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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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(Mark One)

|x | Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
|- | ---------------------------------------------------------------------------------------



For the quarterly period ended October 31, 2005



OR



| ̈ | Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
|- | ----------------------------------------------------------------------------------------



For the transition period from
 to



Commission File Number 000-31257



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McDATA CORPORATION

(Exact name of registrant as specified in its charter)



|                                                              |  |                                    
|------------------------------------------------------------- |  | -----------------------------------
|Delaware                                                      |  | 84-1421844                         
|(State or other jurisdiction ofincorporation of organization) |  | (I.R.S. EmployerIdentification No.)



380 Interlocken
Crescent, Broomfield, Colorado 80021

(Address of principal executive offices)(zip code)



(720) 558-8000

(Registrants telephone number, including area code)



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(Former name, former address and former fiscal year, if changed since last report)



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Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x    No ̈



Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange
Act). Yes  x    No ̈



Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). Yes ̈No  x



At December 6, 2005, 118,119,123 shares of the registrants Class A Common
Stock were outstanding and 34,772,169 shares of the registrants Class B Common Stock were outstanding.



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##### Table of Contents

McDATA CORPORATION



FORM 10-Q

QUARTER ENDED OCTOBER 31, 2005

TABLE OF CONTENTS



|   |  |                                                                                       |  |   
|-- |  | ------------------------------------------------------------------------------------- |  | --
|   |  | PART I  FINANCIAL INFORMATION                                                        |  |   
|   |  |                                                                                      
|1. |  | Financial Statements                                                                  |  |   
|   |  |                                                                                      
|   |  | Condensed Consolidated Balance Sheets                                                 |  | 4 
|   |  |                                                                                      
|   |  | Condensed Consolidated Statements of Operations                                       |  | 5 
|   |  |                                                                                      
|   |  | Condensed Consolidated Statement of Changes in Stockholders Equity                   |  | 6 
|   |  |                                                                                      
|   |  | Condensed Consolidated Statements of Cash Flows                                       |  | 7 
|   |  |                                                                                      
|   |  | Notes to Condensed Consolidated Financial Statements                                  |  | 8 
|   |  |                                                                                      
|2. |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 31
|   |  |                                                                                      
|3. |  | Quantitative and Qualitative Disclosures About Market Risks                           |  | 53
|   |  |                                                                                      
|4. |  | Controls and Procedures                                                               |  | 54
|   |  |                                                                                      
|   |  | PART II  OTHER INFORMATION                                                           |  |   
|   |  |                                                                                      
|1. |  | Legal Proceedings                                                                     |  | 55
|   |  |                                                                                      
|4. |  | Submission of Matters to a Vote of Security Holders                                   |  | 55
|   |  |                                                                                      
|5. |  | Other Information                                                                     |  | 55
|   |  |                                                                                      
|6. |  | Exhibits                                                                              |  | 55



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##### Table of Contents

Special Note Regarding Forward-Looking Statements



Some of the information presented in this Quarterly Report on Form 10-Q contains forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995 (the Reform Act). Although McDATA Corporation (McDATA or the Company, which may also be referred to as we, us or
our) believes that its expectations are based on reasonable assumptions within the bounds of its knowledge of its businesses and operations; there can be no assurance that actual results will not differ materially from our expectations.
Factors that could cause actual results to differ materially from expectations include:



| |  |  | changes in our relationship with EMC Corporation, or EMC, International Business Machines Corporation, or IBM, Hitachi Data Systems, or HDS, and our other distribution partners and
the level of their orders;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | changes in our relationship with our large end-user customers and the level of their orders;
| | - |  | --------------------------------------------------------------------------------------------



| |  |  | our ability to successfully increase sales of McDATAs directors, switches, channel extension products, embedded software, management software, third party products,
maintenance and support contracts, and professional services;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | competition in the storage networking and channel extension market, including competitive pricing pressures and product give-aways, by our competitors such as Brocade Communication
Systems, Inc., or Brocade, QLogic Corp., or QLogic, Cisco Systems, Inc., or Cisco, Emulex Corporation and other IP and multi-protocol switch and software suppliers;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our ability to expand our product offerings including our ability to successfully qualify and ramp sales of new products (including higher port density, multi-protocol and
intelligent network products such as the Intrepid 10000 Director);
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our ability to continue selling legacy CNT products and services to end-user customers;
| | - |  | ---------------------------------------------------------------------------------------



| |  |  | our ability to partner with other companies and jointly sell products, including but not limited to management software with Network Appliance, and software for blade servers with
QLogic;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | unexpected engineering costs or delays, additional manufacturing and component costs or production delays that we may experience in connection with new product development or an
inability to source products from third party product providers;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | a loss of any of our key customers (and our OEMs key customers), distributors, resellers, suppliers or our contract manufacturers;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------



| |  |  | any change in business conditions, our business and sales strategy or product development plans, and our ability to attract and retain highly skilled individuals;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | any industry or technology changes that cause obsolescence of our products or components of those products;
| | - |  | -----------------------------------------------------------------------------------------------------------



| |  |  | one-time events and other important risks and factors disclosed previously and from time to time in our filings with the U.S. Securities and Exchange Commission, or SEC, including
the risk factors discussed in this Quarterly Report; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the impact of any acquisitions by us of businesses, products, or technologies, including difficulties in integrating any acquisitions, including the merger with CNT that closed
June 1, 2005.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



You should not construe these
cautionary statements as an exhaustive list or as any admission by us regarding the adequacy of the disclosures made by us. We cannot always predict or determine after the fact what factors would cause actual results to differ materially from those
indicated by our forward-looking statements or other statements. In addition, you are urged to consider statements that include the terms believes, belief, expects, plans, objectives,
anticipates, intends, or the like to be uncertain and forward-looking. All cautionary statements should be read as being applicable to all forward-looking statements wherever they appear. We do not undertake any obligation to
publicly update or revise any forward-looking statements.



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PART IFINANCIAL INFORMATION



McDATA CORPORATION



CONDENSED
CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

(unaudited)



|                                                                                                                                                                                       |  |                 |           |   |                 |   |         |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------- | --------- | - | --------------- | - | ------- | -
|                                                                                                                                                                                       |  | October 31,2005 |           |   | January 31,2005 |  
|Assets                                                                                                                                                                                 |  |                 |           |   |                 |   |         |  
|Current assets:                                                                                                                                                                        |  |                 |           |   |                 |   |         |  
|Cash and cash equivalents                                                                                                                                                              |  | $               | 166,242   |   |                 | $ | 64,507  |  
|Securities lending collateral                                                                                                                                                          |  |                 | 86,715    |   |                 |   | 130,804 |  
|Short-term investments                                                                                                                                                                 |  |                 | 144,673   |   |                 |   | 145,259 |  
|Accounts receivable, net of allowance for bad debts of $8,153 and $306, respectively                                                                                                   |  |                 | 110,037   |   |                 |   | 63,810  |  
|Inventories, net                                                                                                                                                                       |  |                 | 34,647    |   |                 |   | 13,720  |  
|Prepaid expenses and other current assets                                                                                                                                              |  |                 | 11,415    |   |                 |   | 7,280   |  
|                                                                                                                                                                                       |  |                 |           |   |                 |   |         |  
|Total current assets                                                                                                                                                                   |  |                 | 553,729   |   |                 |   | 425,380 |  
|Property and equipment, net                                                                                                                                                            |  |                 | 130,141   |   |                 |   | 94,929  |  
|Long-term investments                                                                                                                                                                  |  |                 | 32,966    |   |                 |   | 95,589  |  
|Restricted cash                                                                                                                                                                        |  |                 | 10,607    |   |                 |   | 5,047   |  
|Intangible assets, net                                                                                                                                                                 |  |                 | 134,726   |   |                 |   | 87,592  |  
|Goodwill                                                                                                                                                                               |  |                 | 260,812   |   |                 |   | 78,693  |  
|Other assets, net                                                                                                                                                                      |  |                 | 58,161    |   |                 |   | 31,005  |  
|                                                                                                                                                                                       |  |                 |           |   |                 |   |         |  
|Total assets                                                                                                                                                                           |  | $               | 1,181,142 |   |                 | $ | 818,235 |  
|                                                                                                                                                                                       |  |                 |           |   |                 |   |         |  
|Liabilities and Stockholders Equity                                                                                                                                                   |  |                 |           |   |                 |   |         |  
|Current liabilities:                                                                                                                                                                   |  |                 |           |   |                 |   |         |  
|Accounts payable                                                                                                                                                                       |  | $               | 53,107    |   |                 | $ | 20,345  |  
|Accrued liabilities                                                                                                                                                                    |  |                 | 86,650    |   |                 |   | 44,549  |  
|Securities lending collateral payable                                                                                                                                                  |  |                 | 86,715    |   |                 |   | 130,804 |  
|Current portion of deferred revenue                                                                                                                                                    |  |                 | 34,403    |   |                 |   | 22,736  |  
|Current portion of notes payable and obligations under capital leases                                                                                                                  |  |                 | 2,859     |   |                 |   | 912     |  
|                                                                                                                                                                                       |  |                 |           |   |                 |   |         |  
|Total current liabilities                                                                                                                                                              |  |                 | 263,734   |   |                 |   | 219,346 |  
|Notes payable and obligations under capital leases, less current portion                                                                                                               |  |                 | 4,548     |   |                 |   | 256     |  
|Deferred revenue, less current portion                                                                                                                                                 |  |                 | 49,972    |   |                 |   | 27,001  |  
|Other long-term liabilities                                                                                                                                                            |  |                 | 24,558    |   |                 |   | 1,908   |  
|Interest rate swaps                                                                                                                                                                    |  |                 | 7,569     |   |                 |   | 2,005   |  
|Convertible subordinated debt                                                                                                                                                          |  |                 | 285,052   |   |                 |   | 170,495 |  
|                                                                                                                                                                                       |  |                 |           |   |                 |   |         |  
|Total liabilities                                                                                                                                                                      |  |                 | 635,433   |   |                 |   | 421,011 |  
|                                                                                                                                                                                       |  |                 |           |   |                 |   |         |  
|Commitments and contingencies (Note 15)                                                                                                                                                |  |                 |           |   |                 |   |         |  
|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, 119,806,258 and 81,000,000 shares issued and outstanding at
October 31, 2005 and January 31, 2005, respectively |  |                 | 1,200     |   |                 |   | 810     |  
|Common stock, Class B, $0.01 par value, 200,000,000 shares authorized, 38,106,636 and 37,960,526 shares issued and outstanding at
October 31, 2005 and January 31, 2005, respectively  |  |                 | 380       |   |                 |   | 379     |  
|Additional paid-in-capital                                                                                                                                                             |  |                 | 670,803   |   |                 |   | 481,735 |  
|Treasury stock, at cost, 4,524,816 and 3,022,359 shares outstanding at October 31, 2005 and January 31, 2005,
respectively                                                             |  |                 | (23,591   | ) |                 |   | (19,039 | )
|Deferred compensation                                                                                                                                                                  |  |                 | (3,936    | ) |                 |   | (2,738  | )
|Accumulated other comprehensive loss                                                                                                                                                   |  |                 | (618      | ) |                 |   | (1,253  | )
|Accumulated deficit                                                                                                                                                                    |  |                 | (98,529   | ) |                 |   | (62,670 | )
|                                                                                                                                                                                       |  |                 |           |   |                 |   |         |  
|Total stockholders equity                                                                                                                                                             |  |                 | 545,709   |   |                 |   | 397,224 |  
|                                                                                                                                                                                       |  |                 |           |   |                 |   |         |  
|Total liabilities and stockholders equity                                                                                                                                             |  | $               | 1,181,142 |   |                 | $ | 818,235 |  
|                                                                                                                                                                                       |  |                 |           |   |                 |   |         |  



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



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McDATA CORPORATION



CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)



|                                                                                                                                                                           |  |                               |         |   |                              |   |         |      |  |   |         |   |  |   |         |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------- | ------- | - | ---------------------------- | - | ------- | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                                                                                                                           |  | Three Months EndedOctober 31, |         |   | Nine Months EndedOctober 31, |  
|                                                                                                                                                                           |  | 2005                          |         |   | 2004                         |   |         | 2005 |  |   | 2004    |  
|Revenue:                                                                                                                                                                   |  |                               |         |   |                              |   |         |      |  |   |         |   |  |   |         |  
|Product                                                                                                                                                                    |  | $                             | 138,579 |   |                              | $ | 92,805  |      |  | $ | 369,988 |   |  | $ | 279,382 |  
|Service                                                                                                                                                                    |  |                               | 29,926  |   |                              |   | 5,720   |      |  |   | 62,694  |   |  |   | 14,593  |  
|                                                                                                                                                                           |  |                               |         |   |                              |   |         |      |  |   |         |   |  |   |         |  
|Total revenue                                                                                                                                                              |  |                               | 168,505 |   |                              |   | 98,525  |      |  |   | 432,682 |   |  |   | 293,975 |  
|Cost of revenue:                                                                                                                                                           |  |                               |         |   |                              |   |         |      |  |   |         |   |  |   |         |  
|Product                                                                                                                                                                    |  |                               | 68,566  |   |                              |   | 38,804  |      |  |   | 175,737 |   |  |   | 116,589 |  
|Service                                                                                                                                                                    |  |                               | 20,370  |   |                              |   | 4,900   |      |  |   | 41,632  |   |  |   | 12,979  |  
|Restructuring charges                                                                                                                                                      |  |                               | 134     |   |                              |   |        |      |  |   | 826     |   |  |   |        |  
|                                                                                                                                                                           |  |                               |         |   |                              |   |         |      |  |   |         |   |  |   |         |  
|Total cost of revenue                                                                                                                                                      |  |                               | 89,070  |   |                              |   | 43,704  |      |  |   | 218,195 |   |  |   | 129,568 |  
|                                                                                                                                                                           |  |                               |         |   |                              |   |         |      |  |   |         |   |  |   |         |  
|Gross profit                                                                                                                                                               |  |                               | 79,435  |   |                              |   | 54,821  |      |  |   | 214,487 |   |  |   | 164,407 |  
|Operating expenses (recoveries):                                                                                                                                           |  |                               |         |   |                              |   |         |      |  |   |         |   |  |   |         |  
|Research and development (excludes amortization of deferred compensation included in Amortization of deferred compensation of $131, $811,
$1,170 and $3,297, respectively) |  |                               | 31,464  |   |                              |   | 22,828  |      |  |   | 83,783  |   |  |   | 70,077  |  
|Selling and marketing (excludes amortization of deferred compensation included in Amortization of deferred compensation of $182, $98, $632 and
$548, respectively)         |  |                               | 35,787  |   |                              |   | 26,755  |      |  |   | 98,091  |   |  |   | 74,477  |  
|General and administrative (excludes amortization of deferred compensation included in Amortization of deferred compensation of $576, $141,
$3,047 and $952, respectively) |  |                               | 10,496  |   |                              |   | 5,787   |      |  |   | 25,158  |   |  |   | 19,565  |  
|Amortization of acquired intangible assets                                                                                                                                 |  |                               | 11,367  |   |                              |   | 5,645   |      |  |   | 26,474  |   |  |   | 17,218  |  
|Amortization of deferred compensation (excludes amortization of deferred compensation included in Cost of revenue of $25, $26, $151 and $162,
respectively)                |  |                               | 889     |   |                              |   | 1,050   |      |  |   | 4,849   |   |  |   | 4,797   |  
|Restructuring charges (recoveries)                                                                                                                                         |  |                               | 526     |   |                              |   | (55     | )    |  |   | 10,278  |   |  |   | 1,263   |  
|                                                                                                                                                                           |  |                               |         |   |                              |   |         |      |  |   |         |   |  |   |         |  
|Total operating expenses                                                                                                                                                   |  |                               | 90,529  |   |                              |   | 62,010  |      |  |   | 248,633 |   |  |   | 187,397 |  
|Loss from operations                                                                                                                                                       |  |                               | (11,094 | ) |                              |   | (7,189  | )    |  |   | (34,146 | ) |  |   | (22,990 | )
|Interest and other income                                                                                                                                                  |  |                               | 2,768   |   |                              |   | 1,705   |      |  |   | 7,016   |   |  |   | 4,480   |  
|Interest expense                                                                                                                                                           |  |                               | (3,094  | ) |                              |   | (395    | )    |  |   | (6,241  | ) |  |   | (862    | )
|                                                                                                                                                                           |  |                               |         |   |                              |   |         |      |  |   |         |   |  |   |         |  
|Loss before income taxes and equity in net loss of affiliated company                                                                                                      |  |                               | (11,420 | ) |                              |   | (5,879  | )    |  |   | (33,371 | ) |  |   | (19,372 | )
|Income tax expense (benefit)                                                                                                                                               |  |                               | (3,936  | ) |                              |   | (618    | )    |  |   | 2,488   |   |  |   | 40      |  
|                                                                                                                                                                           |  |                               |         |   |                              |   |         |      |  |   |         |   |  |   |         |  
|Loss before equity in net loss of affiliated company                                                                                                                       |  |                               | (7,484  | ) |                              |   | (5,261  | )    |  |   | (35,859 | ) |  |   | (19,412 | )
|Equity in net loss of affiliated company                                                                                                                                   |  |                               |        |   |                              |   | (262    | )    |  |   |        |   |  |   | (1,380  | )
|                                                                                                                                                                           |  |                               |         |   |                              |   |         |      |  |   |         |   |  |   |         |  
|Net loss                                                                                                                                                                   |  | $                             | (7,484  | ) |                              | $ | (5,523  | )    |  | $ | (35,859 | ) |  | $ | (20,792 | )
|                                                                                                                                                                           |  |                               |         |   |                              |   |         |      |  |   |         |   |  |   |         |  
|Basic net loss per share                                                                                                                                                   |  | $                             | (0.05   | ) |                              | $ | (0.05   | )    |  | $ | (0.26   | ) |  | $ | (0.18   | )
|                                                                                                                                                                           |  |                               |         |   |                              |   |         |      |  |   |         |   |  |   |         |  
|Shares used in computing basic net loss per share                                                                                                                          |  |                               | 152,646 |   |                              |   | 115,624 |      |  |   | 135,750 |   |  |   | 115,377 |  
|                                                                                                                                                                           |  |                               |         |   |                              |   |         |      |  |   |         |   |  |   |         |  
|Diluted net loss per share                                                                                                                                                 |  | $                             | (0.05   | ) |                              | $ | (0.05   | )    |  | $ | (0.26   | ) |  | $ | (0.18   | )
|                                                                                                                                                                           |  |                               |         |   |                              |   |         |      |  |   |         |   |  |   |         |  
|Shares used in computing diluted net loss per share                                                                                                                        |  |                               | 152,646 |   |                              |   | 115,624 |      |  |   | 135,750 |   |  |   | 115,377 |  
|                                                                                                                                                                           |  |                               |         |   |                              |   |         |      |  |   |         |   |  |   |         |  



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



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##### Table of Contents

McDATA CORPORATION



CONSOLIDATED
STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY

For the Nine Months Ended October 31, 2005

(in thousands)

(unaudited)



|                                                          |  |              |   |         |                            |       |        |                       |   |     |                                      |     |   |                |   |         |                     |  |   |                            |   |  |   |        |   |  |   |         |   |  |   |         |   |  |   |         |  
|--------------------------------------------------------- |  | ------------ | - | ------- | -------------------------- | ----- | ------ | --------------------- | - | --- | ------------------------------------ | --- | - | -------------- | - | ------- | ------------------- |  | - | -------------------------- | - |  | - | ------ | - |  | - | ------- | - |  | - | ------- | - |  | - | ------- | -
|                                                          |  | Common Stock |   |         | Additional Paid-In Capital |       |        | Deferred Compensation |   |     | Accumulated Other Comprehensive Loss |     |   | Treasury Stock |   |         | Accumulated Deficit |  |   | Total Stockholders Equity |  
|                                                          |  | Class A      |   | Class B |                            |       |        |                       |   |     |                                     
|                                                          |  | Shares       |   |         | Amt                        |       | Shares |                       |   | Amt |                                      |     |   |                |   |         |                    
|Balances at January 31, 2005                              |  | 81,000       |   |         | $                          | 810   |        | 37,960                |   |     | $                                    | 379 |   |                | $ | 481,735 |                     |  | $ | (2,738                     | ) |  | $ | (1,253 | ) |  | $ | (19,039 | ) |  | $ | (62,670 | ) |  | $ | 397,224 |  
|Shares issued in Merger                                   |  | 38,754       |   |         |                            | 388   |        |                      |   |     |                                      |    |   |                |   | 185,651 |                     |  |   | (3,603                     | ) |  |   |       |   |  |   |        |   |  |   |        |   |  |   | 182,436 |  
|Shares issued                                             |  | 130          |   |         |                            |      |        | 252                   |   |     |                                      | 2   |   |                |   | 4,922   |                     |  |   | (4,101                     | ) |  |   |       |   |  |   |        |   |  |   |        |   |  |   | 823     |  
|Forfeitures of deferred compensation                      |  | (77          | ) |         |                            |      |        | (105                  | ) |     |                                      | (1  | ) |                |   | (1,505  | )                   |  |   | 1,505                      |   |  |   |       |   |  |   |        |   |  |   |        |   |  |   | (1      | )
|Compensation expense                                      |  |             |   |         |                            |      |        |                      |   |     |                                      |    |   |                |   |        |                     |  |   | 5,001                      |   |  |   |       |   |  |   |        |   |  |   |        |   |  |   | 5,001   |  
|Acquisition of treasury stock                             |  |             |   |         |                            |      |        |                      |   |     |                                      |    |   |                |   |        |                     |  |   |                           |   |  |   |       |   |  |   | (4,552  | ) |  |   |        |   |  |   | (4,552  | )
|Other                                                     |  |             |   |         |                            | 2     |        |                      |   |     |                                      |    |   |                |   |        |                     |  |   |                           |   |  |   |       |   |  |   |        |   |  |   |        |   |  |   | 2       |  
|Comprehensive loss:                                       |  |              |   |         |                            |       |        |                       |   |     |                                      |     |   |                |   |         |                     |  |   |                            |   |  |   |        |   |  |   |         |   |  |   |         |   |  |   |         |  
|Net loss                                                  |  |             |   |         |                            |      |        |                      |   |     |                                      |    |   |                |   |        |                     |  |   |                           |   |  |   |       |   |  |   |        |   |  |   | (35,859 | ) |  |   | (35,859 | )
|Unrealized loss on investments, net of tax of $0          |  |             |   |         |                            |      |        |                      |   |     |                                      |    |   |                |   |        |                     |  |   |                           |   |  |   | 538    |   |  |   |        |   |  |   |        |   |  |   | 538     |  
|Foreign currency translation adjustment, net of tax of $0 |  |             |   |         |                            |      |        |                      |   |     |                                      |    |   |                |   |        |                     |  |   |                           |   |  |   | 97     |   |  |   |        |   |  |   |        |   |  |   | 97      |  
|                                                          |  |              |   |         |                            |       |        |                       |   |     |                                      |     |   |                |   |         |                     |  |   |                            |   |  |   |        |   |  |   |         |   |  |   |         |   |  |   |         |  
|Total comprehensive loss                                  |  |             |   |         |                            |      |        |                      |   |     |                                      |    |   |                |   |        |                     |  |   |                           |   |  |   | 635    |   |  |   |        |   |  |   | (35,859 | ) |  |   | (35,224 | )
|                                                          |  |              |   |         |                            |       |        |                       |   |     |                                      |     |   |                |   |         |                     |  |   |                            |   |  |   |        |   |  |   |         |   |  |   |         |   |  |   |         |  
|Balances at October 31, 2005                              |  | 119,807      |   |         | $                          | 1,200 |        | 38,107                |   |     | $                                    | 380 |   |                | $ | 670,803 |                     |  | $ | (3,936                     | ) |  | $ | (618   | ) |  | $ | (23,591 | ) |  | $ | (98,529 | ) |  | $ | 545,709 |  
|                                                          |  |              |   |         |                            |       |        |                       |   |     |                                      |     |   |                |   |         |                     |  |   |                            |   |  |   |        |   |  |   |         |   |  |   |         |   |  |   |         |  



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



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##### Table of Contents

McDATA CORPORATION



CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)



|                                                                           |  |                               |          |   |      |   |          |  
|-------------------------------------------------------------------------- |  | ----------------------------- | -------- | - | ---- | - | -------- | -
|                                                                           |  | Nine Months Ended October 31, |         
|                                                                           |  | 2005                          |          |   | 2004 |  
|Cash flows from operating activities:                                      |  |                               |          |   |      |   |          |  
|Net loss                                                                   |  | $                             | (35,859  | ) |      | $ | (20,792  | )
|Adjustments to reconcile net loss to cash flows from operating activities: |  |                               |          |   |      |   |          |  
|Depreciation and amortization                                              |  |                               | 66,130   |   |      |   | 42,070   |  
|Equity in net loss of affiliate                                            |  |                               |         |   |      |   | 1,380    |  
|Loss on disposal of capital assets                                         |  |                               | (7       | ) |      |   | 179      |  
|Net realized loss on investments                                           |  |                               | 300      |   |      |   | 652      |  
|Inventory and inventory commitment provisions                              |  |                               | 7,733    |   |      |   | 4,319    |  
|Impairment loss                                                            |  |                               |         |   |      |   | 50       |  
|Bad debt provision                                                         |  |                               | 819      |   |      |   | 25       |  
|Non-cash compensation expense                                              |  |                               | 5,005    |   |      |   | 4,959    |  
|Unrealized (gains) losses on derivative transactions                       |  |                               | (54      | ) |      |   | 18       |  
|Changes in net assets and liabilities, net of effects of merger with CNT   |  |                               | (28,871  | ) |      |   | (22,905  | )
|                                                                           |  |                               |          |   |      |   |          |  
|Net cash provided by operating activities                                  |  |                               | 15,196   |   |      |   | 9,955    |  
|Cash flows from investing activities:                                      |  |                               |          |   |      |   |          |  
|Purchases of property and equipment                                        |  |                               | (13,453  | ) |      |   | (13,911  | )
|Proceeds from sale of equipment                                            |  |                               | 2,494    |   |      |   |         |  
|Purchases of investments                                                   |  |                               | (271,547 | ) |      |   | (349,582 | )
|Proceeds from maturities and sales of investments                          |  |                               | 334,548  |   |      |   | 357,743  |  
|Cash recognized on merger with CNT, net of transaction costs               |  |                               | 40,395   |   |      |   |         |  
|Decrease (increase) in restricted cash related to interest rate swap       |  |                               | (1,735   | ) |      |   | 101      |  
|Cash received on cash surrender value of life insurance policy             |  |                               | 1,339    |   |      |   |         |  
|                                                                           |  |                               |          |   |      |   |          |  
|Net cash provided by (used in) investing activities                        |  |                               | 92,041   |   |      |   | (5,649   | )
|Cash flows from financing activities:                                      |  |                               |          |   |      |   |          |  
|Payments on long-term notes payable and capital leases                     |  |                               | (1,839   | ) |      |   | (2,317   | )
|Purchase of treasury stock                                                 |  |                               | (4,552   | ) |      |   | (10,100  | )
|Proceeds from the issuance of common stock                                 |  |                               | 792      |   |      |   | 5,500    |  
|                                                                           |  |                               |          |   |      |   |          |  
|Net cash used in financing activities                                      |  |                               | (5,599   | ) |      |   | (6,917   | )
|Effect of exchange rate changes on cash                                    |  |                               | 97       |   |      |   |         |  
|                                                                           |  |                               |          |   |      |   |          |  
|Net increase (decrease) in cash and cash equivalents                       |  |                               | 101,735  |   |      |   | (2,611   | )
|Cash and cash equivalents, beginning of period                             |  |                               | 64,507   |   |      |   | 50,301   |  
|                                                                           |  |                               |          |   |      |   |          |  
|Cash and cash equivalents, end of period                                   |  | $                             | 166,242  |   |      | $ | 47,690   |  
|                                                                           |  |                               |          |   |      |   |          |  
|Supplemental Disclosure of Non-Cash Investing and Financing Activities     |  |                               |          |   |      |   |          |  
|Deferred compensation forfeitures                                          |  | $                             | 619      |   |      | $ | 1,795    |  
|                                                                           |  |                               |          |   |      |   |          |  
|Construction-in-progress-leased facilities and related debt                |  | $                             | 15,205   |   |      | $ |         |  
|                                                                           |  |                               |          |   |      |   |          |  
|Capital lease obligations incurred                                         |  | $                             | 370      |   |      | $ | 204      |  
|                                                                           |  |                               |          |   |      |   |          |  
|Transfer of inventory to fixed assets                                      |  | $                             | 3,135    |   |      | $ | 4,337    |  
|                                                                           |  |                               |          |   |      |   |          |  



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



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##### Table of Contents

McDATA CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(tabular amounts in thousands, except per share data)

(unaudited)



Note 1Overview and Basis of Presentation



Our Business



McDATA Corporation and its subsidiaries provide data infrastructure
solutions that simplify and optimize access to and movement of ever increasing volumes of data held within enterprises across the globe. This access is provided across storage area networks (SANs), metropolitan area networks (MANs) and wide area
networks (WANs) through a combination of products and services. On June 1 2005, McDATA closed the acquisition of Computer Network Technology Corporation (CNT) and created a combined company with the products, talents and services of two
respected names in storage networking. CNT adds significant capabilities in the areas of extending storage networks over distance (MAN and WAN), professional services and maintenance services to McDATAs strength in SAN directors, switches,
routing, security and management. The merger of CNT and McDATA is expected to accelerate McDATAs Global Enterprise Data Infrastructure (GEDI) initiative, whereby customers can evolve to a globally connected, secure, highly-available,
performance-optimized, centrally-managed data access environment.



