company’s common stock. The purchases may be made, from time to time, in the open market or by privately negotiated transactions and will be funded from available working capital. The Company has also entered into a written plan for the automatic repurchase of its securities in accordance with Section 10b5-1 of the Securities Exchange Act of 1934 as part of its share repurchase program. 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.

Item 6. Exhibits

EXHIBIT INDEX


Exhibit
Number		Description of Document
3.1		Amended and Restated Certificate of Incorporation

3.2		Amended and Restated Bylaws of the Registrant amended as of February 22, 2008 (incorporated by reference to Exhibit 3.1 from Brocade’s Form 8-K filed on February 22, 2008)

4.1		Form of Brocade’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		First Supplemental Indenture dated as of January 29, 2007 by and among McDATA Corporation, Brocade, and Wells Fargo Bank, National Association, as successor in interest to Wells Fargo Bank Minnesota, National Association (incorporated by reference to Exhibit 4.2 from Brocade’s Form 10-Q filed on June 7, 2007)

4.3		Second Supplemental Indenture dated as of January 29, 2007 by and among McDATA Corporation, McDATA Services Corporation, a Minnesota corporation f/k/a Computer Network Technology Corporation, Brocade, and U.S. Bank National Association (incorporated by reference to Exhibit 4.3 from Brocade’s Form 10-Q filed on June 7, 2007)

4.4		Indenture dated February 7, 2003 by and among McDATA Corporation and Wells Fargo Bank Minnesota National Association (incorporated by reference to Exhibit 4.4 from Brocade’s Form 10-Q filed on June 7, 2007)

4.5		Indenture dated February 20, 2002 by and among Computer Network Technology Corporation and U.S. Bank National Association (incorporated by reference to Exhibit 4.5 from Brocade’s Form 10-Q filed on June 7, 2007)

10.1**/†		Amendment Number 1 dated November 1, 2007 to SOW #6 of the Goods Agreement between International Business Machines Corporation and Brocade

10.2**/†		Ninth Amendment, dated November 5, 2007 to OEM Purchase Agreement dated December 16, 2002 between Hewlett-Packard Company and Brocade

10.3**/†		Amendment #10 dated November 21, 2007 to Statement of Work to Goods Agreement between International Business Machines Corporation and Brocade

10.4**/†		Tenth Amendment, dated December 21, 2007 to OEM Purchase Agreement dated December 16, 2002 between Hewlett-Packard Company and Brocade

10.5**/†		Amendment Number 31 dated December 30, 2007 to Statement of Work #1 to Goods Agreement between International Business Machines Corporation and Brocade

10.6**/†		Amendment Number 32 dated January 22, 2008 to Statement of Work #1 to Goods Agreement between International Business Machines Corporation and Brocade

10.7*		Senior Leadership Plan, as amended and restated as of November 16, 2007 (incorporated by reference to Exhibit 10.1 from Brocade’s Form 8-K filed on November 21, 2007)

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.


*		Indicates management contract or compensatory plan or arrangement.

**		Filed herewith.

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

EXHIBIT INDEX


Exhibit
Number		Description of Document
3.1		Amended and Restated Certificate of Incorporation

3.2		Amended and Restated Bylaws of the Registrant amended as of February 22, 2008 (incorporated by reference to Exhibit 3.1 from Brocade’s Form 8-K filed on February 22, 2008)

4.1		Form of Brocade’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		First Supplemental Indenture dated as of January 29, 2007 by and among McDATA Corporation, Brocade, and Wells Fargo Bank, National Association, as successor in interest to Wells Fargo Bank Minnesota, National Association (incorporated by reference to Exhibit 4.2 from Brocade’s Form 10-Q filed on June 7, 2007)

4.3		Second Supplemental Indenture dated as of January 29, 2007 by and among McDATA Corporation, McDATA Services Corporation, a Minnesota corporation f/k/a Computer Network Technology Corporation, Brocade, and U.S. Bank National Association (incorporated by reference to Exhibit 4.3 from Brocade’s Form 10-Q filed on June 7, 2007)

4.4		Indenture dated February 7, 2003 by and among McDATA Corporation and Wells Fargo Bank Minnesota National Association (incorporated by reference to Exhibit 4.4 from Brocade’s Form 10-Q filed on June 7, 2007)

4.5		Indenture dated February 20, 2002 by and among Computer Network Technology Corporation and U.S. Bank National Association (incorporated by reference to Exhibit 4.5 from Brocade’s Form 10-Q filed on June 7, 2007)

10.1**/†		Amendment Number 1 dated November 1, 2007 to SOW #6 of the Goods Agreement between International Business Machines Corporation and Brocade

10.2**/†		Ninth Amendment, dated November 5, 2007 to OEM Purchase Agreement dated December 16, 2002 between Hewlett-Packard Company and Brocade

10.3**/†		Amendment #10 dated November 21, 2007 to Statement of Work to Goods Agreement between International Business Machines Corporation and Brocade

10.4**/†		Tenth Amendment, dated December 21, 2007 to OEM Purchase Agreement dated December 16, 2002 between Hewlett-Packard Company and Brocade

10.5**/†		Amendment Number 31 dated December 30, 2007 to Statement of Work #1 to Goods Agreement between International Business Machines Corporation and Brocade

10.6**/†		Amendment Number 32 dated January 22, 2008 to Statement of Work #1 to Goods Agreement between International Business Machines Corporation and Brocade

10.7*		Senior Leadership Plan, as amended and restated as of November 16, 2007 (incorporated by reference to Exhibit 10.1 from Brocade’s Form 8-K filed on November 21, 2007)

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.


*		Indicates management contract or compensatory plan or arrangement.

**		Filed herewith.

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


	Page
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Statements of Income for the Three Months Ended January 26, 2008 and January 27, 2007		4
Condensed Consolidated Balance Sheets as of January 26, 2008 and October 27, 2007		5
Condensed Consolidated Statements of Cash Flows for the Three Months Ended January 26, 2008 and January 27, 2007		6
Notes to Condensed Consolidated Financial Statements		7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		22
Item 3. Quantitative and Qualitative Disclosures About Market Risk		32
Item 4. Controls and Procedures		32
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		47
Item 6. Exhibits		48
SIGNATURES		49
EXHIBIT 10.1
EXHIBIT 10.2
EXHIBIT 10.3
EXHIBIT 10.4
EXHIBIT 10.5
EXHIBIT 10.6
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1


	BROCADE COMMUNICATIONS SYSTEMS, INC.
Date: February 28, 2008	By:	/s/ Richard Deranleau
		Richard Deranleau
		Chief Financial Officer