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UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549

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FORM 10-K

|ý                                           | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934    
|------------------------------------------- | ----------------------------------------------------------------------------------------
|for the fiscal year ended December 31, 2002
|OR                                         
|o                                           | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
|for the transition period from  to         

Commission File No. 000-31257

McDATA Corporation(Exact name of registrant as specified in its charter)

A Delaware Corporation

84-1421844(State or other jurisdiction
of incorporation or organization)

(I.R.S. Employer
Identification No.)


380 Interlocken Crescent, Broomfield, Colorado 80021
Telephone Number (303) 460-9200

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Securities registered pursuant to Section 12(b) of the Act:

Title of each class

Name of Each Exchange on
Which RegisteredMcDATA Class B Common Stock
($0.01 per share, par value)

Nasdaq National Market


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Securities
registered pursuant to Section 12(g) of the Act:

McDATA
Class A Common Stock
($0.01 per share, par value)
Nasdaq National Market

At
March 24, 2003, approximately 81,000,000 shares of the registrant's Class A Common Stock were outstanding and approximately 33,483,479 shares of the registrant's
Class B Common Stock were outstanding.
At June 28, 2002, the aggregate market value of the registrant's Class A Common Stock held by non-affiliates was approximately $713,025,086.48 million and the
aggregate market value of the registrant's Class B Common Stock held by non-affiliates was approximately $201,407,516.20 million.

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 ý    No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K [    ]

Indicate
by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of
1934). Yes ý    No o

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McDATA Corporation
Form 10-K

TABLE OF CONTENTS



|Item |  | Description                                                                           |  | Page
|---- |  | ------------------------------------------------------------------------------------- |  | ----
|     |  | PART I                                                                                |  | 17  
|1.   |  | Business                                                                              |  | 17  
|2.   |  | Properties                                                                            |  | 31  
|3.   |  | Legal Proceedings                                                                     |  | 32  
|4.   |  | Submission of Matters to a Vote of Security Holders                                   |  | 33  
|     |  | PART II                                                                               |  | 34  
|5.   |  | Market for Registrant's Common Equity and Related Stockholder Matters                 |  | 34  
|6.   |  | Selected Financial Data                                                               |  | 35  
|7.   |  | Management's Discussion and Analysis of Financial Condition and Results of Operations |  | 35  
|7A.  |  | Quantitative and Qualitative Disclosures about Market Risk                            |  | 44  
|8.   |  | Consolidated Financial Statements and Supplementary Data                              |  | 45  
|9.   |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure  |  | 45  
|     |  | PART III                                                                              |  | 46  
|10.  |  | Directors and Executive Officers of the Registrant                                    |  | 46  
|11.  |  | Executive Compensation                                                                |  | 51  
|12.  |  | Security Ownership of Certain Beneficial Owners and Management                        |  | 64  
|13.  |  | Certain Relationships and Related Transactions                                        |  | 67  
|14.  |  | Controls and Procedures                                                               |  | 67  
|     |  | PART IV                                                                               |  | 68  
|15.  |  | Exhibits, Financial Statement Schedules, and Reports on Form 8-K                      |  | 68  

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McDATA Corporation
FORM 10-K

Special Note Regarding Forward-Looking Statements

Some of the information presented in this Annual Report on Form 10-K, or the Annual Report, contains "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995, or the Reform Act. Although McDATA Corporation, referred to as McDATA or the Company and also 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 and cause fluctuations in our stock price include:



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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.

Risk Factors

Risks Relating to Our Business

We incurred a substantial loss for the year ended December 31, 2001 and a loss for the year ended December 31, 2002 and may not obtain profitability in the
future.

We
incurred a substantial loss for the year ended December 31, 2001 and a loss for the year ended December 31, 2002. Although recently we have had profitable quarters, we
have not been able to sustain profitability from quarter to quarter and may not be profitable in the future. Our future operating results will depend on many factors, including the growth of the Fibre
Channel 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 also anticipate expenses related to the implementation of an
"outsourcing focused" manufacturing model during 2003. We cannot provide assurance that we will generate sufficient revenue to achieve or sustain profitability.

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. We derived approximately 37% of our 2002 revenue 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:



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Any
negative effects on our international business could harm our business, operating results and financial condition as a whole. To date, substantially all of our international revenue
or costs have 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.

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 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 harmed and we may not be able to obtain financing in the capital markets.

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

In response to changes in product mix, competitive pricing pressures, increased sales discounts, introductions of new products and product enhancements by our
competitors, increase in manufacturing or labor costs or other factors, we may experience declines in both the prices and gross margins in some or all of our products. To maintain our gross margins we
must maintain or increase current shipment volumes, develop and introduce new products and product enhancements and reduce the manufacturing cost of 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, operating results and gross margins may be below our expectations and those of investors and stock market analysts.

We may incur an expense relating to the impairment of our deferred tax assets.

As of December 31, 2002, we have deferred tax assets of $36.4 million, which we believe will be realized more likely than not through future
profitable operations. However, it is possible that if additional operating losses are incurred, or if we otherwise conclude that our deferred tax asset will not be realized through future operations,
we may need to provide a valuation allowance to recognize the impairment of our deferred tax assets. To the extent we were to establish a valuation allowance, we would recognize an expense within the
tax provision of our income statement, which could materially impact our financial position and results of operations.

We depend on two key distribution relationships for most of our revenue and the loss of either of them could significantly reduce our revenues.

We depend on EMC and IBM for a significant portion of our total revenue. Sales and services to EMC, which is an original equipment manufacturer customer,
represented approximately 54% of our

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revenue for the year ended December 31, 2002. In 2001, EMC agreed to resell products offered by one of our competitors, and nothing restricts EMC from expanding those relationships in a manner
that could be adverse to us. Sales to IBM represented approximately 25% of our total revenue for the year ended December 31, 2002. We anticipate that our future operating results will continue
to depend heavily on sales to EMC and IBM. Therefore, the loss of either EMC or IBM as a customer, or a significant reduction in sales to either EMC or IBM could significantly reduce our revenue.

The market for Fibre Channel switches and other products for SANs is highly competitive, new competitors have recently entered this market and we may not be able to
successfully compete against existing or potential competitors.

The market for our Fibre Channel switching products is highly competitive, and is likely to become even more so. Our primary competitor in the Fibre Channel
switch market is Brocade. Other companies are also providing Fibre Channel switches and other products to the SAN market, including QLogic Corporation, or QLogic, and INRANGE. In the future, we may
also compete with networking companies that may develop SAN products or companies in related or other industries for which future direct participation in the market for switching devices becomes
strategic. Some 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 we have.

In
August 2002, Cisco announced that it would be entering the storage switch market with the introduction of a family of switches and directors. In January 2003, Cisco
announced that it had entered into a non-exclusive agreement with IBM which would allow IBM to sell storage switches provided by Cisco in addition to the product lines provided by Brocade
and us. IBM is our second largest customer, and the agreement between Cisco and IBM may significantly reduce our sales to IBM. Also in January 2003, Hewlett-Packard Co., or HPQ, announced that
it would resell Cisco's new line of Fibre Channel switches. HPQ has substantial sales within the SAN infrastructure market, and the agreement between HPQ and Cisco could significantly reduce our
future sales to HPQ. The introduction of Cisco's competing product line may delay purchase decisions by our customers. Furthermore, Cisco has greater access to enterprise customers and greater direct
sales experience and capacity than we do. To be competitive with Cisco and others, we may have to substantially increase our direct sales, which we may not be able to do successfully and which, in any
case, will increase expenses.

In
August 2000, EMC agreed not to develop or manufacture products that compete with our then-existing products for two years. Since August 2002, EMC has
not been contractually restricted from competing with us in the development or manufacture of these products. In addition, EMC has recently agreed to resell certain products offered by two of our
competitors. Moreover, under a cross license agreement between us and EMC, we have granted EMC a license under our patents to make, use and sell any products that EMC was selling or distributing up to
August 9, 2000, including products that compete with ours.

Continued
or increased competition could result in pricing pressures, reduced sales, reduced margins, reduced profits, reduced market share or the failure of our products to achieve or
maintain market acceptance.

We currently have limited product offerings and must successfully introduce new products and product enhancements that respond to rapid technological changes and evolving
industry standards.

For the year ended December 31, 2002, we derived approximately 72% of our revenue from sales of our Director-class products. We expect that revenue from
our Director-class products will continue to account for a substantial portion of our revenue for the foreseeable future. Therefore, continued

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market acceptance of these products and their successor products is critical to our future success. Factors such as performance, market positioning, the availability and price of competing products,
the introduction of new technologies and the success of our OEMs, reseller and systems integrator customers will affect the market acceptance of our products.

In
addition, our future success depends upon our ability to address the changing needs of customers and to transition to new technologies and industry standards. The introduction of
competing products embodying new technologies or the emergence of new industry standards could render our products non-competitive, obsolete or unmarketable and seriously harm our market
share, revenue and gross margin. For instance, there are competing protocols for storage area network switches and related devices, such as SCSI over Internet (iSCSI), Fibre Channel over IP (FCIP),
Internet Fibre Channel and InfiniBand, which may be more readily adopted or accepted by our customers. 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.

We
are currently developing next generation 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 our transition of our products from 1 to 2 Gb transmission speed technology and higher port density, we have begun
introducing products with new features and functionality. We face risks relating to this product transition, including risks relating to
forecasting of demand for 2 Gb and higher port density products and related transition issues, as discussed in the previous paragraph, 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 that are multi-protocol products to compete against
new entrants in the SAN market, or if there is no demand for these or our current products, our business could be seriously harmed.

Our products must continue to support and be interoperable with other SAN products.

SAN products are continuing to emerge and evolve. All components of the SAN must utilize the same standards in order to operate together. To remain competitive,
we must continue to introduce new products and product enhancements that are compatible and interoperable with other SAN products, industry standards and new technology. If our products are not
interoperable with SAN products we may have difficulty in selling our products and we may lose market share.

If we are unable to integrate the new members of our senior executive team, if we lose key personnel or if we are unable to hire additional qualified personnel, we may not be
successful.

Our success depends to a significant degree upon the continued contributions of our key management, technical, sales and marketing, finance and operations
personnel, many of whom would be difficult to replace. In particular, we believe that our future success is highly dependent on our senior executive team. In the past we have experienced high turnover
in our senior executive team. The majority of the current senior executive team was hired during the last eighteen months. Although our executive team consists of experienced members, many of them are
new to our company and have only worked with each other for a short period of time. As a result they may not operate efficiently as part of an integrated management team.

In
addition, our engineering and product development teams are critical in developing our products and have developed important relationships with customers and their technical staffs.
The loss

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of any of these key personnel could harm our operations and customer relationships. We do not have key person life insurance on any of our key personnel.

We
believe our future success will also depend in large part upon our ability to attract and retain highly skilled managerial, engineering, sales and marketing, and finance and
operations personnel. As we increase our production and sales levels, we will need to attract and retain additional qualified skilled workers for our operations. In recent years there has been
great demand for such personnel by companies, some of which are larger and have greater resources to attract and retain highly qualified personnel. We cannot assure you that we will continue to be
able to attract and retain qualified
personnel, or that delays in hiring required personnel, particularly engineers, will not delay the development or introduction of products or negatively impact our ability to sell our products.

If we 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.
In particular we filed on February 14, 2002, a patent infringement lawsuit against Brocade in the United States District Court for the District of Colorado (Case
No. 02-K-0303) alleging that Brocade's Advanced Performance Monitoring feature in its switch products infringed our U.S. Patent No. 6,233,236 "Method and
apparatus for measuring traffic within a switch." On March 5, 2002, we filed for a preliminary injunction against Brocade to immediately stop infringing the patent after Brocade announced
another product containing its Advanced Performance Monitoring feature.

On
April 8, 2002, Brocade filed an answer to the motion for preliminary injunction generally alleging that Brocade has not infringed and is not infringing the patent. Brocade
alleged various counterclaims in its answer including a claim that the patent is invalid and unenforceable, and that we misappropriated trade secret information from Brocade under prior agreements and
that a 1999 OEM agreement contained a covenant not to sue. The United States District Court for the District of Colorado on December 6, 2002 denied our motion for a preliminary injunction. We
filed documents on December 23, 2002 with the American Arbitration Association to initiate an arbitration proceeding to resolve contract and patent issues relating to the 1999 OEM agreement
with Brocade. On January 24, 2003, Brocade, in response to our initiating the arbitration proceeding, filed an answer and counterclaim with the American Arbitration Association that objected to
the inclusion of our patent infringement claims in the arbitration, claims the patent is invalid and unenforceable and claims we misappropriated trade secret information from Brocade. Although we
strongly believe that Brocade's counterclaims are factually incorrect and without any merit and we intend to vigorously pursue our patent infringement claims against Brocade, we cannot assure you we
will prevail.

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.

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Any
potential intellectual property litigation filed against us could also force us to do one or more of the following:



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 harmed and our revenue would be reduced.

In
March 1999, we, as an EMC subsidiary, granted IBM a license to all of our patents under a cross license agreement between IBM and EMC. Under the terms of that agreement,
effective upon EMC's February 7, 2001 distribution of our Class A common stock to its stockholders, the sublicense we previously held to those IBM patents terminated. We believe that the
termination of the sublicense does not materially affect our business. We are not aware of any issued or pending IBM patents that are infringed by our products, but if IBM were to allege any such
infringement, and we were unable to negotiate a settlement with IBM, our ability to produce the alleged infringing product could be affected, which could materially and adversely affect our business.

We have experienced increased inventory costs and delays and have incurred inventory-related write-downs.

We completed an operations review during fiscal year 2001, including an analysis of inventory transferred from our discontinued suppliers, a review of
obsolescence, end-of-life inventories, on-going inventory commitments and a year-end physical inventory analysis. Based on this review, we recorded an
inventory related charge of approximately $21.0 million during fiscal year 2001. Additionally, in the fourth fiscal quarter of 2001, we incurred a charge related to obsolescence of certain
demonstration and test equipment of approximately $4.1 million. For fiscal year 2002, we incurred an additional net $9.5 million inventory related charge related primarily to our 1 Gb
product inventory. There can be no
assurance that we will not incur additional inventory write-downs in the future or that any such write-downs would not have a material adverse affect on our future operating results.

During
2001, we experienced increased manufacturing and component costs related to a transition to multiple product lines and quality problems on component parts. Specifically, we
incurred increased costs and delays related to some mechanical features of our low-end and mid-range switch products. Also, we incurred additional costs related to our
die-cast chassis for these products. During the quarter ended June 30, 2002, we completed the use of this high cost inventory, which negatively affected our gross margins.

The storage area network market in which we compete is still developing, and if this market does not continue to develop and expand as we anticipate, our business will suffer.

The market for storage area network and related products has only recently begun to develop and continues to evolve. Because this market is relatively new, it is
difficult to predict its potential size or future growth rate. Potential end-user customers who have invested substantial resources in their existing data storage and management systems
may be reluctant or slow to adopt a new approach, like

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SANs. Our success in generating net revenue in this developing market will therefore depend on, among other things, our ability to:



Accordingly,
because substantially all of our revenues are derived from our SAN solutions, the adoption of SANs as an integral part of data-intensive enterprise computing environments is
critical to our future success and delays or failure to adopt our SAN and related products will have an adverse effect on revenue and operations.

If we fail to optimize our distribution channels and manage our distribution relationships, our revenue or operating results could be significantly reduced.

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. We purchase application specific integrated circuits (ASICs) and power supplies from
single 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 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. If our suppliers are unable to provide, or we are unable otherwise to obtain these components for our products on the schedule and in the
quantities we require, we will be unable to manufacture our products. 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 are in the process of implementing an "outsourcing-focused" manufacturing model. We rely on Sanmina SCI, Inc., or SSCI, and Solectron Corporation,
together our contract manufacturers, to manufacture substantially all of our circuit boards and to perform extensive testing and assembly of our

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products. Our supply contract with SSCI is cancelable by either party without cause on advance notice. In May 2002, we outsourced to SSCI the integration of our Directors into cabinets.
Recently, we contracted with Solectron to be our contract manufacturer for our Sphereon 4500 24-port switch product. 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 circuit boards
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 this 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 December 31, 2002, our commitment with our contract manufacturers for purchases and anticipated transformation costs over the next sixty days totaled approximately
$54.1 million. Additionally, our contract manufacturers had on hand materials purchased on our behalf valued at approximately $45.8 million.

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 revenue and damage our customer relationships.

The recent general economic slowdown may significantly reduce expenditures on information technology infrastructure.

Recent unfavorable general economic conditions have had a pronounced negative impact on information technology, or IT, spending. Demand for SAN products in the
enterprise-class sector may continue to be adversely impacted as a result of the weakened economy and because larger businesses have begun to focus on more efficiently using their existing IT
infrastructure rather than making new equipment purchases. This in turn may decrease the demand for our SAN products. If there are further reductions in either domestic or international IT
expenditure, or if IT expenditure does not increase from current levels, our revenues, operating results and financial condition may be adversely affected.

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. 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

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communication and coordination. As we grow, our failure to maintain and to continue to improve upon our operational, managerial and financial controls, reporting systems 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.

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

We have operated as a separate company from EMC only since February 2001. EMC, which currently accounts for a significant portion of our revenue, markets
our products under its own brand name. As a result, our name is not widely recognized as a brand in the marketplace. We believe that establishing and maintaining the McDATA brand is a critical
component in maintaining and developing strategic original equipment manufacturer, reseller and systems integrator relationships, and the importance of brand recognition will increase as the number of
vendors of competitive products increases. Our failure to successfully develop our brand may prevent us from expanding our business and growing our revenue. 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.

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

Several purported securities class action lawsuits have been filed against us. In particular, McDATA, one current officer and two former officers 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, Merrill Lynch, Pierce Fenner & Smith Incorporated, Bear, Stearns & Co., Inc., FleetBoston Robertson Stephens et
al., No. 01 CIV. 6627. Three other similar suits have been filed against us. The
complaints are substantially identical to over 300 other complaints filed against other companies that went public over the last several years. 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 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 and (b) that certain of the underwriters had entered into agreements with customers whereby the underwriters agreed to allocate initial public offering shares
in exchange for which the customers agreed to purchase additional company shares in the aftermarket at pre-determined prices. The complaints relating to us allege claims against us, one of
our current officers, two of our former officers and Credit Suisse First Boston, or CSFB, the lead underwriter for our August 9, 2000 initial public offering, under Sections 11 and 15 of
the Securities Act of 1933, as amended, or the Securities Act. Although we believe that all of the lawsuits are without legal merit and intend to defend them vigorously, we cannot assure you we will
prevail.

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In September 2002, plaintiffs' counsel in the above-mentioned lawsuits offered to individual defendants of many of the public companies being sued 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, our Chairman, Mrs. Dee J. Perry, our former chief financial officer, and Mr. Thomas O. McGimpsey, our former Vice President and General
Counsel, and the plaintiffs' executive committee. Under the Reservation of Rights and Tolling Agreement the plaintiffs are required to dismiss 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 that dismissed some, but not all, of the plaintiff's claims
against us.

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 could result in
substantial costs and divert the attention of management and our resources and seriously harm our business, financial condition and results of operation.

Our change of fiscal year may not result in more predictable quarterly earnings.

Historically, our quarterly operating results have depended on our performance in the later part of each quarter, when a large percentage of our product shipments
typically occur. This fluctuation has made consistent quarter-to-quarter performance and revenue forecasting difficult. We have adopted a number of measures to address this
issue, including changing our fiscal year end to January 31, rather than December 31. We cannot be certain that changing our fiscal year or adopting other measures will result in product
shipments occurring more evenly during each quarter, resulting in consistent quarter-to-quarter performance or improving revenue forecasts.

A large percentage of our quarterly sales occur at the end of the calendar quarter, contributing to possible quarterly fluctuations in revenue that could adversely affect our
operating results.

Our quarterly results have historically reflected an uneven pattern in which a disproportionate percentage of a quarter's total sales occurs in the last month,
weeks or even days of each calendar
quarter, resulting in our change of fiscal year end. This pattern makes the prediction of revenue, earnings and working capital for each financial period especially difficult and increases the risk of
unanticipated variations from anticipated quarterly results and financial condition. Additional factors that affect us and which could cause our revenue and operating results to vary in future periods
include:



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Our
uneven sales pattern makes it difficult for our management to predict near-term demand and adjust manufacturing capacity accordingly. If orders for our products vary
substantially from the predicted demand, our ability to assemble, test and ship orders received in the last weeks and days of each quarter may be limited, which could seriously harm quarterly
revenue or earnings. Moreover, an unexpected decline in revenue without a corresponding and timely reduction in expenses could intensify the impact of these factors on our business, financial
condition and results of operations.

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 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.

We may engage in future acquisitions that dilute our stockholders 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:



These
purchases also involve numerous risks, including:



We
may not be able to successfully integrate any businesses, products, technologies or personnel that we might acquire in the future.

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

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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 addition, in the United States, our products comply with various regulations and standards defined by the Federal Communications Commission and Underwriters
Laboratories. Internationally, products that we develop will be required to comply with standards established by authorities in various countries. Failure to comply with existing or evolving industry
standards or to obtain timely domestic or foreign regulatory approvals or certificates could materially harm our business.

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:



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 indebtedness could adversely affect our financial condition, and we may incur substantially more debt.

On February 7, 2003, we issued $172.5 million of our convertible subordinated notes due 2010, or the Notes. Our indebtedness could adversely affect
us. For example, it could:



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Neither
we nor our subsidiaries are restricted from incurring additional debt under the indenture governing the Notes. If we or our subsidiaries were to incur additional debt or
liabilities, the related risks described above could intensify and our ability to pay our obligations could be adversely affected.

We have entered into share option transactions and other transactions that may affect the value of our Class A and Class B common stock.

We have entered into share option transactions on our Class A common stock with Bank of America Securities, N.A. and/or certain of its affiliates to hedge
the market risks associated with our obligations under the Notes. Although we entered into share option transactions on our Class A common stock, Banc of America Securities LLC and/or certain
of its affiliates will take positions in our Class A common stock and/or Class B common stock in secondary market transactions and/or will enter into various derivative transactions in
connection with the issuance of the Notes. Such hedging arrangements could increase or decrease the price of our Class A common stock and Class B common stock. Banc of America Securities
LLC and/or its affiliates are likely to modify their hedge positions from time to time prior to and around the time of conversion or maturity of the Notes by purchasing and selling shares of our
Class A common stock and/or Class B common stock, our other securities or other instruments they may wish to use in connection with such hedging. We cannot assure you that such activity
will not affect the market price of our Class A common stock and/or Class B common stock.

We
may acquire shares of our Class A common stock and/or Class B common stock and enter into other transactions or arrangements to purchase or sell our Class A
common stock and/or Class B common stock during the term of the Notes. Depending on, among other things, future market conditions, the aggregate amount and composition of such transactions or
arrangements, the aggregate amount of any such acquisitions are likely to vary over time.

The
effect, if any, of any of these transactions and activities on the market price of our Class A common stock and/or Class B common stock will depend in part upon market
conditions and cannot be ascertained at this time, but any of these activities could materially and adversely affect the value of our Class A common stock and/or Class B common stock.

Our stock price is volatile.

Since our initial public offering of our Class B common stock in August 2000, the market price of our Class B common stock has been volatile.
Since the distribution of our Class A common stock by EMC in February 2001, the market price of our Class A common stock has been volatile. Because we are a technology company,
the market price of our Class A and Class B common stock is usually subject to the same volatility and fluctuations that have recently characterized the stock prices of other technology
companies. This volatility is often unrelated or disproportionate to the operating performance of these companies and, as a result, the price of our Class A and Class B 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, 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

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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, in the case of the OEM agreement, including the terms of pricing, that are less
beneficial to us than agreements negotiated with unaffiliated third parties. Sales and services revenue pursuant to these agreements represented approximately 54% of our revenue for the year ended
December 31, 2002. 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 by EMC of our Class A common stock to EMC's stockholders may affect
the operation of our business, limit our ability to finance our operations or prevent a change in control of our company.

Under the terms of the Tax Sharing Agreement between EMC and us, until May 2003, we may not, without the consent of EMC or the receipt by EMC of a private
letter ruling from the Internal Revenue Service that the tax treatment of the distribution will not be adversely affected:



These
restrictions may prevent us from being acquired, either in a negotiated transaction or otherwise, from using shares of our common stock as payment in the acquisition by us of other
companies or from financing our operations through sales of securities.

Under
the terms of the Master Confidential Disclosure and License Agreement between EMC and us, EMC has granted us a license under then existing EMC 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.

We may be obligated to indemnify EMC if the distribution of our Series A common stock to EMC's stockholders was not tax free.

The Tax Sharing Agreement that we have entered into with EMC obligates us to indemnify EMC for taxes relating to the failure of EMC's distribution to EMC's
stockholders of our Class A common stock that it indirectly held to be tax free if that failure results from, among other things:



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As
a result, we may be liable to EMC under the Tax Sharing Agreement upon the occurrence of events that are beyond our control. If the distribution of our Class A common stock
fails to qualify as a tax-free distribution, EMC would incur tax liability as if our Class A common stock that was distributed by EMC had been sold by EMC for its fair market value
in a taxable transaction, and we would be required to indemnify EMC under the Tax Sharing Agreement. In the event that we are required to indemnify EMC because the distribution of our Class A
common stock fails to qualify as a tax-free distribution, our liability could exceed 35% of the value of the Class A common stock distributed by EMC as determined on the date of the
distribution. If triggered, this indemnity obligation would have a significant adverse effect on our financial position and results of operations, and we might not have sufficient resources to fulfill
it.

