<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 19, 2000
REGISTRATION NO. 333-38106
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
AMENDMENT NO. 3
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
MCDATA CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C> <C>
DELAWARE 3669 84-1421844
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
</TABLE>
310 INTERLOCKEN PARKWAY
BROOMFIELD, CO 80021
(303) 460-9200
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
------------------------
JOHN F. MCDONNELL
PRESIDENT AND CHIEF EXECUTIVE OFFICER
MCDATA CORPORATION
310 INTERLOCKEN PARKWAY
BROOMFIELD, CO 80021
(303) 460-9200
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)
------------------------
COPIES TO:
<TABLE>
<S> <C> <C>
MARGARET A. BROWN, ESQ. PAUL T. DACIER, ESQ. WILLIAM J. SCHNOOR, JR., ESQ.
SKADDEN, ARPS, SLATE, MEAGHER & SENIOR VICE PRESIDENT AND TESTA, HURWITZ & THIBEAULT, LLP
FLOM LLP GENERAL COUNSEL HIGH STREET TOWER
ONE BEACON STREET EMC CORPORATION 125 HIGH STREET
BOSTON, MA 02180 35 PARKWOOD DRIVE BOSTON, MA 02110
(617) 573-4800 HOPKINTON, MA 01748 (617) 248-7000
(508) 435-1000
</TABLE>
------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after the effective date of this Registration Statement.
------------------------
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, as amended, check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration number of the earlier effective
registration statement for the same offering. [ ] ____________
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration number of the earlier effective registration statement of the same
offering. [ ] ____________
If this Form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration number of the earlier effective registration statement of the same
offering. [ ] ____________
If a delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT WILL
BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING
PURSUANT TO SAID SECTION 8(a), MAY DETERMINE.
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<PAGE> 2
The information in this prospectus is not complete and may be changed.
We may not sell these securities until the registration statement filed
with the Securities and Exchange Commission is effective. This
prospectus is not an offer to sell securities, and we are not soliciting
offers to buy these securities, in any state where the offer or sale is
not permitted.
SUBJECT TO COMPLETION, DATED JULY 19, 2000
12,500,000 Shares
[McData Corp. LOGO]
Class B Common Stock
------------------------
Prior to this public offering, there has been no public market for our
Class B common stock. The initial public offering price of our Class B common
stock is expected to be between $19.00 and $21.00 per share. We have applied to
list the shares on The Nasdaq Stock Market's National Market under the symbol
"MCDT."
The underwriters have an option to purchase a maximum of 1,875,000
additional shares of Class B common stock to cover over-allotments of shares.
INVESTING IN OUR CLASS B COMMON STOCK INVOLVES RISKS. SEE "RISK FACTORS" ON
PAGE 8.
<TABLE>
<CAPTION>
UNDERWRITING
PRICE TO DISCOUNTS AND PROCEEDS TO
PUBLIC COMMISSIONS MCDATA
-------- ------------- -----------
<S> <C> <C> <C>
Per Share..................................... $ $ $
Total......................................... $ $ $
</TABLE>
Delivery of the shares of Class B common stock will be made on or about
, 2000.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
CREDIT SUISSE FIRST BOSTON
DEUTSCHE BANC ALEX. BROWN
MERRILL LYNCH & CO.
The date of this prospectus is , 2000.
<PAGE> 3
MCDATA
The Enterprise Storage Networking Company
MCDATA ED-5000
DIRECTOR
--------------
The Backbone
of the
Enterprise SAN
[GRAPHIC]
[The graphic depicts images and lines representing an enterprise-wide network of
services, storage facilities, workgroups and McDATA products.]
MCDATA ES-1000 SWITCH MCDATA EFC MANAGER
----------------------- -------------------------
Enables Enterprise-wide Manage the Enterprise SAN
Data Centralization From a Central Location
MCDATA's ENTERPRISE STORAGE NETWORKING SOLUTION
-----------------------------------------------
<PAGE> 4
-------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PROSPECTUS SUMMARY.................... 2
RISK FACTORS.......................... 8
OUR RELATIONSHIP WITH EMC AFTER THE
OFFERING............................ 20
INFORMATION REGARDING FORWARD-LOOKING
STATEMENTS.......................... 22
USE OF PROCEEDS....................... 23
DIVIDEND POLICY....................... 23
CAPITALIZATION........................ 24
DILUTION.............................. 25
SELECTED CONSOLIDATED FINANCIAL
DATA................................ 26
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS....................... 28
BUSINESS.............................. 38
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
MANAGEMENT............................ 53
RELATIONSHIPS AND RELATED PARTY
TRANSACTIONS........................ 62
ARRANGEMENTS BETWEEN MCDATA AND EMC... 63
PRINCIPAL STOCKHOLDERS................ 71
DESCRIPTION OF CAPITAL STOCK.......... 73
SHARES ELIGIBLE FOR FUTURE SALE....... 78
UNDERWRITING.......................... 83
NOTICE TO CANADIAN RESIDENTS.......... 86
LEGAL MATTERS......................... 87
EXPERTS............................... 87
WHERE YOU MAY FIND ADDITIONAL
INFORMATION......................... 88
INDEX TO CONSOLIDATED FINANCIAL
STATEMENTS.......................... F-1
</TABLE>
-------------------------
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS DOCUMENT OR TO
WHICH WE HAVE REFERRED YOU. WE HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH
INFORMATION THAT IS DIFFERENT. THIS DOCUMENT MAY ONLY BE USED WHERE IT IS LEGAL
TO SELL THESE SECURITIES. THE INFORMATION CONTAINED IN THIS DOCUMENT MAY ONLY BE
ACCURATE ON THE DATE OF THIS DOCUMENT.
DEALER PROSPECTUS DELIVERY OBLIGATION
UNTIL , 2000 ALL DEALERS EFFECTING TRANSACTIONS IN THESE
SECURITIES, WHETHER OR NOT PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED TO
DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE DEALER'S OBLIGATION TO DELIVER
A PROSPECTUS WHEN ACTING AS AN UNDERWRITER AND WITH RESPECT TO UNSOLD ALLOTMENTS
OR SUBSCRIPTIONS.
1
<PAGE> 5
PROSPECTUS SUMMARY
The following summary highlights information that we present more fully
elsewhere in this prospectus. You should read this entire prospectus, including
"Risk Factors" and the consolidated financial statements and related notes,
before deciding to invest in our Class B common stock. This prospectus contains
forward-looking statements that involve risks and uncertainties. Our actual
results could differ materially from those anticipated in such forward-looking
statements as a result of factors described under "Risk Factors" and elsewhere
in this prospectus.
MCDATA CORPORATION
We are a leading provider of high performance enterprise switches and
related software for connecting servers and storage systems in a storage area
network, or SAN, based on our historic market share in this segment. We sell our
products through industry leading original equipment manufacturers, such as EMC
Corporation, resellers, such as International Business Machines Corporation, and
systems integrators. We invoice the value of sales at shipment and generally
have on-going arrangements with these customers or the ultimate end-users of our
products. We combine years of experience in designing, developing and
manufacturing high performance switching technologies with a knowledge of
business critical applications, service and support to solve complex business
problems at the core of a business enterprise's data infrastructure. Our
products enable business enterprises to cost effectively deploy a comprehensive,
highly available and centrally managed storage network to support growing
storage capacity requirements.
During the past decade, the volume and value of data created throughout
business enterprises has increased dramatically. As a result, the demand for
data storage capacity has exploded as enterprises increasingly need to access,
process and manipulate data that is critical to their businesses. International
Data Corporation, an independent information technology research firm referred
to as IDC, estimates that multi-user disk storage grew from more than 7,000
terabytes in 1993 to more than 185,000 terabytes in 1999, and will reach more
than 1.9 million terabytes in 2003. One terabyte consists of one trillion bytes.
The growing dependence on data for fundamental business processes has also
greatly increased the performance required of servers and storage systems. The
inability of traditional server-to-storage connections to provide the needed
performance enhancements has caused significant performance limitations.
To address the limitations of traditional server-to-storage connections,
fibre channel technology was introduced in the early 1990's as a means to
facilitate high performance storage connectivity, accelerating the development
of SANs. SANs enable fast, efficient and reliable transfer of data across
multiple servers and storage devices to improve the management of data within an
enterprise. However, to date, many SAN solutions are being deployed on a
distributed or localized basis within business enterprises. Consequently,
isolated "islands" of information are created, each of which must be
administered and managed locally. As a result, enterprises have experienced
difficulty in accessing and sharing information on an enterprise-wide basis,
preventing them from realizing the full potential benefits of a SAN.
Our solutions include hardware and software products, methodologies and
education that enable businesses to scale their operations globally through a
comprehensive, manageable, flexible data infrastructure that is optimized for
rapid application deployment and responsiveness to customer needs.
The advantages of our solutions include the following:
- Scalability -- Dynamic Growth. Our solutions are designed to enable
business enterprises to consolidate, add or reconfigure servers and
storage assets within an enterprise-wide network of data storage and
switching devices. The architecture of our products is designed to permit
businesses to expand their computing and storage resource needs without
causing business interruption or a decline in overall storage system
performance.
2
<PAGE> 6
- Connectivity -- Interoperability. We are at the forefront of providing
products that interoperate with the majority of popular servers and
storage devices. Our products are designed to protect customers'
investments in their information infrastructures.
- Availability -- Information Anywhere, Anytime. Our products are designed
to provide maximum availability by using fault-tolerant technology
incorporating spare, or "redundant," components in the architecture of
the products. These products offer internally redundant capabilities that
enable customers to run their businesses on a 24x7 basis with 99.999%, or
"five-nines," operational availability.
- Manageability -- Comprehensive Control for Low Total Cost of
Ownership. Our enterprise-wide switching and network management software
solutions are designed to enable customers to manage their entire SAN
fabric from a central point. Product features simplify the overall
administration, service and support of the infrastructure, permitting
more efficient use of personnel and increased data availability.
- Performance -- High Price to Performance Value. Our product architecture
is designed to provide customers with a higher number of ports per size
of switching device to achieve a lower price-per-port than products
offering lower port counts per device in a networked group of devices.
------------------------
We are a Delaware corporation with our principal executive offices at 310
Interlocken Parkway, Broomfield, Colorado 80021, and our telephone number is
(303) 460-9200. We maintain a Web site at www.mcdata.com. We do not, however,
intend for our Web site to be part of this prospectus. In this prospectus,
"McDATA," "we," "us" and "our" each refers to McDATA Corporation and its
subsidiaries, and not to the underwriters or EMC. "EMC" refers to EMC
Corporation and its subsidiaries, excluding McDATA.
McDATA and McDATA's logo are trademarks of McDATA Corporation. All other
brand names, logos, copyrights and trademarks appearing in this prospectus are
the property of their respective owners.
3
<PAGE> 7
OUR RELATIONSHIP WITH EMC
We are currently an indirect, majority-owned subsidiary of EMC Corporation.
Since October 1, 1997, EMC, through its direct, wholly-owned subsidiary, McDATA
Holdings Corporation, has owned 100% of our Class A common stock. Each share of
our Class A common stock entitles its holder to one vote per share, while each
share of our Class B common stock entitles its holder to one-tenth (1/10) of one
vote per share. The Class A common stock indirectly held by EMC will represent,
immediately following this offering, approximately 97% of the combined voting
power of both classes of our voting stock on a fully diluted basis. Since
October 1, 1997, we have operated substantially as a separate company from
McDATA Holdings Corporation and EMC under the direction of our board of
directors, a majority of whom are unaffiliated with EMC.
EMC currently plans to liquidate McDATA Holdings Corporation and distribute
all of the shares of our Class A common stock to the holders of EMC's common
stock on a pro rata basis approximately six to twelve months after the date of
this offering. However, EMC is not obligated to complete this distribution, and
this distribution may not occur by the anticipated time or at all. EMC will, in
its sole discretion, determine whether to complete the distribution, and the
timing, structure and all other terms of its distribution of our Class A common
stock that it owns. EMC's distribution depends on, among other things, its
receiving a private letter ruling from the Internal Revenue Service that its
distribution of shares of our Class A common stock to its stockholders will be
tax-free to EMC and its stockholders.
EMC acquired McDATA in December 1995. In October 1997, EMC reorganized
McDATA to separate our fibre channel business from EMC. As part of this
reorganization, we became a company focused on designing, developing,
manufacturing and selling fibre channel switching devices for connecting servers
and storage systems in a SAN or other information infrastructure. We continue to
provide, under a services agreement with McDATA Holdings Corporation,
manufacturing and distribution management services for proprietary mainframe
protocol, or ESCON(TM), switching solutions manufactured for and sold to IBM. In
addition to this services agreement, in 1997 we entered into other agreements
with EMC relating to our business and our relationship with EMC. In connection
with the offering described in this prospectus, we have entered into additional
agreements with EMC relating to the offering and the distribution by EMC of our
Class A common stock to its stockholders and to our relationship with EMC after
the completion of the offering. These agreements provide for, among other
things, various interim and ongoing relationships with EMC. We have also entered
into an OEM Purchase and License Agreement with EMC that governs EMC's purchases
of our products. Each of the agreements between us and EMC is described more
fully in the section of this prospectus titled "Arrangements between McDATA and
EMC." The terms of these agreements, which were negotiated in the context of a
parent-subsidiary relationship, may be less favorable to us than if they had
been negotiated with unaffiliated third parties. See "Risk Factors -- Risks
Related to our Relationship with EMC."
4
<PAGE> 8
THE OFFERING
Class B common stock
offered....................... 12,500,000 shares
Common stock to be outstanding
after this offering:
Class A common stock........ 81,000,000 shares
Class B common stock........ 25,452,226 shares
Total......................... 106,452,226 shares
Underwriters' over-allotment
option........................ 1,875,000 shares
Use of proceeds............... We intend to use the net proceeds for general
corporate purposes, including repayment of $1.9
million of outstanding indebtedness to McDATA
Holdings Corporation, a wholly-owned subsidiary
of EMC, capital expenditures and working
capital.
Voting Rights:
Class A common stock........ One (1) vote per share
Class B common stock........ One-tenth ( 1/10) of one vote per share
Other common stock
provisions.................... The holders of our Class A common stock and
Class B common stock generally have identical
rights, except for the different voting rights
described above.
Proposed Nasdaq National
Market trading symbol for the
Class B common stock........ MCDT
------------------------
Unless otherwise indicated, all information contained in this prospectus:
- assumes no exercise of the underwriters' option to purchase up to
1,875,000 additional shares of our Class B common stock to cover
over-allotments; and
- reflects a 2-for-1 split of our Class A and Class B common stock effected
prior to the offering.
The number of shares of our Class B common stock to be outstanding
immediately after the offering:
- is based upon 12,952,226 shares of our Class B common stock outstanding
as of June 30, 2000; and
- does not take into account 12,839,624 shares of our Class B common stock
issuable upon the exercise of options outstanding as of June 30, 2000, at
a weighted average exercise price of $3.26 per share.
------------------------
5
<PAGE> 9
SUMMARY CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
----------------------------------------------- ------------------
1995(1) 1996(1) 1997(1) 1998 1999 1999 2000
------- ------- ------- ------- ------- ------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Consolidated statements of
operations data:
Product revenue................ $11,851 $ 5,370 $ 4,035 $ 5,242 $29,466 $ 9,558 $ 26,475
Product revenue -- Parent...... -- 526 1,336 5,632 48,111 13,264 68,794
Service revenue -- Parent...... 22,438 26,304 27,652 25,674 17,686 11,368 8,326
------- ------- ------- ------- ------- ------- --------
Total revenue.................. $34,289 $32,200 $33,023 $36,548 $95,263 $34,190 $103,595
Gross profit................... 24,382 24,196 21,753 23,443 45,181 17,890 53,647
------- ------- ------- ------- ------- ------- --------
Income (loss) from
operations................... 4,427 8,931 (1,230) (8,565) (273) (1,784) 17,681
------- ------- ------- ------- ------- ------- --------
Net income (loss).............. $ 2,805 $ 5,770 $(3,224) $(2,468) $(1,033) $(1,993) $ 10,827
======= ======= ======= ======= ======= ======= ========
Basic net income (loss) per
share(2)..................... $ 0.03 $ 0.06 $ (0.04) $ (0.03) $ (0.01) $ (0.02) $ 0.12
======= ======= ======= ======= ======= ======= ========
Shares used in computing basic
net income (loss) per
share(2)..................... 91,000 91,000 91,000 91,000 91,638 91,017 93,398
Diluted net income (loss) per
share(2)..................... $ 0.03 $ 0.06 $ (0.04) $ (0.03) $ (0.01) $ (0.02) $ 0.11
======= ======= ======= ======= ======= ======= ========
Shares used in computing
diluted net income (loss) per
share(2)..................... 91,000 91,000 91,000 91,000 91,638 91,017 100,088
Pro forma net income
(loss)(3).................... $ (935) $ 10,854
======= ========
Pro forma net income (loss) per
share(3)..................... $ (0.01) $ 0.12
======= ========
Shares used in computing pro
forma net income (loss) per
share(3)..................... 91,740 93,500
Pro forma diluted net income
(loss) per share(3).......... $ (0.01) $ 0.11
======= ========
Shares used in computing pro
forma diluted net income
(loss) per share(3).......... 91,740 100,190
</TABLE>
<TABLE>
<CAPTION>
JUNE 30, 2000
-------------------------
ACTUAL AS ADJUSTED(4)
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Consolidated balance sheet data:
Cash and cash equivalents................................... $ 6,259 $237,525
Working capital............................................. 27,343 260,509
Total assets................................................ 73,739 305,005
Short-term debt -- Parent................................... 1,900 --
Long-term portion of capital lease obligations.............. 1,719 1,719
Total stockholders' equity.................................. 43,985 277,151
</TABLE>
-------------------------
(1) In October 1997, EMC reorganized McDATA to separate our fibre channel
devices business from EMC. As part of this reorganization, we became a
company focused on designing, developing, manufacturing and selling fibre
channel switching devices. As a result, the historical
6
<PAGE> 10
financial information for the three years ended December 31, 1997 has been
adjusted to reflect the impact of the reorganization as if it occurred at
the beginning of 1995.
(2) Per share computations for 1995, 1996 and 1997 have been calculated using
the actual number of shares issued on October 1, 1997 because the capital
structure for prior periods was not indicative of the current structure. Per
share computations for 1995, 1996 and 1997 are, therefore, pro forma per
share data.
(3) Pro forma per share computations have been calculated assuming that a
portion of the proceeds from this offering were used to repay the $1.9
million in short term debt -- Parent on January 1, 1999 for the year ended
December 31, 1999 and on January 1, 2000 for the six month period ended June
30, 2000. The pro forma net income (loss) is adjusted to add back the
interest expense incurred related to the debt during the respective periods.
The pro forma shares used to compute the pro forma net income (loss) per
share, on both a basic and diluted basis, were adjusted to reflect the
number of shares issued pursuant to this offering to repay the short term
debt -- Parent.
(4) The as adjusted balance sheet reflects this offering at an assumed initial
offering price of $20.00 per share of Class B common stock, the mid-price of
the filing range, after deducting an assumed underwriting discount and
estimated offering expenses payable by us and the repayment of the
short-term debt -- Parent.
7
<PAGE> 11
RISK FACTORS
You should carefully consider the following risk factors and other
information contained in this prospectus before purchasing our Class B common
stock. Investing in our Class B common stock involves a high degree of risk.
Risks and uncertainties that are not presently known to us or that we currently
believe are immaterial may also impair our business, financial condition and
results of operations. If any of the following risks occur, our business,
financial condition and results of operations could be seriously harmed. In
addition, the trading price of our Class B common stock could decline due to the
occurrence of any of these risks, and you may lose all or part of your
investment.
RISKS RELATED TO OUR BUSINESS
WE HAVE INCURRED LOSSES IN THE PAST AND MAY NOT SUSTAIN PROFITABILITY IN THE
FUTURE.
We have incurred losses in all but the three most recent fiscal quarters
since 1997, when we focused our business on the design, development and
manufacture of fibre channel switching devices. In addition, we may incur losses
in the future. Although our revenues have grown in recent quarters, we cannot be
certain that we can sustain our revenue growth rates or that we can sustain
profitability. Our future operating results will depend on many factors,
including the growth of the fibre channel market, market acceptance of new
products, demand for our products and levels of product and price competition.
In addition, we expect to incur continued significant product development, sales
and marketing, and general and administrative expenses and, as a result, we may
not be able to achieve or sustain profitability.
WE DEPEND ON TWO KEY DISTRIBUTION RELATIONSHIPS FOR MOST OF OUR REVENUE, AND THE
LOSS OF EITHER OF THEM COULD SIGNIFICANTLY REDUCE OUR REVENUES.
We depend on EMC Corporation for most of our total revenue. Sales to EMC,
which is an original equipment manufacturer customer, represented approximately
74% of our total revenue for the six months ended June 30, 2000. In addition,
International Business Machines Corporation, or IBM, represented approximately
15% of our total revenue for the same period. We anticipate that our future
operating results will continue to depend heavily on sales to EMC and IBM.
Therefore, the loss of either EMC or IBM as a customer, or a significant
reduction in sales to either EMC or IBM in any fiscal period, could
significantly reduce our revenue.
A LARGE PERCENTAGE OF OUR QUARTERLY SALES OCCURS AT THE END OF THE QUARTER,
CONTRIBUTING TO POSSIBLE QUARTERLY FLUCTUATIONS IN REVENUE THAT COULD ADVERSELY
AFFECT OUR OPERATING RESULTS AND CAUSE OUR STOCK PRICE TO FLUCTUATE.
Our quarterly results have historically reflected an uneven pattern in
which a disproportionate percentage of a quarter's total sales occurs in the
last month, weeks or even days of each quarter. This pattern makes the
prediction of revenue, earnings and working capital for each financial period
especially difficult and increases the risk of unanticipated variations from
budgeted quarterly results and financial condition. Additional factors that
affect us which could cause our revenue and operating results to vary in future
periods include:
- the size, timing, terms and fluctuations of customer orders, particularly
large orders from our significant original equipment manufacturer or
reseller customers;
- our ability to attain and maintain market acceptance of our products;
- seasonal fluctuations in customer buying patterns;
8
<PAGE> 12
- the timing of the introduction or enhancement of products by us, our
significant original equipment manufacturer or reseller customers or our
competitors;
- our ability to obtain sufficient supplies of single- or limited-source
components of our products; and
- increased operating expenses, particularly in connection with our
strategies to increase brand awareness or to invest in accelerated
research and development.
Our uneven sales pattern makes it extremely difficult for our management to
predict near-term demand and adjust manufacturing capacity accordingly. If
orders for our products vary substantially from the predicted demand, our
ability to assemble, test and ship orders received in the last weeks and days of
each quarter may be limited, which could seriously harm quarterly revenue or
earnings.
Moreover, an unexpected decline in revenue without a corresponding and
timely reduction in expenses could intensify the impact of these factors on our
business, financial condition and results of operations and cause our stock
price to fluctuate.
WE CURRENTLY HAVE LIMITED PRODUCT OFFERINGS AND MUST SUCCESSFULLY INTRODUCE NEW
AND ENHANCED PRODUCTS THAT RESPOND TO RAPID TECHNOLOGICAL CHANGES AND EVOLVING
INDUSTRY STANDARDS.
In 1999, we derived approximately 43% of our revenue from sales of our
ED-5000 product. We expect that revenue from this product will continue to
account for a substantial portion of our revenue for the foreseeable future.
Therefore, continued market acceptance of this product is critical to our future
success. Factors such as performance, market positioning, the availability and
price of competing products, the introduction of new technologies and the
success of our original equipment manufacturer, reseller and systems integrator
customers will affect the market acceptance of our products.
In addition, our future success depends upon our ability to address the
changing needs of customers and to transition to new technologies and industry
standards. The introduction of competing products, embodying new technologies or
the emergence of new industry standards could render our products
non-competitive, obsolete or unmarketable and seriously harm our market share,
revenue and gross margin. Risks inherent in this transition include the
inability to expand production capacity to meet demand for new products, the
impact of customer demand for new products on products being replaced, and
delays in the initial shipment of new products. There can be no assurances that
we will successfully manage these transitions.
IF WE FAIL TO EXPAND OUR DISTRIBUTION CHANNELS AND MANAGE OUR DISTRIBUTION
RELATIONSHIPS, OUR REVENUE COULD BE SIGNIFICANTLY REDUCED.
Our success will depend on our continuing ability to develop and manage
relationships with significant original equipment manufacturers, resellers and
systems integrators, as well as on the sales efforts and success of these
customers. We cannot assure you that we will be able to expand our distribution
channels, manage our distribution relationships successfully or that our
customers will market our products effectively. Our failure to expand our
distribution channels or manage successfully our distribution relationships or
the failure of our customers to sell our products could reduce our revenue.
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<PAGE> 13
WE ARE DEPENDENT ON A SINGLE OR LIMITED NUMBER OF SUPPLIERS FOR CERTAIN KEY
COMPONENTS OF OUR PRODUCTS, AND THE FAILURE OF ANY OF THOSE SUPPLIERS TO MEET
OUR PRODUCTION NEEDS COULD SERIOUSLY HARM OUR ABILITY TO MANUFACTURE OUR
PRODUCTS, RESULT IN DELAYS IN THE DELIVERY OF OUR PRODUCTS AND HARM OUR REVENUE.
We currently purchase several key components from single or limited
sources. We purchase application specific integrated circuits, or ASICs, printed
circuit boards and power supplies from single sources, and gigabit interface
converters and 1x9 transceivers from limited sources. Additional sole- or
limited-sourced components may be incorporated into our products in the future.
Delays in the delivery of components for our products could result in decreased
revenue. We do not have any long-term supply contracts to ensure sources of
supply. In addition, our suppliers may enter into exclusive arrangements with
our competitors, stop selling their products or components to us at commercially
reasonable prices or refuse to sell their products or components to us at any
price, which could harm our operating results. If our suppliers are unable to
provide, or we are unable otherwise to obtain these components for our products
on the schedule and in the quantities we require, we will be unable to
manufacture our products. If we fail to effectively manage our relationships
with these key suppliers, or if our suppliers experience delays, disruptions,
capacity constraints or quality control problems in their manufacturing
operations, our ability to manufacture and ship products to our customers could
be delayed, and our competitive position, reputation, business, financial
condition and results of operations could be seriously harmed.
THE LOSS OF OUR CONTRACT MANUFACTURER, OR THE FAILURE TO FORECAST DEMAND
ACCURATELY FOR OUR PRODUCTS OR TO MANAGE OUR RELATIONSHIP WITH OUR CONTRACT
MANUFACTURER SUCCESSFULLY, WOULD NEGATIVELY IMPACT OUR ABILITY TO MANUFACTURE
AND SELL OUR PRODUCTS.
We rely on a third-party manufacturer to manufacture all of our circuit
boards and to perform extensive testing and assembly of our products. We do not
have a long-term supply contract with this manufacturer and, therefore, it is
not obligated to supply products to us for any specific period, or in any
specific quantity, except as may be provided in a particular purchase order. We
generally place orders for circuit boards with our contract manufacturer
approximately three to four months prior to the anticipated delivery date, with
order volumes based on forecasts of demand for our products. If we fail to
forecast demand for our products accurately, we may be unable to obtain adequate
manufacturing capacity from our contract manufacturer to meet our customers'
delivery requirements, or we may accumulate excess inventories. We may be unable
to respond adequately to unexpected increases in customer purchase orders, and
therefore be unable to benefit from this incremental demand. Our contract
manufacturer has not provided assurances to us that adequate capacity will be
available to us within the time required to meet additional demand for our
products.
In addition, we coordinate our efforts with those of our component
suppliers and our contract manufacturer in order to rapidly achieve volume
production. If we should fail to manage effectively our relationships with our
component suppliers and our contract manufacturer, or if any of our suppliers or
our manufacturer experience delays, disruptions, capacity constraints or quality
control problems in its manufacturing operations, our ability to ship products
to our customers could be delayed, and our competitive position and reputation
could be harmed. Qualifying a new contract manufacturer and commencing volume
production can be expensive and time consuming. If we are required to change or
choose to change contract manufacturers, we may lose revenue and damage our
customer relationships.
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IF WE FAIL TO SUCCESSFULLY DEVELOP THE MCDATA BRAND, OUR REVENUE MAY NOT GROW
AND OUR STOCK PRICE MAY FALL.
Our name is not widely recognized as a brand in the marketplace. We have
operated substantially as a separate company from McDATA Holdings Corporation
and EMC only since October 1997. EMC, which currently accounts for the majority
of our revenue, markets our products under its own brand name. As a result, we
have not fully established our brand name. We believe that establishing and
maintaining the McDATA brand is a critical component in maintaining and
developing strategic original equipment manufacturer, reseller and systems
integrator relationships, and the importance of brand recognition will increase
as the number of vendors of competitive products increases. Our failure to
successfully develop our brand may prevent us from expanding our business and
growing our revenue, which could cause the price of our stock to fall.
Similarly, if we incur excessive expenses in an attempt to promote and maintain
the McDATA brand, our business, financial condition and results of operations
could be seriously harmed.
THE STORAGE AREA NETWORK MARKET IN WHICH WE COMPETE IS STILL DEVELOPING AND
UNPREDICTABLE, AND IF THIS MARKET DOES NOT CONTINUE TO DEVELOP AND EXPAND AS WE
ANTICIPATE, OUR BUSINESS WILL SUFFER.
The market for storage area networks, or SANs, and related products has
only recently begun to develop and is rapidly evolving. Because this market is
new, it is difficult to predict its potential size or future growth rate. Our
ED-5000 product, from which we derived approximately 43% of our total revenues
in 1999, is used extensively in SANs. Accordingly, widespread adoption of SANs
as an integral part of data-intensive enterprise computing environments is
critical to our future success. Potential end-user customers who have invested
substantial resources in their existing data storage and management systems may
be reluctant or slow to adopt a new approach, like SANs. Our success in
generating net revenue in this emerging market will depend on, among other
things, our ability to:
- educate our potential original equipment manufacturer, reseller and
systems integrator customers and end users about the benefits of SANs and
the use of our products in the SAN environment; and
- predict, develop and base our products on standards that ultimately
become industry standards.
THE SALES CYCLE FOR OUR PRODUCTS IS LONG, AND WE MAY INCUR SUBSTANTIAL
NON-RECOVERABLE EXPENSES AND DEVOTE SIGNIFICANT RESOURCES TO SALES THAT DO NOT
OCCUR WHEN ANTICIPATED OR AT ALL.
Our original equipment manufacturer, reseller and systems integrator
customers typically conduct significant evaluation, testing, implementation and
acceptance procedures before they begin to market and sell new solutions that
include our products. This evaluation process is lengthy and may extend up to
one year or more. This process is complex and may require significant sales,
marketing and management efforts on our part. This process becomes more complex
as we simultaneously qualify our products with multiple customers. As a result,
we may expend significant resources to develop customer relationships before we
recognize any revenue from these relationships.
GROWTH IN OUR OPERATIONS MAY PLACE A SIGNIFICANT STRAIN ON OUR MANAGEMENT
SYSTEMS AND RESOURCES.
Our future operating results will depend on our management's ability to
manage growth, including but not limited to, hiring and retaining significant
numbers of qualified employees, forecasting revenue, controlling expenses,
managing our manufacturing capacity and other assets and executing on our plans.
Growth in our operations may place a significant strain on our management and
information systems and resources as we address issues such as enhancing and
expanding our infrastructure. To manage expansion effectively, we must implement
and improve our operational systems, procedures, controls and customer service
on a timely basis. If we are unable to properly manage this growth, our
operating results, reputation and customer relationships could be harmed.
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UNDETECTED SOFTWARE OR HARDWARE DEFECTS IN OUR PRODUCTS COULD RESULT IN LOSS OF
OR DELAY IN MARKET ACCEPTANCE OF OUR PRODUCTS AND COULD INCREASE OUR COSTS OR
REDUCE OUR REVENUE.
Our products may contain undetected software or hardware errors when first
introduced or when new versions are released. Our products are complex, and we
have from time to time detected errors in existing products, and we may from
time to time find errors in our existing, new or enhanced products. In addition,
our products are combined with products from other vendors. As a result, should
problems occur, it may be difficult to identify the source of the problem. These
errors could result in a loss of or delay in market acceptance of our products
and would increase our costs, reduce our revenue and cause significant customer
relations problems.
IF WE LOSE KEY PERSONNEL OR ARE UNABLE TO HIRE ADDITIONAL QUALIFIED PERSONNEL,
WE MAY NOT BE SUCCESSFUL.
Our success depends to a significant degree upon the continued
contributions of our key management, technical, sales and marketing, finance and
operations personnel, many of whom would be difficult to replace. In particular,
we believe that our future success is highly dependent on John F. McDonnell, our
President and Chief Executive Officer and the Chairman of our board of
directors. In addition, our engineering and product development teams are
critical in developing our products and have developed important relationships
with customers and their technical staffs. The loss of any of these key
personnel could harm our operations and customer relationships. We do not have
key person life insurance on any of our key personnel.
We believe our future success will also depend in large part upon our
ability to attract and retain highly skilled managerial, engineering, sales and
marketing, and finance and operations personnel. We are presently engaged in a
search for a replacement for our Chief Financial Officer. As we increase our
production and sales levels, we will need to attract and retain additional
qualified skilled workers for our operations. In recent years there has been
great demand among companies in the technology industry for these personnel. In
particular, competition for these personnel has become increasingly intense in
the greater Denver, Colorado metropolitan area, where we have our headquarters
and certain of our manufacturing facilities, and the greater Toronto, Canada
metropolitan area, where we have an engineering group. We cannot assure you that
we will continue to be able to attract and retain qualified personnel, including
a Chief Financial Officer, or that delays in hiring required personnel,
particularly engineers, will not delay the development or introduction of
products or negatively impact our ability to sell our products.
IF WE CANNOT COMPETE SUCCESSFULLY IN THE FUTURE AGAINST EXISTING OR POTENTIAL
COMPETITORS, OUR OPERATING RESULTS WILL SUFFER.
The market for our fibre channel switching products is competitive, and is
likely to become even more so. Our primary competitor in the fibre channel
switch market is Brocade Communications Systems, Inc. Other companies are also
providing fibre channel switches and other products to the SAN market, including
Ancor Communications, Inc., Gadzoox Networks, Inc. and Vixel Corporation. In the
future, we may also compete with networking companies that may develop SAN
products or other companies in related or other industries for which future
direct participation in the market for switching devices may become strategic.
EMC, which represented approximately 74% of our total revenue for the six
months ended June 30, 2000, has agreed not to develop or manufacture products
that compete with our products for two years after the completion of this
offering. Upon the expiration of the two-year period, we have no agreement that
would restrict EMC from competing with us in the development or manufacture of
these products. In addition, EMC has recently agreed to resell certain products
offered by two of our competitors. Moreover, under a cross license agreement
between us and EMC, we have granted EMC
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a license under our patents to make, use and sell any products that EMC is
selling or distributing up to the date of the offering, including products that
compete with ours.
Continued or increased competition could result in pricing pressures,
reduced sales, reduced margins, reduced profits, reduced market share or the
failure of our products to achieve or maintain market acceptance. Some of our
competitors and potential competitors have longer operating histories, greater
name recognition, access to larger customer bases, more established distribution
channels or substantially greater resources than we have. As a result, they may
be able to respond more quickly than we can to new or changing opportunities,
technologies, standards or customer requirements.
WE DO NOT HAVE SIGNIFICANT EXPERIENCE IN INTERNATIONAL MARKETS AND MAY HAVE
UNEXPECTED COSTS AND DIFFICULTIES IN DEVELOPING INTERNATIONAL REVENUE.
We intend to expand the marketing and sales of our products
internationally. We have limited experience in marketing, distributing and
supporting our products internationally and may not be able to maintain or
increase international market demand for our products. In addition, our
international operations are generally subject to inherent risks and challenges
that could harm our operating results, including:
- expenses associated with developing and customizing our products for
foreign countries;
- multiple, conflicting and changing governmental laws and regulations;
- tariffs, quotas and other import restrictions on computer peripheral
equipment;
- longer sales cycles for our products;
- reduced or limited protections of intellectual property rights;
- compliance with international standards that differ from domestic
standards; and
- political and economic instability.