McDATAs product offerings include Intrepid directors, Sphereon switches, embedded blade server switches, Eclipse SAN routers, UltraNet extension products, EFCM management software, storage networking services (SNS) software and
related third party products. Many of these products are an integral part of data services infrastructure solutions sold by most major storage and system vendors including Dell Products L.P. (Dell), EMC Corporation (EMC), Hewlett-Packard (HP),
Hitachi Data Systems (HDS), International Business Machines Corporation (IBM), and Sun Microsystems Inc. (Sun). In addition to these partners, the products are also sold through selected value added distributors (VADs) and value added resellers
(VARs) in major geographic locations across the world. In addition to the products, McDATA also offers services including professional services, education, break/fix maintenance support, network monitoring services, as well as upgraded warranty and
extended maintenance contracts on our hardware products.



McDATA combines products and services to deliver solutions in the areas of data access, storage area networking, FICON, backup and recovery and disaster recovery / business continuity and data migration. While the primary fulfillment method
is through our channel partners, McDATAs field organization works directly with customers to drive preference for McDATA solutions, and McDATA has and may continue to directly sell channel extension, third party products, maintenance and
support and professional services to end-user customers.



The
accompanying condensed consolidated financial statements of McDATA have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Certain information and footnote disclosures normally included in the
Companys annual consolidated financial statements on Form 10-K have been condensed or omitted. The condensed consolidated balance sheet as of January 31, 2005 has been derived from the audited consolidated financial statements as of that
date, but does not include all disclosures required by generally accepted accounting principles. For further information, please refer to and read these interim condensed consolidated financial statements in conjunction with the Companys
audited consolidated financial statements for the year ended January 31, 2005. The accompanying unaudited condensed financial statements do not include the results of CNT prior to the merger of McDATA and CNT (Merger) on June 1, 2005.



The interim condensed consolidated financial statements, in
the opinion of management, reflect all adjustments necessary for a fair presentation of the financial position, results of operations and cash flows of the Company for the periods presented. The results of operations for the interim periods are not
necessarily indicative of the results of operations to be expected for the entire fiscal year or future periods.



Certain prior year amounts have been reclassified to conform to the fiscal 2005 presentation.



Recent Accounting Pronouncements



In December 2003, the Financial Accounting Standards Board (FASB) issued an
exposure draft of its proposed amendment to Statement of Financial Standards (SFAS) No. 128, Earnings Per Share (SFAS No. 128), which specifies the calculation of earnings per share (EPS). This Statement eliminates the
provision of SFAS No. 128 that allows issuing entities to overcome the presumption that certain contracts that may be settled in cash or shares will be settled in shares. Lastly, this Statement requires that shares to be issued upon conversion
of a mandatorily convertible security be included in the computation of basic EPS from the date that conversion becomes mandatory. The FASB made further modifications to this



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exposure draft and reissued it on September 30, 2005, with the final statement expected to be issued in the first quarter of 2006. The proposed
statement would be effective for reporting periods ending after June 15, 2006. The Company has not yet determined the potential future impact of the proposed amendment on its consolidated financial statements.



In November 2004, the FASB issued SFAS No. 151, Inventory
CostAn Amendment of ARB 43, Chapter 4 (SFAS No. 151), to clarify that abnormal amounts of certain costs should be recognized as period costs. This Statement is effective for fiscal years beginning after June 15, 2005. The
Company does not believe that the adoption of SFAS No. 151 will have a material effect on its financial position, results of operations, or cash flows



In December 2004, the FASB issued a revision of SFAS No. 123, Accounting for Stock-Based Compensation, (SFAS No. 123R). SFAS
No. 123R supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. SFAS No. 123R establishes standards for the accounting for transactions in which an entity incurs
liabilities in exchange for goods or services that are based on the fair value of the entitys equity instruments or that may be settled by the issuance of those equity instruments. SFAS No. 123R does not change the accounting guidance for
share-based payment transactions with parties other than employees provided in SFAS No. 123 as originally issued and EITF Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services. Originally, SFAS No. 123R was effective for interim reporting period that begins after June 15, 2005. In August, 2005, October, 2005 and November, 2005 the FASB issued FSP 123R-1, FSP
123R-2 and FSP 123R-3, respectively. These Staff Positions detail with various aspects of the implementation of SFAS No. 123R. In April 2005, the SEC announced the deferral of the required effective date. The SEC rule provides that SFAS 123R is
now effective for registrants as of the beginning of the first fiscal year beginning after June 15, 2005. The Company is in the process of determining the effect that adopting SFAS No. 123R and the related FSPs will have on its financial
position, results of operations, and cash flows.



In December
2004, the FASB issued Staff Position No. 109-2, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004. The Act creates a temporary incentive for U.S. corporations to
repatriate accumulated income earned abroad by providing an 85 percent dividends received deduction for qualifying dividends from controlled foreign corporations, subject to certain limitations. This Staff Position allows companies additional time
beyond the financial reporting period of enactment to evaluate the effect of the Act. The Company has evaluated the potential benefits of this provision and has determined that it will not be paying any dividends pursuant to the specific rules
of the Act. This decision does not prevent the Company from paying dividends from controlled foreign corporations in the future. However, such dividends would not be eligible for the special dividends received deduction provided for by the Act.



In May 2005, the FASB issued SFAS No. 154,
Accounting Changes and Error Corrections (SFAS No. 154), which requires the direct effects of voluntary accounting principle changes to be retrospectively applied to prior periods financial statements. The Statement
does not change the transition provisions of any existing accounting pronouncements, but would apply in the unusual instance that a pronouncement does not include specific transition provisions. SFAS No.154 maintains existing guidance with
respect to accounting estimate changes and corrections of errors. The Statement is effective for the Company beginning in fiscal year 2006. Adoption is not expected to have a material impact on the Companys financial position,
results of operations or cash flows.



In June 2005, the FASB
finalized FASB Staff Positions (FSP) No. 143-1, Accounting for Electronic Equipment Waste Obligations. This FSP addresses accounting by commercial users and producers of electrical and electronic equipment, in connection with
Directive 2002/96/EC on Waste Electrical and Electronic Equipment issued by the European Union on February 13, 2003 (Directive). This Directive requires EU-member countries to adopt legislation to regulate the collection, treatment, recovery,
and environmentally sound disposal of electrical and electronic waste equipment, and sets forth certain obligations relating to covering the cost of disposal of such equipment by commercial users. Producers will also be required to cover the cost of
disposal of such equipment by private household users. The FSP sets forth accounting for such obligations by commercial users and producers, with respect to SFAS No. 143, Asset Retirement Obligations and the related FASB
Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations, since this type of obligation is an asset retirement obligation. The guidance of this FSP shall be applied in the first reporting period after the date
of the adoption of the law by the applicable EU-member country. Adoption is not expected to have a material impact on the Companys financial position, results of operations or cash flows.



In June 2005, the FASB finalized FSP No. 150-5, Issuers
Accounting under Statement 150 for Freestanding Warrants and Other Similar Instruments on Shares That Are Redeemable. This FSP addresses whether freestanding warrants and other similar instruments on shares that are redeemable (either puttable
or mandatorily redeemable) would be subject to the requirements of SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and



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Equity (SFAS No. 150), regardless of the timing of the redemption feature or the redemption price. The Company has not yet determined the effect,
if any, of the FSP on its financial position, results of operations, or cash flows.



In July 2005, the FASB issued an exposure draft of its proposed interpretation of SFAS No. 109 Accounting for Income Taxes titled Accounting for Uncertain Tax Provisions. This
interpretation would clarify the accounting for uncertain tax provisions by requiring an enterprise to recognize, in its financial statements, the best estimate of the impact of a tax position only if that position is probable of being sustained on
audit based solely on the technical merits of the position. The Company has not yet determined the effect, if any, of this proposed interpretation on its financial position, results of operations, or cash flows.



Note 2Revenue Recognition Policy



The Company recognizes revenue when four basic criteria are met:
(a) persuasive evidence of an arrangement exists, (b) products are delivered or services rendered, (c) the sales price is fixed or determinable and (d) collectibility is probable.



Product Revenue



Revenue from product sales to our resellers and end-user customers is recognized when title and risk of loss transfer to the
customer, generally at the time the product is delivered. Revenue from product sales to our OEMs and distributors is recognized when title and risk of loss transfer to the customer in accordance with the master agreement, generally upon sell-through
to the end-user. With respect to revenue from our configured products, we request evidence of sell-through from our OEM and distributor partners prior to recognizing revenue. In situations where our OEM and distributor partners refuse to provide
sell-through information when requested, but all the criteria under SEC Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition (SAB No. 104) have been met, we recognize revenue for such configured products. These
configured products represent high value, customized solutions of directors, cabinets and various combinations of port cards ordered by our OEM and distributor partners as required by the end-user.



Non-configured products and components, such as our switch products, UltraNet
extension products, additional port cards, and FlexPort upgrades, are recognized as revenue when the criteria for SAB No. 104 (as discussed above) have been met, generally at time of shipment.



Revenue is reduced for estimated customer returns, price protection, rebates,
and other offerings that occur under sales programs established with the Companys OEMs, distributors and resellers. If actual credits received by our partners for returns or price protection and inventory rotation actions were to deviate
significantly from our estimates, which are based on historical experience, our revenue could be adversely affected.



The Company accrues for estimated warranty costs at the time of revenue recognition based on its experience.



Service Revenue



Revenue from support or maintenance contracts is recognized ratably over the contractual period. Amounts invoiced to
customers in excess of revenue recognized on these contracts are recorded as deferred revenue until all revenue recognition criteria are met. Revenue from professional services is recognized when such services are performed.



Software Revenue



Revenue from software is comprised of software licensing and post-contract customer support. Software revenue is allocated
to the license and support elements using vendor specific objective evidence of fair value (VSOE). Revenue allocated to software licenses is recognized when the four basic criteria above have been met. Revenue allocated to post-contract support is
recognized ratably over the term of the support contract, assuming the four basic criteria are met.



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Multiple Elements



We enter into certain arrangements where we are obligated to deliver multiple products and/or services. In transactions that include multiple products,
services and/or software, the Company allocates the revenue to each element based upon their VSOE of the fair value of the element (or in the absence VSOE, the residual method). VSOE of the fair value for an element is based upon the price charged
when the element is sold separately. Revenue allocated to each element is then recognized when the basic revenue recognition criteria is met for each element.



Deferred Revenue



Total deferred revenue consists primarily of unearned revenue from our customer support or maintenance contracts on our software and hardware products.
These contracts are billed and collected either upfront or annually at the beginning of each service period. We recognize revenue from these contracts ratably over the contractual period, generally one to three years. In the third quarter of 2005,
we reclassified certain deferred revenue amounts acquired in the purchase of CNT from short to long term based on our analysis of the future periods over which this revenue will be recognized.



The remaining portion of the deferred revenue represents deferred revenue
related to billings and collections for which one or more of the four basic criteria under SAB No. 104 and the American Institute of Certified Public Accountants Statement of Position 97-2, as amended, have not been met. These balances
are all classified as short-term on the balance sheet as all four criteria have historically been met in less than twelve months.



The accounting periods over which we will recognize this revenue is as follows (in thousands):



|                    |  |        |       
|------------------- |  | ------ | ------
|For Fiscal Years:   |  | Amount
|2005(1)             |  | $      | 18,926
|2006                |  |        | 39,295
|2007                |  |        | 18,519
|2008                |  |        | 5,427 
|2009 and thereafter |  |        | 2,208 
|                    |  |        |       
|Total               |  | $      | 84,375
|                    |  |        |       

---

|(1) | Reflects the remaining three months of fiscal 2005.
|--- | ---------------------------------------------------



Note 3Foreign Currency



The financial statements of the Companys international subsidiaries have been translated into U.S. dollars. Assets and liabilities are
translated into U.S. dollars at period-end exchange rates, while fixed assets and equity accounts are translated at historical rates. Income and expenses are translated at the average exchange rates during the period. The resulting translation
adjustments are included in stockholders equity as a component of accumulated other comprehensive loss.



The Company is exposed to market risks related to fluctuations in foreign exchange rates because some sales transactions, and the assets and liabilities
of its foreign subsidiaries, are denominated in foreign currencies. The Company had no outstanding forward exchange contracts as of October 31, 2005. Gains and losses from transactions denominated in foreign currencies and forward exchange
contracts are included in the Companys net loss as part of interest and other income. The Company recognized foreign currency transaction losses for the three and nine months ended October 31, 2005 of $128,000 and $353,000, respectively,
and $46,000 and $59,000 for the same periods in 2004, respectively.



Note
4Merger with CNT



Merger Transaction



On June 1, 2005 the Company consummated the merger transaction between
Condor Acquisition, Inc. (Merger Sub), a wholly-owned subsidiary of McDATA Corporation, and CNT (the Merger) pursuant to the terms and conditions of the previously filed Agreement and Plan of Merger, as amended (the Merger Agreement). The
transactions contemplated by the Merger Agreement were adopted and approved at a special meeting of the stockholders of the Company on May 24, 2005 and at a special meeting of the shareholders of CNT on May 24, 2005. Pursuant to the terms
of the Merger Agreement, Merger Sub was merged with and into CNT with CNT being the surviving corporation as a wholly-owned subsidiary of the Company. In connection with the filing of the Articles of Merger, the surviving corporations name was
changed to McDATA Services Corporation.



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Upon completion of the merger, CNT shareholders received 1.3 shares of McDATA Class A common stock
for each share of CNT common stock held by them, together with cash in lieu of fractional shares, and the Company assumed the CNT employee equity plans and the awards granted under these plans, as follows:



| |  |  | Each outstanding CNT stock option was assumed by McDATA and became exercisable for shares of McDATA Class A common stock at the ratio of 1.3 shares of McDATA Class A stock
for every share of CNT common stock subject to the option. The exercise price per share of each assumed CNT stock option is equal to the exercise price of the assumed CNT option divided by 1.3. All other terms and conditions of the assumed CNT stock
options remained unchanged.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The outstanding CNT restricted stock units and CNT deferred stock units were assumed by the Company and were converted into, and are deemed to constitute, a right to be issued
shares of McDATA Class A common stock. The number of shares of McDATA Class A common stock subject to the assumed CNT restricted stock units and CNT deferred stock units will each be adjusted to reflect the merger exchange ratio. All other
terms and conditions of the assumed CNT restricted stock units and CNT deferred stock units remained unchanged. Notwithstanding the foregoing, all outstanding CNT restricted stock units vested in full upon completion of the merger, and the holders
thereof received 1.3 shares of McDATA Class A common stock for each CNT restricted stock unit owned at the effective time of the merger, together with cash in lieu of any fractional shares. All deferred stock units were fully vested prior to
the acquisition.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | With the exception of retention grants made to certain CNT employees and certain shares of restricted stock issued to one other CNT employee, all outstanding shares of CNT
restricted stock became fully vested as of the completion of the merger, and the holders thereof received 1.3 shares of McDATA Class A common stock for each restricted share of CNT common stock owned at the effective time of the merger,
together with cash in lieu of any fractional shares. All other terms and conditions of the assumed shares of restricted stock remained unchanged.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



On June 1, 2005 simultaneously with the effectiveness of the Merger, the Company entered into a supplemental indenture to the indenture between
CNT and U.S. Bank National Association, (the Trustee), pursuant to which McDATA fully and unconditionally guarantees the payment of principal and interest on CNTs outstanding $124,350,000 3.00% Convertible Subordinated Notes due 2007 (the
3.00% Notes), and that upon conversion, a holder of the 3.00% Notes will receive that number of shares of the Companys Class A common stock that would have been issued if the 3.00% Notes had been converted into CNT common stock
immediately prior to the merger.



Reason for the Merger



The Merger is intended to create a combined company that will establish a
leading position in data access, enterprise storage networking, encompassing world-class products, services and software. The merger will combine the products, talent and expertise of two respected names in storage networking and is expected to
accelerate McDATAs Global Enterprise Data Infrastructure or GEDI to deploy a broadened tiered network infrastructure.



Preliminary Purchase Accounting



McDATA is considered the accounting acquirer in the merger, requiring the purchase consideration of $193.0 million to be allocated to the fair value of
CNTs net assets, with the residual to goodwill. The consolidated financial statements include the operating results of CNT from the June 1, 2005 date of acquisition. The purchase consideration consisted of 38.8 million shares of
McDATA Class A common stock valued at $170.2 million and issued in exchange for 100% of the outstanding CNT common and restricted shares; the exchange of 19.9 million stock options valued at $15.9 million using the Black Scholes option
pricing model; and $6.9 million in direct transaction costs. The value of the stock issued was based upon an average market price per share of $4.39, which was the average McDATA Class A common stock price for the period beginning two days
before and ending two days after the announcement of the merger on January 18, 2005. Under the purchase method of accounting, the total purchase price is allocated to CNTs net tangible and intangible assets and liabilities based on their
estimated fair value as of the completion date of the merger.



We recorded approximately $185.4 million of goodwill, $73.6 million of identified intangible assets, $184.7 million of tangible assets and $154.3 million of liabilities at the time of the acquisition of CNT. Fair values for identifiable
intangible assets, property, plant and equipment as well as deferred revenue were based upon a valuation performed by a third party valuation expert. The initial purchase price allocation for CNT is subject to revision as more detailed analysis is
completed and additional information on the fair values of CNTs assets and liabilities becomes available. During the quarter ended October 31, 2005 we reduced our estimate of liabilities assumed in the merger by approximately $3.3
million, relating



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primarily to a reduction in contract termination liabilities, partially offset by an increase in estimated tax liabilities. The primary areas of the purchase
price allocation that are not yet finalized relate to collectibility of receivables, severance and relocation benefits, office closure costs, contract termination costs, certain legal matters, income and non-income based taxes, and residual
goodwill. With the finalization of the purchase price allocation, additional adjustments to deferred taxes may be made.



Any change in the estimated fair value of the net assets of CNT during the purchase price allocation period (generally within one year of the acquisition
date) will change the amount of the purchase price allocated to goodwill. The actual allocation of purchase cost and its effect on results of operations may differ significantly from the proforma operating results included herein.



Pro Forma Results



The following unaudited pro forma information presents a summary of the results of operations of the Company assuming the
acquisition of CNT occurred at the beginning of each period presented. The pro forma financial information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved if the Merger
had taken place at the beginning of each of the periods presented, nor is it indicative of future operating results.



|                           |  |                               |          |   |                              |   |         |      |  |   |          |  
|-------------------------- |  | ----------------------------- | -------- | - | ---------------------------- | - | ------- | ---- |  | - | -------- | -
|                           |  | Three Months EndedOctober 31, |          |   | Nine Months EndedOctober 31, |  
|                           |  | 2004                          |          |   | 2005                         |   |         | 2004 | 
|Total revenue              |  | $                             | 184,114  |   |                              | $ | 527,403 |      |  | $ | 550,748  |  
|Net loss                   |  | $                             | (106,120 | ) |                              | $ | (76,992 | )    |  | $ | (160,664 | )
|Basic net loss per share   |  | $                             | (.70     | ) |                              | $ | (0.50   | )    |  | $ | (1.06    | )
|Diluted net loss per share |  | $                             | (.70     | ) |                              | $ | (0.50   | )    |  | $ | (1.06    | )



Note 5Restructuring Costs



In connection with the Companys merger with CNT
discussed in Note 4, management approved and initiated a plan of integration which outlined the actions necessary to combine its existing business and resources with those of CNT. An important part of this plan is the integration of the
companies products and customer bases, elimination of duplicative activities, and the reduction of the Companys overall cost structure. The restructuring charges recorded in the quarters ended October 31, 2005 and July 31, 2005
are based on this integration plan. The Company has completed significant milestones of its integration process, including selling the Lumberton manufacturing operations and eliminating more than 500 redundant jobs. The Company expects to
substantially complete the remaining integration activities by the end of the fiscal fourth quarter 2005.



Restructuring Costs Expensed in 2005



After the acquisition of CNT, the Company notified redundant employees that their employment would be terminated and provided them with a detailed explanation of their benefits, which included separation pay as well
as retention pay for transitional employees. Total termination benefits charged to restructuring costs in results of operations as a result of the integration plan was $.6 million for the quarter ended October 31, 2005 and $3.9 million in total
through October 31, 2005. Retention pay offered to all transitional employees is contingent upon the employee rendering future service through a transition period and has no relationship to the employees past service, therefore, these
benefits were recognized as a restructuring cost ratably over the transition period. For the quarter ended October 31, 2005, $.6 million has been recognized as a restructuring cost, for a total of $.9 million through October 31, 2005. No
further retention benefits are expected to be incurred as a result of the CNT integration plan.



Prior to the acquisition, McDATA and CNT each sold a competing Director class productMcDATAs is branded the Intrepid 10000 and CNTs is
the UltraNet Multi-Service Director (UMD). In order to eliminate this redundancy and integrate the two companys product offerings, the Company has decided to withdraw the UMD from the market, and continue to sell the Intrepid 10000 product in
the future. As a result, McDATA has offered, and certain existing UMD customers have accepted, an exchange program which allowed customers to trade in their UMD for a comparable Intrepid 10000 at no cost to them. The Company has also offered
customers up to 20 hours of professional consulting service to assist with the migration to the new product. The net cost of this program of $6.8 million was recorded as a restructuring cost during the quarter ended July 31, 2005, which
represents the difference between the cost of the Intrepid 10000 to be installed over the salvage value of the UMDs to be returned. Consulting costs to be incurred in connection with this program were not accrued because they could not be
reasonably estimated. They will be recorded as restructuring costs in future periods as they are incurred.



13



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##### Table of Contents

Changes to the estimates of executing the currently approved plans of restructuring the pre-merger McDATA
organization will be reflected in our future results of operations.



The following table summarizes the Companys utilization of restructuring accruals during the quarter ended October 31, 2005 (in thousands):



|                                    |  |                             |        |   |                         |   |        |        |  |   |        |  
|----------------------------------- |  | --------------------------- | ------ | - | ----------------------- | - | ------ | ------ |  | - | ------ | -
|                                    |  | Employee Severance Benefits |        |   | UMD /Intrepid10000 Swap |   |        | Totals | 
|Accrual balance as of July 31, 2005 |  | $                           | 2,034  |   |                         | $ | 6,394  |        |  | $ | 8,428  |  
|Net cost of product exchanged       |  |                             |       |   |                         |   | (2,503 | )      |  |   | (2,503 | )
|Cash payments                       |  |                             | (2,204 | ) |                         |   |       |        |  |   | (2,204 | )
|Additional restructuring charges    |  |                             | 740    |   |                         |   |       |        |  |   | 740    |  
|                                    |  |                             |        |   |                         |   |        |        |  |   |        |  
|Accrual balance at October 31, 2005 |  | $                           | 570    |   |                         | $ | 3,891  |        |  | $ | 4,461  |  
|                                    |  |                             |        |   |                         |   |        |        |  |   |        |  



The restructuring liabilities shown
above are included in accrued liabilities in the accompanying balance sheet as of October 31, 2005.



Restructuring Costs Accounted for in CNT Purchase Allocation



In connection with the restructuring of the pre-merger CNT organization, $36.3 million in restructuring liabilities, consisting primarily of severance,
relocation, facility consolidation costs, and contract termination costs, were recorded as liabilities assumed in the initial purchase price allocation of CNT at June 1, 2005 in accordance with EITF Issue No. 95-3, Recognition of
Liabilities in Connection with a Purchase Business Combination. In the quarter ended October 31, 2005, the estimated restructuring costs were decreased by a net $5.9 million due to the settlement of certain purchase commitments, partially
offset by increases to estimated termination benefits.



As of
the acquisition date, management had formulated an integration plan which included, among other things, the elimination of duplicative headcount, elimination of redundant products, the outsourcing of manufacturing, and the closing of duplicative
facilities in overlapping geographies. As a result, over 200 pre-merger CNT employees have been or will be terminated and an estimated $9.8 million in termination and relocation benefits for CNT employees has been recognized in other liabilities
assumed. Also included in other liabilities assumed is $8.1 million related to the planned closure of certain pre-merger CNT offices. For sites where the Company expected to negotiate an early termination of the lease, the expected termination costs
were accrued. The amounts accrued for the remaining sites were based upon the fair value of the liability at the cease-use date based on the remaining lease rentals reduced by estimated sublease rentals. An additional estimated $10.6 million has
been included in other liabilities assumed, which is primarily related to estimated settlements of various unfulfilled contractual commitments.



In execution of its plan to continue to outsource its manufacturing operations, on June 24, 2005, the Company sold its manufacturing operations and
transferred assets related to the former CNT Lumberton, New Jersey manufacturing operations to Solectron Corporation, Inc (Solectron). The terms of the sales agreement include (a) the transfer of equipment related to the
manufacturing operations for $1.5 million, (b) the assumption by Solectron of a certain lease obligation related to the facility in Lumberton, New Jersey and a sublease back to the Company for certain space at the facility, (c) the
transfer of 123 Company employees to Solectron, and (d) the payment of $3 million in installments over the next year by the Company to Solectron in partial consideration for anticipated restructuring costs to be incurred by Solectron related to
this facility. The net payment of $1.5 million required by the Company to transfer these assets and liabilities has been reflected as a liability assumed in the purchase allocation. As discussed more fully in Note 15, in connection with this sale,
the Company has agreed to indemnify the buyer and hold them harmless from any loss, as defined in the agreement, that relates to specific issues outlined in the agreement. In accordance with FIN 45, Guarantors Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, the Company has recognized a liability of approximately $0.4 million for the underlying fair value of these obligations, which has also been included in
liabilities assumed in the purchase of CNT.