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Part I

ITEM 1. Business

Who We Are

McDATA Corporation is a leading provider of open storage networking solutions and provides highly available, scalable and centrally managed SANs that address
enterprise-wide storage problems. McDATA's core-to-edge enterprise solutions consist of hardware products, software products and professional services. McDATA's SAN
solutions improve the network reliability and availability of data, simplify the management of SANs and reduce the total cost of ownership. As companies continue to migrate from server-centric to
storage-centric environments, they will require SAN solutions and a comprehensive family of products that span their enterprise from the core of their data center to the very edge of their SAN fabric.
McDATA Corporation was reorganized and incorporated in the state of Delaware in October of 1997.

Hardware Products

At the core of an enterprise's data center, we are the leading provider of high availability SAN directors with our Intrepid 6000
Series Directors consisting of the Intrepid 6140 Director (140 ports) and Intrepid 6064 Director (64 ports). The Intrepid 6000 Series Directors are
high performance, flexible building blocks for storage networks with hundreds and even thousands of connections. The distinction between a director-class environment and a simple combined or clustered
switching solution environment is significant at the core of the data center. Directors offer full redundancy, "five-nines" (99.999%) of availabilitya result of our near
instantaneous fail-over recovery, ultra-high predictive performance provided by our non-blocking architecture, security and highly integrated centralized management
provided through our software management tools. This provides customers with the most scalable, highest performance and highest availability solution to use for their SAN. Both the
Intrepid
6140 Director and Intrepid 6064 Director provide optimal port granularity with 4 ports per module with 35 and 16 swappable port card modules per chassis respectively for a total of 140
and 64 ports respectively. In the rare event of a single port failure, only one port module in a director would be affected and can be replaced without network disruption unlike a similar failure with
a combined or clustered switching solution that has sixteen ports per module. In addition, the extensibility and openness of our architecture provides customers with unrivaled investment protection by
providing a platform that can be upgraded to new performance levels and protocols, including mainframe, or FICON, environments.

For
small and mid-sized enterprises that want high performance features at a cost effective "pay as you grow" price, we introduced in October 2002 our
Sphereon 4500 Fabric Switch (up to 24 ports) with FlexPort Technology that delivers "connectivity on demand" in 8 port increments. We continue to offer the Sphereon 3232
Fabric Switch (32 ports) for larger departments and small workgroups within a data center. The Spheron 3232 Series Fabric Switches are designed to extend high-speed SAN
capability from the core of the data center to its outer edgesthe departmental and outlying workgroups to the data center.

We
also sell our Fabricenter Cabinet that can house multiple directors and switches, addressing and optimizing space and connectivity issues for our customers and partners.
To provide investment protection, all of our hardware products are backward and forward compatible.

Software Products

Through our Extendable Open Network, or EON, software architecture, we offer end-to-end total open SAN management through a layered
software approach. Our SANavigator® software provides complete SAN monitoring, management, visualization and control of multi-vendor fabric environments.

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Our Enterprise Fabric Connectivity Manager, or EFCM, software systematically simplifies the setup and configuration of a SAN with our directors and switches and provides fabric level SAN management
and administration. Both SANavigator® and EFCM software can be run locally on the server platform or remotely on any network-attached user workstation in the enterprise. We plan to
integrate certain of the features of EFCM into SANavigator® in 2003.

Our
Product Manager, or PM, software provides device level management and administration of our directors and switches. Our Enterprise Operating System, or E/OS, software is
embedded in our directors and switches and forms the foundation for our Core-to-Edge Enterprise Architecture providing a myriad of advanced services to upper layers of software
applications including non-disruptive software code loads (HotCAT). Finally, our FICON Management Server software is available with our Intrepid Directors to
provide mainframe customers with automated control of FICON storage networks through a single user interface.

Professional Services and Solutions

Backing our customers with one of the most experienced and comprehensive SAN consulting organizations in the industry, our Professional Services group helps
customers create and implement a SAN that best meets their business objectives and IT strategy. Our full line of service offerings and state-of-the-art tools such
as ProSADA and SANavigator® allow our customers to efficiently plan, implement, and manage complex SANs world wide. We provide customers with complete turnkey solutions that
solve critical customer problems such as e-mail and data protection allowing the customers to focus on their business mission with the assurance of high availability and functionality. We
also provide technology-centric, vendor-neutral SAN training to IT professionals through our Learning Services group. Our training emphasizes system-level solutions by teaching IT professionals the
skills necessary to be effective in today's multi-vendor, heterogeneous SAN environments.

Our
directors, switches, and software enable enterprises to connect and centrally manage large numbers of storage and networking devices. These products enable business enterprises to
cost-effectively manage growth and storage capacity requirements, improve the networking performance of their servers and storage systems, and scale the size and scope of their SAN or
other information infrastructure while allowing them to operate data-intensive applications on the SAN.

We
sell our products through industry leading OEMs and resellers, including EMC, IBM, Hitachi Data Systems, or HDS, HPQ, Storage Technology Corporation, or StorageTek, Sun
Microsystems, Inc., or Sun, and Dell Products L.P., or Dell, as well as distributors and systems integrators around the world. Our goal is to build on our leadership position in providing
director class devices to become the leading provider of a full range of switching, software and professional services solutions for the entire business enterprise.

Industry Background

During the past decade, the volume and value of data created throughout business enterprises has increased dramatically. As a result, the demand for data storage
capacity has increased as enterprises increasingly need to access, process and manipulate data that is critical to their businesses. This growth in the volume of data storage has been driven by a
number of factors including:



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In
addition, organizations have recognized that rapid and reliable access to enterprise data 24 hours a day, 7 days a week (24×7), 365 days a year is
essential to operating a business. The growing dependence on data for fundamental business processes has greatly increased the number of input-output data storage transactions required of storage
servers and systems. The continued deployment of client-server and Internet-based applications combined with the rapid growth of enterprise data has placed significant strain on traditional data
storage architectures. Furthermore, the increased use of open-system computing environments, which link multiple applications, files and databases to networked computers, makes the task of
data management increasingly difficult. As a result, data storage products and services have accounted for an increasing percentage of business enterprises' information technology budgets and
management resources.

Business
enterprises have historically attempted to support and manage data requirements by directly attaching storage devices to the individual servers on a local area network, or LAN.
Servers communicate in this direct attached environment using the small computer systems interface, or SCSI. The SCSI protocol, however, has several drawbacks, including a short transport distance,
limited performance and capacity of the connection, limited configuration flexibility, low reliability and inability to support more than a limited number of connections. The result has been
significant congestion at the point of communication between storage systems and servers.

To
address the limitations of traditional server-to-storage connections, Fibre Channel technology and related industry standards evolved in the early 1990's as a
means to facilitate high-performance storage connectivity. Fibre Channel technology supports large data transfers at transmission speeds of two billion bits, or two gigabit, per
second, and is therefore well-suited for data transfers between storage
systems and servers, with guaranteed delivery and transmission distances of up to 20 kilometers. "Fibre" refers to the optical or copper cable through which the communication among data storage
systems and workstations, servers and other peripherals flows. Connecting network devices through Fibre Channel technology enables the efficient and reliable transfer of data from one network device
to another, allowing access from any server to any storage device on the network. Fibre Channel offers the connectivity, distance and access benefits of a network, combined with the high performance
and increased capacity of a channel. Since its introduction, Fibre Channel technology has earned widespread acceptance from industry and independent testing organizations.

The Emergence of SANs

The introduction of Fibre Channel technology to facilitate high performance storage connectivity has facilitated the development of SANs. SANs enable fast,
efficient and reliable transfer of data between multiple storage devices and servers to improve the management of data within a business enterprise. SANs also permit the traffic from storage
applications to be handled outside of the LAN by decoupling computer storage systems from servers, which enhances the LAN's performance. SANs advance the traditional SCSI-based direct
attached storage and server configuration to a network of storage devices that can be accessed by multiple servers and network users, significantly increasing the performance and availability of
enterprise data storage.

SANs
are typically configured in either a switched fabric or arbitrated loop topology. Two or more Fibre Channel directors/switches can be interconnected in such a way that data can be
physically transmitted between any two ports on any of the directors/switches, which is referred to as a "fabric."

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Fabrics allow business enterprises to connect any device on the network to any other device on the network. Optimally, fabrics have directors at the core of the enterprise's data center with switches
deployed to the edge of the enterprise's data center. Fabric switching configurations enable every device on the network to have full network bandwidth. Arbitrated loop topology is the simplest SAN
configuration, which interconnects up to approximately 126 devices on the network. In an arbitrated loop configuration, unlike a fabric configuration, all devices share available network bandwidth on
the network, resulting in decreased performance as the number of devices in the loop increases.

A
SAN incorporates one or more classes of networking devices that connect the SAN with server and storage devices. These devices are:



To
date, many Fibre Channel SAN solutions are deployed only within particular areas of an end-customer organization, as opposed to a deployment on an
enterprise-wide basis. This localized deployment requires that each SAN be administered and managed locally, which hinders access to and sharing of information on a centrally-managed
enterprise-wide basis.

As
organizations deploy SANs across the enterprise, they seek to address the following requirements:



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In
order to address these requirements, organizations are increasingly adopting an enterprise-wide strategy to SAN deployment, requiring SAN infrastructure providers to adopt
features and practices that deliver on the full promise of SANs.

The McDATA Solution

We are a leading provider of high availability SAN hardware and software for connecting servers and storage devices from the core to the edge of an enterprise's
data infrastructure. We combine experience in designing, developing and manufacturing high performance SAN solutions with knowledge of business critical applications, service and support to solve
complex business problems facing an enterprise's data infrastructure. Our solutions include hardware and software products, methodologies and education that enable businesses to scale their operations
globally through a comprehensive, manageable, flexible data infrastructure that is optimized for rapid deployment and responsiveness to customer needs. We believe that our ability to provide
interoperable hardware, software and services has allowed us to be the first company to offer true core-to-edge enterprise SAN solutions to our customers in both open and FICON
environments. The advantages of our solutions include the following:



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The McDATA Strategy

We are focused on becoming the leading provider of open storage networking solutions. The key elements of our strategy are the following:



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The McDATA Products

We design, develop, manufacture and sell directors, switches and software that enable enterprise-wide, high performance SANs. We are a technology and
market leader for SAN backbone director class devices. We also offer a comprehensive suite of core-to-edge SAN switching products that leverage the core technology advantages
of our hardware and software design architecture to address the connectivity needs of business enterprises. Our products are as follows:



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Technology

We have developed ASIC technology that serves as the foundation for the development of our complete family of SAN products. Our ASICs provide building blocks at
the circuit level for implementing Fibre Channel directors and switches. These ASICs combine a number of Fibre Channel
functions in a single chip that reduces the number of components needed in our Fibre Channel directors and switches.

These
ASICs are used in our current director and switch products and we intend to use variations of such ASICs in our future products. The implementation of our director and switch
architecture is based on a common hardware and software design. The architecture enables product designs that span from the high-end data center to low-end workgroup storage
computing environments with gigabit performance and 24x7 operation.

Our
technology/architecture allows us to offer director-class products with a higher number of data transmission ports per device than similarly sized products and department and
workgroup switches with a higher port density per unit of rack space than similarly sized products. Switches with fewer ports must be networked together to provide the same number of available ports.
Our comparatively high number of available ports per device and our durable serial crossbar non-blocking architecture allows our device to offer higher performance than switches that must
be networked together because none of our switch ports needs to be diverted to network to other switches. Our current architecture enables us to address large enterprise
core-to-edge customer fabrics with thousands of ports. In addition to the support of high data throughput speed of the switch, our architecture supports very low latency,
generally indicating a two microsecond delay regardless of the number of the ports of the switch. The architecture supports transmission of up to 2 gigabits per second and we believe will support
transmission of up to 10 gigabits per second in the future. The flexibility of our architecture provides customers with investment protection by allowing the director platform to be upgraded from 1
gigabits, to 2 gigabits and to 10 gigabits, when generally available, as well as future technology protocols like internet protocol (IP), iSCSI and Infiniband (IB).

Our
current director products include, and we expect our future products will include, many of the following characteristics:



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Our
software architecture is based on a McDATA-developed E/OS embedded real-time operating system that provides state-of-the-art
intelligent services. Coupled with our EFCM and SANavigator® fabric management applications, our software architecture delivers advanced Fibre Channel services for the entire SAN, using a
common set of management applications.

Customers

Two major customers, EMC and IBM, are significant providers of enterprise storage systems. In 2002, EMC accounted for approximately 54% (down from 69% in 2001),
and IBM accounted for approximately 25% (up from 17% in 2001) of our total revenue, respectively. In August 2002 and January and February 2003, we entered into purchase agreements
with Dell, StorageTek and Sun, respectively. In addition to our original equipment manufacturers, or OEMs, we also have relationships with resellers and systems integrators. These and our other
systems integrator partners will continue to be a strategic focus for us as we continue to expand our business and deploy our OpenReady solutions.

Backlog

We manufacture our products on the basis of our forecast of near-term demand and maintain inventory in advance of receipt of firm orders from
customers. Products are configured to customer specifications and are generally shipped by us shortly after receipt of the order. For this reason, our backlog at any particular time is not meaningful
because it is not necessarily indicative of future sales levels.

Sales and Marketing

Our sales and marketing approach is focused on an indirect sales model executed through OEMs and resellers, such as EMC, IBM, HDS, HPQ, StorageTek, Sun and
Dell and our distributors and system integrators. We support these distribution customers in a direct assist model with our field sales and service personnel. In addition, our Professional and
Learning services groups are recognized within the industry as technical experts with proven deployment methodologies and a comprehensive Fibre Channel education curricula.

Our
OEM and reseller customers incorporate our directors and switches into their end-user products that are installed and field-serviced by the OEM technical support
organizations. IBM Global Services provides our first level of field support for all products that are sold directly or through our indirect channel partners (distributors and system integrators). The
sales cycle used in selling to an OEM customer can vary significantly in terms of its length and complexity. Often, it involves the use of our testing labs or those of our strategic partners, where
substantial testing takes place. It also often involves the submission of proposal documentation and presentations to the customer. This sales process generally involves the combined efforts of our
sales and marketing, engineering and management teams and can take from several weeks to more than one year.

In
May of 2000, we entered into a five-year agreement to sell our products to EMC under which we will manufacture our products for EMC's internal use or for delivery
directly to EMC's end user customers. Under the terms of this agreement, we provide varying degrees of support for these

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products to EMC's end user customers. We also entered into a Resale Agreement with IBM in February of 2000 that governs IBM's purchases of our products and appoints IBM as a
non-exclusive authorized reselling agent of ours to resell our products and services to IBM reseller and end-user customers. In August 2002 and January and
February of 2003, we entered into purchase agreements with Dell, StorageTek, and Sun, respectively. None of these agreements provide for the purchase of a guaranteed minimum amount of product.

We
also intend to continue to sell our products to an expanding list of systems integrators who combine our products with products of other vendors to provide complete SAN solutions.
Systems integrators typically provide installation, service and technical support to their end-user customers.

As
of December 31, 2002, our sales organization was located in several major cities in North America and in Germany, the United Kingdom, Japan, France, Italy, Norway, Australia,
Hong Kong, Korea, Switzerland, Singapore and China. Our sales and marketing organization includes field sales personnel, systems engineers, channel sales professionals, professional and educational
services providers and sales operations professionals.

For
financial information about geographic areas, see Note 13"Segment Information," of the Notes to Consolidated Financial Statements

Customer Service, Support and Solutions

We believe that superior customer service and support are critical to maintain successful long-term relationships with our customers and enhance our
leadership position in the SAN market. This service and support will also contribute to building our brand, as our products are introduced and integrated with products of other manufacturers and
resellers.

We
have been certified to ISO9001 standards since 1994 and we are transitioning to ISO9001:2000 standards.

We
provide technical support to our OEM and reseller customers and systems integrators, enabling them to provide technical support to their end users. We do this by providing training
and documentation together with 24x7 support. When a customer issue originates from our call center, we remain in contact with the customer until the issue is resolved. Our customer support includes a
comprehensive array of full-service support elements, including: 24x7 call home monitoring; spare parts depots; direct support through IBM Global Services; field engineers,
manufacturer-based technical support specialists and regional support specialists available to handle on-site requirements. In addition, our Professional Services group provides our
customers with one of the most experienced and comprehensive SAN consulting and solutions in the industry. Our full line of service offerings and state of the art tools such as ProSADA
allows customers to plan, implement, and manage the most complex SAN networks world wide. We provide our customers with complete turnkey solutions that solve critical customer problems such as
e-mail and data protection allowing the customers to focus on their business mission with assurance of high availability and functionality.

Manufacturing

Our manufacturing facility, located in Louisville, Colorado, is approximately 91,000 square feet. We perform final assembly and testing, finished goods
distribution, customer service repair and logistics in this facility. We currently anticipate that this facility will be adequate for us to meet demand for our products for the foreseeable future. In
addition, we have available additional manufacturing floor space, multiple shifts and outsourcing options to provide significantly higher volume manufacturing capability if required. In
November of 2001, we announced that we planned to implement an "outsourcing focused" manufacturing model. As part of this model, we are in the process of transitioning our manufacturing
operations to a contract manufacturer. Please see "Commitments" on page 38 for a further discussion of our outsourcing activities.

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We subcontract a majority of our production activities, including the manufacture, assembly and testing of a substantial part of our products. We currently utilize Sanmina
SCI, Inc., or SSCI, as the primary contract manufacturer for printed circuit board assembly and testing and box build for our Directors and switch products (excluding the Sphereon 4500 fabric
switch). SSCI has multiple sites in multiple countries that can be used for disaster recovery or to significantly expand their manufacturing capacity. In May 2002, we outsourced to SSCI the
integration of our Directors into cabinets. In February 2003, we renewed our agreement with SSCI for a period of two years. In June 2002, we signed a one-year contract
with Solectron Corporation to manufacture our Sphereon 4500 (24 port) fabric switch product. Solectron produces these products in Texas and Guadalajara,
Mexico.We currently depend upon LSI Logic and IBM for the production of all of our custom ASICs.

We
depend on SSCI, Solectron, IBM, LSI Logic and our other subcontractors to deliver high-quality products in a timely manner, but we cannot assure you that they will be able
to do so. We currently have no long-term supply contracts with any of our subcontractors.

We
design test processes for all of our products to identify the causes and measure the frequency of product failures. We and our major component suppliers use these test processes in
connection with the manufacture of our products. Our tests include environmental stress screening, which seeks to ensure product performance and reduce premature product failures, and other test
processes, which are designed to identify product defects prior to shipping. In addition to qualifying our products, we also qualify our component suppliers based on their ability to manufacture
components within defined specifications.

Research and Development

The SAN and other information infrastructure markets are characterized by rapid technological change, including changes in customer requirements, frequent new
product introductions and enhancements, and evolving industry standards. We believe that continued research and development efforts are an important factor in our ability to maintain technological
competitiveness. We employ individuals in engineering and development efforts that are focused on the development, enhancement and testing of directors and switches, ASICs and the associated software
offerings that address the needs of the SAN market. In addition, we currently cooperate with leading software companies, including Microsoft Corporation and Tivoli, a division of IBM, to develop and
test the interoperability of our products with their software to provide both our and their end users with more fully tested, interoperable SAN solutions. We do not believe that our relationships with
these companies are material to our business, financial condition or results of operation. We intend to dedicate resources to the continued
development of the Fibre Channel standards and to achieve interoperability with the Fibre Channel devices of other companies. Finally, our Systems Integration Lab located in Broomfield, Colorado is
the industry's foremost Fibre Channel switched fabric interoperability lab and is staffed by Fibre Channel and open systems experts.

Our
research and development expenditures were approximately $59 million in 2002, approximately $49 million in 2001 and approximately $38 million in 2000.

Competition

Although the competitive environment in the SAN market has not yet developed fully, we anticipate that the current and potential market for our products will be
highly competitive, continually evolving and subject to rapid technological change. New SAN products are being introduced by various server and storage providers and existing products will be
continually enhanced. Our primary competitor in the Fibre Channel switch market is Brocade. Other companies are also providing Fibre Channel switches and other products to the SAN market, including
QLogic and INRANGE. In addition, a number of companies, including Emulex Corporation, Interphase Corporation, JNI

28

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Corporation, and Crossroads Systems, Inc. are developing, or have developed, Fibre Channel products other than switches, including adapters and hubs. In the future, we may also compete with
networking companies that may develop SAN products or other companies in related or other industries for which future direct participation in the market for switching devices may become strategic. We
anticipate that these and other manufacturers of network equipment may introduce new Fibre Channel switch products in the near future. In the future, we may also compete with networking companies or
other companies in related or other industries for which future direct participation in the market for switching devices may become strategic. In addition, although EMC agreed for a period of
two years after the completion of our August 2000 initial public offering not to develop or manufacture products that compete with our then existing products, since August 2002
EMC has not been contractually restricted from competing with us in the development or manufacture of these products. Moreover, we have granted EMC a license under our patents to make, use and sell
any products that EMC was selling or distributing up to the date of the offering, including products that compete with ours. In addition, EMC has agreed to resell certain products offered by one of
our competitors.

In
August 2002, Cisco announced that it would be entering the storage switch market with the introduction of a family of switches and directors. In January 2003, Cisco
announced that it had entered into a non-exclusive agreement with IBM which would allow IBM to sell storage switches provided by Cisco in addition to the product lines provided by Brocade
and us. IBM is our second largest customer, and the agreement between Cisco and IBM may significantly reduce our sales to IBM. Also in January 2003, HP announced that it would resell Cisco's
new line of Fibre Channel switches. HPQ has substantial sales within the SAN infrastructure market, and the agreement between HPQ and Cisco could significantly reduce our future sales to HPQ.

It
is also possible that our existing or potential customers could develop and introduce products competitive with our product offerings. We believe the competitive factors in the SAN
market segment include: product performance and features; product reliability and interoperability; price; ability to meet delivery schedules; customer service and technical support; and systems
management.

Some
of our current and potential competitors have established operating histories, greater resources and name recognition, and a larger installed base of customers than we have. As a
result, these competitors may have greater credibility with our existing and potential customers. They also may be able to adopt more aggressive pricing policies and devote greater resources to the
development, promotion and sale of their products than we can to ours. This may allow them to respond more quickly than we can to new or emerging technologies and changes in customer requirements. In
addition, some of our current and potential customers have already established supplier or joint development relationships to discourage these customers from purchasing additional products from us or
persuade them to replace our products with their products. Increased competition could result in pricing pressures, reduced sales, reduced margins, reduced profits, reduced market share or the failure
of our products to achieve or maintain market acceptance. We may not have the financial resources, technical expertise or marketing, manufacturing, distribution and support capabilities to compete
successfully in the future. Additionally, we may not be able to compete successfully against current or future competitors and competitive pressures may materially harm our business.

Intellectual Property

Our success depends on our ability to protect our proprietary technology and to operate without infringing the proprietary rights of third parties. We rely on a
combination of patents, copyrights, trademarks and trade secrets, as well as confidentiality agreements and other contractual restrictions with employees and third parties, to establish and protect
our proprietary rights. We cannot be certain that the steps we take to protect our intellectual property will adequately protect our proprietary rights, that others will not copy or otherwise obtain
and use our products and technology without authorization, independently develop or otherwise acquire equivalent or superior technology or that we

29

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can maintain such technology as trade secrets. In addition, the laws of some of the countries in which our products are or may be sold may not protect our proprietary rights as fully as the laws of
the United States.

Currently,
we hold 27 U.S. patents and have 29 additional U.S. patents pending (including 12 pending for SANavigator®). We are seeking additional patent protection for
certain additional aspects of our technology. However, it is possible that patents may not be issued for these applications. It is possible that litigation may be necessary in the future to enforce
our intellectual property rights, to protect our trade secrets or to determine the validity and scope of the proprietary rights of others. Please see "Item 3 Legal Proceedings" in this
Form 10-K for a recent patent infringement lawsuit we are pursuing. Litigation could result in substantial costs and diversion of our resources and could materially harm our
business. From time to time, we have received, and may receive in the future, notice of claims of infringement of other parties' proprietary rights. Infringement or other claims could be asserted or
prosecuted against us in the future, and it is possible that past or future assertions or prosecutions
could harm our business. Any such claims, with or without merit, could be time-consuming, result in costly litigation and diversion of technical and management personnel, cause delays in
the development and release of our products, or require us to develop non-infringing technology or enter into royalty or licensing arrangements. Such royalty arrangements, if required, may
not be available on terms acceptable to us, or at all. For these reasons, infringement claims could materially harm our business.

Under
the terms of the Master Confidential Disclosure and License Agreement between EMC and us, EMC has granted us a license under existing EMC patents. If we are acquired, our 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 after an acquisition of us by a third party may make an acquisition of us by a third party unlikely.