Any negative effects on our international business could harm our business,
operating results and financial condition as a whole. To date, none of our
international revenue or costs have been denominated in foreign currencies. As a
result, an increase in the value of the U.S. dollar relative to foreign
currencies could make our products more expensive and thus less competitive in
foreign markets. A portion of our international revenue may be denominated in
foreign currencies in the future, which will subject us to risks associated with
fluctuations in those foreign currencies.
IF WE ARE UNABLE TO ADEQUATELY PROTECT OUR INTELLECTUAL PROPERTY, WE MAY NOT BE
ABLE TO COMPETE EFFECTIVELY.
We rely on a combination of patent, copyright, trademark and trade secret
laws and restrictions on disclosure to protect our intellectual property rights.
We also enter into confidentiality and/or license agreements with our employees,
consultants and corporate partners. Despite our efforts to protect our
proprietary rights, unauthorized parties may copy or otherwise obtain and use
our products or technology. Monitoring unauthorized use of our products is
difficult and the steps we have taken may not prevent unauthorized use of our
technology, particularly in foreign countries where the laws may not protect our
proprietary rights as fully as in the United States. For a more complete
discussion of the protection of our intellectual property, see
"Business -- Intellectual Property."
We may be a party to intellectual property litigation in the future, either
to protect our intellectual property or as a result of alleged infringements of
others' intellectual property. These claims and any resulting litigation could
subject us to significant liability for damages or could cause our proprietary
rights to be invalidated. Litigation, regardless of the merits of the claim or
outcome,
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would likely be time consuming and expensive to resolve and would divert
management time and attention. Any potential intellectual property litigation
could also force us to do one or more of the following:
- stop using the challenged intellectual property or selling our products
or services that incorporate it;
- obtain a license to use the challenged intellectual property or to sell
products or services that incorporate it, which license may not be
available on reasonable terms, or at all; and
- redesign those products or services that are based on or incorporate the
challenged intellectual property.
If we are forced to take any of these actions, we may be unable to
manufacture and sell our products, and our revenue would be reduced.
We currently hold a sublicense to certain IBM patents under the terms of a
cross license agreement between IBM and EMC. We have granted IBM a license to
all of our patents under this cross license agreement. Under the terms of that
agreement, if EMC distributes the shares of our Class A common stock indirectly
held by it to its stockholders as it currently contemplates, the sublicense we
hold to those IBM patents will terminate. We are not aware of any issued or
pending IBM patents that are infringed by our products, but if IBM, after the
contemplated distribution by EMC of our Class A common stock to its
stockholders, were to allege any such infringement, we may have difficulty
negotiating a settlement. If we were unable to negotiate a settlement with IBM,
our ability to produce an infringing product could be affected, which could
materially and adversely affect our business.
IF WE BECOME SUBJECT TO UNFAIR HIRING CLAIMS, WE COULD INCUR SUBSTANTIAL COSTS
IN DEFENDING OURSELVES.
Companies in our industry whose employees accept positions with competitors
frequently claim that their competitors have engaged in unfair hiring practices
or that employees have misappropriated confidential information or trade
secrets. We may receive claims of this kind or other claims relating to our
employees in the future as we seek to hire qualified personnel or that those
claims will not result in material litigation. We could incur substantial costs
in defending ourselves or our employees against such claims, regardless of their
merits. In addition, defending ourselves or our employees from such claims could
divert the attention of our management away from our operations.
RISKS RELATED TO OUR RELATIONSHIP WITH EMC
THE SUPERIOR VOTING RIGHTS OF CLASS A COMMON STOCK RELATIVE TO CLASS B COMMON
STOCK COULD ADVERSELY AFFECT THE STOCK PRICE AND LIQUIDITY OF THE CLASS B COMMON
STOCK YOU PURCHASE IN THE OFFERING.
The holders of our Class A and Class B common stock generally have
identical rights, except that holders of our Class A common stock are entitled
to one vote per share and holders of our Class B common stock are entitled to
one-tenth of a vote per share on all matters to be voted on by stockholders. You
will be purchasing our Class B common stock if you purchase shares in the
offering. EMC, which currently owns all of the outstanding shares of Class A
common stock through its wholly-owned subsidiary, McDATA Holdings Corporation,
currently plans to distribute all of the shares of Class A common stock it owns
to its stockholders approximately six to twelve months after this offering. The
difference in the voting rights of the Class A and Class B common stock could
diminish the value of the Class B common stock to the extent that investors or
any potential future purchasers of our Class B common stock ascribe value to the
superior voting rights of the Class A
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common stock. In addition, the existence of two separate classes of publicly
traded common stock after EMC's intended distribution could result in less
liquidity for either class of our common stock than if there were only one class
of common stock. For more information about the rights associated with owning
our Class A and Class B common stock, see "Description of Capital Stock."
WE HAVE ENTERED INTO AGREEMENTS WITH EMC THAT, DUE TO OUR PARENT-SUBSIDIARY
RELATIONSHIP, MAY CONTAIN TERMS LESS BENEFICIAL TO US THAN IF THEY HAD BEEN
NEGOTIATED WITH UNAFFILIATED THIRD PARTIES.
In October 1997, in connection with the reorganization of our business, we
entered into certain agreements with EMC relating to our business relationship
with EMC after the 1997 reorganization. In addition, we have recently entered
into agreements with EMC relating to our relationship with EMC after the
completion of the offering and distribution. We have also recently entered into
an OEM Purchase and License Agreement with EMC that governs EMC's purchases of
McDATA products and grants EMC rights to use, support and distribute software
for use in connection with these products. These agreements were negotiated and
made in the context of a parent-subsidiary relationship. As a result, some of
these agreements may have terms and conditions, in the case of the OEM
agreement, including the terms of pricing, that are less beneficial to us than
agreements negotiated with unaffiliated third parties. Revenue from EMC
represented approximately 74% of our total revenue for the six month period
ended June 30, 2000. In addition, in some instances, our ability to terminate
these agreements is limited, which may prevent us from being able to negotiate
more favorable terms with EMC after the offering or from entering into similar
agreements with third parties. See "Arrangements between McDATA and EMC."
WE DEPEND HEAVILY ON EMC AS OUR KEY OEM CUSTOMER; IF OUR RELATIONSHIP WITH EMC
ADVERSELY CHANGES AFTER THE OFFERING, OUR REVENUE WILL BE SIGNIFICANTLY REDUCED.
For the six month period ended June 30, 2000, our product sales to EMC
represented approximately 66% of our total revenue. In addition, during the same
period, revenue under our service agreement with McDATA Holdings Corporation,
pursuant to which we manufacture and supply ESCON switching devices for IBM,
represented approximately 8% of our total revenue. EMC has recently agreed to
resell products offered by two of our competitors, and nothing restricts EMC
from expanding those relationships in a manner that could be adverse to us.
After the offering and the proposed distribution by EMC of our Class A common
stock to its stockholders, if our business relationship with EMC ends or
significantly changes, resulting in reduced sales to EMC, our revenue will be
significantly reduced.
IF EMC DOES NOT COMPLETE ITS DISTRIBUTION OF OUR CLASS A COMMON STOCK, EMC WILL
CONTINUE TO BE IN A POSITION TO EXERCISE CONTROL OVER OUR BUSINESS AND THE
LIQUIDITY OF OUR CLASS B COMMON STOCK IN THE PUBLIC MARKET MAY BE CONSTRAINED.
EMC currently intends, subject to, among other things, obtaining approval
by the EMC board of directors and a ruling from the Internal Revenue Service
that EMC's proposed distribution of our Class A common stock indirectly held by
it will be tax-free to EMC and its stockholders, to distribute to its
stockholders on a pro rata basis all of our Class A common stock that it owns
approximately six to twelve months after this offering, although it is not
obligated to do so. This distribution may not occur by that time or at all. At
the time of this offering, we will not know what the ruling from the Internal
Revenue Service regarding the tax treatment of the distribution will be. If EMC
does not receive a favorable tax ruling, it is not likely to make the
distribution by the anticipated time or at all. If the distribution is delayed
or not completed, the liquidity of our Class B common stock in the public market
may be constrained unless and until EMC elects to sell some of its significant
ownership of our company. The sale or potential sale by EMC of all or a
significant portion of our Class A common stock in the public market could
diminish market prices for our
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Class B common stock. Because of the limited liquidity of the Class B common
stock until the proposed distribution occurs, relatively small trades of our
Class B common stock may have a disproportionate effect on the stock price for
our Class B common stock. Until this distribution occurs, the risks discussed
below relating to EMC's control of us and the potential business conflicts of
interest between EMC and us will continue to be relevant to our stockholders.
WE WILL BE CONTROLLED BY EMC AS LONG AS IT OWNS A MAJORITY OF THE COMBINED
VOTING POWER OF OUR COMMON STOCK, AND OUR OTHER STOCKHOLDERS WILL BE UNABLE TO
AFFECT THE OUTCOME OF STOCKHOLDERS' VOTING DURING THAT TIME.
Immediately after the completion of this offering of shares of our Class B
common stock, EMC will continue to own 100% of our Class A common stock through
McDATA Holdings Corporation, which will represent approximately 97% of the
combined voting power of all classes of our voting stock. In addition, EMC is
not prohibited from selling a controlling interest in us to a third-party or to
third parties. As long as EMC controls a majority of the voting power of our
outstanding common stock, EMC will continue to be able to elect our entire board
of directors and to remove any director, with or without cause. Investors in
this offering will not be able to affect the outcome of any stockholder vote
prior to the planned distribution of our stock to the EMC stockholders. As a
result, EMC will control all matters affecting us, including:
- the composition of our board of directors and, through it, any
determination with respect to our business direction and policies,
including the appointment and removal of officers;
- any determinations with respect to mergers, acquisitions or other
business combinations;
- our acquisition or disposition of assets;
- our financing;
- the payment of dividends on our common stock; and
- determinations with respect to our tax returns.
The ability of EMC to affect the outcome of any stockholder vote could
delay or prevent someone from acquiring or merging with us and could prevent you
from receiving a premium for your shares of Class B common stock.
WE MAY HAVE POTENTIAL BUSINESS CONFLICTS OF INTEREST WITH EMC WITH RESPECT TO
OUR PAST AND ONGOING RELATIONSHIPS, AND BECAUSE OF EMC'S CONTROLLING OWNERSHIP,
WE MAY NOT RESOLVE THESE CONFLICTS ON THE MOST FAVORABLE TERMS TO US.
Conflicts of interest may arise between EMC and us in a number of areas
relating to our past and ongoing relationships including:
- tax, indemnification and other matters arising in connection with our
past and current position as a subsidiary of EMC and as a member of EMC's
consolidated financial reporting group;
- intellectual property matters;
- environmental matters;
- employee retention and recruiting;
- sales or distribution by EMC of all or any portion of its ownership
interest in us; and
- business opportunities that may be attractive to both EMC and us.
Subject to certain exceptions, for a period of two years after the
completion of this offering, EMC has agreed that it will not develop or
manufacture products that are competitive to our
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products. For the same period of time and subject to certain exceptions, we have
agreed not to develop or manufacture products that are competitive to EMC's
products. Upon the termination of that non-competition restriction, EMC may
compete directly with us. In addition, EMC has recently entered into reseller
relationships with two of our competitors, and nothing restricts EMC from
expanding or extending those relationships in a manner that could adversely
affect our business.
We may not be able to resolve any potential conflicts, and even if we do,
the resolution may be less favorable than if we were dealing with an
unaffiliated party. The agreements that we have entered into with EMC may be
amended upon agreement between the parties. While we are controlled by EMC, EMC
may be able to require us to agree to amendments to these agreements that may be
less favorable to us than the current terms of the agreements or agreements not
negotiated in a parent-subsidiary context.
SOME OF OUR DIRECTORS AND EXECUTIVE OFFICERS MAY HAVE CONFLICTS OF INTEREST
BECAUSE OF THEIR OWNERSHIP OF EMC CAPITAL STOCK.
Some of our directors and executive officers own a substantial amount of
EMC common stock and options to purchase EMC common stock. In addition, one of
our directors, David A. Donatelli, is currently employed by EMC. Ownership of
EMC common stock by our directors and officers or the position of employment by
Mr. Donatelli at EMC could create, or appear to create, potential conflicts of
interest when directors and officers are faced with decisions that could have
different implications for EMC and us.
RISKS RELATING TO THE SECURITIES MARKETS AND OWNERSHIP OF OUR COMMON STOCK
SUBSTANTIAL SALES OF OUR COMMON STOCK MAY OCCUR AFTER THIS OFFERING, WHICH COULD
CAUSE OUR STOCK PRICE TO DECLINE.
EMC currently intends to distribute the 81 million shares of our Class A
common stock it indirectly owns to EMC stockholders on a pro rata basis
approximately six to twelve months after this offering. Substantially all of
these shares will be eligible for immediate resale in the public market. We are
unable to predict whether significant amounts of our Class B common stock will
be sold in the open market in anticipation of, or following, this distribution.
We are also unable to predict whether a sufficient number of buyers of Class B
common stock will be in the market at that time. In addition, current holders of
our Class B common stock hold a substantial number of shares, which they will be
able to sell in the public market in the near future. Any sales of substantial
amounts of our Class B common stock in the public market, or the perception that
such sales might occur, whether as a result of EMC's distribution of the Class A
common stock or otherwise, could harm the market price of the Class B common
stock being offered by us.
OUR STOCK PRICE MAY BE VOLATILE, WHICH COULD SUBJECT US TO CLASS ACTION
LITIGATION AND PREVENT YOU FROM RESELLING YOUR SHARES AT OR ABOVE THE INITIAL
PUBLIC OFFERING PRICE.
The stock market has recently experienced extreme volatility. In addition,
the market prices of securities of technology companies have recently been
particularly volatile and have experienced fluctuations that have often been
unrelated or disproportionate to the operating performance of such companies.
These market fluctuations may cause the stock price of our Class B common stock
to fall regardless of our performance.
In the past, securities class action litigation often has been brought
against companies following periods of volatility in the market price of their
securities. If the market price of our common stock is volatile, we may be the
target of similar litigation. Securities litigation could result in substantial
costs
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and divert management's attention and resources and seriously harm our business,
financial condition and results of operations.
The initial public offering price for our Class B common stock may vary
from the market price of our Class B common stock after the offering. The market
price of our Class B common stock may fluctuate significantly in response to
factors, some of which are beyond our control, including the following:
- actual or anticipated fluctuations in our operating results;
- announcements by us or our competitors of significant technical
innovations, product releases, contracts, acquisitions, strategic
partnerships, joint ventures or capital commitments;
- the loss of EMC, or any of our other original equipment manufacturer
customers, IBM, or any of our other distributors, or any of our value
added resellers; and
- the distribution of our Class A common stock by EMC to its stockholders.
Because the market price of our Class B common stock may fluctuate
significantly, if you purchase shares of our Class B common stock in this
offering, you may not be able to resell those shares at or above the initial
offering price.
PROVISIONS IN OUR CHARTER DOCUMENTS AND DELAWARE LAW COULD PREVENT OR DELAY A
CHANGE IN CONTROL OF McDATA AND MAY REDUCE THE MARKET PRICE OF OUR COMMON STOCK.
Provisions of our certificate of incorporation and by-laws may discourage,
delay or prevent a merger, acquisition or other business combination 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;
- limiting the persons who may call special meetings of stockholders;
- requiring super-majority voting for stockholder action by written
consent;
- establishing advance notice requirements for nominations for election to
the board of directors and for proposing other matters that can be acted
on by stockholders at stockholder meetings;
- prohibiting cumulative voting for the election of directors; and
- requiring super-majority voting to effect certain amendments to our
certificate of incorporation and by-laws.
We are incorporated in Delaware and certain provisions of Delaware law may
also discourage, delay or prevent someone from acquiring or merging with us,
which may cause the market price of our Class B common stock to decline.
PROVISIONS OF OUR AGREEMENTS WITH EMC RELATING TO OUR RELATIONSHIP WITH EMC
AFTER THE DISTRIBUTION BY EMC OF OUR CLASS A COMMON STOCK INDIRECTLY HELD BY IT
TO ITS STOCKHOLDERS MAY AFFECT THE OPERATION OF OUR BUSINESS, LIMIT OUR ABILITY
TO FINANCE OUR OPERATIONS, PREVENT A CHANGE IN CONTROL OF OUR COMPANY AND REDUCE
THE MARKET PRICE OF OUR CLASS B COMMON STOCK.
Under the terms of the Tax Sharing Agreement between EMC and us, until 27
months after the date of EMC's distribution of our Class A common stock
indirectly held by it to its stockholders, we may not, without the consent of
EMC or the receipt by EMC of a private letter ruling from the Internal Revenue
Service that the tax treatment of the distribution will not be adversely
affected:
- enter into any transaction that would result in any person acquiring a
50% or greater interest in us;
- take or fail to take any other action which would cause the distribution
to be taxable to EMC stockholders;
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- issue stock or other equity interests in us, or redeem or repurchase any
of our capital stock which would involve the acquisition by one or more
persons of more than 35% of our stock; or
- undertake any transaction which would be treated as a liquidation or
reorganization for tax purposes.
These restrictions may prevent us from being acquired, either in a
negotiated transaction or otherwise, from using shares of our common stock as
payment in the acquisition by us of other companies or from financing our
operations through sales of securities.
Under the terms of the Master Confidential Disclosure and License Agreement
between EMC and us, EMC has granted us a license under existing EMC patents. If
we are acquired, our acquiror will retain this license as long as our acquiror
grants to EMC a license under all of the acquiror's patents for all products
licensed under the agreement under the same terms as the license we have granted
to EMC under the agreement. The potential loss of the license from EMC after an
acquisition of us by a third party may make an acquisition of us by a third
party unlikely.
WE MAY BE OBLIGATED TO INDEMNIFY EMC FROM TAXES RELATING TO THE FAILURE OF THE
DISTRIBUTION BY EMC OF OUR CLASS A COMMON STOCK INDIRECTLY HELD BY IT TO ITS
STOCKHOLDERS TO BE TAX FREE.
The Tax Sharing Agreement that we have entered into with EMC obligates us
to indemnify EMC from taxes relating to the failure of EMC's distribution to
EMC's stockholders of our Class A common stock that it indirectly holds to be
tax free if that failure results from, among other things:
- any act or omission by us that would cause the distribution to fail to
qualify as a tax free distribution under the Internal Revenue Code;
- any act or omission by us that is inconsistent with any representation
made to the Internal Revenue Service in connection with the request for a
private letter ruling regarding the tax-free nature of the distribution
by EMC of our Class A common stock indirectly held by it to its
stockholders;
- any acquisition by a third party of our stock or assets; or
- any issuance by us of stock or any change in ownership of our stock.
As a result, we may be liable to EMC under the Tax Sharing Agreement upon
the occurrence of events that are beyond our control. If the distribution of our
Class A common stock fails to qualify as a tax-free distribution, EMC would
incur tax liability as if our Class A common stock that was distributed by EMC
had been sold by EMC for its fair market value in a taxable transaction. In the
event that we are required to indemnify EMC because the distribution of our
Class A common stock fails to qualify as a tax-free distribution, our liability
could exceed 35% of the value of the Class A common stock distributed by EMC as
determined on the date of the distribution.
19
<PAGE> 23
OUR RELATIONSHIP WITH EMC AFTER THE OFFERING
OVERVIEW
After the completion of the offering described in this prospectus, EMC,
through its wholly-owned subsidiary, McDATA Holdings Corporation, will continue
to own 100% of our outstanding Class A common stock, which will represent,
immediately following this offering, approximately 97% of the combined voting
power of our Class A and Class B common stock, which are all classes of our
voting stock. Until EMC holds less than a majority of the combined voting power
of our outstanding common stock, EMC will be able to control the vote on all
matters submitted to stockholders, including the election of directors and the
approval of extraordinary corporate transactions. In addition, in the event that
we issue any securities of any class, or any other event occurs that would
result in EMC having less than 50% of the combined voting power of our capital
stock, EMC has the right to acquire a portion of those securities such that it
will retain greater than 50% of the combined voting power of our capital stock.
As a result, EMC can effectively retain, in its discretion, at least 50% of the
combined voting power of all our capital stock.
THE DISTRIBUTION BY EMC OF OUR CLASS A COMMON STOCK
EMC currently plans to liquidate McDATA Holdings Corporation and to
distribute all of the shares of our Class A common stock to the holders of its
common stock approximately six to twelve months after the offering. However, EMC
is not obligated to complete the distribution, and we cannot assure you as to
whether or when it will occur.
EMC has advised us that it will not complete the distribution if its board
of directors determines that the distribution is no longer in the best interests
of EMC and its stockholders. EMC has further advised us that it currently
expects that the principal factors it would consider in determining whether and
when to complete the distribution include:
- the issuance by the Internal Revenue Service of a ruling that the
proposed distribution would be tax-free to EMC and its stockholders;
- the relative market prices of our Class B common stock and EMC's common
stock;
- the absence of any court orders or regulations prohibiting or restricting
the completion of the distribution; and
- other conditions affecting our business or that of EMC.
ANTICIPATED BENEFITS OF THE OFFERING AND DISTRIBUTION
We believe that our contemplated complete separation from EMC will benefit
us by, among other things:
- Facilitating future partnerships, combinations and other arrangements
with other companies. As a separate company, we will have a greater
ability to partner with other companies. In particular, companies that
compete with EMC directly in the development and sale of products not
currently developed and sold by us may be more willing to enter into
arrangements with us as a separate company than they would with us prior
to the separation.
- Providing more direct access to capital markets. As a public company, we
will have more direct access to the capital markets to issue debt or
equity securities and to grow through acquisitions.
20
<PAGE> 24
- Allowing us greater ability to develop the McDATA brand name. As a
separate company, we will be better able to build awareness of our McDATA
brand as we position ourselves as the leading provider of enterprise-wide
SAN switching solutions.
AGREEMENTS BETWEEN MCDATA AND EMC
In October 1997, in connection with the reorganization of our business, we
entered into agreements with EMC relating to our business, our relationship with
EMC after the 1997 reorganization and the manufacture and supply of ESCON
switching devices for IBM. In addition, we have recently entered into agreements
with EMC in connection with this offering and EMC's contemplated distribution of
our Class A common stock to its stockholders that govern various ongoing
relationships between EMC and us, including agreements with respect to future
purchases of our products by EMC, information management, intellectual property,
tax sharing and other matters.
These agreements were made in the context of a parent-subsidiary
relationship and were negotiated in the overall context of the 1997
reorganization, this offering and the proposed distribution by EMC of the shares
of our Class A common stock owned by it to its stockholders. The terms of these
agreements may be less favorable than those we could have negotiated with
unaffiliated third parties. For more information regarding the separation
arrangements, see "Arrangements Between McDATA and EMC."
21
<PAGE> 25
INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements. The forward-looking
statements are contained principally in the sections entitled "Prospectus
Summary," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Business." These statements involve known and
unknown risks, uncertainties and other factors that may cause our actual
results, performance or achievements to be materially different from any future
results, performances or achievements expressed or implied by the
forward-looking statements.
In some cases, you can identify forward-looking statements by terms such as
"may," "will," "should," "could," "would," "expects," "plans," "anticipates,"
"believes," "estimates," "projects," "predicts," "potential" and similar
expressions intended to identify forward-looking statements. These statements
reflect our current views with respect to future events and are based on
assumptions and subject to risks and uncertainties. Given these uncertainties,
you should not place undue reliance on these forward-looking statements. We
discuss many of these risks in greater detail in "Risk Factors." Also, these
forward-looking statements represent our estimates and assumptions only as of
the date of this prospectus.
You should read this prospectus and the documents that we incorporate by
reference in this prospectus completely and with the understanding that our
actual future results may be materially different from what we expect. We
qualify all of our forward-looking statements by these cautionary statements.
22
<PAGE> 26
USE OF PROCEEDS
We estimate that our net proceeds from the sale of the 12,500,000 shares of
our Class B common stock that we are offering will be approximately
$233,165,000, or $268,415,000 if the underwriters exercise their over-allotment
option in full, at an assumed initial public offering price of $20.00 per share
and after deducting estimated underwriting discounts, commissions and our
estimated offering expenses.
The primary purposes of this offering are to achieve greater visibility for
our company, obtain additional working capital, create a public market for our
Class B common stock and facilitate our future access to public markets.
We expect to use $1.9 million of the net proceeds from the offering to
repay a promissory note in favor of McDATA Holdings Corporation in the principal
amount of $1.9 million, which bears interest at the prime rate and matures upon
the completion of this offering. We intend to use the remainder of the net
proceeds from this offering primarily for general corporate purposes, including
working capital, increased marketing expenses to establish the McDATA brand,
expansion of our selling and marketing services organizations, development of
new distribution channels, expansion of research and development efforts and
improvement of our operational and financial systems. We have not allocated any
portion of the net proceeds for any specific purpose. We may use a portion of
the net proceeds from this offering to acquire or invest in businesses,
technologies or services that are complementary to our business. However, we
have no present plans or commitments and are not engaged in any negotiations
with respect to any transaction of this type.
We may use up to approximately $12.0 million of the net proceeds from this
offering to acquire approximately 90 acres of land in Broomfield, Colorado. We
have entered into a letter of intent to acquire the land, subject to certain
conditions. Under this letter of intent, we have six months to conduct due
diligence on the property to determine its suitability for our requirements. We
may terminate the letter of intent for any reason during this six month period.
If we determine to purchase the land after conducting our due diligence, we may
then develop the land for a corporate campus for our company or sell the land to
a third party to be developed and leased back to us. If we decide to develop the
land ourselves, we may finance such development through the use of additional
proceeds from this offering.
We will retain broad discretion in the allocation and use of the net
proceeds of this offering. We intend to invest the remainder of the net proceeds
in short-term, interest bearing investment-grade securities.
DIVIDEND POLICY
We have never declared or paid cash dividends on shares of our capital
stock. We intend to retain any future earnings to finance growth and do not
anticipate paying cash dividends in the foreseeable future.
23
<PAGE> 27
CAPITALIZATION
The following table sets forth our capitalization as of June 30, 2000:
- on an actual basis;
- on an as adjusted basis to reflect the sale of 12,500,000 shares of Class
B common stock in this offering at an assumed initial public offering
price of $20.00 per share and the application of the net proceeds, after
deducting estimated underwriting discounts and commissions, our estimated
offering expenses and the repayment of short-term debt due parent.
You should read this table together with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and our consolidated
financial statements and the related notes appearing elsewhere in this
prospectus.
The outstanding share information excludes 12,839,624 shares of our Class B
common stock issuable on exercise of options outstanding at June 30, 2000, with
a weighted average exercise price of $3.26 per share. In addition, as of June
30, 2000, 3,208,150 shares of our Class B common stock have been reserved for
issuance under our stock option plan.
<TABLE>
<CAPTION>
AS OF JUNE 30, 2000
-----------------------
ACTUAL AS ADJUSTED
-------- -----------
(IN THOUSANDS, EXCEPT
SHARE DATA)
<S> <C> <C>
Short-term debt -- Parent................................... $ 1,900 $ --
-------- --------
Long-term portion of capital lease obligations.............. 1,719 $ 1,719
Stockholders' equity:
Preferred stock, $0.01 par value; 25,000,000 shares
authorized; no shares issued or outstanding, actual and
as adjusted............................................ -- --
Common stock, Class A, $0.01 par value, 250,000,000 shares
authorized; 81,000,000 shares issued and outstanding,
actual and as adjusted................................. 810 810
Common stock, Class B, $0.01 par value; 200,000,000 shares
authorized; 12,952,226 shares issued and outstanding,
actual; 200,000,000 shares authorized; 25,452,226
shares issued and outstanding, as adjusted............. 130 255
Additional paid-in capital................................ 56,457 289,498
Deferred compensation..................................... (17,496) (17,496)
Retained earnings......................................... 4,084 4,084
-------- --------
Total stockholders' equity............................. 43,985 277,151
-------- --------
Total capitalization................................... $ 47,604 278,870
======== ========
</TABLE>
24
<PAGE> 28
DILUTION
The pro forma net tangible book value of all of our common stock as of June
30, 2000 was approximately $43.2 million or $0.46 per share of common stock. Pro
forma net tangible book value per share represents the amount of our total
tangible assets reduced by the amount of our total liabilities, divided by
93,952,226 shares of common stock outstanding at June 30, 2000. After giving
effect to our sale of 12,500,000 shares of Class B common stock in this offering
at an assumed initial offering price of $20.00 per share and after deducting the
estimated underwriting discounts and commissions and our estimated offering
expenses, our net tangible book value at June 30, 2000 would have been
approximately $274.5 million, or $2.58 per share of common stock. This
represents an immediate increase in net tangible book value of $2.12 per share
to existing stockholders and an immediate dilution in net tangible book value of
$17.42 per share to purchasers of common stock in this offering, as illustrated
in the following table:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share of our Class
B common stock............................................ $20.00
Net tangible book value per share as of June 30, 2000..... $0.46
Increase in net tangible book value per share attributable
to new investors....................................... 2.12
-----
Net tangible book value per share after this offering....... 2.58
------
Dilution per share to new investors......................... $17.42
======
</TABLE>
The following table summarizes, on a pro forma basis, as of June 30, 2000,
the differences between the number of shares of common stock purchased from us,
the aggregate cash consideration paid to us and the average price per share paid
by existing stockholders and new investors purchasing shares of our Class B
common stock in this offering. The calculations below are based on an assumed
initial public offering price of $20.00 per share, before deducting estimated
underwriting discounts and commissions and estimated offering expenses payable
by us:
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
---------------------- ----------------------- PRICE PER
NUMBER PERCENT AMOUNT PERCENT SHARE
----------- ------- ------------ ------- ---------
<S> <C> <C> <C> <C> <C>
Existing stockholders..... 93,952,226 88.3% $ 21,101,000 8.0% $ 0.23
New stockholders.......... 12,500,000 11.7 250,000,000 92.0 $20.00
----------- ----- ------------ -----
Total................... 106,452,226 100.0% $271,101,000 100.0% $ 2.55
===== =====
</TABLE>
The cash consideration paid by the existing stockholders does not include
the value of the assets transferred to us by McDATA Holdings Corporation in
exchange for our Class A common stock.
As of June 30, 2000, there were options outstanding to purchase a total of
12,839,624 shares of our Class B common stock at a weighted average exercise
price of $3.26 per share. The exercise of these outstanding stock options would
not significantly further dilute new investors as the net tangible book value
after this offering will be $2.58 per share. For more information, see
"Management -- Employee Benefit Plans" and the notes to our consolidated
financial statements.
25
<PAGE> 29
SELECTED CONSOLIDATED FINANCIAL DATA
You should read the following selected consolidated financial data in
conjunction with our consolidated financial statements and related notes and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," and other financial information appearing elsewhere in this
prospectus. The consolidated statements of operations data set forth below with
respect to the years ended December 31, 1997, 1998 and 1999, and the
consolidated balance sheets data as of December 31, 1998 and 1999 are derived
from our audited financial statements appearing elsewhere in this prospectus.
The consolidated statements of operations data set forth below with respect to
the years ended December 31, 1995 and 1996 and the consolidated balance sheets
data at December 31, 1995, 1996 and 1997 are derived from unaudited consolidated
financial statements not included in this prospectus. The consolidated
statements of operations data for the six months ended June 30, 1999 and 2000
and the consolidated balance sheet data as of June 30, 2000 are derived from
unaudited consolidated financial statements appearing elsewhere in this
prospectus, which, in the opinion of our management, reflect all normal
recurring adjustments that we consider necessary for a fair presentation of such
information in accordance with generally accepted accounting principles.
Historical results are not necessarily indicative of the results of any future
period.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEARS ENDED DECEMBER 31, JUNE 30,
----------------------------------------------- ------------------
1995(1) 1996(1) 1997(1) 1998 1999 1999 2000
------- ------- ------- ------- ------- ------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Product revenue.................................. $11,851 $ 5,370 $ 4,035 $ 5,242 $29,466 $ 9,558 $ 26,475
Product revenue -- Parent........................ -- 526 1,336 5,632 48,111 13,264 68,794
Service revenue -- Parent........................ 22,438 26,304 27,652 25,674 17,686 11,368 8,326
------- ------- ------- ------- ------- ------- --------
Total revenue.................................... $34,289 $32,200 $33,023 $36,548 $95,263 $34,190 $103,595
Total cost of revenue............................ 9,907 8,004 11,270 13,105 50,082 16,300 49,948
------- ------- ------- ------- ------- ------- --------
Gross profit..................................... 24,382 24,196 21,753 23,443 45,181 17,890 53,647
------- ------- ------- ------- ------- ------- --------
Operating expense................................ 19,955 15,265 22,983 32,008 45,454 19,674 35,966
------- ------- ------- ------- ------- ------- --------
Income (loss) from operations.................... 4,427 8,931 (1,230) (8,565) (273) (1,784) 17,681
------- ------- ------- ------- ------- ------- --------
Net income (loss)................................ $ 2,805 $ 5,770 $(3,224) $(2,468) $(1,033) $(1,993) $ 10,827
======= ======= ======= ======= ======= ======= ========
Basic net income (loss) per share(2)............. $ 0.03 $ 0.06 $ (0.04) $ (0.03) $ (0.01) $ (0.02) $ 0.12
======= ======= ======= ======= ======= ======= ========
Shares used in computing basic net income (loss)
per share(2)................................... 91,000 91,000 91,000 91,000 91,638 91,017 93,398
Diluted net income (loss) per share(2)........... $ 0.03 $ 0.06 $ (0.04) $ (0.03) $ (0.01) $ (0.02) $ 0.11
======= ======= ======= ======= ======= ======= ========
Shares used in computing diluted net income
(loss) per share(2)............................ 91,000 91,000 91,000 91,000 91,638 91,017 100,088
Pro forma net income (loss)(3)................... $ (935) $ 10,854
======= ========
Pro forma net income (loss) per share (3)........ $ (0.01) $ 0.12
======= ========
Shares used in computing pro forma net income
(loss) per share(3)............................ 91,740 93,500
Pro forma diluted net income (loss) per share
(3)............................................ $ (0.01) $ 0.11
======= ========
Shares used in computing pro forma diluted net
income (loss) per share (3).................... 91,740 100,190
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------- JUNE 30,
1995 1996 1997 1998 1999 2000
------- ------- ------- ------- ------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Total assets............................................... $22,558 $26,593 $36,813 $39,383 $48,350 $73,739
Working capital............................................ 7,853 13,092 22,016 14,028 15,739 27,343
Debt payable to parent..................................... -- -- 1,900 1,900 1,900 1,900
Long-term portion of capital lease obligations............. 550 388 335 1,262 1,175 1,719
Total stockholders' equity................................. 10,660 16,431 28,465 25,999 29,550 43,985
</TABLE>
-------------------------
(1) In October 1997, EMC reorganized McDATA to separate our fibre channel
devices business from EMC. As part of this reorganization, we became a
company focused on designing, developing, manufacturing and selling fibre
channel switching devices. As a result, the historical financial information
for the three years ended December 31, 1997 has been adjusted to reflect the
impact of the reorganization as if it occurred at the beginning of 1995.
26
<PAGE> 30
(2) Per share computations for 1995, 1996 and 1997 have been calculated using
the actual number of shares issued on October 1, 1997 because the capital
structure for prior periods was not indicative of the current structure. Per
share computations for 1995, 1996 and 1997 are, therefore, pro forma per
share data.
(3) Pro forma per share computations have been calculated assuming that a
portion of the proceeds from this offering were used to repay the $1.9
million in short term debt -- Parent on January 1, 1999 for the year ended
December 31, 1999 and on January 1, 2000 for the six month period ended June
30, 2000. The pro forma net income (loss) is adjusted to add back the
interest expense incurred related to the debt during the respective periods.
The pro forma shares used to compute the pro forma net income (loss) per
share, on both a basic and diluted basis, were adjusted to reflect the
number of shares issued pursuant to this offering to repay the short term
debt -- Parent.
27
<PAGE> 31
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion and analysis in conjunction with
"Selected Consolidated Financial Data" and our consolidated financial statements
and the related notes appearing elsewhere in this prospectus.
OVERVIEW
We were acquired by EMC in December 1995. In October 1997, EMC reorganized
our company to separate our fibre channel switching devices business from EMC.