Further changes to
estimated restructuring costs as a result of executing the currently approved plans associated with the pre-merger activities of CNT will be recorded as an adjustment to goodwill during the purchase price allocation period, and as operating expenses
thereafter.



14



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##### Table of Contents

The following table summarizes the Companys utilization of restructuring accruals pertaining to pre-merger
operations of CNT during the quarter ended October 31, 2005 (in thousands):



|                                    |  |                                            |        |   |                                 |   |        |                            |  |   |        |   |  |   |        |  
|----------------------------------- |  | ------------------------------------------ | ------ | - | ------------------------------- | - | ------ | -------------------------- |  | - | ------ | - |  | - | ------ | -
|                                    |  | Employee Severance and Relocation Benefits |        |   | Facility Closure and Exit Costs |   |        | Contract Termination Costs |  |   | Totals |  
|Accrual balance at July 31, 2005    |  | $                                          | 6,228  |   |                                 | $ | 11,510 |                            |  | $ | 16,686 |   |  | $ | 34,424 |  
|Cash payments                       |  |                                            | (4,361 | ) |                                 |   | (207   | )                          |  |   | (730   | ) |  |   | (5,298 | )
|Change to estimated costs           |  |                                            | 198    |   |                                 |   |       |                            |  |   | (6,065 | ) |  |   | (5,867 | )
|                                    |  |                                            |        |   |                                 |   |        |                            |  |   |        |   |  |   |        |  
|Accrual balance at October 31, 2005 |  | $                                          | 2,065  |   |                                 | $ | 11,303 |                            |  | $ | 9,891  |   |  | $ | 23,259 |  
|                                    |  |                                            |        |   |                                 |   |        |                            |  |   |        |   |  |   |        |  



Of the restructuring
liabilities described above, $15.5 million is included in accrued liabilities and the remaining $7.8 million is included in other long-term liabilities in the accompanying balance sheet as of October 31, 2005.



Note 6Components of Selected Balance Sheet Accounts



|                                                  |  |                  |         |   |                  |   |         |  
|------------------------------------------------- |  | ---------------- | ------- | - | ---------------- | - | ------- | -
|                                                  |  | October 31, 2005 |         |   | January 31, 2005 |  
|Inventories:                                      |  |                  |         |   |                  |   |         |  
|Raw materials                                     |  | $                | 25,255  |   |                  | $ | 5,375   |  
|Work-in-progress                                  |  |                  | 1,282   |   |                  |   | 623     |  
|Finished goods                                    |  |                  | 16,329  |   |                  |   | 12,626  |  
|                                                  |  |                  |         |   |                  |   |         |  
|Total inventories at cost                         |  |                  | 42,866  |   |                  |   | 18,624  |  
|Less reserves                                     |  |                  | (8,219  | ) |                  |   | (4,904  | )
|                                                  |  |                  |         |   |                  |   |         |  
|Total inventories, net                            |  | $                | 34,647  |   |                  | $ | 13,720  |  
|                                                  |  |                  |         |   |                  |   |         |  
|                                                  |  |                 
|                                                  |  | October 31, 2005 |         |   | January 31, 2005 |  
|Property and Equipment:                           |  |                  |         |   |                  |   |         |  
|Land                                              |  | $                | 17,799  |   |                  | $ | 16,091  |  
|Building                                          |  |                  | 32,573  |   |                  |   | 32,573  |  
|Equipment and Furniture (1)                       |  |                  | 123,160 |   |                  |   | 94,389  |  
|Computer software for internal use                |  |                  | 29,699  |   |                  |   | 29,146  |  
|Leasehold Improvements                            |  |                  | 7,908   |   |                  |   | 6,029   |  
|Construction in progress                          |  |                  | 634     |   |                  |   | 492     |  
|Construction in progressleased facilities (2)    |  |                  | 15,205  |   |                  |   |        |  
|                                                  |  |                  |         |   |                  |   |         |  
|                                                  |  |                  | 226,978 |   |                  |   | 178,720 |  
|Less accumulated depreciation and amortization    |  |                  | (96,837 | ) |                  |   | (83,791 | )
|                                                  |  |                  |         |   |                  |   |         |  
|Total property and equipment, net                 |  | $                | 130,141 |   |                  | $ | 94,929  |  
|                                                  |  |                  |         |   |                  |   |         |  
|                                                  |  |                 
|                                                  |  | October 31, 2005 |         |   | January 31, 2005 |  
|Accrued liabilities:                              |  |                  |         |   |                  |   |         |  
|Wages and employee benefits                       |  | $                | 24,017  |   |                  | $ | 19,483  |  
|Purchase commitments and other supply obligations |  |                  | 6,663   |   |                  |   | 5,867   |  
|Warranty reserves (3)                             |  |                  | 6,558   |   |                  |   | 5,592   |  
|Income taxes payable                              |  |                  | 10,627  |   |                  |   | 1,573   |  
|Taxes, other than income tax                      |  |                  | 5,120   |   |                  |   | 2,662   |  
|Interest payable                                  |  |                  | 1,660   |   |                  |   | 1,774   |  
|Customer obligations                              |  |                  | 6,390   |   |                  |   | 4,784   |  
|Restructuring accruals                            |  |                  | 19,968  |   |                  |   |        |  
|Other accrued liabilities                         |  |                  | 5,647   |   |                  |   | 2,814   |  
|                                                  |  |                  |         |   |                  |   |         |  
|                                                  |  | $                | 86,650  |   |                  | $ | 44,549  |  
|                                                  |  |                  |         |   |                  |   |         |  

---

|(1) | Includes equipment under capitalized leases of $7.7 million, and $4.9 million, respectively.
|--- | --------------------------------------------------------------------------------------------



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##### Table of Contents

|(2) | As discussed in Note 15, the Company entered into a contract on September 9, 2004 for the future lease of 168,127 square feet of office space in Broomfield, Colorado. The
Company intends to begin moving its current world headquarters location to the new location early in 2006 with the lease commencing in February of 2006. The lease agreement states that the landlord is liable for build out costs up to $40 per square
foot, with any excess costs paid by the Company. EITF 97-10, The Effect of Lessee Involvement in Asset Construction requires that the lessee be deemed the owner of the project for accounting purposes if the lease agreement could require,
under any circumstances regardless of how remote, that the lessee pay 90% or more of the total project costs as of any point in time during the construction period. Since the lease agreement does not limit the Companys total potential
expenditures related to this project, the Company is deemed to be the accounting owner of the project, and therefore total project costs incurred to date by all parties have been reflected as Construction in progress  leased assets, and as
Non-cash obligations for construction in progresslease facilities in the long term liability section of the accompanying balance sheet.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | Activity in the warranty reserves is as follows:
|--- | ------------------------------------------------



|                                  |  |                               |        |   |                              |   |       |      |  |   |        |   |  |   |       |  
|--------------------------------- |  | ----------------------------- | ------ | - | ---------------------------- | - | ----- | ---- |  | - | ------ | - |  | - | ----- | -
|                                  |  | Three Months EndedOctober 31, |        |   | Nine Months EndedOctober 31, |  
|                                  |  | 2005                          |        |   | 2004                         |   |       | 2005 |  |   | 2004   |  
|Balance at beginning of period    |  | $                             | 6,765  |   |                              | $ | 4,396 |      |  | $ | 5,592  |   |  | $ | 4,522 |  
|Warranty expense, net             |  |                               | 1,337  |   |                              |   | 68    |      |  |   | 3,448  |   |  |   | 562   |  
|Non-expensed warranty obligations |  |                               |       |   |                              |   | 69    |      |  |   | 17     |   |  |   | 69    |  
|Warranty claims                   |  |                               | (1,544 | ) |                              |   | (234  | )    |  |   | (4,243 | ) |  |   | (854  | )
|Acquired warranty liability       |  |                               |       |   |                              |   |      |      |  |   | 1,744  |   |  |   |      |  
|                                  |  |                               |        |   |                              |   |       |      |  |   |        |   |  |   |       |  
|Balance at end of period          |  | $                             | 6,558  |   |                              | $ | 4,299 |      |  | $ | 6,558  |   |  | $ | 4,299 |  
|                                  |  |                               |        |   |                              |   |       |      |  |   |        |   |  |   |       |  



From time to time the
Company is indemnified by its suppliers for warranty claims related to components that are contained within its products. In these circumstances, the Company records a non-expensed warranty obligation against which future warranty claims for those
components will be provided by the Company to its customers.



Note
7Goodwill and Intangible assets



The Company is
currently amortizing its acquired intangible assets with finite lives over periods ranging from one to seven years. The following table summarizes the components of gross and net intangible asset balances:



|                        |  |                     |         |                         |   |                    |  |                     |         |                         |   |                    |  |   |        |  |   |       
|----------------------- |  | ------------------- | ------- | ----------------------- | - | ------------------ |  | ------------------- | ------- | ----------------------- | - | ------------------ |  | - | ------ |  | - | ------
|                        |  | October 31, 2005    |         | January 31, 2005       
|                        |  | GrossCarryingAmount |         | AccumulatedAmortization |   | Net CarryingAmount |  | GrossCarryingAmount |         | AccumulatedAmortization |   | Net CarryingAmount
|Developed technology    |  | $                   | 143,490 |                         | $ | 48,878             |  | $                   | 94,612  |                         | $ | 116,866            |  | $ | 31,595 |  | $ | 85,271
|Customer relationships  |  |                     | 30,234  |                         |   | 2,848              |  |                     | 27,386  |                         |   | 1,622              |  |   | 739    |  |   | 883   
|Backlog                 |  |                     | 17,152  |                         |   | 6,126              |  |                     | 11,026  |                         |   |                   |  |   |       |  |   |      
|Other                   |  |                     | 5,041   |                         |   | 3,339              |  |                     | 1,702   |                         |   | 3,813              |  |   | 2,375  |  |   | 1,438 
|                        |  |                     |         |                         |   |                    |  |                     |         |                         |   |                    |  |   |        |  |   |       
|Total intangible assets |  | $                   | 195,917 |                         | $ | 61,191             |  | $                   | 134,726 |                         | $ | 122,301            |  | $ | 34,709 |  | $ | 87,592
|                        |  |                     |         |                         |   |                    |  |                     |         |                         |   |                    |  |   |        |  |   |       



Expected annual
amortization expense related to acquired intangible assets is as follows:



|                                    |  |   |        
|----------------------------------- |  | - | -------
|Fiscal Years:                       |  |  
|2005(1)                             |  | $ | 11,060 
|2006                                |  |   | 35,949 
|2007                                |  |   | 26,857 
|2008                                |  |   | 26,522 
|2009 and thereafter                 |  |   | 34,338 
|                                    |  |   |        
|Total expected amortization expense |  | $ | 134,726
|                                    |  |   |        

---

|(1) | Reflects the remaining three months of fiscal 2005.
|--- | ---------------------------------------------------



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Amortization expense related to acquired intangible assets was $11.4 million and $5.6 million for the
quarters ended October 31, 2005 and 2004, respectively. For the nine months ended October 31, 2005 and 2004, amortization of acquired intangibles was $26.5 million and $17.2 million, respectively.



Changes in the carrying amount of goodwill for the nine
months ended October 31, 2005 are as follows:



|                               |  |                |         |   |                 |   |         |  |   |         |  
|------------------------------ |  | -------------- | ------- | - | --------------- | - | ------- |  | - | ------- | -
|                               |  | ProductSegment |         |   | ServicesSegment |   | Total   | 
|Balance as of January 31, 2005 |  | $              | 78,693  |   |                 | $ |        |  | $ | 78,693  |  
|Goodwill Acquired              |  |                | 51,905  |   |                 |   | 133,469 |  |   | 185,374 |  
|Goodwill Impaired              |  |                |        |   |                 |   |        |  |   |        |  
|Other(1)                       |  |                | (5,278  | ) |                 |   | 2,023   |  |   | (3,255  | )
|                               |  |                |         |   |                 |   |         |  |   |         |  
|Balance as of October 31, 2005 |  | $              | 125,320 |   |                 | $ | 135,492 |  | $ | 260,812 |  
|                               |  |                |         |   |                 |   |         |  |   |         |  

---

|(1) | Represents a net reduction to goodwill in the three months ended October 31, 2005, as a result of adjusting the estimated fair market value of certain purchased assets and
liabilities of CNT.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



As a result of the merger
with CNT, and upon completing the integration of CNTs service business in the third quarter of fiscal 2005, the Company operates in two distinct reporting segments, each constituting a separate reporting unit for purposes of allocating
goodwill. Goodwill acquired in the merger with CNT has been allocated to these two reporting segments based on the work of a third party valuation expert. Goodwill was allocated between the two segments based upon each segments relative
projected operating profits. As discussed in Note 4, the amount of goodwill and its allocations to the reporting segments are subject to change. We will re-evaluate the goodwill allocation between the segments in the future. The product and service
segment goodwill balances will each be tested for impairment annually or more frequently, if events or circumstances indicate that an impairment might exist. There were no impairments of goodwill recognized for the quarter and nine months ended
October 31, 2005.



Note 8Convertible Subordinated Debt



Convertible subordinated debt includes the Companys
2.25% convertible subordinated notes due February 15, 2010 which are described more fully in Note 8Convertible Subordinated Debt, in the Companys fiscal 2004 Annual Report filed on Form 10-K, as well the $124,350,000 3.00%
Convertible Subordinated Notes due February 15, 2007 previously issued by CNT (the 3.00% Notes), which were assumed in the Merger.



On June 1, 2005, effective upon the consummation of the Merger, the Company fully and unconditionally guaranteed the 3.00% Notes and became a
co-obligor on the 3.00% Notes with CNT and the 3.00% Notes became convertible into the Companys Class A stock at a price of approximately $14.75 per share (aggregate of approximately 8.4 million shares) at any time prior to maturity
on February 15, 2007, all pursuant to the terms of the Supplemental Indenture. All other terms of the 3.00% Notes remained unchanged.



The 3.00% Notes may be redeemed upon payment of the outstanding principal balance, accrued interest and a make whole payment if the closing price of the
Class A stock exceeds 175% of the conversion price for at least twenty (20) consecutive trading days within a period of thirty (30) consecutive trading days ending on the trading day prior to the date of the mailing of the
redemption notice. The make whole payment represents additional interest payments that would be made if the 3.00% Notes were not redeemed prior to their due date. Interest is payable on February 15 and August 15 of each year while the
3.00% Notes are outstanding. Payment of the notes will also accelerate upon certain events of default.



Prior to the Merger, CNT entered into an interest-rate swap agreement with a notional amount of $75 million that has the economic effect of modifying that
dollar portion of the fixed interest obligations associated with $75 million of the Notes such that the interest payable effectively becomes variable based on the three month LIBOR plus 69.5 basis points. The payment and reset dates of the swap
are January 31st, April 30th, July 31st and October 31st of each year, until maturity on February 15, 2007. At October 31, 2005, the three-month LIBOR setting for the swap was 4.243%, resulting in a combined
effective rate of approximately 4.938% which is effective until January 2006. The swap was designated as a fair value hedge, and as such, the gain or loss on the swap, as well as the fully offsetting gain or loss on the notes attributable to the
hedged risk, are recognized in earnings. Fair value hedge accounting is provided only if the hedging instrument is expected to be, and actually is, effective at offsetting changes in the value of the hedged item. During the third quarter, the fair
value of the interest rate swap decreased $0.7 million, resulting in a swap liability of $1.8 million as of October 31, 2005, which has been included in other long-term liabilities. Corresponding to this decrease, the carrying value



17



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of the notes covered by the swap agreement has also been decreased by $0.7 million. As part of the agreement, the Company is also required to post collateral
based on changes in the fair value of the interest rate swap. This collateral, in the form of restricted cash, was $3.8 million at October 31, 2005, and has been included in restricted cash in the accompanying consolidated balance sheets.



Note 9Interest and Other Income, Net



Interest and other income, net consists of:



|                                                              |  |                               |       |   |                              |   |       |      |  |   |       |   |  |   |       |  
|------------------------------------------------------------- |  | ----------------------------- | ----- | - | ---------------------------- | - | ----- | ---- |  | - | ----- | - |  | - | ----- | -
|                                                              |  | Three Months EndedOctober 31, |       |   | Nine Months EndedOctober 31, |  
|                                                              |  | 2005                          |       |   | 2004                         |   |       | 2005 |  |   | 2004  |  
|Interest income                                               |  | $                             | 2,674 |   |                              | $ | 1,852 |      |  | $ | 7,209 |   |  | $ | 5,148 |  
|Net realized gains/(losses) on available-for-sale investments |  |                               | 112   |   |                              |   | (170  | )    |  |   | (266  | ) |  |   | (653  | )
|Unrealized gain/(loss) on hedged investments                  |  |                               | (18   | ) |                              |   | 23    |      |  |   | 73    |   |  |   | (15   | )
|                                                              |  |                               |       |   |                              |   |       |      |  |   |       |   |  |   |       |  
|Interest and other income, net                                |  | $                             | 2,768 |   |                              | $ | 1,705 |      |  | $ | 7,016 |   |  | $ | 4,480 |  
|                                                              |  |                               |       |   |                              |   |       |      |  |   |       |   |  |   |       |  



Note 10Income Tax



For the three-month periods ended October 31, 2005
and October 31, 2004 the Company recorded an income tax benefit of $3.9 million and $618,000, respectively. For the nine-month periods ended October 31, 2005 and October 31, 2004 the Company recorded an income tax expense of $2.5
million and $40,000, respectively. In October 2005, the Company released previously accrued tax contingencies in the amount of $1.35 million due to the expiration of state Statutes of Limitations with respect to returns filed for a prior year,
resulting in a one-time benefit to the income tax provision. This benefit is included in the amounts reported for the three- and nine-month periods ended October 31, 2005.



The calculation of income tax expense or benefit is based in part on estimates of future results and projections of taxable
income for the full fiscal year in each jurisdiction in which the Company operates. These projections could be affected, positively or negatively, by such factors as future changes in tax law or implementation of possible tax planning strategies.
The tax provision for each of the periods reported in the Consolidated Statement of Operations includes foreign taxes accrued on the projected net profits of foreign branch and subsidiary operations, as well as state taxes for jurisdictions where
there are insufficient tax operating losses to offset allocable taxable income.



The Company has established a valuation allowance against its entire domestic net deferred tax asset. Therefore, no federal tax benefit is recognized currently if there is an increase to the net deferred tax asset.
The need for a valuation allowance is determined in accordance with the provisions of SFAS No. 109, which requires an assessment of all available negative and positive evidence, including past operating results, the existence of cumulative
losses in the most recent fiscal years and forecasts of future taxable income. Significant management judgment is required in determining the need to establish or maintain a valuation allowance. SFAS No. 109 requires that greater weight be
given to previous cumulative losses than the outlook for future profitability when determining whether it is more likely than not that the benefits of a recorded deferred tax asset will be realized. To the extent future realization of the benefits
of a deferred tax asset is unlikely, a valuation allowance is recorded. The Company has re-evaluated the need for a valuation allowance based on its most recent results and concluded that a valuation allowance is still required with respect to the
entire net deferred tax asset, except for $185,000 of foreign deferred tax assets expected to be realized by one of the legacy CNT subsidiaries.



Note 11Net Loss Per Share



Basic net loss per share excludes dilution and is computed by dividing loss available to common stockholders by the weighted-average number of common
shares outstanding for the period. Diluted net loss per share is based on the weighted-average number of shares outstanding during each period and the assumed exercise of dilutive common stock equivalents less the number of treasury shares assumed
to be purchased from the proceeds using the average market price of the Companys common stock for each of the periods presented. No dilutive effect is included for shares sold in relation to McDATAs agreement with International Business
Machines Corporation (IBM) in which the Company granted IBM five-year warrants for the purchase of up to 350,000 shares of McDATAs Class B common stock because of their anti-dilutive impact. No dilutive effect has been included for the
convertible subordinated debt or the share options sold in relation to the convertible subordinated debt because of their anti-dilutive impact.



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Following is a reconciliation between basic and diluted loss per share:



|                                                                                                  |  |                               |         |   |                              |   |         |      |  |   |         |   |  |   |         |  
|------------------------------------------------------------------------------------------------- |  | ----------------------------- | ------- | - | ---------------------------- | - | ------- | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                                                  |  | Three Months EndedOctober 31, |         |   | Nine Months EndedOctober 31, |  
|                                                                                                  |  | 2005                          |         |   | 2004                         |   |         | 2005 |  |   | 2004    |  
|Net loss                                                                                          |  | $                             | (7,484  | ) |                              | $ | (5,523  | )    |  | $ | (35,859 | ) |  | $ | (20,792 | )
|Weighted average shares of common stock outstanding used in computing basic net loss per share    |  |                               | 152,646 |   |                              |   | 115,624 |      |  |   | 135,750 |   |  |   | 115,377 |  
|Effect of dilutive stock options and warrants                                                     |  |                               |        |   |                              |   |        |      |  |   |        |   |  |   |        |  
|                                                                                                  |  |                               |         |   |                              |   |         |      |  |   |         |   |  |   |         |  
|Weighted average shares of common stock used in computing diluted net loss per share              |  |                               | 152,646 |   |                              |   | 115,624 |      |  |   | 135,750 |   |  |   | 115,377 |  
|                                                                                                  |  |                               |         |   |                              |   |         |      |  |   |         |   |  |   |         |  
|Basic net loss per share                                                                          |  | $                             | (0.05   | ) |                              | $ | (0.05   | )    |  | $ | (0.26   | ) |  | $ | (0.18   | )
|                                                                                                  |  |                               |         |   |                              |   |         |      |  |   |         |   |  |   |         |  
|Diluted net loss per share                                                                        |  | $                             | (0.05   | ) |                              | $ | (0.05   | )    |  | $ | (0.26   | ) |  | $ | (0.18   | )
|                                                                                                  |  |                               |         |   |                              |   |         |      |  |   |         |   |  |   |         |  
|Options and warrants not included in diluted share base because of the exercise prices            |  |                               | 19,960  |   |                              |   | 11,407  |      |  |   | 20,830  |   |  |   | 10,184  |  
|                                                                                                  |  |                               |         |   |                              |   |         |      |  |   |         |   |  |   |         |  
|Options, warrants and restricted stock not included in diluted share base because of the net loss |  |                               | 3,572   |   |                              |   | 7,134   |      |  |   | 3,381   |   |  |   | 8,016   |  
|                                                                                                  |  |                               |         |   |                              |   |         |      |  |   |         |   |  |   |         |  



Note 12Stock-Based
Compensation



The Company has stock-based employee
compensation plans and employee stock purchase plans, which are described more fully in the Companys Annual Report on Form 10-K for the year ended January 31, 2005, and in Note 13.



The Company accounts for these plans according to Accounting Principles Board
(APB) Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), and related interpretations and has adopted the disclosure-only alternative of SFAS No. 123, as amended by SFAS No. 148, Accounting for
Stock-Based CompensationTransition and Disclosure, an amendment of SFAS No. 123. Any deferred stock compensation calculated pursuant to APB 25 is amortized ratably over the vesting period of the individual options, generally two to
four years. The following table illustrates the effect on net loss per share if the Company had applied the fair value recognition provisions of SFAS No. 123.



|                                                                                                                                                     |  |                               |         |   |                              |   |        |      |  |   |         |   |  |   |         |  
|---------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------- | ------- | - | ---------------------------- | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                                                                                                     |  | Three Months EndedOctober 31, |         |   | Nine Months EndedOctober 31, |  
|                                                                                                                                                     |  | 2005                          |         |   | 2004                         |   |        | 2005 |  |   | 2004    |  
|Net loss, as reported                                                                                                                                |  | $                             | (7,484  | ) |                              | $ | (5,523 | )    |  | $ | (35,859 | ) |  | $ | (20,792 | )
|Add: Total stock-based employee compensation expense included in net loss as determined under the intrinsic value method, net of related tax
effects |  |                               | 914     |   |                              |   | 1,076  |      |  |   | 5,000   |   |  |   | 4,959   |  
|Deduct: Total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax
effects      |  |                               | (5,501  | ) |                              |   | (4,273 | )    |  |   | (17,111 | ) |  |   | (14,234 | )
|                                                                                                                                                     |  |                               |         |   |                              |   |        |      |  |   |         |   |  |   |         |  
|Pro forma net loss                                                                                                                                   |  | $                             | (12,071 | ) |                              | $ | (8,720 | )    |  | $ | (47,970 | ) |  | $ | (30,067 | )
|                                                                                                                                                     |  |                               |         |   |                              |   |        |      |  |   |         |   |  |   |         |  
|Loss per share:                                                                                                                                      |  |                               |         |   |                              |   |        |      |  |   |         |   |  |   |         |  
|Basic-as reported                                                                                                                                    |  | $                             | (0.05   | ) |                              | $ | (0.05  | )    |  | $ | (0.26   | ) |  | $ | (0.18   | )
|                                                                                                                                                     |  |                               |         |   |                              |   |        |      |  |   |         |   |  |   |         |  
|Basic-pro forma                                                                                                                                      |  | $                             | (0.08   | ) |                              | $ | (0.08  | )    |  | $ | (0.35   | ) |  | $ | (0.26   | )
|                                                                                                                                                     |  |                               |         |   |                              |   |        |      |  |   |         |   |  |   |         |  
|Diluted-as reported                                                                                                                                  |  | $                             | (0.05   | ) |                              | $ | (0.05  | )    |  | $ | (0.26   | ) |  | $ | (0.18   | )
|                                                                                                                                                     |  |                               |         |   |                              |   |        |      |  |   |         |   |  |   |         |  
|Diluted-pro forma                                                                                                                                    |  | $                             | (0.08   | ) |                              | $ | (0.08  | )    |  | $ | (0.35   | ) |  | $ | (0.26   | )
|                                                                                                                                                     |  |                               |         |   |                              |   |        |      |  |   |         |   |  |   |         |  



Note 13Stockholders
Equity



Stock Repurchase Plan



In October 2005, the Companys Board of Directors amended its stock
repurchase plan to authorize the repurchase of up to $25 million of its common stock (Class A, Class B or a combination thereof). This repurchase plan will expire on October 31, 2006 and allows the Company to repurchase shares on the open
market, in negotiated transactions off the market, or pursuant to a Rule 10b5-1 plan adopted by the Company. The Company adopted a Rule 10b5-1 plan in September 2004, which allows the Company to repurchase its shares during a period in which the
Company is in possession of material non-



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public information, provided the Company communicates share repurchase instructions to the broker at a time when the Company was not in possession of such
material non-public information. Since inception of the original repurchase plan in fiscal 2003, approximately 4.5 million shares (approximately 1.3 million shares of Class A and approximately 3.2 million shares of Class B) have
been repurchased with a total cost of approximately $23.6 million. During the three months ended October 31, 2005, there were no share repurchases.



Stock Awards



McDATA Stock Plans



Prior to the Merger, the Company had three stock-based employee compensation plans, known as the 2001 McDATA Equity Incentive Plan, the 2003 McDATA Acquisition Equity Incentive Plan, and the McDATA 2004 Inducement Equity Grant Plan. These
plans are described more fully in the Companys Annual Report on Form 10-K for the year ended January 31, 2005.