EMC
and IBM entered into a cross-license agreement on March 19, 1999, and amended that agreement on May 12, 2000, under which each party, on behalf of itself and its
subsidiaries, granted the other a license under patents issued or issuing on applications entitled to an effective filing date through December 31, 2005. Under the terms of this cross-license
agreement, patents held by us were licensed to IBM and patents held by IBM were sublicensed to us by EMC. Each party released the other and its subsidiaries from claims of patent infringement
committed prior to the date of the cross-license. Effective as of the February 7, 2001 distribution of our Class A common stock by EMC, IBM, pursuant to the cross-license agreement,
retained the benefit of a license to our patents with an effective filing date through the date of such distribution, but the sublicense to us under IBM patents terminated upon such date in accordance
with the terms of the cross license agreement. We believe that the termination of the sublicense does not materially affect our business.

Employees

At December 31, 2002, we had 900 full-time employees. Of these employees, 315 were engaged in engineering and development, 279 in sales and
marketing, 137 in manufacturing and customer support, and 169 in finance and administration. None of our employees are represented by a labor union. We have not experienced any work
stoppages and consider our relations with our employees to be good. We anticipate that we will need to hire additional employees to meet the expected growth of our business.

Available Information

Our company web site is located atwww.mcdata.com. Our web site contains a link to a third party SEC filings web
site that makes our filings with the SEC available free of charge as soon as reasonably

30

---

practicable after they are electronically filed with the SEC. Our filings with the SEC are available free of charge by contacting:

McDATA
Corporation
Attn: Investor Relations
380 Interlocken Cresent
Broomfield, Colorado 80021
(303) 460-9200

ITEM 2. Properties

Our principal facilities for administration, sales, marketing, customer support, manufacturing, engineering and research and development are described below.

|Location                                        |  | Size            |  | Lease
Termination |  | General Use               
|----------------------------------------------- |  | --------------- |  | ----------------- |  | --------------------------
|380 Interlocken Crescent, Broomfield, Colorado  |  | 100,207 sq. ft. |  | February 2006     |  | Admin., Sales & Support   
|310 Interlocken Boulevard, Broomfield, Colorado |  | 120,129 sq. ft. |  | December 2003     |  | Labs and Learning Services
|1722 Boxelder Street, Louisville, Colorado      |  | 91,000 sq. ft.  |  | March 2004        |  | Manufacturing             
|111 Gordon Baker Road, North York, Ontario      |  | 13,263 sq. ft.  |  | June 2003         |  | Engineering               
|2030 Fortune Drive, San Jose, California        |  | 19,779 sq. ft.  |  | Month-to-month    |  | Software Development      
|4 McDATA Parkway                                |  | 164,984 sq. ft. |  | Owned             |  | Engineering               

Our headquarters, manufacturing and engineering operations are currently in separate locations in the greater Broomfield, Colorado area. Based on
our anticipated facility growth requirements over the next several years, and in light of lease terms for our currently occupied space, we completed the construction of our new office and
engineering building in July 2002. The building has approximately 164,984 sq. ft. of which approximately 137,000 sq. ft. is currently occupied. On February 9, 2001, the Company entered
into an operating lease and associated agreements with Deutsche Bank AG, New York Branch, or Deutsche Bank, for the lease of this multi-story office and engineering building. Construction of the
building commenced in the first half of 2001 and was completed in July 2002, at which time lease payments were scheduled to commence. As part of the transaction, the Company guaranteed a
residual value of the facility to Deutsche Bank of approximately 89% during the construction period and 85% thereafter of the $60 million total original cost and agreed to restrict up to
$63 million of its investment securities as collateral for specified obligations under the lease. During the first quarter of 2002, the Company elected to terminate the lease under the
provisions of the agreements. On May 9, 2002, the Company entered into a Termination Agreement with Deutsche Bank and recorded approximately $39 million in construction costs as property
and equipment. $41 million in restricted assets were used to pay off the lease obligation and construction costs. In addition, a loss of $1.25 million was recorded during the first
quarter of 2002 to reflect the write-off of certain lease costs that could not be capitalized.

As
part of our move to the new engineering building, we performed a review of our real estate and facility requirements and identified excess leased facility space that was offered for
sublease in August 2002 (see Note 12, "Commitments and Contingencies," of the Notes to Consolidated Financial Statements). We currently intend to vacate the 310 Interlocken building
during the third quarter of our new fiscal year and relocate our labs and learning service functions to our new building at 4 McDATA Parkway.

In
addition to the facilities discussed above, we also lease smaller sales, marketing and administrative office space in various locations throughout the world.

31

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With
the leases coming due at our North York, Ontario, Canada and San Jose, California facilities, we will be moving these offices to new locations. These facilities will be slightly
increased in size to accommodate growth over the term of the lease. Both new facilities will be occupied in the May/June 2003 time frame.

ITEM 3. 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
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, the ultimate
disposition of any of the claims described below will not have a material adverse effect on our consolidated results of operations, financial position or cash flow.

Class Action Laddering Lawsuits

The Company, one current officer and two former officers have been 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, Merrill Lynch, Pierce
Fenner & Smith Incorporated, Bear, Stearns & Co., Inc., FleetBoston Robertson Stephens et al., No. 01 CIV. 6627. Three other similar suits have been filed against the
Company. The complaints are substantially identical to numerous other complaints filed against other companies that went public over the last several years. 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 relating to the Company
allege claims against the Company, one of the Company's current officers, two former officers of the Company, 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 we believe that all of the lawsuits are without legal merit and intend
to defend them vigorously, we cannot assure you we will prevail.

In
September 2002, plaintiffs' counsel in the above-mentioned lawsuits offered to individual defendants of many of the public companies being sued 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, our Chairman, Mrs. Dee J. Perry, our former chief financial officer, and Mr. Thomas O. McGimpsey, our former Vice President and General
Counsel and the plaintiffs' executive committee. Under the Reservation of Rights and Tolling Agreement the plaintiffs are required to dismiss 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 us.

32

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Patent Infringement Lawsuit

On February 14, 2002, we filed a patent infringement lawsuit against Brocade in the United States District Court for the District of Colorado alleging that
Brocade's Frame Filtering feature in their products infringed our U.S. Patent No. 6,233,236 "Method and apparatus for measuring traffic within a switch." On March 5, 2002, we filed for a
preliminary injunction against Brocade to immediately stop infringing the patent after Brocade announced another product containing its Advanced Performance Monitoring feature.

On
April 8, 2002, Brocade filed an answer to the motion for preliminary injunction generally alleging that Brocade has not infringed and is not infringing the patent. Brocade
alleged various counterclaims in its answer including a claim that the patent is invalid and unenforceable, and that we misappropriated trade secret information from Brocade under prior agreements and
that a 1999 OEM agreement contained a covenant not to sue. The United States District Court for the District of Colorado on December 6, 2002 denied our motion for a preliminary injunction. We
filed documents on December 23, 2002 with the American Arbitration Association to initiate an arbitration proceeding to resolve contract and patent issues relating to the 1999 OEM agreement
with Brocade. On January 24, 2003, Brocade, in response to our initiating the arbitration proceeding, filed an answer and counterclaim with the American Arbitration Association that objected to
the inclusion of our patent infringement claims in the arbitration, claims the patent is invalid and unenforceable and claims we misappropriated trade secret information from Brocade. Although we
strongly believe that Brocade's counterclaims are factually incorrect and without any merit and we intend to vigorously pursue our patent infringement claims against Brocade, we cannot assure you we
will prevail.

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

No shareholder meeting was held in the fourth quarter of 2002. We intend to hold our annual meeting of shareholders in August of 2003. Accordingly,
shareholder proposals for inclusion in the annual meeting proxy statement should have been sent to our Secretary at 380 Interlocken Crescent, Broomfield, Colorado 80021 and must have been received by
February 16, 2003.

33

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PART II

ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters

Our Class B common stock has been quoted on the Nasdaq National Market under the symbol "MCDT" since our initial public offering on August 9, 2000.
Our Class A common stock has been quoted on the Nasdaq National Market under the symbol "MCDTA" since EMC's distribution of that stock on February 7, 2001. Prior to those respective
times there was no public market for either class of stock.

We
currently expect to retain future earnings, if any, for use in the operation and expansion of our business and we have not declared or paid any cash dividends on our capital stock
since inception, and do not anticipate paying any cash dividends in the foreseeable future. At March 24, 2003, there were approximately 10,430 stockholders of record of our Class A
common stock and approximately 295 stockholders of record of our Class B common stock.

The
following table sets forth the range of high and low closing prices per share of our Class A and Class B common stock reported on the Nasdaq National Market during
2003, 2002 and 2001:

Class A

Class BHigh

Low

High

LowYear Ended December 31, 2001First Quarter

$
37.06
*
$
14.38
*
$
69.25

$
18.38Second Quarter


33.56


14.94


39.80


18.13Third Quarter


21.21


7.70


22.01


7.75Fourth Quarter


29.71


7.86


29.90


7.98Year Ended December 31, 2002First Quarter

$
32.45

$
11.08

$
33.11

$
11.41Second Quarter


12.99


5.88


13.26


6.11Third Quarter


11.02


5.43


11.30


5.49Fourth Quarter


8.99


4.40


8.92


4.35Through March 24, 2003

$
10.25

$
6.99

$
7.02

$
10.25


---

34

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ITEM 6. Selected Financial Data

You should read the following selected consolidated financial data in conjunction with our consolidated financial statements and related notes and "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"and other financial information appearing elsewhere in this
document. The consolidated income statements data set forth below with respect to the years ended December 31, 2002, 2001 and 2000, and the consolidated balance sheets data as of
December 31, 2002 and 2001 are derived from our audited financial statements appearing in Item 15. The consolidated income statement data set forth below with respect to the years ended
December 31, 1999 and 1998, and the consolidated balance sheet data as of December 31, 2000, 1999 and 1998 were derived from audited financial statements not included herein. Historical
results are not necessarily indicative of the results of any future period.

|                                                             |  | Years Ended December 31, |        
|------------------------------------------------------------ |  | ------------------------ | -------
|
|
|Consolidated Income Statements Data:                         |  |                          |        
|Total revenue                                                |  | $                        | 328,279
|Total cost of revenue                                        |  |                          | 178,114
|                                                             |  |                          |        
|Gross profit                                                 |  |                          | 150,165
|Total operating expenses                                     |  |                          | 172,312
|                                                             |  |                          |        
|Income (loss) from operations                                |  |                          | (22,147
|Net income (loss)                                            |  | $                        | (9,987 
|                                                             |  |                          |        
|Basic net income (loss) per share                            |  | $                        | (0.09  
|                                                             |  |                          |        
|Shares used in computing basic net income (loss) per share   |  |                          | 113,185
|Diluted net income (loss) per share                          |  | $                        | (0.09  
|                                                             |  |                          |        
|Shares used in computing diluted net income (loss) per share |  |                          | 113,185

|                                               |  | December 31,
|---------------------------------------------- |  | ------------
|
|
|Consolidated Balance Sheets Data:              |  |             
|Total assets                                   |  | $           
|Working capital                                |  |             
|Debt payable                                   |  |             
|Long-term portion of capital lease obligations |  |             
|Total stockholders' equity                     |  |             

ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion and analysis in conjunction with "Risk Factors" and our consolidated financial statements and the
related notes appearing elsewhere in this document.

Critical Accounting Policies and Estimates

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

35

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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.

Revenue Recognition

We generally recognize revenue, in accordance with SAB 101, when persuasive evidence of an arrangement exists, products are delivered or services rendered, the
sales price is fixed or determinable and collectibility is assured. With respect to revenue from product sales to our resellers and end-user customers, we recognize revenue when title and
risk of loss transfer to the customer, generally at the time the product is delivered to the customer. 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. 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.

Service
revenues, which to date have not been material, include training, consulting and customer support. Revenue from training and consulting are recognized when the service has been
performed and the customer has accepted the work. We recognize revenue from support or maintenance contracts, including post-contract customer support, or PCS, services, ratably over the
contractual period.

We
recognize revenue from software products in accordance with the American Institute of Certified Public Accountants' Statement of Position 97-2 (SOP 97-2), as
amended. Software revenue is allocated to the software license and PCS service elements using vendor specific objective evidence of fair value, or VSOE, and recognized appropriately as discussed
above. VSOE of the fair value for an element is based upon the price charged when the element is sold separately.

In
transactions that include multiple products, services and/or software, we allocate the revenue to each element based on their relative fair values (or in the absence of fair value,
the residual method) and recognize the revenue when the above recognition criteria have been met for each element.

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 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 evaluate these open
purchase orders 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

36

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and cannot be redirected to other uses by our contract manufacturers. Adverse changes in our and our contract manufacturers' calculations and assumptions concerning these purchase commitments may
result in an increase to our vendor obligations and increase our cost of revenue.

During
the year ended December 31, 2002 and 2001, we recorded $9.5 and $25.1 million, respectively, of net write downs to our inventory related to a review of obsolescence,
end-of-life and demonstration/evaluation inventories, on-going inventory commitments and a year-end physical inventory
analysis. As a result of our outsource-focused manufacturing model, our net inventory balance at December 31, 2002 was $8.1, down from $24.8 million at December 31, 2001.

Valuation of Accounts Receivable

We review accounts receivable to determine which are doubtful of collection. In addition, we also make estimates of potential future product returns. In making
the determination of the appropriate allowance for doubtful accounts and product returns, we consider specific accounts, analysis of our accounts receivable aging, changes in customer payment terms,
historical write-offs and returns, changes in customer demand and relationships, concentrations of credit risk and customer credit worthiness. Historically, we have experienced a low level
of write-offs and returns given our customer relationships, contract provisions and credit assessments. Changes in the credit worthiness of customers, general economic conditions and other
factors may impact the level of future write-offs and product returns and increase our general and administrative expenses.

Warranty Provision

We also provide for estimated expenses for warranty obligations as revenue is recognized. Our warranty accruals utilize management's estimates of potential future
product warranty claims including the estimated numbers of failures by product and estimated costs to repair or replace failed product. We have not experienced material warranty claims, however
material warranty claims, including the catastrophic or epidemic failure of any one of our products, would require revisions to the estimated warranty liability and could significantly increase our
product costs, reduce revenue and cause significant customer relations problems.

Valuation of Deferred Taxes

Significant management judgment is required in determining the provision for income taxes, deferred tax assets and liabilities and any valuation allowance
recorded against net deferred tax assets. We are required to estimate our income taxes in each jurisdiction where we operate. This process involves estimating our actual current tax exposure together
with assessing temporary differences resulting from different treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in
our consolidated balance sheet. At December 31, 2002, our deferred tax assets equaled $36.4 million. We are required to assess the likelihood that our net deferred tax assets will be
recovered from future taxable income. We have considered estimated future taxable income and our ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance
and concluded that no such allowance is required at December 31, 2002. In the event we were to determine that we would not be able to realize deferred tax assets in the future, we would have to
record a valuation allowance that would significantly reduce net income in the period such a determination were made.

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

We review property, plant and equipment and purchased intangible assets for impairment whenever events or changes in circumstances indicate the carrying value of
an asset may not be recoverable. Our asset impairment review assesses the fair value of the assets based on the future cash

37

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flows the assets are expected to generate. An impairment loss is recognized when estimated undiscounted future cash flows expected to result from the use of the asset plus net proceeds expected from
disposition of the asset (if any) are less than the carrying value of the asset. This approach uses our estimates of future market growth, forecasted revenue and costs, expected periods the assets
will be utilized and appropriate discount rates.

We
have performed and will perform an annual impairment test for goodwill in accordance with Statement of Financial Accounting Standards No. 142 (SFAS 142). This review is
based on a comparison of the fair value of our assets including goodwill balances using discounted estimated cash flows to the net carrying value of our assets. The assumptions used to estimate fair
value include our best estimate of future growth rates, capital expenditures, discount rates and market conditions over an estimate of the remaining operating period. We performed the 2002 impairment
test and determined that no impairment loss should be recognized. Due to changing business conditions, future tests may result in a need to record a loss due to write down of the value of goodwill. At
December 31, 2002, goodwill recorded in the consolidated balance sheet totaled $11.7 million.

We
currently operate our business as a single solutions business and do not maintain separate cash flows or operating margins. Future operating losses, deterioration of our business or
segmentation of our operations in the future could also lead to impairment adjustments as such issues are identified.

Results of Operations

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

Years Ended December 31,2002

2001

2000Revenue

100.0
%
100.0
%
100.0
%Cost of revenue

54.2

62.6

48.1Gross profit

45.8

37.4

51.9Operating Expenses:Research and development

18.1

14.3

15.2Selling and marketing

22.9

20.5

13.6General and administrative

9.0

5.9

3.0Acquired in-process research & development and other acquisition related costs



2.7

Amortization of deferred compensation

2.5

2.1

2.6Operating expenses

52.5

45.5

34.4Income (loss) from operations

(6.7
)
(8.1
)
17.5Interest and other income (expense), net

2.0

4.1

3.3Income (loss) before income taxes

(4.7
)
(4.0
)
20.8Income tax expense (benefit)

(1.7
)
(1.5
)
8.4Net income (loss)

(3.0
)%
(2.5
)%
12.4
%


Revenues

Our revenue for the year ended December 31, 2002 was $328.3 million, a 5% decrease compared with revenue of $344.4 million for the year ended
December 31, 2001. Our revenue in 2002 was negatively impacted by the unfavorable economic conditions and suppressed IT storage and infrastructure spending, in particular in the
high-end director market and our transition from 1 Gb to 2 Gb products in the first half of 2002. This environment had a particularly negative effect on our

38

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product revenue, which declined to $284.1 million for the year ended December 31, 2002 from $300.3 million for the year ended December 31, 2001. In the last half of 2002,
however, our new product introductions, including our 2 Gb directors and switches and our Sphereon 4500 switch, with Flexport capability, were widely received with higher than expected
demand and revenue in the last half of 2002. We cannot predict when the IT spending environment will improve, if at all. There continues to be a level of uncertainty as to how the macro economic
environment may influence IT spending in 2003. We are pleased, however, with the demand for our new products and expect the demand to continue into our fiscal 2003 year. Lastly, our sale of the
HBA product line in early 2002 reduced our product revenue by approximately $12.8 million from 2001 levels.

Revenue
for the year ended December 31, 2001 represented a 39% increase over revenue of $248.7 million in 2000. Product revenue of $300.3 million for the year ended
December 31, 2001 was a 35% increase over product revenue of $222.7 million in 2000. This revenue increase was generated from the increased demand in our storage products including our
newly introduced 6000 Series Director and 3000 Series switch products.

Software
and service revenue increased 8% to $29.8 million in 2002 from $27.5 million in 2001 and $9.3 million in 2000. We continue to experience revenue growth from
the sale of all our software products, in particular our SANavigator® software product that was acquired as part of the business acquisition completed in late September 2001. The
195% increase in software and service revenue for the year ended December 31, 2001 from the year ended December 31, 2000 included an approximate $4.9 million of software revenue
that was deferred pursuant to a contract obligation that did not meet our revenue recognition criteria until 2001 when the deferred software revenue was recognized in full.

Other
revenues for the year, including service fees earned under an ESCON Service agreement with EMC, declined to $14.4 million in 2002 from $16.6 million in 2001 and
$16.7 million in 2000. This revenue also reflects the growth in maintenance fees, which outpaced the decline in service fees related to the ESCON products. We anticipate that service revenue
from EMC under the ESCON service agreement will continue to decrease in future years.

A
significant portion of our revenue is concentrated with two of our OEM customers. For the year ended December 31, 2002, approximately 53% of our total revenue, excluding the
ESCON service fee, came from our former parent, EMC, compared to 66% in 2001 and 71% in 2000. In February 2001, EMC distributed its remaining shares of McDATA Class A common stock in a
tax-free distribution to its shareholders. EMC no longer has any ownership in or voting power over McDATA and, therefore, is no longer considered a related party. Additionally, IBM
contributed approximately 25% of our total revenue for the year ended December 31, 2002 compared to 17% in 2001 and 14% in 2000. We expect a majority of our revenues in the foreseeable future
to be derived from these two customers. 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.

Domestic
and international revenue was approximately 63%and 37% of our total revenue, respectively, for the year ended December 31, 2002. For the year ended December 31,
2001, domestic and international revenue was approximately 76% and 24% of our total revenue, respectively, and for the year ended December 31, 2000, domestic and international revenue was
approximately 69% and 31%, respectively. Revenue is attributed to geographic areas based on the location of the customers to which our products are shipped including shipments to OEM customers who
take possession of our products domestically and then distribute the products to their international customers.

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Gross Profit

Gross profit for the year ended December 31, 2002 was 46% compared to 37% in 2001 and 52% in 2000. The significant increase in our gross margin during 2002
was the result of higher margin sales realized on our 2002 product and software introductions as well as reduced inventory costs related to lower inventory write-downs of $9.4 million in 2002
compared to $21.0 million in 2001 when we discontinued certain products, and our increased focus in 2002 on our outsource-focused manufacturing model. Offsetting the impact of these activities
was the sale of certain high-cost inventory manufactured in the last half of 2001 and increased capitalized software amortization expense. As expected, this high cost inventory was fully
depleted by the end of the quarter ended June 30, 2002.

The
decrease in our gross margin percentage for the year ended December 31, 2001 from the year ended December 31, 2000 was primarily the result of increased manufacturing
and component costs and inventory related charges. During 2001, we experienced increased manufacturing and component costs related to a transition to multiple product lines and quality problems on
component parts. Specifically, we incurred increased costs related to some mechanical features of our low-end and mid-range switch products. Also, we incurred additional costs
related to our die-cast chassis for these products. We continued to use this high cost inventory at the end of December 31, 2001. In addition, gross margins in 2001 were adversely
affected by charges of approximately $21.0 million primarily related to excess and obsolete inventory held by both the company and our contract manufacturers.

Operating Expenses

Research and Development Expenses.Research and development expenses increased to $59.3 million for 2002, compared
with $49.2 million and $37.8 million for the years ended December 31, 2001 and 2000, respectively. The approximate $10.2 million or 21% increase was primarily
attributable to increases in staffing levels, non-recurring engineering charges, and depreciation related to engineering and test equipment. Offsetting these expenses were approximately
$8.7 million of software development costs that have been capitalized and are amortized over the useful life of the underlying products as costs of revenue. Capitalized software costs were
$481,000 and $0 for the years ended December 31, 2001 and 2000, respectively. Capitalized software development costs have increased with the acquisition of the SANavigator®
software business and the development of our new director and switch products.

Selling and Marketing Expenses.Selling and marketing expenses increased to $75.2 million for 2002, compared with
$70.5 million and $34.0 million for the years ended December 31, 2001 and 2000, respectively. Increases in sales and marketing expenses were primarily due to the expansion
of our sales and marketing organizations, and increased salaries and commissions associated with increased revenues. In addition, as a result of our anticipated transition of our products to 2 Gb
technology in the second quarter of 2002, we recorded a charge of $4.1 million in the fourth quarter of 2001 primarily related to the impairment of certain 1 Gb related equipment currently used
for demonstration and evaluation purposes. We believe that continued investment in our sales and marketing functions is critical to the success of our business strategies.

General and Administrative Expenses.General and administrative expenses increased to $29.5 million for 2002 compared
with $20.3 million for 2001 and $7.5 million for 2000. The increase for the year ended December 31, 2002 was due primarily to increased staffing levels, higher facilities costs
associated with our new campus building, a $1.25 million charge related to the termination of our collateralized lease agreement and increased legal fees due to the patent infringement lawsuit.

Acquired In-Process Research and Development and Other Acquisition-related Costs.In connection with our
acquisition of SANavigator in September 2001, we incurred non-recurring acquisition costs and integration-related charges. Additionally, a portion of the SANavigator purchase price
was allocated to

40

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in-process research and development (IPR&D). This IPR&D was expensed at the time of purchase because technological feasibility had not been established and no future alternative use
existed. The IPR&D charge totaled $7.2 million for the year ended December 31, 2001. There were no corresponding charges for the years ended December 31, 2002 and 2000. The
other acquisition-related charges recorded during the year ended December 31, 2001, related primarily to one-time consideration paid for the completion of ongoing employment
arrangements with SANavigator employees. There have been no acquisitions of IPR&D during the years ended December 31, 2002 and 2000.

Amortization of Deferred Compensation.We have recorded deferred compensation in connection with certain Class B stock
options granted prior to our August 9, 2000 initial public offering and certain restricted Class B stock grants issued under our executive compensation
plan.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 of $8.9 million, $8.7 million and $8.4 million in the years ended December 31, 2002, 2001 and 2000, respectively (of which
approximately $601,000, $1,437,000, and $1,907,000, respectively, is included in costs of revenue).

Interest and Other Income.Interest income and other consisted primarily of interest earnings on our cash, cash equivalents
and various investment holdings. Interest income was $6.9 million, $14.5 million and $8.8 million for the years ended December 31, 2002, 2001 and 2000, respectively.
The decrease in investment income during 2002 was primarily the result of a decrease in our investment balances and declining interest rates realized during 2002. The average rate of return on
investments for the year ended December 31, 2002 was 2.2% compared to 3.9% and 5.9% for the years ended December 31, 2001
and 2000, respectively. Increases in interest income from 2001 were due primarily from the investment of the net proceeds from our initial public offering in August 2000. Interest income is
expected to increase in future periods as a result of income earned on the proceeds from our February 2003 convertible debt offering. This increased income will be offset in future periods by
increased interest expense related to the debt.