At that time we were re-incorporated in Delaware and became an indirect,
majority-owned subsidiary of EMC through its direct, wholly-owned subsidiary,
McDATA Holdings Corporation. As part of the reorganization, we became a company
focused on designing, developing, manufacturing and selling fibre channel
switching devices that enable enterprise-wide high performance, storage area
networks, or SANs. We also continue to provide services for McDATA Holdings
Corporation's ESCON switch business under a services agreement. Since 1997, when
we focused our business on fibre channel switching devices, we have incurred
losses in all but the two most recent fiscal quarters.
We are a provider of fibre channel switching solutions for enterprise
storage applications. We sell our switching solutions through leading original
equipment manufacturers, such as EMC, and resellers, such as IBM. In addition,
we have recently entered into a distribution agreement with Hitachi Data
Systems. We also sell our products and services to distribution channel
partners, including solutions providers and systems integrators, who combine our
switching products with other system elements and services for enterprise data
centers. In addition, we provide manufacturing and distribution management
services to McDATA Holdings Corporation for ESCON switching solutions
manufactured for and sold exclusively to IBM. In 1998 and 1999, revenues from
EMC were approximately 86% and 69% of our total revenues, respectively; revenues
from Hewlett-Packard Company were approximately 3% and 13% of our total
revenues, respectively, and revenues from IBM were approximately 2% and 11% of
our total revenues, respectively. Although we plan to expand our target customer
base in 2000 and 2001, we may not be successful in our efforts to diversify our
product offerings and introduce these products to a larger number of customers.
We currently derive substantially all of our revenues from a limited number
of products. During 1998 and 1999, substantially all of our revenues were
derived from sales of our ED-5000 Enterprise Fibre Channel Director, our ES-2500
Enterprise Fibre Channel Switch and the FICON Bridge card sold exclusively to
IBM.
We generally recognize product revenue when products are shipped to
customers. We do not provide our customers with product return programs.
Reserves for warranty repairs are provided based upon historical warranty
repairs experience. Service and maintenance revenues are recognized as earned.
We do not have long term purchase commitments from our customers. Our
customer contracts typically contain provisions regarding pricing, rescheduling,
order cancellation, warranties, licensing, limitations of liability and field
support. In addition, our original equipment manufacturer customer contracts
typically contain further provisions regarding product specifications,
manufacturing, labeling, shipping arrangements and forecasts.
Our gross profit percentage may be impacted by changes in average unit
selling prices due to competitive pressures, fluctuations in manufacturing
volumes, the mix of products sold and the introduction of new products.
Additionally, our future gross profit percentage may be impacted by the mix of
distribution channels through which our products are sold. We expect our gross
profit
28
<PAGE> 32
percentage from product sales to EMC to decline in future periods as a result of
recently negotiated pricing on future products, partially offset by expected
declines in unit manufacturing costs.
We currently outsource a significant portion of the manufacturing of the
components that are used in our products to SCI Systems, Inc., a third-party
manufacturer. A significant portion of our cost of revenues consists of payments
to SCI. Our agreement with SCI provides for rolling purchase orders and rolling
six month forecasts. Component purchase prices are typically negotiated on an
ongoing basis. We are liable for materials that SCI purchases on our behalf that
are not consumed in preparing components for us and cannot be redirected to
other uses by SCI. We conduct final test and assembly, manufacturing,
engineering, quality assurance and repair at our primary manufacturing facility
in Louisville, Colorado.
Research and development expenses consist primarily of salaries and related
personnel expenses, materials used in fabrication of prototype equipment, fees
paid to consultants, testing agencies and other service providers, design tools
and equipment, and computer support services expenses. We believe that continued
investment in research and development is critical to the success of our future
operations.
Selling and marketing expenses consist primarily of salaries, commissions
and related personnel expenses, fees paid to consultants, advertisers and other
service providers, and travel expenses. We expect selling and marketing expenses
to increase as we add field sales personnel in order to expand market awareness
and generate increased sales of our products. However, we cannot give any
assurances that increased expenditures will result in higher net revenues.
General and administrative expenses consist primarily of salaries and
related personnel expenses, fees paid for legal, accounting and other
professional services, and other general corporate expenses. We expect general
and administrative expenses to increase as we add personnel and incur costs
related to the anticipated growth of our business and the infrastructure
required to operate as a public company.
29
<PAGE> 33
RESULTS OF OPERATIONS
The following table sets forth certain financial data for the periods
indicated as a percentage of total revenues.
<TABLE>
<CAPTION>
YEARS ENDED SIX MONTHS ENDED
DECEMBER 31, JUNE 30,
------------------------ -----------------
1997 1998 1999 1999 2000
----- ------ ----- ------- ------
<S> <C> <C> <C> <C> <C>
Revenue:
Product revenue................................ 12.2% 14.3% 30.9% 28.0% 25.6%
Product revenue -- Parent...................... 4.0 15.4 50.5 38.8 66.4
Service revenue -- Parent...................... 83.8 70.3 18.6 33.2 8.0
----- ------ ----- ------ -----
Total revenue............................... 100.0 100.0 100.0 100.0 100.0
Cost of revenue:
Cost of product revenue........................ 13.0 10.4 22.3 20.7 14.1
Cost of product revenue -- Parent.............. 2.1 8.8 24.3 18.7 31.9
Cost of service revenue -- Parent.............. 19.0 16.7 6.0 8.2 2.2
----- ------ ----- ------ -----
Total cost of revenue....................... 34.1 35.9 52.6 47.6 48.2
----- ------ ----- ------ -----
Gross profit..................................... 65.9 64.1 47.4 52.4 51.8
----- ------ ----- ------ -----
Operating expenses:
Research and development....................... 50.0 50.1 25.2 30.2 16.6
Selling and marketing.......................... 11.4 28.2 16.6 20.8 13.5
General and administrative..................... 8.2 9.3 4.1 5.4 2.8
Amortization of deferred compensation.......... -- -- 1.8 1.2 1.8
----- ------ ----- ------ -----
Total operating expenses.................... 69.6 87.6 47.7 57.6 34.7
----- ------ ----- ------ -----
Income (loss) from operations.................... (3.7) (23.4) (0.3) (5.2) 17.1
Interest income (expense), net................... 1.0 0.8 (0.9) (1.2) (0.0)
----- ------ ----- ------ -----
Income (loss) before income taxes................ (2.7) (22.6) (1.2) (6.4) 17.1
Income tax expense (benefit)..................... 7.1 (15.8) (0.1) (0.6) 6.7
----- ------ ----- ------ -----
Net income (loss)................................ (9.8)% (6.8)% (1.1)% (5.8)% 10.4%
===== ====== ===== ====== =====
</TABLE>
Six Months ended June 30, 1999 and 2000
Revenues
Total revenue increased by approximately 203% to $103.6 million for the six
months ended June 30, 2000 from $34.2 million for the six months ended June 30,
1999. This increase was primarily due to an increase in revenue for unit sales
of McDATA's ED-5000 Enterprise Fibre Channel Director sold primarily to EMC to
$68.8 million from $13.3 million for the first six months of 1999 and an
increase in revenue for unit sales of the FICON Bridge card sold exclusively to
IBM to $13.4 million from $1.0 million for the first six months of 1999. This
increase was offset in part by a decline in revenue under the ESCON service
agreement of 26.8% from the first six months of 1999 compared to the comparable
period in 2000 due to reduced sales of ESCON switch products by McDATA Holdings
Corporation. We anticipate that service revenue from McDATA Holdings
Corporation, which relates to sales of ESCON products to IBM, will continue to
decrease in the future. As ESCON revenue continues to decrease we anticipate
that it will represent an increasingly smaller percentage of total revenue.
30
<PAGE> 34
Gross Profit
Gross profit increased by approximately 199.9% to $53.6 million for the six
months ended June 30, 2000 from $17.9 million for the six months ended June 30,
1999. Gross profit percentages were relatively unchanged between the periods.
Gross profit percentages on product sales were approximately 50% in the six
months ended June 30, 2000, compared to approximately 41% in the comparable
period of 1999, reflecting a much higher proportion from sales of our ED-5000
product in the current year period, which has earned significantly higher
profits than the mix of products sold in the prior year period. The increase in
gross profit percentage reflects increased sales of fibre channel products in
the first six months of 2000, partially offset by increased manufacturing
expenses and reduced gross profit attributable to the decline in ESCON service
contract fee revenue. We expect our gross profit percentage from product sales
to EMC to decline in future periods as a result of recently negotiated pricing
on future products partially offset by expected declines in unit manufacturing
costs. Manufacturing expenses increased in the first six months of 2000 compared
to the comparable period in 1999 due to expenses associated with reengineering
production processes and increased manufacturing staffing levels, as the number
of manufacturing employees increased to 80 at June 30, 2000 from 56 at June 30,
1999, to accommodate production of multiple fibre channel product lines
simultaneously.
Operating Expenses
Research and Development. Research and development expenses increased by
approximately 67% to $17.2 million for the first six months of 2000 from $10.3
million for the first six months of 1999. The increase was due primarily to
increased staffing levels, which increased approximately 25% from 1999, and to
expenditures for prototype materials, design consulting services and other
materials and services, which increased approximately 337% to $5.1 million for
the first six months of 2000 from $1.2 million for the first six months of 1999.
Sales and Marketing Expenses. Selling and marketing expenses increased by
approximately 97% to $14.0 million for the first six months of 2000 from $7.1
million for the first six months of 1999. This increase was due primarily to
increased staffing levels, as the number of selling and marketing employees
increased to 129 at June 30, 2000 from 67 at June 30, 1999, increases in costs
of approximately $0.6 million associated with recruiting and relocating
employees, increases in costs of approximately $0.7 million associated with
expanding and operating our field offices and integration laboratory for product
demonstration and systems integration testing, and $0.6 million increased
expenses associated with consulting and public relations programs to increase
brand awareness.
General and Administrative Expenses. General and administrative expenses
increased by approximately 59% to $2.9 million for the first six months of 2000
from $1.8 million for the first six months of 1999. This increase was due
primarily to increased staffing levels, as the number of administrative
employees increased to 70 at June 30, 2000 from 55 at June 30, 1999, increases
in costs of approximately $0.2 million associated with recruiting and relocating
employees and increases in costs of approximately $0.3 million for business
system consulting and facility move expenses.
Amortization of Deferred Compensation. During 1999 and the first six
months of 2000, we recorded deferred compensation of $19.8 million and $2.5
million, respectively, in connection with stock options grants. We are
amortizing this amount on a straight-line basis over the vesting period of the
applicable options, resulting in amortization expense of $0.4 million and $2.5
million in the six months ended June 30, 1999 and 2000, respectively (of which
approximately $23,000 and $620,000, respectively, is included in cost of product
and service revenue).
Provision for Income Taxes. The effective tax rates for the six months
ended June 30, 2000 and 1999 were 38.9% and 9.8%, respectively. The effective
tax rate in 2000 increased primarily due to
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<PAGE> 35
the amortization of deferred compensation, which is not deductible for income
tax purposes. As we become independent of the consolidated EMC group for tax
filing purposes, we expect our tax rates to approximate statutory federal and
state income tax rates.
Years Ended December 31, 1997, 1998 and 1999
Revenue
Product revenue, including sales to EMC, increased approximately 613% to
$77.6 million for the year ended December 31, 1999 from $10.9 for the year ended
December 31, 1998. Product revenue, including unit sales to EMC, increased
approximately 102% to $10.9 million for the year ended December 31, 1998 from
$5.4 million for the year ended December 31, 1997. These increases primarily
reflect increased sales of our ED-5000 Fibre Channel Director to EMC and the
FICON Bridge card to IBM during 1998 and 1999. Service revenue from McDATA
Holdings Corporation, which consist of fees earned under McDATA's service fee
arrangement for producing ESCON director products, decreased approximately 31%
to $17.7 million for the year ended December 31, 1999 from $25.7 million for the
year ended December 31, 1998. Service revenue from EMC decreased by
approximately 7% to $25.7 million for the year ended December 31, 1998 from
$27.7 million in the year ended December 31, 1997. Actual revenue realized from
McDATA's service fee arrangement have declined due to reduced shipments of ESCON
director products in 1998 and 1999 in comparison to 1997. We anticipate that
service fees from McDATA Holdings Corporation will continue to decrease.
Gross Profit
Our gross profit increased approximately 93% to $45.2 million for the year
ended December 31, 1999 from $23.4 million for the year ended December 31, 1998.
Our gross profit increased approximately 8% to $23.4 million for the year ended
December 31, 1998 from $21.8 million for the year ended December 31, 1997. Our
gross profit percentage decreased to 47% in 1999, from 64% in 1998. This
decrease in gross profit percentage is primarily due to the change in mix
between products and sales service fees. Gross profit percentage on the service
fee arrangement has exceeded those earned from product sales. Gross profit
percentage on product revenue in 1999 of approximately 43% increased from 1998,
reflecting a larger component of 1999 activity attributable to sales of McDATA's
director class product; the gross profit percentage on the director class
product is higher than the margins earned on non-director class products
manufactured by third parties and resold by us. We expect our gross profit
percentage from product sales to EMC to decline as a result of recently
negotiated pricing on future products, partially offset by expected declines in
unit manufacturing costs. Our gross profit percentage decreased to 64% for the
year ended December 31, 1998 from 66% for the year ended December 31, 1997. This
decrease primarily reflects reductions in both service fees earned and in gross
profit percentage realized from the service fee arrangement. The decline in
gross profit percentage from the service fee arrangement partially reflects
generally higher manufacturing expenses incurred by us in preparation for the
simultaneous production of multiple fibre channel product lines.
Operating Expenses
Research and Development. Research and development expenses increased
approximately 31% to $24.0 million in the year ended December 31, 1999 from
$18.3 million in year ended December 31, 1998. Research and development
increased approximately 11% to $18.3 million in the year ended December 31, 1998
from $16.5 million in the year ended December 31, 1997. These increased expenses
primarily reflect increased staffing levels and expenses related to the
completion of development for fibre channel products introduced during 1998 and
1999.
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<PAGE> 36
Selling and Marketing. Selling and marketing expenses increased
approximately 53% to $15.8 million in the year ended December 31, 1999 from
$10.3 million in year ended December 31, 1998. Selling and marketing expenses
increased approximately 175% to $10.3 million in the year ended December 31,
1998 from $3.7 million in the year ended December 31, 1997. The increase in 1998
reflects increased staffing levels and increased use of market data and public
relations consultants. The increased expenditures in 1999 primarily reflect
increased staffing levels, establishment of compensation plans related to field
sales and support activities and investments in demonstration equipment and
facilities.
General and Administrative. General and administrative expenses increased
approximately 16% to $3.9 million in the year ended December 31, 1999 from $3.4
million in the year ended December 31, 1998. General and administrative expenses
increased approximately 25% to $3.4 million in the year ended December 31, 1998
from $2.7 million in the year ended December 31, 1997. The increase in
expenditures from 1997 to 1998 reflected expenses incurred during 1998 related
to implementing a new business system and redeploying personnel and fixtures
within our facilities. The increased expenditures in 1999 primarily reflected
increased staffing levels and increased expenditures in facilities and
networking equipment to support our overall expansion in staffing levels.
Amortization of Deferred Compensation. During 1999, we recorded deferred
compensation of $19.8 million in connection with stock option grants. We are
amortizing this amount on a straight-line basis over the vesting period of the
applicable options, resulting in amortization expense of $2.2 million in 1999
(of which, approximately $511,000 is included in cost of product and service
revenue). No compensation was recorded in 1997 or 1998.
Provision for Income Taxes. The effective tax rates for 1997, 1998 and
1999, were (261.8)%, 70.1%, and 9.8%, respectively. These rates are not
indicative of our future expected effective tax rates. At December 31, 1997, we
had recorded a valuation allowance of $2,650,000 for the full amount of
estimated deferred tax assets. Management estimated that it was more likely than
not that such benefits would not be realized based upon our operating history,
thus negating the impact of tax benefits for 1997. As of December 31, 1998,
management determined that a valuation allowance was no longer required (see
Note 10 to the Consolidated Financial Statements). The effective tax rate for
1999 was significantly reduced by the portion of the pre-tax loss associated
with amortization of deferred compensation, a portion of which is not deductible
for income tax purposes. Following EMC's contemplated distribution of all of its
shares of our Class A common stock, with the exception of the effects related to
deferred compensation, we anticipate that our effective federal tax rate will
approximate the statutory tax rate.
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<PAGE> 37
QUARTERLY RESULTS OF OPERATIONS
The following tables set forth certain unaudited statement of operations
data for each of the six quarters ended June 30, 2000, as well as such data
expressed as a percentage of our total revenue for the quarters presented. This
unaudited quarterly information has been prepared on the same basis as our
audited financial statements and, in management's opinion, reflects all normal
recurring adjustments that we consider necessary for a fair presentation of the
information for the periods presented. Operating results for any quarter are not
necessarily indicative of results for any future period.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
----------------------------------------------------------------
MAR. 31, JUN. 30, SEPT. 30, DEC. 31, MAR. 31, JUN. 30,
1999 1999 1999 1999 2000 2000
-------- -------- --------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Revenue:
Product revenue................... $ 2,943 $ 6,615 $ 6,550 $13,358 $13,760 $12,715
Product revenue -- Parent......... 4,764 8,500 13,211 21,636 29,271 39,523
Service revenue -- Parent......... 5,456 5,912 2,900 3,418 4,103 4,223
------- ------- ------- ------- ------- -------
Total revenue.................. $13,163 $21,027 $22,661 $38,412 $47,134 56,461
Cost of revenue:
Cost of product sales............. 2,212 4,861 4,521 9,660 7,781 6,818
Cost of product sales -- Parent... 2,479 3,929 6,198 10,542 13,513 19,533
Cost of services -- Parent........ 1,404 1,415 1,424 1,437 1,183 1,120
------- ------- ------- ------- ------- -------
Total cost of revenue.......... 6,095 10,205 12,143 21,639 22,477 27,471
------- ------- ------- ------- ------- -------
Gross profit........................ 7,068 10,822 10,518 16,773 24,657 28,990
------- ------- ------- ------- ------- -------
Operating expenses:
Research and development.......... 4,739 5,582 6,529 7,151 7,644 9,550
Selling and marketing............. 3,341 3,760 3,723 4,963 5,856 8,127
General and administrative........ 859 974 1,081 1,026 1,357 1,558
Amortization of deferred
compensation................... 137 282 482 825 933 941
------- ------- ------- ------- ------- -------
Total operating expenses....... 9,076 10,598 11,815 13,965 15,790 20,176
------- ------- ------- ------- ------- -------
Income (loss) from operations....... (2,008) 224 (1,297) 2,808 8,867 8,814
Interest income (expense), net...... (186) (239) (284) (163) (35) 74
------- ------- ------- ------- ------- -------
Income (loss) before income taxes... (2,194) (15) (1,581) 2,645 8,832 8,888
Income tax expense (benefit)........ (214) (2) (155) 259 3,520 3,373
------- ------- ------- ------- ------- -------
Net income (loss)................... $(1,980) $ (13) $(1,426) $ 2,386 $ 5,312 $ 5,515
======= ======= ======= ======= ======= =======
</TABLE>
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<PAGE> 38
<TABLE>
<CAPTION>
AS A PERCENTAGE OF TOTAL REVENUES
--------------------------------------------------------------------------
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, MARCH 31, JUNE 30,
1999 1999 1999 1999 2000 2000
--------- -------- ------------- ------------ --------- --------
<S> <C> <C> <C> <C> <C> <C>
Revenue:
Product revenue.......... 22.4% 31.5% 28.9% 34.8% 29.2% 22.5%
Product
revenue -- Parent..... 36.2 40.4 58.3 56.3 62.1 70.0
Service
revenue -- Parent..... 41.4 28.1 12.8 8.9 8.7 7.5
----- ----- ----- ----- ----- -----
Total revenue......... 100.0 100.0 100.0 100.0 100.0 100.0
Cost of revenue:
Cost of product
revenue............... 16.8 23.1 20.0 25.2 16.5 12.1
Cost of product
revenue -- Parent..... 18.8 18.7 27.3 27.4 28.7 34.6
Cost of service
revenue -- Parent..... 10.7 6.7 6.3 3.7 2.5 2.0
----- ----- ----- ----- ----- -----
Total cost of
revenue............. 46.3 48.5 53.6 56.3 47.7 48.7
----- ----- ----- ----- ----- -----
Gross profit............... 53.7 51.5 46.4 43.7 52.3 51.3
----- ----- ----- ----- ----- -----
Operating expenses:
Research and
development........... 36.0 26.6 28.8 18.6 16.2 16.9
Sales and marketing...... 25.4 17.9 16.4 12.9 12.4 14.4
General and
administrative........ 6.5 4.6 4.8 2.7 2.9 2.7
Amortization of deferred
compensation.......... 1.1 1.3 2.1 2.2 2.0 1.7
----- ----- ----- ----- ----- -----
Total operating
expenses............ 69.0 50.4 52.1 36.4 33.5 35.7
----- ----- ----- ----- ----- -----
Income (loss) from
operations............... (15.3) 1.1 (5.7) 7.3 18.8 15.6
Income (expense), net...... (1.4) (1.2) (1.3) (0.4) (0.1) 0.1
----- ----- ----- ----- ----- -----
Loss before income taxes... (16.7) (0.1) (7.0) 6.9 18.7 15.7
Income tax expense
(benefit)................ (1.6) -- (0.7) 0.7 7.5 (5.9)
----- ----- ----- ----- ----- -----
Net income (loss).......... (15.1)% (0.1)% (6.3)% 6.2% 11.2% 9.8%
===== ===== ===== ===== ===== =====
</TABLE>
Revenue. The increases in our total product revenue in each of the six
quarters presented above primarily reflect quarterly increases in unit shipment
volumes of our ED-5000 Fibre Channel Director and FICON Bridge card products.
The quarter-to-quarter changes in service revenue from McDATA Holdings
Corporation reflect changes in the shipments of ESCON products to IBM.
Gross Profit. Our gross profit in the three months ended June 30, 1999 and
September 30, 1999 increased to $10.8 million and $10.5 million, respectively,
from $7.1 million in the three months ended March 31, 1999 primarily due to
increased product revenue, including sales to EMC. Our gross profit in the three
months ended December 31, 1999 increased to $16.8 million, primarily due to
increased product revenues, including sales to EMC. Our gross profit percentage
in the three months ended December 31, 1999 of approximately 44% was less than
the prior quarters due to costs associated with inventory writeoffs and order
cancellation fees for a discontinued product. Our gross profit in the three
months ended June 30, 2000 increased to $29.0 million, primarily reflecting
increased products sold to EMC. We expect our gross profit percentage from
product sales to EMC to decline in future periods as a result of recently
negotiated pricing on future products, partially offset by expected declines in
unit manufacturing costs.
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<PAGE> 39
Operating Expenses. Operating expenses increased each of the last six
quarters primarily due to increased staffing levels and other expenditures in
research and development and sales and marketing. We expect costs in these areas
to continue to increase.
LIQUIDITY AND CAPITAL RESOURCES
We have funded our operations through second quarter 2000 primarily through
funds received from McDATA Holdings Corporation and John F. McDonnell in
exchange for our capital stock in connection with our reorganization in October
1997, and borrowings from EMC. Cash generated from operations was $7.6 million
for the year ended December 31, 1999, reflecting improved results from
operations during the second half of 1999. Cash provided by operations in the
six months ended June 30, 2000 of $3.8 million funded our expenditures for
personnel, equipment and services to continue expansion of our fibre channel
business.
Our principal sources of liquidity at June 30, 2000 consisted of our
equipment financing arrangements, which totaled approximately $4.0 million at
June 30, 2000, and a note payable to McDATA Holdings Corporation, which totaled
approximately $1.9 million at June 30, 2000. The note payable to McDATA Holdings
Corporation is unsecured and bears interest at the prime rate as published in
the Wall Street Journal, which was 9.5% at June 30, 2000. Borrowings under our
equipment financing arrangements are secured by the related capital equipment
and are payable through March 31, 2003. We intend to repay $1.9 million borrowed
from McDATA Holdings Corporation, if any remain outstanding, with a portion of
the net proceeds of this offering.
We believe the net proceeds of this offering, together with existing cash
balances and borrowing facilities to be negotiated with a bank, will be
sufficient to meet our capital and operating requirements at least through the
next twelve months, although we could be required, or could elect, to seek
additional funding prior to that time.
Our manufacturing and headquarters operations are currently in separate
locations. In June 2000, we entered into a letter of intent to acquire, subject
to certain conditions, approximately 90 acres of land at a cost of approximately
$12.0 million for the purpose of consolidating our operations. Under this letter
of intent, we made a fully refundable $100,000 earnest money deposit and have
six months to conduct due diligence on the property to determine its suitability
for our requirements. We may terminate the letter of intent for any reason
during this six month period and have our earnest money deposit fully refunded.
If we determine to complete the purchase after conducting our due diligence, we
may develop the land for a corporate campus for our company or may enter into
agreements to have the land sold and developed by a third party and leased back
to us. We have not yet entered into negotiations regarding the development of
the property or the financing of such development and have not prepared an
estimate of the potential cost of development. If we decide to proceed, we may
finance the development through the use of proceeds of this offering, direct
bank financing, third-party financing under a sale/leaseback or synthetic lease
arrangement, some other financing arrangement that may be available at the time
the development commences, or a combination of these financing sources. If we
determine to proceed with the development of a corporate campus, it is likely
that financing will be required within six months after the offering and the
development activities may take up to 24 months to complete.
Our future capital requirements will depend on many factors, including our
rate of revenue growth, the timing and extent of spending to support development
of new products and expansion of sales and marketing, the timing of new product
introductions and enhancements to existing products, and market acceptance of
our products.
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<PAGE> 40
YEAR 2000 COMPLIANCE
The year 2000 issue arises from the ability of computer programs to
distinguish 21st century dates from 20th century dates due to the two digit date
fields used by many systems. Failure to distinguish these dates properly could
result in system failures or disruptions of operations for companies using these
computer programs or hardware. Many companies' computer systems may still need
to be upgraded or replaced in order to avoid year 2000 issues.
We, our suppliers, our customers and other third parties we rely upon use a
wide variety of information technologies, computer systems and other equipment
containing computer chips dedicated to a specific task. As of July 10, 2000,
neither we nor, to our knowledge, any of the third parties we depend upon, have
experienced any material problems associated with the year 2000 issue. If we or
these third parties experience problems in the future as a result of any year
2000-related issues, our operations could be adversely affected. We will face
year 2000 risks if we encounter undetected errors or defects in systems used by
us to run our business, including information systems, equipment and facilities
or if our suppliers encounter undetected errors or defects in systems used by
them. We currently are unable to estimate the duration and extent of any
potential year 2000 issues that may affect us, or estimate the effect that any
such issues may have on our future revenue. We cannot be certain that year 2000
issues will not have a material adverse impact on us.
INFLATION
We believe that our revenue and results of operations have not been
significantly impacted by inflation during the last three fiscal years.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities." SFAS 133 is effective for all fiscal quarters of all
fiscal years beginning after June 15, 2000. We adopted SFAS 133 on January 1,
1999. To date, we have not entered into any derivative instruments, so the
adoption has had no effect on our financial position or results of operations.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 "Revenue Recognition in Financial Statements", as
amended. SAB 101 summarizes certain of the Securities and Exchange Commission's
views in applying generally accepted accounting principles to revenue
recognition in financial statements. We have applied the provisions of SAB 101
in the consolidated financial statements. The adoption of SAB 101 did not have a
material impact on our financial condition or results of operations.
QUALITATIVE AND QUANTITATIVE DISCLOSURE ABOUT MARKET RISK
Our interest income is sensitive to changes in the general level of U.S.
interest rates, as all of our investments are in cash equivalents. Due to the
nature of our short-term investments, we do not believe that we have had
material exposure to market risk. Therefore, no quantitative tabular disclosures
are presented.
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<PAGE> 41
BUSINESS
OVERVIEW
We are the leading provider of high availability storage director switching
devices that enable enterprises to connect and centrally manage large numbers of
storage and networking devices. We design, develop, manufacture and sell
switching devices that enable enterprise-wide high performance storage area
networks, or SANs. Our products enable business enterprises to cost-effectively
manage growth in storage capacity requirements, improve the networking
performance of their servers and storage systems, and scale the size and scope
of their SAN or other information infrastructure while allowing them to operate
data-intensive applications on the SAN. We sell our products through industry
leading original equipment manufacturers and resellers, including EMC and IBM,
as well as systems integrators. We are focused on leveraging our leadership
position in providing high availability storage director switching devices to
become the leading provider of comprehensive switching solutions for the entire
business enterprise.
INDUSTRY BACKGROUND
Significant growth in critical data requirements
During the past decade, the volume and value of data created throughout
business enterprises has increased dramatically. As a result, the demand for
data storage capacity has exploded as enterprises increasingly need to access,
process and manipulate data that is critical to their businesses. International
Data Corporation, an independent information technology research firm known as
IDC, estimates that multi-user disk storage grew from more than 7,000 terabytes
in 1993 to more than 185,000 terabytes in 1999, and will reach more than 1.9
million terabytes in 2003. One terabyte consists of one trillion bytes. This
growth in the volume of data storage has been driven by a number of factors
including:
- the rapid expansion of data intensive applications such as e-mail, data
mining and enterprise resource planning;
- the increase in complexity of enterprise computing environments and use
of multiple, incompatible servers and operating systems;
- the need to store redundant copies of enterprise data for business
continuance applications;
- the increase in the number of users accessing the network;
- the growth of e-commerce;
- the rapid growth of web hosting, digital video and other multimedia
applications; and
- the decline in the cost of storage as a result of advances in storage
technology.
In addition, organizations have recognized that rapid and reliable access
to enterprise data 24 hours a day, 7 days a week, 365 days a year (24x7) is
essential to operating a business. The growing dependence on data for
fundamental business processes has greatly increased the number of input-output
data storage transactions required of storage servers and systems. The continued
deployment of client-server and Internet-based applications combined with the
rapid growth of enterprise data has placed significant strain on traditional
data storage architectures. Furthermore, the increased use of open-system
computing environments, which link multiple applications, files and databases to
networked computers, makes the task of data management increasingly difficult.
As a result, data storage products and services have accounted for an increasing
percentage of business enterprises' information technology budgets and
management resources.
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<PAGE> 42
Business enterprises have historically attempted to support and manage data
requirements by directly attaching storage devices to the individual servers on
a local area network. Servers communicate in this direct attached environment
using the small computer systems interface. The small computer systems interface
protocol, however, has several drawbacks, including a short transport distance,
limited performance and capacity of the connection, limited configuration
flexibility, low reliability and inability to support more than a limited number
of connections. According to IDC, advances in technology increased local area
network transmission speeds by 100 times during the 1990's, while
storage-to-server data transmission speeds utilizing the small computer systems
input-output interface have increased less than 20 times during this period. The
result has been significant congestion at the point of communication between
storage systems and servers.
To address the limitations of traditional server-to-storage connections,
fibre channel technology and related industry standards evolved in the early
1990's as a means to facilitate high-performance storage connectivity. Fibre
channel technology is a reliable, gigabit interconnect technology that allows
concurrent communications among data storage systems and workstations, servers
and other peripherals using small computer system interface and networking
protocols. "Fibre" refers to the optical or copper cable through which the
communication among data storage systems and workstations, servers and other
peripherals flows. Connecting network devices through fibre channel technology
enables the efficient and reliable transfer of data from one network device to
another, allowing access from any server to any storage device on the network.
Fibre channel offers the connectivity, distance and access benefits of a
network, combined with the high performance and increased capacity of a channel.
Since its introduction, fibre channel technology has earned widespread
acceptance from industry and independent testing organizations. IDC forecasts
that the market for fibre channel host bus adapters, hubs and switches will
exceed $4 billion by 2003.
The emergence of storage area networks (SANs)
The introduction of fibre channel technology to facilitate high performance
storage connectivity has facilitated the development of storage area networks.
SANs enable fast, efficient and reliable transfer of data between multiple
storage devices and servers to improve the management of data within a business
enterprise. SANs also permit the traffic from storage applications to be handled
outside of the local area network by decoupling computer storage systems from
servers, which enhances the local area network's performance. SANs advance the
traditional small computer systems interface-based direct attached storage and
server configuration to a network of storage devices that can be accessed by
multiple servers and network users, significantly increasing the performance and
availability of enterprise data storage.
SANs are typically configured in either a switched fabric or arbitrated
loop topology. A fibre channel switch or two or more fibre channel switches
interconnected in such a way that data can be physically transmitted between any
two ports on any of the switches is referred to as a "fabric." Fabric allows
business enterprises to connect any device on the network to any other device on
the network. Fabric switching configurations enable every device on the network
to have full network bandwidth. Arbitrated loop topology is the simplest SAN
configuration, which interconnects up to approximately 126 devices on the
network. In an arbitrated loop configuration, unlike a fabric configuration, all
devices share available network bandwidth on the network, resulting in decreased
performance as the number of devices in the loop increases.
A SAN incorporates one or more classes of networking devices that connect
the SAN with server and storage devices. These devices are:
- Storage Director -- the backbone device that enables the broadest
connectivity of servers and storage devices in a SAN configuration. It
has the highest bandwidth performance and provides the highest number of
ports per size of device (which is referred to as port density)
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<PAGE> 43
of all SAN networking devices. A director class switch, unlike other
types of SAN networking devices, has built throughout its design fault
tolerant technology, which allows the switch to continue performing its
function when one or more of its components have failed, and redundancy,
which is achieved by including spare, or "redundant," components in the
architecture of the switch that, in the event of failure of functioning
switch components, assume the function of those failed components.
Storage directors support a fabric configuration and provide a highly
available platform for a centralized SAN management system. Directors can
be used in configurations that connect large numbers of servers with
multi-terabyte storage arrays in either a fabric or arbitrated loop
configuration.
- Storage Switch -- a device that addresses typical department level
requirements to connect a range of server and storage devices with less
capability than a director. Storage switches provide increased
flexibility in building larger SAN configurations and higher performance
than storage hubs. Typical configurations connect a limited number of
servers with multi-hundred gigabyte storage arrays.
- Storage Hub -- a networking device that addresses entry level, or
workgroup, performance requirements. Storage hubs link servers with
storage devices in an arbitrated loop configuration in which all devices
on the network share available bandwidth. Some hubs offer basic device
level management but do not offer fabric or centralized SAN management.
Typical workgroup configurations use a hub to connect one to four servers
with one or two storage array devices.
The following diagram depicts a configuration of servers and storage
devices using the three types of networking devices in a SAN that are referenced
above.
EDGAR DESCRIPTION, SEE FOLLOWING
[The diagram depicts a SAN configuration showing a storage director linked to
enterprise UNIX servers, enterprise disk storage devices, a tape library and to
storage switches. In addition, the diagram depicts storage switches linked to
departmental UNIX servers, departmental disk storage devices, a LAN, NT servers
and a storage hub which, in turn, is linked to a tape library.]
Although still in its early stages of development, the SAN market is
expected to grow rapidly. According to Dataquest, an independent industry
research company, more than 70% of newly installed shared storage in networked
environments is projected to be SANs by the year 2002. IDC
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<PAGE> 44
forecasts that worldwide SAN storage systems market revenue will grow from an
estimated $3.4 billion in 1999 to over $13.8 billion in 2003, representing a
compound annual growth rate of approximately 42%. This includes SAN systems
shipped both with and without mainframe servers.
Many fibre channel SAN solutions being installed today are deployed on a
distributed and localized basis across an end-user's enterprise. Consequently,
isolated "islands" of information are created throughout the enterprise, each of
which must be administered and managed locally. As a result of this localized
approach, enterprises have experienced difficulty in accessing and sharing
information on an enterprise-wide basis, preventing them from realizing the full
SAN benefits of managing a centralized data network.
As organizations deploy SANs across the enterprise, they seek to address
the following requirements:
- Provide the ability to scale. Enterprises deploy SANs in order to
provide the ability to scale servers and storage capacity independently,
connecting hundreds of storage devices or subsystems to multiple servers,
allowing users to scale and upgrade the capabilities of their information
infrastructures for demanding enterprise data needs.