CNT Stock Plans



Upon completion of the Merger, McDATA assumed the CNT stock plans in accordance with the terms of each such plan (the CNT Plans), which provide for the
grant of stock options, restricted stock, stock units and other stock based awards to officers, directors, employees, and consultants. In July 2005, the Company filed an SEC Registration Statement on Form S-8 to register McDATA Class A common
stock that may be issued pursuant to the exercise or settlement of outstanding awards under the CNT Plans and shares of McDATA Class A common stock that are still available for issuance under the CNT Plans. As of October 31, 2005,
approximately 9.8 million shares of McDATA Class A common stock may be issued pursuant to outstanding awards and approximately 8.9 million shares of McDATA Class A common stock are still available for issuance under the CNT
Plans.



Upon completion of the Merger, each outstanding option
to purchase shares of CNT common stock under any CNT Plan, whether or not exercisable or vested, was converted into an option to acquire, that number of shares of McDATA Class A common stock equal to the number of shares of CNT common stock
subject to such option immediately prior to the effective time of the merger multiplied by the exchange ratio of 1.3, rounded down to the nearest whole share. The per share exercise price for shares of McDATA Class A common stock assumable upon
exercise of each assumed option was adjusted to equal to the exercise price per share of CNT common stock at which such option was exercisable immediately prior to the effective time of the merger divided by the exchange ratio of 1.3, rounded up to
the nearest whole cent. In addition, outstanding CNT restricted stock units and deferred stock units, whether or not vested, were converted into a right to be issued that number of shares of McDATA Class A common stock equal to the number of
shares of CNT common stock covered by the CNT restricted stock unit or deferred stock unit immediately prior to the effective time of the merger multiplied by the exchange ratio of 1.3.



Restricted Stock Issued to Board of Directors and Executives



In March 2005, the Company issued 80,000 shares of Class B restricted stock to its Board of Directors with an aggregate fair
value of approximately $302,400. These shares vest over a two-year period. Compensation expense will be recognized over the vesting period, and was $50,000 and $152,000 for the three and nine month periods ending October 31, 2005, respectively.



In May 2005, the Company granted 640,000 Class B restricted
stock units (RSUs) to eligible participants of the Executive Performance Incentive Bonus (EPIB) Plan with an aggregate fair value at date of grant of $1.9 million. 25% of the total grant will vest each year immediately upon the attainment of
the annual corporate milestone established by the Company. If the annual milestone is not achieved 12.5% of the total grant is forfeited, and the remaining 12.5% will cliff vest as of February 1, 2009. Compensation expense related to these
RSUs will be recognized evenly over their related vesting periods, and was $457,000 and $852,000 for the three and nine month periods ending October 31, 2005, respectively. As of October 31, 2005, 430,000 RSUs for this grant
are still outstanding.



As part of the CNT integration, one
executive member of the Integration Team received 75,000 shares of Class B restricted stock. These shares will become fully vested on September 9, 2006.



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##### Table of Contents

Note 14Segment Information



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



Prior to the Merger with CNT, the Company had one reporting segment relating to the design, development, manufacture and
sale of data access and storage networking solutions that provide highly available, scalable and centrally managed storage area networks (SANs). The Companys Chief Operating Decision Makers, as defined by SFAS No. 131, Disclosures
about Segments of an Enterprise and Related Information, had allocated resources and assessed the performance of the Company based on consolidated revenue and overall profitability. As a result of the merger with CNT, and the completion of the
integration of CNTs service business, the Company is operating in two distinct reporting segments, one for products and the other for services beginning with the three months ended October 31, 2005. The products segment consists of
hardware and software products and related software maintenance and support revenue. The services segment consists of break/fix maintenance, extended warranty, installation, consulting, network management and telecommunications services.



Financial decisions and the allocation of resources are based on the
information from the Companys management reporting system. The Company does not allocate selling and marketing or general and administrative expenses to its operating segments. At this point in time, we do not track all of our assets by
operating segments. Consequently, it is not practical to show assets by operating segments.



Summarized financial information by operating segment for the three months ended October 31, 2005, based on the internal management system is as follows:



|                           |  |                                     |         |         |   |             |  |       |        |  |   |        
|-------------------------- |  | ----------------------------------- | ------- | ------- | - | ----------- |  | ----- | ------ |  | - | -------
|                           |  | Three Months Ended October 31, 2005
|                           |  | Product                             |         | Service |   | Unallocated |  | Total
|Revenue                    |  | $                                   | 138,579 |         | $ | 29,926      |  | $     |       |  | $ | 168,505
|Cost of revenue            |  | $                                   | 68,566  |         | $ | 20,370      |  | $     | 134    |  | $ | 89,070 
|Research and development   |  | $                                   | 31,464  |         | $ |            |  | $     |       |  | $ | 31,464 
|Selling and marketing      |  | $                                   |        |         | $ |            |  | $     | 35,787 |  | $ | 35,787 
|General and administrative |  | $                                   |        |         | $ |            |  | $     | 10,469 |  | $ | 10,469 



The following table
presents supplemental data for McDATA revenue channels. A significant portion of revenue is concentrated with the largest storage OEMs, EMC, IBM and HDS. Other major storage and system vendors, including Dell, HP, and Sun, offer McDATA solutions to
their customers. In addition to storage and system vendors, the Company has relationships with many resellers, distributors and systems integrators.



|               |  |                                |   |  |                               |   |  |      |   |  |      |  
|-------------- |  | ------------------------------ | - |  | ----------------------------- | - |  | ---- | - |  | ---- | -
|               |  | Three Months Ended October 31, |   |  | Nine Months Ended October 31, |  
|               |  | 2005                           |   |  | 2004                          |   |  | 2005 |   |  | 2004 |  
|EMC            |  | 28                             | % |  | 49                            | % |  | 33   | % |  | 47   | %
|IBM            |  | 22                             | % |  | 23                            | % |  | 24   | % |  | 25   | %
|HDS            |  | 11                             | % |  | 10                            | % |  | 9    | % |  | 19   | %
|Other channels |  | 39                             | % |  | 18                            | % |  | 34   | % |  | 9    | %
|               |  |                                |   |  |                               |   |  |      |   |  |      |  
|Total revenue  |  | 100                            | % |  | 100                           | % |  | 100  | % |  | 100  | %
|               |  |                                |   |  |                               |   |  |      |   |  |      |  



Revenues are
attributed to geographic areas based on the location of the customers to which products are shipped. International revenues primarily consist of sales to customers in Western Europe and the greater Asia Pacific region. Included in domestic revenues
are sales to certain OEM customers who take possession of products domestically and then distribute these products to their international customers. In addition, included in revenues from Western Europe are sales to certain OEM customers who take
possession of products in distribution centers designated for international-bound product and then



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distribute these products among various international regions. The mix of international and domestic revenue can, therefore, vary depending on the relative
mix of sales to certain OEM customers. For the quarter ended October 31, 2005, domestic and international revenue was 68% and 32% of our total revenue, respectively, as compared to 66%, and 34%, respectively, for the same period in 2004. For
the nine months ended October 31, 2005, domestic and international revenue was 67% and 33% of our total revenue, respectively, as compared to 64% and 36% for the same period in 2004.



Note 15Commitments and Contingencies



Commitments



Operating and Capital Leases



The Company had various operating and capital leases in effect at October 31, 2005 for certain buildings, office space and machinery and equipment. Future minimum lease payments under non-cancelable capital and operating leases with
terms of one year or more are as follows at October 31, 2005 (in thousands):



|                                           |  |                |        |   |                  |   |       
|------------------------------------------ |  | -------------- | ------ | - | ---------------- | - | ------
|                                           |  | Capital Leases |        |   | Operating Leases
|2005(1)                                    |  | $              | 528    |   |                  | $ | 3,497 
|2006                                       |  |                | 1,470  |   |                  |   | 10,871
|2007                                       |  |                | 630    |   |                  |   | 6,836 
|2008                                       |  |                | 287    |   |                  |   | 6,123 
|2009                                       |  |                |       |   |                  |   | 3,793 
|Thereafter                                 |  |                |       |   |                  |   | 25,122
|                                           |  |                |        |   |                  |   |       
|Total minimum lease payments               |  |                | 2,915  |   |                  | $ | 56,242
|                                           |  |                |        |   |                  |   |       
|Less portion representing interest         |  |                | (265   | ) |                  |   |       
|Less current portion                       |  |                | (1,681 | ) |                  |   |       
|                                           |  |                |        |   |                  |   |       
|Long term obligations under capital leases |  | $              | 969    |   |                  |   |       
|                                           |  |                |        |   |                  |   |       

---

|(1) | Reflects the remaining three months of fiscal 2005.
|--- | ---------------------------------------------------



Rent expense for the quarter and nine months ended October 31, 2005 was $4.8 million and $11.6 million, respectively, and for the same periods in
2004 were $2.7 million and $8.3 million, respectively.



On
September 9, 2004, the Company entered into a triple net office lease for the future lease of approximately 168,127 square feet of office space in Broomfield, Colorado (the New Premises). The Company intends to begin moving its current world
headquarters location to the New Premises early in 2006 with the lease and related rent payments commencing in February of 2006. The Companys current headquarter office lease expires at the end of April 2006. The contractual term of the new
lease is 11 years (with two 5 year renewal options) and is at market lease rates that are substantially lower than the current lease rate paid by the Company. The base annual lease rates per rentable square foot for the New Premises range from $0 in
the first year to $14.15 in the last year of the lease, plus normal operating expenses. The Company began recognizing rent expense in July 2005 with the start of the build-out of the premises. In addition, the Company has an option to purchase the
New Premises at varying amounts until December 31, 2005. The lease and option to purchase have customary terms and conditions.



Manufacturing and Purchase Commitments



The Company has contracted with Sanmina SCI Systems, Inc. (SSCI), Solectron Corporation (Solectron) and others (collectively, Contract Manufacturers)
for the manufacture of printed circuit boards and box build assembly and configuration for specific multi-protocol directors and switches. The agreements require the Company to submit purchasing forecasts and place orders sixty calendar days in
advance of delivery. At October 31, 2005, the Companys commitment with our Contract Manufacturers for purchases over the next sixty days totaled $95.1 million, and $19.2 million for commitments beyond 60 days. The Company may be liable
for materials that the Contract Manufacturers purchase on McDATAs behalf if the Companys actual requirements do not meet or exceed its forecasts and those materials cannot be redirected to other uses. We may also be liable for materials
that certain component suppliers or product manufacturers have produced or made available to us if our actual requirements do not meet or exceed minimums that we have committed to purchase. At October 31, 2005, the Company had recorded
approximately $6.6 million of purchase obligations that we believe is excess or obsolete and cannot be redirected to other uses. Management does not expect the remaining commitments under these agreements to have a material adverse effect on the
Companys business, results of operations, financial position or cash flows.



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Indebtedness



As discussed in Note 8, as part of the acquisition of CNT, McDATA guaranteed the payment of principal and interest on approximately $124.4 million
principal amount of CNTs 3.00% Notes. In addition, McDATA has $172.5 million principal amount of outstanding 2.25% subordinated convertible notes due 2010. Unless the price of our common stock increases significantly so that the holders
of the convertible notes find it economically advantageous to exercise the conversion feature and receive common stock in lieu of a cash payment of the principal amount and any accrued interest, we may have to repay the debt in cash. At present, we
have sufficient resources to satisfy these obligations as they mature. However, in the future, we may lack the resources to satisfy these obligations as they mature, and there can be no assurance that we will possess the resources or be able to
secure the resources to satisfy these obligations on commercially reasonable terms, if at all. Any failure by us to satisfy these obligations when due would have a material adverse effect on our business.



ContingenciesLitigation



From time to time, the Company is subject to claims arising in the
ordinary course of business. Litigation is subject to inherent risks and uncertainties and an adverse result in a matter that may arise from time to time may harm our business, financial condition or results of operations. In the opinion of
management and, except as set forth below, no such lawsuit, individually or in the aggregate, exists which is expected to have a material adverse effect on the Companys consolidated results of operations, financial position or cash flows.



McDATAs IPO Laddering Class Action Lawsuits



The Company, Mr. John F. McDonnell, the former Chairman of the board of
directors, Mrs. Dee J. Perry, a former officer and Mr. Thomas O. McGimpsey a current officer were named as defendants in purported securities class-action lawsuits filed in the United States District Court, Southern District of New York.
The first of these lawsuits, filed on July 20, 2001, is captioned Gutner v. McDATA Corporation, Credit Suisse First Boston (CSFB), Merrill Lynch, Pierce Fenner & Smith Incorporated, Bear, Stearns & Co., Inc., FleetBoston
Robertson Stephens et al., No. 01 CIV. 6627. Three other similar suits were filed against the Company and the individuals. The complaints are substantially identical to numerous other complaints filed against other companies that went public in
1999 and 2000. These lawsuits generally allege, among other things, that the registration statements and prospectus filed with the SEC by such companies were materially false and misleading because they failed to disclose (a) that certain
underwriters had allegedly solicited and received excessive and undisclosed commissions from certain investors in exchange for which the underwriters allocated to those investors material portions of shares in connection with the initial public
offerings, or IPOs, and (b) that certain of the underwriters had allegedly entered into agreements with customers whereby the underwriters agreed to allocate IPO shares in exchange for which the customers agreed to purchase additional company
shares in the aftermarket at pre-determined prices. The complaints allege claims against the Company, the named individuals, and CSFB, the lead underwriter of the Companys August 9, 2000 initial public offering, under Sections 11 and 15
of the Securities Act. The complaints also allege claims solely against CSFB and the other underwriter defendants under Section 12(a)(2) of the Securities Act, and claims against the individual defendants under Section 10(b) of the
Securities Exchange Act. Although management believes that all of the lawsuits are without legal merit and they intend to defend against them vigorously, there is no assurance that the Company will prevail. In September 2002, plaintiffs
counsel in the above-mentioned lawsuits offered to individual defendants of many of the public companies being sued, including the Company, the opportunity to enter into a Reservation of Rights and Tolling Agreement that would dismiss without
prejudice and without costs all claims against such persons if the company itself had entity coverage insurance. This agreement was signed by Mr. John F. McDonnell, the former Company Chairman, Mrs. Dee J. Perry, the former chief financial
officer, and Mr. Thomas O. McGimpsey, the current General Counsel and Vice President of Business Development and the plaintiffs executive committee. Under the Reservation of Rights and Tolling Agreement, the plaintiffs dismissed the
claims against such individuals. On February 19, 2003, the court in the above-mentioned lawsuits entered a ruling on the pending motions to dismiss, which dismissed some, but not all, of the plaintiffs claims against the Company. These
lawsuits have been consolidated as part of In Re Initial Public Offering Securities Litigation (SDNY). The Company has considered and agreed to enter into a proposed settlement offer with representatives of the plaintiffs in the consolidated
proceeding, and we believe that any liability on behalf of the Company that may accrue under that settlement offer would be covered by our insurance policies. On August 31, 2005, the court preliminarily approved the proposed settlement. After
notice of the proposed settlement is sent to settlement class members, a fairness hearing will be held in 2006 before any final settlement is approved, if at all. Until that settlement is fully effective, Management intends to defend against the
consolidated proceeding vigorously.



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Eclipsys Indemnification Claim



Inrange Technologies Corporation, which was a wholly owned subsidiary of CNT, had been named as a defendant in the case
SBC Technology Resources, Inc. v. Inrange Technologies Corp., Eclipsys Corp. and Resource Bancshares Mortgage Group, Inc., No. 303-CV-418-N, that was pending in the United States District Court for the Northern District of Texas,
Dallas Division (the SBC Patent Litigation). The SBC Patent Litigation was commenced on February 27, 2003. The complaint claimed that Inrange was infringing U.S. Patent No. 5,530,845 (845 patent) by manufacturing and selling
storage area networking equipment, in particular the FC/9000, that is used in storage networks. On May 31, 2005, Inrange and SBC Laboratories, Inc. (f/k/a SBC Technology Resources, Inc.) entered into a Settlement Agreement settling
the SBC Patent Litigation on confidential terms that included a license to the 845 patent, and the case was dismissed with prejudice. Eclipsys Corp. (Eclipsys) had settled earlier with SBC Technology Resources, Inc. for an undisclosed sum. Eclipsys
has demanded that Inrange indemnify and defend Eclipsys pursuant to alleged documentation under which it acquired certain allegedly infringing products from Inrange. Hitachi Data Systems Corporation (a non-party to the litigation) has also informed
Inrange that it received a demand from Eclipsys that Hitachi indemnify and defend Eclipsys in connection with the Litigation. Hitachi has put Inrange on notice that it will tender to Inrange any claim by Eclipsys for indemnification and defense of
any aspect of the litigation. Inrange is evaluating the indemnification demands asserted by Eclipsys and Hitachi. McDATA intends to defend vigorously against any claims, if any, made by Eclipsys or Hitachi for indemnification.



State of Connecticut Tax Audit of InRange



The audit division of the State of Connecticut Department of Revenue
Services (Audit Division) has proposed adjustments to the Connecticut income tax returns for Inrange for the years ended December 31, 1996, through December 31, 1999. The proposed adjustments, in the amount of $433,995 plus interest,
relate to (1) gain from a stock sale following the exercise of warrants, and whether Inrange had sufficient nexus with Connecticut to subject the gain to Connecticut taxation, and (2) the availability of claimed credits for certain
research and development expenditures, and whether Inrange has provided sufficient documentation to support the claimed credits. Inrange made a written offer to settle the matter, which was rejected by the Audit Division. Inrange has formally
appealed the matter and has posted a $750,000 appeal bond to avoid the accrual of interest.



InRanges IPO Laddering Class Action Lawsuits



A shareholder class action was filed against Inrange and certain of its officers on November 30, 2001, in the United States District Court for the Southern District of New York, seeking recovery of damages caused
by Inranges alleged violation of securities laws, including section 11 of the Securities Act of 1933 and section 10(b) of the Exchange Act of 1934. The complaint, which was also filed against the various underwriters that
participated in Inranges initial public offering (IPO), is identical to hundreds of shareholder class actions pending in this court in connection with other recent IPOs and is generally referred to as In re Initial Public Offering Securities
Litigation. The complaint alleges, in essence, (a) that the underwriters combined and conspired to increase their respective compensation in connection with the IPO by (i) receiving excessive, undisclosed commissions in exchange for
lucrative allocations of IPO shares, and (ii) trading in Inranges stock after creating artificially high prices for the stock post-IPO through tie-in or laddering arrangements (whereby recipients of allocations of
IPO shares agreed to purchase shares in the aftermarket for more than the public offering price for Inrange shares) and dissemination of misleading market analysis on Inranges prospects; and (b) that Inrange violated federal securities
laws by not disclosing these underwriting arrangements in its prospectus. The defense has been tendered to the carriers of Inranges director and officer liability insurance, and a request for indemnification has been made to the various
underwriters in the IPO. At this point the insurers have issued a reservation of rights letter and the underwriters have refused indemnification. The court has granted Inranges motion to dismiss claims under section 10(b) of the
Securities Exchange Act of 1934 because of the absence of a pleading of intent to defraud. The court granted plaintiffs leave to replead these claims, but no further amended complaint has been filed. The court denied Inranges motion to dismiss
claims under section 11 of the Securities Act of 1933. The court has also dismissed Inranges individual officers without prejudice, after they entered into a tolling agreement with the plaintiffs. On July 25, 2003, Inranges
board of directors conditionally approved a proposed partial settlement with the plaintiffs in this matter. The settlement would provide, among other things, a release of Inrange and of the individual defendants for the conduct alleged in the action
to be wrongful in the complaint. Inrange would agree to undertake other responsibilities under the partial settlement, including agreeing to assign away, not assert, or release certain potential claims Inrange may have against its underwriters. Any
direct financial impact of the proposed settlement is expected to be borne by Inranges insurers. In June 2004, an agreement of settlement was submitted to the court for preliminary approval. On August 31, 2005, the court preliminarily
approved the proposed settlement. After notice of the proposed settlement is sent to settlement class members, a fairness hearing will be held in 2006 before any final settlement is approved, if at all. Until the settlement is effective, management
intends to defend against this consolidated proceeding vigorously.



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Indemnifications and Guarantees



Ordinary Course Purchase and Sale Agreements



During its normal course of business, the Company may enter into agreements with, among others, customers, resellers, OEMs,
systems integrators and distributors. These agreements typically require the Company to indemnify the other party against third party claims or product infringements on patents or copyrights. The Company provides indemnifications of varying scope
and size to certain customers against claims of intellectual property infringement made by third parties arising for the use of our products.



In addition, the majority of these indemnities, commitments and guarantees do not provide for any limitation of the maximum potential future payments the
Company could be obligated to make. The Company evaluates and estimates losses from such indemnification under SFAS No. 5, Accounting for Contingencies, as interpreted by FASB Interpretation No. 45. To date, the Company has not
incurred any material costs as a result of such obligations and has not accrued any liabilities related to such indemnification and guarantees in our financial statements.



Sale of Lumberton, New Jersey Manufacturing Operations



As described in Note 5, on June 24, 2005 the Company entered into a series of agreements with Solectron in connection
with the sale of manufacturing operations and transfer of assets related to its Lumberton, New Jersey production facility. As part of the Asset Purchase Agreement between the Company and Solectron, the Company has made a number of representations
and has agreed to indemnify the buyer and hold them harmless from certain losses suffered in connection with their purchase of assets and assumption of liabilities of the Lumberton facility. The more significant indemnifications relate to
representations made by the Company as to the proper maintenance of the tangible assets purchased, compliance with ERISA as it relates to benefit plans in which the transferred employees have participated prior to the sale, and the absence of
undisclosed environmental issues or significant contracts. The term of the representations relating to undisclosed environmental issues is five years, with the term of the remaining representations being two years. Although, there are no maximum
potential indemnification amounts stated in the agreement for these representations, based on facts currently available, management estimates the maximum potential amount of payments that could be required under these representations to be $5.3
million. However, it is managements judgment that the probability of the Company having to make any payments under any one of the representations ranges from 0% to 20%. In calculating the fair value of the Companys obligation under these
representations, the maximum potential loss estimate was multiplied by the probability of each occurring. The resulting potential future cash flows were then discounted using a rate of 8%, resulting in the Company recognizing a liability of
approximately $400,000 in accordance with FIN 45. Due to the uncertainty surrounding the risks involved, the liability balance will be maintained and reevaluated as needed, over the full term of the related indemnifications. Any future reversals of
previous accrual amounts which were recorded during the purchase accounting period as an increase to goodwill, will be recorded as a reduction to goodwill. Otherwise, any portion of the liability that is derecognized in the future, will be credited
to operating results.



SPX Tax Sharing Agreement



Inrange Technologies Corporation (Inrange) is subject to a tax sharing
agreement with SPX Corporation (SPX) relating to previous tax years when Inrange was part of the SPX consolidated tax group (the SPX Agreement). Inrange was acquired by CNT from SPX in May 2003. When CNT merged with McDATA, Inrange became a
subsidiary of McDATA. Pursuant to the SPX Agreement, if the Internal Revenue Service (IRS) makes an adjustment to Inrange losses utilized in previous tax years by the SPX consolidated group, Inrange must compensate SPX for the lost tax benefits. The
IRS is currently examining tax returns filed by SPX for certain years that Inrange was included in the SPX consolidated return. At this time, we are not aware of any issues raised during the audit that would require Inrange to compensate SPX for
lost tax benefits.



Note 16Supplemental Guarantor Information



On June 1, 2005, as part of the merger with CNT,
McDATA Corporation (Parent Guarantor) fully and unconditionally guaranteed CNTs convertible debt. In February 2002, CNT (Issuer of Notes) sold $125,000,000 of 3% convertible subordinated notes due February 15, 2007. The notes were
convertible into CNT common stock at the price of $19.17 per share. Due to the Merger, the notes are now convertible into Class A McDATA stock at a price of approximately $14.75 per share (aggregate of approximately 8.4 million shares) at
any time prior to their maturity on February 15, 2007. At October 31, 2005, the amount outstanding on the CNT notes was $124.4 million. After the merger, the corporate name of CNT was changed to McDATA Services Corporation.



25



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##### Table of Contents

The following condensed consolidating financial statements have been prepared from the Companys
financial information on the same basis of accounting as of the condensed consolidated financial statements. Investments in our subsidiaries are accounted for on the equity method; accordingly, entries necessary to consolidate the Parent Guarantor,
Issuer of Notes, and all of its subsidiaries are reflected in the eliminations column.