Provision for Income Taxes.Our effective tax rate for the year ended December 31, 2002 was 35.6%, compared with 37.0%
and 40.4% for the years ended December 31, 2001 and 2000, respectively. Our effective tax rates have historically differed from the federal statutory rate for various reasons. The
effective tax rate in 2001 decreased from 2000 primarily due to the favorable tax benefit of increased municipal interest income. We currently anticipate an effective tax rate of approximately 36% for
our new fiscal year ending on January 31, 2004. Our ability to realize this tax rate requires that we generate the pretax income as planned, including maintaining the level of research and
development spending. To the extent that our revenues and earnings differ from our expectations, or unfavorable changes in tax laws and regulations occur, our tax rate could change.

Liquidity and Capital Resources

Cash and cash equivalents and available-for-sale investments were $303 million at December 31, 2002, a decrease of
$8 million from $311 million at December 31, 2001. We generated approximately $30.5 million in net cash from operating activities, primarily from net income before
non-cash charges including depreciation and amortization, deferred compensation, inventory-related charges and deferred income tax benefits. Also, included in cash from operations was
$3.1 million of income tax benefits related to employee stock option transactions. At December 31, 2002, we had deferred tax assets of $36.4 million which we believe will be
realizable through future profitable operations.

Net
cash used in investing activities was $27 million. During the year ended December 31, 2002, we completed and occupied our office and engineering building in which
contributed to the approximate $72 million of purchases of property and equipment. Offsetting these capital purchases was $46 million of net maturities of our short- and
long-term investments, including the approximately

41

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$41 million of restricted assets used for the campus building under the terminated collateralized lease agreement (see discussion below).

Net
cash from financings was near zero as proceeds of $2.4 million from the issuance of common stock related to employee participation in our employee stock plans substantially
offset $2.7 million of repayments of our obligations under our capital leases.

Our
principal sources of liquidity at December 31, 2002 consisted of our cash and available-for-sale investments of $303 million, net accounts
receivable of $73.9 million and our equipment financing
arrangements, which totaled approximately $2.7 million. Borrowings under our equipment financing arrangements are secured by the related capital equipment and are payable through
December 31, 2005. In addition, in February 2003, the Company sold $172.5 million of 2.25% convertible subordinated notes due February 15, 2010, raising net proceeds of
approximately $167.1 million. The notes are convertible into our Class A common stock at conversion rate of 93.3986 shares per $1,000 principal amount of notes (aggregate of
approximately 16.1 million shares). 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.

Commitments

We have contracted with the contract manufacturers for the manufacture of printed circuit boards and box build assembly for specific Fibre Channel directors and
switches. The agreements require us to submit purchasing forecasts and place orders sixty calendar days in advance of delivery. At December 31, 2002, our commitment with the contract
manufacturers for purchases over the next sixty days totaled $54 million. Additionally, the contract manufacturers had on hand materials purchased on behalf of McDATA valued at
approximately $46 million. Finally, the contract manufacturers have outstanding purchase commitments outstanding related to materials that had also been ordered by our contract manufacturers on
our behalf. We may be liable for materials that the contract 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. At December 31, 2002, we had recorded obligations of approximately $10.0 million primarily related to materials purchased by SSCI for certain
end-of-life and obsolete material used to manufacture our products. We do not expect the remaining commitments under these agreements to have a continued material adverse
effect on our business, results of operations, financial position or cash flows.

On
February 9, 2001 (and amended on May 18, 2001, November 9, 2001 and January 24, 2002), we entered into an operating lease and associated agreements with
Deutsche Bank for the lease of an approximately 167,000 square foot multi-story office and engineering building to be constructed on a 106 acre parcel of land located in Broomfield, Colorado.
Construction of the building commenced in the first half of 2001 and completed in July 2002, at which time lease payments were scheduled to commence. As part of the transaction, we guaranteed a
residual value of the facility to Deutsche Bank of approximately 89% during the construction period and 85% thereafter of the $60 million total original cost. We agreed to restrict up to
$63 million of our investment securities as collateral for specified obligations under the lease. During the first quarter of 2002, we elected to terminate the lease under the provisions of the
agreements. On May 9, 2002, we entered into a Termination Agreement with Deutsche Bank and recorded approximately $37 million in construction costs as property and equipment.
Additionally, $41 million in restricted assets were used to pay down the balance of the lease obligation and construction costs. A loss of $1.25 million was recorded during the first
quarter of 2002 to reflect the write-off of certain lease costs that could not be capitalized. As of June 30, 2002, construction of the new building was substantially complete and
occupation of the building by our engineering departments began in July 2002.

42

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The
following table summarizes our contractual obligations (including interest expense) and commitments as of December 31, 2002 (in thousands):

Total

Less than 1 year

1-3 yearsNon-cancelable operating leases

$
14,730

$
7,865

$
6,865Capital leases


3,360


1,755


1,605Vendor reserves


10,000


10,000





We
believe our existing cash, 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.

Inflation

We believe that our revenue and results of operations have not been significantly impacted by inflation during the last three fiscal years.

Recent Accounting Pronouncements

In July 2002, the Financial Accounting Standards Board (FASB) issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities" (SFAS 146). SFAS 146 provides guidance related to accounting for costs associated with disposal activities covered by SFAS 144 or with exit or restructuring activities
previously covered by Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)." SFAS 146 supercedes EITF Issue No. 94-3 in its entirety. SFAS 146 requires that costs related to exiting an
activity or to a restructuring not be recognized until the liability is incurred. SFAS No. 146 will be applied prospectively to exit or disposal activities that are initiated after
December 31, 2002. The adoption of this statement is not currently anticipated to have a material impact on the Company's financial position or results of operations.

In
November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others." FIN 45 requires that upon issuance of a guarantee, a guarantor must recognize a liability for the fair value of the obligation assumed under a guarantee. In addition, FIN 45
requires interim and annual disclosures about the guarantees that an entity has issued, including a rollforward of the entity's product warranty liabilities. The recognition and measurement provisions
of FIN 45 are effective for any guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for financial statements of interim and annual periods ending
after December 15, 2002. Management is currently evaluating the recognition and measurement effects of FIN 45, however, management does not expect that the adoption of FIN 45 will have a
material effect on the Company's financial position, results of operations, or cash flows. The Company adopted the disclosure provisions of FIN 45 during the fourth quarter of fiscal 2002.

In
November 2002, the EITF reached a consensus on Issue No. 00-21, Revenue Arrangements with Multiple Deliverables." EITF Issue No. 00-21
provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF Issue
No. 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. Management is currently evaluating the effect that the adoption of
EITF Issue No. 00-21 will have on its financial position and results of operations.

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In
December 2002, the FASB issued Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based CompensationTransition and Disclosure"
(SFAS 148). SFAS 148 amends SFAS 123, "Accounting for Stock-Based Compensation," to provide alternative methods of transition for a voluntary change to the fair value based method
of accounting for stock-based employee compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. SFAS 148 is effective for fiscal years
beginning after December 15, 2002. The interim disclosure provisions are effective for financial reports containing financial statements for interim periods beginning after December 15,
2002.
Management does not expect the adoption of SFAS 148 to have a material effect on the Company's financial position, results of operations, or cash flows.

Item 7A. Qualitative and Quantitative Disclosure about Market Risk

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

Interest Rate Risk

Our exposure to market risk due to changes in the general level of United States interest rates relates primarily to our cash and cash equivalents and our
investment portfolio. Our investment portfolio is primarily maintained in four major financial institutions in the United States and consists primarily of readily marketable investment-grade debt
securities of various issuers and maturities ranging from overnight to ten 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 unrealized gain or loss on these securities will change.

We
have performed a sensitivity analysis as of December 31, 2002, using a modeling technique that measures the change in the fair values arising from a hypothetical 10% adverse
movement in the levels of interest rates with all other variables held constant. The discount rates used were based on the market interest rates in effect at December 31, 2002. The sensitivity
analysis indicated that a hypothetical 10% increase in interest rates would result in a decrease in the fair values of our investment instruments of approximately $320,000 assuming that such
investment holdings remained constant through the year 2002 and an increase of investment income of approximately $594,000. A hypothetical 10% decrease in interest rates would result in an increase of
the fair values of our investment instruments of approximately $325,000 and a decrease in investment income of approximately $601,000.

Credit Risk

Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of temporary cash investments, short- and
long-term investments, trade receivables and certain share option transactions. The Company places its temporary cash investments and short- and long-term investments in
investment grade instruments and limits the amount of investment with any one financial institution. The Company evaluates the credit risk associated with each of its customers and has concluded that
it does not have a material exposure to credit risk with its customers.

In
February 2003, the Company sold $172.5 million of 2.25% convertible subordinated notes due February 15, 2010. In conjunction with the issuance of these
convertible 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

44

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concluded that we do not have a material exposure to credit risk as a result of these share option transactions.

ITEM 8. Consolidated Financial Statements and Supplementary Data

For a discussion of the information required by this item, you should refer to pages F-1 through F-26 in Item 15(a) of this
Form 10K.

ITEM 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure

We have nothing to report under this item.

45

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PART III

ITEM 10. Directors and Executive Officers of the Registrant

The following table sets forth certain information regarding our executive officers and directors as of the date of this Annual Report:

|Name                     |  | Age |  | Position                                                                   
|------------------------ |  | --- |  | ---------------------------------------------------------------------------
|John F. McDonnell        |  | 58  |  | Chairman of the Board of Directors                                         
|John A. Kelley, Jr.      |  | 53  |  | President, Chief Executive Officer and Director                            
|Ernest J. Sampias        |  | 52  |  | Chief Financial Officer and Senior Vice President of Finance               
|Alain F. Andreoli        |  | 43  |  | Executive Vice President of Sales and Service                              
|Jean M. Becker           |  | 43  |  | Senior Vice President of Engineering                                       
|Robert F. Finley         |  | 53  |  | Vice President of Manufacturing                                            
|Michael B. Gustafson     |  | 36  |  | Senior Vice President of Worldwide Marketing                               
|Karen L. Niparko         |  | 46  |  | Vice President of Business Operations and Vice President of Human Resources
|Donald P. Wenninger      |  | 52  |  | Vice President and Chief Information Officer                               
|John W. Gerdelman(3)(4)  |  | 50  |  | Director                                                                   
|Charles C. Johnston(1)   |  | 67  |  | Director                                                                   
|D. Van Skilling(1)(3)    |  | 69  |  | Director                                                                   
|Thomas M. Uhlman(2)(4)   |  | 55  |  | Director                                                                   
|Laurence G. Walker(2)(4) |  | 54  |  | Director                                                                   
|Betsy S. Atkins(2)(3)    |  | 48  |  | Director                                                                   
|Michael J. Sophie(1)     |  | 45  |  | Director                                                                   

---

Executive Officers and Directors

John F. McDonnellis a founder and Chairman of McDATA and served as Chief Executive Officer of McDATA from its
inception in 1982 to 2002, as President from 1982 to 2001 and as Chairman of the Board of Directors since 1998. Mr. McDonnell has more than 31 years of experience in the data
communications field, including 26 years in corporate and technical management and 5 years in engineering. Prior to founding McDATA, he held various corporate management and engineering
positions at Storage Technology Corporation and Computer Communications, Inc. Mr. McDonnell attended California State University at Long Beach.

John A. Kelley, Jr.has been President and Chief Executive Officer since August 2002 and a Director since August 2001 and
was President and Chief Operating Officer from August 2001 to August 2002. Prior to joining McDATA, Mr. Kelley was Executive Vice President for Qwest Communications
International Inc., or Qwest, from July 2000 to January 2001. Prior to the acquisition of U S WEST by Qwest, he was Executive Vice President for U S WEST from
April 1995 to June 2000. Prior to his employment at U S WEST, Mr. Kelley was in key positions at Mead Corporation's Zellerbach Southwest businesses.
Mr. Kelley received his Bachelor of Science degree in business from the University of Missouri, St. Louis. He serves on the board of directors of Polycom, Inc. and Captaris, Inc.,
and is also chairperson of the board of directors of INROADS of Colorado, a not-for-profit mentoring program and a board member of the Women's Vision Foundation.

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Ernest J. Sampiashas been the Senior Vice President of Finance and Chief Financial Officer since June 1, 2002. Prior thereto he
was Vice President of Finance from September 2001 to May 2002 and Controller from September 2001 to February 2003. Prior to joining McDATA, Mr. Sampias was Vice
President and Chief Financial Officer of Convergent Communications, Inc. from November 2000 to May 2001 and was Vice President and Chief Financial Officer of
U S WEST Dex, Inc. from 1997 to 2000 and held various financial management positions with U S WEST from 1985 to 2000. Mr. Sampias is a Certified Public
Accountant, received a Masters degree in Taxation in 1979 from Depaul University in Chicago, Illinois, and received a Bachelor of Science Degree (with distinction) in Business in 1973 from Indiana
University. Mr. Sampias also sat on the Board of Directors of PointServe Corporation from March 2000 to November 2000.

Alain F. Andreolihas been Executive Vice President of Sales and Services since December 2002. Prior to joining McDATA,
Mr. Andreoli was President, Chief Operating Officer and Executive Director for Verio Inc., or Verio, since July 2001. Prior to joining Verio, Mr. Andreoli was Corporate
Vice President and General Manager for International Operations, Global Services and e-Business from February 2000 and Vice President and General Manager, EAME from June 1997
at Storage Technology Corporation. Prior to joining Storage Technology Corporation, Mr. Andreoli held various international and global management positions with Texas Instruments Incorporated.
Mr. Andreoli holds a degree from the CERAM School of Business in Valbonne, France (French MBA equivalent).

Jean M Beckerhas been the Senior Vice President of Engineering since December 2002. Prior to joining McDATA, Ms. Becker was
President of Qwest Solutions from July 2001 and Senior Vice President of Qwest National xDSL/Broadband Deployment from July 2000. Prior to Qwest, Ms. Becker held the Chief
Technology Officer and Senior Vice President, Vice President of Network Planning and other senior management positions with U S WEST since 1988. Ms. Becker earned a Masters of
Business and Administration degree in 1992 from Portland State University and earned a Bachelor of Science in Electrical Engineering in 1988 from Portland State University.

Robert F. Finleyhas been Vice President of Manufacturing since June 2001. Prior to joining McDATA, he served as Vice President,
Business Programs ManagementGlobal Accounts at SMTC Corp. from December 1996 to May 2001. Prior to joining McDATA, Mr. Finley held several positions at SMTC including
Director of Materials, MIS, Document Control, Component Engineering and Supplier Quality Assurance and Director of Manufacturing Operations from February 1991 to December 1996. In
addition, Mr. Finley worked for McDATA from 1987 to 1990 as a manager of quality assurance, reliability engineering and mechanical procurement and a manager of turnkey operations.
Mr. Finley holds a Bachelor's degree in electronics engineering technology from Arizona State University.

Michael B. Gustafsonhas been Senior Vice President of Worldwide Marketing since June 2002. From March 1999 until
June 2002, he served as our Vice President of Worldwide Sales. Mr. Gustafson also had responsibility for McDATA's Professional and Learning Services offerings from March 1999 to
December 2000. From May 1998, when he joined McDATA, until March 1999, Mr. Gustafson served as a regional sales manager of McDATA. Prior to joining McDATA,
Mr. Gustafson spent nine years with IBM serving in various sales management positions, including most recently as Business Unit Executive and Director of U.S. Channel Field Sales of IBM
from June 1997 until May 1998. Mr. Gustafson received his Bachelor of Science degree in business administration from Washington University in St. Louis.

Karen L. Niparkohas been Vice President of Business Operations since October 2002 and prior thereto was Vice President of Human
Resources from September 2001 to October 2002. Prior to joining McDATA, Mrs. Niparko was Executive Consultant for Corporate Solutions, Inc. from April 2001 to
September 2001, Corporate Vice President of Human Resources and Officer and former Vice-President of Human Resources for Worldwide Sales & Service of Storage Technology
Corporation

47

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from April 1997 to February 2001, Vice President of Operations for Auto-trol Technology Corporation from January 1993 to April 1997. Mrs. Niparko has a
Master of Business Administration from the University of Colorado, a Bachelor of Arts degree from the University of Michigan and a Certificate for Leadership for Sr. Executives Programs from Harvard
University. Mrs. Niparko serves on the Boards of the Colorado Safety Association and INROADS-Colorado Inc., both non-profit organizations. She served as Chair for the
eLearning committee of Governor Owen's Strategy Workforce Development Council. She is an advisor for the Chancellor's Community Advisory Committee for the University of Colorado at Boulder and a
member of the Women's Vision Foundation.

Donald P. Wenningerhas been Vice President and Chief Information Officer since February 2000. Prior to joining McDATA,
Mr. Wenninger served as Vice President of Information Technology at Vixel
Corporation from December 1996 to February 2000, and from 1979 to 1996 held IS management, engineering and planning positions at Intemec, Boeing and IBM. Mr. Wenninger holds a
Bachelor of Science degree in Business, a Masters of Business Administration degree in Engineering Technology, and a Masters of Business Administration degree in Information Technology from City
University in Bellevue, Washington.

John W. Gerdelman,Chief Executive Officer of Metromedia Fiber Network, has served as a director of McDATA since May 1998.
Mr. Gerdelman took on the position of Chief Executive Officer of MFN, a fully integrated fiber optic and data center services company, in April 2002 in connection with a bankruptcy
reorganization of MFN. Prior thereto, he was Managing Member of Mortonsgroup LLC, an information technology and telecommunications venture firm, from October 1999. From April 1999 to
October 1999, Mr. Gerdelman was Chief Executive Officer of U.S.A.NET, a privately held provider of innovative e-mail solutions. Prior to U.S.A.Net, Mr. Gerdelman was
President of the network and information technology division of MCI Telecommunications Corporation, or MCI. Mr. Gerdelman's 13-year tenure at MCI covered all areas of the company,
including sales, marketing, service, network operations and information technology. His experience at MCI included three years as President and Chief Executive Officer of a startup call center
company, PTI Services Corporation, after which he returned to MCI upon its acquisition. Before joining MCI, Mr. Gerdelman was with Baxter Travenol Corporation in sales operation. He also served
in the U.S. Navy as a Naval Aviator. He received his Bachelor of Science degree in chemistry from the College of William and Mary. Mr. Gerdelman currently serves as a director of APAC, Sycamore
Networks, Inc. and Intelliden Corporation.

Charles C. Johnston,Chairman of Ventex Technologies, Inc., AFD Technologies, Inc., J&C Resources, LLC, and Ultraclenz
Corporation, has served as a director of McDATA since May 1998. Mr. Johnston has been Chairman of AFD Technologies, Inc., J&C Resources, LLC, and Ultraclenz Corporation since 1992
and Chairman of Ventex Technologies, Inc. Mr. Johnston was founder, Chairman and CEO of ISI Systems, a developer of software systems and related services, from 1969 to 1992 (ISI was sold
to Teleglobe Corporation of Montreal, Canada in 1989). He served in various capacities at IBM from 1959 until 1965 and served as Director of Grumman Corporation and Teleglobe Corporation from 1989 to
1994. He received his Bachelor of Science degree in 1957 from Worcester Polytechnic Institute. He currently serves as a director of AuthentiDate Holding Corporation, Internet Commerce Company and
Visual Data.

D. Van Skilling,President of Skilling Enterprises, has served as a director of McDATA since May 1998. Mr. Skilling has
served as President of Skilling Enterprises since March 1999. He retired as Chairman and Chief Executive Officer of Experian Information Solutions, Inc., formerly TRW Information
Systems & Services, in April 1999. From September 1996 until April 1999, Mr. Skilling was Chairman and Chief Executive Officer of Experian. From March 1970
until September 1996, Mr. Skilling was the Executive Vice President of TRW Information Systems and Services. He received his Bachelor of Science degree in chemistry from Colorado College
and his Master of Business

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Administration degree in International Business from Pepperdine University. He currently serves on the Boards of Directors of The Lamson & Sessions Company, First American l Corporation and
American Business Bank and is Chairman of the Board of Trustees of Colorado College.

Thomas M. Uhlman,Managing Partner of New Ventures Partners, LLC, has served as a director of McDATA since May 1998.
Mr. Uhlman has been Managing Partner, New Venture Partners, LLC since January 2001. From 1997 to 2001, Mr. Uhlman was President, New Ventures Group at Lucent Technologies. From
1996 to 1997, Mr. Uhlman was Senior Vice President, Corporate Strategy, Business Development and Public Affairs of Lucent Technologies. From 1995 to 1996 Mr. Uhlman was the Vice
President, Corporate Development of AT&T Corp. Prior to joining AT&T, he was with Hewlett-Packard Company in various advisory and management roles. He received his Ph.D. in Political Science from the
University of North CarolinaChapel Hill, his Masters degree in management from Stanford University School of Business and his Bachelor of Arts degree in political science from the
University of Rochester.

Laurence G. Walker,an independent investor, has served as a director of McDATA since May 1998. Previously, Mr. Walker
served as Vice President of Strategy of the Network & Computing Systems Group of Motorola from February 2002 until May 2002. From August 2001 until February 2002,
Mr. Walker served as Vice President and General Manager of the Network & Computing Systems Group of Motorola. Mr. Walker co-founded C-Port in
November 1997 and was Chief Executive Officer until August 2001. C-Port was acquired by Motorola in May 2000. From June 1997 until October 1997,
Mr. Walker was self-employed. From August 1996 until May 1997, Mr. Walker served as Chief Executive Officer of CertCo, a digital certification supplier. Prior
thereto, he was Vice President and General Manager, Network Product Business Unit, Digital Equipment Corporation from January 1994 to July 1996. From 1981 to 1994, he held a variety of
other management positions at Digital Equipment Corporation. He received his Ph.D. and Master of Science degree in electrical engineering from the Massachusetts Institute of Technology and his
Bachelor of Science degree in Electrical Engineering from Princeton.

Betsy S. Atkins, Chief Executive Officer of Accordiant Ventures, has served as a director of McDATA since April 2002.
Ms. Atkins has been the Chief Executive Officer of Accordiant Ventures, an independent venture capital firm focused on the telecommunications industry, since 1996. Ms. Atkins was a
co-founder of Ascend Communications, Inc. in 1989, and served as its International Sales and Marketing Vice President and as a member of its board of directors prior to its
acquisition by Lucent Technologies in 1999. Ms. Atkins currently serves on the Boards of Directors of Polycom, Inc. and webMethods Inc. She received her Bachelor of Arts degree
from the University of Massachusetts. Ms. Atkins publishes and keynote speaks on Board Governance, best practices for the National Association of Corporate Directors. Ms. Atkins is also
a member of the President-appointed Pension Benefit Guaranty Corporation advisory committee and a Governor-appointed member of the Florida International University Board of Trustees.

Michael J. Sophie,Senior Vice President Finance and Chief Financial Officer of UTStarcom Inc., has served as a director of McDATA
since March 2003. Mr. Sophie has served as Senior Vice President Finance of UTStarcom Inc., a manufacturer and marketer of telecommunications equipment for use in worldwide
markets, from January 2003 to present and as Chief Financial Officer from August 1999 to present. He served as Vice President Finance of UTStarcom from August 1999 to
January 2003. From 1993 to 1999, Mr. Sophie was Vice President Finance and Chief Financial Officer of P-Com, Inc., a manufacturer of microwave radio stations for
worldwide wireless telecommunications markets. Mr. Sophie holds a Bachelor of Science degree in business administration from California State University and a Masters of Business Administration
degree from the University of Santa Clara.

Our
Board of Directors is divided into three classes, the members of which serve for a staggered three-year term and until they or their successors are duly elected and
qualified. Messrs. Johnston,

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McDonnell and Walker serve in the class whose term expires at the annual meeting of stockholders in 2003; Messrs. Gerdelman and Kelley and Ms. Atkins serve in the class whose term
expires at the annual meeting of stockholders in 2004 and Messrs. Skilling, Uhlman and Sophie serve in the class whose term expires at the annual meeting of stockholders in 2005. Upon the
expiration of the term of a class of directors, directors in that class will be elected for three-year terms at the annual meeting of stockholders in the year in which that term expires.

Our
officers serve at the discretion of the Board of Directors. There are no family relationships among our directors and officers.

Other Matters

In June 2002, Richard G. Search, our former Vice President of Marketing and Janet K. Cooper, our former Chief Financial Officer and Vice President of
Finance and Administration, left the Company to pursue other interests. In July 2002, Earl T. Carothers, our Vice President of Corporate Quality and Customer Services, and in
November 2002, James E. Kuenzel, our former Vice President of Engineering, left the Company to pursue other interests. In February 2003 Thomas O. McGimpsey, our Vice President of
Corporate Development, Secretary and General Counsel left the Company to pursue other interests. Mr. McGimpsey has agreed to rejoin the Company as Vice President and General Counsel effective
April 1, 2003.