- Ensure interoperability. Enterprises require SAN infrastructure
interoperability, which allows them to integrate SAN products into
existing storage architectures, thereby preserving investments in legacy
equipment.
- Offer on-demand access to data. Enterprises demand SAN products that are
designed with significant high availability, functionality and features
that address the demand for information infrastructures with substantial
fault tolerance and higher availability of data.
- Promote cost effective use and management of data. Enterprises require
SAN products designed to provide centralized monitoring and control of
storage and networking devices across the enterprise. This enables
enterprise users to minimize downtime by monitoring, detecting, isolating
and troubleshooting faults as they occur, thereby lowering the total cost
of ownership as SAN resources are utilized more efficiently.
- Optimize performance in an increasingly complex information
infrastructure. Enterprises rely on SANs to provide multiple users
simultaneous access to stored data over independent paths within the SAN.
This permits access to data by more users than is possible with
traditional storage architectures. SAN switches need to provide high port
count and throughput capability. These features enable higher performance
and more cost effective scaling because more devices can be connected
than with clustered switches.
In order to address these requirements, organizations are increasingly
adopting an enterprise-wide strategy to SAN deployment, requiring SAN
infrastructure providers to adopt features and practices that deliver on the
full promise of SANs.
THE MCDATA SOLUTION
We are the leading provider of high availability storage director switching
devices for connecting servers and storage devices. We combine years of
experience in designing, developing and manufacturing high performance switching
technologies with a knowledge of business critical applications, service and
support to solve complex business problems at the core of a business
enterprise's data infrastructure. Our solutions include hardware and software
products, methodologies and education that enable businesses to scale their
operations globally through a comprehensive, manageable, flexible data
infrastructure that is optimized for rapid deployment and responsiveness to
customer needs. We believe that the completeness of our preconfigured hardware,
software and services necessary to provide interoperable SAN solutions will
enable us to be one of the first
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companies to offer enterprise-wide SAN solutions to our customers. The
advantages of our solutions include the following:
- Scalability -- Dynamic Growth. Our solutions are designed to enable
users to consolidate, add or reconfigure servers and storage devices
within an enterprise-wide network of data storage and switching devices.
The architecture of our products is designed to permit businesses to
expand their computing and storage resource needs without causing
business interruption or a decline in overall storage system performance.
- Connectivity -- Interoperability. We are at the forefront of providing
products that interoperate with the majority of popular servers and
storage devices. Our products are designed to protect customers'
investment in their information infrastructures.
- Availability -- Information Anywhere, Anytime. Our SAN solutions are
designed to offer users a reliable and a highly available information
infrastructure. Our products are designed to provide maximum availability
by using fault-tolerant technology incorporating spare, or "redundant,"
components in the architecture of the product. These products offer
internally redundant capabilities that enable customers to run their
businesses on a 24x7 basis with 99.999%, or "five-nines," operational
availability.
- Manageability -- Comprehensive Control for Low Total Cost of
Ownership. Our switching and network management software solutions are
designed to enable customers to manage their entire SAN fabric from a
central point. For example, our Enterprise Fabric Connectivity Manager
Software is designed to minimize downtime by proactively monitoring,
detecting and isolating fabric conditions that may interrupt the access
to or availability of data. Our products are easy to install and operate,
have powerful, built-in diagnostic capabilities designed to enhance
troubleshooting methods that reduce the time it takes to restore a fabric
to full operation. Product features simplify the overall administration,
service and support of the infrastructure, permitting more efficient use
of personnel and increased data availability.
- Performance -- High Price to Performance Value. Our products are
designed to offer maximum performance throughout a fabric as the increase
in business applications drives growth in storage and server connections.
Our product architecture is designed to provide customers with a higher
number of ports per size of device to achieve a lower price-per-port than
products offering lower port counts per device in a networked group of
devices.
THE MCDATA STRATEGY
We are focused on becoming the leading provider of enterprise-wide SAN
switching solutions. The key elements of our strategy are the following:
- Capitalize on our market leadership. We intend to capitalize on our
market leadership in providing storage director switching devices through
continual enhancement of our existing products and the development of new
products. We have extensive experience in developing high availability
switching solutions that are essential to business computing, including
SAN solutions and other information infrastructures.
- Leverage technology leadership to provide an enterprise-wide
solution. We intend to leverage our leadership in high availability
storage director switching devices technology for the data center
environment and our backbone infrastructure experience to expand our
common application specific integrated circuit, or ASIC, architecture
into products that are suitable for other segments of the enterprise. To
extend the industry leading technology of our high availability storage
director switching devices, we plan to offer a complete portfolio of
managed switching solutions for the entire enterprise. We will leverage
our backbone infrastructure experience to enable customers to architect,
design and deploy large scale, centrally managed, enterprise-wide SAN
solutions with a high level of infrastructure availability, performance
and manageability. The key attributes of our director class product, our
experience in the enterprise
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and our expanded hardware and software products will provide customers
with a complete line of solutions for their entire enterprise SAN
infrastructure requirements.
- Extend leadership in interoperability. We intend to lead the development
and establishment of the next generation of standards for the SAN and
information infrastructure industry. We pioneered and currently chair the
Open Standards Fabric Initiative, which focuses on the development and
deployment of industry standards to advance interoperability among fibre
channel switch products. In addition, we have developed and operate a
state-of-the-art interoperability lab that enables us to develop products
that we certify as interoperable with a wide variety of SAN and other
information infrastructures. Our leadership of the Open Standards Fabric
Initiative and our continued investment in our interoperability efforts
will enable us to define and support standards for new SAN market
opportunities.
- Develop and deploy a fabric management system. We intend to leverage our
Enterprise Fabric Connectivity Manager installed base to deploy a fabric
switching and network management software system that enables
multi-device, multi-vendor software-based management. We will combine the
capabilities of our ASIC technology with our management software products
to achieve high availability through the fabric. We will invest in our
network management software tools to continuously improve overall fabric
performance. Our network management software works in conjunction with
McDATA management software tools and other system and storage management
platforms to provide a proactive, single system view capability that is
required to provide the highest availability of data.
- Expand multi-channel distribution capability across the enterprise. We
will continue to develop and expand our direct assist sales model with
our existing and future original equipment manufacturer, reseller and
systems integrator customers. With these new relationships, we intend to
develop new markets both in the United States and abroad. We have
recently entered into renewed arrangements with EMC and IBM. Our future
success depends in part on the successful creation of an open market
channel through distributors and resellers. To this end, we have
developed a network of leading distributor and reseller partners. We
intend to enter into agreements with additional distributors and
resellers, both in the United States and abroad, to increase our
geographic coverage and address new vertical markets.
- Increase brand awareness. We plan to actively build awareness of our
brand to position ourselves as the leading provider of high performance,
highly available SAN and information infrastructure products for
enterprise business applications. We will extend our brand through our
distribution and original equipment manufacturer partners. We intend to
promote our brand through increased investment in a range of marketing
programs, including advertising in industry print publications, trade
show participation, direct marketing and public relations.
McDATA PRODUCTS
McDATA designs, develops, manufactures and sells switching devices and
related software that enable enterprise-wide high performance SANs. We are a
technology and market leader for storage director switching devices. We are
developing a comprehensive suite of SAN switching products that leverage the
core technology advantages of our hardware and software design architecture to
address the connectivity needs of business enterprises.
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The following table summarizes the key features and functions of our
primary products:
[PRIMARY PRODUCTS GRAPH]
* We are conducting final systems verification testing on the ES-1000 with plans
to initiate initial beta customer activities in the third quarter of 2000. We
expect the ES-1000 to be commercially available in the second half of 2000.
ED-5000 Enterprise Fibre Channel Director. The ED-5000 provides high
performance switching for mass storage clusters and client-server environments.
The ED-5000 is a 32-port fibre channel switch that offers high-performance
connectivity and high availability as well as shared network management protocol
support in high-end open systems, such as those using UNIX, Windows2000 and
Linux. The product is a high-end solution for applications requiring gigabit
performance and 24x7 operation. The ED-5000 provides full redundancy in a
non-blocking, any-to-any, 32-port, configuration within the switch. The major
sub-assemblies of the ED-5000 are "hot-swappable," meaning that a replacement
may be substituted for a defective assembly while the product is performing its
normal functioning, thereby allowing customers to replace and service the unit
without interrupting the basic operation of the switch.
ES-1000 Fibre Channel Switch. The ES-1000 is an entry level fibre channel
switching device that, when combined with the ED-5000 Director, enables an
end-to-end switching solution for the consolidation of workgroup and department
level storage and servers. High availability features include redundant fans,
power supplies and other components. The ES-1000 switch is equipped to be
managed with our enterprise software products, providing a centralized,
fabric-wide statistical view of the entire storage network.
Software Products. Our management software products, branded Enterprise Fabric
Connectivity Manager, which are licensed separately from our other products,
leverage our director class experience to provide open-systems network
management capabilities. The Enterprise Fabric Connectivity Manager platform
utilizes standards-based and proprietary technologies to provide user-friendly
distributed network management configuration and control capabilities. Using
Java-based and
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client-server technologies, we have designed the Enterprise Fabric Connectivity
Manager management architecture to be operating system independent.
FabricReady Solutions. Our FabricReady solutions are comprised of our
director products and other SAN networking devices and form comprehensive
enterprise storage connectivity solutions. These FabricReady offerings are
preconfigured and qualified with hardware, software and services necessary to
provide interoperable SAN solutions. FabricReady offerings provide customers and
channel partners with an integrated, application based SAN solution for solving
business critical problems across the enterprise. It offers customers a
predictable and reliable way to deploy SAN solutions into their production
environments while substantially minimizing overall risks and the costs
associated with new technologies. FabricReady services combine our long standing
commitment and investments in interoperability with the capability to provide
complete end-to-end SAN infrastructure solutions based on the integration and
rigorous testing of applications. We currently provide FabricReady solutions for
NT and Sun consolidation and local area network-free back-up applications.
Protocol routers and host bus adapters represent significant enabling
technologies that provide an essential part of a total FabricReady solution.
Host bus adapters are required to provide the fibre channel interface on the
server platforms. We offer the majority of popular interfaces from leading
vendors such as Emulex Corporation, Jaycor and QLogic Corporation as part of a
qualified packaged solution to end-user and systems integrator channels.
The small computer system interface to fibre channel router devices are
another key element in our FabricReady solutions portfolio. The EB-1200 is sold
as part of a bundled solution to end-user and systems integrator channels. The
EB-1200 provides two 16-bit small computer system interface ports and one 1.062
gigabit fibre channel port connection for customers requiring fibre channel
connectivity to existing small computer system interface devices. Additionally,
we are working with router companies, including Crossroads Systems, Inc. and
Chaparral Network Storage, Inc. to integrate and qualify third party software to
enable serverless back-up.
FICON Bridge. We designed and manufacture the FICON(TM) feature card
within IBM's 9032 Model 5 Director that functions as a bridge between FICON and
ESCON protocols. FICON is designed to provide fibre channel connectivity to
mainframe storage devices. FICON takes advantage of the American National
Standards Institute fibre channel standard transport with the introduction of
IBM's performance-enhancing S/390 layer. The FICON Bridge card helps provide
customers with investment protection for currently installed ESCON control
units, such as disk storage and tape control units.
TECHNOLOGY
We have developed ASIC technology that serves as the foundation for the
development of a complete family of SAN products. Our ASICs provide building
blocks at the circuit level for implementing fibre channel switches. These ASICs
combine a number of fibre channel functions in a single chip that substantially
reduces the number of components needed in our fibre channel switches. Our years
of design expertise in fibre channel technology and large scale switching
solutions allows us to deploy high availability SAN fabrics.
These ASICs are used in our next generation switch products, which are
currently undergoing testing. The implementation of our new switch architecture
is based on a common hardware and software design. The architecture enables
product designs that span the high-end and mid-range storage computing
environments with gigabit performance and 24x7 operation. Our next generation of
fibre channel SAN products provides the highest port density, non-blocking,
single stage switch that enables a fabric to scale beyond 8000 ports. In
addition to the support for full duplex 1.0625 Gbps
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ports at very low latencies, generally indicating a two micro-second or less
delay in the data throughput speed of a switch, the design supports 2.125 Gbps
and future 10 Gbps links.
We expect that our next generation of switch products will include the
following characteristics:
- system status monitoring;
- ability to automatically replace faulty internal component parts without
interruption of data transmission through the switch;
- non-disruptive serviceability;
- component failure detection and reporting;
- user friendly operation;
- automated call home facilities;
- network management that supports both in-band and out-of-band systems;
and
- management via our Enterprise Fabric Connectivity Manager software
management products.
Our software product architecture is based on a McDATA-developed embedded
real-time operating system which provides state-of-the-art characteristics.
Coupled with hardware architecture, the software design delivers fibre channel
services for the entire family of SAN products, using a single, common code
image.
CUSTOMERS
Our major customers represent significant providers of enterprise storage
systems, including EMC, IBM, Hitachi Data Systems, Amdahl Corporation and
Hewlett-Packard Company. We currently market our products primarily through one
key original equipment manufacturer, EMC, and one key reseller, IBM. In 1999,
EMC accounted for approximately 69% and IBM accounted for approximately 11% of
our total revenue, respectively.
As of March 31, 2000, we had core product placements with over 400 end
users purchasing directly from us and our original equipment manufacturer and
reseller customers in the United States and internationally. The following is a
list of all of the end users that purchased McDATA products directly from us and
our original equipment manufacturer and reseller customers based on billings by
McDATA in excess of $70,000 in fiscal 1999:
International Business Machines
Corporation
EMC Corporation
Hewlett-Packard Company
Comparex Informationsystems GmbH
Amdahl Corporation
Williams Communications, Inc.
People's Bank
Netmarks Inc.
Northpoint Communications Group, Inc.
Citibank (South Dakota), N.A.
21st Century Insurance Group
Pfizer Inc.
Computer Sales International, Inc.
GE Capital Information Technology
Solutions, Inc.
Edward Jones
Our investment in building a world-class sales organization has been a
critical component of growing our installed base of products and end user
deployment in a direct-assist sales model with our original equipment
manufacturer and systems integrator partners. Our close contact with our
original equipment manufacturer and systems integrator partners provides us with
direct feedback on our products and solutions and helps accelerate our sales
cycle.
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Our success with our partners and with the market for our products is based
on our solution offerings, including professional, education and FabricReady
solutions. Over the past 18 months, we have enabled our partners to accelerate
the time to deploy their SAN solutions by leveraging our expertise with hundreds
of installations and by training over 1300 people with our education.
Our goal is to enhance our current original equipment manufacturer
partnerships, increase the proportion of our revenue from additional original
equipment manufacturer and reseller relationships and to attract additional
customers. We anticipate, however, that a significant percentage of our future
revenue may continue to be derived from a limited number of original equipment
manufacturer and reseller customers.
In addition to our original equipment manufacturer and reseller customers,
we also have relationships with systems integrators, including Berkshire
Computer Products, Netmarks Inc., Ciber, Inc., Arraid, Inc., HPS Ltd., the Salem
Computer Group and Vion Corporation. These and our other systems integrator
partners will continue to be a strategic focus for us as we continue to expand
our business and deploy our FabricReady solutions.
SALES AND MARKETING
Our sales and marketing approach is focused on an indirect sales model
executed through original equipment manufacturers, such as EMC, resellers, such
as IBM, and systems integrator customers. We support these distribution
customers in a direct assist model with our field sales and service personnel.
In addition, our professional and educational services teams are recognized
within the industry as technical experts with proven deployment methodologies
and a comprehensive fibre channel education curricula.
Our original equipment manufacturer and reseller customers incorporate our
switches into their end-user products that are installed and field-serviced by
the original equipment manufacturer technical support organizations. IBM Global
Services provides our first level of field support for all products that are
sold directly or through our indirect channel partners. The sales cycle used in
selling to an original equipment manufacturer customer can vary significantly in
terms of its length and complexity. Often, it involves the use of our testing
labs or those of our strategic partners, where substantial testing takes place.
It also often involves the submission of proposal documentation and
presentations to the customer. This sales process generally involves the
combined efforts of our sales and marketing, engineering and management teams
and can take from several weeks to more than one year.
We recently entered into a five-year agreement to sell our products to EMC
under which we will manufacture our products for EMC's internal use or for
delivery directly to EMC's end user customers. Under the terms of this
agreement, we are obligated to provide varying degrees of support for these
products to EMC's end user customers.
We also recently entered into a Resale Agreement with IBM that governs
IBM's purchases of our products and appoints IBM as a non-exclusive authorized
reselling agent of ours to resell our products and services to IBM reseller and
end-user customers. This agreement also grants to IBM the non-exclusive,
non-transferable worldwide right and license to use and to distribute software
in connection with these products. The agreement does not transfer any
intellectual property and does not commit IBM to purchase any products from us.
The agreement has an initial term of five years. Either IBM or we may terminate
the agreement in the event of a material breach without cure within 30 days or
in the event of any insolvency.
We also intend to continue to sell our products to a limited number of
systems integrators who combine our products with products of other vendors to
provide complete SAN solutions. Systems integrators typically provide
installation, service and technical support to their end-user customers.
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As of June 30, 2000, our sales organization consisted of nine sales
regions, including six in North America and one in each of Germany, the United
Kingdom and Japan. Our sales organization consisted of 129 people, including
field sales personnel, systems engineers, channel sales professionals,
professional and educational services providers and sales operations
professionals.
CUSTOMER SERVICE AND SUPPORT
We believe that superior customer service and support are critical to
maintain successful long-term relationships with our customers and enhance our
leadership position in the SAN market. This service and support will also
contribute to building our brand, as our products are introduced and integrated
with products of other manufacturers and resellers.
We provide technical support to our original equipment manufacturer
customers and systems integrators, enabling them to provide technical support to
their end users. We do this by providing training and documentation together
with 24x7 support. When a customer issue originates from our call center, we
remain in contact with the customer until the issue is resolved. Our customer
support includes a comprehensive array of full-service support elements,
including:
- 24x7 call home monitoring;
- spare parts depots;
- direct support through IBM Global Services; and
- field engineers, manufacturer-based technical support specialists and
regional support specialists available to handle on-site requirements.
MANUFACTURING
Our manufacturing facility, located in Louisville, Colorado, is
approximately 91,000 square feet. We perform final assembly and testing,
finished goods distribution, customer service repair and logistics in this
facility. We currently anticipate that this facility will be adequate for us to
meet demand for our products for the foreseeable future. In addition, we have
available additional manufacturing floor space, multiple shifts and outsourcing
options to provide significantly higher volume manufacturing capability if
required.
We subcontract a majority of our production activities, including the
manufacture, assembly and testing of a substantial part of our products. We
currently utilize SCI Systems as the primary contract manufacturer for printed
circuit board assembly and testing and box build. SCI has multiple sites in
multiple countries that can be used for disaster recovery or to significantly
expand their manufacturing capacity. We currently depend upon LSI Logic for the
production of our ASICs.
We depend on SCI, LSI Logic and our other subcontractors to deliver
high-quality products in a timely manner, but we cannot assure you that they
will be able to do so. We currently do not have a long-term supply contract with
any of our subcontractors.
We control all external test processes. We utilize comprehensive
qualification and test methodologies. Our product qualification includes the
performance of the highly accelerated life testing process, which seeks to
extend product performance and operation margins, reduce field issues due to the
gradual divergence of product performance from product specifications caused by
environmental conditions and failures caused by variability of interdependent
components or sub-components. We utilize the highly accelerated stress screening
process as part of our manufacturing test process. The highly accelerated stress
screening process seeks to remove manufacturing and component defects from our
products prior to shipping.
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RESEARCH AND DEVELOPMENT
The SAN and other information infrastructure markets are characterized by
rapid technological change, including changes in customer requirements, frequent
new product introductions and enhancements, and evolving industry standards. We
believe that continued research and development efforts are an important factor
in our ability to maintain technological competitiveness. As of June 30, 2000,
we employed 172 individuals in engineering and development efforts that are
focused on the development, enhancement and testing of switches, ASICs and the
associated software offerings that address the needs of the SAN market. In
addition, we currently have relationships with leading software companies,
including Microsoft Corporation and Tivoli, a division of IBM, to develop and
test the interoperability of our products with their software to provide end
users with more complete SAN solutions. We intend to dedicate resources to the
continued development of the fibre channel standards and to achieve
interoperability with the fibre channel devices of other companies. Finally, our
Systems Integration Lab is the industry's foremost fibre channel switched fabric
interoperability lab and is staffed by fibre channel and open systems experts.
Our research and development expenditures were approximately $17 million in
1997, approximately $18 million in 1998 and approximately $24 million in 1999.
Expenses associated with our Systems Integration Lab are incorporated in our
marketing expenditures and are not included in our research and development
costs.
COMPETITION
Although the competitive environment in the SAN market has not yet
developed fully, we anticipate that the current and potential market for our
products will be highly competitive, continually evolving and subject to rapid
technological change. New SAN products are being introduced by various server
and storage providers and existing products will be continually enhanced. Our
primary competitor in the fibre channel switch market is Brocade Communications
Inc. Other companies are also providing fibre channel switches and other
products to the SAN market, including Ancor Communications, Inc., Gadzoox
Networks, Inc. and Vixel Corporation. In addition, a number of companies,
including Emulex Corporation, Interphase Corporation, JNI Corporation, QLogic
Corporation and Crossroads Systems, Inc. are developing, or have developed,
fibre channel products other than switches, including adapters and hubs. We
anticipate that these and other manufacturers of network equipment may introduce
new fibre channel switch products in the near future. In the future, we may also
compete with networking companies or other companies in related or other
industries for which future direct participation in the market for switching
devices may become strategic. In addition, although EMC has agreed for a period
of two years after the completion of this offering not to develop or manufacture
products that compete with our products, upon the expiration of that two-year
period, EMC may directly compete with us. Moreover, we have granted EMC a
license under our patents to make, use and sell any products that EMC is selling
or distributing up to the date of the offering, including products that compete
with ours.
It is also possible that our existing or potential customers could develop
and introduce products competitive with our product offerings. We believe the
competitive factors in this market segment include:
- product performance and features;
- product reliability and interoperability;
- price;
- ability to meet delivery schedules;
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- customer service and technical support; and
- systems management.
Some of our current and potential competitors have established operating
histories, greater resources and name recognition, and a larger installed base
of customers than we have. As a result, these competitors may have greater
credibility with our existing and potential customers. They also may be able to
adopt more aggressive pricing policies and devote greater resources to the
development, promotion and sale of their products than we can to ours. This may
allow them to respond more quickly than we can to new or emerging technologies
and changes in customer requirements. In addition, some of our current and
potential customers have already established supplier or joint development
relationships to discourage these customers from purchasing additional products
from us or persuade them to replace our products with their products. Increased
competition could result in pricing pressures, reduced sales, reduced margins,
reduced profits, reduced market share or the failure of our products to achieve
or maintain market acceptance. We may not have the financial resources,
technical expertise or marketing, manufacturing, distribution and support
capabilities to compete successfully in the future. Additionally, we may not be
able to compete successfully against current or future competitors and
competitive pressures may materially harm our business.
INTELLECTUAL PROPERTY
Our success depends on our ability to protect our proprietary technology
and to operate without infringing the proprietary rights of third parties. We
rely on a combination of patents, copyrights, trademarks and trade secrets, as
well as confidentiality agreements and other contractual restrictions with
employees and third parties, to establish and protect our proprietary rights. We
cannot be certain that the steps we take to protect our intellectual property
will adequately protect our proprietary rights, that others will not copy or
otherwise obtain and use our products and technology without authorization,
independently develop or otherwise acquire equivalent or superior technology or
that we can maintain such technology as trade secrets. In addition, the laws of
some of the countries in which our products are or may be sold may not protect
our proprietary rights as fully as the laws of the United States.
As of June 30, 2000, we held 16 U.S. patents and had 20 additional U.S.
patents pending. We are seeking additional patent protection for certain
additional aspects of our technology. However, it is possible that patents may
not be issued for these applications.
It is possible that litigation may be necessary in the future to enforce
our intellectual property rights, to protect our trade secrets or to determine
the validity and scope of the proprietary rights of others. Litigation could
result in substantial costs and diversion of our resources and could materially
harm our business. From time to time, we have received, and may receive in the
future, notice of claims of infringement of other parties' proprietary rights.
Infringement or other claims could be asserted or prosecuted against us in the
future, and it is possible that past or future assertions or prosecutions could
harm our business. Any such claims, with or without merit, could be time-
consuming, result in costly litigation and diversion of technical and management
personnel, cause delays in the development and release of our products, or
require us to develop non-infringing technology or enter into royalty or
licensing arrangements. Such royalty arrangements, if required, may not be
available on terms acceptable to us, or at all. For these reasons, infringement
claims could materially harm our business.
Under the terms of the Master Confidential Disclosure and License Agreement
between EMC and us, EMC has granted us a license under existing EMC patents. If
we are acquired, our acquiror will retain this license as long as our acquiror
grants to EMC a license under all of the acquiror's
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patents for all products licensed under the agreement under the same terms as
the license we have granted to EMC under the agreement. The potential loss of
the license from EMC after an acquisition of us by a third party may make an
acquisition of us by a third party unlikely.
EMC and IBM entered into a cross-license agreement on March 19, 1999, and
amended that agreement on May 12, 2000, under which each party, on behalf of
itself and its subsidiaries, granted the other a license under patents issued or
issuing on applications entitled to an effective filing date through December
31, 2005. Under the terms of this cross-license agreement, patents held by us
were licensed to IBM and patents held by IBM were sublicensed to us by EMC. Each
party released the other and its subsidiaries from claims of patent infringement
committed prior to the date of the cross-license. In the event of the
distribution of our Class A common stock as currently contemplated by EMC, IBM,
pursuant to the cross-license agreement, will retain the benefit of a license to
our patents with an effective filing date through the date of such distribution,
but the sublicense to us under IBM patents will terminate upon such date in
accordance with the terms of the cross license agreement. We are not aware of
any issued or pending IBM patents that are infringed by our products, nor have
we received any notice of alleged infringement from IBM. However, in the event
that IBM were to allege any such infringement following the distribution of our
Class A common stock by EMC, our ability to negotiate a settlement may be
impaired either by the absence of any incentive for IBM to negotiate a
cross-license arrangement or otherwise.
The cross-license agreement further provides that if either party transfers
a product line after the effective date of the cross license agreement, either
as part of or separate from a disposition of a subsidiary to any third party,
and if such transfer includes patents and tangible assets having a net value of
at least $100,000,000, relating to the product line being transferred with the
subsidiary, then after written request by the transferring party and, if
applicable, by such third party, to the other party within 60 days following the
transfer, the other party will grant to the ex-subsidiary, in the case of a
disposition of a subsidiary, a royalty-free license under its licensed patents,
subject to the following limitations: (1) the field would be limited to only the
particular product line being transferred, including subsequent versions under
development by the transferring party at the time of the disposition, (2) the
license would only cover, in any twelve month period, a volume of licensed
products generating revenue equal to 110% of product revenue for the preceding
twelve month period, (3) the ex-subsidiary would be required to grant IBM a
royalty-free cross-license under its patents and (4) the license to the
ex-subsidiary would terminate should the license from IBM to EMC terminate.
Although we believe that the foregoing provision would apply to us following the
distribution of our Class A common stock by EMC, there can be no assurance that
IBM will agree with our interpretation. In addition, even if IBM accepts our
interpretation, the cross-license agreement does not specify the consequences if
a transferred subsidiary exceeds the limit of 10% annual increases in product
revenue.
EMPLOYEES
At June 30, 2000, we had 473 full-time employees. Of these employees, 172
were engaged in engineering and development, 151 in sales, marketing and
customer support, 80 in manufacturing and 70 in finance and administration. None
of our employees are represented by a labor union. We have not experienced any
work stoppages and consider our relations with our employees to be good.
Our future performance depends in significant part upon the continued
service of our key technical, sales and senior management personnel, several of
whom are not bound by an employment agreement requiring service for any defined
period of time. The loss of the services of one or more of our key employees
could have a material adverse effect on our business, financial condition and
results of operations. Our future success also depends on our continuing ability
to attract, train and retain highly qualified technical, sales and managerial
personnel. We face rigorous competition for
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<PAGE> 55
such personnel in the greater metropolitan Denver and metropolitan Toronto
areas, where our main facilities are located. We may not be able to retain our
key personnel in the future.
LITIGATION
From time to time, we may become involved in various lawsuits and legal
proceedings that arise in the ordinary course of business. Litigation is subject
to inherent uncertainties and an adverse result in a matter that may arise from
time to time may harm our business, financial condition or results of operation.
FACILITIES
Our principal facilities for administration, sales, marketing, customer
support, manufacturing, research and development are located in two facilities
in the greater Broomfield, Colorado area. We currently occupy 122,000 square
feet of office space under a lease that expires in December 2003 and
approximately 91,000 square feet of manufacturing space under a lease that
expires in February 2003. We also occupy 10,400 square feet of office space in
Toronto, Ontario under a lease that expires in June 2003. We believe our current
facilities will be adequate to meet our needs for the next twelve months. If our
growth continues, we will need larger facilities at that time. There can be no
assurance that suitable additional facilities will be available as needed on
commercially reasonable terms. We have signed a letter of intent to acquire
approximately 90 acres of land in Broomfield, Colorado for a cost of
approximately $12.0 million. Under this letter of intent, we have six months to
conduct due diligence on the property to determine its suitability for our
requirements. We may terminate the letter of intent for any reason during this
six month period.
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<PAGE> 56
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The following table sets forth certain information regarding our executive
officers and directors as of the date of this prospectus:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
John F. McDonnell......................... 56 Chairman of the Board of Directors, Chief Executive
Officer and President
Richard A. Carlson........................ 47 Vice President of Quality and Customer Support
Michael B. Gustafson...................... 33 Vice President of Worldwide Sales and Services
James E. Kuenzel.......................... 46 Vice President of Engineering
Thomas O. McGimpsey....................... 38 Vice President and General Counsel
Dee J. Perry.............................. 48 Chief Financial Officer and Vice President of
Finance and Administration
Jeffery O. Vogel.......................... 44 Vice President of Marketing and Systems Integration
Services
David M. Weishaar......................... 48 Vice President of Manufacturing and Customer
Service
David A. Donatelli........................ 35 Director
John W. Gerdelman......................... 47 Director
Charles C. Johnston....................... 65 Director
D. Van Skilling........................... 66 Director
Thomas M. Uhlman.......................... 53 Director
Laurence G. Walker........................ 51 Director
</TABLE>
EXECUTIVE OFFICERS AND DIRECTORS
John F. McDonnell is a founder of McDATA and has served as Chief Executive
Officer and President of McDATA since its inception in 1982, and has served as
Chairman of the Board of Directors since 1998. Mr. McDonnell has more than 31
years of experience in the data communications field, including 26 years in
corporate and technical management and 5 years in engineering. Prior to founding
McDATA, he held various corporate management and engineering positions at
Storage Technology Corporation and Computer Communications, Inc. Mr. McDonnell
attended California State University at Long Beach.
Richard A. Carlson has been Vice President of Corporate Quality and
Customer Support since May 1995. Mr. Carlson joined McDATA as a support
technician in 1986 and served in a variety of support and management positions
until 1995, most recently as Director of Customer Support from October 1992 to
May 1995. Mr. Carlson received his associate degree in management from Front
Range Community College in Colorado.
Michael B. Gustafson has been Vice President of Worldwide Sales and
Services since March 1999. From May 1998, when he joined McDATA, until March
1999, Mr. Gustafson served as a regional sales manager of McDATA. Prior to
joining McDATA, Mr. Gustafson spent 9 years with IBM serving in various sales
management positions, including most recently as Business Unit Executive and
Director of U.S. Channel Field Sales of IBM from June 1997 until May 1998. Mr.
Gustafson received his Bachelor of Science degree in business administration
from Washington University in St. Louis.
James E. Kuenzel has been Vice President of Engineering since joining
McDATA in November 1999. He was previously Vice President of Engineering at
Cabletron Systems Inc. from February 1998 until October 1999 and held a variety
of engineering management positions at Digital
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<PAGE> 57
Equipment Corporation over a period of twenty years, including having served as
the Vice President of Engineering from January 1997 until February 1998 and as a
Director of Engineering from March 1994 until January 1997. Mr. Kuenzel received
his associate degree in electronics from the Philco Ford Technical Institute.
Thomas O. McGimpsey has been Vice President and General Counsel since July
2000. Prior to joining McDATA, Mr. McGimpsey was the senior corporate and
securities attorney at U.S. WEST, Inc. and U.S. WEST Communications, Inc. from
1998 until July 2000. From 1991 to 1998, Mr. McGimpsey was in private practice
at several national law firms. Mr. McGimpsey received his Juris Doctor degree
from the University of Colorado and his Bachelor of Science Degree in Computer
Science from Embry-Riddle Aeronautical University.
Dee J. Perry has been the Chief Financial Officer and Vice President of
Finance and Administration since May 2000. Ms. Perry also served in this
capacity from January 1991 until April 2000. Ms. Perry was previously Controller
at Celestial Seasonings from April 1989 to September 1990 and Controller at NBI,
Inc. from April 1985 to March 1989. Ms. Perry received her Bachelor of Arts and
Master of Science degrees in accounting from the University of Colorado and her
Master of Business Administration degree from Arizona State University.
Jeffery O. Vogel has been the Vice President of Marketing and System
Integration Services since joining McDATA in December 1998. He served as Vice
President of Marketing and Business Development at Vixel Corporation, a provider
of fibre channel software, switches, hubs and other components for storage area
networks, from November 1993 until November 1998. Previously, he held sales,
marketing and IT management positions at Hitachi Data Systems, Seagate
Technology, Inc., Western Digital Corporation and Bank of America. Mr. Vogel
received his Bachelor of Science degree in engineering from the DeVry Institute.
David M. Weishaar has been the Vice President of Manufacturing since
joining McDATA in July 1999. From January 1999 to June 1999, Mr. Weishaar was a
self-employed consultant. From November 1994 to December 1998 Mr. Weishaar
served as Vice President of Manufacturing and Customer Service, and Chief
Quality Officer for Stratus Computer and from June 1993 to November 1994 he
served as the Vice President of Manufacturing at Stratus Computer. He has also
held executive management positions at Sun Microsystems, Sequoia Systems, and
ZTEL, Inc., and management positions at Digital Equipment Corporation. He
received his Bachelor of Science degree in Electrical Engineering from the
University of Wyoming and his Master of Business Administration degree from
Northeastern University.
David A. Donatelli, Senior Vice President, New Business Development, EMC
Corporation, has served as a director of McDATA since May 1999. Mr. Donatelli
has been employed by EMC for 12 years, serving in a number of senior management
positions, most recently as Vice President and General Manager, EMC Data Manager
group from February 1998 to March 1999 and Senior Vice President, New Business
Development of EMC from April 1999 to present. He is a graduate of Boston
College and received his Master of Business Administration degree from
Northwestern University's Kellogg School of Management.
John W. Gerdelman, Managing Member, Mortonsgroup LLC, has served as a
director of McDATA since May 1998. Mr. Gerdelman has been Managing Member of
Mortonsgroup LLC, an early stage venture firm, since October 1999. From April
1999 to October 1999, Mr. Gerdelman was Chief Executive Officer of USA.NET, a
provider of outsourced e-mail applications for consumers and business customers.
Mr. Gerdelman was employed by MCI Telecommunications Corporation as an Executive
Vice President from 1986 through April 1999. He received his Bachelor of Science
degree in chemistry from the College of William and Mary. Mr. Gerdelman
currently serves as a director of Sycamore Networks, Inc.
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<PAGE> 58
Charles C. Johnston, Chairman, Ventex Technology, Inc., AFD Technologies
and J & C Resources, has served as a director of McDATA since May 1998. Mr.
Johnston has been Chairman of Ventex Technology, Inc., AFD Technologies and J&C
Resources since 1993. Mr. Johnston was founder, Chairman and CEO of ISI Systems
from 1990 to 1992 before it was sold to Teleglobe Corporation of Montreal,
Canada. He served in various capacities at IBM Corporation from 1959 until 1965
and served as Director of Grumman Corporation and Teleglobe Corporation from
1989 to 1994. He received his Bachelor of Science degree in 1957 from the
Worcester Polytechnic Institute. He currently serves as a director of Bitwise
Designs, Inc., Hydron Technologies, Inc., Internet Commerce Corporation and
Waste Systems International, Inc.