26



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McDATA CORPORATION



CONDENSED CONSOLIDATING BALANCE SHEETS (1)

As of October 31, 2005

(in thousands, unaudited)



|                                                                         |  |                  |           |   |                 |   |         |                             |  |   |              |   |  |              |          |   |  |   |          
|------------------------------------------------------------------------ |  | ---------------- | --------- | - | --------------- | - | ------- | --------------------------- |  | - | ------------ | - |  | ------------ | -------- | - |  | - | ---------
|                                                                         |  | Parent Guarantor |           |   | Issuer of Notes |   |         | Subsidiaries Non Guarantors |  |   | Eliminations |   |  | Consolidated
|Assets                                                                   |  |                  |           |   |                 |   |         |                             |  |   |              |   |  |              |          |   |  |   |          
|Current assets:                                                          |  |                  |           |   |                 |   |         |                             |  |   |              |   |  |              |          |   |  |   |          
|Cash and cash equivalents                                                |  | $                | 145,516   |   |                 | $ | 18,023  |                             |  | $ | 2,703        |   |  | $            |         |   |  | $ | 166,242  
|Securities lending collateral                                            |  |                  | 86,715    |   |                 |   |        |                             |  |   |             |   |  |              |         |   |  |   | 86,715   
|Short-term investments                                                   |  |                  | 144,673   |   |                 |   |        |                             |  |   |             |   |  |              |         |   |  |   | 144,673  
|Accounts receivable, net                                                 |  |                  | 87,294    |   |                 |   | 22,673  |                             |  |   | 70           |   |  |              |         |   |  |   | 110,037  
|Intercompany accounts receivable, net                                    |  |                  | (289,882  | ) |                 |   | 150,844 |                             |  |   | (36,576      | ) |  |              | 175,614  |   |  |   |         
|Inventories, net                                                         |  |                  | 23,629    |   |                 |   | 11,300  |                             |  |   |             |   |  |              | (282     | ) |  |   | 34,647   
|Prepaid expenses and other current assets                                |  |                  | 13,278    |   |                 |   | 4,469   |                             |  |   | 580          |   |  |              | (6,912   | ) |  |   | 11,415   
|                                                                         |  |                  |           |   |                 |   |         |                             |  |   |              |   |  |              |          |   |  |   |          
|Total current assets                                                     |  |                  | 211,223   |   |                 |   | 207,309 |                             |  |   | (33,223      | ) |  |              | 168,420  |   |  |   | 553,729  
|Property and equipment, net                                              |  |                  | 103,543   |   |                 |   | 24,840  |                             |  |   | 1,758        |   |  |              |         |   |  |   | 130,141  
|Long-term investments                                                    |  |                  | 32,972    |   |                 |   | (6      | )                           |  |   |             |   |  |              |         |   |  |   | 32,966   
|Investment in subsidiaries                                               |  |                  | 402,938   |   |                 |   | 2       |                             |  |   |             |   |  |              | (402,940 | ) |  |   |         
|Restricted cash                                                          |  |                  | 6,782     |   |                 |   | 3,825   |                             |  |   |             |   |  |              |         |   |  |   | 10,607   
|Intangible assets, net                                                   |  |                  | 63,699    |   |                 |   | (9      | )                           |  |   | 71,036       |   |  |              |         |   |  |   | 134,726  
|Goodwill                                                                 |  |                  | 182,058   |   |                 |   | 61      |                             |  |   | 78,693       |   |  |              |         |   |  |   | 260,812  
|Other assets, net                                                        |  |                  | 38,835    |   |                 |   | 19,028  |                             |  |   | 298          |   |  |              |         |   |  |   | 58,161   
|                                                                         |  |                  |           |   |                 |   |         |                             |  |   |              |   |  |              |          |   |  |   |          
|Total assets                                                             |  | $                | 1,042,050 |   |                 | $ | 255,050 |                             |  | $ | 118,562      |   |  | $            | (234,520 | ) |  | $ | 1,181,142
|                                                                         |  |                  |           |   |                 |   |         |                             |  |   |              |   |  |              |          |   |  |   |          
|Liabilities and Stockholders Equity                                     |  |                  |           |   |                 |   |         |                             |  |   |              |   |  |              |          |   |  |   |          
|Current liabilities:                                                     |  |                  |           |   |                 |   |         |                             |  |   |              |   |  |              |          |   |  |   |          
|Accounts payable                                                         |  | $                | 43,308    |   |                 | $ | 9,419   |                             |  | $ | 380          |   |  | $            |         |   |  | $ | 53,107   
|Accrued liabilities                                                      |  |                  | 55,175    |   |                 |   | 34,732  |                             |  |   | (3,257       | ) |  |              |         |   |  |   | 86,650   
|Securities lending collateral payable                                    |  |                  | 86,715    |   |                 |   |        |                             |  |   |             |   |  |              |         |   |  |   | 86,715   
|Current portion of deferred revenue                                      |  |                  | (4,238    | ) |                 |   | 38,313  |                             |  |   | 328          |   |  |              |         |   |  |   | 34,403   
|Current portion of notes payable and obligations under capital leases    |  |                  | 627       |   |                 |   | 2,213   |                             |  |   | 19           |   |  |              |         |   |  |   | 2,859    
|                                                                         |  |                  |           |   |                 |   |         |                             |  |   |              |   |  |              |          |   |  |   |          
|Total current liabilities                                                |  |                  | 181,587   |   |                 |   | 84,677  |                             |  |   | (2,530       | ) |  |              |         |   |  |   | 263,734  
|Notes payable and obligations under capital leases, less current portion |  |                  | 1,213     |   |                 |   | 3,335   |                             |  |   |             |   |  |              |         |   |  |   | 4,548    
|Deferred revenue, less current portion                                   |  |                  | 49,972    |   |                 |   |        |                             |  |   |             |   |  |              |         |   |  |   | 49,972   
|Other long-term liabilities                                              |  |                  | 16,815    |   |                 |   | 7,743   |                             |  |   |             |   |  |              |         |   |  |   | 24,558   
|Interest rate swap                                                       |  |                  | 6,556     |   |                 |   | 1,013   |                             |  |   |             |   |  |              |         |   |  |   | 7,569    
|Convertible subordinated debt                                            |  |                  | 165,944   |   |                 |   | 119,108 |                             |  |   |             |   |  |              |         |   |  |   | 285,052  
|                                                                         |  |                  |           |   |                 |   |         |                             |  |   |              |   |  |              |          |   |  |   |          
|Total liabilities                                                        |  |                  | 422,087   |   |                 |   | 215,876 |                             |  |   | (2,530       | ) |  |              |         |   |  |   | 635,433  
|Total stockholders equity                                               |  |                  | 617,349   |   |                 |   | 40,441  |                             |  |   | 122,439      |   |  |              | (234,520 | ) |  |   | 545,709  
|                                                                         |  |                  |           |   |                 |   |         |                             |  |   |              |   |  |              |          |   |  |   |          
|Total liabilities and stockholders equity                               |  | $                | 1,039,436 |   |                 |   | 256,317 |                             |  | $ | 119,909      |   |  |              | (234,520 | ) |  | $ | 1,181,142
|                                                                         |  |                  |           |   |                 |   |         |                             |  |   |              |   |  |              |          |   |  |   |          

---

|(1) | In conjunction with the guarantee of McDATA Services Corporations (formerly known as CNT) convertible debt, the accompanying condensed consolidating financial information has
been prepared and presented pursuant to SEC Regulation S-X Rule 3-10 Financial statements of guarantors and affiliates whose securities collateralize an issue registered or being registered. This information is not intended to present
the financial position, results of operations and cash flows of the individual companies or groups of companies in accordance with generally accepted accounting principles and is not representative of the operations of McDATA or the former CNT on
either a pre-merger or stand-alone basis.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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McDATA CORPORATION



CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS (1)

For the Three Months Ended October 31, 2005

(in thousands, except per share data)

(unaudited)



|                                                                               |  |                  |         |   |                 |   |        |                             |  |   |              |   |  |              |        |   |  |   |         |  
|------------------------------------------------------------------------------ |  | ---------------- | ------- | - | --------------- | - | ------ | --------------------------- |  | - | ------------ | - |  | ------------ | ------ | - |  | - | ------- | -
|                                                                               |  | Parent Guarantor |         |   | Issuer of Notes |   |        | Subsidiaries Non Guarantors |  |   | Eliminations |   |  | Consolidated |       
|Total revenue                                                                  |  | $                | 128,567 |   |                 | $ | 41,570 |                             |  | $ | 178          |   |  | $            | (1,810 | ) |  | $ | 168,505 |  
|Total cost of revenue                                                          |  |                  | 58,171  |   |                 |   | 31,523 |                             |  |   | 474          |   |  |              | (1,098 | ) |  |   | 89,070  |  
|                                                                               |  |                  |         |   |                 |   |        |                             |  |   |              |   |  |              |        |   |  |   |         |  
|Gross profit                                                                   |  |                  | 70,396  |   |                 |   | 10,047 |                             |  |   | (296         | ) |  |              | (712   | ) |  |   | 79,435  |  
|Operating expenses:                                                            |  |                  |         |   |                 |   |        |                             |  |   |              |   |  |              |        |   |  |   |         |  
|Research and development                                                       |  |                  | 29,778  |   |                 |   | 1,355  |                             |  |   | 331          |   |  |              |       |   |  |   | 31,464  |  
|Selling and marketing                                                          |  |                  | 22,323  |   |                 |   | 6,178  |                             |  |   | 7,286        |   |  |              |       |   |  |   | 35,787  |  
|General and administrative                                                     |  |                  | 8,982   |   |                 |   | 1,053  |                             |  |   | 461          |   |  |              |       |   |  |   | 10,496  |  
|Amortization of purchased intangible assets                                    |  |                  | 5,951   |   |                 |   |       |                             |  |   | 5,416        |   |  |              |       |   |  |   | 11,367  |  
|Amortization of deferred compensation                                          |  |                  | 889     |   |                 |   |       |                             |  |   |             |   |  |              |       |   |  |   | 889     |  
|Restructuring charges                                                          |  |                  | 419     |   |                 |   | (51    | )                           |  |   | 158          |   |  |              |       |   |  |   | 526     |  
|                                                                               |  |                  |         |   |                 |   |        |                             |  |   |              |   |  |              |        |   |  |   |         |  
|Total operating expenses                                                       |  |                  | 68,342  |   |                 |   | 8,535  |                             |  |   | 13,652       |   |  |              |       |   |  |   | 90,529  |  
|Income (loss) from operations                                                  |  |                  | 2,054   |   |                 |   | 1,512  |                             |  |   | (13,948      | ) |  |              | (712   | ) |  |   | (11,094 | )
|Interest and other income, net of interest expense                             |  |                  | (9,314  | ) |                 |   | (1,096 | )                           |  |   | 10,084       |   |  |              |       |   |  |   | (326    | )
|                                                                               |  |                  |         |   |                 |   |        |                             |  |   |              |   |  |              |        |   |  |   |         |  
|Income (loss) before income taxes and equity in net loss of affiliated company |  |                  | (7,260  | ) |                 |   | 416    |                             |  |   | (3,864       | ) |  |              | (712   | ) |  |   | (11,420 | )
|Income tax expense (benefit)                                                   |  |                  | (1,341  | ) |                 |   | (2,448 | )                           |  |   | (147         | ) |  |              |       |   |  |   | (3,936  | )
|                                                                               |  |                  |         |   |                 |   |        |                             |  |   |              |   |  |              |        |   |  |   |         |  
|Net income (loss)                                                              |  | $                | (5,919  | ) |                 | $ | 2,864  |                             |  | $ | (3,717       | ) |  | $            | (712   | ) |  | $ | (7,484  | )
|                                                                               |  |                  |         |   |                 |   |        |                             |  |   |              |   |  |              |        |   |  |   |         |  

---

|(1) | In conjunction with the guarantee of McDATA Services Corporations (formerly known as CNT) convertible debt, the accompanying condensed consolidating financial information has
been prepared and presented pursuant to SEC Regulation S-X Rule 3-10 Financial statements of guarantors and affiliates whose securities collateralize an issue registered or being registered. This information is not intended to present
the financial position, results of operations and cash flows of the individual companies or groups of companies in accordance with generally accepted accounting principles and is not representative of the operations of McDATA or the former CNT on
either a pre-merger or stand-alone basis.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



28



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##### Table of Contents

McDATA CORPORATION



CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS (1)

For the Nine Months Ended October 31, 2005

(in thousands, except per share data)

(unaudited)



|                                                                               |  |                  |         |   |                 |   |         |                             |  |   |              |   |  |              |        |   |  |   |         |  
|------------------------------------------------------------------------------ |  | ---------------- | ------- | - | --------------- | - | ------- | --------------------------- |  | - | ------------ | - |  | ------------ | ------ | - |  | - | ------- | -
|                                                                               |  | Parent Guarantor |         |   | Issuer of Notes |   |         | Subsidiaries Non Guarantors |  |   | Eliminations |   |  | Consolidated |       
|Total revenue                                                                  |  | $                | 327,991 |   |                 | $ | 108,193 |                             |  | $ | 556          |   |  | $            | (4,058 | ) |  | $ | 432,682 |  
|Total cost of revenue                                                          |  |                  | 155,243 |   |                 |   | 64,449  |                             |  |   | 1,849        |   |  |              | (3,346 | ) |  |   | 218,195 |  
|                                                                               |  |                  |         |   |                 |   |         |                             |  |   |              |   |  |              |        |   |  |   |         |  
|Gross profit                                                                   |  |                  | 172,748 |   |                 |   | 43,744  |                             |  |   | (1,293       | ) |  |              | (712   | ) |  |   | 214,487 |  
|Operating expenses:                                                            |  |                  |         |   |                 |   |         |                             |  |   |              |   |  |              |        |   |  |   |         |  
|Research and development                                                       |  |                  | 79,068  |   |                 |   | 3,621   |                             |  |   | 1,094        |   |  |              |       |   |  |   | 83,783  |  
|Selling and marketing                                                          |  |                  | 64,757  |   |                 |   | 12,146  |                             |  |   | 21,141       |   |  |              | 47     |   |  |   | 98,091  |  
|General and administrative                                                     |  |                  | 21,568  |   |                 |   | 1,889   |                             |  |   | 1,701        |   |  |              |       |   |  |   | 25,158  |  
|Amortization of purchased intangible assets                                    |  |                  | 9,919   |   |                 |   |        |                             |  |   | 16,555       |   |  |              |       |   |  |   | 26,474  |  
|Amortization of deferred compensation                                          |  |                  | 4,849   |   |                 |   |        |                             |  |   |             |   |  |              |       |   |  |   | 4,849   |  
|Restructuring charges                                                          |  |                  | 10,171  |   |                 |   | (51     | )                           |  |   | 158          |   |  |              |       |   |  |   | 10,278  |  
|                                                                               |  |                  |         |   |                 |   |         |                             |  |   |              |   |  |              |        |   |  |   |         |  
|Total operating expenses                                                       |  |                  | 190,332 |   |                 |   | 17,605  |                             |  |   | 40,649       |   |  |              | 47     |   |  |   | 248,633 |  
|Income (loss) from operations                                                  |  |                  | (17,584 | ) |                 |   | 26,139  |                             |  |   | (41,942      | ) |  |              | (759   | ) |  |   | (34,146 | )
|Interest and other income, net of interest expense                             |  |                  | (23,486 | ) |                 |   | (2,426  | )                           |  |   | 26,538       |   |  |              | 149    |   |  |   | 775     |  
|                                                                               |  |                  |         |   |                 |   |         |                             |  |   |              |   |  |              |        |   |  |   |         |  
|Income (loss) before income taxes and equity in net loss of affiliated company |  |                  | (41,070 | ) |                 |   | 23,713  |                             |  |   | (15,404      | ) |  |              | (610   | ) |  |   | (33,371 | )
|Income tax expense                                                             |  |                  | (1,230  | ) |                 |   | 1,644   |                             |  |   | 2,074        |   |  |              |       |   |  |   | 2,488   |  
|                                                                               |  |                  |         |   |                 |   |         |                             |  |   |              |   |  |              |        |   |  |   |         |  
|Net income (loss)                                                              |  | $                | (39,840 | ) |                 | $ | 22,069  |                             |  | $ | (17,478      | ) |  | $            | (610   | ) |  | $ | (35,859 | )
|                                                                               |  |                  |         |   |                 |   |         |                             |  |   |              |   |  |              |        |   |  |   |         |  

---

|(1) | In conjunction with the guarantee of McDATA Services Corporations (formerly known as CNT) convertible debt, the accompanying condensed consolidating financial information has
been prepared and presented pursuant to SEC Regulation S-X Rule 3-10 Financial statements of guarantors and affiliates whose securities collateralize an issue registered or being registered. This information is not intended to present
the financial position, results of operations and cash flows of the individual companies or groups of companies in accordance with generally accepted accounting principles and is not representative of the operations of McDATA or the former CNT on
either a pre-merger or stand-alone basis.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



29



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##### Table of Contents

McDATA CORPORATION



CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS (1)

For the Nine Months Ended October 31, 2005

(in thousands)

(unaudited)



|                                                               |  |                  |          |   |                 |   |         |                             |  |   |              |   |              |   |   |  |   |          |  
|-------------------------------------------------------------- |  | ---------------- | -------- | - | --------------- | - | ------- | --------------------------- |  | - | ------------ | - | ------------ | - | - |  | - | -------- | -
|                                                               |  | Parent Guarantor |          |   | Issuer of Notes |   |         | Subsidiaries Non Guarantors |  |   | Eliminations |   | Consolidated |  
|Net cash provided by (used in) operating activities            |  | $                | 43,720   |   |                 | $ | (29,657 | )                           |  | $ | 1,133        |   |              | $ |  |  | $ | 15,196   |  
|Cash flows from investing activities: (2)                      |  |                  |          |   |                 |   |         |                             |  |   |              |   |              |   |   |  |   |          |  
|Purchases of property and equipment                            |  |                  | (11,083  | ) |                 |   | (2,117  | )                           |  |   | (253         | ) |              |   |  |  |   | (13,453  | )
|Proceeds from sale of equipment                                |  |                  | 146      |   |                 |   | 2,346   |                             |  |   | 2            |   |              |   |  |  |   | 2,494    |  
|Purchases of investments                                       |  |                  | (271,547 | ) |                 |   |        |                             |  |   |             |   |              |   |  |  |   | (271,547 | )
|Proceeds from maturities and sales of investments              |  |                  | 334,548  |   |                 |   |        |                             |  |   |             |   |              |   |  |  |   | 334,548  |  
|Cash used for acquisition costs                                |  |                  | (6,912   | ) |                 |   | 47,307  |                             |  |   |             |   |              |   |  |  |   | 40,395   |  
|Restricted cash related to interest rate swap                  |  |                  | (1,735   | ) |                 |   |        |                             |  |   |             |   |              |   |  |  |   | (1,735   | )
|Cash received on cash surrender value of life insurance policy |  |                  |         |   |                 |   | 1,339   |                             |  |   |             |   |              |   |  |  |   | 1,339    |  
|                                                               |  |                  |          |   |                 |   |         |                             |  |   |              |   |              |   |   |  |   |          |  
|Net cash provided by (used in) investing activities            |  |                  | 43,417   |   |                 |   | 48,875  |                             |  |   | (251         | ) |              |   |   |  |   | 92,041   |  
|Cash flows from financing activities:                          |  |                  |          |   |                 |   |         |                             |  |   |              |   |              |   |   |  |   |          |  
|Payments on long-term notes payable and capital leases         |  |                  | (336     | ) |                 |   | (1,290  | )                           |  |   | (213         | ) |              |   |  |  |   | (1,839   | )
|Purchase of treasury stock                                     |  |                  | (4,552   | ) |                 |   |        |                             |  |   |             |   |              |   |  |  |   | (4,552   | )
|Proceeds from the issuance of common stock                     |  |                  | 792      |   |                 |   |        |                             |  |   |             |   |              |   |  |  |   | 792      |  
|                                                               |  |                  |          |   |                 |   |         |                             |  |   |              |   |              |   |   |  |   |          |  
|Net cash used in financing activities                          |  |                  | (4,096   | ) |                 |   | (1,290  | )                           |  |   | (213         | ) |              |   |   |  |   | (5,599   | )
|Effect of exchange rate changes on cash                        |  |                  |         |   |                 |   | 97      |                             |  |   |             |   |              |   |  |  |   | 97       |  
|                                                               |  |                  |          |   |                 |   |         |                             |  |   |              |   |              |   |   |  |   |          |  
|Net increase (decrease) in cash and cash equivalents           |  |                  | 83,041   |   |                 |   | 18,025  |                             |  |   | 669          |   |              |   |  |  |   | 101,735  |  
|Cash and cash equivalents, beginning of period                 |  |                  | 62,473   |   |                 |   |        |                             |  |   | 2,034        |   |              |   |  |  |   | 64,507   |  
|                                                               |  |                  |          |   |                 |   |         |                             |  |   |              |   |              |   |   |  |   |          |  
|Cash and cash equivalents, end of period                       |  | $                | 145,514  |   |                 | $ | 18,025  |                             |  | $ | 2,703        |   |              | $ |  |  | $ | 166,242  |  
|                                                               |  |                  |          |   |                 |   |         |                             |  |   |              |   |              |   |   |  |   |          |  

---

|(1) | In conjunction with the guarantee of McDATA Services Corporations (formerly known as CNT) convertible debt, the accompanying condensed consolidating financial information has
been prepared and presented pursuant to SEC Regulation S-X Rule 3-10 Financial statements of guarantors and affiliates whose securities collateralize an issue registered or being registered. This information is not intended to present
the financial position, results of operations and cash flows of the individual companies or groups of companies in accordance with generally accepted accounting principles and is not representative of the operations of McDATA or the former CNT on
either a pre-merger or stand-alone basis.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | Cash acquired in the merger with CNT, net of transaction costs, is recognized as investing inflow of cash in the consolidated cash flows statement for the nine-month period ended
October 31, 2005.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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|ITEM 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations
|------- | -------------------------------------------------------------------------------------



You should read the following discussion and analysis in conjunction with the condensed consolidated financial statements
and notes thereto included in Item 1 of this Quarterly Report and with Managements Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report filed on Form 10-K with the Securities and Exchange
Commission on April 4, 2005.



Overview



McDATA acquired CNT on June 1, 2005, and two months of their results
are included in the three months ended July 31, 2005 and three months in the quarter ended October 31, 2005. Therefore, the acquisition of CNT has significantly affected the quarter over quarter and year over year comparisons in the
results of operations.



Revenue Growth and Competitive Industry



Our revenue for the three months ended October 31,
2005 increased approximately 71% over the three months ended October 31, 2004. This year over year revenue increase is the result of the CNT acquisition resulting in higher sales of hardware and service products. The increase in product revenue
was driven by higher sales of directors, SAN routers, and third party products. The market for our SAN and WAN products and solutions remains competitive with (a) the entrance of competitors into our market, (b) pricing pressures resulting
from an increase in competitive products and solutions, (c) challenges to our direct-assist sales model, and (d) anticipated competition from our own storage OEM partners through their partnerships with competitors to jointly sell
complementary products. These market conditions present unique risks and uncertainties in a number of respects. Management believes the competitive market environment defines the overall performance of the Company and provides a specific context to
further analyze revenues, operating expenses and liquidity. In particular, we anticipate continued elongated sales cycles and downward pricing pressures that could negatively impact our revenue growth rate. Moreover, revenue growth in fiscal 2005 is
dependent on the success of our new products, including the Intrepid 10000 Director and higher performance switch products.



In addition to the increased competition in the industry, we have experienced a shift in the buying patterns of our customers from configured director
products to non-configured product sales including our switch products, director port cards, and our FlexPort upgrades. Our OEM and reseller partners may purchase certain of these component products ahead of end-user demand, which could reduce
subsequent purchases by those partners. Variations in the buying patterns of our customers would limit our ability to assemble, test and ship orders received in the last weeks and days of each quarter and could cause fluctuations in our 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.



Management believes the trend of revenue, controlling of operating expense
and the related competitive environment define the overall performance of the Company and provide a specific context to further analyze the financial results of the Company.



Results of Operations



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



|                                                                  |  |                                |    |  |                               |    |  |       |    |  |       |   
|----------------------------------------------------------------- |  | ------------------------------ | -- |  | ----------------------------- | -- |  | ----- | -- |  | ----- | --
|                                                                  |  | Three Months Ended October 31, |    |  | Nine Months Ended October 31, |   
|                                                                  |  | 2005                           |    |  | 2004                          |    |  | 2005  |    |  | 2004  |   
|Total revenue                                                     |  | 100.0                          | %  |  | 100.0                         | %  |  | 100.0 | %  |  | 100.0 | % 
|Total cost of revenue                                             |  | 52.9                           |    |  | 44.4                          |    |  | 50.4  |    |  | 44.1  |   
|                                                                  |  |                                |    |  |                               |    |  |       |    |  |       |   
|Gross profit                                                      |  | 47.1                           |    |  | 55.6                          |    |  | 49.6  |    |  | 55.9  |   
|Operating expenses:                                               |  |                                |    |  |                               |    |  |       |    |  |       |   
|Research and development                                          |  | 18.7                           |    |  | 23.2                          |    |  | 19.4  |    |  | 23.8  |   
|Selling and marketing                                             |  | 21.2                           |    |  | 27.2                          |    |  | 22.7  |    |  | 25.3  |   
|General and administrative                                        |  | 6.2                            |    |  | 5.9                           |    |  | 5.8   |    |  | 6.7   |   
|Amortization of purchased intangible assets                       |  | 6.7                            |    |  | 5.7                           |    |  | 6.1   |    |  | 5.9   |   
|Amortization of deferred compensation                             |  | .5                             |    |  | 1.1                           |    |  | 1.1   |    |  | 1.6   |   
|Restructuring charges                                             |  | .3                             |    |  | (0.1                          | )  |  | 2.4   |    |  | 0.4   |   
|                                                                  |  |                                |    |  |                               |    |  |       |    |  |       |   
|Total operating expenses                                          |  | 53.6                           |    |  | 63.0                          |    |  | 57.5  |    |  | 63.7  |   
|Loss from operations                                              |  | (6.5                           | )  |  | (7.4                          | )  |  | (7.9  | )  |  | (7.8  | ) 
|Interest and other income, net                                    |  | (.2                            | )  |  | 1.3                           |    |  | .2    |    |  | 1.2   |   
|                                                                  |  |                                |    |  |                               |    |  |       |    |  |       |   
|Loss before income taxes and equity in loss of affiliated company |  | (6.7                           | )  |  | (6.1                          | )  |  | (7.7  | )  |  | (6.6  | ) 
|Income tax expense (benefit)                                      |  | 2.3                            |    |  | (0.7                          | )  |  | .7    |    |  |      |   
|                                                                  |  |                                |    |  |                               |    |  |       |    |  |       |   
|Loss before equity in net loss of affiliated company              |  | (4.4                           | )  |  | (5.4                          | )  |  | (8.4  | )  |  | (6.6  | ) 
|Equity in net loss of affiliated company                          |  |                               |    |  | (0.3                          | )  |  |      |    |  | (0.5  | ) 
|                                                                  |  |                                |    |  |                               |    |  |       |    |  |       |   
|Net loss                                                          |  | (4.4                           | )% |  | (5.7                          | )% |  | (8.4  | )% |  | (7.1  | )%
|                                                                  |  |                                |    |  |                               |    |  |       |    |  |       |   



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Revenues



|                                         |  |                                |         |                               |   |        |  |      |         |  |   |        
|---------------------------------------- |  | ------------------------------ | ------- | ----------------------------- | - | ------ |  | ---- | ------- |  | - | -------
|                                         |  | Three Months Ended October 31, |         | Nine Months Ended October 31,
|                                         |  | 2005                           |         | 2004                          |   | 2005   |  | 2004
|Product revenue                          |  | $                              | 117,171 |                               | $ | 73,210 |  | $    | 312,642 |  | $ | 227,367
|Software and related maintenance revenue |  |                                | 20,149  |                               |   | 14,563 |  |      | 53,363  |  |   | 42,428 
|Service revenue                          |  |                                | 29,926  |                               |   | 5,720  |  |      | 62,694  |  |   | 14,593 
|Other revenue                            |  |                                | 1,259   |                               |   | 5,032  |  |      | 3,983   |  |   | 9,587  
|                                         |  |                                |         |                               |   |        |  |      |         |  |   |        
|Total revenue                            |  | $                              | 168,505 |                               | $ | 98,525 |  | $    | 432,682 |  | $ | 293,975
|                                         |  |                                |         |                               |   |        |  |      |         |  |   |        



Our total revenue for
the three months ended October 31, 2005 was $168.5 million, which represented an approximate 71% increase over the three months ended October 31, 2004. For the nine months ended October 31, 2005, total revenue increased to $432.7
million, an approximate 47% increase over the nine months period ended October 31, 2004. Although we continue to see solid end-user interest for our products and solutions, the on-going competitive marketplace is expected to create a
challenging sales environment for the foreseeable future. Given the nature of competitors and products in our industry, we anticipate longer sales cycles and price declines that could negatively impact our revenue growth rate.



Product



Product revenue of $117.2 million for the three months ended October 31, 2005 was a 60% increase over the three
months ended October 31, 2004. For the nine months ended October 31, 2005, product revenue increased approximately 38% to $312.6 million from $227.4 million for the same period in the prior fiscal year. This year over year revenue increase
in product revenue reflects five months of results with CNT in 2005 and a 34% increase in estimated ports sold offset by a 24% decrease in estimated average sales prices. The increase in sales of hardware ports reflects the market strength of our
high-end Director products despite the economic and competitive environment. We expect the number of ports shipped to fluctuate depending on the demand for our existing and newly introduced products including the timing of product introductions by
our OEM customers. Ongoing competition and macroeconomic factors could continue to provide downward pricing pressures that could impact our revenue growth and related margins.



Software and related maintenance revenue of $20.1 million for the quarter ended October 31, 2005 increased
approximately 38% over the quarter ended October 31, 2004. For the nine months ended October 31, 2005, software and related maintenance revenue of $53.4 million increased approximately 26% from $42.4 million for the nine months ended
October 31, 2004. This revenue growth is due to higher sales of our embedded software products including our SANtegrity security solution, higher sales of Eclipse software and higher maintenance revenue that attaches to the sale of software
licenses. A significant portion of our software revenue is generated from sales of our Enterprise Fabric Connectivity Manager, or EFCM, software product.