Board of Directors Committees and Other Information

Our Board of Directors has an Audit Committee, a Compensation Committee, a Governance and Nominating Committee and a newly appointed Technology Committee. The
Audit Committee, currently comprised of Messrs. Johnston, Skilling and Sophie, reviews our accounting policies and practices and financial reporting and internal control structures, recommends
to our Board of Directors the appointment of independent auditors to audit our financial statements each year and confers with the auditors and our officers for purposes of reviewing our internal
controls, accounting practices, financial structures and financial reporting. Beginning in 2003, Mr. Gerdelman is no longer a member of the Audit Committee, and joins the new Technology
Committee. The Compensation Committee, currently comprised of Messrs. Uhlman and Walker and Ms. Atkins, reviews salaries, incentives and other forms of compensation for our executive
officers and administers our incentive compensation plan. The Compensation Committee has delegated its duties with respect to option grants for non-executive officers to a compensation
subcommittee, which is chaired by Mr. McDonnell, in accordance with the terms of the Company's 2001 Equity Incentive Plan (formerly the 1997 Stock Option Plan). The Governance and Nominating
Committee is currently comprised of Messrs. Gerdelman and Skilling and
Ms. Atkins, and is responsible for general corporate governance, board compensation and evaluation and nomination of new board members, periodically reviews and recommends the charter and
composition of new Board committees and considers questions of conflicts of interest of Board members and of corporate officers. Messrs. Gerdelman, Uhlman and Walker are members of the newly
appointed Technology Committee, whose charter is to review long-term strategic technical direction and product roadmap and review the Company's planned investments in research and
development.

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Securities Exchange Act requires our executive officers and directors, and persons who own more than 10% of our common stock,
to file with the SEC reports of ownership and changes in ownership of common stock and other equity securities of our Company. Executive officers, directors and greater than 10% shareholders are
required by the SEC regulation to furnish to us copies of all Section 16(a) forms they file.

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Based solely on a review of the copies of Section 16(a) forms furnished to us and written representations that no other filings were required, we believe that all the SEC
filing requirements applicable to our executive officers, directors and greater than 10% shareholders were complied with for 2002, other than the late filing of a report on Form 4 by D. Van
Skilling, our director, for the sale of 1,500 shares of Class B common stock in November 2002.

ITEM 11. Executive Compensation

The following table sets forth information for the fiscal year ended December 31, 2002 concerning the compensation paid to persons who served as our Chief
Executive Officer, our four other most highly compensated executive officers at fiscal year end and two executives that resigned prior to fiscal year end, all of whose total salary and bonus for such
fiscal year exceeded $100,000, collectively referred to below as the Named Executive Officers:

Summary Compensation Table

|                                                                                                        |  |                |  |     |                         |  |     | Long-Term Compensation
Awards |  |   |            
|------------------------------------------------------------------------------------------------------- |  | -------------- |  | --- | ----------------------- |  | --- | ----------------------------- |  | - | -----------
|
|
|
|John F. McDonnell(1)
Chairman of the Board of Directors                                                 |  | 2002
2001
2000 |  | $$$ | 100,000
251,944
280,883 |  | $$  | 140,625

92,115              |  |   | 

      
|John A. Kelley, Jr.(5)
President and Chief Executive Officer                                            |  | 2002
2001
2000 |  | $$  | 339,234
98,082
        |  | $$  | 127,452
56,829
              |  | $ | 427,490


|Michael B. Gustafson
Senior Vice President of Worldwide Marketing and Vice President of Worldwide Sales |  | 2002
2001
2000 |  | $$$ | 234,615
136,669
115,935 |  | $$$ | 192,871
245,794
275,626       |  | $ | 

      
|Ernest J. Sampias
Chief Financial Officer and Senior Vice President of Finance                          |  | 2002
2001
2000 |  | $$  | 217,308
46,769
        |  | $$  | 150,000
12,469
              |  | $ | 180,110


|Robert F. Finley
Vice President of Manufacturing                                                        |  | 2002
2001
2000 |  | $$  | 198,846
87,923
        |  | $$  | 100,000
18,619
              |  | $ | 97,650

 
|Thomas O. McGimpsey(17)
Vice President of Corporate Development, Secretary and General Counsel          |  | 2002
2001
2000 |  | $$$ | 189,654
147,885
60,000  |  | $$$ | 71,250
16,822
49,128          |  | $ | 113,925


|Earl T. Carothers(22)
Vice President of Corporate Quality and Customer Support                          |  | 2002
2001
2000 |  | $$$ | 138,339
186,481
6,538   |  | $$  | 12,654
55,672
               |  |   | 

      
|James E. Kuenzel(25)
Vice President of Engineering                                                      |  | 2002
2001
2000 |  | $$$ | 212,156
208,180
200,000 |  | $$$ | 5,000
38,150
50,578           |  | $ | 

      

---

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Option Grants in Last Fiscal Year

The following table sets forth certain information for each grant of stock options during the year ended December 31, 2002 to each of the Named Executive
Officers. All of these options granted by us were granted under our 2001 Equity Incentive Plan (formerly the 1997 Stock Option Plan) and have a term of 10 years, subject to earlier termination
in the event an optionee's services to us cease. For more information, see "Employee Benefit Plans" below for descriptions of the material terms of these options. During the year ended
December 31, 2002, we granted options to purchase an aggregate of 3,296,293 shares of Class B common stock under the 2001 Equity Incentive Plan. Options were granted at an exercise price
equal to the fair market value (as determined under the 2001 Equity Incentive Plan) of our Class B common stock on the day prior to the grant date. Potential realizable values are net of
exercise prices before taxes, and are based on the assumption that our Class B common stock appreciates at the annual rate shown, compounded annually, from the date of grant until the
expiration of the ten-year term and that the option is exercised at the exercise price and sold on the last day of its term at the appreciated price. These numbers are calculated based on
SEC requirements and do not reflect any projection or estimate of future stock price growth. No stock appreciation rights were granted during the fiscal year ended December 31, 2002.

|                     |  | Individual Grants |  |         |    |           
|-------------------- |  | ----------------- |  | ------- | -- | ----------
|
|
|
|
|
|John F. McDonnell    |  |                  |  |        |    |          
|John A. Kelley, Jr.  |  | 315,000           |  | 9.6     | %  | 10.91     
|Michael B. Gustafson |  | 50,000
40,000     |  | 1.5
1.2 | %% | 25.85
9.21
|Ernest J.Sampias     |  | 20,000
50,000     |  | *
1.5   | %  | 25.85
8.15
|Robert F. Finley     |  | 25,000            |  | *       |    | 25.85     
|Thomas O. McGimpsey  |  | 20,000            |  | *       |    | 25.85     
|Earl T. Carothers    |  | 25,000            |  | *       |    | 25.85     
|James E. Kuenzel     |  | 75,000            |  | 2.3     | %  | 25.85     

---

Aggregated Option Exercises in Last Fiscal Year

The following table sets forth information with respect to the Named Executive Officers concerning exercisable and unexercisable options held as of
December 31, 2002. The dollar value of

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in-the-money options at December 31, 2002 is calculated by determining the difference between the year-end fair market value of $7.03 per share and the
option exercise price.

|                     |  |         |  |   |           | Number of Securities Underlying Unexercised Options at
December 31, 2002 |         | Value of Unexercised In-the-Money Options at
December 31, 2002
|-------------------- |  | ------- |  | - | --------- | ------------------------------------------------------------------------ | ------- | --------------------------------------------------------------
|
|
|John F. McDonnell    |  |        |  |   |          |                                                                          | 940,000 |                                                               
|John Kelley          |  |        |  |   |          |                                                                          | 62,500  |                                                               
|Michael B. Gustafson |  | 55,000  |  | $ | 856,350   |                                                                          | 167,500 |                                                               
|Ernest J. Sampias    |  |        |  |   |          |                                                                          | 8,750   |                                                               
|Robert Finley        |  |        |  |   |          |                                                                          | 20,000  |                                                               
|Thomas O. McGimpsey. |  | 6,000   |  | $ | 29,580    |                                                                          | 30,250  |                                                               
|Earl T. Carothers    |  |        |  |   |          |                                                                          |        |                                                               
|James E. Kuenzel     |  | 222,500 |  | $ | 1,431,175 |                                                                          |        |                                                               

Management Bonus Program

McDATA is a pay-for-performance company. Our philosophy and incentive plans are designed to reward plan participants for performance.
During the first half of 2002, all of our executive officers and many
of our other senior employees were eligible for a bonus based upon achievement of specified annual or quarterly corporate and individual objectives. The target bonus was calculated as a percentage of
base compensation and ranged from 10% to 40% for non-executive officers and from 25% to 100% for executive officers. This plan remained in place for the first and second quarters of 2002,
during which time the financial objectives of the company were not met, and, therefore, no payments were made under this plan to our executive officers. Certain other eligible members of management
received a bonus payment based upon individual objectives achieved during the first quarter. The plan was terminated as of April 1, 2002, and replaced with new plans beginning in the third and
fourth quarter of 2002.

Beginning
in the third quarter of 2002, a revised executive incentive bonus plan was implemented in lieu of the earlier plan. The revised plan uses restricted stock with accelerated
vesting opportunities to reward participants for the collective achievement of strategic corporate revenue and EPS goals on a quarterly basis. The plan is designed to further drive performance beyond
target levels through the availability of additional cash bonus opportunities when target metrics are substantially exceeded. Currently the cash bonus component of the plan is calculated as a
percentage of base compensation and can range from 7.5% to 18.75% of quarterly base salary if corporate objectives are achieved, and from 30% to 75% if more progressive objectives are met. Corporate
performance objectives were not met for the third quarter and the plan did not pay. The plan did pay for corporate performance in the fourth quarter and the restricted shares were accelerated per the
plan.

Beginning
in the fourth quarter, a new performance plan was implemented for non-executive members of management and certain high-level individual contributors.
Participants are eligible for a bonus based upon achievement of specified quarterly company and individual objectives. This plan paid for corporate and individual achievement for the fourth quarter.

Throughout
2002, Mr. Gustafson transitioned from sales to marketing and his compensation remained tied directly to the attainment of annual and quarterly revenue objectives. He
was paid under his compensation plan for performance in 2002. Beginning in 2003, he has transitioned to the revised executive incentive bonus plan with the other executives. Mr. McDonnell
participates in an incentive compensation plan which is based upon the attainment of annual corporate financial objectives established by the Board of Directors. Upon attainment of these objectives,
the plan provides for a

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payment equal to a percentage of annual salary. Mr. McDonnell received payment under the plan for the attainment of these objectives in 2002.

Change of Control Arrangements/Employment Agreements

All of our executive officers have entered into severance agreements and key employee agreements with us. Our severance agreements grant our executive officers a
payment, in a lump sum or according to our normal payroll timetable, equal to four times the average of their quarterly compensation over the preceding eight calendar quarters, payment for all accrued
but unused vacation days, the provision
of health benefits for a period of time and automatic acceleration of the vesting of all stock options held if we terminate their employment upon a change in control and provide that our executive
officers will not engage in any activity that conflicts with their obligations to us, induce other employees to leave us, or compete with us for a period of one year after termination of their
employment. Under the terms of the key employee agreement, all confidential, proprietary or other trade secret information and all other discoveries, inventions, processes, methods and improvements
made by the employee are our property. In addition, pursuant to the agreement, employees may not compete with us for one year after termination of their employment.

Limitation of Liability and Indemnification

Our amended and restated certificate of incorporation and amended and restated by-laws provide that we shall indemnify our directors and officers to
the fullest extent that Delaware law permits. Delaware law permits a corporation to indemnify any director, officer, employee or agent made or threatened to be made a party to any pending or completed
proceeding if the person acted in good faith and in a manner that the person reasonably believed to be in the best interests of the corporation and, with respect to any criminal proceeding, had no
reasonable cause to believe that his or her conduct was unlawful.

Our
amended and restated certificate of incorporation limits the liability of our directors to the maximum extent permitted by Delaware law. Delaware law provides that directors will not
be personally liable for monetary damages for breach of their fiduciary duties as directors, except liability for:



This
provision has no effect on any non-monetary remedies that may be available to us or our stockholders, nor does it relieve us or our officers or directors from compliance
with federal or state securities laws.

Given
the increasing difficulty in obtaining additional liability insurance for officers and in recognition of the need to protect certain officers from unwarranted personal liability,
in October 2001 the Board of Directors authorized the Company to extend indemnification agreements to our CEO, President, CFO and certain of our other officers to provide specific contractual
assurance that the indemnification protection promised by the by-laws will be available to such officers.

Insofar
as indemnification for liabilities arising under the Securities Act may be permitted to directors, officers, or persons controlling us under the provisions that we describe above
or otherwise, we have been informed that in the opinion of the SEC, this indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable.

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Our
amended and restated by-laws also permit us to purchase and maintain insurance on behalf of any officer or director for any liability arising out of his or her actions in
that capacity, regardless of whether our by-laws would otherwise permit indemnification for that liability. We currently have such liability insurance for our officers and directors.

At
the present time, there are several class action lawsuits (see Item 3. Legal Proceedings) involving certain of our current and former officers. We believe these lawsuits are without
legal merit. Accordingly, the Board of Directors has authorized indemnification for such current and former officers.

Employee Benefit Plans

2001 Equity Incentive Plan

Our Board of Directors and our stockholders approved and adopted our 1997 Stock Option Plan in October 1997, which was amended and restated in
August 2001 as the 2001 Equity Incentive Plan by the Board of Directors and stockholders. This amendment of the plan increased the authorized number of Class B common stock shares
issuable under the plan by 5 million shares (from 19 million to 24 million) and expanded the type of awards to include restricted stock and stock awards and other necessary
changes. As of December 31, 2002, approximately 3,755,210 million shares of our Class B common stock were reserved for issuance under the 2001 Equity Incentive Plan. Under the
terms of the 2001 Equity Incentive Plan, our Board of Directors may grant incentive stock options, non-qualified stock options, stock bonuses and rights to acquire restricted stock to our
employees and non-qualified stock options to
our directors, provided that certain eligibility requirements are satisfied. Our Board of Directors administers the 2001 Equity Incentive Plan, but has delegated to the Compensation Committee the
authority to administer the plan.

Subject
to the provisions of the 1997 Stock Option Plan, our Board of Directors or Compensation Committee has the authority to select eligible persons to whom options will be granted and
determine the terms of each option, including:



The
exercise price per share of Class B common stock for:



Initially,
each incentive stock option granted is exercisable over a period determined by the Board of Directors or the Compensation Committee in its discretion, not to exceed
ten years from the date of the grant as required by the Internal Revenue Code of 1986. In addition, the exercise period for an incentive stock option may not exceed five years from the
date of the grant if the option is granted to an individual who, at the time of the grant, owns more than 10% of the total combined voting power of all classes of our capital stock. The Board of
Directors or the Compensation Committee generally has
the right to accelerate the exercisability of any options granted under the 2001 Equity Incentive Plan that would otherwise be unexercisable. In the event of certain changes in control, the acquiring
or successor corporation may assume or grant substitute options for options then outstanding under the 2001 Equity Incentive Plan, or such options shall terminate.

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The 2001 Equity Incentive Plan expires on September 30, 2007, except as to options or awards outstanding on that date. Subject to the terms of the 2001 Equity Incentive Plan, the
Board of Directors or the Compensation Committee may terminate or amend the 2001 Equity Incentive Plan at any time.

The
Board of Directors or the Compensation Committee determines the purchase price of other stock awards. However, the Board of Directors or the Compensation Committee may award stock
bonuses in consideration of past services without purchase payment. Shares that we sell or award under the 2001 Equity Incentive Plan may, but need not be, restricted and subject to a repurchase
option in our favor in accordance with a vesting schedule that the Board of Directors or the Compensation Committee determines. The Board of Directors or the Compensation Committee, however, may
accelerate the vesting of the restricted stock. In accordance with the terms of the 2001 Equity Incentive Plan, the Compensation Committee has delegated its duties with respect to equity grants for
non-executive officers to a Compensation Subcommittee, which is chaired by Mr. McDonnell.

As
of December 31, 2002, options for the purchase of an aggregate of 11,654,040 shares of Class B common stock at a weighted average exercise price of $11.56 were
outstanding under the 2001 Equity Incentive Plan. As of December 31, 2002, stock awards in the form of 169,917 shares of Class B common stock were reserved for issuance relating to our
executive incentive plan.

Employee Stock Purchase Plan

In 2002, our Board of Directors adopted and our stockholders approved the McDATA Employee Stock Purchase Plan, or the Purchase Plan. The Purchase Plan became
effective as of August 1, 2002. The Purchase Plan is an employee stock purchase plan under Section 423 of the Internal Revenue Code. The Purchase Plan will be administered by the
Compensation Committee and the Compensation Committee is authorized to determine any questions arising in the administration, interpretation and application of the Purchase Plan. The Board of
Directors may at any time amend the Purchase Plan in any respect which shall not adversely affect the rights of participants pursuant to shares previously acquired under the Purchase Plan, provided
that approval by our stockholders of the Company is required to (i) increase the number of shares to be reserved under the Purchase Plan (except for adjustments by reason of stock dividends,
stock splits, corporate separations, recapitalizations, mergers, consolidations, combinations, exchanges of shares and similar transactions), (ii) decrease the minimum purchase price,
(iii) withdraw the administration of the Purchase Plan from the Compensation Committee, or (iv) change the definition of employees eligible to participate in the Purchase Plan.

Up
to 1.2 million shares of our Class B common stock are available for distribution under the Purchase Plan, subject to appropriate adjustments by the Compensation
Committee in the event of certain changes in the outstanding shares of Class B common stock by reason of stock dividends, stock splits, corporate separations, recapitalizations, mergers,
consolidations, combinations, exchanges of shares or similar transactions. As of December 31, 2002 approximately 1.2 million shares of our Class B common stock remain available
for issuance under the Purchase Plan.

Any
of our employees or, subject to approval by the Board of Directors, employees of any of our subsidiary corporations (including officers and any directors who are also employees) will
be eligible to participate in the Purchase Plan for any Purchase Period. "Purchase Period" means a six-month period ending on the last day of February or August of each year
(or another period determined by the Compensation Committee). No employee may participate in the Purchase Plan if such employee would be deemed for purposes of the Internal Revenue Code to own stock
possessing 5% or more of the total combined voting power or value of all classes of our stock. If the employment of a participant terminates for any reason, including death, disability or retirement,
the amounts previously withheld will be refunded. The rights of a participant under the Purchase Plan are exercisable only by the participant during his or her lifetime. No right or interest of any
participant in the Purchase Plan may

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be sold, pledged, assigned or transferred in any manner other than by will or the laws of descent and distribution.

An
eligible employee who elects to participate in the Purchase Plan will deliver a signed election form which authorizes us to make payroll deductions of a specified whole percentage
from 1% to 10% of the employee's gross cash compensation as defined in the Purchase Plan. A participant may elect to withdraw from the Purchase Plan at any time before the end of a Purchase Period. As
of the last day of each Purchase Period, the amounts withheld for a participant in the Purchase Plan will be used to purchase shares of our Class B common stock. The purchase price of each
share will be equal to 85% of the lesser of the fair market value (as determined under the provisions of the Purchase Plan) of a share of Class B common stock on either the first or last day of
the Purchase Period. All amounts so withheld will be used to purchase the number of shares of Class B common stock that can be purchased with such amounts at such price, unless the participant
has properly notified us that he or she elects to purchase a lesser number of shares or to receive all or a portion of the entire amount in cash in accordance with the terms of the Purchase Plan.

No
more than $25,000 in fair market value (determined on the first day of the respective Purchase Periods) of shares of Class B common stock may be purchased by any participant
for each calendar year under the Purchase Plan and all other employee stock purchase plans, if any, that we or any of our parent or subsidiary corporations may establish. If purchases by all
participants would exceed the number of shares of Class B common stock available for purchase under the Purchase Plan, each participant will be allocated a ratable portion of such available
shares. Any amount not used to purchase shares of Class B common stock will be refunded to the participant in cash.

Shares
of Class B common stock acquired by each participant will be held in a general securities brokerage account maintained by the Agent for the benefit of all participants,
with an agent, selected by us, maintaining individual sub accounts for each participant. Each participant will be entitled to vote all shares held for the benefit of such participant in the general
securities brokerage account. After meeting certain holding requirements, certificates for the number of shares of Class B common stock purchased by a participant will be issued and delivered
to him or her only upon the request of such participant or his or her representative.

All
rights of participants in any offering under the Purchase Plan will terminate at the earlier of (i) the day that participants become entitled to purchase a number of shares of
Class B common stock equal to or greater than the number of shares remaining available for purchase or (ii) at any time, at the discretion of the Board of Directors, after
30 days' notice has been given to all participants. Upon termination of the Purchase Plan, shares of Class B common stock will be purchased for participants in accordance with the terms
of the Purchase Plan, and cash, if any, previously withheld and not used to purchase Class B common stock will be refunded to the participants, as if the Purchase Plan were terminated at the
end of a Purchase Period.

401(k) Plan

The Company has adopted a 401(k) Plan. Participants in our 401(k) plan may contribute up to 15% of their total annual compensation, not to exceed
the specified statutory limit, which was $11,500 in calendar year 2002. The 401(k) plan permits, but does not require, us to make contributions to the 401(k) plan on behalf of our
employees. Our current practice is to match $.50 on each dollar of an employee's contributions up to the first 6% of an employee's compensation with a total maximum matching contribution of 3% of an
employee's compensation. All contributions to the 401(k) plan by or on behalf of employees are subject to the aggregate annual limits prescribed by the Internal Revenue Service. Under our
401(k) plan, our participants received full and immediate vesting of their contributions and are vested in matching contributions over a three-year period.

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Profit Sharing

Subject to approval by the Board of Directors or the Compensation Committee, we have historically awarded limited profit sharing to eligible employees based on
Company performance. For 2001, the amount approved was 2.5% of annual base salary. For 2002, the amount approved was 7.5% of an employee's fourth quarter base earnings if the employee did not
participate in any other incentive compensation plan of the Company.

Compensation Committee Interlocks and Insider Participation

No interlocking relationship exists between our Board of Directors or Compensation Committee and the board of directors or compensation committee of any other
entity, nor has any interlocking relationship existed in the past.

Director Compensation

With the exception of John F. McDonnell and John A. Kelley, Jr., all of our directors are compensated for their services as board or committee members in fiscal
year 2002. Each director other than Mr. McDonnell and Mr. Kelley received in fiscal year 2002 an annual director's fee of $10,000, plus $1,000 for each board meeting and $1,000 for each
committee meeting. Our practice has been to grant directors options to purchase 50,000 shares of our Class B common stock when they became directors and to grant them options to purchase an
additional 20,000 shares of our Class B common stock each year thereafter. In October 1997, before he became a director, Mr. McDonnell was granted an option to purchase 1,000,000
shares of our Class B common stock and has not been granted options since. Mr. Kelley was granted an option to purchase 250,000 shares of our Class B common stock upon his hire as
President and Chief Operating Officer in late August 2001. In August 2002, Mr. Kelley was granted an additional 315,000 shares of our Class B common stock upon his
appointment as our President and Chief Executive Officer.

Report of the Compensation Committee of the Board of Directors

The following is the report of the Compensation Committee of the Board of Directors with respect to the compensation paid to the Company's executive officers
during fiscal year 2002. Actual compensation earned during fiscal year 2002 by the Named Executive Officers is shown in the Summary Compensation Table.

Compensation Philosophy

The Company operates in the extremely competitive and rapidly changing high technology industry. The Compensation Committee believes that the compensation
programs for the executive officers should be designed to attract, motivate and retain talented executives responsible for the success of the Company and should be determined within a competitive
framework and based on the achievement of designated business objectives, individual contribution, customer satisfaction and financial performance. Within this overall philosophy, the Compensation
Committee's objectives are to:



59

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Components of Executive Compensation

The compensation program for the Company's executive officers consists of the following components:



Base Salary

The Compensation Committee reviews salaries for the Chief Executive Officer and other executive officers at its first annual meeting of each year. Base salaries
are established by the Compensation Committee based upon competitive compensation data, an executive's job responsibilities, their level of experience, individual performance and contribution to the
business. No specific formula is applied to determine the weight of each factor. The Compensation Committee bases its determination of Mr. McDonnell's and Mr. Kelley's salary on both his
individual performance and the salaries paid to chief executive officers of peer companies. Based upon a review of competitive compensation data in early 2002, the Compensation Committee determined to
increase Mr. McDonnell's salary to $400,000 for 2002. At Mr. McDonnell's request to be firmly aligned with stockholders, he recommended, and the Compensation Committee agreed, that his
base salary would be paid only upon meeting certain 2002 financial and operational milestones (which are the same company milestones for the other executive
officers under the Management Bonus Program). Mr. McDonnell may take recoverable draws against his anticipated salary if needed. Upon assumption of the role of Non-Executive
Chairman of the Board of Directors in August 2002, Mr. McDonnell's salary was reduced, at his request, to $100,000. At the same time, upon assumption of the role of Chief Executive
Officer, Mr. Kelley's salary was increased to $400,000.

Management Bonus Program

McDATA is a pay-for-performance company. Our philosophy and incentive plans are designed to reward plan participants for performance.
During the first half of 2002, all of our executive officers and many of our other senior employees were eligible for a bonus based upon achievement of specified annual or quarterly corporate and
individual objectives. The target bonus was calculated as a percentage of base compensation and ranged from 10% to 40% for non-executive officers and from 25% to 100% for executive
officers. This plan remained in place for the first and second quarters of 2002, during which time the financial objectives of the company were not met, and, therefore, no payments were made under
this plan to our executive officers. Certain other eligible members of management received a bonus payment based upon individual objectives achieved during the first quarter. The plan was terminated
as of April 1, 2002, and replaced with new plans beginning in the third and fourth quarter of 2002.