D. Van Skilling, President, Skilling Enterprises, Chairman Emeritus,
Experian, has served as a director of McDATA since May 1998. Mr. Skilling
retired as Chairman and Chief Executive Officer of Experian Information
Solutions, Inc., formerly TRW Information Systems & Services, in April 1999.
From September 1996 until April 1999, Mr. Skilling was Chairman and Chief
Executive Officer of Experian. From March 1970 until September 1996, Mr.
Skilling was the Executive Vice President of TRW Information Systems and
Services. He received his Bachelor of Science degree in chemistry from Colorado
College and his Master of Business Administration degree in International
Business from Pepperdine University. He currently serves on the Boards of
Directors of The Lamson & Sessions Company and First American Financial
Corporation.
Thomas M. Uhlman, President, New Ventures Group, Lucent Technologies, Inc.,
has served as a director of McDATA since May 1998. Mr. Uhlman has been
President, New Ventures Group of Lucent Technologies since 1997. From 1996 to
1997, Mr. Uhlman was Senior Vice President, Corporate Strategy, Business
Development and Public Affairs of Lucent Technologies. From 1995 to 1996 Mr.
Uhlman was the Vice President, Corporate Development of AT&T Corp. Prior to
joining AT&T, he was with Hewlett-Packard Company in various advisory and
management roles. He received his Ph.D. in Political Science from the University
of North Carolina, his Masters Degree in management from Stanford University and
his Bachelor of Arts degree in political science and psychology from the
University of Rochester.
Laurence G. Walker, Chief Executive Officer, C-Port Corporation, which
recently became a wholly-owned subsidiary of Motorola, has served as a director
of McDATA since May 1998. Mr. Walker co-founded C-Port in November 1997 and has
been Chief Executive Officer since that time. From June 1997 until October 1997,
Mr. Walker was self employed. From August 1996 until May 1997, Mr. Walker served
as Chief Executive Officer of CertCo, a digital certification supplier. Prior to
that, he was Vice President and General Manager, Network Product Business Unit,
Digital Equipment Corporation from January 1994 to July 1996. From 1981 to 1994,
he held a variety of other management positions at Digital Equipment
Corporation. He received his Ph.D. and Master of Science degree in electrical
engineering from the Massachusetts Institute of Technology and his Bachelor of
Science degree in Electrical Engineering from Princeton.
We are presently engaged in a search for a replacement for our Chief
Financial Officer. In May 2000, a candidate we had retained for this position
determined that he would be unable to serve in that capacity for personal
reasons. Ms. Perry has agreed to serve in her current position until a
replacement candidate has been hired and to assist in any transition process.
Our board of directors is divided into three classes, the members of which
serve for a staggered three-year term and until they or their successors are
duly elected and qualified. Messrs. Donatelli and Gerdelman serve in the class
whose term expires at the annual meeting of stockholders in 2001; Messrs.
Skilling and Uhlman serve in the class whose term expires at the annual meeting
of stockholders in 2002; and Messrs. Johnston, McDonnell and Walker serve in the
class whose term expires at the annual meeting of stockholders in 2003. Upon the
expiration of the term of a class of directors, directors in that class will be
elected for three-year terms at the annual meeting of stockholders in the year
in which that term expires.
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Our officers serve at the discretion of the board of directors. There are
no family relationships among our directors and officers.
BOARD OF DIRECTORS COMMITTEES AND OTHER INFORMATION
Our board of directors has an audit committee and a compensation committee.
The audit committee, currently comprised of Messrs. Gerdelman, Johnston and
Skilling, determines our accounting policies and practices and financial
reporting and internal control structures, recommends to our board of directors
the appointment of independent auditors to audit our financial statements each
year and confers with the auditors and our officers for purposes of reviewing
our internal controls, accounting practices, financial structures and financial
reporting. The compensation committee, currently comprised of Messrs. Donatelli,
Uhlman and Walker determines salaries, incentives and other forms of
compensation for our executive officers and administers our incentive
compensation plan.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
No interlocking relationship exists between our board of directors or
compensation committee and the board of directors or compensation committee of
any other entity, nor has any interlocking relationship existed in the past.
DIRECTOR COMPENSATION
With the exception of John F. McDonnell and David A. Donatelli, all of our
directors are compensated for their services as board or committee members. Each
director other than Mr. McDonnell and Mr. Donatelli currently receives an annual
director's fee of $10,000, plus $1,000 for each board meeting and $1,000 for
each committee meeting. Our practice has been to grant directors options to
purchase 25,000 shares of our Class B common stock when they became directors
and to grant them options to purchase an additional 10,000 shares of our Class B
common stock each year thereafter. In October 1997, before he became a director,
Mr. McDonnell was granted an option to purchase 1,000,000 shares of our Class B
common stock and has not been granted options since. Mr. Donatelli has not been
granted any options to purchase our common stock.
LIMITATION OF LIABILITY AND INDEMNIFICATION
We have adopted provisions in our amended and restated certificate of
incorporation and amended and restated by-laws that limit or eliminate the
personal liability of our directors for a breach of their fiduciary duty of care
as a director. The duty of care generally requires that, when acting on behalf
of the corporation, directors exercise an informed business judgment based on
all material information reasonably available to them. Consequently, a director
will not be personally liable to us or our stockholders for monetary damages or
breach of fiduciary duty as a director, except for liability for:
- any breach of the director's duty of loyalty to us or our stockholders;
- acts or omissions not in good faith or that involve intentional
misconduct or a knowing violation of law;
- unlawful payments of dividends or unlawful stock purchases, redemptions
or other distributions; or
- any transaction from which the director derived an improper personal
benefit.
Our amended and restated certificate of incorporation also allows us to
indemnify our officers, directors and other agents to the full extent permitted
by Delaware law.
The limited liability and indemnification provisions in our amended and
restated certificate of incorporation and amended and restated by-laws may
discourage stockholders from bringing a lawsuit
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<PAGE> 60
against our directors for breach of their fiduciary duty and may reduce the
likelihood of derivative litigation against our directors and officers, even
though a derivative action, if successful, might otherwise benefit us and our
stockholders. Moreover, a stockholder's investment in McDATA may be adversely
affected to the extent we pay the costs of settlement or damage awards against
our directors and officers under these indemnification provisions.
At present, there is no pending litigation or proceeding involving any of
our directors, officers, or employees in which indemnification is sought, nor
are we aware of any threatened litigation that may result in claims for
indemnification.
EXECUTIVE COMPENSATION
The following table sets forth information for the fiscal year ended
December 31, 1999 concerning the compensation paid to our Chief Executive
Officer and our four other most highly compensated executive officers and one
former executive officer whose total salary and bonus for such fiscal year
exceeded $100,000, collectively referred to below as the Named Executive
Officers:
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
COMPENSATION
AWARDS
------------
ANNUAL COMPENSATION SECURITIES OTHER
----------------------- UNDERLYING COMPENSATION
NAME AND PRINCIPAL POSITION SALARY($) BONUS($)(1) OPTIONS(#) ($)
--------------------------- --------- ----------- ------------ ------------
<S> <C> <C> <C> <C>
John F. McDonnell........................... $269,039 $ 35,131 -- $ 9,525(2)
Chief Executive Officer and President
Michael A. Klayko(3)........................ 200,769 91,047 60,000 22,968(4)
Executive Vice President of Sales and
Marketing
Dee J. Perry................................ 140,002 14,785 -- 5,776(5)
Chief Financial Officer and Vice President
of Finance and Administration
Paul F. Lilly(6)............................ 122,353 9,802 -- 4,481(7)
Vice President of Engineering
Michael B. Gustafson........................ 100,384 112,916 120,000 45,547(8)
Vice President of Worldwide Sales and
Services
Jeffery O. Vogel............................ 100,769 78,750 200,000 69,871(9)
Vice President of Marketing and Systems
Integration Services
</TABLE>
-------------------------
(1) Includes performance bonuses and commissions accrued in 1999 whether paid in
1999 or in a succeeding year.
(2) Includes $1,806 for term life insurance premiums, $2,000 paid to Mr.
McDonnell's account in our 401(k) plan and $5,719 for reimbursement of
travel expenses.
(3) Mr. Klayko became Senior Vice President of Business Development in January
2000 and ceased to be an executive officer on April 25, 2000.
(4) Includes $6,630 for term life insurance premiums, $3,000 paid to Mr.
Klayko's account in our 401(k) plan, $1,906 for reimbursement of travel
expenses and $11,432 for financial planning advice.
(5) Includes $412 for term life insurance premiums and $5,364 paid to Ms.
Perry's account in our 401(k) plan.
(6) Mr. Lilly resigned as Vice President of Engineering effective November 4,
1999.
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(7) Includes $448 for term life insurance premiums and $4,033 paid to Mr.
Lilly's account in our 401(k) plan.
(8) Includes $96 for term life insurance premiums for Mr. Gustafson, $4,765 paid
to Mr. Gustafson's account in our 401(k) plan and $40,686 for reimbursement
of relocation expenses.
(9) Includes $180 for term life insurance premiums and $69,691 for reimbursement
of relocation expenses.
OPTIONS GRANTS IN LAST FISCAL YEAR
The following table sets forth certain information for each grant of stock
options during the year ended December 31, 1999 to each of the Named Executive
Officers. All of these options granted by us were granted under our 1997 Stock
Option Plan and have a term of 10 years, subject to earlier termination in the
event an optionee's services to us cease. For more information, see "Employee
Benefit Plans" for descriptions of the material terms of these options. During
the year ended December 31, 1999, we granted options to purchase an aggregate of
3,646,700 shares of Class B common stock under the 1997 Stock Option Plan.
Options were granted at an exercise price equal to the fair market value of our
Class B common stock on the date of grant, as determined in good faith by our
board of directors. Our board of directors determined the fair market value
based on our financial results and prospects and evaluations conducted by
valuation experts and by management. Potential realizable values are net of
exercise prices before taxes, and are based on the assumption that our Class B
common stock appreciates at the annual rate shown, compounded annually, from the
date of grant until the expiration of the ten-year term and that the option is
exercised at the exercise price and sold on the last day of its term at the
appreciated price. These numbers are calculated based on Securities and Exchange
Commission requirements and do not reflect any projection or estimate of future
stock price growth. No stock appreciation rights were granted during the fiscal
year ended December 31, 1999.
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
--------------------------------------------------- POTENTIAL REALIZABLE
PERCENT OF VALUE AT ASSUMED
NUMBER TOTAL ANNUAL RATES OF
OF OPTIONS STOCK PRICE
SECURITIES GRANTED TO EXERCISE APPRECIATION FOR
UNDERLYING EMPLOYEES PRICE PER OPTION TERM
OPTIONS IN SHARE EXPIRATION --------------------
NAME GRANTED 1999 ($/SHARE) DATE 5% 10%
---- ---------- ---------- --------- ---------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
John F. McDonnell....... -- -- -- -- -- --
Michael A. Klayko....... 60,000 1.65% $2.00 4/28/09 75,467 191,249
Dee J. Perry............ -- -- -- -- -- --
Paul F. Lilly........... -- -- -- -- -- --
Michael B. Gustafson.... 120,000 3.29 1.62 2/2/09 122,257 309,824
Jeffery O. Vogel........ 200,000 5.50 1.62 2/2/09 203,762 516,273
</TABLE>
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<PAGE> 62
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
The following table sets forth information with respect to the Named
Executive Officers concerning exercisable and unexercisable options held as of
December 31, 1999. The dollar value of in-the-money options at December 31, 1999
is calculated by determining the difference between the fair market value of
$10.65 per share and the option exercise price.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF
UNDERLYING UNEXERCISED
UNEXERCISED IN-THE-MONEY
OPTIONS AT OPTIONS AT
SHARES DECEMBER 31, 1999 DECEMBER 31, 1999
ACQUIRED ON VALUE --------------------------- ---------------------------
NAME EXERCISE(#) REALIZED($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- ----------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
John F. McDonnell...... 60,000 $ 579,000 440,000 500,000 $4,246,000 $4,825,000
Michael A. Klayko...... 250,000 2,412,500 -- 810,000 -- 7,756,500
Dee J. Perry........... 300,000 2,895,000 100,000 400,000 965,000 3,860,000
Paul F. Lilly.......... 400,000 3,860,000 -- 400,000 -- 3,860,000
Michael B. Gustafson... -- -- 20,000 180,000 190,600 1,655,400
Jeffery O. Vogel....... -- -- -- 200,000 -- 1,806,000
</TABLE>
MANAGEMENT BONUS PROGRAM
All of our executive officers and many of our other senior employees are
eligible for a bonus based upon achievement of specified annual or quarterly
objectives. There is no formal agreement with respect to this program and
objectives for bonuses are set annually by the board of directors. Currently the
bonus is calculated as a percentage of base compensation and can range from 10%
to 35% for non-executive officers and from 25% to 50% for executive officers.
For non-executive officers, the bonus is tied to achievement of quarterly
objectives agreed to by the employee and their manager. For executive officers,
the bonus is tied to achievement of annual planned operating profit or revenue
and achievement of quarterly objectives. Typically, 70% of an executive
officer's bonus is tied to achievement of annual planned profit and 30% to
achievement of quarterly objectives. To date, no executive officer has received
any portion of a bonus tied to operating profitability.
EMPLOYMENT AGREEMENTS
All of our executive officers have entered into severance agreements and
key employee agreements with us. Our severance agreements grant our executive
officers a payment, in a lump sum or according to our normal payroll timetable,
equal to four times the average of their quarterly compensation over the
preceding eight calendar quarters, payment for all accrued but unused vacation
days, the provision of health benefits for a period of time and automatic
acceleration of the vesting of all stock options held if we terminate their
employment upon a change in control and provide that our executive officers will
not engage in any activity that conflicts with their obligations to us, induce
other employees to leave us, or compete with us for a period of one year after
termination of their employment. Under the terms of the key employee agreement,
all confidential, proprietary or other trade secret information and all other
discoveries, inventions, processes, methods and improvements made by the
employee are our property. In addition, pursuant to the agreement, employees may
not compete with us for one year after termination of their employment.
EMPLOYEE BENEFIT PLANS
1997 Stock Option Plan
Our board of directors and our stockholders approved and adopted our 1997
Stock Option Plan in October 1997. As of June 30, 2000, approximately 3.2
million shares of our Class B common stock
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were reserved for issuance under the 1997 Stock Option Plan. Under the terms of
the 1997 Stock Option Plan, our board of directors may grant incentive stock
options and non-qualified stock options to our employees and non-qualified stock
options to our directors, provided that certain eligibility requirements are
satisfied. Our board of directors administers the 1997 Stock Option Plan, but
has the authority to delegate the administration of the plan to a committee that
may include non-employee directors and outside directors, within the meaning of
the Plan.
Subject to the provisions of the 1997 Stock Option Plan, our board of
directors or committee has the authority to select eligible persons to whom
options will be granted and determine the terms of each option, including:
- the duration of the option, which may not exceed 10 years;
- whether an option will be an incentive stock option or a non-qualified
stock option;
- the number of shares of Class B common stock covered by the option; and
- when the option becomes exercisable.
The exercise price per share of Class B common stock for:
- non-qualified options must be no less than 85% of the fair market value
per share of the Class B common stock subject to the option on the date
of grant;
- incentive stock options must be no less than the fair market value of the
Class B common stock subject to the option on the date of the grant; and
- incentive stock options granted to an employee owning more than 10% of
the total combined voting power of all classes of our capital stock, or
of any related company, must not be less than 110% of the fair market
value per share of the Class B common stock on the date of the grant.
Initially, each incentive stock option granted is exercisable over a period
determined by the board of directors in its discretion, not to exceed ten years
from the date of the grant as required by the Internal Revenue Code of 1986. In
addition, the exercise period for an incentive stock option may not exceed five
years from the date of the grant if the option is granted to an individual who,
at the time of the grant, owns more than 10% of the total combined voting power
of all classes of our capital stock. The board of directors generally has the
right to accelerate the exercisability of any options granted under the 1997
Stock Option Plan that would otherwise be unexercisable. In the event of certain
changes in control, the acquiring or successor corporation may assume or grant
substitute options for options then outstanding under the 1997 Stock Option
Plan, or such options shall terminate.
The 1997 Stock Option Plan expires on September 30, 2007, except as to
options or awards outstanding on that date. Subject to the terms of the 1997
Stock Option Plan, the board of directors may terminate or amend the 1997 Stock
Option Plan at any time.
As of June 30, 2000, options for the purchase of an aggregate of 12,839,624
shares of Class B common stock at a weighted average exercise price of $3.26
were outstanding under the 1997 Stock Option Plan.
401(k) Plan
Effective January 1, 1999, we adopted a 401(k) Plan. Participants in our
401(k) plan may contribute up to 15% of their total annual compensation, not to
exceed the specified statutory limit, which was $10,000 in calendar year 1999.
The 401(k) plan permits, but does not require, us to make contributions to the
401(k) plan on behalf of our employees. Our current practice is to match $.50 on
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each dollar of an employee's contributions up to the first 6% of an employee's
compensation with a total maximum matching contribution of 3% of an employee's
compensation. All contributions to the 401(k) plan by or on behalf of employees
are subject to the aggregate annual limits prescribed by the Internal Revenue
Service. Under our 401(k) plan, our participants received full and immediate
vesting of their contributions and are vested in matching contributions over a
three year period.
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RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
Since January 1, 1999, there has not been nor is there currently proposed
any transaction or series of similar transactions to which we were or are a
party in which the amount involved exceeds $60,000 and in which any director,
executive officer, holder of more than 5% of our common stock or any member of
the immediate family of any of the foregoing persons had or will have a direct
or indirect material interest other than (1) compensation agreements and other
arrangements, which are described in "Management" and (2) the transactions
described below and in "Arrangements Between McDATA and EMC."
TRANSACTIONS WITH 5% SHAREHOLDERS
Under the terms of the Services Agreement dated October 1, 1997 by and
among EMC, McDATA Holdings Corporation and us, we provide manufacturing and
distribution management services to McDATA Holdings Corporation for ESCON
switching solutions manufactured for and sold exclusively to IBM in return for a
service fee payable by McDATA Holdings Corporation. The Services Agreement is
described more fully in "Arrangements between McDATA and EMC." This fee amounted
to $17,337,000 for the year ended December 31, 1999, $25,674,000 for the year
ended December 31, 1998 and $7,848,000 for the three month period ended December
31, 1997. The terms of the Services Agreement, which were negotiated in the
context of a parent-subsidiary relationship, may be less favorable to us than if
they had been negotiated with unaffiliated third parties. One of our directors,
David A. Donatelli, is the Senior Vice President, New Business Development of
EMC. McDATA Holdings Corporation is a direct, wholly-owned subsidiary of EMC.
INDEMNIFICATION OF DIRECTORS AND EXECUTIVE OFFICERS
Our amended and restated certificate of incorporation and amended and
restated by-laws provide that we will indemnify each of our directors and
officers to the fullest extent permitted by the Delaware General Corporation
Law. For more information, see "Limitation of Liability and Indemnification."
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ARRANGEMENTS BETWEEN McDATA AND EMC
We have provided below a summary description of our continuing rights and
obligations with respect to certain agreements entered into in connection with
the 1997 restructuring of McDATA by EMC and with respect to certain agreements
entered into with EMC in connection with the offering and the distribution. This
description is a summary. You should read the full text of these agreements,
which have been filed with the Securities and Exchange Commission as exhibits to
the registration statement of which this prospectus is a part. The terms of
these agreements, which were negotiated in the context of a parent-subsidiary
relationship, may be less favorable to us than if they had been negotiated with
unaffiliated third parties.
THE 1997 AGREEMENTS
ASSET TRANSFER AGREEMENT
Under the terms of the Asset Transfer Agreement dated as of October 1, 1997
by and among EMC, McDATA Holdings Corporation and us, McDATA Holdings
Corporation agreed, among other things, to transfer to us substantially all of
its tangible and intangible assets, except for certain assets relating to its
ESCON business, including its exclusive manufacturing and marketing contracts
with IBM. In consideration for the transfer, we agreed to issue 81,000,000
shares of Class A common stock to, and to assume all liabilities (excluding,
among other things, certain tax and accrued liabilities) of, McDATA Holdings
Corporation related to the transferred assets.
INVESTORS' RIGHTS AGREEMENT
Under the terms of the Investors' Rights Agreement dated as of October 1,
1997 by and among us, EMC, McDATA Holdings Corporation and John F. McDonnell, as
amended, we agreed to certain protective provisions in favor of McDATA Holdings
Corporation, a wholly-owned subsidiary of EMC and the holder of all of the
outstanding shares of our Class A common stock. In particular, we agreed that in
the event that we issue any of our equity securities, or any other event occurs,
that would result in McDATA Holdings Corporation's percentage interest in the
voting power or value of all of our outstanding capital stock to fall below 50%,
then McDATA Holdings Corporation would have the right to purchase shares of
those equity securities for the price and upon the terms and conditions in the
proposed issuance, in an amount sufficient to enable it to maintain a 50%
interest in the voting power or value of all of our outstanding capital stock.
EMC presently intends to terminate this right at the time of its contemplated
distribution of our Class A common stock to its stockholders.
In addition, McDATA Holdings Corporation has, in certain circumstances, a
right of first refusal with respect to transfers of Class B common stock held by
John McDonnell. McDATA Holdings Corporation has the right to purchase Mr.
McDonnell's Class B common stock if Mr. McDonnell is no longer employed by us
and wishes to sell his Class B common stock in a private sale. In such instance,
McDATA Holdings Corporation has the right to purchase Mr. McDonnell's Class B
common stock at the same price and upon the same terms and conditions offered by
the third party in the private sale.
We have also agreed to maintain certain basic financial and information
reporting standards and have agreed to allow McDATA Holdings Corporation and
John McDonnell to inspect our books. We have also agreed, for the benefit of
McDATA Holdings Corporation and John McDonnell and their assignees, to make and
keep available certain information concerning us at all times after the
effective date of the registration statement of which this prospectus is a part;
and to file all reports and documents required of us under the Securities
Exchange Act of 1934.
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We have also agreed to require that all our employees enter into
non-competition agreements prohibiting them from competing with us for one year
after termination of their employment for any reason and have agreed to require
all our employees and consultants to enter into assignment of inventions
agreements which state that all confidential, proprietary or other trade secret
information and all other discoveries, inventions, processes, methods and
improvements made by them are our property.
SERVICES AGREEMENT
Under the terms of the Services Agreement entered into on October 1, 1997
by and among EMC, McDATA Holdings Corporation and us, we have agreed to continue
the ESCON business on behalf of McDATA Holdings Corporation and to perform all
of McDATA Holdings Corporation's duties and responsibilities under the ESCON
contracts for a specified service fee. All revenues from IBM under the ESCON
contracts flow directly to McDATA Holdings Corporation, with the exception of
any and all revenues generated by the sale of the FICON Bridge card to IBM,
which flow directly to us. McDATA Holdings Corporation has retained all
liability for (1) costs for the purchase of materials and supplies for the
production of ESCON products and (2) any royalty costs related to the ESCON
contracts. Under the Services Agreement, we are responsible for all obligations
incurred in the ordinary course of its business, including performance
obligations incurred under the Services Agreement. McDATA Holdings Corporation
has agreed to reimburse us for raw materials used in the production of such
goods. We share liability with McDATA Holdings Corporation, in proportion to the
respective amounts of revenue we receive pursuant to the Services Agreement, for
certain liabilities and costs that may arise in connection with the ESCON
contracts, including claims for intellectual property infringement, breach of
warranty claims, and other liabilities not incurred in the ordinary course.
In addition, we have agreed not to perform any work that would conflict in
any material way with our performance under the Services Agreement or the ESCON
contracts. The Services Agreement may only be terminated by the mutual consent
of EMC, McDATA Holdings Corporation and us. In addition, under the terms of a
letter agreement dated April 19, 1999 by and between us and McDATA Holdings
Corporation, all revenues generated from the sale of the FICON Bridge card will
be paid directly to us.
TECHNOLOGY RIGHTS AGREEMENT
In connection with our reorganization in October 1997, we entered into a
Technology Rights Agreement with EMC and McDATA Holdings Corporation on October
1, 1997. Under the terms of the Technology Rights Agreement, McDATA Holdings
Corporation transferred to us all its right, title and interest to its high
performance connectivity products including ESCON and fibre channel used
primarily in information switching applications, except for any connectivity
technology related to storage products owned by EMC. EMC retained all rights,
title and interest in enterprise storage products, including ICDA and software
applications used primarily in computer and network based applications.
McDATA Holdings Corporation and EMC retained the right and license
(including the right to sublicense) to make, use and sell all high performance
connectivity products used primarily in information switching applications
transferred to us, including ESCON and fibre channel products. However, except
for ESCON connectivity products, McDATA Holdings Corporation and EMC and their
sublicensees may only embed the high performance connectivity products to which
EMC and McDATA Holdings Corporation retained rights and licenses pursuant to the
Technology Rights Agreement to extend or enhance the connectivity features of
EMC's current and future storage
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products. Additionally, McDATA Holdings Corporation and EMC have no license
under the Technology Rights Agreement to any of the trademark or service mark
rights assigned to us.
We have also agreed that if the obligation to sell ESCON products
exclusively to IBM terminates or expires, we will work exclusively with McDATA
Holdings Corporation to make available any ESCON products for sale or lease to
third parties.
Should we fail to supply products which fulfill the contractual commitments
of McDATA Holdings Corporation to IBM, we have agreed to:
- grant McDATA Holdings Corporation and IBM a license to all of our
intellectual property rights necessary to fulfill McDATA Holdings
Corporation's contractual commitments to IBM pursuant to manufacturing
rights provisions in McDATA Holdings Corporation's contracts with IBM;
and
- provide McDATA Holdings Corporation and IBM all documentation and
information necessary to manufacture the products and fulfill McDATA
Holdings Corporation's obligations and IBM's requirements pursuant to
manufacturing rights provisions and within the contractual time frame in
McDATA Holdings Corporation's contracts with IBM.
Under the terms of the Technology Rights Agreement, EMC and McDATA Holdings
Corporation agreed to certain non-competition covenants, which have been amended
and superceded by the Master Confidential Disclosure and License Agreement.
THE PRE-OFFERING AGREEMENTS
We have provided below a summary description of the agreements that we have
entered into with EMC in connection with the offering and the distribution. This
description summarizes the material terms of such agreements. You should read
the full text of these agreements, which have been filed with the Securities and
Exchange Commission as exhibits to the registration statement of which this
prospectus is a part.
MASTER TRANSACTION AGREEMENT
We recently entered into a Master Transaction Agreement with EMC that
contains key provisions relating to the offering, to our relationship with EMC
after the offering and to the proposed distribution of our shares of Class A
common stock owned by EMC to stockholders of EMC.
The Distribution. EMC currently intends to, approximately six to twelve
months following the consummation of the offering, distribute the shares of our
Class A common stock held by it to its stockholders on a pro rata basis. Under
the terms of the Master Transaction Agreement, we agree to prepare an
information statement with EMC and send it to EMC stockholders before the
distribution becomes effective. The information statement will inform the
stockholders of the distribution. EMC may, in its sole discretion, delay the
distribution date for any period of time. EMC intends to consummate the
distribution only if the following conditions, among others, are met, any of
which may be waived by EMC:
- the Internal Revenue Service must issue a ruling that the distribution of
our Class A common stock by EMC to EMC stockholders will be tax-free to
EMC and its stockholders;
- all required governmental approvals must be in effect;
- no legal restraints must exist preventing this distribution; and
- nothing must have happened in the intervening time between this offering
and the distribution that makes the distribution harmful to EMC or its
stockholders.
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Information Exchange. We have agreed with EMC to share information with
each other, for a variety of purposes, unless the sharing would be commercially
detrimental. In connection with this, we and EMC have agreed as follows:
- to maintain adequate internal accounting to allow the other party to
satisfy its own reporting obligations and prepare its own financial
statements;
- to retain records beneficial to the other party for a specified period of
time. If the records are going to be destroyed, the destroying party will
give the other party an opportunity to retrieve all relevant information
from the records, unless the records are destroyed in accordance with
adopted record retention policies; and
- to use commercially reasonable efforts to provide the other party with
directors, officers, employees, other personnel and agents who may be
used as witnesses in and books, records and other documents which may
reasonably be required in connection with legal, administrative or other
proceedings.
Auditing Practices. So long as EMC is required to consolidate our results
of operations and financial position, we have agreed to:
- not select a different independent accounting firm from that used by EMC
without EMC's written consent;
- use commercially reasonable efforts to enable our auditors to date their
opinion on our audited annual financial statements on or earlier than the
date provided by EMC;
- exchange all relevant information needed to prepare financial statements;
- grant each other's internal auditors access to each other's records as
may be reasonably necessary; and
- notify each other of any change in accounting principles.
Dispute Resolution. If disagreements arise between us and EMC regarding
the interpretation or performance of the Master Transaction Agreement, we have
agreed to the following procedures:
- the parties agree to submit the dispute to binding arbitration; and
nothing prevents either party acting in good faith from initiating
litigation at any time if failure to do so would cause serious and
irreparable injury to one of the parties or to others.
Expenses. We will bear all of the costs and expenses related to this
offering as well as the costs and expenses related to distribution, or any costs
and expenses related to any actions taken in furtherance of either of them.
Termination of the Master Transaction Agreement. EMC in its sole
discretion can terminate the Master Transaction Agreement and all ancillary
agreements and abandon the distribution at any time prior to the closing of this
offering. Both EMC and we must agree to terminate the Master Transaction
Agreement and all ancillary agreements at any time between the closing of this
offering and the distribution.
INDEMNIFICATION AND INSURANCE MATTERS AGREEMENT
General Release of Pre-Closing Claims. Effective as of the date of the
offering, we have released EMC and its affiliates, agents, successors and
assigns, and EMC has released us, and our affiliates, agents, successors and
assigns, from any liabilities arising from events occurring on or before the
offering date, including events occurring in connection with the activities to
implement the initial public offering and the distribution. This provision will
not impair EMC or us from enforcing the
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Master Transaction Agreement, any ancillary agreement or any arrangement
specified in any of these agreements.
Indemnification. The Indemnification and Insurance Matters Agreement also
contains provisions governing indemnification. In general, we have agreed to
indemnify EMC and its affiliates, agents, successors and assigns from all
liabilities arising from:
- our business, any of our liabilities or any of our contracts; and
- any breach by us of the Master Transaction Agreement or any ancillary
agreement.
EMC has agreed to indemnify us and our affiliates, agents, successors and
assigns from all liabilities arising from:
- EMC's business; and
- any breach by EMC of the Master Transaction Agreement or any ancillary
agreement.
The indemnifying party will make all indemnification payments net of
insurance proceeds that the indemnified party receives. The agreement also
contains provisions governing indemnification procedures.
Liability Arising From This Prospectus. We have agreed to bear any and all
liability arising from or relating to any untrue statement of a material fact or
any omission of a material fact in any version of this prospectus or in the
registration statement of which this prospectus forms a part.
Insurance Matters. The agreement also contains provisions governing our
insurance coverage during the period between the effective date of this offering
until the earlier of the distribution date or a date specified by EMC upon at
least 90 days notice. We agree to reimburse EMC for premium expenses related to
insurance coverage during this period. In addition, we agree to reimburse EMC
for all amounts necessary to exhaust or satisfy uninsured retention, deductible
and similar amounts in connection with our liabilities that are covered under
such insurance, as well as for all amounts incurred by EMC to pursue insurance
recoveries on our behalf. Prior to the date that the insurance coverage
terminates, EMC will maintain insurance policies on our behalf that are
generally comparable to those maintained generally by EMC on behalf of itself
and its subsidiaries, if at all. EMC is not prohibited, however, from presenting
claims on its own behalf that exhaust such insurance coverage. There can be no
guarantee that the amount, terms or scope of any such coverage will not be
materially inferior to the level of coverage maintained by EMC immediately prior
to this offering.
Environmental Matters. We and EMC have generally assumed environmental
liabilities associated with the operation of our respective businesses. This
would include, for example, liabilities associated with non-compliance with
environmental laws prior to the date of the offering. In addition, we agree to
indemnify EMC and its affiliates, subsidiaries, agents, successors and assigns
from claims, investigations or other allegations of liabilities associated with
environmental contamination at any property other than that owned, leased or
used by EMC.
Each party will be responsible for all liabilities associated with any
environmental contamination caused by that party after the offering.
Assignment. The indemnification and insurance matters agreement is not
assignable by either party without prior written consent.
MASTER CONFIDENTIAL DISCLOSURE AND LICENSE AGREEMENT
Under the terms of the Master Confidential Disclosure and License
Agreement, we and EMC agree not to disclose confidential information of the
other party except in specific circumstances. We
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and EMC also agree not to use this information in violation of any use
restrictions in one of the other written agreements between us.
Technology. We agree to grant EMC a fully paid up, unrestricted,
non-exclusive, non-assignable license under our existing patents to manufacture
or sell those products being sold or otherwise distributed by EMC as of the
effective date of this offering, including products existing as of the effective
date of the offering or in development as of that date and first sold or
distributed within one year after that date.
EMC agrees to grant us a fully paid up, unrestricted, non-exclusive,
non-assignable license under existing EMC patents to manufacture or sell those
products being sold or otherwise distributed by us as of the effective date of
this offering, including products existing as of the effective date of the
offering or in development as of that date and first sold or distributed within
one year after that date. EMC's license to us expires automatically in the event
of an acquisition of us, even though our license to EMC will survive any
acquisition of us or EMC.
Subject to certain exceptions, EMC has agreed that, for a period of two
years after the effective date of this offering, it will not develop or
manufacture products competitive to our products sold or distributed by us at
any time prior to the effective date of this offering.
For the same period and subject to certain exceptions, we have agreed not
to develop or manufacture products competitive to EMC products sold or
distributed by EMC at any time prior to the effective date of this offering.
TAX SHARING AGREEMENT
In general, we will be included in EMC's consolidated group for federal
income tax purposes for so long as EMC beneficially owns at least 80% of the
total voting power and value of our outstanding stock. Each member of a
consolidated group is jointly and severally liable for the federal income tax
liability of each other member of the consolidated group. We have entered into a
tax sharing agreement with EMC, McDATA Holdings Corporation and the other
members of EMC's consolidated group that allocates tax liabilities between us
and the other members of the consolidated group during the period in which we
are included in EMC's consolidated group. We could, however, be liable in the
event that any federal income tax liability is incurred, but not discharged, by
other members of EMC's consolidated group.
For periods during which we are included in EMC's consolidated group, we
and EMC will make payments to each other such that the amount of taxes to be
paid by us will generally be determined as though we had filed separate federal,
state and local income tax returns. We will be responsible for any taxes with
respect to tax returns that include us and our subsidiaries. In determining the
amount of our tax-sharing payments, EMC will prepare for us pro forma returns
with respect to federal and applicable state and local income taxes.
The tax sharing agreement provides special rules for determining our share
of any tax liability of EMC's consolidated group for the first year in which we
are no longer included in the consolidated group.
The tax sharing agreement provides that we shall indemnify EMC for any
taxes arising out of the failure of the distribution of our stock by EMC to
EMC's shareholders to qualify as tax-free as a result of actions taken, or the
failure to take action, by us or our subsidiaries. Among other things, we are
required under the tax sharing agreement to comply with representations made to
the Internal Revenue Service in connection with the request for a private letter
ruling regarding the tax-free nature of the distribution of our stock by EMC to
EMC's shareholders. Moreover, we could have liability to EMC as a result of
events beyond our control, such as a successful tender for our stock. If the
distribution of our stock fails to qualify as a tax-free distribution, EMC would
incur tax liability
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as if our stock that was distributed by EMC had been sold by EMC for its fair
market value in a taxable transaction. In the event that we are required to
indemnify EMC because the distribution of our Class A common stock fails to
qualify as a tax-free distribution, our liability could exceed 35% of the value
of the Class A common stock distributed by EMC determined as of the date of the
distribution.