Other revenue of $1.3 million for the quarter ended October 31, 2005 decreased $3.8 million from the $5.0 million for the quarter ended
October 31, 2004. For the nine months ended October 31, 2005, other revenue of $4.0 million decreased from $9.6 million for the same period of fiscal 2004. Other revenue represents the ESCON business which is expected to continue to
decline. IBM announced end of life on several ESCON products in 2004; therefore, we expect revenue from this category to be less than $1 million through the remainder of fiscal 2005.



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Service



Service revenue includes professional service revenue, break/fix maintenance support, network monitoring services, and revenue earned from our upgraded
warranty and extended maintenance contracts on our hardware products. Service revenue for the three months ended October 31, 2005 was $29.9 million. This represents a $24.2 million increase from the same period in fiscal 2004. For the nine
months ended October 31, 2005, service revenue of $62.7 million increased $48.1 million from $14.6 million for the nine months ended October 31, 2004. These increases are due primarily to the addition of CNTs business.



The following table presents supplemental data for McDATA revenue channels. A
significant portion of revenue is concentrated with the largest storage OEMs, EMC, IBM and HDS. Other major storage and system vendors, including Dell, HP, STK and Sun, offer McDATA solutions to their customers. In addition to storage and system
vendors, the Company has relationships with many resellers, distributors and systems integrators.



|               |  |                                |   |  |                               |   |  |      |   |  |      |  
|-------------- |  | ------------------------------ | - |  | ----------------------------- | - |  | ---- | - |  | ---- | -
|               |  | Three Months Ended October 31, |   |  | Nine Months Ended October 31, |  
|               |  | 2005                           |   |  | 2004                          |   |  | 2005 |   |  | 2004 |  
|EMC            |  | 28                             | % |  | 49                            | % |  | 33   | % |  | 47   | %
|IBM            |  | 22                             | % |  | 23                            | % |  | 24   | % |  | 25   | %
|HDS            |  | 11                             | % |  | 10                            | % |  | 9    | % |  | 19   | %
|Other channels |  | 39                             | % |  | 18                            | % |  | 34   | % |  | 9    | %
|               |  |                                |   |  |                               |   |  |      |   |  |      |  
|Total revenue  |  | 100                            | % |  | 100                           | % |  | 100  | % |  | 100  | %
|               |  |                                |   |  |                               |   |  |      |   |  |      |  



Expanding our
reseller, distributor and system integrator channels into commercial and vertical markets will be a strategic focus for us as we continue to grow our business. However, the level of sales to any single customer may vary and the loss of any one
significant customer, or a decrease in the level of sales to any significant or group of significant customers, could harm our financial condition and results of operations. Given the dependencies on our limited number of OEM resellers combined with
an increasingly competitive environment, we may experience continued adverse price pressures at critical times near the end of the fiscal quarters. In addition, the fiscal quarters for many of our largest OEM and reseller partners begin during the
last month of our fiscal quarter. While we do not have complete insight into the purchasing processes of our OEM and reseller partners, we believe that such partners may purchase some amount of our non-configured product in anticipation of end-user
customer demand that will be realized in the later portion of their fiscal quarter. Large end-of-quarter purchases by our partners could result in lower future revenues or earnings if market demand as forecasted by our partners is not met.



Domestic and international revenue was approximately 68% and
32% of our total revenue, respectively, for the three months ended October 31, 2005. For the three months ended October 31, 2004, domestic and international revenue was approximately 66% and 34% of our total revenue, respectively. For the
nine months ended October 31, 2005, domestic and international revenue was 67% and 33% of total revenue as compared to 64% and 36%, respectively for the nine months ended October 31, 2004. Revenues are attributed to geographic areas based
on the location of the customers to which our products are shipped. International revenues primarily consist of sales to customers in Western Europe and the greater Asia Pacific region. Included in domestic revenues are sales to certain OEM
customers who take possession of our products domestically and then distribute these products to their international customers. In addition, included in revenues from Western Europe are sales to certain OEM customers who take possession of our
products in distribution centers designated for international-bound product and then distribute these products among various international regions. Our mix of international and domestic revenue can, therefore, vary depending on the relative mix of
sales to certain OEM customers.



For a description of our
revenue recognition policies, see the Revenue Recognition section of the Critical Accounting Policies.



Gross Margin



Product



Product gross margin percentages were 51% and 58% for
the three months ended October 31, 2005 and 2004, respectively. For the nine months ended October 31, 2005 and 2004, product gross margins were 53% and 58%, respectively. Costs of goods sold consists of product costs, which are generally
variable, and manufacturing operating cost, which include both variable and fixed expenses. The decline in product margins for both the three month and nine month periods ending October 31, 2005 compared to the same periods ending
October 31, 2004 was principally due to discounting that we offered



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during the market introduction phase for our Intrepid 10000 director product along with the added costs associated with lower start up production volumes.
Gross margins were adversely affected by $1.4 million of provisions for underutilization of certain manufacturing facilities and unusual warranty expenses that were recognized in the quarter ended October 31, 2005. For the three months ended
October 31, 2005, the inclusion of CNT resulted in higher product margins from CNT legacy products sold to direct end-user customers offset by lower margins for the resale of products from third parties.



In anticipation of the competitive-driven and natural decline in selling
prices, we continue to drive cost advantages through our engineering and manufacturing processes. The terms of our agreement with Solectron will allow for a reduction of manufacturing costs once Solectron moves manufacturing processes to their other
facilities.



Service



Service gross margin percentages were 32% and 14% for the three months ended
October 31, 2005 and 2004, respectively. For the nine months ended October 31, 2005, service gross margin percentage was 34% compared to 11% for the nine months ended October 31, 2004. Gross margins increased in 2005 due to the
acquisition of CNTs service business. Management expects future service gross margins to be comparable to the results achieved in the third quarter 2005.



Operating Expenses



Research and Development Expenses. Research and development expenses consist primarily of salaries and related expenses for personnel engaged in
engineering and R&D activities; fees paid to consultants and outside service providers; nonrecurring engineering charges; prototyping expenses related to the design, development, testing and enhancement of our products; depreciation related to
engineering and other test equipment; and IT and facilities expenses. Research and development expenses are applicable to the Companys product segment.



For the three months ended October 31, 2005, research and development expenses increased $8.6 million to $31.5 million compared with $22.8 million
for the three months ended October 31, 2004. For the nine months ended October 31, 2005, research and development expenses increased by $13.7 million to $83.8 million as compared to $70.1 million for the nine months ended October 31,
2004. These increases in research and development expense reflect an 18% increase in personnel, increased depreciation expense for equipment, spending related to outsourced services and product development and testing. These increases are due
primarily to the Merger. Research and development expenses also reflect the net impact of capitalized software development costs which reduce research and development expenses when recorded on the balance sheet and amortized against cost of goods
sold upon introduction of the software product. For the quarter ended October 31, 2005, capitalized software costs were $4.5 million compared to $6.0 million for the three months ended October 31, 2004. For the nine months ended
October 31, 2005, capitalized software costs were $15.3 million as compared to $12.9 million for the same period during fiscal 2004. This $2.4 million decrease in research and development expense partially offsets the increases as discussed
above for the nine months ended October 31, 2005 as compared to the same period in the prior fiscal year. These costs vary in conjunction with stages of development of our application software, our new director and switch products and related
firmware software.



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



For the three months ended October 31, 2005, selling and marketing
expenses increased $9.0 million to $35.8 million as compared to $26.8 million for the three months ended October 31, 2004. Selling and marketing expenses increased by $23.6 million to $98.1 million for the nine months ended October 31,
2005 as compared to $74.5 million for the nine months ended October 31, 2004. These increases were primarily due to a 35% increase in personnel.



General and Administrative Expenses. General and administrative expenses consist primarily of salaries and related expenses for corporate
executives, finance, human resources and investor relations, as well as accounting and professional fees, corporate legal expenses, other corporate expenses, and IT and facilities expenses.



For the three months ended October 31, 2005 and 2004, respectively,
general and administrative expenses were $10.5 million and $5.8 million. General and administrative expenses for the nine months ended October 31, 2005 and 2004 were $25.2 million and $19.6 million respectively. These increases over prior year
were attributable to increased personnel costs related to the increase in personnel and severance costs and increased facility costs associated with the Merger.



Amortization of Purchased Intangible Assets. Amortization of purchased intangible assets was $11.4 million and $5.6 million for the three months
ended October 31, 2005 and 2004, respectively and $26.5 million and $17.2 million for the nine



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months ended October 31, 2005 and 2004, respectively. These increases are due to the increase of purchased intangibles acquired through the merger with
CNT. These assets are being amortized on a straight-line basis over a period of one to nine years.



Amortization of Deferred Compensation.We have recorded deferred compensation related to retention shares granted to Nishan and Sanera employees.
In addition, certain CNT employees were issued retention grants of restricted stock. Upon completion of the CNT acquisition, these share converted into 1.3 shares of McDATA Class A common stock for each restricted share of CNT common stock
owned. These shares vest over an 18 month period. We are amortizing all deferred compensation on a straight-line basis over the vesting period of the applicable options and stock awards, resulting in amortization expense, net of forfeitures, of
$889,000 for the three months ended October 31, 2005 and $1.1 million for the three months ended October 31, 2004 (of which approximately $25,000 and $26,000 was included in cost of revenue, respectively). Deferred amortization
expense of $4.8 million was recorded for the nine months ended October 31, 2005 and 2004 (of which approximately $151,000 and $162,000 was included in total cost of revenue, respectively. Deferred compensation expense related to these awards
will decrease as the awards become fully vested over the following two to five years.



After the acquisition of CNT, the Company notified redundant employees that their employment would be terminated and provided them with a detailed explanation of their benefits, which included separation pay as well
as retention pay for transitional employees. Total termination benefits charged to restructuring costs in results of operations as a result of the integration plan was $.6 million for the quarter ended October 31, 2005 and $3.9 million in total
through October 31, 2005. Retention pay offered to all transitional employees is contingent upon the employee rendering future service through a transition period and has no relationship to the employees past service, therefore, these
benefits were recognized as a restructuring cost ratably over the transition period. For the quarter ended October 31, 2005, $.6 million has been recognized as a restructuring cost, for a total of $.9 million through October 31, 2005. No
further retention benefits are expected to be incurred as a result of the CNT integration plan.



Prior to the acquisition, McDATA and CNT each sold a competing Director class productMcDATAs is branded the Intrepid 10000 and CNTs is
the UltraNet Multi-Service Director (UMD). In order to eliminate this redundancy and integrate the two companys product offerings, the Company has decided to withdraw the UMD from the market, and continue to sell the Intrepid 10000 product in
the future. As a result, McDATA has offered, and certain existing UMD customers have accepted, an exchange program which allowed customers to trade in their UMD for a comparable Intrepid 10000 at no cost to them. The Company has also offered
customers up to 20 hours of professional consulting service to assist with the migration to the new product. The net cost of this program of $6.8 million was recorded as a restructuring cost during the quarter ended July 31, 2005, which
represents the difference between the cost of the Intrepid 10000 to be installed over the salvage value of the UMDs to be returned. Consulting costs to be incurred in connection with this program were not accrued because they could not be
reasonably estimated. They will be recorded as restructuring costs in future periods as they are incurred.



Changes to the estimates of executing the currently approved plans of restructuring the pre-merger McDATA organization will be reflected in our future
results of operations.



Interest and Other Income.
Interest and other income consisted primarily of interest earnings on our cash, cash equivalents and various investment holdings. Interest and other income increased to $2.8 million for the three months ended October 31, 2005 as compared with
$1.7 million for the three months ended October 31, 2004. For the nine months ended October 31, 2005 and 2004, interest and other income was $7.0 million and $4.5 million, respectively. The increase in income from the prior year level
reflects an increase in interest rates. Fluctuations in our investment balances as well as fluctuations in interest rates could cause our investment income to vary between periods.



Interest Expense.Interest expense consists primarily of the amortization of issuance costs related to the
convertible subordinated debt, the convertible debt interest expense not offset by the interest rate swap interest income (discussed below), the amortization of the discount on the CNT debt, and interest expense related to capital leases and notes
payable.



For the three months ended October 31, 2005,
interest expense increased to $3.1 million compared with $395,000 for the three months ended October 31, 2004, due primarily to the effect of increased interest rates. In order to manage interest expense on our convertible debt, the Company has
two interest-rate swap agreements in effect, which have the economic effect of modifying the fixed interest obligations associated with our convertible debt so that the interest payable on the majority of the debt effectively becomes variable. The
rate on the interest rate swap agreement covering $155.3 million of the 2.25% Convertible Notes is based on the six-month London Interbank Offered Rate (LIBOR) minus 152 basis points, is reset semiannually on February 15 and August 15 of
each year until maturity on February 15, 2010, and was 2.51% as of October 31, 2005. The rate on the interest rate swap agreement covering $75 million of the 3.00% Convertible Notes is based on the three-month LIBOR plus 69.5 basis points,
is reset quarterly on January 31, April 30, July 31, and October 31 of each



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year, and was 4.938% as of October 31, 2005. Significant increases in interest rates in future periods could significantly increase interest expense.



Provision for Income Taxes.The Company has recorded
tax expense for the nine months ended October 31, 2005 even though the pre-tax result on the books is a loss. This is due primarily to taxes payable in foreign jurisdictions where the net taxable income of our branch and subsidiary operations
is projected to be positive, as well as state taxes for jurisdictions where there are insufficient tax operating losses to offset allocable taxable income. No federal tax benefit is recorded currently for the year-to-date loss because the Company
has established a valuation allowance against its entire domestic net deferred tax asset. Management believes available evidence indicates that sufficient income is not expected during the remainder of the fiscal year to realize any such benefit.
The calculation of income tax expense or benefit for the current period is based in part on estimates of future results and projections of taxable income for the full fiscal year in each jurisdiction in which the Company operates. These projections
could be affected, positively or negatively, by such factors as future changes in tax law or implementation of possible tax planning strategies.



We are subject to audit by federal, state and foreign tax authorities. These audits may result in additional tax liabilities. We account for such
contingent liabilities in accordance with SFAS No. 5, Accounting for Contingencies, and believe that we have appropriately provided for taxes for all years. Several factors drive the calculation of our tax reserves including
(i) the expiration of statutes of limitations, (ii) changes in tax law and regulations, and (iii) settlements with tax authorities. The occurrence of any of these events may result in adjustments to our reserves that could impact our
reported financial results. During the three-month period ended October 31, 2005, the Company released previously accrued tax contingencies in the amount of $1.35 million due to the expiration of state Statutes of Limitations with respect to
returns filed for a prior year, resulting in a one-time benefit to the income tax provision. This benefit is included in the amounts reported for the three- and nine-month periods ended October 31, 2005.



Liquidity and Capital Resources



At October 31, 2005, cash and cash equivalents, short- and long-term
investments were approximately $354 million compared to approximately $310 million as of January 31, 2005. The October 31, 2005 balance includes approximately $11 million of restricted cash, classified as long-term, that we are required to
maintain in relation to the interest rate swap we have executed in connection with our convertible debt. We invest excess cash predominantly in debt and equity instruments that are highly liquid, of high-quality investment grade, and predominantly
have maturities of less than three years with the intent to make such funds readily available for operating purposes, including expansion of operations and potential acquisitions or other transactions.



We believe our existing cash and cash equivalents, short-term and long-term
investment balances, and cash expected to be generated from future operations 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 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.



In summary, our cash flows were:



|                                                    |  |                              |        |   |      |   |        |  
|--------------------------------------------------- |  | ---------------------------- | ------ | - | ---- | - | ------ | -
|                                                    |  | Nine Months EndedOctober 31, |       
|Source (use) (in thousands)                         |  | 2005                         |        |   | 2004 |  
|Net cash provided by operating activities           |  | $                            | 15,196 |   |      | $ | 9,955  |  
|Net cash provided by (used in) investing activities |  |                              | 92,041 |   |      |   | (5,649 | )
|Net cash used in financing activities               |  |                              | (5,599 | ) |      |   | (6,917 | )



Cash provided by
operating activities of $15.2 million for the nine months ended October 31, 2005 consists of our net loss adjusted for non-cash charges (including depreciation, amortization, deferred compensation and inventory-related charges) and changes in
working capital and other activities. Working capital items include accounts receivable, inventories, other current and non-current assets, accounts payable, accrued liabilities and deferred revenue.



Cash provided by investing activities of $92.0 million for the nine months
ended October 31, 2005 consists of $40.4 million in cash recognized from the CNT acquisition, net of $6.9 of acquisition costs, as well as $63 million in proceeds from investment sales and maturities (net of purchases), partially offset by
$13.5 million of capital expenditures. For the nine months ended October 31, 2004, $5.6 million of cash used in investing activities consists of approximately $8.2 million in cash from investment sales and maturities (net of purchases) less
approximately $14 million of capital expenditures.



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Cash used in financing activities of $5.6 million for the nine months ended October 31, 2005 was
primarily due to the stock repurchase program. For the nine months ended October 31, 2004, net cash used by financing activities of $6.9 million consists primarily of purchases under the stock repurchases program, net of proceeds from the
exercise of stock options and the employee stock purchase plan.



Off-Balance
Sheet Arrangements



Other than facility and equipment
leasing arrangements classified as operating leases, the Company does not engage in off-balance sheet financing activities.



Ordinary Course Purchase and Sale Agreements



During its normal course of business, the Company may enter into agreements with, among others, customers, resellers, OEMs, systems integrators and
distributors. These agreements typically require the Company to indemnify the other party against third party claims or product infringements on patents or copyrights. The Company provides indemnifications of varying scope and size to certain
customers against claims of intellectual property infringement made by third parties arising for the use of our products. We have also indemnified our former parent, EMC, for any income taxes arising out of the distribution of our Class A
common stock in February 2001.



In addition, the majority of
these indemnities, commitments and guarantees do not provide for any limitation of the maximum potential future payments the Company could be obligated to make. The Company evaluates and estimates losses from such indemnification under SFAS
No. 5, Accounting for Contingencies, as interpreted by FASB Interpretation No. 45 (FIN 45). To date, the Company has not incurred any material costs as a result of such obligations and has not accrued any liabilities related to
such indemnification and guarantees in our financial statements.



Sale of
Lumberton, New Jersey Manufacturing Operations



As
described in Note 15, on June 24, 2005 the Company entered into a series of agreements with Solectron in connection with the sale of manufacturing operations and transfer of assets related to its Lumberton, New Jersey production facility. As
part of the Asset Purchase Agreement between the Company and Solectron, the Company has made a number of representations and has agreed to indemnify the buyer and hold them harmless from certain losses suffered in connection with their purchase of
assets and assumption of liabilities of the Lumberton facility. Although, there are no maximum potential indemnification amounts stated in the agreement for these representations, based on facts currently available, management estimates the maximum
potential amount of payments that could be required under these representations to be $5.3 million. Based on the probability of having to make payments under any one of the representations, management has calculated potential discounted future cash
flows of approximately $400,000, which has been recorded in the accompanying financial statements as a liability assumed in the acquisition of CNT, in accordance with FIN 45.



SPX Tax Sharing Agreement



Inrange Technologies Corporation (Inrange) is subject to a tax sharing agreement with SPX Corporation (SPX) relating to previous tax years when Inrange
was part of the SPX consolidated tax group (the SPX Agreement). Inrange was acquired by CNT from SPX in May 2003. When CNT merged with McDATA, Inrange became a subsidiary of McDATA.



Pursuant to the SPX Agreement, if the Internal Revenue Service (IRS) makes an adjustment to Inrange losses utilized in
previous tax years by the SPX consolidated group, Inrange must compensate SPX for the lost tax benefits. The IRS is currently examining tax returns filed by SPX for certain years that Inrange was included in the SPX consolidated return. At this
time, we are not aware of any issues raised during the audit that would require Inrange to compensate SPX for lost tax benefits.



Commitments



Purchase Commitments



The Company has contracted with Sanmina SCI Systems, Inc. (SSCI), Solectron Corporation (Solectron) and others (collectively, Contract Manufacturers) for the manufacture of printed circuit boards and box build assembly and
configuration for specific multi-protocol directors and switches. The agreements require the Company to submit purchasing forecasts and place orders sixty calendar days in advance of delivery. At October 31, 2005, the Companys commitment
with our Contract Manufacturers for purchases over the next sixty days totaled $95.1 million, and $19.2 million for commitments beyond 60 days. The Company may be liable for materials that the Contract Manufacturers purchase on McDATAs behalf
if the Companys actual requirements do not meet or exceed its forecasts and those materials cannot be redirected to other uses. We may also be liable for materials that certain component suppliers or product manufacturers have produced or made



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available to us if our actual requirements do not meet or exceed minimums that we have committed to purchase. At October 31, 2005, the company had
recorded approximately $6.6 million of purchase obligations that we believe is excess or obsolete and cannot be redirected to other uses. Management does not expect the remaining commitments under these agreements to have a material adverse effect
on the Companys business, results of operations, financial position or cash flows.



Convertible Notes



In
February 2003, the Company sold $172.5 million of 2.25% convertible subordinated notes due February 15, 2010 (2.25% Notes). The 2.25% Notes are convertible into our Class A common stock at a conversion rate of 93.3986 shares per
$1,000 principal amount of notes (aggregate of approximately 16.1 million shares) or $10.71 per share, subject to certain conversion adjustments. Upon a conversion, the Company may choose to deliver shares of our Class A common stock, or,
in lieu of shares of our Class A common stock, cash or a combination of cash and shares of Class A common stock. We are required to pay interest on February 15 and August 15 of each year, beginning August 15, 2003. Debt
issuance costs of $5.6 million are being amortized over the term of the 2.25% Notes. The amortization of debt issuance costs will accelerate upon early redemption or conversion of the Notes. The net proceeds remain available for general
corporate purposes, including working capital requirements and capital expenditures.



Concurrent with the issuance of the 2.25% Notes, the Company entered into share option transactions using approximately $20.5 million of proceeds. As part of these share option transactions, the Company purchased
options that cover approximately 16.1 million shares of Class A common stock, at a strike price of $10.71. The Company also sold options that cover approximately 16.9 million shares of Class A common stock, at a strike price of
$15.08. The net cost of the share option transactions was recorded against additional paid in capital. These share option transactions are intended to give the Company the option to mitigate dilution as a result of the 2.25% Notes being converted to
common shares up to the $15.08 price per common share and mitigate dilution if the share price exceeds $15.08 at that time. Should there be an early unwind of either of the share option transactions, the amount of cash or net shares potentially
received or paid by the Company will be dependent on then existing overall market conditions, the stock price, the volatility of the stock, and the amount of time remaining until expiration of the options.



On June 1, 2005, effective upon the consummation of the Merger, the
Company fully and unconditionally guaranteed the $124,350,000 3.00% convertible subordinated notes due February 15, 2007 previously issued by CNT (3.00% Notes), and became a co-obligor on the 3.00% Notes with CNT and the 3.00% Notes became
convertible into the Companys Class A stock at a price of approximately $14.75 per share (aggregate of approximately 8.4 million shares) at any time prior to maturity on February 15, 2007, all pursuant to the terms of the
Supplemental Indenture. All other terms of the 3.00% Notes remained unchanged. The 3.00% Notes may be redeemed upon payment of the outstanding principal balance, accrued interest and a make whole payment if the closing price of the Class A
stock exceeds 175% of the conversion price for at least twenty (20) consecutive trading days within a period of thirty (30) consecutive trading days ending on the trading day prior to the date of the mailing of the redemption
notice. The make whole payment represents additional interest payments that would be made if the 3.00% Notes were not redeemed prior to their due date. Interest is payable on February 15 and August 15 of each year while the 3.00% Notes are
outstanding. Payment of the notes will also accelerate upon certain events of default.



In order to manage interest expense on our convertible debt, the Company has two interest-rate swap agreements in effect, which have the economic effect of modifying the fixed interest obligations associated with our
convertible debt so that the interest payable on the majority of the debt effectively becomes variable. In July 2003, we entered into an interest rate swap agreement covering $155.3 million of the 2.25% Notes which is based on the six-month London
Interbank Offered Rate (LIBOR) minus 152 basis points. The rate on this swap agreement is reset semiannually on February 15 and August 15 of each year until maturity on February 15, 2010, and was 2.51% as of October 31, 2005.
Prior to the Merger, CNT entered into an interest rate swap agreement covering $75 million of the 3.00% Notes which is based on the three-month LIBOR plus 69.5 basis points. This rate is reset quarterly on
January 31, April 30, July 31, and October 31 of each year until maturity on February 15, 2007, and was 4.938% as of October 31, 2005. Increases in interest rates could significantly increase the interest
expense we are obligated to pay under the interest-rate swap agreements in future periods. The swaps were designated as a fair value hedge and, as such, the gain or loss on the derivative instrument, as well as the fully offsetting gain or loss on
the Notes attributable to the swaps, were recognized in earnings. We are also required to post collateral based on changes in the fair value of the interest rate swaps. This collateral, in the form of restricted cash, was $10.6 million as of
October 31, 2005 and $5.0 million as of January 31, 2005.



Headquarters Lease Commitment



On
September 9, 2004, McDATA entered into a triple net office lease with Ridge Parkway Associates, LLC, a Delaware limited liability company for the future lease of office space at 11802 Ridge Parkway, Building 2, Broomfield, Colorado (the
New Premises). The Company intends to begin moving its current world headquarters location at 380



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Interlocken Crescent, Broomfield, Colorado 80021 to the New Premises early in 2006 with the lease commencing in February of 2006. The Companys current
headquarters office lease expires at the end of April 2006. The term of the new lease is for 11 years (with two 5 year renewal options) and is at market lease rates that are substantially lower than the current lease rate paid
by the Company. The base annual lease rates per rentable square foot for the New Premises range from $0 in the first year to $14.15 in the last year of the lease, plus normal operating expenses. The Company has begun recognizing rent expense in July
2005 upon the start of the build-out of the premises. In addition, the Company has an option to purchase the New Premises at varying amounts until December 31, 2005. The lease and option to purchase have customary terms and conditions. Since
the lease agreement does not limit the Companys total potential expenditures related to this project, the Company is deemed to be the accounting owner of the project, and therefore total project costs incurred to date by all parties have been
reflected as Construction in progress  leased assets, and as Non-cash obligations for construction in progresslease facilities in the long term liability section of the accompanying balance sheet.



Contractual Obligations



The following table summarizes our contractual obligations (including interest expense) and commitments as of
October 31, 2005 (in thousands):



|                                          |  |         |  |                 |  |          |  |          |  |                 
|----------------------------------------- |  | ------- |  | --------------- |  | -------- |  | -------- |  | ----------------
|                                          |  | Total   |  | Less Than1 Year |  | 1-3Years |  | 3-5Years |  | More Than5 Years
|Convertible subordinated debt             |  | 296,850 |  |                |  | 124,350  |  | 172,500  |  |                
|Interest on convertible subordinated debt |  | 23,224  |  | 7,612           |  | 10,680   |  | 4,932    |  |                
|Non-cancelable operating leases           |  | 56,242  |  | 12,039          |  | 13,743   |  | 7,922    |  | 22,538          
|Non-cancelable purchase agreements        |  | 114,363 |  | 99,363          |  | 10,000   |  | 5,000    |  |                
|Capital leases, including interest        |  | 3,180   |  | 1,946           |  | 739      |  | 495      |  |                
|                                          |  |         |  |                 |  |          |  |          |  |                 
|Total contractual obligations             |  | 493,859 |  | 120,960         |  | 159,512  |  | 190,849  |  | 22,538          
|                                          |  |         |  |                 |  |          |  |          |  |                 



Recent Accounting Pronouncements



In December 2003, the Financial Accounting Standards
Board (FASB) issued an exposure draft of its proposed amendment to Statement of Financial Standards (SFAS) No. 128, Earnings Per Share (SFAS No. 128), which specifies the calculation of earnings per share (EPS). This Statement
eliminates the provision of SFAS No. 128 that allows issuing entities to overcome the presumption that certain contracts that may be settled in cash or shares will be settled in shares. Lastly, this Statement requires that shares to be issued
upon conversion of a mandatorily convertible security be included in the computation of basic EPS from the date that conversion becomes mandatory. The FASB made further modifications to this exposure draft and plans to reissue it in the third
quarter of 2005, with the final statement expected to be issued in the first quarter of 2006. The Company has not yet determined the potential future impact of the proposed amendment on its consolidated financial statements.