Beginning
in the third quarter of 2002, a revised executive incentive bonus plan was implemented in lieu of the earlier plan. The revised plan uses restricted stock with accelerated
vesting opportunities to reward participants for the collective achievement of strategic corporate revenue and EPS goals on a quarterly basis. The plan is designed to further drive performance beyond
target levels through the availability of additional cash bonus opportunities when target metrics are substantially exceeded. Currently the cash bonus component of the plan is calculated as a
percentage of base compensation and can range from 7.5% to 18.75% of quarterly base salary if corporate objectives are achieved, and from 30% to 75% if more progressive objectives are met. Corporate
performance objectives were not met for the third quarter and the plan did not pay. The plan did pay for corporate performance in the fourth quarter and the restricted shares were accelerated per the
plan.

60

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Beginning
in the fourth quarter, a new performance plan was implemented for non-executive members of management and certain high-level individual contributors.
Participants are eligible for a bonus based upon achievement of specified quarterly company and individual objectives. This plan paid for corporate and individual achievement for the fourth quarter.

Throughout
2002, Mr. Gustafson transitioned from sales to marketing and his compensation remained tied directly to the attainment of annual and quarterly revenue objectives. He
was paid under his compensation plan for performance in 2002. Beginning in 2003, he has transitioned to the revised executive incentive bonus plan with the other executives. Mr. McDonnell
participates in an incentive
compensation plan which is based upon the attainment of annual corporate financial objectives established by the Board of Directors. Upon attainment of these objectives, the plan provides for a
payment equal to a percentage of annual salary. Mr. McDonnell received payment under the plan for the attainment of these objectives in 2002.

Long-Term Stock Option Incentives

The Compensation Committee provides the Company's executive officers with long-term incentive compensation through grants of options to purchase the
Company's Class B common stock. The goal of the long-term stock option incentive program is to align the interests of executive officers with those of the Company's stockholders and
to provide each executive officer with a significant incentive to manage the Company from the perspective of an owner with an equity stake in the business. It is the belief of the Compensation
Committee that stock options directly motivate an executive to maximize long-term stockholder value. The options also utilize vesting periods that encourage key executives to continue in
employ of the Company. The Compensation Committee considers the grant of each option subjectively, reviewing factors such as the anticipated future contribution of the executive toward the attainment
of the Company's long-term strategic performance goals. In 2002, the Compensation Committee granted new hire options to executive officers joining the Company, Mr. Andreoli and
Ms. Becker received 360,000 and 150,000 new hire options to purchase Class B common stock, respectively, that vests one quarter each year. In 2002, the Compensation Committee approved of
(i) an additional option grant for eligible executives as part of the annual compensation review, (ii) a broad-based option grant program for eligible employees and directors,
(iii) a retention option grant program for high performing employees and directors, (iv) restricted stock grants to eligible executives and certain other senior employees participating
in the Executive Performance Incentive Bonus plan. As part of the option program described in (i) above, Mr. Gustafson, Mr. Kuenzel, Mr. Carothers, Mr. Finley,
Mr. McGimpsey, Mr. Wenninger, and Ms. Niparko, were granted 50,000, 75,000, 25,000, 25,000, 20,000, 25,000, and 25,000 options to purchase Class B common stock,
respectively. In August 2002, as part of his annual compensation review and promotion to Chief Executive Officer, Mr. Kelley was granted 315,000 options to purchase Class B common
stock. As part of the restricted stock program described in (iv) above, Mr. Kelley, Mr. Sampias, Mr. Kuenzel, Mr. Finley, Ms. Niparko, Mr. McGimpsey,
and Mr. Wenninger were granted 39,400, 16,600, 12,000, 9,000, 10,500, 10,500, and 10,600 restricted shares of Class B common stock, respectively. In fiscal 2002, no options were granted
to Mr. McDonnell because the Compensation Committee believed that his current option status was competitive based on market data.

61

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Section 162(m)

The Company has considered the potential future effects of Section 162(m) of the Internal Revenue Code on the compensation paid to the Company's executive
officers. Section 162(m) disallows a tax deduction for any publicly held corporation for individual compensation exceeding $1.0 million in any taxable year for any of the Named Executive
Officers, unless compensation is performance-based. The Company will seek to qualify the variable compensation paid to its executive officers for an exemption from the deductibility limitations of
Section 162(m).

| |  | Respectfully submitted by:                                                             
| |  | ---------------------------------------------------------------------------------------
| |  | /s/THOMAS M. UHLMAN                                                                    
| |  | The Compensation CommitteeThomas M. Uhlman, Chairman
Laurence G. Walker
Betsy S. Atkins

62

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Performance Graph

Set forth below is a line graph comparing the annual percentage change in the cumulative return to the stockholders of our Class A Common Stock with the
cumulative return of the NASDAQ Market Index
and the SIC Code Computer Peripheral Equipment Index for the period commencing February 8, 2001 and ending on December 31, 2002. Returns for the indices are weighted based on market
capitalization at the beginning of each measurement point.

COMPARE CUMULATIVE TOTAL RETURN
AMONG MCDATA CORPORATION,
NASDAQ MARKET INDEX AND SIC CODE INDEX

Performance Graph

ASSUMES $100 INVESTED ON AUG. 5 2000
ASSUMES DIVIDEND REINVESTED
FISCAL YEAR ENDING DEC. 31, 2002

|Company/Index      |  | 02/08/01 |        | 03/31/01 |   | 06/30/01 |  | 09/30/01 |       | 12/31/01
|------------------ |  | -------- | ------ | -------- | - | -------- |  | -------- | ----- | --------
|McDATA Corporation |  | $        | 100.00 |          | $ | 40.18    |  | $        | 37.95 |         
|SIC Code 3669      |  | $        | 100.00 |          | $ | 46.89    |  | $        | 41.13 |         
|NASDAQ             |  | $        | 100.00 |          | $ | 67.24    |  | $        | 78.80 |         

|Company/Index      |  | 03/31/02 |       | 06/30/02 |   | 09/30/02 |  | 12/31/02
|------------------ |  | -------- | ----- | -------- | - | -------- |  | --------
|McDATA Corporation |  | $        | 25.66 |          | $ | 19.05    |  | $       
|SIC Code 3669      |  | $        | 23.32 |          | $ | 13.46    |  | $       
|NASDAQ             |  | $        | 67.61 |          | $ | 54.23    |  | $       

---

63

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Set
forth below is a line graph comparing the annual percentage change in the cumulative return to the stockholders of our Class B Common Stock with the cumulative return of the
NASDAQ Market Index
and the SIC Code Computer Peripheral Equipment Index for the period commencing August 9, 2000 and ending on December 31, 2002. Returns for the indices are weighted based on market
capitalization at the beginning of each measurement point.

COMPARE CUMULATIVE TOTAL RETURN
AMONG MCDATA CORPORATION CLASS B,
NASDAQ MARKET INDEX AND SIC CODE INDEX

Performance Graph

ASSUMES $100 INVESTED ON AUG. 5 2000
ASSUMES DIVIDEND REINVESTED
FISCAL YEAR ENDING DEC. 31, 2001

|Company/Index      |  | 08/09/00 |        | 09/30/00 |   | 12/31/00 |  | 03/31/01 |       | 06/30/01 |   | 09/30/01 |  | 12/31/01
|------------------ |  | -------- | ------ | -------- | - | -------- |  | -------- | ----- | -------- | - | -------- |  | --------
|McDATA Corporation |  | $        | 100.00 |          | $ | 143.63   |  | $        | 63.99 |          | $ | 26.50    |  | $       
|SIC Code 3669      |  | $        | 100.00 |          | $ | 96.41    |  | $        | 72.33 |          | $ | 35.07    |  | $       
|NASDAQ             |  | $        | 100.00 |          | $ | 97.44    |  | $        | 65.48 |          | $ | 49.37    |  | $       

|Company/Index      |  | 03/31/02 |       | 06/30/02 |   | 09/30/02 |  | 12/31/02
|------------------ |  | -------- | ----- | -------- | - | -------- |  | --------
|McDATA Corporation |  | $        | 14.14 |          | $ | 10.40    |  | $       
|SIC Code 3669      |  | $        | 17.44 |          | $ | 10.07    |  | $       
|NASDAQ             |  | $        | 49.64 |          | $ | 39.81    |  | $       

---

The
information contained above under the captions "Report of the Compensation Committee of the Board of Directors" and
"Performance Graph" shall not be deemed to be "soliciting material" or to be "filed" with the SEC, nor shall such information be incorporated by
reference into any future filing under the Securities Act or the Securities Exchange Act, except to the extent that the Company specifically incorporates it by reference into such filing.

64

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ITEM 12. Security Ownership of Certain Beneficial Owners and Management

The following table sets forth certain information concerning the beneficial ownership of our common stock as of December 31, 2002. Unless otherwise
indicated, the address of each listed shareholder is c/o McDATA Corporation, 380 Interlocken Crescent, Broomfield, Colorado 80021.

We
have determined beneficial ownership in accordance with the rules of the SEC. Except as indicated by the footnotes below, we believe, based on the information furnished to us, that
the persons and entities named in the tables below have sole voting and investment power with respect to all shares of common stock that they beneficially own, subject to applicable community property
laws. We have based our calculation of the percentage of beneficial ownership on the number of shares of Class A common stock outstanding on December 31, 2002, or the number of shares of
Class B common stock outstanding on December 31, 2002, as the case may be. There were 81,000,000 shares of Class A common stock outstanding on December 31, 2002, and
32,962,212 shares of Class B common stock outstanding on December 31, 2002.

In
computing the number of shares of Class B common stock beneficially owned by a person and the percentage ownership of that person, we deemed outstanding shares of
Class B common stock subject to options held by that person that are currently exercisable or exercisable within 60 days of December 31, 2002. Asterisks represent beneficial
ownership of less than one percent.

65

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|                                                             |  |           |      |           |      | Percent of Shares of Common Stock Class Beneficially Owned |  
|------------------------------------------------------------ |  | --------- | ---- | --------- | ---- | ---------------------------------------------------------- | -
|
|
|
|5% Stockholders                                              |  |           |      |           |      |                                                            |  
|Oak Associates LTD.                                          |  | 6,470,000 | (1)  |          |      | 8.0                                                        | %
|3875 Embassy Parkway #250
Akron, OH 44333                    |  |           |      |           |      |                                                            |  
|Brookside Capital Partners Fund LP                           |  | 5,728,808 | (1)  |          |      | 7.1                                                        | %
|111 Huntington Avenue
Boston, MA 02199                       |  |           |      |           |      |                                                            |  
|Essex Investment Management Co. LLC.                         |  | 5,576,785 | (1)  |          |      | 6.9                                                        | %
|125 High Street, 29th Floor
Boston, MA 02110                 |  |           |      |           |      |                                                            |  
|Putnam LLC.                                                  |  | 4,773,347 | (1)  |          |      | 5.8                                                        | %
|One Post Office Square
Boston, MA 02109                      |  |           |      |           |      |                                                            |  
|Patricia L. McDonnell                                        |  | 37,816    | (2)  | 3,631,500 | (3)  | *                                                          |  
|John F. McDonnell                                            |  | 28,311    | (4)  | 6,530,000 | (5)  | *                                                          |  
|Executive Officers and Directors                             |  |           |      |           |      |                                                            |  
|John F. McDonnell                                            |  | 28,311    | (4)  | 6,530,000 | (5)  | *                                                          |  
|John A. Kelley                                               |  |          |      | 113,715   | (6)  |                                                           |  
|Alain Andreoli                                               |  |          |      | 7,750     | (7)  |                                                           |  
|Jean Becker                                                  |  |          |      | 6,000     | (8)  |                                                           |  
|Robert F. Finley                                             |  | 185       |      | 29,000    | (9)  |                                                           |  
|Michael B. Gustafson                                         |  | 53        |      | 250,750   | (10) | *                                                          |  
|Thomas O. McGimpsey                                          |  |          |      | 30,250    | (11) |                                                            |  
|Karen L. Niparko                                             |  |          |      | 26,750    | (12) |                                                           |  
|Ernest J. Sampias                                            |  |          |      | 26,350    | (13) |                                                           |  
|Donald P. Wenninger                                          |  |          |      | 56,450    | (14) |                                                           |  
|Earl T. Carothers                                            |  |          |      |          |      |                                                           |  
|James E. Kuenzel                                             |  |          |      | 183,400   | (15) |                                                           |  
|John W. Gerdelman                                            |  |          |      | 96,125    | (16) |                                                           |  
|Charles C. Johnston                                          |  |          |      | 96,125    | (17) |                                                           |  
|D. Van Skilling                                              |  | 300       |      | 96,125    | (16) | *                                                          |  
|Thomas M. Uhlman                                             |  |          |      | 96,125    | (16) |                                                           |  
|Laurence G. Walker                                           |  | 1         | (18) | 96,225    | (16) | *                                                          |  
|Betsy S. Atkins                                              |  |          |      |          |      |                                                           |  
|                                                             |  |           |      |           |      |                                                            |  
|All Executive Officers and Directors as a Group (18 persons) |  | 28,850    |      | 7,827,740 |      | *                                                          |  

---

66

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On
February 7, 2001, EMC distributed all the shares of our Class A common stock held by EMC to EMC stockholders on a pro rata basis in a transaction that was tax free to EMC. A total of
81,000,000 shares of our Class A common stock were distributed. EMC stockholders paid no consideration for the shares of Class A common stock distributed to them.

The
following table sets forth certain information concerning all equity compensation plans previously approved by stockholders and all equity compensation plans not previously approved
by stockholders as of December 31, 2002. The 2001 Equity Incentive Plan is our only equity compensation plan and it was approved by stockholders.

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Equity Compensation Plan Information as of December 31, 2002

|Plan Category                                              |       | Number of Securities to be issued upon exercise of outstanding options, warrants and rights |            | Weighted average exercise price of outstanding option, warrants and rights |       | Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
|---------------------------------------------------------- | ----- | ------------------------------------------------------------------------------------------- | ---------- | -------------------------------------------------------------------------- | ----- | -------------------------------------------------------------------------------------------------------------------------------------------
|Equity compensation plans approved by security holders     |       | 11,654,040                                                                                  |            | $                                                                          | 11.56 |                                                                                                                                            
|Equity compensation plans not approved by security holders |       | N/A                                                                                         |            |                                                                            | N/A   |                                                                                                                                            
|                                                           | Total |                                                                                             | 11,654,040 |                                                                            | $     | 11.56                                                                                                                                      

Other Matters

In October 2000, new SEC rules went into effect that establish affirmative defenses to insider trading claims under certain defined circumstances,
irrespective of the possession of material non-public information, for transactions planned before coming into possession of such information. Generally, such persons may purchase or sell
such securities pursuant to a binding pre-existing plan, contract or instruction, or collectively a Pre-Existing Plan, which sets forth either (a) the amount, price and
date of such trade, (b) a formula, algorithm or computer program for determining amounts, prices and dates; or (c) such Pre-Existing Plan does not permit the person to
exercise any subsequent influence over the trade. Patricia McDonnell, John F. McDonnell, Michael Gustafson and Betsy F. Atkins have established
Pre-Existing Plans for the purpose of selling a portion of their shares of Class B common stock to diversify their holdings. Other officers may enter into Pre-existing
Plans to diversify their holdings.

ITEM 13. Certain Relationships and Related Transactions

There has not been nor is there currently proposed any transaction or series of similar transactions to which we were or are a party in which the amount involved
exceeds $60,000 and in which any director, executive officer, holder of more than 5% of our common stock or any member of the immediate family of any of the foregoing persons had or will have a direct
or indirect material interest other than (a) compensation agreements and other arrangements, which are described in "Item 11Executive Compensation" and (b) the transactions
described in our Registration Statement on Form S-1, SEC File No. 333-38106, declared effective on August 8, 2000.

In
connection with the February 7, 2001 distribution of our Class A common stock by EMC, the Investors' Rights Agreement to which Mr. McDonnell was a party was
terminated in accordance with its terms.

ITEM 14. Controls and Procedures

Within 90 days prior to the date of this report, we carried out an evaluation, under the supervision and with the participation of our principal executive
officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, our principal executive officer and
principal financial officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic SEC reports. It
should be noted that the design of any system of controls is based in part upon certain assumptions, and there can be no assurance that any design will succeed in achieving its stated goals.

In
addition, we reviewed our internal controls, and there have been no significant changes in our internal controls or in other factors that could significantly affect those controls
subsequent to the date of their last evaluation.

68

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PART IV

ITEM 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K

Page(i)

Index to Consolidated Financial Statements

F-1Report of Independent Accountants

F-2Consolidated Financial Statements:Consolidated Balance Sheets as of December 31, 2002 and 2001

F-3Consolidated Income Statements for the years ended December 31, 2002, 2001 and 2000

F-4Consolidated Statements of Changes in Stockholders' Equity for the years ended December 31, 2002, 2001 and 2000

F-5Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001 and 2000

F-6Notes to Consolidated Financial Statements

F-7 through F-29(ii)

Consolidated Financial Statement Schedule:Schedule IIValuation and Qualifying Accounts

S-1


Financial
statement schedules other than the one listed above have been omitted because the required information is contained in the consolidated financial statements and notes thereto or because such
schedules are not required or applicable.

We
filed the following reports on Form 8-K during the fourth quarter of 2002, the period from January 1, 2003 to January 31, 2003 and the first quarter
of 2003 through the date of the filing of this Annual Report: Form 8-K filed on October 21, 2002, Form 8-K filed on October 31, 2002,
Form 8-K filed on December 23, 2002, Form 8-K filed on January 16, 2003, Form 8-K filed on January 23, 2003,
Form 8-K filed on February 3, 2003, Form 8-K/A filed on February 5, 2003, Form 8-K filed on February 14, 2003, Forms
8-K (two) filed on March 5, 2003, Form 8-K filed on March 6, 2003 and Form 8-K filed on March 26, 2003.

Exhibits
identified in parentheses below are on file with the SEC and are incorporated herein by reference. All other exhibits are provided as part of this submission.

Exhibits filed for the Company through the filing of this Form 10-K.

|(3.1)   |  | Amended and Restated Certificate of Incorporation of the Company                                                                                    
|------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------
|(3.2)   |  | Amended and Restated By-laws of the Company                                                                                                         
|(4.1)   |  | Form of Company's Class B Common Stock Certificates                                                                                                 
|(4.1.1) |  | Form of Company's Class A Common Stock Certificates                                                                                                 
|(4.2)   |  | Investors' Rights Agreement dated as of October 1, 1997 by and among the Company, EMC Corporation, McDATA Holdings Corporation and Certain Investors
|(4.3)   |  | Amendment No. 1 to the Investors' Rights Agreement dated May 23, 2000 by and among the Company, McDATA Holdings Corporation and certain Investors   
|        |  |                                                                                                                                                     

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|(4.4)    |  | Rights Agreement dated as of May 18, 2001, by and between the Company and the Bank of New York, as rights agent (Filed on Form 8-K dated May 21, 2001).                                                  
|-------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(4.5)    |  | Form of Indenture dated as of February 7, 2003 by and between the Company and Wells Fargo Bank Minnesota, National Association (Filed on Form 8-K dated February 14, 2003)                               
|(4.6)    |  | Form of Registration Rights Agreement dated as of February 7, 2003 by and among the Company and the parties thereto (Filed on Form 8-K dated February 14, 2003)                                          
|(10.1)   |  | Asset Transfer Agreement dated as of October 1, 1997 by and among the Company, EMC Corporation, and McDATA Holdings Corporation                                                                          
|(10.2)   |  | Investors' Rights Agreement dated as of October 1, 1997 by and among the Company, EMC Corporation, McDATA Holdings Corporation and certain Investors (see Exhibit 4.2)                                   
|(10.3)   |  | Amendment No. 1 to the Investors' Rights Agreement dated May 23, 2000 by and among the Company, McDATA Holdings Corporation and certain Investors (see Exhibit 4.3)                                      
|(10.3.1) |  | Termination of Investors' Rights Agreement, dated as of January 24, 2001, by and among the Company, McDATA Holdings Corporation and Certain Investors (Filed on Form 10-K for the fiscal year ended 2000)
|(10.4)   |  | Services Agreement dated as of October 1, 1997 by and among EMC Corporation, McDATA Holdings Corporation and the Company                                                                                 
|(10.5)   |  | Letter Agreement dated April 19, 1999 by and between the Company and McDATA Holdings Corporation                                                                                                         
|(10.6)   |  | Technology Rights Agreement dated as of October 1, 1997 by and among the Company, EMC Corporation and McDATA Holdings Corporation                                                                        
|(10.7)   |  | Amended and Restated Tax Sharing Agreement dated as of May 31, 2000 by and among EMC Corporation, McDATA Holdings Corporation and the Company                                                            
|(10.8)   |  | Form of Master Transaction Agreement entered into by and among the Company and EMC Corporation dated May 31, 2000                                                                                        
|(10.9)   |  | Form of Indemnification and Insurance Matters Agreement entered into by and among the Company and EMC Corporation dated May 31, 2000                                                                     
|(10.10)  |  | Master Confidential Disclosure and License Agreement dated as of May 31, 2000 by and among the Company and EMC Corporation                                                                               
|(10.11)+ |  | Reseller Agreement dated as of February 22, 2000 by and between International Business Machines Corporation and the Company                                                                              
|(10.12)  |  | Amendment Number One to the Resale Agreement dated September 30, 2000 by and between International Business Machines Corporation and the Company                                                         
|(10.13)+ |  | OEM Purchase and License Agreement dated as of May 19, 2000 by and between EMC Corporation and the Company                                                                                               
|10.13.1+ |  | Amendment to OEM Purchase and License Agreement dated as of September 21, 2001, by and between EMC Corporation and the Company                                                                           
|(10.14)+ |  | Development Agreement dated as of May 19, 2000 by and between EMC Corporation and the Company                                                                                                            
|         |  |                                                                                                                                                                                                          

70

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|(10.15)+   |  | Manufacturing Agreement dated as of September 17, 1992 by and between SCI Systems, Inc. and the Company                                                                                                    
|---------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(10.15.1)+ |  | Manufacturing and Purchasing Agreement dated as of December 14, 2001 by and between SCI Systems, Inc. and the Company (Filed on Form 8-K dated February 25, 2002)                                          
|10.15.2+   |  | Manufacturing and Purchase Agreement effective as of March 1, 2003 by and between Sanmina-SCI Corporation and the Company                                                                                  
|(10.16)+   |  | OEM and License Agreement dated as of April 27, 1999 by and between Brocade Communication Systems, Inc. and the Company                                                                                    
|(10.17)    |  | Lease dated September 12, 1997 by and between the Company and WHLNF Real Estate Limited Partnership                                                                                                        
|(10.18)    |  | Lease dated November 2, 1999 by and between the Company and the Mills Family LLC                                                                                                                           
|(10.19)    |  | Lease dated May 28, 1997 by and between the Company and 1211486 Ontario Limited                                                                                                                            
|(10.19.1)  |  | Lease dated October 6, 2000, by and between the Company and Amber Drive I, LLC (Filed on Form 10-Q for the fiscal quarter ended September 30, 2000)                                                        
|(10.19.2)  |  | Lease dated February 9, 2001 by and between the Company and Deutsche Bank (Filed on Form 10-K for the fiscal year ended 2000)                                                                              
|(10.19.3)  |  | Participation Agreement dated February 9, 2001 by and between the Company and Deutsche Bank (Filed on Form 10-K for the fiscal year ended 2000)                                                            
|(10.19.4)  |  | Second Amendment to Participation Agreement dated November 9, 2001 by and between the Company and Deutsche Bank (Filed on Form 10-Q for the fiscal quarter ended September 30, 2001)                       
|(10.19.5)  |  | Third Amendment to Participation Agreement dated January 24, 2002 by and between the Company and Deutsche Bank (Filed on Form 8-K dated February 25, 2002)                                                 
|(10.20)*   |  | Form of Severance Agreement                                                                                                                                                                                
|(10.21)*   |  | 1997 Stock Option Plan                                                                                                                                                                                     
|(10.21.1)* |  | 2001 McDATA Equity Incentive Plan (Filed on Form 10-Q for the fiscal quarter ended September 30, 2001)                                                                                                     
|(10.21.2)* |  | Employee Stock Purchase Plan (Filed on Schedule 14A Proxy Statement filed June 10, 2002)                                                                                                                   
|(10.22)*   |  | Form of Stock Option Agreement for 1997 Stock Option Plan                                                                                                                                                  
|(10.23)*   |  | Description of the Company's Management Bonus Program                                                                                                                                                      
|(10.24)    |  | Asset Purchase Agreement dated August 3, 2001 by and among the Company, SANavigator, Inc., Western Digital Corporation and Connex Inc. (Filed on Form 10-Q for the fiscal quarter ended September 30, 2001)
|10.25*     |  | Performance Incentive Bonus Plan                                                                                                                                                                           
|10.26*     |  | Executive Performance Incentive Bonus Plan                                                                                                                                                                 
|10.27*     |  | Chairman of the Board of Directors Performance Incentive Bonus Plan                                                                                                                                        
|21         |  | Subsidiaries of Company                                                                                                                                                                                    
|23         |  | Consent of PricewaterhouseCoopers LLP                                                                                                                                                                      
|           |  |                                                                                                                                                                                                            

71

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|24 |  | Power of Attorney
|-- |  | -----------------

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72

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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, in the City of Broomfield, State of Colorado, on March 26, 2003.

| |  | McDATA Corporation
| |  | ------------------
| |  | By:               

Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on
the date indicated.

|Principal Executive Officer                                                                        |  |                |  | 
|-------------------------------------------------------------------------------------------------- |  | -------------- |  | 
|/s/JOHN A. KELLEY, JR.John A. Kelley, Jr.
President and Chief Executive Officer                    |  | March 26, 2003 |  | 
|Principal Financial Officer                                                                        |  |                |  | 
|/s/ERNEST J. SAMPIASErnest J. Sampias
Senior Vice President of Finance and Chief Financial Officer |  | March 26, 2003 |  | 
|Principal Accounting Officer                                                                       |  |                |  | 
|/s/ERNEST J. SAMPIASErnest J. Sampias
Senior Vice President of Finance and Chief Financial Officer |  | March 26, 2003 |  | 
|                                                                                                   |  |                |  | 

73

---

|Directors:                                                  |  |                |  | 
|----------------------------------------------------------- |  | -------------- |  | 
|/s/JOHN F. MCDONNELLJohn F. McDonnell
Chairman of the Board |  | March 26, 2003 |  | 
|/s/JOHN A. KELLEY, JR.John A. Kelley, Jr.                   |  | March 26, 2003 |  | 
|John W. Gerdelman                                           |  | March 26, 2003 |  | 
|/s/CHARLES C. JOHNSTONCharles C. Johnston                   |  | March 26, 2003 |  | 
|D. Van Skilling                                             |  | March 26, 2003 |  | 
|/s/THOMAS M. UHLMANThomas M. Uhlman                         |  | March 26, 2003 |  | 
|/s/LAURENCE G. WALKERLaurence G. Walker                     |  | March 26, 2003 |  | 
|/s/BETSY S. ATKINSBetsy S. Atkins                           |  | March 26, 2003 |  | 
|/s/MICHAEL J. SOPHIEMichael J. Sophie                       |  | March 26, 2003 |  | 

74

---

CERTIFICATIONS

I,
John A. Kelley, Jr., certify that:



|Dated: March 26, 2003 |  | /s/JOHN A. KELLEY, JR.John A. Kelley, Jr.
President and Chief Executive Officer
|--------------------- |  | -------------------------------------------------------------------------------

75

---

I,
Ernest J. Sampias, certify that:



|Dated: March 26, 2003 |  | /s/ERNEST J. SAMPIASErnest J. Sampias
Senior Vice President of Finance and Chief Financial Officer
|--------------------- |  | --------------------------------------------------------------------------------------------------

76

---



McDATA CORPORATION

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS



|                                                          
|----------------------------------------------------------
|Report of Independent Accountants                         
|Audited Financial Statements                              
|Consolidated Balance Sheets                               
|Consolidated Income Statements                            
|Consolidated Statements of Changes in Stockholders' Equity
|Consolidated Statements of Cash Flows                     
|Notes to Consolidated Financial Statements                
|Schedule:                                                 
|Schedule IIValuation and Qualifying Accounts             

Note:
All other financial statement schedules are omitted because they are not applicable or the required information is included in the consolidated financial statements or notes
thereto.