In addition, we have agreed in the tax sharing agreement not to take or
fail to take any action that would cause the distribution of our stock by EMC to
EMC's shareholders to fail to qualify as a tax-free distribution under the
Internal Revenue Code, undertake any transaction that is treated as a
liquidation or reorganization under the Internal Revenue Code, or issue more
than 35% of our stock in acquisitions or offerings within the 27-month period
following a tax-free distribution of our stock by EMC to EMC's shareholders
unless (1) EMC consents to such action, which consent would not be unreasonably
withheld if we provide EMC with an opinion of nationally recognized counsel or
"Big 5" accounting firm, satisfactory to EMC, that such action will not
adversely affect the tax treatment of the distribution, or (2) EMC obtains, at
our expense, a private letter ruling from the IRS that such action will not
adversely affect the tax treatment of the distribution. The limitations on the
issuance of shares of our stock and other restrictions discussed above could
have a negative impact on our ability to finance our operations and/or prevent
us from being acquired following a tax-free distribution of our stock by EMC to
EMC's shareholders.
Under the tax sharing agreement, EMC is entitled to all actual tax benefits
relating to (1) exercises by our employees of options to acquire EMC common
stock, and (2) disqualifying dispositions (within the meaning of Section 421(b)
of the Internal Revenue Code of 1986) by our employees of EMC common stock
obtained on exercise of incentive stock options. Disqualifying dispositions of
EMC common stock by our employees could result in the availability of deductions
to us equal to the difference between the fair market value of the EMC common
stock on the date the options are exercised and their exercise price, and the
tax sharing agreement will require us to pay EMC an amount equal to 37 percent
of those deductions if, when and to the extent that our tax liability is
actually reduced by them.
For periods during which we are included in EMC's consolidated group, (1)
EMC will be the sole and exclusive agent for us in any and all matters relating
to tax liabilities covered by the tax sharing agreement, (2) EMC will have sole
responsibility for the preparation and filing of consolidated federal and
consolidated or combined or unitary state income tax returns or amended returns,
and (3) EMC will have the power, in its sole discretion, to contest, compromise
or settle any asserted tax adjustment or deficiency and to file, litigate or
compromise any claim for refund on our behalf. For periods after we are no
longer members of EMC's consolidated group, and for any taxes which are not
covered by the tax sharing agreement, we will have sole responsibility for
preparing and filing tax returns and contesting, compromising or settling any
audits or controversies relating thereto.
EMC OEM AGREEMENT
We recently entered into an OEM Purchase and License Agreement with EMC
that governs EMC's purchases of our products and the grant to EMC of rights to
use and support, and to distribute software for use in connection with, these
products. Except for EMC's grant to us of trademark licenses for the private
labeling of the products and for the ownership of certain EMC custom features,
which will remain in EMC, the agreement does not transfer any intellectual
property. The agreement does not commit EMC to purchase any products from us.
For as long as the agreement is effective, we have agreed to ensure that the
products it sells to EMC are compliant with fibre channel industry standards.
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The agreement has an initial term of five years and may be extended for
additional one-year periods at the request of either party. EMC may terminate
the agreement on sixty days' prior written notice. Either party may terminate in
the event of an uncured material breach or in the event of any insolvency or
cessation of operations. With respect to us, such an event would give EMC a
right to a source code escrow and manufacturing rights license.
EMC DEVELOPMENT AGREEMENT
We recently entered into a Development Agreement with EMC that defines the
future performance capabilities of products that EMC may purchase from us.
The agreement has an initial term of five years and may be extended for
additional one-year periods at the request of either party. EMC may terminate
the agreement on sixty days' prior written notice. Either party may terminate
the agreement in the event of any insolvency or cessation of operations. With
respect to us, such an event would give EMC a right to a source code escrow and
a manufacturing rights license.
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PRINCIPAL STOCKHOLDERS
The following table sets forth certain information concerning the
beneficial ownership of our common stock as of June 30, 2000. Unless otherwise
indicated, the address of each listed shareholder is c/o McDATA Corporation, 310
Interlocken Parkway, Broomfield, CO 80021.
We have determined beneficial ownership in accordance with the rules of the
Securities and Exchange Commission. Except as indicated by the footnotes below,
we believe, based on the information furnished to us, that the persons and
entities named in the tables below have sole voting and investment power with
respect to all shares of common stock that they beneficially own, subject to
applicable community property laws. We have based our calculation of the
percentage of beneficial ownership on 93,952,226 shares of common stock
outstanding on June 30, 2000 and 106,452,226 shares of common stock outstanding
upon completion of this offering.
In computing the number of shares of common stock beneficially owned by a
person and the percentage ownership of that person, we deemed outstanding shares
of common stock subject to options held by that person that are currently
exercisable or exercisable within 60 days of June 30, 2000. We did not deem
these shares outstanding, however, for the purpose of computing the percentage
ownership of any other person. Asterisks represent beneficial ownership of less
than one percent.
<TABLE>
<CAPTION>
NUMBER OF SHARES OF PERCENT OF SHARES OF
COMMON STOCK COMMON STOCK
BENEFICIALLY OWNED BENEFICIALLY OWNED
BEFORE THE OFFERING -----------------------
--------------------- BEFORE THE AFTER THE
NAME AND ADDRESS OF THE BENEFICIAL OWNER CLASS NUMBER OFFERING OFFERING
---------------------------------------- ------- ---------- ---------- ---------
<S> <C> <C> <C> <C>
5% STOCKHOLDER
McDATA Holdings Corporation................. Class A 81,000,000 86.2% 76.1%
EXECUTIVE OFFICERS AND DIRECTORS
John F. McDonnell(1)........................ Class B 10,500,000 11.2% 9.9%
Richard A. Carlson(2)....................... Class B 400,000 * *
Michael B. Gustafson(3)..................... Class B 70,000 * *
James E. Kuenzel............................ Class B -- -- --
Thomas O. McGimpsey(4)...................... Class B -- -- --
Dee J. Perry................................ Class B 400,000 * *
Jeffery O. Vogel(5)......................... Class B 50,000 * *
David M. Weishaar........................... Class B 150,000 * *
David A. Donatelli.......................... Class B -- -- --
John W. Gerdelman(6)........................ Class B 30,000 * *
Charles C. Johnston(7)...................... Class B 30,000 * *
D. Van Skilling(8).......................... Class B 30,000 * *
Thomas M. Uhlman(9)......................... Class B 30,000 * *
Laurence G. Walker(10)...................... Class B 30,000 * *
All Executive Officers and Directors as a
group (13 persons)(11).................... Class B 11,720,00 12.5% 11.0%
</TABLE>
-------------------------
(1) Includes 40,000 shares held by the McDonnell Family Partnership, L.L.L.P.,
a limited liability limited partnership of which Mr. McDonnell is the
general partner; 4,000,000 shares held by
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Patricia L. McDonnell, Mr. McDonnell's wife; 50,000 shares held by
Patricia L. McDonnell, as custodian for a custodial account; and 440,000
shares subject to stock options exercisable within 60 days after June 30,
2000. Mr. McDonnell disclaims beneficial ownership of the shares of Class
B common stock held by Mrs. McDonnell personally and as custodian.
(2) Includes 100,000 shares held by Kelly L. Carlson, Mr. Carlson's daughter,
and 100,000 shares held by Alan J. Carlson, Mr. Carlson's son. Mr. Carlson
disclaims beneficial ownership of the shares of Class B common stock held
by Kelly Carlson and Alan Carlson.
(3) Includes 70,000 shares subject to stock options exercisable within 60 days
after June 30, 2000.
(4) Mr. McGimpsey joined McDATA in July 2000 and does not beneficially hold
any shares of common stock of McDATA as of June 30, 2000.
(5) Includes 50,000 shares subject to stock options exercisable within 60 days
after June 30, 2000.
(6) Includes 150,000 shares subject to stock options exercisable within 60
days after June 30, 2000.
(7) Includes 30,000 shares subject to stock options exercisable within 60 days
after June 30, 2000.
(8) Includes 30,000 shares subject to stock options exercisable within 60 days
after June 30, 2000.
(9) Includes 30,000 shares subject to stock options exercisable within 60 days
after June 30, 2000.
(10) Includes 30,000 shares subject to stock options exercisable within 60 days
after June 30, 2000.
(11) Includes 30,000 shares subject to stock options exercisable within 60 days
after June 30, 2000.
(12) Includes an aggregate of 860,000 shares subject to stock options
exercisable within 60 days after June 30, 2000.
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DESCRIPTION OF CAPITAL STOCK
The following is a description of our capital stock and certain provisions
of our amended and restated certificate of incorporation and our amended and
restated by-laws. This description summarizes portions of our amended and
restated certificate of incorporation and our amended and restated by-laws. You
should read our entire amended and restated certificate of incorporation and the
amended and restated by-laws, copies of which have been filed with the
Securities and Exchange Commission as exhibits to our registration statement of
which this prospectus constitutes a part.
Our authorized capital stock consists of 250,000,000 shares of Class A
common stock, par value $.01 per share, 200,000,000 shares of Class B common
stock, par value $0.01 per share, and 25,000,000 shares of preferred stock, par
value $0.01 per share.
COMMON STOCK
As of June 30, 2000, there were 81,000,000 shares of Class A common stock
outstanding and held of record by one stockholder and 12,952,226 shares of Class
B common stock outstanding and held of record by 107 stockholders. Upon
completion of this offering, based on the number of shares outstanding as of
June 30, 2000, there will be 81,000,000 shares of our Class A common stock
outstanding and 25,452,226 shares of our Class B common stock outstanding. As of
June 30, 2000, there were no outstanding stock options for the purchase of
shares of Class A common stock, and there were outstanding options for the
purchase of a total of 12,839,624 shares of our Class B common stock. We are not
offering for sale to the public any shares of our Class A common stock. No
shares of our Class A common stock will be issued pursuant to this offering.
Shares of our Class A and Class B common stock have the following rights,
preferences and privileges:
- Voting Rights. Each outstanding share of Class A common stock entitles
its holder to one vote on all matters submitted to a vote of our
stockholders, including the election of directors. Each outstanding share
of Class B common stock entitles its holder to one-tenth ( 1/10) of one
vote on all matters submitted to a vote of our stockholders, including
the election of directors. There are no cumulative voting rights. Our
Class A common stock and Class B common stock vote together as one class
on all matters. Based on the number of shares of our Class A and Class B
common stock outstanding as of June 30, 2000 and proposed to be
outstanding after the offering, the holders of a plurality of the shares
of Class A common stock voting for the election of directors may elect
all of our directors standing for election.
- Dividends. Subject to the rights of the holders of preferred stock if
any, the holders of Class A and Class B common stock are entitled to
receive dividends at the same rate, as, when and if dividends are
declared by our board of directors out of assets legally available for
the payment of dividends. No dividends shall be paid on or declared and
set apart for the shares of Class A or Class B common stock unless at the
same time an equal dividend shall be paid on or declared or set apart for
the shares of the other class of common stock.
- Liquidation. In the event of a liquidation, dissolution or winding up of
our affairs, whether voluntary or involuntary, after payment of our
liabilities and obligations to creditors and any holders of preferred
stock, our remaining assets will be distributed ratably among the holders
of shares of Class A common stock and Class B common stock on a per share
basis, regardless of class.
- Rights and Preferences. The Class A and Class B common stock have no
preemptive, redemption, conversion or subscription rights. The rights,
powers, preferences and privileges of holders of our common stock are
subject to, and may be adversely affected by, the rights of the holders
of shares of any series of preferred stock that we may designate and
issue in the future.
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- Merger. In the event of a merger or consolidation of us with or into
another entity, holders of each share of Class A common stock and Class B
common stock will be entitled to receive the same per share
consideration. However, if the consideration is voting securities,
holders of Class A common stock may receive ten times the number of such
securities as given to the holders of Class B common stock.
PREFERRED STOCK
The board of directors is authorized to issue preferred stock with voting,
conversion and other rights and preferences that could adversely affect the
voting power or other rights of the holders of Class B common stock. We have no
current plans to issue any preferred stock. However, the issuance of preferred
stock or of rights to purchase preferred stock could have the effect of making
it more difficult for a third party to acquire, or of discouraging a third party
from attempting to acquire, a majority of our outstanding common stock.
PREEMPTIVE RIGHTS
Under the terms of the Investors Rights Agreement dated as of October 1,
1997 by and among us, EMC and the holders of our Class A common stock and Class
B common stock, we agreed to certain protective provisions in favor of McDATA
Holdings Corporation, a subsidiary of EMC and the holder of all of the
outstanding shares of our Class A common stock. In particular, we agreed that in
the event that we issue any equity securities, or any other event occurs, that
would result in McDATA Holdings Corporation's percentage interest in the voting
power or value of all of our outstanding capital stock to fall below 50%, then
McDATA Holdings Corporation would have the right to purchase equity securities
(for the price and upon the terms and conditions in the proposed issuance) in an
amount sufficient to enable it to maintain a 50% interest in the voting power or
value of all of our outstanding capital stock. EMC presently intends to
terminate this right at the time of its contemplated distribution of our Class A
common stock to its stockholders.
RIGHT OF FIRST REFUSAL
Under the terms of the Investors Rights Agreement, McDATA Holdings
Corporation also has, in certain circumstances, a right of first refusal with
respect to common stock held by Mr. McDonnell. McDATA Holdings Corporation has
the right to purchase Mr. McDonnell's Class B common stock if Mr. McDonnell is
no longer employed by us and wishes to sell his Class B common stock in a
private sale. McDATA Holdings Corporation has the right to purchase Mr.
McDonnell's Class B common stock at the price and upon the terms and conditions
offered by the third party in the private sale.
ANTI-TAKEOVER EFFECTS OF PROVISIONS OF OUR CHARTER AND BY-LAWS
Our amended and restated certificate of incorporation and amended and
restated by-laws contain certain provisions that could discourage, delay or
prevent a change in control of McDATA or an acquisition of McDATA at a price
that many stockholders may find attractive. The existence of these provisions
could limit the price that investors might be willing to pay in the future for
shares of common stock.
Blank Check Preferred Stock. As noted above, our board of directors,
without stockholder approval, will have the authority under our amended and
restated certificate of incorporation to issue preferred stock with rights
superior to the rights of the holders of Class B common stock. As a result,
preferred stock could be issued quickly and easily, could adversely affect the
rights of holders of Class B common stock and could be issued with terms
calculated to delay or prevent a change of control or make removal of management
more difficult.
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Staggered Board -- Election and Removal of Directors. Our amended and
restated certificate of incorporation provides for the division of the board of
directors into three classes as nearly equal in size as possible with staggered
three-year terms. Newly created directorships resulting from an increase in the
authorized number of directors may be filled by a majority of the Board of
Directors then in office, provided a quorum is present and any other vacancy
occurring on the board of directors may be filled only by a majority of the
directors then in office, even though less than a quorum may then be in office.
These provisions may have the effect of discouraging a third-party from
initiating a proxy contest, making a tender offer or otherwise attempting to
gain control of us, or attempting to change the composition or policies of the
board of directors.
Stockholder Meetings and Action. Our amended and restated by-laws provide
that special meetings of stockholders may be called by (1) the Chairman of the
Board of Directors, (2) the Chief Executive Officer, (3) the Board of Directors
pursuant to a resolution adopted by a majority of the total number of authorized
directors (whether or not there exist any vacancies in previously authorized
directorships at the time any such resolution is presented to the board of
directors for adoption), or (4) stockholders who are entitled to cast at least
seventy percent (70%) of the total number of votes entitled to be cast at an
election of directors; and shall be held at such place, on such date, and at
such time as the board of directors, shall fix. Our amended and restated by-laws
also provide that stockholder action may be taken at a duly called and convened
annual or special meeting of the stockholders or by written consent of
stockholders who are entitled to cast at least seventy percent (70%) of the
total number of votes entitled to be cast. These provisions, taken together, may
in the future prevent stockholders from forcing consideration by the
stockholders of stockholder proposals over the opposition of the board of
directors, except at an annual meeting.
Requirement for Advance Notification of Stockholder Nominations and
Proposals. Our amended and restated by-laws provide that a stockholder seeking
to bring business, including action to nominate candidates for election as
directors at an annual meeting of stockholders, must provide timely notice of
this intention in writing. To be timely, a stockholder notice must be delivered
to our principal executive officers not less than sixty (60) days nor more than
ninety (90) days prior to the anniversary date of the immediately preceding
annual meeting of stockholders. However, if no annual meeting of stockholders
was held the previous year or the date of the annual meeting of stockholders has
been changed more than thirty (30) days from the date contemplated at the time
of the previous year's proxy statement, then the notice by stockholder must be
received not earlier than ninety (90) days prior to the annual meeting of
stockholders and no later than sixty (60) days prior to the annual meeting of
stockholders or, in the event that public announcement of the date of the annual
meeting is first made by us fewer than seventy (70) days prior to the date of
such annual meeting, the notice by stockholder must be received within ten (10)
days from the public announcement. These provisions can delay stockholder
action. The Delaware General Corporation Law provides generally that the
affirmative vote of a majority of the shares issued and outstanding is required
to amend a corporation's certificate of incorporation or by-laws, unless a
corporation's certificate of incorporation or by-laws, as the case may be,
requires a greater percentage. Our amended and restated certificate of
incorporation requires the affirmative vote of stockholders who are entitled to
cast at least seventy percent (70%) of the total number of votes entitled to be
cast at an election of directors to amend or repeal any of the foregoing
provisions.
DELAWARE ANTI-TAKEOVER STATUTE
We are a Delaware corporation subject to Section 203 of the Delaware
General Corporation Law. Under Section 203, some "business combinations" between
a Delaware corporation whose stock generally is publicly traded or held of
record by more than 2,000 stockholders and an "interested
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stockholder" are prohibited for a three-year period following the date that the
stockholder became an interested stockholder, unless:
- the corporation has elected in its certificate of incorporation not to be
governed by Section 203;
- the transaction which resulted in the stockholder becoming an interested
stockholder was approved by the board of directors of the corporation
before the stockholder became an interested stockholder;
- upon consummation of the transaction which resulted in the stockholder
becoming an interested stockholder, the interested stockholder owned at
least 85% of the voting stock of the corporation outstanding at the
commencement of the transaction, excluding voting stock owned by
directors who are also officers or held in employee benefit plans in
which the employees do not have a confidential right to tender stock held
by the plan in a tender or exchange offer; or
- the business combination is approved by the board of directors of the
corporation and authorized at a meeting by two-thirds of the voting stock
which the interested stockholder did not own.
We have not made an election in our amended and restated certificate of
incorporation to opt-out of Section 203.
In addition to the above exceptions to Section 203, the three-year
prohibition does not apply to some business combinations proposed by an
interested stockholder following the announcement or notification of an
extraordinary transaction involving the corporation and a person who had not
been an interested stockholder during the previous three years or who became an
interested stockholder with the approval of a majority of the corporation's
directors. The term "business combination" is defined generally to include
mergers or consolidations, transactions involving the assets or stock of the
corporation or its majority-owned subsidiaries and transactions which increase
an interested stockholder's percentage ownership of stock. The term "interested
stockholder" is defined generally as a stockholder who becomes beneficial owner
of 15% or more of a Delaware corporation's voting stock, or is an affiliate or
associate of the corporation and was the owner of 15% or more of the outstanding
voting stock of the corporation at any time within the three year period
immediately prior to the date on which it is sought to be determined whether
such person is an interested stockholder, together with the affiliates or
associates of that stockholder.
LIMITATION OF LIABILITY AND INDEMNIFICATION
Our amended and restated certificate of incorporation and amended and
restated by-laws provide that we shall indemnify our directors and officers to
the fullest extent that Delaware law permits. Delaware law permits a corporation
to indemnify any director, officer, employee or agent made or threatened to be
made a party to any pending or completed proceeding if the person acted in good
faith and in a manner that the person reasonably believed to be in the best
interests of the corporation and, with respect to any criminal proceeding, had
no reasonable cause to believe that his or her conduct was unlawful.
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Our amended and restated certificate of incorporation limits the liability
of our directors to the maximum extent permitted by Delaware law. Delaware law
provides that directors will not be personally liable for monetary damages for
breach of their fiduciary duties as directors, except liability for:
- any breach of their duty of loyalty to the corporation or its
stockholders;
- acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law;
- unlawful payments of dividends or unlawful stock repurchases or
redemptions; or
- any transaction from which the director derived an improper personal
benefit.
This provision has no effect on any non-monetary remedies that may be
available to us or our stockholders, nor does it relieve us or our officers or
directors from compliance with federal or state securities laws.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers, or persons controlling us under
the provisions that we describe above or otherwise, we have been informed that
in the opinion of the Securities and Exchange Commission, this indemnification
is against public policy as expressed in the Securities Act of 1933 and is
therefore unenforceable.
Our amended and restated by-laws also permit us to purchase and maintain
insurance on behalf of any officer or director for any liability arising out of
his or her actions in that capacity, regardless of whether our by-laws would
otherwise permit indemnification for that liability. We currently have liability
insurance for our officers and directors.
At the present time, there is no pending litigation or proceeding involving
any of our directors, officers, employees or agents in which indemnification
will be required or permitted. We are not aware of any threatened litigation or
proceeding which may result in a claim for indemnification.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the Class B common stock is The Bank
of New York.
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SHARES ELIGIBLE FOR FUTURE SALE
All of the shares of our Class B common stock sold in this offering will be
freely tradable without restriction under the Securities Act of 1933, except for
any shares that may be acquired by an affiliate of McDATA, as that term is
defined in Rule 144 under the Securities Act of 1933. Persons who may be deemed
to be affiliates generally include individuals or entities that control, are
controlled by, or are under common control with, us and may include our
directors and officers as well as our significant stockholders, if any.
The shares of our Class A common stock held by EMC before the distribution
are deemed "restricted securities" as defined in Rule 144, and may not be sold
other than through registration under the Securities Act of 1933 or under an
exemption from registration, such as the exemptions provided by Rule 144, Rule
144(k) or Rule 701.
EMC currently plans approximately six to twelve months following this
offering to distribute all of the shares of our Class A common stock indirectly
owned by EMC, or 81 million shares, which is 100% of our Class A common stock,
to the holders of EMC's common stock. Shares of our Class A common stock
distributed to EMC stockholders in the distribution generally will be freely
transferable, except for shares of Class A common stock received by persons who
may be deemed to be affiliates. Persons who are affiliates will be permitted to
sell the shares of common stock that are issued in this offering or that they
receive in the distribution only through registration under the Securities Act
of 1933, or under an exemption from registration, such as the exemptions
provided by Rule 144, Rule 144(k) or Rule 701 under the Securities Act of 1933.
In general, under Rule 144, commencing 90 days after the date of this
prospectus, a person who has beneficially owned shares of our Class B common
stock for at least one year, including persons who are affiliates, is entitled
to sell within any three-month period a number of shares that does not exceed
the greater of:
- 1% of the number of shares of our Class B common stock then outstanding,
which is expected to be approximately 254,523 shares upon completion of
this offering, based on the number of shares of our Class B common stock
outstanding as of June 30, 2000; or
- the average weekly trading volume of the common stock on The Nasdaq
National Market during the four calendar weeks preceding the filing of a
notice on Form 144 with respect to a sale, subject to restrictions
specified in Rule 144.
Sales under Rule 144 are also subject to manner of sale provisions and
notice requirements and to the availability of current public information about
us. Commencing 90 days after the date of this prospectus, 562,326 shares of our
Class B common stock that are not subject to lock-up agreements will be
available for resale to the public in accordance with Rule 144.
Under Rule 144(k), a person who has not been one of our affiliates at any
time during the three months preceding a sale, and who has beneficially owned
the shares proposed to be sold for at least two years, is entitled to sell those
shares without regard to the volume, manner-of-sale or other limitations
contained in Rule 144. Upon completion of this offering, no shares of our Class
B common stock may be sold under Rule 144(k).
In general, any of our employees who purchase shares from us in connection
with a compensatory stock plan or other written agreement in a transaction
exempt under Rule 701 of the Securities Act of 1933 is eligible to resell the
shares 90 days after the effective date of this offering in reliance on Rule
144, but without compliance with various restrictions, including the holding
period, contained in Rule 144.
Our directors, officers and other stockholders have agreed, with limited
exceptions, not to offer, sell, contract to sell or, with limited exceptions,
otherwise dispose of any shares of Class B common stock or any security
convertible into Class B common stock for a period of 180 days from the date of
this prospectus without the prior written consent of Credit Suisse First Boston
Corporation. These
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directors, officers and other stockholders, totaling 490 persons, will own
15,044,946 shares of Class B common stock, based upon their beneficial ownership
as of June 30, 2000. Upon expiration of the lock-up period, 180 days after the
date of this prospectus, 14,360,806 of those shares of Class B common stock will
be available for resale to the public in accordance with and subject to the
restrictions of Rule 144. In addition, EMC, except for its contemplated
distribution of our Class A common stock to its stockholders, has agreed, with
limited exceptions, not to offer, sell, contract to sell or, with limited
exceptions, otherwise dispose of, directly or indirectly, any securities of
McDATA for a period of 180 days from the date of this prospectus without the
prior written consent of Credit Suisse First Boston Corporation.
We will grant options to purchase shares of our Class B common stock
pursuant to our 1997 Stock Option Plan, subject to certain restrictions. See the
section of this prospectus titled "Employee Benefit Plans." Upon completion of
this offering, we intend to file a registration statement under the Securities
Act of 1933 to register shares reserved for issuance under the 1997 Stock Option
Plan. That registration statement will become effective immediately upon filing.
Accordingly, shares covered by that registration statement will become eligible
for sale in the public markets, subject to vesting restrictions, Rule 144 volume
limitations applicable to our affiliates or the lock-up agreements with Credit
Suisse First Boston Corporation.
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MATERIAL UNITED STATES FEDERAL TAX CONSEQUENCES
TO NON-UNITED STATES HOLDERS
GENERAL
The following is a general discussion of the material United States federal
income and estate tax consequences of the ownership and disposition of common
stock that may be relevant to you if you are a non-United States holder. In
general, a "non-United States holder" is any person or entity that is, for
United States federal income tax purposes, a foreign corporation, a nonresident
alien individual, a foreign partnership or a foreign estate or trust. This
discussion is based on current law, which is subject to change, possibly with
retroactive effect, or different interpretations. This discussion is limited to
non-United States holders who hold shares of common stock as capital assets.
Moreover, this discussion is for general information only and does not address
all of the tax consequences that may be relevant to you in light of your
personal circumstances, nor does it discuss special tax provisions which may
apply to you if you relinquished United States citizenship or residence.
If you are an individual, you may, in many cases, be deemed to be a
resident alien, as opposed to a nonresident alien, by virtue of being present in
the United States for at least 31 days in the calendar year and for an aggregate
of at least 183 days during a three-year period ending in the current calendar
year (counting for such purposes all of the days present in the current year,
one-third of the days present in the immediately preceding year, and one-sixth
of the days present in the second preceding year). Resident aliens are subject
to United States federal income tax as if they were United States citizens.
EACH PROSPECTIVE PURCHASER OF COMMON STOCK IS ADVISED TO CONSULT A TAX
ADVISOR WITH RESPECT TO CURRENT AND POSSIBLE FUTURE TAX CONSEQUENCES OF
PURCHASING, OWNING AND DISPOSING OF OUR COMMON STOCK AS WELL AS ANY TAX
CONSEQUENCES THAT MAY ARISE UNDER THE LAWS OF ANY STATE, MUNICIPALITY OR OTHER
TAXING JURISDICTION IN THE UNITED STATES.
DIVIDENDS
If dividends are paid, as a non-United States holder, you will be subject
to withholding of United States federal income tax at a 30% rate or a lower rate
as may be specified by an applicable income tax treaty. To claim the benefit of
a lower rate under an income tax treaty, you must properly file with the payor
an IRS Form 1001 or IRS Form W-8BEN, or successor form, claiming an exemption
from or reduction in withholding under the applicable tax treaty.
If dividends are considered effectively connected with the conduct of a
trade or business by you within the United States and, where a tax treaty
applies, are attributable to a United States permanent establishment of yours,
those dividends will not be subject to withholding tax, but instead will be
subject to United States federal income tax on a net basis at applicable
graduated individual or corporate rates, provided an IRS Form 4224 or IRS Form
W-8ECI, or successor form, is filed with the payor. If you are a foreign
corporation, any effectively connected dividends may, under certain
circumstances, be subject to an additional "branch profits tax" at a rate of 30%
or a lower rate as may be specified by an applicable income tax treaty.
Unless the payor has knowledge to the contrary, dividends paid prior to
January 1, 2001 to an address outside the United States are presumed to be paid
to a resident of such country for purposes of the withholding discussed above
and for purposes of determining the applicability of a tax treaty rate. However,
recently finalized Treasury Regulations pertaining to United States federal
withholding tax provide that you must comply with certification procedures, or,
in the case of payments made outside the United States with respect to an
offshore account, certain documentary evidence
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procedures, directly or under certain circumstances through an intermediary, to
obtain the benefits of a reduced rate under an income tax treaty with respect to
dividends paid after December 31, 2000. In addition, these regulations will
require you, if you provide an IRS Form 4224 or IRS Form W-8ECI or successor
form, as discussed above, to also provide your tax identification number.
If you are eligible for a reduced rate of United States withholding tax
pursuant to an income tax treaty, you may obtain a refund of any excess amounts
withheld by filing an appropriate claim for refund with the IRS.
GAIN ON DISPOSITION OF COMMON STOCK
As a non-United States holder, you generally will not be subject to United
States federal income tax on any gain recognized on the sale or other
disposition of common stock unless:
(1) the gain is considered effectively connected with the conduct of a
trade or business by you within the United States and, where a tax treaty
applies, is attributable to a United States permanent establishment of
yours (in which case, if you are a foreign corporation, you may be subject
to an additional branch profits tax equal to 30% or a lower rate as may be
specified by an applicable income tax treaty).
(2) you are an individual who holds the common stock as a capital
asset and are present in the United States for 183 or more days in the
taxable year of the sale or other disposition and other conditions are met;
or
(3) we are or have been a "United States real property holding
corporation", or a USRPHC, for United States federal income tax purposes.
We believe that we are not currently, and are likely not to become, a
USRPHC. If we were to become a USRPHC, then gain on the sale or other
disposition of common stock by you generally would not be subject to United
States federal income tax provided:
- the common stock was "regularly traded" on an established
securities market; and
- you do not actually or constructively own more than 5% of the
common stock during the shorter of the five-year period preceding
the disposition or your holding period.
FEDERAL ESTATE TAX
If you are an individual, common stock held at the time of your death will
be included in your gross estate for United States federal estate tax purposes,
and may be subject to United States federal estate tax, unless an applicable
estate tax treaty provides otherwise.
INFORMATION REPORTING AND BACKUP WITHHOLDING TAX
We must report annually to the IRS and to each of you the amount of
dividends paid to you and the tax withheld with respect to those dividends,
regardless of whether withholding was required. Copies of the information
returns reporting those dividends and withholding may also be made available to
the tax authorities in the country in which you reside under the provisions of
an applicable income tax treaty or other applicable agreements.
Backup withholding is generally imposed at the rate of 31% on certain
payments to persons that fail to furnish the necessary identifying information
to the payer. Backup withholding generally will not apply to dividends paid
prior to January 1, 2001 to a non-United States holder at an address outside the
United States, unless the payer has knowledge that the payee is a United States
person. In the case of dividends paid after December 31, 2000, the recently
finalized Treasury Regulations provide that you generally will be subject to
withholding tax at a 31% rate unless you certify your non-United States status.
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The payment of proceeds of a sale of common stock effected by or through a
United States office of a broker is subject to both backup withholding and
information reporting unless you provide the payor with your name and address
and you certify your non-United States status or you otherwise establish an
exemption. In general, backup withholding and information reporting will not
apply to the payment of the proceeds of a sale of common stock by or through a
foreign office of a broker. If, however, such broker is for United States
federal income tax purposes, a United States person, a controlled foreign
corporation, or a foreign person that derives 50% or more of its gross income
for certain periods from the conduct of a trade or business in the United
States, or, in addition, for periods after December 31, 2000, a foreign
partnership that at any time during its tax year either is engaged in the
conduct of a trade or business in the United States or has as partners one or
more United States persons that, in the aggregate, hold more than 50% of the
income or capital interest in the partnership, such payments will be subject to
information reporting, but not backup withholding, unless such broker has
documentary evidence in its records that you are a non-United States holder and
certain other conditions are met or you otherwise establish an exemption.
Any amounts withheld under the backup withholding rules generally will be
allowed as a refund or a credit against your United States federal income tax
liability provided the required information is furnished in a timely manner to
the IRS.
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UNDERWRITING
Under the terms and subject to the conditions contained in an underwriting
agreement dated , 2000, we have agreed to sell to the underwriters
named below, for whom Credit Suisse First Boston Corporation, Deutsche Bank
Securities Inc. and Merrill Lynch, Pierce, Fenner & Smith Incorporated are
acting as representatives, the following respective numbers of shares of Class B
common stock:
<TABLE>
<CAPTION>
UNDERWRITERS NUMBER OF SHARES
------------ ----------------
<S> <C>
Credit Suisse First Boston Corporation......................
Deutsche Bank Securities Inc. ..............................
Merrill Lynch, Pierce, Fenner & Smith
Incorporated...................................
------
Total.....................................................
======
</TABLE>
The underwriting agreement provides that the underwriters are obligated to
purchase all the shares of Class B common stock in the offering if any are
purchased, other than those shares covered by the over-allotment option
described below. The underwriting agreement also provides that if an underwriter
defaults the purchase commitments of non-defaulting underwriters may be
increased or the offering of Class B common stock may be terminated.
We have granted to the underwriters a 30-day option to purchase on a pro
rata basis up to 1,875,000 additional shares at the initial public offering
price less the underwriting discounts and commissions. The option may be
exercised only to cover any over-allotments of Class B common stock.
The underwriters propose to offer the shares of Class B common stock
initially at the public offering price on the cover page of this prospectus and
to selling group members at that price less a concession of $ per share.
The underwriters and selling group members may allow a discount of $ per
share on sales to other broker/dealers. After the initial public offering, the
public offering price and concession and discount to broker/dealers may be
changed by the representatives.
The following table summarizes the compensation and estimated expenses we
will pay:
<TABLE>
<CAPTION>
PER SHARE TOTAL
------------------------------- -------------------------------
WITHOUT WITH WITHOUT WITH
OVER-ALLOTMENT OVER-ALLOTMENT OVER-ALLOTMENT OVER-ALLOTMENT
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Underwriting Discounts and
Commissions paid by us...... $ $ $ $
Expenses payable by us........
</TABLE>
The underwriters have informed us that they do not expect discretionary
sales to exceed 5% of the shares of Class B common stock being offered.
We have agreed that we will not offer, sell, contract to sell, pledge or
otherwise dispose of, directly or indirectly, or file with the Securities and
Exchange Commission a registration statement under the Securities Act of 1933
relating to, any shares of our Class B common stock or securities convertible
into or exchangeable or exercisable for any shares of our Class B common stock,
or publicly disclose the intention to make any such offer, sale, pledge,
disposition or filing, without the prior written consent of Credit Suisse First
Boston Corporation for a period of 180 days after the date of this prospectus.
EMC, except for its contemplated distribution of our Class A common stock,
our officers, directors and other stockholders have agreed not to offer, sell,
contract to sell, pledge or otherwise dispose of, directly or indirectly, any
shares of our Class A or Class B common stock or securities convertible into or
exchangeable or exercisable for any shares of our Class A or Class B common
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stock, enter into a transaction which would have the same effect, or enter into
any swap, hedge or other arrangement that transfers, in whole or in part, any of
the economic consequences of ownership of our Class A or Class B common stock,
whether any such aforementioned transaction is to be settled by delivery of our
Class A or Class B common stock or such other securities, in cash or otherwise,
or publicly disclose the intention to make any such offer, sale, pledge or
disposition, or to enter into any such transaction, swap, hedge or other
arrangement, without, in each case, the prior written consent of Credit Suisse
First Boston Corporation for a period of 180 days after the date of this
prospectus.
We have agreed to indemnify the underwriters against liabilities under the
Securities Act of 1933, or contribute to payments that the underwriters may be
required to make in that respect.
We have applied to list the shares of Class B common stock on The Nasdaq
Stock Market's National Market, subject to official notice of issuance, under
the symbol "MCDT".