In November 2004, the FASB issued SFAS No. 151, Inventory
CostAn Amendment of ARB 43, Chapter 4 (SFAS No. 151), to clarify that abnormal amounts of certain costs should be recognized as period costs. This Statement is effective for fiscal years beginning after June 15, 2005. The
Company does not believe that the adoption of SFAS No. 151 will have a material effect on its financial position, results of operations, or cash flows.



In December 2004, the FASB issued a revision of SFAS No. 123, Accounting for Stock-Based Compensation, (SFAS No. 123R). SFAS
No. 123R supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. SFAS No. 123R establishes standards for the accounting for transactions in which an entity incurs
liabilities in exchange for goods or services that are based on the fair value of the entitys equity instruments or that may be settled by the issuance of those equity instruments. SFAS No. 123R does not change the accounting guidance for
share-based payment transactions with parties other than employees provided in SFAS No. 123 as originally issued and EITF Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services. Originally, SFAS No. 123R was effective for interim reporting periods that begins after June 15, 2005. In April 2005, the SEC announced the deferral of the required effective date. The SEC
rule provides that SFAS 123R is now effective for registrants as of the beginning of the first fiscal year beginning after June 15, 2005. The Company is in the process of determining the effect that adopting SFAS No. 123R will have on its
financial position, results of operations, and cash flows.



In
December 2004, the FASB issued Staff Position No. 109-2, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004. The Act creates a temporary incentive for U.S.
corporations to repatriate accumulated income earned abroad by providing an 85 percent dividends received deduction



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for qualifying dividends from controlled foreign corporations, subject to certain limitations. This Staff Position allows companies additional time beyond
the financial reporting period of enactment to evaluate the effect of the Act. The Company has evaluated the potential benefits of this provision and has determined that it will not be paying any dividends pursuant to the specific rules of the
Act. This decision does not prevent the Company from paying dividends from controlled foreign corporations in the future. However, such dividends would not be eligible for the special dividends received deduction provided for by the Act.



In May 2005, the FASB issued SFAS No. 154, Accounting Changes
and Error Corrections (SFAS No. 154), which requires the direct effects of voluntary accounting principle changes to be retrospectively applied to prior periods financial statements. The Statement does not change the
transition provisions of any existing accounting pronouncements, but would apply in the unusual instance that a pronouncement does not include specific transition provisions. SFAS No. 154 maintains existing guidance with respect to accounting
estimate changes and corrections of errors. The Statement is effective for the Company beginning in fiscal year 2006. Adoption is not expected to have a material impact on the Companys financial position, results of operation or cash
flows.



In June 2005, FASB finalized FASB Staff Positions (FSP)
No. 143-1, Accounting for Electronic Equipment Waste Obligations. This FSP addresses accounting by commercial users and producers of electrical and electronic equipment, in connection with Directive 2002/96/EC on Waste Electrical
and Electronic Equipment issued by the European Union on February 13, 2003 (Directive). This Directive requires EU-member countries to adopt legislation to regulate the collection, treatment, recovery, and environmentally sound disposal of
electrical and electronic waste equipment, and sets forth certain obligations relating to covering the cost of disposal of such equipment by commercial users. Producers will also be required to cover the cost of disposal of such equipment by private
household users. The FSP sets forth accounting for such obligations by commercial users and producers, with respect to SFAS No. 143, Asset Retirement Obligations and the related FASB Interpretation No. 47, Accounting for
Conditional Asset Retirement Obligations, since this type of obligation is an asset retirement obligation. The guidance of this FSP shall be applied in the first reporting period after the date of the adoption of the law by the applicable
EU-member country. Adoption is not expected to have a material impact on the Companys financial position, results of operations or cash flows.



In June 2005, the FASB finalized FSP No. 150-5, Issuers Accounting under Statement 150 for Freestanding Warrants and Other Similar
Instruments on Shares That Are Redeemable. This FSP addresses whether freestanding warrants and other similar instruments on shares that are redeemable (either puttable or mandatorily redeemable) would be subject to the requirements of SFAS
No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (SFAS No. 150), regardless of the timing of the redemption feature or the redemption price. The Company has not yet
determined the effect, if any, of the FSP on its financial position, results of operations, or cash flows.



In June 2005, the FASB ratified the Emerging Issues Task Force (EITF) consensus on Issue No. 05-6, Determining the Amortization Period for
Leasehold Improvements (EITF 05-6). The guidance requires that leasehold improvements acquired in a business combination or purchased subsequent to the inception of a lease be amortized, based on facts available as of the date of the
business combination or purchase, over the shorter of the useful life of the assets or a term that includes renewals that are reasonably assured. The EITF is effective for the Companys third quarter 2005. The Company does not believe
that the adoption of EITF 05-6 will have a material effect on its financial position, results of operations or cash flows.



Critical Accounting Policies



General



Managements Discussion and Analysis of Financial Condition and Results of Operations is based upon our consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and
liabilities, revenue and expenses, and the related disclosure of contingent assets and liabilities as of the date of the financial statements. Management bases its estimates on historical experience and on various other assumptions that are believed
to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Senior management has discussed the development,
selection and disclosure of these estimates with the Audit Committee of McDATAs Board of Directors. Actual results may differ materially from these estimates under different assumptions or conditions. Management believes the following critical
accounting policies reflect its more significant estimates and assumptions used in the preparation of its consolidated financial statements.



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Revenue Recognition



The Company recognizes revenue when four basic criteria are met: (a) persuasive evidence of an arrangement exists
(b) products are delivered or services rendered (c) the sales price is fixed or determinable and (d) collectibility is probable.



Product Revenue



Revenue from product sales to our resellers and end-user customers is recognized when title and risk of loss transfer to the customer, generally at the
time the product is delivered. Revenue from product sales to our OEMs and distributors is recognized when title and risk of loss transfer to the customer in accordance with the master agreement, generally upon sell-through to the end-user. With
respect to revenue from our configured products, we request evidence of sell-through from our OEM and distributor partners prior to recognizing revenue. In situations where our OEM and distributor partners refuse to provide sell-through information
when requested, but all the criteria under SEC Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition (SAB No. 104) have been met, we recognize revenue for such configured products. These configured products represent
high value, customized solutions of directors, cabinets and various combinations of port cards ordered by our OEM and distributor partners as required by the end user.



Non-configured products and components, such as our switch products, UltraNet extension products, additional port cards, and
FlexPort upgrades, are recognized as revenue when the criteria for SAB No. 104 (as discussed above) have been met, generally at time of shipment.



Revenue is reduced for estimated customer returns, price protection, rebates, and other offerings that occur under sales programs established with the
Companys OEMs, distributors and resellers. If actual credits received by our partners for returns or price protection and inventory rotation actions were to deviate significantly from our estimates, which are based on historical experience,
our revenue could be adversely affected.



The Company accrues
for estimated warranty costs at the time of revenue recognition based on its experience.



Service Revenue



Revenue from support or maintenance contracts is recognized ratably over the contractual period. Amounts invoiced to customers in excess of revenue recognized on these contracts are recorded as deferred revenue until all revenue recognition
criteria are met. Revenue from professional services is recognized when such services are performed.



Software Revenue



Revenue from software is comprised of software licensing and post-contract customer support. Software revenue is allocated to the license and support elements using vendor specific objective evidence of fair value (VSOE). Revenue allocated
to software licenses is recognized when the four basic criteria above have been met. Revenue allocated to post-contract support is recognized ratably over the term of the support contract, assuming the four basic criteria are met.



Multiple Elements



We enter into certain arrangements where we are obligated to deliver multiple products and/or services. In transactions that
include multiple products, services and/or software, the Company allocates the revenue to each element based upon their VSOE of the fair value of the element (or in the absence VSOE, the residual method). VSOE of the fair value for an element is
based upon the price charged when the element is sold separately. Revenue allocated to each element is then recognized when the basic revenue recognition criteria is met for each element.



Deferred Revenue



Total deferred revenue consists primarily of unearned revenue from our customer support or maintenance contracts on our software and hardware products.
These contracts are billed and collected either upfront or annually at the beginning of each service period. We recognize revenue from these contracts ratably over the contractual period, generally one to three years.



The remaining portion of deferred revenue represents deferred revenue related
to billings and collections for which one or more of the four basic criteria under SAB No. 104 and the American Institute of Certified Public Accountants Statement of Position 97-2, as amended, have not been met. These balances are all
classified as short-term on the balance sheet as all four criteria have historically been met in less than twelve months.



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Inventory Reserves



We value our inventory at the lower of cost or net realizable values. We regularly review inventory on hand and record a
provision for excess and obsolete inventory based upon assumptions about current and future demand for our products, the current market conditions, new product introductions, new technologies and the current life cycle of our products. Adverse
changes in these factors and our assumptions could result in an increase in the amount of excess and obsolete inventory on hand and increase our cost of revenue.



Additionally, we have certain purchase commitments with our Contract Manufacturers and other suppliers that are
non-cancelable. We may be liable for materials that our third-party manufacturers purchase on our behalf if our actual requirements do not meet or exceed our forecasts and those materials cannot be redirected to other uses by the Contract
Manufacturers. We may also be liable for materials that certain component suppliers or product manufacturers have produced or made available for us if our actual requirements do not meet or exceed minimums that we have committed to purchase. We
evaluate these open purchase commitments in light of our current inventory on hand, expected demand, market conditions and new product introductions. Based on this information, we record purchase obligations for inventory we believe is excess or
obsolete and cannot be redirected to other uses by our contract manufacturers or other suppliers. At October 31, 2005, the Companys commitment with our Contract Manufacturers for purchases over the next 60 days totaled $95.1 million, and
$19.2 million for commitments beyond 60 days. At October 31, 2005, the company had recorded approximately $6.6 million of purchase obligations that we believe is excess or obsolete and cannot be redirected to other uses.



Warranty Provision



We also provide for estimated expenses for warranty obligations as revenue
is recognized. These estimates are based primarily on our historical experience with product failures, cost to repair and known identified product quality issues. Our historical warranty claims has been immaterial with actual warranty claims
representing less than 1% of our annual cost of sales. Future material changes in our product and component quality or significant increases in our warranty repair and replacement cost could require revisions to the estimated warranty liability and
could significantly increase our product costs, cause significant customer relations problems and reduce revenue.



Income Taxes



Significant management judgment is required in determining the provision for income taxes, deferred tax assets and liabilities and any valuation allowance
recorded against deferred tax assets. We are required to estimate our income taxes in each jurisdiction where we operate. This process involves estimating our actual current income tax expense together with assessing temporary differences resulting
from items that have different timing or treatment for income tax and financial accounting purposes. These differences result in deferred tax assets and liabilities. The calculation of income tax expense or benefit is based in part on estimates of
future results and projections of taxable income for the full fiscal year in each jurisdiction in which the Company operates. These projections could be affected, positively or negatively, by such factors as future changes in tax law or
implementation of possible tax planning strategies.



If
management determines that it is more likely than not that some or all of the deferred tax assets will not be realized, then a valuation allowance is established against that portion of the deferred tax assets. In evaluating the need for a valuation
allowance, we assessed the likelihood that our net deferred tax assets will be recovered from future taxable income. In assessing the need for a valuation allowance, we have considered past operating losses, cumulative losses for financial
accounting in recent years, estimated future taxable income and our ongoing prudent and feasible tax planning strategies. After considering all available evidence, both positive and negative, management concluded, after applying the provisions of
SFAS No. 109, that it is more likely than not that we will not be able to realize our deferred tax assets in the future. Therefore, a valuation allowance has been established against the Companys net domestic deferred tax asset. The
establishment of the valuation allowance does not impair our ability to use the deferred tax assets upon achieving profitability.



The portion of the valuation allowance relating to the acquisitions of CNT and Nishan is applied as an increase to the basis of other assets from the
acquired companies (primarily goodwill) instead of a charge against net income. If this portion of the valuation allowance is released in subsequent periods, goodwill will decrease by a like amount and we will record a charge to tax expense when the
related deferred tax asset is realized.



We are subject to
audit by federal, state and foreign tax authorities. These audits may result in additional tax liabilities. We account for such contingent liabilities in accordance with SFAS No. 5, Accounting for Contingencies, and believe that we
have appropriately provided for taxes for all years. Several factors drive the calculation of our tax reserves



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including (i) the expiration of statutes of limitations, (ii) changes in tax law and regulations, and (iii) settlements with tax authorities.
The occurrence of any of these events may result in adjustments to our reserves, which could impact our reported financial results.



Valuation of Long-Lived Assets Including Goodwill and Purchased Intangible Assets



We perform an annual impairment test for goodwill in accordance with SFAS No. 142, Goodwill and Other Intangible
Assets. Goodwill is evaluated for impairment at least annually (beginning with the first anniversary of the acquisition date) and whenever events or changes in circumstances indicate the carrying value of goodwill may not be recoverable based
on the fair value of the reporting unit to which the goodwill relates. We performed a goodwill impairment test during our first fiscal quarter for the balance as of April 30, 2005 and determined that no impairment loss should be recognized. In
the event that business conditions change and/or our market value were to drop significantly, future tests may result in a need to record a loss due to write down of the value of goodwill. At October 31, 2005, goodwill recorded in the
consolidated balance sheet totaled $260.8 million.



Intangible assets with finite lives are amortized using the straight-line method over the estimated economic lives of the assets. The Company reviews long-lived assets, including intangibles and property and equipment for impairment
whenever there is an indication that the carrying amount may not be recoverable from future estimated cash flows.



Capitalized Software Development Costs



We capitalize certain software development costs in accordance with SFAS No. 86, Accounting for the Costs of Computer Software to Be Sold,
Leased, or Otherwise Marketed (SFAS No. 86). Under SFAS No. 86, costs incurred to develop a computer software product are charged to research and development expenses as incurred until technological feasibility has been established.
We establish technological feasibility upon completion of a detailed program design or working model from which point all research and development costs for that project are capitalized until the product is available for general release to
customers. The establishment of technological feasibility and the ongoing assessment of recoverability of capitalized software development costs require considerable judgment by management with respect to certain external factors, including, but not
limited to, anticipated future revenues, estimated economic life of the products, or both.



Cautionary StatementsRisk Factors



Our Quarterly Revenues and Operating Results Have Historically Fluctuated for a Number of Reasons, Which Has Also Caused Our Stock Price to Fluctuate



Quarterly revenues and operating results from continuing operations have varied significantly in the past due to a number of
factors, which has caused our stock price to fluctuate. The primary factors that have historically affected our quarterly financial performance include the following:



| |  |  | fluctuations in demand for our products and services;
| | - |  | -----------------------------------------------------



| |  |  | increasing competition from competitors which have products similar to ours and the availability of alternative products that can address storage networking needs of customers;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | potentially negative financial impact related to our acquisition of CNT, and our ability to integrate our sales and marketing efforts;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the timing of customer orders, which are often grouped toward the end of a quarter, particularly large orders from our significant customers and whether any orders are cancelled;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | sales mix among our storage networking products and services;
| | - |  | -------------------------------------------------------------



| |  |  | our traditionally long sales cycle, which can range from 90 days to 12 months or more;
| | - |  | --------------------------------------------------------------------------------------



| |  |  | the fact that our products and services are usually only part of an overall solution that our customers may have problems implementing or obtaining the required components or
services from other vendors;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our ability to successfully qualify our products with storage OEMs and our ability to source third party products that we resell;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------



| |  |  | announcements and new product introductions by our competitors and deferrals of customer orders in anticipation of new products, services or product enhancements introduced by us or
our competitors;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | decreases over time in the prices at which we can sell our products;
| | - |  | --------------------------------------------------------------------



| |  |  | our ability to obtain sufficient supplies of components, including limited sourced components, and products we supply at reasonable prices, or at all;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | communication costs and the availability of communication lines;
| | - |  | ----------------------------------------------------------------



| |  |  | increases in the prices of the components and supplied products we purchase;
| | - |  | ----------------------------------------------------------------------------



| |  |  | under utilization of consultants;
| | - |  | ---------------------------------



| |  |  | our ability to attain and maintain production volumes and quality levels for our products;
| | - |  | ------------------------------------------------------------------------------------------



| |  |  | increased expenses, particularly in connection with our strategy to continue to expand our relationships with the parties with whom we have entered into strategic
relationships; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | general economic and political conditions and related customer budget constraints.
| | - |  | ----------------------------------------------------------------------------------



Accordingly, you should not rely on the results of any past periods as an indication of our future performance. Because most
of our expenses are fixed in the short-term or incurred in advance of anticipated revenue, we may not be able to decrease our expenses in a timely manner to offset any unexpected shortfall in revenue.



Changing Market Conditions and Increased Competitive Risks.



The competition in the data access and SAN, MAN, and WAN market for our
products, software and solutions has grown and will continue to become more competitive with (a) the recent introduction of competitive products (b) alternative competitive technologies offered by other network companies that can
effectively network storage data, and (c) pricing pressures resulting from this increased competition. As a result of these market changes, we anticipate continued lengthened sales cycles and price erosion in an environment where storage OEM
certification of our products may still be required for end-user customer acceptance. Given that a majority of our revenues are derived from our direct-assist sales model with distribution through our channel partners, we are still highly dependent
upon our channel partners relationships with end-user customers to promote the value of our products. If our channel partners do not promote the value of our products or competitors begin to control end-user customer preference, we may lose
sales in key enterprise accounts that would materially adversely affect our revenues. While our recent acquisition of CNT allows us to offer SAN extension products, third party products and services directly to end-user customers, and such offerings
are generally not in conflict with our channel partners, we are nonetheless cautious in our sales model to properly manage and leverage the existing channel relationships we have.



We may not be able to successfully compete against existing or potential SAN competitors.



The market for our SAN switching products, software and solutions is highly
competitive, especially with the entrance of Cisco into the market in 2002. Our competitors are providing SAN switching hardware, server blade solutions and software that is multi-protocol capable (such as Fibre Channel over IP (FCIP), SCSI over
Internet (iSCSI), Internet Fibre Channel (iFCP) and InfiniBand). Our competitors in this market include Brocade, Cisco, QLogic Corp., Emulex Corporation (which acquired Vixel Corporation), Broadcom Corporation (which acquired the assets of Gadzoox
Networks), AppIQ, Fujitsu Softech and others, including storage hardware device providers. Given the market share gain by Cisco, other IP based switching companies such as Juniper, Extreme, Foundry and others may enter the market for SAN products.
Many of our competitors and potential competitors have longer operating histories, greater name recognition, access to larger customer bases, more established distribution channels and substantially greater financial and managerial resources than
McDATA. Given the highly competitive market, we anticipate continued lengthened sales cycles and continued downward pricing pressures. To be competitive, we recently acquired CNT to expand our Global Enterprise Data Infrastructure (GEDI) strategy,
which is to enable customers to consolidate their data assets in storage networks and to extend the boundary of those networks through network connectivity and distance products (i.e., SAN extension products previously offered by CNT). These
products and services are sold directly and through channels partners. Continued or increased competition could result in pricing pressures, reduced sales, reduced margins, reduced profits, reduced market share, further elongating of sales cycles,
or the failure of our products to achieve or maintain market acceptance.



We
incurred a substantial loss for the nine months ended October 31, 2005 and for the fiscal year ended January 31, 2005 and may not be profitable in the future.



We incurred losses of $35.9 million and $20.9 million, respectively, for the nine months ended October 31, 2005 and for
the fiscal year ended January 31, 2005. Our future operating results will depend on many factors, including the growth of



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the SAN market, market acceptance of new products we introduce, demand for our products, levels of product and price competition and our reaching and
maintaining targeted costs for our products. In addition, we expect to incur continued significant product development, sales and marketing, and general and administrative expenses. We cannot provide assurance that we will generate sufficient
revenue to achieve or sustain profitability.



The prices and gross margins
of our products may decline, which would reduce our revenues and profitability.



In response to changes in product mix, competitive pricing pressures, increased sales discounts, introductions of new competitive products, product enhancements by our competitors, increases in manufacturing or labor
costs or other operating expenses, we may experience declines in the prices, gross margins and profitability. To maintain our gross margins we must maintain or increase current shipment volumes, develop and introduce new products and product
enhancements and reduce the costs to produce our products. Moreover, most of our expenses are fixed in the short-term or incurred in advance of receipt of corresponding revenue. As a result, we may not be able to decrease our spending to offset any
unexpected shortfall in revenues. If this occurs, we could incur losses, and our revenue, gross margins and operating results may be below our expectations and those of investors and stock market analysts.



We depend on large distribution and end-user customer relationships.



We depend on EMC, IBM and HDS, for a significant portion of our total
revenue. Sales to EMC, IBM and HDS represented approximately 33%, 24% and 9%, respectively, of our revenue for the nine months ended October 31, 2005. We anticipate that our future operating results will continue to depend heavily on sales to
EMC, IBM and HDS. EMC, IBM and HDS resell products offered by our competitors, and nothing restricts EMC, IBM and HDS from expanding those relationships in a manner that could be adverse to us. Therefore, the loss of either EMC, IBM or HDS as a
channel customer, or a significant reduction in sales to either EMC, IBM and HDS could significantly reduce our revenue. While we are aware that Dell sources some of our switch product through EMC, it is unclear whether this mitigates our dependency
on EMC. Our product sales agreements with sales partners do not provide for the purchase of a guaranteed minimum amount of product.



With our acquisition of CNT, a significant portion of our total revenue is also dependent on large sale transactions with Fortune 500 customers in the
financial services, telecommunications, information outsourcing and retail market segments. Failure to close a large SAN extension or solutions sale with a single end-user customer may adversely affect our revenue in any particular fiscal quarter.



We currently have limited product offerings and must successfully introduce
new products (such as the Intrepid 10000) and product enhancements that respond to rapid technological changes and evolving industry standards.



We derive a substantial portion of our revenue from a limited number of products. As a result, we could have a significant decrease in revenue if one of
our products lines becomes obsolete, does not obtain and maintain market acceptance or if there is a decrease in demand for our products for any other reason.



For the nine months ended October 31, 2005, we derived a significant portion of our revenue from sales of our director-class Intrepid switch
products. We expect that revenue from our director-class Intrepid products will continue to account for a substantial portion of our revenue for the foreseeable future. Factors such as performance, market positioning, the availability and price of
competing products, the introduction of new technologies and the success of our OEM, reseller and systems integrator customers will affect the market acceptance of our products. Therefore, continued market acceptance of these products and their
successor products, along with our Intrepid 10000 Director, are critical to our future success. The Intrepid 10000 Director is currently in qualification testing by EMC. The qualification process with EMC is taking longer than previously
anticipated. Should EMC not qualify the Intrepid 10000 Director, McDATAs revenue and financial performance could be adversely affected given its sales concentration with EMC. Further, the sale of other SAN product lines and software may also
be adversely affected since the Intrepid 10000 is a key part of the overall SAN solution that we and our channel partners architect for end-user customers.



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 transitions to new technology, industry standards and new protocols include the inability to expand production capacity to meet demand for new products, write-downs of our existing inventory due to obsolescence, the impact
of customer demand for new products or products being replaced, and delays in the introduction or initial shipment of new products. There can be no assurance that we will successfully manage these transitions.



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We are currently developing products that contain untested devices and subassemblies. As with any
development, there are inherent risks should such devices or subassemblies require redesign or rework. In particular, in conjunction with the transition of our products from fibre channel to multi-protocol, 2 Gb to 4 Gb to 8 Gb to 10 Gb transmission
speed technology, higher port densities, and advanced management capabilities, we will be introducing products with new features and functionality, such as our next generation director-class switch product, the Intrepid 10000 Director and our next
generation switch, such as the Sphereon 4400 and Sphereon 4700. We face risks relating to this product transition, including risks relating to getting storage and system OEMs to qualify such products, forecasting of demand, as well as possible
product and software defects and a potentially different sales and support environment due to the complexity of these new systems. Finally, if we fail to timely introduce new products, or to add new features and functions to existing products to
compete against new entrants in the market, or if there is no demand for these or our current products, our business could be seriously harmed.



We may not successfully integrate or realize the benefits of the acquisition of Computer Network Technology Corporation.



On June 1, 2005, we acquired CNT. While management believes that such
acquisitions are an integral part of our long-term strategy, there are risks and uncertainties related to acquiring companies. The integration of CNT is a complex, time-consuming and expensive process that, without proper planning and
implementation, could significantly disrupt our business, controls and procedures. We may not successfully integrate CNT and the failure to meet the challenges involved in integrating the operations of McDATA and CNT successfully or otherwise to
realize any of the anticipated benefits of the merger could seriously harm our business. The challenges involved in this integration include, but are not limited to, the following:



| |  |  | successfully combining product and service offerings;
| | - |  | -----------------------------------------------------



| |  |  | integrating and coordinating sales and marketing activities;
| | - |  | ------------------------------------------------------------



| |  |  | realizing the financial, operational and headcount synergies to improve the overall business model of the company;
| | - |  | ------------------------------------------------------------------------------------------------------------------



| |  |  | integrating and coordinating research and development activities to enhance existing or introduce new products and services;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------



| |  |  | preserving customer, distribution, reseller, OEM, manufacturing, supplier and other important relationships of both McDATA and CNT and resolving potential conflicts that may arise;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | minimizing the diversion of management attention from other strategic opportunities and operational matters;
| | - |  | ------------------------------------------------------------------------------------------------------------



| |  |  | integrating the diverse financial systems of both McDATA and CNT;
| | - |  | -----------------------------------------------------------------



| |  |  | addressing differences in the business cultures of McDATA and CNT, maintaining employee morale and retaining key employees; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------



| |  |  | coordinating and combining overseas operations, relationships and facilities, which may be subject to additional constraints imposed by geographic distance, local laws and
regulations.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The anticipated benefits of the
merger are based on projections and assumptions, including successful integration, not actual experience. In addition to the integration risks discussed above, our ability to realize these benefits could be adversely affected by practical or legal
constraints on our ability to combine operations. Finally, if our stock price decreases significantly, this may result in a reassessment of our goodwill (which includes significant goodwill related to the acquisition of CNT) to determine if an
impairment is necessary.



Our business is subject to risks from global
operations.