F-1

---



REPORT OF INDEPENDENT ACCOUNTANTS

To
the Board of Directors and Stockholders
    of McDATA Corporation:

In
our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of McDATA Corporation and its subsidiaries at
December 31, 2002 and 2001, and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United
States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read
in conjunction with the related consolidated financial statements. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we
plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion.

PricewaterhouseCoopers
LLP

Denver,
Colorado
January 20, 2003, except for Note 14 which is as of February 7, 2003

F-2

---



McDATA CORPORATION        CONSOLIDATED BALANCE SHEETS        (in thousands, except share data)

|                                                                                      |                                                                                                                                | DECEMBER 31,                               |        
|------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------ | ------------------------------------------ | -------
|
|Assets                                                                                |                                                                                                                                |                                            |        
|Current assets:                                                                       |                                                                                                                                |                                            |        
|                                                                                      | Cash and cash equivalents                                                                                                      |                                            | $      
|                                                                                      | Short-term investments                                                                                                         |                                            |        
|                                                                                      | Accounts receivable, net of allowances for doubtful accounts of $1,265 and $783, respectively                                  |                                            |        
|                                                                                      | Inventories, net                                                                                                               |                                            |        
|                                                                                      | Deferred tax asset                                                                                                             |                                            |        
|                                                                                      | Prepaid expenses and other current assets                                                                                      |                                            |        
|                                                                                      |                                                                                                                                |                                            |        
|Total current assets                                                                  |                                                                                                                                |                                            | 349,659
|Property and equipment, net                                                           |                                                                                                                                |                                            | 99,927 
|Long-term investments                                                                 |                                                                                                                                |                                            | 73,099 
|Restricted investments                                                                |                                                                                                                                |                                            |       
|Intangible assets, net of accumulated amortization of $5,037 and $2,864, respectively |                                                                                                                                |                                            | 7,887  
|Goodwill                                                                              |                                                                                                                                |                                            | 11,780 
|Other assets, net                                                                     |                                                                                                                                |                                            | 12,839 
|                                                                                      |                                                                                                                                |                                            |        
|                                                                                      |                                                                                                                                | Total assets                               |        
|                                                                                      |                                                                                                                                |                                            |        
|Liabilities and Stockholders' Equity                                                  |                                                                                                                                |                                            |        
|Current liabilities:                                                                  |                                                                                                                                |                                            |        
|                                                                                      | Accounts payable                                                                                                               |                                            | $      
|                                                                                      | Accrued liabilities                                                                                                            |                                            |        
|                                                                                      | Current portion of deferred revenue                                                                                            |                                            |        
|                                                                                      | Income taxes payable                                                                                                           |                                            |        
|                                                                                      | Current portion of obligations under capital leases                                                                            |                                            |        
|                                                                                      |                                                                                                                                |                                            |        
|Total current liabilities                                                             |                                                                                                                                |                                            | 66,032 
|Obligations under capital leases, net of current portion                              |                                                                                                                                |                                            | 1,540  
|Deferred revenue, less current portion                                                |                                                                                                                                |                                            | 13,114 
|                                                                                      |                                                                                                                                |                                            |        
|                                                                                      |                                                                                                                                | Total liabilities                          |        
|                                                                                      |                                                                                                                                |                                            |        
|Commitments and contingencies (Note 12)                                               |                                                                                                                                |                                            |        
|Stockholders' Equity:                                                                 |                                                                                                                                |                                            |        
|                                                                                      | Preferred stock, $0.01 par value, 25,000,000 shares authorized, no shares issued or outstanding                                |                                            |        
|                                                                                      | Common stock, Class A, $0.01 par value, 250,000,000 shares authorized, 81,000,000 shares issued and outstanding                |                                            |        
|                                                                                      | Common stock, Class B, $0.01 par value, 200,000,000 shares authorized, 32,962,212 and 31,562,223 shares issued and outstanding |                                            |        
|                                                                                      | Additional paid-in-capital                                                                                                     |                                            |        
|                                                                                      | Deferred compensation                                                                                                          |                                            |        
|                                                                                      | Accumulated other comprehensive income                                                                                         |                                            |        
|                                                                                      | Retained earnings                                                                                                              |                                            |        
|                                                                                      |                                                                                                                                |                                            |        
|Total stockholders' equity                                                            |                                                                                                                                |                                            | 474,505
|                                                                                      |                                                                                                                                |                                            |        
|                                                                                      |                                                                                                                                | Total liabilities and stockholders' equity |        
|                                                                                      |                                                                                                                                |                                            |        

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

F-3

---

McDATA CORPORATION        CONSOLIDATED INCOME STATEMENTS        (in thousands, except per share data)

|                                                             |                                                                                                                                                              | YEAR ENDED DECEMBER 31, |                   
|------------------------------------------------------------ | ------------------------------------------------------------------------------------------------------------------------------------------------------------ | ----------------------- | ------------------
|
|Revenue                                                      |                                                                                                                                                              | $                       | 328,279           
|Cost of revenue                                              |                                                                                                                                                              |                         | 178,114           
|                                                             |                                                                                                                                                              |                         |                   
|                                                             |                                                                                                                                                              | Gross profit            |                   
|Operating expenses:                                          |                                                                                                                                                              |                         |                   
|                                                             | Research and development                                                                                                                                     |                         |                   
|                                                             | Selling and marketing                                                                                                                                        |                         |                   
|                                                             | General and administrative                                                                                                                                   |                         |                   
|                                                             | Acquired in-process research and development and other acquisition-related costs                                                                             |                         |                   
|                                                             | Amortization of deferred compensation (excludes amortization of deferred compensation included in cost of revenue of $601, $1,437, and $1,907, respectively) |                         |                   
|                                                             |                                                                                                                                                              |                         |                   
|                                                             |                                                                                                                                                              |                         | Operating expenses
|                                                             |                                                                                                                                                              |                         |                   
|Income (loss) from operations                                |                                                                                                                                                              |                         | (22,147           
|Interest and other income                                    |                                                                                                                                                              |                         | 6,924             
|Interest expense                                             |                                                                                                                                                              |                         | (293              
|                                                             |                                                                                                                                                              |                         |                   
|Income (loss) before income taxes                            |                                                                                                                                                              |                         | (15,516           
|Income tax expense (benefit)                                 |                                                                                                                                                              |                         | (5,529            
|                                                             |                                                                                                                                                              |                         |                   
|Net income (loss)                                            |                                                                                                                                                              | $                       | (9,987            
|                                                             |                                                                                                                                                              |                         |                   
|Basic net income (loss) per share                            |                                                                                                                                                              | $                       | (0.09             
|                                                             |                                                                                                                                                              |                         |                   
|Shares used in computing basic net income (loss) per share   |                                                                                                                                                              |                         | 113,185           
|                                                             |                                                                                                                                                              |                         |                   
|Diluted net income (loss) per share                          |                                                                                                                                                              | $                       | (0.09             
|                                                             |                                                                                                                                                              |                         |                   
|Shares used in computing diluted net income (loss) per share |                                                                                                                                                              |                         | 113,185           
|                                                             |                                                                                                                                                              |                         |                   

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

F-4

---



McDATA CORPORATION        CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY        (in thousands)

|                              |                                                                                   | Common Stock                                       |   |   |     |   |        |        |   |     |     |   |        
|----------------------------- | --------------------------------------------------------------------------------- | -------------------------------------------------- | - | - | --- | - | ------ | ------ | - | --- | --- | - | -------
|
|
|
|Balances at December 31, 1999 |                                                                                   | 81,000                                             |   | $ | 810 |   | 11,981 |        | $ | 120 |     | $ | 60,265 
|                              | Issuance of common stock, through initial public offering, net of issuance costs  |                                                    |  |   |     |  |        | 14,375 |   |     | 144 |   |        
|                              | Issuance of common stock, upon exercise of stock options                          |                                                    |  |   |     |  |        | 2,552  |   |     | 25  |   |        
|                              | Deferred compensation                                                             |                                                    |  |   |     |  |        |       |   |     |    |   |        
|                              | Compensation expense                                                              |                                                    |  |   |     |  |        |       |   |     |    |   |        
|                              | Tax benefit of stock options                                                      |                                                    |  |   |     |  |        |       |   |     |    |   |        
|                              | Comprehensive income:                                                             |                                                    |   |   |     |   |        |        |   |     |     |   |        
|                              |                                                                                   | Net income                                         |   |  |     |   |       |        |  |     |     |  |        
|                              |                                                                                   | Unrealized gain on investments, net of tax of $71  |   |  |     |   |       |        |  |     |     |  |        
|                              |                                                                                   |                                                    |   |   |     |   |        |        |   |     |     |   |        
|Total comprehensive income    |                                                                                   |                                                   |   |   |    |   |       |        |   |    |     |   |       
|                              |                                                                                   |                                                    |   |   |     |   |        |        |   |     |     |   |        
|Balances at December 31, 2000 |                                                                                   | 81,000                                             |   |   | 810 |   | 28,908 |        |   | 289 |     |   | 454,009
|                              | Shares issued pursuant to the restricted stock plan and exercise of stock options |                                                    |  |   |     |  |        | 2,654  |   |     | 27  |   |        
|                              | Forfeitures of deferred compensation                                              |                                                    |  |   |     |  |        |       |   |     |    |   |        
|                              | Compensation expense                                                              |                                                    |  |   |     |  |        |       |   |     |    |   |        
|                              | Tax benefit of stock options                                                      |                                                    |  |   |     |  |        |       |   |     |    |   |        
|                              | Comprehensive income (loss):                                                      |                                                    |   |   |     |   |        |        |   |     |     |   |        
|                              |                                                                                   | Net loss                                           |   |  |     |   |       |        |  |     |     |  |        
|                              |                                                                                   | Unrealized gain on investments, net of tax of $234 |   |  |     |   |       |        |  |     |     |  |        
|                              |                                                                                   |                                                    |   |   |     |   |        |        |   |     |     |   |        
|                              | Total comprehensive loss                                                          |                                                    |  |   |     |  |        |       |   |     |    |   |        
|                              |                                                                                   |                                                    |   |   |     |   |        |        |   |     |     |   |        
|Balances at December 31, 2001 |                                                                                   | 81,000                                             |   |   | 810 |   | 31,562 |        |   | 316 |     |   | 468,133
|                              | Shares issued pursuant to the restricted stock plan and exercise of stock options |                                                    |  |   |     |  |        | 1,407  |   |     | 14  |   |        
|                              | Forfeitures of deferred compensation                                              |                                                    |  |   |     |  |        | (7     | ) |     |    |   |        
|                              | Compensation expense                                                              |                                                    |  |   |     |  |        |       |   |     |    |   |        
|                              | Tax benefit of stock options                                                      |                                                    |  |   |     |  |        |       |   |     |    |   |        
|                              | Comprehensive income (loss):                                                      |                                                    |   |   |     |   |        |        |   |     |     |   |        
|                              | Net loss                                                                          |                                                    |  |   |     |  |        |       |   |     |    |   |        
|                              | Unrealized gain on investments, net of tax of $188                                |                                                    |  |   |     |  |        |       |   |     |    |   |        
|                              |                                                                                   |                                                    |   |   |     |   |        |        |   |     |     |   |        
|                              | Total comprehensive loss:                                                         |                                                    |  |   |     |  |        |       |   |     |    |   |        
|                              |                                                                                   |                                                    |   |   |     |   |        |        |   |     |     |   |        
|Balances at December 31, 2002 |                                                                                   | 81,000                                             |   | $ | 810 |   | 32,962 |        | $ | 330 |     | $ | 474,609
|                              |                                                                                   |                                                    |   |   |     |   |        |        |   |     |     |   |        

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

F-5

---

McDATA CORPORATION        CONSOLIDATED STATEMENTS OF CASH FLOWS        (in thousands)

|                                                                                   |                                                   | YEAR ENDED DECEMBER 31,                   |         
|---------------------------------------------------------------------------------- | ------------------------------------------------- | ----------------------------------------- | --------
|
|Cash flows from operating activities:                                              |                                                   |                                           |         
|Net income (loss)                                                                  |                                                   | $                                         | (9,987  
|Adjustments to reconcile net income (loss) to cash flows from operating activities |                                                   |                                           |         
|                                                                                   | Depreciation and amortization                     |                                           |         
|                                                                                   | Loss from write-off of collateralized lease costs |                                           |         
|                                                                                   | Net realized (gain) loss on investments           |                                           |         
|                                                                                   | Net loss on retirement of assets                  |                                           |         
|                                                                                   | Acquired in-process research and development      |                                           |         
|                                                                                   | Inventory and inventory commitment provisions     |                                           |         
|                                                                                   | Non-cash compensation expense                     |                                           |         
|                                                                                   | Tax benefit from stock options exercised          |                                           |         
|                                                                                   | Changes in net assets and liabilities:            |                                           |         
|                                                                                   |                                                   | Accounts receivable                       |         
|                                                                                   |                                                   | Inventories                               |         
|                                                                                   |                                                   | Deferred tax asset                        |         
|                                                                                   |                                                   | Prepaid expenses and other current assets |         
|                                                                                   |                                                   | Other assets, net                         |         
|                                                                                   |                                                   | Accounts payable                          |         
|                                                                                   |                                                   | Accrued liabilities                       |         
|                                                                                   |                                                   | Deferred revenue                          |         
|                                                                                   |                                                   | Accrued income taxes                      |         
|                                                                                   |                                                   |                                           |         
|Net cash provided by operating activities                                          |                                                   |                                           | 30,456  
|Cash flows from investing activities:                                              |                                                   |                                           |         
|Acquisitions                                                                       |                                                   |                                           |        
|Purchases of property and equipment                                                |                                                   |                                           | (71,937 
|Payment of collateralized lease costs                                              |                                                   |                                           | (1,256  
|Purchases of investments                                                           |                                                   |                                           | (481,078
|Maturities of investments                                                          |                                                   |                                           | 403,123 
|Sales of investments                                                               |                                                   |                                           | 124,109 
|                                                                                   |                                                   |                                           |         
|Net cash used in investing activities                                              |                                                   |                                           | (27,039 
|Cash flows from financing activities:                                              |                                                   |                                           |         
|Payment of short-term debt                                                         |                                                   |                                           |        
|Payment of obligations under capital leases                                        |                                                   |                                           | (2,712  
|Proceeds from sale of stock, net of issuance costs                                 |                                                   |                                           |        
|Proceeds from the exercise of stock options                                        |                                                   |                                           | 2,421   
|                                                                                   |                                                   |                                           |         
|Net cash provided by (used in) financing activities                                |                                                   |                                           | (291    
|                                                                                   |                                                   |                                           |         
|Net increase (decrease) in cash and cash equivalents                               |                                                   |                                           | 3,126   
|Cash and cash equivalents, beginning of period                                     |                                                   |                                           | 69,285  
|                                                                                   |                                                   |                                           |         
|Cash and cash equivalents, end of period                                           |                                                   | $                                         | 72,411  
|                                                                                   |                                                   |                                           |         
|Supplemental Disclosure of Non-cash Investing and Financing Activities             |                                                   |                                           |         
|Interest paid                                                                      |                                                   | $                                         | 293     
|Income taxes paid (received)                                                       |                                                   |                                           | (3,285  
|Capital lease obligations incurred                                                 |                                                   |                                           | 4,634   
|Transfer of inventory to fixed assets                                              |                                                   |                                           | 5,679   
|Fixed assets exchanged for capital leases                                          |                                                   |                                           | (1,501  
|Restricted stock grant                                                             |                                                   |                                           | 1,867   
|Unrealized gain on investments                                                     |                                                   |                                           | 441     

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

F-6

---



McDATA CORPORATION        NOTES TO CONSOLIDATED FINANCIAL STATEMENTS        (tabular amounts in thousands, except per share data)

NOTE 1 OVERVIEW AND BASIS OF PRESENTATION

McDATA Corporation (McDATA or the Company) designs, develops, manufactures and sells open storage networking solutions and provides highly available, scalable and
centrally managed storage area networks (SANs) that address enterprise-wise storage problems. The Company sells its products, software, services and solutions through original equipment
manufacturers ("OEMs") and resellers, including EMC Corporation ("EMC"), Hewlett-Packard, Co., Hitachi Data Systems Corp., and IBM, as well as systems integrators. The Company also provides services
for EMC's proprietary mainframe protocol ("ESCON") switch business.

During
2000 and a portion of 2001, McDATA was a majority-owned subsidiary of EMC. On August 9, 2000, the Company completed an initial public offering of 14,375,000 shares of its
Class B Common stock of approximately $377 million, net of offering costs of approximately $2.7 million. After completion of the offering, McDATA remained a majority-owned
subsidiary of EMC due to its ownership of 81 million shares of Class A common stock. On February 7, 2001, EMC distributed all of the shares it held of McDATA Class A common
stock to EMC's shareholders of record as of January 24, 2001 (the Distribution). EMC has received a ruling from the Internal Revenue Service that the distribution to EMC stockholders was tax
free for U.S. federal income tax purposes. The Company continues to believe that the distribution of its Class A common stock by EMC was tax-free. As a result of the Distribution,
EMC no longer has any ownership in or voting power over McDATA and, therefore, is no longer considered a related party.

The
consolidated financial statements have been prepared using EMC's historical bases in the assets and liabilities and the historical operating results and cash flows of McDATA. Because
McDATA's operations were substantially independent of EMC's operations during all periods presented in the financial statements, the Company's management does not believe that there were any corporate
expenses incurred by EMC that should have been allocated to the Company. Accordingly, no intercompany expense allocations have been included in the financial statements. The consolidated financial
statements do include certain allocations of interest income and expense from participation in EMC's cash management system through December 31, 2000 (see Note 11).

NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The consolidated financial statements include the assets, liabilities, results of operations, cash flows and changes in stockholders' equity of the Company and
its wholly-owned subsidiaries. All material intercompany transactions and balances have been eliminated.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make
estimates and assumptions that effect the reported amounts of assets, liabilities, revenues and expenses and disclosure of contingent assets and liabilities. Actual results could differ from these
estimates.

F-7

---

Cash and Cash Equivalents

Cash equivalents are short-term, highly liquid investments that are readily convertible to cash and have remaining maturities of ninety days or
less at date of purchase.

Valuation of Accounts Receivable

Accounts receivable are reviewed to determine which are doubtful of collection. Estimates are also made for potential future product returns. In making the
determination of the appropriate allowance for doubtful accounts and product returns, the Company considers specific accounts, analysis of accounts receivable agings, changes in customer payment
terms, historical write-offs and returns, changes in customer demand and relationships, concentrations of credit risk and customer credit worthiness. The provision for doubtful accounts
was $525,000, $707,000 and $248,000 in 2002, 2001 and 2000, respectively.

Inventories

Inventories, which include material, labor and factory overhead, are stated using standard costs which approximate the lower of cost (first-in,
first-out method) or market. The Company evaluates the need for reserves associated with obsolete, slow-moving and non-salable inventory by reviewing net realizable
values on a quarterly basis. The Company's inventories do not include materials purchased and held by the Company's component subcontractors, as the Company does not own this inventory.

Investments

The Company's short- and long-term investments consist primarily of marketable debt and equity securities, all of which are classified as
available-for-sale and recorded at fair value. Fair values are determined using quoted market prices. Unrealized holding gains and losses are recorded, net of any tax effect,
as a separate component of accumulated other comprehensive income. Securities with stated maturities of one year or less at time of purchase are classified as short-term investments.
Securities with remaining maturities longer than one year are classified as long-term investments.

Fair Value of Financial Instruments

The carrying value of financial instruments, including cash equivalents, accounts receivable, accounts payable and accrued liabilities, approximate fair value due
to their short maturities. Based upon borrowing rates currently available to the Company, with similar terms, the carrying value of the capital lease obligations approximate their fair value. The fair
values of the Company's investments are determined using quoted market prices for those securities.

Property and Equipment

Property and equipment is stated at cost less accumulated depreciation. Expenditures that substantially extend the useful life of an asset are capitalized.
Ordinary repair and maintenance

F-8

---

expenditures are expensed as incurred. For financial reporting purposes, depreciation is recorded principally on a straight-line method over the estimated useful lives of the asset as
follows:

Building

39 yearsBuilding equipment

5-39 yearsEquipment and furniture

3-5 yearsComputer software

2-5 yearsCapital lease equipment

The shorter of the useful life of 3-5 years or lease termLeasehold improvements

The shorter of the useful life of 3-5 years or lease term


Depreciation
expense was approximately $18,648,000, $14,297,000, and $8,256,000 in 2002, 2001, and 2000, respectively. Equipment and furniture at December 31, 2002 and 2001
includes assets under capitalized leases of $10,679,000 and $8,916,000, respectively, with related accumulated amortization of approximately $6,436,000 and $6,341,000, respectively.

In
accordance with American Institute of Certified Public Accountants (AICPA) Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use," certain costs incurred in connection with the application development state of internal-use software projects are capitalized and amortized over the estimated
useful life of the asset.

Goodwill and Intangible Assets

The Company has adopted Statement of Financial Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142") for the year ended
December 31, 2002. SFAS No. 142 primarily addresses the accounting for goodwill and intangible assets subsequent to their acquisition. Under SFAS No. 142, goodwill and other
indefinite lived intangible assets are not subject to amortization, but are subject to an impairment test upon adoption and at least annually thereafter. In 2002, the Company completed its initial and
annual impairment analysis for its $11.8 million of goodwill and determined that there is no impairment. In addition, there were no changes to the carrying amount of goodwill during the year
ended December 31, 2002. Further, as the Company's Goodwill resulted almost entirely from an acquisition occurring subsequent to July, 1, 2001, no significant goodwill amortization was incurred
in prior years.

At
December 31, 2002, the Company has an intangible asset with a definite life of five years related to acquired developed technology with a gross carrying amount of
$10.5 million and accumulated amortization of $2.7 million. Amortization expense for the year ended December 31, 2002 and 2001 was approximately $2,100,000 and $565,000,
respectively. Amortization expense for the 2003 through 2005 fiscal years will be approximately $2.1 million per year. Amortization expense for fiscal year 2006 will be approximately
$1.5 million. The Company does not have any material intangible assets with indefinite lives at December 31, 2002.

Concentrations

Financial instruments that potentially subject the Company to concentrations of credit risk are cash equivalents, short and long-term investments and
accounts receivable. The Company maintains cash and cash equivalents and short- and long-term investments with various financial institutions. These financial institutions are
geographically dispersed and company policy restricts investments and limits the amount invested with any single financial institution. The Company has not sustained material credit losses from
instruments held at financial institutions.