Prior to this offering, there has been no public market for the Class B
common stock. The initial public offering price has been determined by
negotiation between us and the representatives. The principal factors considered
in determining the public offering price included:
- the information set forth in this prospectus and otherwise available to
the representatives;
- the history and the prospects for the industry in which we will compete;
- the ability of our management;
- the prospects for our future earnings;
- the present state of our development and our current financial condition;
- the general condition of the securities markets at the time of this
offering; and
- the recent market prices of, and the demand for, publicly-traded common
stock of generally comparable companies.
The initial offering price may not correspond to the price at which our
Class B common stock will trade in the public market subsequent to this
offering, and an active trading market for our Class B common stock may not
develop or continue after this offering.
The representatives may engage in over-allotment, stabilizing transactions,
syndicate covering transactions and penalty bids in accordance with Regulation M
under the Securities Exchange Act of 1934.
- Over-allotment involves syndicate sales in excess of the offering size,
which creates a syndicate short position.
- "Covered" short sales are sales made in an amount not greater than the
over-allotment option granted to the underwriters to purchase
additional shares in the offering. The underwriters may close out any
covered short position by either (1) exercising their over-allotment
option or (2) purchasing shares in the open market. In determining the
source of shares to close out the covered short position, the
underwriters will consider, among other things, the price of shares
available for purchase in the open market as compared to the price
which they may purchase them through the over-allotment option.
- "Naked" short sales are sales in excess of the underwriters'
over-allotment option. The underwriters close out naked short
positions by purchasing shares in the open market.
- Stabilizing transactions permit bids to purchase the underlying security
so long as the stabilizing bids do not exceed a specified maximum.
84
<PAGE> 88
- Syndicate covering transactions involve purchases of the Class B common
stock in the open market after the distribution has been completed in
order to cover syndicate short positions.
- Penalty bids permit the representatives to reclaim a selling concession
from a syndicate member when the Class B common stock originally sold by
such syndicate member is purchased in a stabilizing or syndicate covering
transaction to cover syndicate short positions.
These stabilizing transactions, syndicate covering transactions and penalty bids
may cause the price of the Class B common stock to be higher than it would
otherwise be in the absence of these transactions. These transactions may be
effected on The Nasdaq National Market or otherwise and, if commenced, may be
discontinued at any time.
A prospectus in electronic format will be made available on the Web sites
maintained by one or more of the underwriters participating in this offering.
The representatives may agree to allocate a number of shares to underwriters for
sale to their online brokerage account holders. Internet distributions will be
allocated by the underwriters that will make internet distributions on the same
basis as other allocations.
85
<PAGE> 89
NOTICE TO CANADIAN RESIDENTS
RESALE RESTRICTIONS
The distribution of the Class B common stock in Canada is being made only
on a private placement basis exempt from the requirement that we prepare and
file a prospectus with the securities regulatory authorities in each province
where trades of Class B common stock are effected. Accordingly, any resale of
the Class B common stock in Canada must be made in accordance with applicable
securities laws which will vary depending on the relevant jurisdiction, and
which may require resales to be made in accordance with available statutory
exemptions or pursuant to a discretionary exemption granted by the applicable
Canadian securities regulatory authority. Purchasers are advised to seek legal
advice prior to any resale of the Class B common stock.
REPRESENTATIONS OF PURCHASERS
Each purchaser of Class B common stock in Canada who receives a purchase
confirmation will be deemed to represent to us and the dealer from whom such
purchase confirmation is received that (1) such purchaser is entitled under
applicable provincial securities laws to purchase such common stock without the
benefit of a prospectus qualified under such securities laws; (2) where required
by law, that such purchaser is purchasing as principal and not as agent, and (3)
such purchaser has reviewed the text above under "Resale Restrictions."
RIGHTS OF ACTION (ONTARIO PURCHASERS)
The securities being offered are those of a foreign issuer and Ontario
purchasers will not receive the contractual right of action prescribed by
Ontario securities law. As a result, Ontario purchasers must rely on other
remedies that may be available, including common law rights of action for
damages or rescission or rights of action under the civil liability provisions
of the U.S. federal securities laws.
ENFORCEMENT OF LEGAL RIGHTS
All of the issuer's directors and officers as well as the experts named
herein may be located outside of Canada and, as a result, it may not be possible
for Canadian purchasers to effect service of process within Canada upon the
issuer or such persons. All or a substantial portion of the assets of the issuer
and such persons may be located outside of Canada and, as a result, it may not
be possible to satisfy a judgment against the issuer or such persons in Canada
or to enforce a judgment obtained in Canadian courts against such issuer or
persons outside of Canada.
NOTICE TO BRITISH COLUMBIA RESIDENTS
A purchaser of Class B common stock to whom the Securities Act (British
Columbia) applies is advised that such purchaser is required to file with the
British Columbia Securities Commission a report within ten days of the sale of
any Class B common stock acquired by such purchaser in this offering. Such
report must be in the form attached to British Columbia Securities Commission
Blanket Order BOR #95/17, a copy of which may be obtained from us. Only one such
report must be filed in respect of Class B common stock acquired on the same
date and under the same prospectus exemption.
TAXATION AND ELIGIBILITY FOR INVESTMENT
Canadian purchasers of Class B common stock should consult with their own
legal and tax advisors with respect to the United States, Canadian and other tax
consequences of an investment in
86
<PAGE> 90
the Class B common stock in their particular circumstances and with respect to
the eligibility of the Class B common stock for investment by the purchaser
under relevant Canadian legislation.
LEGAL MATTERS
The validity of the shares of common stock offered hereby will be passed
upon for us by Paul T. Dacier, Esq., Senior Vice President and General Counsel
of EMC. Certain other legal matters in connection with this offering will be
passed upon for us by Mr. Dacier and Skadden, Arps, Slate, Meagher & Flom LLP,
Boston, Massachusetts. Certain legal matters in connection with this offering
will be passed upon for the underwriters by Testa, Hurwitz & Thibeault, LLP.
EXPERTS
The consolidated financial statements as of December 31, 1998 and 1999 and
for each of the three years in the period ended December 31, 1999 included in
this prospectus have been included in reliance on the report of
PricewaterhouseCoopers LLP, independent accountants, given on the authority of
said firm as experts in auditing and accounting.
87
<PAGE> 91
WHERE YOU MAY FIND ADDITIONAL INFORMATION
We have filed with the Securities and Exchange Commission a registration
statement on Form S-1 under the Securities Act of 1933 with respect to the Class
B common stock we propose to sell in this offering. This prospectus, which
constitutes part of the registration statement, does not contain all of the
information set forth in the registration statement. For further information
about us and the Class B common stock we propose to sell in this offering, we
refer you to the registration statement and the exhibits and schedules filed as
a part of the registration statement. Statements contained in this prospectus as
to the contents of any contract or other document filed as an exhibit to the
registration statement are not necessarily complete. If a contract or document
has been filed as an exhibit to the registration statement, we refer you to the
copy of the contract or document that has been so filed.
You may read or copy any contract, agreement or other document referred to
in this prospectus and any portion of our registration statement at the
Securities and Exchange Commission's public reference room at 450 Fifth Street,
N.W., Judiciary Plaza, Room 1024, Washington, D.C. 20549, and at the
Commission's regional offices located at Citicorp Center, 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661-2511, and 7 World Trade Center,
Suite 1300, New York, New York 10048. Copies of such material can also be
obtained at prescribed rates by mail from the Securities and Exchange
Commission's public reference room at 450 Fifth Street, N.W., Washington, D.C.
20549. You may obtain more information about the public reference room by
calling the Securities and Exchange Commission at 1-800-SEC-0330. In addition,
the Securities and Exchange Commission maintains a Web site (http://www.sec.gov)
that contains reports, proxy and information statements and other information
regarding registrants that file electronically with the Securities and Exchange
Commission. As a result of this offering, we will become subject to the
information and reporting requirements of the Securities Exchange Act of 1934,
and we will file periodic reports, proxy statements, and other information with
the Securities and Exchange Commission.
We intend to furnish our stockholders with annual reports containing
audited financial statements and make available to our stockholders quarterly
reports for the first three quarters of each fiscal year containing unaudited
interim financial information.
88
<PAGE> 92
McDATA CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Report of Independent Accountants........................... F-2
Consolidated Balance Sheets................................. F-3
Consolidated Statements of Operations....................... F-4
Consolidated Statements of Changes in Stockholders'
Equity.................................................... F-5
Consolidated Statements of Cash Flows....................... F-6
Notes to Consolidated Financial Statements.................. F-7
</TABLE>
F-1
<PAGE> 93
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of McDATA Corporation:
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, changes in stockholders' equity
and cash flows present fairly, in all material respects, the financial position
of McDATA Corporation and its subsidiaries at December 31, 1998 and 1999, and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 1999 in conformity with accounting principles
generally accepted in the United States. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with auditing standards generally
accepted in the United States, which require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
Broomfield, Colorado
April 19, 2000, except for Note 14 which is as of July 12, 2000
F-2
<PAGE> 94
McDATA CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
------------------- JUNE 30,
1998 1999 2000
------- -------- -----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................... $ 2,111 $ 6,897 $ 6,259
Accounts receivable, net of allowance for doubtful
accounts of $65, $95 and $130 (unaudited),
respectively......................................... 2,636 9,993 10,789
Receivable from Parent.................................. 10,531 3,591 23,587
Inventories............................................. 4,494 6,952 8,378
Deferred tax asset...................................... 2,046 2,541 4,788
Prepaid expenses and other current assets............... 2,025 3,115 1,373
------- -------- --------
Total current assets...................................... 23,843 33,089 55,174
Property and equipment, net............................... 12,120 13,800 17,410
Other assets, net......................................... 3,420 1,461 1,155
------- -------- --------
Total Assets.................................... $39,383 $ 48,350 $ 73,739
======= ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short term debt -- Parent............................... $ -- $ 1,900 $ 1,900
Accounts payable........................................ 3,896 9,013 12,857
Accrued liabilities..................................... 4,842 4,851 10,749
Obligations under capital leases........................ 1,077 1,586 2,325
------- -------- --------
Total current liabilities................................. 9,815 17,350 27,831
Note payable -- Parent.................................... 1,900 -- --
Obligations under capital leases.......................... 1,262 1,175 1,719
Deferred tax liability.................................... 407 275 204
Commitments and contingencies (Note 12)
Stockholders' equity:
Preferred Stock, $0.01 par value, 25,000,000 shares
authorized, no shares issued or outstanding.......... -- -- --
Common stock, Class A, $0.01 par value, 250,000,000
shares authorized, 81,000,000 shares issued and
outstanding.......................................... 810 810 810
Common stock, Class B, $0.01 par value, 200,000,000
shares authorized, 10,002,000, 11,980,936 and
12,952,226 (unaudited) shares issued and outstanding
at December 31, 1998 and 1999 and June 30, 2000,
respectively......................................... 100 120 130
Additional paid-in capital.............................. 30,799 52,930 56,457
Deferred compensation................................... -- (17,567) (17,496)
Retained earnings (accumulated deficit)................. (5,710) (6,743) 4,084
------- -------- --------
Total stockholders' equity................................ 25,999 29,550 43,985
------- -------- --------
Total liabilities and stockholders' equity...... $39,383 $ 48,350 $ 73,739
======= ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE> 95
McDATA CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
SIX MONTHS
ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
----------------------------- -------------------
1997 1998 1999 1999 2000
------- ------- ------- ------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues:
Product revenue..................... $ 4,035 $ 5,242 $29,466 $ 9,558 $ 26,475
Product revenue -- Parent........... 1,336 5,632 48,111 13,264 68,794
Service revenue -- Parent........... 27,652 25,674 17,686 11,368 8,326
------- ------- ------- ------- --------
Total revenue............. 33,023 36,548 95,263 34,190 103,595
Cost of revenues:
Cost of product revenue............. 4,296 3,786 21,254 7,073 14,599
Cost of product revenue -- Parent... 705 3,208 23,148 6,408 33,046
Cost of service revenue -- Parent... 6,269 6,111 5,680 2,819 2,303
------- ------- ------- ------- --------
Gross profit.............. 21,753 23,443 45,181 17,890 53,647
Operating expenses:
Research and development............ 16,512 18,298 24,001 10,321 17,194
Selling and marketing............... 3,747 10,305 15,787 7,101 13,983
General and administrative.......... 2,724 3,405 3,940 1,833 2,915
Amortization of deferred
compensation (excludes
amortization of deferred
compensation included in costs of
product and service revenue of $0,
$0, $511, $23 (unaudited), and
$620 (unaudited), respectively)... -- -- 1,726 419 1,874
------- ------- ------- ------- --------
Operating expenses........ 22,983 32,008 45,454 19,674 35,966
------- ------- ------- ------- --------
Income (loss) from operations....... (1,230) (8,565) (273) (1,784) 17,681
Interest income..................... 458 632 241 120 318
Interest expense.................... (119) (309) (1,113) (545) (279)
------- ------- ------- ------- --------
Income (loss) before income taxes... (891) (8,242) (1,145) (2,209) 17,720
Income tax expense (benefit)........ 2,333 (5,774) (112) (216) 6,893
------- ------- ------- ------- --------
Net income (loss)................... $(3,224) $(2,468) $(1,033) $(1,993) $ 10,827
======= ======= ======= ======= ========
Basic net income (loss) per share... $ (0.04) $ (0.03) $ (0.01) $ (0.02) $ 0.12
======= ======= ======= ======= ========
Shares used in computing basic net
income (loss) per share........... 91,000 91,000 91,638 91,017 93,398
======= ======= ======= ======= ========
Diluted net income (loss) per
share............................. $ (0.04) $ (0.03) $ (0.01) $ (0.02) $ 0.11
======= ======= ======= ======= ========
Shares used in computing diluted net
income (loss) per share........... 91,000 91,000 91,638 91,017 100,088
======= ======= ======= ======= ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE> 96
McDATA CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
COMMON STOCK
-----------------------------------------
CLASS A CLASS B ADDITIONAL RETAINED
------------------- ------------------- PAID-IN DIVISIONAL DEFERRED EARNINGS
SHARES AMOUNT SHARES AMOUNT CAPITAL EQUITY COMPENSATION (DEFICIT)
---------- ------ ---------- ------ ---------- ---------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balances at December 31,
1996.................. -- $ -- -- $ -- $ -- $ 16,431 $ -- $ --
Net income from January
1, 1997 to September
30, 1997.............. -- -- -- -- -- 18 -- --
Stock issued in exchange
for net contributed
assets................ 81,000,000 810 -- -- 20,897 (16,449) -- --
Sale of common stock,
Class B............... -- -- 10,000,000 100 9,900 -- -- --
Net loss from October 1,
1997 to December 31,
1997.................. -- -- -- -- -- -- -- (3,242)
---------- ---- ---------- ---- ------- -------- -------- --------
Balances at December 31,
1997.................. 81,000,000 810 10,000,000 100 30,797 -- -- (3,242)
Issuance of common
stock, Class B upon
exercise of stock
options............... -- -- 2,000 -- 2 -- -- --
Net loss................ -- -- -- -- -- -- -- (2,468)
---------- ---- ---------- ---- ------- -------- -------- --------
Balances at December 31,
1998.................. 81,000,000 810 10,002,000 100 30,799 -- -- (5,710)
Issuance of common
stock, Class B upon
exercise of stock
options............... -- -- 1,978,936 20 1,960 -- -- --
Deferred compensation... -- -- -- -- 19,804 -- (19,804) --
Amortization of deferred
compensation.......... -- -- -- -- -- -- 2,237 --
Tax benefit of stock
options............... -- -- -- -- 367 -- -- --
Net loss................ -- -- -- -- -- -- -- (1,033)
---------- ---- ---------- ---- ------- -------- -------- --------
Balances at December 31,
1999.................. 81,000,000 810 11,980,936 120 52,930 -- (17,567) (6,743)
Issuance of common
stock, Class B upon
exercise of stock
options (unaudited),
net................... -- -- 971,290 10 1,009 -- -- --
Deferred compensation
(unaudited)........... -- -- -- -- 2,423 -- (2,423) --
Amortization of deferred
compensation
(unaudited)........... -- -- -- -- -- -- 2,494 --
Tax benefit of stock
options (unaudited)... -- -- -- -- 95 -- -- --
Net income
(unaudited)........... -- -- -- -- -- -- -- 10,827
---------- ---- ---------- ---- ------- -------- -------- --------
Balances at June 30,
2000 (unaudited)...... 81,000,000 $810 12,952,226 $130 $56,457 $ -- $(17,496) $ 4,084
========== ==== ========== ==== ======= ======== ======== ========
<CAPTION>
TOTAL
STOCKHOLDERS'
EQUITY
-------------
<S> <C>
Balances at December 31,
1996.................. $16,431
Net income from January
1, 1997 to September
30, 1997.............. 18
Stock issued in exchange
for net contributed
assets................ 5,258
Sale of common stock,
Class B............... 10,000
Net loss from October 1,
1997 to December 31,
1997.................. (3,242)
-------
Balances at December 31,
1997.................. 28,465
Issuance of common
stock, Class B upon
exercise of stock
options............... 2
Net loss................ (2,468)
-------
Balances at December 31,
1998.................. 25,999
Issuance of common
stock, Class B upon
exercise of stock
options............... 1,980
Deferred compensation... --
Amortization of deferred
compensation.......... 2,237
Tax benefit of stock
options............... 367
Net loss................ (1,033)
-------
Balances at December 31,
1999.................. 29,550
Issuance of common
stock, Class B upon
exercise of stock
options (unaudited),
net................... 1,019
Deferred compensation
(unaudited)........... --
Amortization of deferred
compensation
(unaudited)........... 2,494
Tax benefit of stock
options (unaudited)... 95
Net income
(unaudited)........... 10,827
-------
Balances at June 30,
2000 (unaudited)...... $43,985
=======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE> 97
McDATA CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS
ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
--------------------------- ------------------
1997 1998 1999 1999 2000
------- ------- ------- ------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)..................................... $(3,224) $(2,468) $(1,033) $(1,993) $ 10,827
Adjustments to reconcile net loss to cash flows from
operating activities:
Depreciation and amortization..................... 2,738 4,213 5,734 2,579 3,578
Inventory provision............................... 2,476 1,326 1,907 252 579
Noncash compensation expense...................... -- -- 2,237 442 2,494
Changes in current assets and liabilities:
Accounts receivable............................. 739 (2,344) (7,357) (1,638) (796)
Receivable from parent.......................... (5,868) 9,318 7,185 4,505 (19,846)
Inventories..................................... (3,009) (4,693) (6,054) (5,336) (2,329)
Deferred tax asset.............................. 1,259 (2,046) (495) (266) (2,247)
Prepaid expenses and other current assets....... 509 (1,145) (1,090) (1,447) 1,742
Other assets.................................... (16) (1,946) 1,605 1,386 89
Accounts payable................................ (201) 1,922 5,117 2,844 3,844
Accrued liabilities............................. (3,685) 1,438 9 222 5,898
Deferred tax liability.......................... -- 407 (132) (185) (71)
------- ------- ------- ------- --------
Net cash used in operating activities................. (8,282) 3,982 7,633 1,365 3,762
------- ------- ------- ------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment................... (3,495) (6,238) (3,305) (2,228) (4,058)
Acquisition of assets................................. (4,972) -- -- -- --
------- ------- ------- ------- --------
Net cash used in investing activities................. (8,467) (6,238) (3,305) (2,228) (4,058)
------- ------- ------- ------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payment of obligations under capital leases........... (879) (1,054) (1,522) (655) (1,361)
Proceeds received from issuance of debt to parent
company............................................. 1,900 -- -- -- --
Proceeds from sale of common stock.................... 15,258 2 1,980 192 1,019
------- ------- ------- ------- --------
Net cash provided by (used in) financing activities... 16,279 (1,052) 458 (463) (342)
------- ------- ------- ------- --------
Net increase (decrease) in cash and cash
equivalents......................................... (470) (3,308) 4,786 (1,326) (638)
Cash and cash equivalents, beginning of period........ 5,889 5,419 2,111 2,111 6,897
------- ------- ------- ------- --------
Cash and cash equivalents, end of period.............. $ 5,419 $ 2,111 $ 6,897 $ 785 $ 6,259
======= ======= ======= ======= ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest incurred, expensed and paid.................. $ 119 $ 309 $ 1,113 $ 545 $ 279
Income taxes received from (paid to) parent........... -- (202) 4,302 -- 6,981
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND
FINANCING ACTIVITIES:
Capital lease obligations incurred.................... $ 826 $ 2,323 $ 1,944 $ 979 $ 2,647
Transfer of inventory to fixed assets................. -- -- 1,357 416 193
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE> 98
McDATA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 -- OVERVIEW AND BASIS OF PRESENTATION
On October 1, 1997 EMC Corporation (EMC or the Parent) formed McDATA
Corporation (McDATA or the Company) which is incorporated in Delaware. The
Company was formed when McDATA Holdings Corporation, a wholly-owned subsidiary
of EMC, transferred cash and net assets to McDATA pursuant to an Asset Transfer
Agreement. In exchange, EMC received 81,000,000 shares of the Company's Class A
common stock. Concurrently, with the Asset Transfer Agreement, minority
shareholders contributed $10,000,000 in cash in exchange for 10,000,000 shares
of the Company's Class B common stock. Each share of the Company's Class A
common stock entitles its holder to one vote, and each share of the Company's
Class B common stock entitles its holder to one-tenth ( 1/10) of one vote. After
the issuance and sale of the Company's Class A and Class B common stock to EMC
and the minority shareholders, respectively, EMC owned 89% of the Company and
the minority shareholders owned 11% of the Company. As McDATA was under the
control of EMC, there was no change in the accounting basis of the Company's
assets and liabilities in the consolidated financial statements.
As of December 31, 1999, EMC held 81,000,000 shares of the Company's Class
A common stock, representing 77.2% ownership of the Company on a fully diluted
basis, and minority shareholders held 23,921,450 shares of the Company's Class B
common stock, representing 22.8% ownership of the Company. As of that date,
EMC's ownership of all of the issued and outstanding shares of the Company's
Class A common stock represented 97.1% of the combined voting power of the
Company's Class A and Class B common stock.
McDATA was formed to continue the design, development, manufacturing and
selling of EMC's fibre channel switching devices that enable enterprise-wide
high performance storage area networks. The Company continues to provide
services for EMC's ESCON switch business under a service agreement with EMC.
The consolidated financial statements include the assets, liabilities,
operating results and cash flows of McDATA and have been prepared using EMC's
historical bases in the assets and liabilities and the historical results of
operations of McDATA. Because McDATA's operations were substantially independent
of EMC's operations during all periods presented in the financial statements,
the Company's management does not believe there were any corporate expenses
incurred by EMC that should be allocated to the Company. Accordingly, no
intercompany expense allocations have been included in the financial statements.
The consolidated financial statements do include certain allocations of interest
income and expense from participation in EMC's cash management system (see Note
11).
The following is a list of the Company's subsidiaries as of December 31,
1999:
<TABLE>
<CAPTION>
NAME: COUNTRY OF FORMATION: DATE OF FORMATION:
----- --------------------- ------------------
<S> <C> <C>
McDATA Technology Systems Ltd................. Ireland April 4, 1999
(formerly Ecksberg Nominees Ltd.)
McDATA F.S.C.................................. Barbados July 28, 1999
</TABLE>
F-7
<PAGE> 99
McDATA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the assets, liabilities,
results of operations, cash flows and changes in stockholders' equity of the
Company and its wholly-owned subsidiaries. All material intercompany
transactions and balances have been eliminated.
Unaudited Interim Financial Data
The unaudited interim consolidated financial statements as of June 30, 2000
and for the three months ended June 30, 1999 and 2000 have been prepared on the
same basis as the audited financial statements and, in the opinion of
management, reflect all normal recurring adjustments necessary to present fairly
the financial information set forth therein, in accordance with generally
accepted accounting principles. The results of operations for the interim
periods are not necessarily indicative of the results to be expected for future
periods.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that effect the reported amounts of assets, liabilities, revenues
and expenses and disclosure of contingent assets and liabilities. Actual results
could differ from these estimates.
Revenue Recognition
The Company generally recognizes revenue from product sales upon shipment
provided that (a) evidence of an arrangement exists (b) delivery has occurred
(c) the price to the customer is fixed and determinable and (d) collectibility
is assured. The Company accrues for warranty costs and sales returns at the time
of shipment based on its experience. In transactions that include multiple
products and/or services, the Company allocates the sales value among each of
the deliverables based on their relative fair values. Service revenue is
recognized over the contractual period or as the services are rendered. Revenue
from the service agreement with EMC (see Note 11) is recorded as earned pursuant
to the terms of the servicing contract.
Concentration of Credit Risk
The Company performs ongoing evaluations of its customers' financial
condition and, generally, requires no collateral from its customers. The
Company's customers include its Parent, as well as original equipment
manufacturers, distributors, systems integrators and end users. The majority of
the Company's customers operate in the computer industry.
The Company had the following customers which accounted for greater than
10% of each respective period's revenue:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------
1997 1998 1999
----- ----- -----
<S> <C> <C> <C>
Customer A (Parent)......................................... 88% 86% 69%
Customer B.................................................. -- -- 13%
Customer C.................................................. -- -- 11%
</TABLE>
F-8
<PAGE> 100
McDATA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
At December 31, 1999, these customers accounted for 26%, 31% and 18%,
respectively, of the Company's gross accounts receivable, which is comprised of
accounts receivable and receivable from Parent. At December 31, 1998, Customer A
accounted for 80% of the Company's gross accounts receivable.
Financial instruments which potentially subject the Company to
concentrations of credit risk are accounts receivable and cash equivalents. The
Company has a cash investment policy which generally restricts investments to
ensure preservation of principal and maintenance of liquidity.
Cash Equivalents
Cash equivalents are short-term, highly liquid investments that are readily
convertible to cash and have remaining maturities of three months or less.
Fair Value of Financial Instruments
The carrying value of financial instruments, including cash equivalents,
gross accounts receivable, accounts payable and accrued liabilities, approximate
fair value due to their short maturities. Based upon borrowing rates currently
available to the Company, with similar terms, the carrying value of debt and
capital lease obligations approximate their fair value.
Impairment of Long-Lived Assets
The Company periodically evaluates the carrying value of long-lived assets
when events and circumstances warrant such a review. The carrying value of a
long-lived asset is considered impaired when the anticipated undiscounted cash
flows from such asset is separately identifiable and is less than its carrying
value. In that event, a loss is recognized to the extent that the carrying value
exceeds the fair value of the long-lived asset. Fair value is determined
primarily using the anticipated cash flows discounted at a rate commensurate
with the risk involved.
Earnings and Loss Per Share
Basic net income or loss per share is computed using the weighted average
number of common shares outstanding during the period. Diluted net income per
share is computed using the weighted average number of common and dilutive
common equivalent shares outstanding during the period. Dilutive common
equivalent shares consist of stock options. Prior to October 1, 1997, the
Company's capital structure was not indicative of the current structure. As
such, earnings per share for 1997 has been calculated using the actual number of
shares distributed on October 1, 1997.
Potentially dilutive securities totaling 8,799,000, 11,262,750 and
11,940,514 for the years ended December 31, 1997, 1998 and 1999, respectively,
were excluded from historical diluted loss per common share because of their
anti-dilutive effect.
F-9
<PAGE> 101
McDATA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Following is a reconciliation between basic and diluted earnings per share
for the period ended June 30, 2000 (unaudited) (in thousands except per share
information):
<TABLE>
<CAPTION>
PERIOD ENDED JUNE 30, 2000
----------------------------
PER
SHARE
INCOME SHARES AMOUNT
------- ------- ------
<S> <C> <C> <C>
Net income -- basic EPS................................. $10,827 93,398 $0.12
Effect of stock options................................. 6,690
-------
Net income -- diluted EPS............................... 100,088 $0.11
=======
</TABLE>
Stock-Based Compensation
The Company accounts for grants of stock options and common stock purchase
rights according to Accounting Principles Board Opinion No. 25, Accounting for
Stock Issues to Employees (APB 25), and related interpretations. Any deferred
stock compensation calculated pursuant to APB 25 is amortized ratably over the
vesting period of the individual options, generally four years.
Advertising
The Company expenses advertising costs as incurred. Advertising expenses
for the periods ended December 31, 1997, 1998 and 1999 were approximately
$439,000, $696,000 and $531,000, respectively.
Research and Development
Research and development costs are expensed as incurred.
Software Development Costs
In accordance with Statement of Financial Accounting Standards No. 86,
Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise
Marketed, the Company capitalizes eligible computer software development costs
upon the establishment of technological feasibility, which it has defined as
completion of designing, coding and testing activities. For the years ended
December 31, 1997, 1998 and 1999, the amount of costs eligible for
capitalization, after consideration of factors such as realizable value, were
not material and, accordingly, all software development costs have been charged
to research and development expenses in the consolidated statements of
operations.
Internal-Use Software Development Costs
The Company accounts for its development and implementation of internal-use
software according to Statement of Position No. 98-1, Accounting for the Cost of
Computer Software Developed or Obtained for Internal Use. This statement
provides guidance regarding the conditions under which the costs of internal-use
software should be capitalized. Costs of developing and implementing software
for internal use, which meet certain criteria, were capitalized and are being
amortized over a five-year period. The Company capitalized approximately
$1,913,000 and $401,000 during 1998 and 1999, respectively, of which
approximately $0 and $424,000 was amortized to expense, respectively.
F-10
<PAGE> 102
McDATA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Comprehensive Income
Effective January 1, 1998, the Company adopted the provisions of Statement
of Financial Accounting Standards No. 130, Reporting Comprehensive Income. This
statement established standards for reporting comprehensive income and its
components in financial statements. Comprehensive income includes all changes in
equity during a period from non-owner sources. During each of the three years
ended December 31, 1999 and the six-month periods ended June 30, 1999 and 2000,
the Company did not have any significant transactions that were required to be
reported as adjustments to determine comprehensive income.
Reclassifications
Certain prior year amounts have been reclassified to conform with the 1999
presentation.
Recent Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities." SFAS 133 is effective for all fiscal quarters of all
fiscal years beginning after June 15, 2000. The Company adopted SFAS 133 on
January 1, 1999. To date, the Company has not entered into any derivative
instruments, so the adoption has had no effect on the financial position or
results of operations of the Company.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, Revenue Recognition in Financial Statements, as
amended. SAB 101 summarizes certain of the Securities and Exchange Commission's
views in applying generally accepted accounting principles to revenue
recognition in financial statements. The Company has applied the provisions of
SAB 101 in the consolidated financial statements. The adoption of SAB 101 did
not have a material impact on the Company's financial condition or results of
operations.
NOTE 3 -- INVENTORIES
Inventories, which include material, labor and factory overhead, are stated
at the lower of cost (first-in, first-out method) or market. The Company
evaluates the need for reserves associated with obsolete, slow-moving and
nonsalable inventory by reviewing net realizable values on a quarterly basis.
The Company's inventories do not include materials purchased and held by the
Company's component subcontractors, as this inventory is not owned by the
Company. The components of inventory were as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
----------------- JUNE 30
1998 1999 2000
------ ------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Raw materials.................................... $4,086 $ 6,450 $ 5,619
Work-in-progress................................. 231 1,081 2,041
Finished goods................................... 817 1,485 4,552
------ ------- -------
5,134 9,016 12,212
Less reserves.................................... (640) (2,064) (3,834)
------ ------- -------
$4,494 $ 6,952 $ 8,378
====== ======= =======
</TABLE>
F-11
<PAGE> 103
McDATA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 4 -- PROPERTY AND EQUIPMENT
Property and equipment is stated at cost. For financial reporting purposes,
depreciation is recorded principally on a straight-line method over the
estimated useful lives of the asset as follows:
<TABLE>
<S> <C>
Equipment and furniture............... 3-5 years
Computer software..................... 3-5 years
Capital lease equipment............... The shorter of the useful life of 3-5
years or lease term
Leasehold improvements................ The shorter of the useful life of 3-5
years or lease term
</TABLE>
Accelerated depreciation methods are generally used for income tax
purposes. Expenditures that substantially extend the useful life of an asset are
capitalized. Ordinary repair and maintenance expenditures are expensed as
incurred.
Property and equipment consisted of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1998 1999
------- -------
<S> <C> <C>
Equipment and furniture............................. $19,947 $24,290
Computer software................................... 4,760 5,992
Leasehold improvements.............................. 1,244 1,748
------- -------
25,951 32,030
Less accumulated depreciation and amortization...... (13,831) (18,230)
------- -------
$12,120 $13,800
======= =======
</TABLE>
Equipment and furniture at December 31, 1998 and 1999 includes assets under
capitalized leases of $4,314,000 and $5,896,000, respectively, with related
accumulated amortization of $1,882,000 and $3,168,000, respectively.
The minimum future lease payments under capital leases as of December 31,
1999 are as follows (in thousands):
<TABLE>
<S> <C>
2000.................................................... $1,752
2001.................................................... 1,062
2002.................................................... 205
2003.................................................... --
2004.................................................... --
------
3,019
Less amount representing interest....................... (258)
------
Present value of minimum lease payments (including
$1,586 classified as current)......................... $2,761
======
</TABLE>
F-12
<PAGE> 104
McDATA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 5 -- PREPAID EXPENSES AND OTHER ASSETS
Prepaid expenses and other assets consisted of the following (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1998 1999
------ ------
<S> <C> <C>
Prepaid technology license fees....................... $1,336 $1,702
Other................................................. 689 1,413
------ ------
$2,025 $3,115
====== ======
</TABLE>
Prepaid technology license fees are amortized over the shorter of
consumption per unit or estimated period to be benefited.
Other assets consisted of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1998 1999
------ ------
<S> <C> <C>
Intangible assets and goodwill........................ $2,636 $2,408
Prepaid technology license fees (non-current
portion)............................................ 1,811 --
Other................................................. 278 485
------ ------
4,725 2,893
Less accumulated amortization......................... (1,305) (1,432)
------ ------
$3,420 $1,461
====== ======
</TABLE>
On March 20, 1997, the Company purchased certain assets and assumed certain
liabilities from Hewlett-Packard Canada Ltd. for $4,972,000 in cash. The Company
retained an independent appraiser to assist with assigning fair values to the
tangible and intangible assets acquired. The valuation relied on methodologies
that most closely related to the fair market value assignment with the economic
benefits provided by each asset and the risks associated with the assets. The
net identifiable assets were assigned a portion of the consideration based upon
their estimated fair values as follows (in thousands):
<TABLE>
<S> <C>
Property and equipment...................................... $1,190
Inventory................................................... 1,060
Prepaids.................................................... 779
Intellectual property....................................... 300
Workforce................................................... 370
Goodwill.................................................... 1,498
Assumed liabilities......................................... (225)
------
Total consideration............................... $4,972
======
</TABLE>
The identifiable intangible assets and goodwill are being amortized over
five years.
F-13
<PAGE> 105
McDATA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 6 -- ACCRUED LIABILITIES
Accrued liabilities consisted of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1998 1999
------ ------
<S> <C> <C>
Wages and employee benefits........................... $1,269 $2,104
Warranty reserves..................................... 1,485 986
Other taxes........................................... 772 612
Technology purchase obligation........................ 1,000 --
Other accrued liabilities............................. 316 1,149
------ ------
$4,842 $4,851
====== ======
</TABLE>
NOTE 7 -- NOTE PAYABLE TO PARENT COMPANY
On October 1, 1997, the Company entered into an unsecured term note with
the Parent in the amount of $1,900,000. The note requires quarterly payments of
interest in arrears, with principle to be paid in 2007 or upon the consummation
of a sale of all or part of the Company, including an initial public offering.
As the Company anticipates consummating its initial public offering in 2000, the
note has been classified as a current liability as of December 31, 1999. The
note bears simple interest at the prime rate as published in the Wall Street
Journal (8.5% at December 31, 1999). Interest expense incurred and paid to the
Parent for the periods ended December 31, 1997, 1998 and 1999 totaled $63,000,
$161,000 and $154,000, respectively.
NOTE 8 -- STOCKHOLDERS' EQUITY
The Company has both Class A and Class B common stock. Holders of Class A
and Class B common stock have voting rights equal to one vote and one-tenth
vote, respectively, for each share held. Holders of Class A and Class B common
stock share equal rights as to dividends. No dividends attributable to common
stock were declared or paid during the years ended December 31, 1997, 1998 or
1999.