We conduct significant sales and customer
support operations in countries outside of the United States and also depend on non-U.S. operations of our contract manufacturers, and our distribution partners. Further, we utilize an India based firm, HCL Technologies, to provide certain software
engineering services, and our virtualization chip supplier, Aarohi Communications, is also reliant on offshore engineering. We derived approximately 33% of our revenue for the nine months ended October 31, 2005, from customers located outside
of the United States. We believe that our continued growth and profitability will require us to continue to expand marketing and selling efforts 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 and different languages;
| | - |  | ---------------------------------------------------------------------------------------------------------------



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| |  |  | difficulties in staffing and managing international operations, including recruiting qualified personnel in foreign markets and reliance on third parties to manage certain aspects
of our foreign operations, including hub inventory locations;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | unusually high expenses and timeliness with the hiring and termination of employees in foreign countries;
| | - |  | ---------------------------------------------------------------------------------------------------------



| |  |  | multiple, conflicting and changing governmental laws and regulations, including difficulty in enforcing our legal rights in foreign jurisdictions;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | tariffs, quotas and other import or export restrictions, trade protection measures and other regulatory requirements on computer peripheral equipment;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | longer sales cycles for our products;
| | - |  | -------------------------------------



| |  |  | reduced or limited protections of intellectual property rights;
| | - |  | ---------------------------------------------------------------



| |  |  | adverse tax consequences, including imposition of withholding or other taxes on payments by subsidiaries and customers;
| | - |  | -----------------------------------------------------------------------------------------------------------------------



| |  |  | compliance with international standards that differ from domestic standards;
| | - |  | ----------------------------------------------------------------------------



| |  |  | risks surrounding any product and software outsourcing activities in foreign countries; and
| | - |  | -------------------------------------------------------------------------------------------



| |  |  | political, social and economic instability in a specific country or region.
| | - |  | ---------------------------------------------------------------------------



Any negative effects on our international business could harm our business, operating results and financial condition as a whole. To date, a large
percentage of our international revenue has been denominated in U.S. dollars. As a result, an increase in the value of the U.S. dollar relative to foreign currencies could make our products more expensive 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.



Unforeseen environmental costs could impact our future net earnings.



Some of our operations use substances regulated under various federal, state
and international laws governing the environment, including those governing the discharge of pollutants into the air and water, the management and disposal of hazardous substances and wastes and the cleanup of contaminated sites. Certain of our
products are subject to various federal, state and international laws governing chemical substances in electronic products. We could incur costs, fines and civil or criminal sanctions, loss of revenue, third-party property damage or personal injury
claims if we were to violate or become liable under environmental laws. The ultimate costs under environmental laws and the timing of these costs are difficult to predict.



The European Union has finalized the Waste Electrical and Electronic Equipment Directive, which makes producers of
electrical goods financially responsible for specified collection, recycling, treatment and disposal of past and future covered products. This directive is being enacted and implemented by individual European Union governments (such legislation
together with the directive, the WEEE Legislation), and certain producers are to be financially responsible under the WEEE Legislation beginning in August 2005. In addition, the European Parliament has enacted a requirement for the
elimination or reduction of hazardous substances (RoHS). This legislation governs the recovery of such substances as mercury, lead, cadmium, and hexavalent chromium. We are currently reviewing the applicability of WEEE and RoHS Legislation to our
electronic products. Accordingly, we cannot currently estimate the extent of increased costs resulting from the WEEE and RoHS Legislation. Similar legislation may be enacted in other geographies, including federal and state legislation in the United
States, the cumulative impact of which could be significant costs.



Increased international political instability may decrease customer purchases, increase our costs and disrupt our business.



Increased international political instability as demonstrated by the September 11, 2001 terrorist attacks, disruption in air transportation and
enhanced security measures as a result of the terrorist attacks and increasing tension in the Middle East, may hinder our ability to do business and may increase our costs. Additionally, this increased instability may, for example, negatively impact
the capital markets and the reliability and cost of transportation and adversely affect our ability to obtain adequate insurance at reasonable rates or require us to incur costs for extra security precautions for our operations. In



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addition, to the extent that air transportation is delayed or disrupted, the operations of our contract manufacturers and suppliers may be disrupted,
particularly if shipments of components and raw materials are delayed. If this international political instability continues or increases, our business and results of operations could be seriously harmed and we may not be able to obtain financing in
the capital markets.



Risks related to internal controls.



Public companies in the United States are required to review their internal
controls under the Sarbanes-Oxley Act of 2002. It should be noted that any system of controls, however well designed and operated, can provide only reasonable, and not absolute, assurance that the objectives of the system are met. In addition, the
design of any control system is based in part upon certain assumptions about the likelihood of future events. Because of these and other inherent limitations of control systems, there can be no assurance that any design will succeed in achieving its
stated goals under all potential future conditions, regardless of how remote. The acquisition of CNT in June, 2005 added significantly to the size, complexity and geographic reach of our operations and increased the risk that our control systems
will not be adequate to prevent or detect errors in our financial statements. If the internal controls put in place by us are not adequate or in conformity with the requirements of the Sarbanes-Oxley Act of 2002, and the rules and regulations
promulgated by the Securities and Exchange Commission, we may be forced to restate our financial statements and take other actions which will take significant financial and managerial resources, as well as be subject to fines and other government
enforcement actions.



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 we may not
be aware that someone is using our rights without our authorization. In addition, the steps we have taken, and those we may take in the future, 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. 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 or other claims and any resulting
litigation or arbitration could subject us to significant costs, liability for damages or could cause our proprietary rights to be invalidated or deemed unenforceable, which could allow third parties to use our rights without reservation. Litigation
or arbitration, regardless of the merits of the claim or outcome, would likely be time consuming and expensive to resolve and would divert management time and attention. Any potential intellectual property litigation filed against us 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, our customer relationships would be seriously harmed and our revenue would be reduced.



If we fail to optimize our distribution channels and manage our distribution relationships, our revenue or operating results could be significantly reduced. Our
competitors may sell their products directly to end-user customers.



Our success will depend on our continuing ability to develop and manage relationships with significant OEMs, resellers and systems integrators, as well as on the sales efforts and success of these customers. We cannot
provide assurance that we will be able to expand our distribution channels or 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 OEM and reseller customers to sell our products could reduce our revenue and operating results.



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 including IBM, LSI Logic and eSilicon. We
purchase application specific integrated circuits (ASICs), special purpose processors and power supplies from single



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sources, and gigabit interface converters and optic 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 delays or the inability to meet our customers demands and result in decreased revenue. We do not have any long-term supply contracts to ensure
sources of supply of components. 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. Further, we have purchased components from our suppliers from time to time that have been subsequently found not to meet the suppliers published specifications. If our suppliers are
unable to provide (or we are unable otherwise to obtain) components for our products on the schedule and in the quantities and quality we require, we will be unable to manufacture our products. We have experienced and may continue to experience
production delays and quality control problems with certain of our suppliers, which, if not effectively managed, could prevent us from satisfying our production requirements. 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 manufacturers, or the failure to forecast demand accurately for our products or to manage our relationship with our contract manufacturers successfully, would negatively impact our ability
to manufacture and sell our products.



We rely on Sanmina
SCI, Inc. (SSCI) and Solectron Corporation, together our contract manufacturers, to manufacture our products. Our contract manufacturers are 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. In addition, our contract manufacturers do not guarantee that adequate capacity will be available to us within the time required to meet additional demand for our products. We generally place forecasts for
products with our contract manufacturers approximately four to five months prior to the anticipated delivery date, with order volumes based on forecasts of demand for our products. We generally place purchase orders sixty calendar days in advance of
delivery. If we fail to forecast demand for our products accurately, we may be unable to obtain adequate manufacturing capacity from our contract manufacturers to meet our customers delivery requirements or unexpected increases in customer
purchase orders. As a result, we may not be able to benefit from any incremental demand and could lose customers. If we over-estimate demand for our product, we may accumulate excess inventories and obligations to our contract manufacturers under
binding purchase orders in excess of our needs. At October 31, 2005, the Companys commitment with our Contract Manufacturers for purchases over the next 60 days totaled $95.1 million, and $19.2 million for commitments beyond 60 days.



In addition, we coordinate our efforts with those of our
component suppliers and contract manufacturers in order to rapidly achieve volume production. We have experienced and may continue to experience production delays and quality control problems with certain of our suppliers and with our contract
manufacturers, which, if not effectively managed, could prevent us from satisfying our production requirements on a timely basis and could harm our customer relationships. If we should fail to manage effectively our relationships with our component
suppliers or contract manufacturers, or if any of our suppliers or our manufacturers experience delays, disruptions, capacity constraints or quality control problems in their manufacturing operations, our ability to ship products to our customers
could be delayed, and our competitive position and reputation could be harmed. Qualifying a new 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 significant revenue and seriously damage our customer relationships.



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



Our ability to successfully implement our business plan, develop and offer products, and manage expansion in a rapidly evolving market requires a
comprehensive and effective planning and management process. We continue to increase the scope of our operations domestically and internationally. In addition, in September 2003, we acquired Sanera and Nishan and in June 2005, we acquired CNT, which
significantly increased the size of our operations. Our growth in business and relationships with customers and other third parties has placed, and will continue to place, a significant strain on management systems, resources, intercompany
communication and coordination. As we grow, our failure to maintain and to continue to improve upon our operational, managerial and financial controls, reporting systems, processes and procedures, and/or our failure to continue to expand, train, and
manage our work force worldwide, could seriously harm our business and financial results.



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If we fail to successfully develop the McDATA brand, our revenue may not grow.



Our name is not widely recognized as a brand in the marketplace given our
historical indirect sales model. We believe that establishing and maintaining the McDATA brand is a critical component in maintaining and developing strategic OEM, 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. 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.



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. In addition, our products are combined with products from other vendors. As a
result, should problems occur, it might 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, cause delays in delivering our products or meeting customer demands and
would increase our costs, reduce our revenue and cause significant customer relations problems. Errors could also result in the need for us to upgrade existing products at customer locations, which would increase our costs or cause significant
customer relations problems.



We are a defendants in class action lawsuits
and we may be subject to further litigation in the future which could seriously harm our business.



As more fully set forth our Consolidated Financial Statements, we are a defendant in several class action lawsuits. We may become subject to additional
class action litigation following a period of volatility in the market price of our common stock. Securities class action litigation results in substantial costs and diverts the attention of management and our resources and seriously harms our
business, financial condition and results of operations. In addition, and as a result of the CNT acquisition, CNT and its subsidiaries are involved in various lawsuits that we are now defending against. Defense costs, an adverse judgment or even a
significant settlement of these lawsuits may adversely affect our financial results in any given fiscal quarter.



We have an uneven sales pattern.



Our quarterly operating results may vary due to the following factors:



| |  |  | the size, timing, terms and fluctuations of customer orders, which are often grouped toward the end of a calendar quarter, particularly large orders from EMC, IBM or HDS;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | pricing discussions late in a quarter and a limited capability to ramp shipments near the end of that quarter;
| | - |  | --------------------------------------------------------------------------------------------------------------



| |  |  | sales mix among our storage network products and services;
| | - |  | ----------------------------------------------------------



| |  |  | fluctuations in our direct sales to customers;
| | - |  | ----------------------------------------------



| |  |  | our ability to attain and maintain market acceptance of our existing product and new products;
| | - |  | ----------------------------------------------------------------------------------------------



| |  |  | seasonal fluctuations in customer buying patterns;
| | - |  | --------------------------------------------------



| |  |  | the timing of the introduction of, or enhancement to, products by us, our significant OEM or reseller customers or our competitors (e.g., transition to higher speed, higher port
density and multi-protocol products);
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our ability to obtain sufficient supplies of third party products or single- or limited-source components for our own products; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------



| |  |  | increased operating expenses, particularly in connection with our strategies to increase customer touch and purchase preference for our products or to invest in research and
development.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Our uneven sales pattern makes it
difficult for our management to predict near-term demand and adjust manufacturing capacity. Further, our OEM and reseller partners may purchase certain of our products ahead of end-user customer demand, which could reduce subsequent purchases by
those partners. 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



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corresponding and timely reduction in expenses could intensify the impact of these factors on our business, financial condition and results of operations.



The sales cycle for our products is long, and we may incur substantial
non-recoverable expenses and devote significant resources to prospects that do not produce revenues in the foreseeable future or at all.



Our OEMs, reseller and systems integrator customers typically conduct significant evaluation, testing, implementation and quality 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 revenue, if any, from these
relationships. Products that are not qualified by storage and system OEMs and resellers may not gain market acceptance. Our OEM and reseller customers have multiple sources for products similar to ours, and as such, may not qualify our products for
any number of reasons.



We may engage in future acquisitions that dilute our
stockholders ownership and cause us to use cash, incur debt or assume contingent liabilities.



As part of our strategy, from time to time we expect to review opportunities to buy other businesses or technologies that would complement our current
products, expand the breadth of our markets or enhance our technical capabilities, or that may otherwise offer growth opportunities. We may buy businesses, products or technologies in the future. In the event of any future purchases, we could:



| |  |  | issue stock that would dilute our current stockholders percentage ownership;
| | - |  | -----------------------------------------------------------------------------



| |  |  | use cash, which may result in a reduction of our liquidity;
| | - |  | -----------------------------------------------------------



| |  |  | incur debt; or
| | - |  | --------------



| |  |  | assume liabilities.
| | - |  | -------------------



These purchases also involve numerous risks, including:



| |  |  | problems combining and integrating the purchased operations, technologies, personnel or products;
| | - |  | -------------------------------------------------------------------------------------------------



| |  |  | unanticipated costs;
| | - |  | --------------------



| |  |  | diversion of managements attention from our core business;
| | - |  | -----------------------------------------------------------



| |  |  | adverse effects on existing business relationships with suppliers and customers;
| | - |  | --------------------------------------------------------------------------------



| |  |  | risks associated with entering markets in which we have no or limited prior experience; and
| | - |  | -------------------------------------------------------------------------------------------



| |  |  | potential loss of key employees of acquired organizations.
| | - |  | ----------------------------------------------------------



We may not be able to successfully integrate any businesses, products, technologies or personnel that we might acquire in the future. In addition,
technology acquisitions of start-up companies could result in one-time charges related to acquisition costs, severance costs, employee retention costs and in-process research and development.



We may require, or could elect, to seek additional funding.



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, any acquisitions of businesses, and
market acceptance of our products. With changes in operating and industry expectations, we could require, or could elect, to seek additional funding including accessing the equity and debt markets. Moreover, we may have difficulty obtaining
additional financing and our ability to obtain financing will be dependent on our operating performance.



McDATA has guaranteed the payment of principal and interest on approximately $124.4 million principal amount of CNTs 3.00 % convertible
subordinated notes due 2007. In addition, McDATA has $172.5 million principal amount of outstanding 2.25% subordinated convertible notes due 2010. Unless the price of our common stock increases significantly so that the holders of the
convertible notes find it economically advantageous to exercise the conversion feature and receive common stock in lieu of a cash payment of the principal amount and any accrued interest, we may have to repay the debt in cash. At present, we have
sufficient resources to satisfy these obligations as they mature. However, in the future, we may lack



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the resources to satisfy these obligations as they mature, and there can be no assurance that we will possess the resources or be able to secure the
resources to satisfy these obligations on commercially reasonable terms, if at all. Any failure by us to satisfy these obligations when due would have a material adverse effect on 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. Because we often seek to hire individuals
with relevant experience in our industry, we may be subject to claims of this kind or other claims relating to our employees in the future. 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.



Our products must comply with governmental regulation.



In the United States, our products comply with various regulations and standards defined by the Federal Communications Commission and Underwriters
Laboratories. Internationally, products that we develop will be required to comply with standards established by authorities in various countries. In the last several years, the European Union (EU) has adopted a number of initiatives (WEEE, RoHS,
etc.) related to equipment emissions, electronic waste, privacy of information and expanded consumer warranties. Failure to comply with existing or evolving industry standards or to obtain timely domestic or foreign regulatory approvals or
certificates could seriously harm our business.



Providing
telecommunications services to our customers subjects us to new risks.



Our provision of telecommunications and bandwidth to our customers subjects us to various risks. First, telecommunications networks and circuits can fail which would make it difficult for us to attract and retain
clients. In addition, we may experience difficulty in obtaining or developing circuits to provide to our clients. The telecommunications industry is heavily regulated by state and federal governments, and changes in these regulations could make it
difficult for us to compete. In addition, the regulatory framework under which we operate and new regulatory requirements or new interpretations of existing regulatory requirements could require substantial time and resources for compliance, which
could make it difficult for us to operate our business. Such regulation could also impede our ability to enter into change-of-control transactions.



Provisions in our charter documents, our rights agreement 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, by-laws and rights agreement 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;
| | - |  | ------------------------------------------------------------



| |  |  | requiring super-majority voting to effect certain amendments to our certificate of incorporation and by-laws; and
| | - |  | -----------------------------------------------------------------------------------------------------------------



| |  |  | requiring parties to request board approval prior to acquiring 15% or more of the voting power of our common stock to avoid economic and voting dilution of their stock holdings.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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 common stock to decline.



Our stock price is volatile.



The market price of our common stock has been volatile. Because we are a technology company, the market price of our common stock is usually subject to
similar volatility and fluctuations that occur in our sector and to our competitors. This



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volatility is often unrelated or disproportionate to the operating performance of our company and, as a result, the price of our common stock could fall
regardless of our performance.



Risks Related to Our Relationship With EMC



We have entered into agreements with EMC that, due to our prior
parent-subsidiary relationship, may contain terms less beneficial to us than if they had been negotiated with unaffiliated third parties.



In October 1997, and in connection with the reorganization of our business, we entered into certain agreements with EMC relating to our business
relationship with EMC. In addition, we have entered into agreements with EMC relating to our relationship with EMC after the completion of our initial public offering in August 2000 and the distribution by EMC of our Class A common stock in
February 2001. We have also entered into an OEM Purchase and License Agreement with EMC that governs EMCs purchases of our products and grants EMC rights to use, support and distribute software for use in connection with these products. The
agreement does not provide for the purchase of a guaranteed minimum amount of product. These agreements were negotiated and made in the context of our prior parent-subsidiary relationship. As a result, some of these agreements may have terms and
conditions, including the terms of pricing, that are less beneficial to us than agreements negotiated with unaffiliated third parties. Sales and services revenue pursuant to these agreements with EMC represented approximately 33% of our revenue for
the nine months ended October 31, 2005. 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 or from entering into similar
agreements with third parties.



Provisions of our agreements with EMC
relating to our relationship with EMC after the distribution of our Class A common stock to EMCs stockholders may prevent a change in control of our company.



Under the terms of the May 2000 Master Confidential Disclosure and License Agreement between EMC and us, EMC has granted us
a license to then existing EMC patents and we granted to EMC a license to then existing McDATA patents. If we are acquired, our acquirer will retain this license as long as our acquirer grants to EMC a license under all of the acquirer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 under this agreement could decrease our attractiveness as an acquisition
target.



|ITEM 3. | Quantitative and Qualitative Disclosures about Market Risks
|------- | -----------------------------------------------------------



We are exposed to market risk, primarily from changes in interest rates, foreign currency exchange rates and credit risks.



Interest Rate Risk



We earn interest income on both our cash and cash equivalents and our investment portfolio. Our investment portfolio
generally consists of readily marketable investment-grade debt securities of various issuers and maturities ranging primarily from overnight to three years. All investments are denominated in U.S. dollars and are classified as available for
sale. These instruments are not leveraged, and are not held for trading purposes. As interest rates change, the amount of realized and unrealized gain or loss on these securities will change. The quantitative and qualitative disclosures about
market risk are discussed in Item 7AQualitative and Quantitative Disclosure About Market Risk, contained in our Form 10-K for fiscal year 2004.



Our convertible subordinated debt is subject to a fixed interest rate and the notes are based on a fixed conversion ratio into Class A common stock.
The Company has two interest-rate swap agreements covering its convertible debt. The first was entered into by the Company in July 2003 covering $155.3 million of its 2.25% convertible subordinated notes (2.25% Notes) and is set at six-month
LIBOR minus 152 basis points, and the second was assumed in the acquisition of CNT which covers $75.0 million of the 3.00% convertible subordinated notes (3.00% Notes) previously issued by CNT and is set at three-month LIBOR plus 69.5 basis points.
Both agreements have the economic effect of modifying the fixed interest obligations associated with the notes so that the interest payable on the majority of the notes effectively becomes variable. If interest rates on this variable rate debt were
to increase or decrease, our annual interest expense would increase or decrease accordingly. This increased or decreased interest expense would be partially offset by the effects of these interest rate changes on our cash and investment portfolio.
The 2.25% Notes are not listed on any securities exchange or included in any automated quotation system; however, the notes are eligible for trading on the PortalSM Market. On October 31, 2005, the approximate bid and ask prices per $100 of our
2.25% Notes was $83.50 and $84.50, respectively, resulting in an aggregate fair value of between $144.0 million and $145.8 million. On October 31, 2005, the approximate bid and ask prices per $100 of our 3.00% Notes was $96.00 and $97.00,
respectively, resulting in an aggregate fair value of between $119.4 million and $120.6 million. Our Class A common stock is quoted on the Nasdaq National Market under the symbol, MCDTA. On December 6, 2005, the last
reported sale price of our Class A common stock on the Nasdaq National Market was $3.64 per share.



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Foreign Currency Exchange Risk



We operate sales and support offices in several countries. We are exposed to market risks related to fluctuations in foreign
exchange rates because some sales transactions, and the assets and liabilities of our foreign subsidiaries, are denominated in foreign currencies, primarily the euro and British pounds sterling. As of October 31, 2005, we had no open forward
exchange contracts.



Credit Risk



Financial instruments, which potentially subject us to concentrations of
credit risk, consist principally of temporary cash investments, investments and trade receivables. We place our temporary cash investments and investment securities in primarily investment grade instruments and limit the amount of investment with
any one financial institution. We evaluate the credit risk associated with each of our customers, including our largest customers, EMC and IBM, but generally do not require collateral. We depend on these two customers for most of our total revenue.
They also comprise a significant portion of our trade receivables and, therefore, expose us to a concentration of credit risk.



A small portion of our cash is invested in higher yielding investments, and within those investments there may be small amounts invested in derivative
financial instruments. These investments are diminimus relative to our overall cash portfolio, and are not subject to any risk beyond our principal investment. We mainly invest our cash, cash equivalents and marketable securities in investment
grade, highly liquid investments, consisting of money market instruments, bank certificates of deposits, government obligations and corporate debt instruments.



In conjunction with the issuance of our convertible subordinated notes, we also entered into share option transactions on our Class A common stock
with Bank of America, N.A. and /or certain of its affiliates. Subject to the movement in our Class A common stock price, we could be exposed to credit risk arising out of net settlement of these options in our favor. Based on our review of the
possible net settlements and the credit strength of Bank of America, N.A. and its affiliates, we have concluded that we do not have a material exposure to credit risk as a result of these share option transactions.



In July 2003, we entered into an interest-rate swap agreement with
JPMorgan Chase Bank (JPMorgan). Subject to the movement in interest rates, we could be exposed to credit risk arising out of net interest payments due to us from JPMorgan. Based on our review of the possible movement in interest rates and the credit
strength of JPMorgan, we have concluded that we do not have a material exposure to credit risk as a result of this interest-rate swap.



In January 2004, CNT entered into an interest-rate swap agreement with Credit Suisse First Boston (CFSB). Subject to the movement in interest rates, we
could be exposed to credit risk arising out of net interest payments due to us from CFSB. Based on our review of the possible movement interest rates and the credit strength of CFSB, we have concluded that we do not have a material exposure to
credit risk as a result of this interest-rate swap



|ITEM 4. | Controls and Procedures
|------- | -----------------------



Evaluation of Disclosure Controls and Procedures



The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Companys
reports under Securities Exchange Act of 1934, as amended (the Exchange Act), is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms, and that such information is accumulated and
communicated to the management of McDATA Corporation (Management), including the Companys Chief Executive Officer (CEO) and Chief Financial Officer (CFO), as appropriate, to allow timely decisions regarding required disclosure. In designing
and evaluating the disclosure controls and procedures, Management recognizes that any controls and procedures, no matter how well designed and operated, can only provide reasonable assurance of achieving the desired control objectives. As a result,
the Companys CEO and CFO have concluded that, based upon the evaluation of disclosure controls and procedures (as defined in Rule 13a-15(e) or 15d-15(e) under the Exchange Act), the Companys disclosure controls and procedures were
effective as of the end of the period covered by this report.



Changes in
Internal Control Over Financial Reporting



The
Companys Management, with the participation of the CEO and CFO, have evaluated whether any change in the Companys internal control over financial reporting occurred during the third quarter of fiscal 2005. Based on that evaluation,
Management concluded that there has been no change in the Companys internal control over financial reporting



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during the third quarter of fiscal 2005 that has materially affected, or is reasonably likely to materially affect, the Companys internal control over
financial reporting.



PART IIOTHER INFORMATION



|ITEM 1. | Legal Proceedings
|------- | -----------------



From time to time, we become involved in various lawsuits and legal proceedings that arise in the normal course of business. Litigation is subject to
inherent risks and uncertainties and an adverse result in any matter may harm our business, financial condition or results of operations. In the opinion of management and except as otherwise noted, the ultimate disposition of any of the claims
described herein are not expected to have a material adverse effect on our consolidated results of operations, financial position or cash flow. Please see Note 15 of the Condensed Consolidated Financial Statements for a description of the litigation
matters.



ITEMS 2 and 3 are not applicable and have been omitted.



|ITEM 4. | Submission of Matters to a Vote of Security Holders
|------- | ---------------------------------------------------



The annual meeting of the Companys stockholders was held on December 6, 2005. At that meeting, two proposals were submitted to a vote of the
Companys stockholders. Proposal 1 was a proposal to elect three directors, D. Van Skilling, Thomas M. Uhlman and Michael J. Sophie to serve until the 2008 Annual Meeting of Stockholders. Proposal 2 was a proposal to ratify the appointment of
Deloitte & Touche LLP as the Companys independent public accountants for the fiscal year ending January 31, 2006. For further information regarding the annual meeting, please see the Companys Proxy Statement on Schedule 14A filed
with the SEC. All proposals were approved by shareholders.



|                                                               |  |                 |  |         |  |                 
|-------------------------------------------------------------- |  | --------------- |  | ------- |  | ----------------
|                                                               |  | Number of Votes
|Proposal                                                       |  | For             |  | Against |  | Abstain/Withhold
|Proposal 1 - Election of director: D. Van Skilling             |  | 111,262,962     |  |        |  | 2,275,480       
|Proposal 1 - Election of director: Thomas M. Uhlman            |  | 108,639,037     |  |        |  | 4,899,405       
|Proposal 1 - Election of director: Michael J. Sophie           |  | 111,563,505     |  |        |  | 1,974,937       
|Proposal 2 - Ratification of Deloitte & Touche LLP appointment |  | 112,913,715     |  | 545,781 |  | 78,943          



|ITEM 5. | Other Information
|------- | -----------------



On December 6, 2005, the Board of Directors, upon recommendation by the Corporate Governance and Nominating Committee based on bench mark
compensation information, approved changes in the cash compensation for directors. Effective February 1, 2006, the annual director retainer will be increased from $15,000 a year to $25,000 a year, the audit committee chair fee will be increased
from $2,000 a year to $10,000 a year and the other committee chair fees will be increased from $1,500 a year to $2,000 a year.



|ITEM 6. | Exhibits
|------- | --------



|(a) | Exhibits filed for the Company through the filing of this Form 10-Q.
|--- | --------------------------------------------------------------------



|     |  |                                                                     
|---- |  | --------------------------------------------------------------------
|31.1 |  | Certification of Chief Executive Officer                            
|     | 
|31.2 |  | Certification of Chief Financial Officer                            
|     | 
|32   |  | Certification of Chief Executive Officer and Chief Financial Officer



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SIGNATURE



Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.



McDATA CORPORATIONBy:

/s/ SCOTT BERMANScott BermanSenior Vice President of Finance and Chief Financial Officer




By:

/s/ RANDY SCHEERRandy (Larry R.) ScheerController Chief Accounting Officer




December 9, 2005



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