NOTE 9 -- EMPLOYEE BENEFIT PLANS AND STOCK OPTIONS
Defined Contribution Plan
The Company has a defined contribution plan that covers eligible employees.
Effective January 1, 1998, the Board of Directors authorized the Company to
prospectively provide a matching contribution to the McDATA Retirement Savings
Plan at a rate of 50% of an employee's contribution up to 6% of the employee's
compensation, subject to restrictions of such plans. Such Company contributions
are made in cash, and amounted to $393,000 and $550,000 in 1998 and 1999,
respectively.
Profit Sharing Plan
Effective October 1, 1997, the Board of Directors authorized a profit
sharing plan whereby the Company contributes a portion of each year's profits to
a profit sharing pool. The profit sharing amount is determined annually by the
Board of Directors and is distributed to employees
F-14
<PAGE> 106
McDATA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
approximately 50% in cash and approximately 50% in the employees' behalf as
contributions to the McDATA Retirement Savings Plan. Expense recognized under
the profit sharing plan during the period ended December 31, 1997 approximated
$988,000. No expense was recognized in 1998 or 1999 as no Company contributions
were approved by the Board of Directors.
Stock Option Plan
The 1997 Stock Option Plan (the Plan), adopted on October 1, 1997, provides
for the grant of either incentive or nonstatutory options to employees for the
purchase of Class B common stock. The Company has reserved 19,000,000 shares for
issuance under the Plan. Options under the Plan become exercisable over a
four-year period with one-fourth exercisable on each annual anniversary of grant
date and expire ten years from the date of grant.
The following summarizes option transactions for the period from December
31, 1996 to June 30, 2000:
<TABLE>
<CAPTION>
WEIGHTED- WEIGHTED-
SHARES AVERAGE AVERAGE
COVERED EXERCISE OPTIONS EXERCISE
BY OPTIONS PRICE EXERCISABLE PRICE
---------- --------- ----------- ---------
<S> <C> <C> <C> <C>
Outstanding at December 31, 1996......... -- $ -- -- $ --
Granted.................................. 8,883,000 1.00
Forfeited or expired..................... (84,000) 1.00
----------
Outstanding at December 31, 1997......... 8,799,000 1.00 -- --
Granted.................................. 2,725,600 1.06
Exercised................................ (2,000) 1.00
Forfeited or expired..................... (259,850) 1.00
----------
Outstanding at December 31, 1998......... 11,262,750 1.02 2,173,938 1.00
Granted.................................. 3,646,700 2.29
Exercised................................ (1,978,936) 1.00
Forfeited or expired..................... (990,000) 1.10
----------
Outstanding at December 31, 1999......... 11,940,514 1.40 2,584,690 1.02
Granted (unaudited)...................... 2,655,400 12.64
Exercised (unaudited).................... (971,290) 1.05
Forfeited or expired (unaudited)......... (785,000) 9.53
----------
Outstanding at June 30, 2000
(unaudited)............................ 12,839,624 $ 3.26 2,231,024 $1.10
==========
</TABLE>
At December 31, 1999 and June 30, 2000, there were 5,078,550 and 3,208,150
(unaudited) options available for grant under the Plan, respectively.
F-15
<PAGE> 107
McDATA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The status of total stock options outstanding and exercisable at December
31, 1999 was as follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
----------------------------------- OPTIONS EXERCISABLE
WEIGHTED --------------------
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
EXERCISE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
PRICES OF SHARES LIFE PRICE OF SHARES PRICE
-------- ---------- ----------- -------- --------- --------
<S> <C> <C> <C> <C> <C>
$1.00 7,504,376 7.8 years $1.00 2,373,626 $1.00
$1.13 - 1.25 856,438 8.7 years $1.17 211,064 $1.17
$1.63 927,000 9.1 years $1.63 -- --
$2.00 375,250 9.3 years $2.00 -- --
$2.50 - 2.75 2,277,450 9.7 years $2.61 -- --
---------- ---------
$1.00 - 2.75 11,940,514 8.4 years $1.40 2,584,690 $1.02
========== =========
</TABLE>
The status of total stock options outstanding and exercisable at June 30,
2000 was as follows (unaudited):
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
----------------------------------- OPTIONS EXERCISABLE
WEIGHTED --------------------
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
EXERCISE NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
PRICE OF SHARES LIFE PRICE OF SHARES PRICE
-------- ---------- ----------- -------- --------- --------
<S> <C> <C> <C> <C> <C>
$1.00 6,480,876 7.3 years $ 1.00 1,807,751 $1.00
$1.13 - 1.25 741,564 8.2 years $ 1.17 154,689 $1.16
$1.63 881,270 8.6 years $ 1.63 204,208 $1.63
$2.00 330,814 8.8 years $ 2.00 64,376 $2.00
$2.50 - 2.75 2,272,700 9.2 years $ 2.61 -- --
$11.54 1,315,450 9.7 years $11.54 -- --
$13.75 816,950 9.8 years $13.75 -- --
----------
$1.00 - 13.75 12,839,624 8.2 years $ 3.26 2,231,024 $1.10
========== =========
</TABLE>
The Company applies APB 25 and related interpretations in accounting for
its stock-based compensation plan. During the year ended December 31, 1999 and
the six months ended June 30, 2000, in connection with the grant of certain
stock options to employees, the Company recorded deferred stock-based
compensation of $19,804,000 and $2,423,000 (net of forfeitures), (unaudited),
respectively, representing the difference between the exercise price and the
deemed fair market value of the Company's common stock on the dates these stock
options were granted. Deferred compensation is included as a reduction of
stockholders' equity and is being amortized on a straight-line basis over the
vesting periods of the related options, which is generally four years. During
the year ended December 31, 1999 and the six months ended June 30, 2000, the
Company recorded amortization of $2,237,000 and $2,494,000 (unaudited),
respectively (of which, $511,000 and $620,000 (unaudited) is included in the
cost of product and service revenue for the year ended December 31, 1999 and the
six months ended June 30, 2000, respectively).
F-16
<PAGE> 108
McDATA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company has adopted the disclosure provisions of Statement of Financial
Accounting Standards No. 123, Accounting for Stock-Based Compensation. The pro
forma impact on the company's net loss and net loss per share as reported for
the years ended December 31 pursuant to SFAS 123 to reflect the fair value
method of accounting for stock-based compensation plans would have been as
follows (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------
1997 1998 1999
------- ------- -------
<S> <C> <C> <C>
Net income (loss):
As reported..................................... $(3,224) $(2,468) $(1,033)
Pro forma....................................... $(3,299) $(2,823) $(1,452)
Net income (loss) per share:
As reported..................................... $ (0.04) $ (0.03) $ (0.01)
Pro forma....................................... $ (0.04) $ (0.03) $ (0.02)
</TABLE>
The fair value of each option is estimated as of the date of grant using
the Black Scholes valuation pricing model with the following assumptions: (i)
dividend yield of 0%; (ii) expected volatility of 0%; (iii) weighted-average
risk-free rate of 5.985% in 1997, 5.4% in 1998 and 5.5% in 1999; and (iv)
expected life of four years in 1997, 1998 and 1999. The weighted-average per
share fair value of options granted was $0.21, $0.21 and $5.94 per share during
1997, 1998 and 1999, respectively.
NOTE 10 -- INCOME TAXES
The Company is included in a consolidated Federal and Colorado income tax
return with EMC. Pursuant to a tax sharing agreement entered into with EMC, the
Company will be compensated by EMC for the use of its United States net
operating losses at 35%, and its tax credits, including research and development
credits, utilized by the Parent.
Had the Company's tax provision been calculated as if the Company were a
separate, independent United States taxpayer, the income tax provision would not
have materially changed for the year ended December 31, 1999 or the six months
ended June 30, 2000.
F-17
<PAGE> 109
McDATA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Income tax expense (benefit) consisted of the following (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------
1997 1998 1999
------ ------- -----
<S> <C> <C> <C>
Current:
Federal........................................... $ 257 $(3,918) $ 508
State............................................. 12 (217) 7
------ ------- -----
269 (4,135) 515
Deferred:
Federal........................................... 1,900 (1,625) (605)
State............................................. 164 (14) (22)
------ ------- -----
2,064 (1,639) (627)
------ ------- -----
Total expense (benefit)............................. $2,333 $(5,774) $(112)
====== ======= =====
</TABLE>
The total income tax expense (benefit) differs from the amount computed
using the federal income tax rate of 35% for the following reasons (in
thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------
1997 1998 1999
------ ------- -----
<S> <C> <C> <C>
Federal income tax benefit at statutory rate........ $ (312) $(2,885) $(401)
Research and development credit..................... -- (100) (300)
State taxes, net of federal benefit................. (12) (107) (15)
Change in valuation allowance....................... 2,650 (2,650) --
Stock-based compensation............................ -- -- 613
Other............................................... 7 (32) (9)
------ ------- -----
Income tax expense (benefit)........................ $2,333 $(5,774) $(112)
====== ======= =====
</TABLE>
Deferred income taxes reflect the tax effect of temporary differences
between the amount of assets and liabilities for financial reporting purposes
and income tax purposes. The tax effects of each
F-18
<PAGE> 110
McDATA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
type of temporary difference that give rise to significant portions of the net
deferred tax assets are as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1998 1999
------ ------
<S> <C> <C>
Deferred tax asset:
Inventory reserves and costs........................ $1,126 $1,329
Warranty reserves................................... 539 358
Reserves related to employee benefits............... 354 597
Stock-based compensation............................ 27 199
Other............................................... -- 58
------ ------
2,046 2,541
Deferred tax (liability):
Difference between book and tax depreciation........ (407) (275)
------ ------
Net deferred income tax asset......................... $1,639 $2,266
====== ======
</TABLE>
The Internal Revenue Service (IRS) has begun its examination of the EMC
consolidated Federal income tax return for the periods ended December 31, 1996,
1997 and 1998.
The Company evaluates a variety of factors in determining the amount of the
deferred income tax assets to be recognized pursuant to SFAS No. 109, including
the number of years the Company's operating loss and tax credits can be carried
forward, the existence of taxable temporary differences, the Company's earnings
history, the Company's near-term earnings expectations and the existence of any
tax sharing agreements. At December 31, 1997 the Company had recorded a
valuation allowance for the full amount of the deferred tax assets because it
was more likely than not that such benefits would not be realized based upon the
Company's recent loss and short operating history. At December 31, 1998, the
Company determined that a valuation allowance was no longer required based on
its tax sharing agreement with EMC.
Changes in the ownership of the Company may affect the ability of the
Company to be included in EMC's consolidated Federal and State income tax
returns. The Company anticipates that as a result of the offering, EMC may no
longer be able to include the Company in EMC's consolidated Federal tax returns.
In such event, the Company would file a separate return for the tax period which
begins immediately following the offering. Once the Company is no longer a
member of EMC's consolidated tax group, the tax sharing agreement between the
Company and EMC would continue to affect the Company in two principal ways.
First, if a taxing authority were to effect a change to the EMC consolidated
return, the Company would be required to reimburse EMC for the tax of any
Company-related unfavorable adjustment. Conversely, the Company would be
entitled to any refund for any Company-related favorable adjustment. Second, the
Company would be required to remit to EMC any tax savings generated by the tax
deductions, if any, related to the issuance or sale of EMC stock upon the
exercise of options held by Company employees.
Once the Company is no longer included in EMC's consolidated tax group, the
Company will no longer be reimbursed by EMC for its tax losses. However, the
Company does not believe that a valuation allowance is required for the
Company's deferred tax assets at December 31, 1999, as it is more likely than
not that it will have taxable income sufficient to realize its deferred tax
assets.
F-19
<PAGE> 111
McDATA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 11 -- TRANSACTIONS WITH PARENT
McDATA, as EMC's majority-owned subsidiary, has engaged in several
related-party transactions with EMC and its subsidiaries. These included
benefiting from a service agreement to provide services for the Parent's ESCON
switch business, making direct sales of fibre channel products to the Parent,
participating in the Parent's cash management system and filing as a member of
the Parent's consolidated tax return (see Note 10). The terms of these
arrangements, which were negotiated in the context of a parent-subsidiary
relationship, may be more or less favorable to us than if they had been
negotiated with unaffiliated third parties.
Under the terms of the service agreement with the Parent, the Company
provides management, manufacturing, research, development, sales, support and
administrative services with respect to specified customers of the Parent. The
amount of such service fee is subject to annual revision based on the review and
concurrence of both parties. Such service fee revenue totaled $27,652,000,
$25,674,000 and $17,337,000 for the years ended December 31, 1997, 1998 and
1999, respectively. Additionally, the Company provided $349,000 of consulting
services to the Parent for the year ended December 31, 1999. No such services
were provided to the Parent in 1997 or 1998.
The Company sells fibre channel products to the Parent. Such sales
comprised 4%, 15% and 51% of Company revenue for the years ended December 31,
1997, 1998 and 1999, respectively.
The Company participates in EMC's cash management program, in which it
deposits excess operating funds with EMC for short-term investment when funds in
excess of operating requirements are available or borrows funds from EMC during
periods of operating cash needs. Such funds are repaid on demand and earn simple
interest, calculated monthly (5.6% at December 31, 1999). Interest income
(expense) includes $68,000, $312,000 and $(740,000) earned (paid) from
participation in EMC's cash management program for the years ended December 31,
1997, 1998 and 1999, respectively.
Certain directors and executive officers of the Company own a substantial
amount of EMC common stock and options to purchase EMC common stock. One of the
Company's directors is currently employed by EMC.
NOTE 12 -- COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company had various operating leases in effect at December 31, 1999, or
which were entered into shortly after year-end, for certain buildings, office
space and machinery and equipment. Future minimum lease payments under
non-cancelable operating leases with terms of one year or more are as follows at
December 31, 1999 (in thousands):
<TABLE>
<S> <C>
2000.................................................... $2,573
2001.................................................... 2,635
2002.................................................... 2,675
2003.................................................... 1,905
2004 and thereafter..................................... 9
------
$9,797
======
</TABLE>
F-20
<PAGE> 112
McDATA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Rent expense the years ended December 31, 1997, 1998 and 1999 totaled
approximately $1,540,000, $2,115,000 and $2,218,000, respectively.
The Company has various commitments for sales, purchases and employee
benefit plans in the ordinary course of business. In the aggregate, such
commitments do not differ significantly from current market prices or
anticipated usage requirements.
Contingencies
From time to time, the Company is subject to claims arising in the ordinary
course of business. In the opinion of management, no such matter, individually
or in the aggregate, exists which is expected to have a material effect on the
results of operations, financial position or cash flows of the Company.
Outsourcing Agreements
The Company has contracted with SCI Systems, Inc. for the manufacture of
printed circuit boards and box build assembly for specific fibre channel
directors and switches. The agreement with SCI Systems requires the Company to
submit purchasing forecasts, place orders and reschedule orders for products as
necessary. Price is negotiated by the parties based upon current component
market conditions and anticipated volumes. The agreement renews monthly. Both
parties have customary termination rights.
The Company contracts with LSI Logic Corporation on an on-going basis for
the manufacture of application specific integrated circuits ("ASICs"). Under the
terms of the relationship between the Company and LSI Logic, LSI Logic provides
the Company with a quote for the cost to produce ASICs to the Company's custom
specification, together with a quote for the final ASICs produced by LSI Logic
pursuant to those custom specifications. If the Company accepts the quoted
prices for the production, the Company is obligated to pay for the production of
the ASICs. Either the Company or a contract manufacturer used by the Company
will purchase the manufactured ASICs at the price quoted by LSI Logic. The
Company contracts with LSI Logic on an "as needed" basis.
Supply Agreements
The Company has contracted with EMC pursuant to an OEM Purchase and License
Agreement effective as of May 19, 2000 to sell the Company's EC-1100 and ED-5000
director products to EMC. The agreement with EMC requires the Company to
manufacture and deliver these products to EMC and EMC's end-user customers. The
agreement also obligates the Company to provide support to EMC's technical
support group, if necessary, to resolve EMC end-user customer issues concerning
the products. The prices under the agreement for the covered products were
determined by negotiation between EMC and the Company. The initial term of the
agreement is five years from the effective date. Both EMC and the Company have
the option to extend this term for successive periods of one year each on 90
days' prior written notice. Both parties have customary termination rights.
The Company has contracted with IBM Corporation pursuant to a Resale
Agreement to sell the Company's ED-5000 director product and related software to
IBM Corporation. The agreement with IBM Corporation requires the Company to
deliver and support these products for IBM's internal use or directly to IBM's
end user customers. The prices under the agreement for the covered products were
determined by negotiation between IBM and the Company. The initial term of the
agreement is
F-21
<PAGE> 113
McDATA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
five years from the effective date and automatically renews for successive one
year terms unless the agreement is cancelled by either party with 60 days' prior
written notice. Both parties have customary termination rights.
NOTE 13 -- SEGMENT INFORMATION
The Company has one reporting segment relating to the manufacturing and
marketing of computer-based hardware systems. The Company's operations are
conducted in the United States with sales offices in Germany and the United
Kingdom and a research and development facility in Canada, none of which are
individually significant to the Company's overall operations. The Company has
not incurred any foreign currency translation adjustments as all of its sales
are settled in U.S. dollars. In addition, all of its subsidiaries' books are
maintained in U.S. dollars.
Certain information related to the Company's operations by geographic area
is presented below (in thousands). Long-lived assets include property and
equipment and other non-current assets.
<TABLE>
<CAPTION>
NET LONG-LIVED
SALES ASSETS
------- ----------
<S> <C> <C>
1997
United States...................................... $30,547 $ 5,404
Foreign countries.................................. 2,476 3,280
------- -------
Total.................................... $33,023 $ 8,684
======= =======
1998
United States...................................... $34,463 $13,126
Foreign countries.................................. 2,085 2,414
------- -------
Total.................................... $36,548 $15,540
======= =======
1999
United States...................................... $80,055 $13,755
Foreign countries.................................. 15,208 1,506
------- -------
Total.................................... $95,263 $15,261
======= =======
</TABLE>
NOTE 14 -- SUBSEQUENT EVENTS
On May 23, 2000 the Board of Directors approved a 2-for-1 stock split of
the Company's Class A and B common stock. All share and per share amounts have
been adjusted for all periods presented to give retroactive effect to this stock
split. The Board of Directors also authorized, after giving effect to the stock
split, an increase in the authorized shares of the Company's Class A common
stock to 250,000,000 shares and an increase in the Class B common stock to
200,000,000 shares. In addition, the Board of Directors authorized 25,000,000
shares of undesignated preferred stock. All of these transactions were
consummated on or about July 12, 2000.
F-22
<PAGE> 114
[THIS PAGE INTENTIONALLY LEFT BLANK]
<PAGE> 115
[THIS PAGE INTENTIONALLY LEFT BLANK]
<PAGE> 116
MCDATA
THE ENTERPRISE
STORAGE NETWORKING
COMPANY
<PAGE> 117
[McData Logo]
<PAGE> 118
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
The expenses, other than underwriting discounts and commissions, expected
to be incurred by us in connection with the issuance and distribution of the
securities being registered under this registration statement are estimated to
be as follows:
<TABLE>
<S> <C>
Securities and Exchange Commission registration fee......... $ 75,900*
NASD filing fees............................................ 29,250*
The Nasdaq National Market listing fee...................... 88,500*
Printing and engraving expenses............................. 700,000*
Legal fees and expenses..................................... 400,000*
Accounting fees and expenses................................ 425,000*
Blue Sky fees and expenses (including legal fees)........... 5,000*
Registrar and Transfer agent fees........................... 10,000*
Miscellaneous............................................... 100,000*
----------
Total..................................................... $1,833,650*
==========
</TABLE>
-------------------------
* Estimated
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
Section 145 of the Delaware General Corporate Law permits indemnification
of officers, directors and other corporate agents under certain circumstances
and subject to certain limitations. Our amended and restated certificate of
incorporation and our amended and restated by-laws, provide that we shall
indemnify our directors and officers to the fullest extent authorized or
permitted by law.
Our amended and restated certificate of incorporation further provides that
our directors will not be personally liable to us or any stockholder for
monetary damages for breach of fiduciary duty, except to the extent such
exemption is not permitted by law. Section 102 of the Delaware General Corporate
Law provides that officers and directors will not be personally liable for
monetary damages for breach of their fiduciary duties as directors, except
liability for:
- any breach of their duty of loyalty to the corporation or its
stockholders;
- acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law; or
- unlawful payments of dividends or unlawful stock repurchases or
redemption.
This provision has no effect on any non-monetary remedies that may be
available to us or our stockholders, nor does it relieve us or our officers or
directors from compliance with federal or state securities laws.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers or persons controlling us
pursuant to the foregoing provisions or otherwise, we have been informed that in
the opinion of the Securities and Exchange Commission, such indemnification is
against public policy as expressed in the Securities Act of 1933 and is
therefore unenforceable.
Our amended and restated by-laws also permit us to purchase and maintain
insurance on behalf of any officer or director for any liability arising out of
his or her actions in such capacity, regardless
II-1
<PAGE> 119
of whether our by-laws would otherwise permit indemnification for that
liability. We currently have directors' and officers' liability insurance which
would indemnify our directors and officers against damages arising out of claims
which might be made against them based on their negligent acts or omissions
while acting in their capacity as officers and directors.
The underwriting agreement provides that the underwriters are obligated,
under certain circumstances, to indemnify our directors, officers and
controlling persons against some liabilities, including liabilities under the
Securities Act of 1933. Reference is made to the form of underwriting agreement
filed as Exhibit 1.1 hereto.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
In the three years preceding the filing of this registration statement, we
have issued the securities set forth below that were not registered under the
Securities Act of 1933. The share amounts and option exercise prices set forth
below have been adjusted to give effect to the 2-for-1 stock split of the common
stock to be effected prior to the closing of this offering.
(a) Issuance of Capital Stock.
On October 1, 1997, we sold 81,000,000 shares of our Class A common stock
in exchange for substantially all of the assets of McDATA Holdings Corporation
according to the terms of the Asset Transfer Agreement among us, McDATA Holdings
Corporation and EMC Corporation dated as of October 1, 1997.
On October 1, 1997, we sold 10,000,000 shares of our Class B common stock
for an aggregate purchase price of $10,000,000.
No underwriters were involved in the foregoing sales of securities. The
sales of capital stock were made in reliance upon an exemption from registration
under the Securities Act of 1933 provided by Section 4(2) of the Securities Act,
and its related rules and regulations, regarding sales by an issuer not
involving a public offering. All of the foregoing securities are deemed
restricted securities for purposes of the Securities Act of 1933.
(b) Grants and Exercises of Stock Options.
From October 1, 1997 through June 30, 2000, we granted stock options to
purchase 17,910,700 shares of our Class B common stock at exercise prices
ranging from $1.00 to $13.75 per share to employees and directors pursuant to
our 1997 Stock Option Plan.
From October 1, 1997 through June 30, 2000, we issued and sold an aggregate
of 2,952,226 shares of our Class B common stock to employees and directors for
aggregate consideration of $3,001,000 pursuant to exercises of options granted
under our 1997 Stock Option Plan.
The issuance of options and the issuance of Class B common stock upon the
exercise of these options was exempt from registration under the Securities Act
of 1933 either pursuant to Rule 701 under the Securities Act of 1933, as a
transaction pursuant to a compensatory benefit plan, or pursuant to this Section
4(2) of the Securities Act of 1933, as a transaction by an issuer not involving
a public offering. All of the foregoing securities are deemed restricted
securities for purposes of the Securities Act of 1933.
II-2
<PAGE> 120
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) EXHIBITS.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
<C> <S>
1.1* Form of Underwriting Agreement
3.1* Amended and Restated Certificate of Incorporation of the
Registrant
3.2* Amended and Restated By-laws of the Registrant
4.1* Form of Registrant's Class B Common Stock Certificate
4.2* Investors' Rights Agreement dated as of October 1, 1997 by
and among the Registrant, EMC Corporation, McDATA Holdings
Corporation and Certain Investors
4.3* Amendment No. 1 to the Investors' Rights Agreement dated May
23, 2000 by and among the Registrant, McDATA Holdings
Corporation and certain Investors
5.1* Opinion of Paul T. Dacier, Esq.
10.1* Asset Transfer Agreement dated as of October 1, 1997 by and
among the Registrant, EMC Corporation, and McDATA Holdings
Corporation
10.2* Investors' Rights Agreement dated as of October 1, 1997 by
and among the Registrant, EMC Corporation, McDATA Holdings
Corporation and certain Investors (see Exhibit 4.2)
10.3* Amendment No. 1 to the Investors' Rights Agreement dated May
23, 2000 by and among the Registrant, McDATA Holdings
Corporation and certain Investors (see Exhibit 4.3)
10.4* Services Agreement dated as of October 1, 1997 by and among
EMC Corporation, McDATA Holdings Corporation and the
Registrant
10.5* Letter Agreement dated April 19, 1999 by and between the
Registrant and McDATA Holdings Corporation
10.6* Technology Rights Agreement dated as of October 1, 1997 by
and among the Registrant, EMC Corporation and McDATA
Holdings Corporation
10.7* Amended and Restated Tax Sharing Agreement dated as of May
31, 2000 by and among EMC Corporation, McDATA Holdings
Corporation and the Registrant
10.8* Form of Master Transaction Agreement to be entered into by
and among the Registrant and EMC Corporation
10.9* Form of Indemnification and Insurance Matters Agreement to
be entered into by and among the Registrant and EMC
Corporation
10.10* Master Confidential Disclosure and License Agreement dated
as of May 31, 2000 by and among the Registrant and EMC
Corporation
10.11*+ Reseller Agreement dated as of February 22, 2000 by and
between International Business Machines Corporation and the
Registrant
10.12* Amendment Number One to the Resale Agreement dated June 30,
2000 by and between International Business Machines
Corporation and the Registrant
10.13*+ OEM Purchase and License Agreement dated as of May 19, 2000
by and between EMC Corporation and the Registrant
10.14*+ Development Agreement dated as of May 19, 2000 by and
between EMC Corporation and the Registrant
10.15*+ Manufacturing Agreement dated as of June 17, 1996 by and
between SCI Systems, Inc. and the Registrant, Addendum
Number 1 thereto, dated as of May 23, 1996 and Addendum
Number 2 thereto, dated as of April 30, 1998
</TABLE>
II-3
<PAGE> 121
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
<C> <S>
10.16*+ OEM and License Agreement dated as of April 27, 1999 by and
between Brocade Communication Systems, Inc. and the
Registrant
10.17* Lease dated September 12, 1997 by and between the Registrant
and WHLNF Real Estate Limited Partnership
10.18* Lease dated November 2, 1999 by and between the Registrant
and the Mills Family LLC
10.19* Lease dated May 28, 1997 by and between the Registrant and
1211486 Ontario Limited
10.20* Form of Severance Agreement
10.21* 1997 Stock Option Plan
10.22* Form of Stock Option Agreement for 1997 Stock Option Plan
10.23* Description of Registrant's Management Bonus Program
21.1* List of Subsidiaries of the Registrant
23.1 Consent of PricewaterhouseCoopers LLP, Independent
Accountants
23.2* Consent of Counsel (included in Exhibit 5.1)
24.1* Power of Attorney (included on the signature page in Part
II, as previously filed with the Securities and Exchange
Commission)
27.1* Financial Data Schedule
</TABLE>
-------------------------
* Previously filed.
+ Portions of this exhibit have been omitted and filed separately with the
Securities and Exchange Commission pending a request for confidential
treatment.
(b) FINANCIAL STATEMENT SCHEDULE(S).
Schedule II -- Valuation and Qualifying Accounts.
Schedules not listed above have been omitted because the information
required to be set forth therein is not applicable or it is shown in the
consolidated financial statements or notes thereto.
ITEM 17. UNDERTAKINGS.
The undersigned Registrant hereby undertakes to provide to the underwriters
at the closing specified in the underwriting agreement, certificates in the
denominations and registered in the names as required by the underwriters to
permit prompt delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities Act
of 1933 and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
Registrant of expenses incurred or paid by a director, officer or controlling
person of the Registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
II-4
<PAGE> 122
indemnification by it is against public policy as expressed in the Securities
Act of 1933 and will be governed by the final adjudication of such issue.
The Registrant hereby undertakes:
(1) That for purposes of determining any liability under the
Securities Act of 1933, the information omitted from the form of prospectus
filed as part of this registration statement in reliance upon Rule 430A and
contained in a form of prospectus filed by the Registrant pursuant to Rule
424(b)(1) or (4) or 497(h) under the Securities Act of 1933 is deemed to be
part of this registration statement as of the time it was declared
effective.
(2) That for the purpose of determining any liability under the
Securities Act of 1933, each post-effective amendment that contains a form
of prospectus is deemed to be a new registration statement relating to the
securities offered therein, and the offering of such securities at that
time will be deemed to be the initial bona fide offering thereof.
II-5
<PAGE> 123
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Amendment No. 3 to the Registration Statement to be signed
on its behalf by the undersigned, thereunto duly authorized, in the City of
Broomfield, County of Boulder, State of Colorado, on the 19th day of July, 2000.
McDATA CORPORATION
By: /s/ JOHN F. MCDONNELL
------------------------------------
John F. McDonnell
President and Chief Executive
Officer
Pursuant to the requirements of the Securities Act of 1933, this
registration statement has been signed by the following persons in the
capacities indicated and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ JOHN F. MCDONNELL Chairman of the Board, President and July 19, 2000
--------------------------------------------------- Chief Executive Officer (Principal
John F. McDonnell Executive Officer)
/s/ DEE J. PERRY Chief Financial Officer and Vice July 19, 2000
--------------------------------------------------- President of Finance and
Dee J. Perry Administration (Principal Financial
and Chief Accounting Officer)
* Director July 19, 2000
---------------------------------------------------
David A. Donatelli
* Director July 19, 2000
---------------------------------------------------
John W. Gerdelman
* Director July 19, 2000
---------------------------------------------------
Charles C. Johnston
* Director July 19, 2000
---------------------------------------------------
D. Van Skilling
* Director July 19, 2000
---------------------------------------------------
Thomas M. Uhlman
* Director July 19, 2000
---------------------------------------------------
Laurence G. Walker
</TABLE>
*By: /s/ DEE J. PERRY
--------------------------------
Dee J. Perry
attorney-in-fact
II-6
<PAGE> 124
REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE
To the Board of Directors
of McDATA Corporation:
Our audits of the consolidated financial statements referred to in our
report dated April 19, 2000 appearing in this Registration Statement on Form S-1
of McDATA Corporation also included an audit of the consolidated financial
statement schedule listed in Item 16(b) of this Registration Statement. In our
opinion, this consolidated financial statement schedule presents fairly, in all
material respects, the information set forth therein when read in conjunction
with the related consolidated financial statements.
PRICEWATERHOUSECOOPERS LLP
Broomfield, Colorado
April 19, 2000
S-1
<PAGE> 125
SCHEDULE 2
McDATA CORPORATION
FINANCIAL STATEMENT SCHEDULE
VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
<TABLE>
<CAPTION>
BALANCE AT CHARGED TO BALANCE
BEGINNING COSTS AND AT END
OF PERIOD EXPENSES DEDUCTIONS OF PERIOD
------------ ------------ ------------ -----------
<S> <C> <C> <C> <C>
Year ended December 31, 1997
Allowance for doubtful accounts.............. $ 42 $ 12 $ (6) $ 48
Valuation allowance for deferred tax
assets..................................... -- 2,650 -- 2,650
Inventory reserves........................... 708 2,476 (55) 3,129
Warranty reserve............................. 648 405 (227) 826
Year ended December 31, 1998
Allowance for doubtful accounts.............. $ 48 $ 18 $ (1) $ 65
Valuation allowance for deferred tax
assets..................................... 2,650 -- (2,650) --
Inventory reserves........................... 3,129 1,326 (3,815) 640
Warranty reserve............................. 826 905 (246) 1,485
Year ended December 31, 1999
Allowance for doubtful accounts.............. $ 65 $ 30 $ -- $ 95
Valuation allowance for deferred tax
assets..................................... -- -- -- --
Inventory reserves........................... 640 1,907 (483) 2,064
Warranty reserve............................. 1,485 12 (511) 986
</TABLE>
S-2
<PAGE> 126
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
<C> <S>
1.1* Form of Underwriting Agreement
3.1* Amended and Restated Certificate of Incorporation of the
Registrant
3.2* Amended and Restated By-laws of the Registrant
4.1* Form of Registrant's Class B Common Stock Certificate
4.2* Investors' Rights Agreement dated as of October 1, 1997 by
and among the Registrant, EMC Corporation, McDATA Holdings
Corporation and Certain Investors
4.3* Amendment No. 1 to the Investors' Rights Agreement dated May
23, 2000 by and among the Registrant, McDATA Holdings
Corporation and certain Investors
5.1* Opinion of Paul T. Dacier, Esq.
10.1* Asset Transfer Agreement dated as of October 1, 1997 by and
among the Registrant, EMC Corporation, and McDATA Holdings
Corporation
10.2* Investors' Rights Agreement dated as of October 1, 1997 by
and among the Registrant, EMC Corporation, McDATA Holdings
Corporation and certain Investors (see Exhibit 4.2)
10.3* Amendment No. 1 to the Investors' Rights Agreement dated May
23, 2000 by and among the Registrant, McDATA Holdings
Corporation and certain Investors (see Exhibit 4.3)
10.4* Services Agreement dated as of October 1, 1997 by and among
EMC Corporation, McDATA Holdings Corporation and the
Registrant
10.5* Letter Agreement dated April 19, 1999 by and between the
Registrant and McDATA Holdings Corporation
10.6* Technology Rights Agreement dated as of October 1, 1997 by
and among the Registrant, EMC Corporation and McDATA
Holdings Corporation
10.7* Amended and Restated Tax Sharing Agreement dated as of May
31, 2000 by and among EMC Corporation, McDATA Holdings
Corporation and the Registrant
10.8* Form of Master Transaction Agreement to be entered into by
and among the Registrant and EMC Corporation
10.9* Form of Indemnification and Insurance Matters Agreement to
be entered into by and among the Registrant and EMC
Corporation
10.10* Master Confidential Disclosure and License Agreement dated
as of May 31, 2000 by and among the Registrant and EMC
Corporation
10.11*+ Reseller Agreement dated as of February 22, 2000 by and
between International Business Machines Corporation and the
Registrant
10.12* Amendment Number One to the Resale Agreement dated on June
30, 2000 by and between International Business Machines
Corporation and the Registrant
10.13*+ OEM Purchase and License Agreement dated as of May 19, 2000
by and between EMC Corporation and the Registrant
10.14*+ Development Agreement dated as of May 19, 2000 by and
between EMC Corporation and the Registrant
10.15*+ Manufacturing Agreement dated as of June 17, 1996 by and
between SCI Systems, Inc. and the Registrant, Addendum
Number 1 thereto, dated as of May 23, 1996 and Addendum
Number 2 thereto, dated as of April 30, 1998
10.16*+ OEM and License Agreement dated as of April 27, 1999 by and
between Brocade Communication Systems, Inc. and the
Registrant
</TABLE>
<PAGE> 127
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
------- -----------------------
<C> <S>
10.17* Lease dated September 12, 1997 by and between the Registrant
and WHLNF Real Estate Limited Partnership
10.18* Lease dated November 2, 1999 by and between the Registrant
and the Mills Family LLC
10.19* Lease dated May 28, 1997 by and between the Registrant and
1211486 Ontario Limited
10.20* Form of Severance Agreement
10.21* 1997 Stock Option Plan
10.22* Form of Stock Option Agreement for 1997 Stock Option Plan
10.23* Description of Registrant's Management Bonus Program
21.1* List of Subsidiaries of the Registrant
23.1 Consent of PricewaterhouseCoopers LLP, Independent
Accountants
23.2* Consent of Counsel (included in Exhibit 5.1)
24.1* Power of Attorney (included on the signature page in Part
II, as previously filed with the Securities and Exchange
Commission)
27.1* Financial Data Schedule
</TABLE>
-------------------------
* Previously filed.
+ Portions of this exhibit have been omitted and filed separately with the
Securities and Exchange Commission pending a request for confidential
treatment.