The
Company sells a significant portion of its products through third-party OEMs, distributors and resellers. At December 31, 2002 and 2001, 80% and 86% of accounts receivable
were concentrated with

F-9

---

our two largest customers. The Company performs ongoing evaluations of its customers' financial condition and, generally, requires no collateral from its customers.

For
the years ended December 31, 2002, 2001, and 2000, the Company had two customers each who contributed greater than 10% of the Company's total revenues for combined
totals of 79%, 86%, and 90% to total revenue, respectively. The level of sales to any single customer may vary and the loss of any one of these customers, or a decrease in the level of sales to any
one of these customers, could
have a material impact on the Company's financial condition or results of operations. In addition, approximately 72%, 71% and 83% of the Company's total revenues were earned from sales of its
Director-class products for the years ended December 31, 2002, 2001 and 2000, respectively.

The
Company currently relies on single and limited supply sources for several key components used in the manufacture of its products. Additionally, the Company relies on a single
third-party manufacturer for the production of a majority of its products. The inability of the Company's single and limited source suppliers or the inability of the Company's third-party manufacturer
to fulfill supply and production requirements, respectively, could negatively impact future results.

Revenue Recognition

The Company generally recognizes revenue when (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 assured. 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. 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. The Company accrues for warranty costs and sales returns at
the time of shipment based on its experience. 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 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.

In
transactions that include multiple products, services and/or software, the Company allocates the revenue to each element based on their relative fair value (or in the absence of fair
value, the residual method) and recognizes the associated revenue when all revenue recognition criteria have been met for each element.

Research and Development

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

Software Development Costs

The Company capitalizes eligible computer software development costs upon the establishment of technological feasibility, which it has defined as completion of
designing, coding and testing activities or

F-10

---

the completion of a working model. Costs incurred prior to the establishment of technological feasibility are expensed to research and development. 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 and changes in software and hardware technologies. Upon the general release of the software product to customers, capitalization ceases and such
costs are amortized (using the straight-line method) on a product-by-product basis over the estimated life, which is generally one to three years.
Capitalized software costs and accumulated amortization included in other assets at December 31, 2002, were approximately $9,220,000 and $1,546,000, respectively. Capitalized software costs and
accumulated amortization at December 31, 2001, were approximately $481,000 and $27,000, respectively. There were no capitalized software costs at December 31, 2000. Capitalized software
amortization expense for 2002 and 2001 were approximately $1,520,000 and $27,000, respectively.

Advertising

The Company expenses advertising costs as incurred. Advertising expenses for 2002, 2001, and 2000 were approximately $6,222,000, $6,941,000, and $1,449,000,
respectively.

Impairment of Long-Lived Assets

The Company periodically evaluates the carrying value of long-lived assets when events and circumstances warrant such a review. The carrying value of
a long-lived asset is considered impaired when the anticipated undiscounted cash flows from such asset (or asset group) are separately identifiable and less than the asset's (or asset
group's) carrying value. In that event, a loss is recognized to the extent that the carrying value exceeds the fair value of the long-lived asset. Fair value is determined primarily using
the anticipated cash flows discounted at a rate commensurate with the risk involved.

Earnings Per Share

Basic net income or loss per share is computed using the weighted average number of common shares outstanding during the period. Diluted net income per share is
computed using the weighted average number of common and dilutive common equivalent shares outstanding during the period. Dilutive common equivalent shares consist of stock options and restricted
stock grants.

F-11

---

Following is a reconciliation between basic and diluted earnings per share (in thousands except per share information):

|                                                                                                            |  | Year Ended December 31,
|----------------------------------------------------------------------------------------------------------- |  | -----------------------
|
|Net income (loss)                                                                                           |  | $                      
|Weighted average shares of common stock outstanding used in computing basic net income (loss) per share     |  |                        
|Net effect of dilutive stock options                                                                        |  |                        
|                                                                                                            |  |                        
|Weighted average shares of common stock used in computing diluted net income (loss) per share               |  |                        
|                                                                                                            |  |                        
|Basic net income (loss) per share                                                                           |  | $                      
|                                                                                                            |  |                        
|Diluted net income (loss) per share                                                                         |  | $                      
|                                                                                                            |  |                        
|Options not included in diluted share base because of the exercise prices anti-dilutive effect              |  |                        
|                                                                                                            |  |                        
|Options and restricted stock not included in diluted share because of net loss base because of the net loss |  |                        
|                                                                                                            |  |                        

Stock-Based Compensation

At December 31, 2002, the Company has stock-based employee compensation and employee purchase plans, which are described more fully in Note 7. The
Company accounts for these plans according to Accounting Principles Board Opinion No. 25, Accounting for Stock Issues 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" (SFAS No. 123). Any deferred stock compensation
calculated pursuant to APB 25 is amortized ratably over the vesting period of the individual options, generally four years. The following table illustrates the effect on net income and earnings
per share if the Company had applied the fair value recognition provisions of SFAS No. 123.

|                                                                                                                                                       |                     | Year Ended December 31, |        
|------------------------------------------------------------------------------------------------------------------------------------------------------ | ------------------- | ----------------------- | -------
|
|Net income, as reported                                                                                                                                |                     | $                       | (9,987 
|Add: Total stock-based employee compensation expense included in net income as determined under the intrinsic value method, net of related tax effects |                     |                         | 5,542  
|Deduct: Total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effects        |                     |                         | (16,879
|                                                                                                                                                       |                     |                         |        
|Pro forma net income                                                                                                                                   |                     | $                       | (21,324
|                                                                                                                                                       |                     |                         |        
|Earnings per share:                                                                                                                                    |                     |                         |        
|                                                                                                                                                       | Basic-as reported   |                         | $      
|                                                                                                                                                       |                     |                         |        
|                                                                                                                                                       | Basic-pro forma     |                         | $      
|                                                                                                                                                       |                     |                         |        
|                                                                                                                                                       | Diluted-as reported |                         | $      
|                                                                                                                                                       |                     |                         |        
|                                                                                                                                                       | Diluted-pro forma   |                         | $      
|                                                                                                                                                       |                     |                         |        

F-12

---

The
fair value of each option granted during 2002, 2001, and 2000 is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average
assumptions:

|                        |  | Year Ended December 31,
|----------------------- |  | -----------------------
|
|Dividend yield          |  | 0%                     
|Expected volatility     |  | 90%                    
|Risk-free interest rate |  | 2.7% to 4.9%           
|Expected life, in years |  | 2.0 - 4.0              

Comprehensive Income (Loss)

Comprehensive income (loss) includes net earnings as well as additional other comprehensive income. McDATA's other comprehensive income consists of unrealized
gains and losses on available-for-sale securities, recorded net of tax, that are recorded as changes in equity and not an element of the Company's income statement.

Reclassifications

Certain prior year amounts have been reclassified to conform to the 2002 presentation.

Recent Accounting Pronouncements

In July 2002, the Financial Accounting Standards Board (FASB) issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities" (SFAS 146). SFAS 146 provides guidance related to accounting for costs associated with disposal activities covered by SFAS 144 or with exit or restructuring activities
previously covered by Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)." SFAS 146 supercedes EITF Issue No. 94-3 in its entirety. SFAS 146 requires that costs related to exiting an
activity or to a restructuring not be recognized until the liability is incurred. SFAS No. 146 will be applied prospectively to exit or disposal activities that are initiated after
December 31, 2002.

In
November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45), "Guarantor's Accounting and Disclosure Requirements of Guarantees, Including Indirect Guarantees of
Indebtedness of Others." FIN 45 requires that upon issuance of a guarantee, a guarantor must recognize a liability for the fair value of the obligation assumed under a guarantee. In addition, FIN 45
requires interim and annual disclosures about the guarantees that an entity has issued, including a rollforward of the entity's product warranty liabilities. The recognition and measurement provisions
of FIN 45 are effective for any guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for financial statements of interim and annual periods ending
after December 15, 2002. Management is currently evaluating the recognition and measurement effects of FIN 45, however, management does not expect that the adoption of FIN 45 will have a
material effect on the Company's financial position, results of operations, or cash flows. The Company adopted the disclosure provisions of FIN 45 during the fourth quarter of fiscal 2002. The Company
is currently evaluating the recognition provisions of FIN 45 but expects that they will not have a material adverse impact on its consolidated financial statements upon adoption.

In
November 2002, the EITF reached a consensus on Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables." EITF Issue No. 00-21
provides guidance on how to account for arrangements
that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF Issue No. 00-21 will apply to revenue arrangements
entered into in fiscal periods beginning after June 15, 2003. Management does not expect this guidance to have a significant impact on the Company's financial position and results of
operations.

F-13

---

In
December 2002, the FASB issued Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based CompensationTransition and Disclosure"
(SFAS 148). SFAS 148 amends SFAS 123, "Accounting for Stock-Based Compensation," to provide alternative methods of transition for a voluntary change to the fair value based method
of accounting for stock-based employee compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim
financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. SFAS 148 is effective for fiscal years
ending after December 15, 2002. The transition and annual disclosure provisions of SFAS 148 are effective for fiscal years ending after December 15, 2002. The new interim
disclosure provisions are effective for the first interim period beginning after December 15, 2002. The Company adopted the disclosure requirements of SFAS 148 effective
December 31, 2002.

NOTE 3 COMPONENTS OF SELECTED BALANCE SHEET ACCOUNTS

December 31,2002

2001Inventories:Raw materials

$
8,070

$
27,206Work-in-progress


1,123


1,864Finished goods


6,316


14,740Total inventories at cost


15,509


43,810Less reserves


(7,412
)

(18,965
)Total inventories, net

$
8,097

$
24,845Property and equipment:Land

$
16,091

$
Building


29,712


Equipment and furniture


74,608


53,858Computer software for internal use


18,877


14,959Leasehold improvements


4,805


4,900Construction in progress


2,361


2,095146,454


75,812Less accumulated depreciation and amortization


(46,527
)

(34,974
)$
99,927

$
40,838Accrued liabilities:Wages and employee benefits

$
16,643

$
9,409Purchase commitments


12,022


6,289Warranty reserves(1)


3,461


2,174Agency funds held for campus construction





1,683Taxes, other than income tax


1,050


773Other accrued liabilities


4,603


2,113$
37,779

$
22,441


---

2002

2001

2000Balance at beginning of year

$
2,174

$
956

$
986Warranty expense


1,853


1,937


707Warranty claims


(566
)

(719
)

(737
)Balance at end of year

$
3,461

$
2,174

$
956


F-14

---

NOTE 4 ACQUISITION

On September 21, 2001, the Company acquired the assets of SANavigator, Inc. (SANavigator) for a cash purchase price of $29.75 million. In
addition, one-time costs associated with the acquisition were approximately $2.1 million. The results of SANavigator's operations have been included in the consolidated financial
statements since that date. SANavigator is a software company that designs and develops a scalable and stable SAN management tool that manages entry-level through complex SAN environments utilizing
vendor- and platform-independent software. As a result of the acquisition, the Company is expected to be in a leading position in offering storage network management software that provides visibility
and discovery in a multi-vendor fabric environment.

The
estimated excess of the purchase price over the fair value of the tangible net assets acquired was valued at $29.2 million. Of this excess, $10.5 million was allocated
to developed technology (5 year average useful life), $7.2 million was allocated to in-process research and development (IPR&D), and the remaining $11.5 million was
allocated to goodwill. In accordance with SFAS No. 141 and No. 142, the
amount allocated to goodwill is not being amortized and will be evaluated at least annually for impairment. Of the total goodwill amount, $11.5 million is expected to be deductible for tax
purposes.

The
IPR&D was expensed at the time of purchase because technological feasibility had not been established and no future alternative use existed. The IPR&D arose from SANavigator's
on-going development of the next-generation of SANavigator software. This software was intended to significantly enhance the features of the current version of SANavigator
software. The status of the development at the acquisition date was dependent on several factors including the complexity of working with diverse servers and storage devices and integrating with other
applications. Overall, SANavigator's IPR&D project was estimated to be approximately 40% complete at the time of acquisition and it was expected that the remaining 60% would be completed during the
Company's 2002 fiscal year at a cost of approximately $2.1 million. The remaining efforts, which were completed during 2002, included completion of coding, finalizing user interface design and
development, and testing. The amount allocated to in-process research and development was determined using the discounted cash flow method. This model employed cash flow projections for
revenue based on the projected incremental increase in revenue that the Company expected to receive from the completed IPR&D. Estimated operating expenses, capital charges and applicable income taxes
were deducted to arrive at an estimated after-tax cash flow. The Company discounted the after-tax cash flow projections using a risk-adjusted rate of return of 75%.

The
unaudited pro forma information presented below (in thousands, except per share amounts) assumes that SANavigator was acquired at the beginning of the periods presented and includes
the effect of amortization of identified intangibles and costs from that date. The impact of charges for IPR&D and non-recurring employee compensation has been excluded. This is presented
for informational purposes only and is not necessarily indicative of the results of future operations or results that would have been achieved had the acquisition taken place at the beginning of the
periods presented.

Year Ended December 31,2001

2000Revenue

$
344,636

$
248,686Net income (loss)

$
(9,248
)
$
26,343Basic net income (loss) per share

$
(0.08
)
$
0.26Diluted net income (loss) per share

$
(0.08
)
$
0.24


In
conjunction with the acquisition, the Company issued approximately 192,000 shares of Class B common stock, with a fair value of $1.9 million, for the completion of
ongoing employment arrangements with certain SANavigator employees. The stock awards are contingent upon the

F-15

---

continued employment of these employees. As such, these awards were recorded as deferred compensation and recognized ratably through the expiration date of the employee agreements. At
December 31, 2002, all awards were fully vested.

NOTE 5 INVENTORIES

During the year ended December 31, 2002, the Company recorded net inventory-related charges of $9.5 million, primarily for excess 1 gigabit (Gb)
components used in the Company's director-class products. The excess inventory resulted primarily from the Company's introduction of 2 Gb products in the second quarter of 2002 and the unanticipated
reduction in demand for the 1 Gb product orders prior the new product release.

During
the year ended December 31, 2001, the Company completed a thorough review of operations including an analysis of inventory transferred from its discontinued suppliers, a
review of obsolescence, end-of-life inventories, on-going inventory commitments, and the completion of a physical inventory. Based on this review, the Company
recorded a $25 million inventory-related charge.

NOTE 6 INVESTMENTS

Short and long-term investments consisted of the following available-for-sale securities at December 31 (in thousands):

|                                       |  | Amortized
Cost |         | Unrealized
Holding
Gains |   | Unrealized
Holding
Losses |  | Fair
Values
|-------------------------------------- |  | -------------- | ------- | ------------------------ | - | ------------------------- |  | -----------
|2002                                   |  |                |         |                          |   |                           |  |            
|U.S. Government obligations            |  | $              | 87,570  |                          | $ | 1,026                     |  | $          
|State and local government obligations |  |                | 89,614  |                          |   | 118                       |  |            
|Corporate obligations                  |  |                | 18,954  |                          |   | 127                       |  |            
|Marketable equity securities           |  |                | 32,956  |                          |   |                          |  |            
|                                       |  |                |         |                          |   |                           |  |            
|                                       |  | $              | 229,094 |                          | $ | 1,271                     |  | $          
|                                       |  |                |         |                          |   |                           |  |            
|2001                                   |  |                |         |                          |   |                           |  |            
|U.S. Government obligations            |  | $              | 93,338  |                          | $ | 922                       |  | $          
|State and local government obligations |  |                | 107,897 |                          |   | 380                       |  |            
|Mutual funds                           |  |                | 16,249  |                          |   |                          |  |            
|Marketable equity securities           |  |                | 23,301  |                          |   |                          |  |            
|                                       |  |                |         |                          |   |                           |  |            
|                                       |  | $              | 240,785 |                          | $ | 1,302                     |  | $          
|                                       |  |                |         |                          |   |                           |  |            

Amortized
cost is determined based on specific identification. Realized gains and losses on sales of securities for the year ended December 31, 2002 were approximately $3,000 and
$343,000, respectively. Realized gains and losses on sales of securities for the year ended December 31, 2001 were approximately $396,000 and $134,000, respectively. Realized gains on sales of
securities were $2,000 in 2000.

The
amortized cost and estimated fair value of debt securities held at December 31, 2002, by contractual maturity, are shown below. Expected maturities will differ from
contractual maturities because the issuers of securities may have the right to repay obligations without prepayment penalties.

F-16

---

Certain instruments, although possessing a contractual maturity greater than a year, are classified as short-term investments based on methods of trade and availability of current
operations.

Amortized
Cost

Fair ValuesLess than one year

$
26,381

$
26,568Greater than one year through five years


87,288


88,350Greater than five years through ten years


4,000


4,000Greater than ten years


78,469


78,491$
196,138

$
197,409


At
December 31, 2001, the Company had restricted assets relating to a collateralized lease agreement with Deutsche Bank (See Note 12). These assets represented holdings in
short- and long-term government securities with a fair market value and amortized cost of approximately $36,199,000 and $36,305,000, respectively, at December 31, 2001. In
May 2002, the Company entered into a Termination Agreement with Deutsche Bank. Approximately $41 million in then restricted assets were used to pay down the balance of the lease
obligation. Losses of $383,000 were realized for the year ended December 31, 2002.

NOTE 7 STOCKHOLDERS' EQUITY

The Company has both Class A and Class B common stock. Holders of Class A and Class B common stock have voting rights equal to one
vote and one-tenth vote, respectively, for each share held. Holders of Class A and Class B common stock share equal rights as to dividends. No dividends attributable to
common stock were declared or paid during 2002, 2001 or 2000.

The
Board of Directors is authorized to issue preferred stock with voting, conversion and other rights and preferences that may differ from the Class A and Class B common
stock. At December 31, 2002, there is no outstanding preferred stock.

Stock Split

On May 23, 2000, the Board of Directors approved a 2-for-1 stock split of the Company's Class A and B common stock. All
share and per share amounts have been adjusted for all periods presented to give retroactive effect to this stock split. The Board of Directors also authorized, after giving effect to the stock split,
an increase in the authorized shares of the Company's Class A common stock to 250,000,000 shares and an increase in the Class B common stock to 200,000,000 shares. In addition, the Board
of Directors authorized 25,000,000 shares of undesignated preferred stock. All of these transactions were consummated on or about July 12, 2000.

Stockholders' Rights Plan

Effective June 5, 2001, the Company's Board of Directors approved a Stockholder Rights Plan in which preferred stock purchase rights were distributed as a
dividend. Each Right, expiring June 5, 2011,
represents a right to buy from the Company one ten-thousandth (1/10,000) of a share of Series A Junior Participating Preferred Stock, $0.01 par value, at a price of $200 per Right.
This dividend distribution of the Rights was not taxable to the Company or its stockholders.

Separate
certificates for Rights will not be distributed, nor will the Rights be exercisable, unless a person or group acquires 15 percent or more, or announces an offer that
could result in acquiring 15 percent or more, of the aggregate number of votes entitled to be cast by all then outstanding shares of Common Stock (a Stock Acquisition). Following a Stock
Acquisition, each Right holder, except the 15 percent or more stockholder, has the right to receive, upon exercise, common shares valued at twice the then applicable exercise price of the Right
(or, under certain circumstances, cash, property or other

F-17

---

Company securities), unless the 15 percent or more stockholder has offered to acquire all of the outstanding shares of the Company under terms that a majority of the independent directors of
the Company have determined to be fair and in the best interest of the Company and its stockholders. Similarly, unless certain conditions are met, if the Company engages in a merger or other business
combination following a Stock Acquisition where it does not survive or survives with a change or exchange of its common shares or if 50 percent or more of its assets, earning power, or cash
flow is sold or transferred, the Rights will become exercisable for shares of the acquirer's stock having a value of twice the exercise price (or under certain circumstances, cash or property). The
Rights are not exercisable, however, until the Company's right of redemption described below has expired. Generally, Rights may be redeemed for $0.01 each (in cash, common shares or other
consideration the Company deems appropriate) until the earlier of (i) the tenth day following public announcement that a 15 percent or greater position has been acquired in the Company's
stock or (ii) the final expiration of the Rights. Until exercise, a Right holder, as such, has no rights as a stockholder of the Company.

Stock Options and Restricted Stock

The Company maintains a stock option and restricted stock plan (the Plan) which provide for the grant of stock options, restricted stock and other stock based
awards to officers, other employees, and consultants as determined by the compensation committee of the Board of Directors. A maximum of 24,000,000 shares of common stock were issuable under the terms
of the Plan as of December 31, 2002, of which no more than 2,400,000 shares may be issued as restricted stock or other stock based awards. As of December 31, 2002, there were 3,755,210
shares of common stock available for future grants under the plan.

The
Company applies APB 25 and related interpretations in accounting for the Plan. All stock option grants under the Plan since August 2000 have been granted at an exercise price
equal to the fair market value of the Company's stock. During 2000 and 1999, in connection with the grant of certain stock options to employees, the Company recorded deferred stock-based compensation,
net of forfeitures, of $8,971,000 and $27,139,000, respectively, representing the difference between the exercise price and the deemed fair market value of the Company's common stock on the dates
these stock options were granted. Deferred compensation related to these grants is included as a reduction of stockholders' equity and is being amortized on a straight-line basis over the
vesting periods of the related options, which is generally four years. During 2002, 2001, and 2000 after considering the impact of forfeitures,
the Company recorded amortization of approximately $7,218,000, $8,195,000, and $8,366,000, respectively (of which $584,000, $1,437,000, and $1,907,000 is included in the cost of revenue for 2002,
2001, and 2000, respectively).

Restricted
stock bonuses issued under the Plan are recorded at fair market value on the date of the grant and generally vest over a one to four year period. Vesting for some grants may
be accelerated if certain performance criteria are achieved. Compensation expense is recognized over the applicable vesting period. During the years ended December 31, 2002, and 2001,
the Company issued approximately 182,000 and 192,000 of restricted shares, respectively, having an aggregate fair market value of $1,867,000 and $1,896,000, respectively. There were no grants of
restricted shares for the year ended December 31, 2000. Compensation expense recognized for restricted shares in 2002 and 2001 was $1,663,000 (of which $17,000 is included in the cost of
revenue) and $501,000, respectively. There were no restricted shares issued in 2000. See Note 4 for discussion of restricted stock granted in 2001 pursuant to the SANavigator acquisition.

F-18

---

The following summarizes stock option transactions for the period from January 1, 2000 to December 31, 2002:

|                                                                                                 |  | Year Ended December 31,
|------------------------------------------------------------------------------------------------ |  | -----------------------
|
|
|Outstanding at beginning of period                                                               |  | 10,672                 
|Granted                                                                                          |  | 3,296                  
|Exercised                                                                                        |  | (1,234                 
|Forfeited or expired                                                                             |  | (1,080                 
|                                                                                                 |  |                        
|Outstanding end of period                                                                        |  | 11,654                 
|                                                                                                 |  |                        
|Exercisable at end of period                                                                     |  | 5,194                  
|Weighted-average fair value of options granted with an exercise price equal to fair market value |  |                        
|Weighted-average fair value of options granted with an exercise price below fair market value    |  |                        

The
status of total stock options outstanding and exercisable at December 31, 2002 was as follows:

|              |  | Options Outstanding |  |     |  |  
|------------- |  | ------------------- |  | --- |  | -
|
|
|
|$1.00$9.99   |  | 6,110               |  | 7.0 |  | $
|$10.00$19.99 |  | 3,671               |  | 8.2 |  |  
|$20.00$29.99 |  | 1,451               |  | 8.2 |  |  
|$30.00$39.99 |  | 108                 |  | 8.4 |  |  
|$40.00$49.99 |  | 57                  |  | 8.0 |  |  
|$50.00$59.99 |  | 13                  |  | 8.1 |  |  
|$60.00$69.99 |  | 49                  |  | 8.0 |  |  
|$70.00$79.99 |  | 181                 |  | 7.9 |  |  
|$80.00$93.36 |  | 14                  |  | 7.7 |  |  
|              |  |                     |  |     |  |  
|              |  | 11,654              |  | 7.6 |  | $
|              |  |                     |  |     |  |  

Employee Stock Purchase Plan

On August 1, 2002, the Board of Directors approved the 2002 Employee Stock Purchase Plan (the Purchase Plan). The Purchase Plan allows eligible employees
an opportunity to purchase an aggregate of 1,200,000 shares of the Company's Class B common stock at a price per share equal to 85% of the lesser of the fair market value of the Company's
common stock at the beginning or the end of each six-month purchase period. Under the terms of the Purchase Plan, no participant may acquire more than more than $25,000 in aggregate fair
market value of common stock during any one-year calendar period. No shares have been sold to employees under the Purchase Plan at December 31, 2002. The fair value of each purchase
right granted in 2002 was $3.83.

F-19

---

NOTE 8 OTHER COMPREHENSIVE INCOME

Other comprehensive income consisted solely of unrealized gains (losses) on investments. The changes in the components of other comprehensive income, net of taxes
wee as follows for the years ended December 31, 2002, 2001 and 2000.

2002

2001

2000Change in net unrealized gains (losses) on investments, net of related income tax expense (benefit) of $(94), $331, and $71, respectively

$
(189
)
$
570

$
117Reclassification adjustment for net realized (gains) losses included in net income, net of related income tax (expense) benefit of $282, $(97), and $0, respectively


442


(167
)

$
253

$
403

$
117


NOTE 9 EMPLOYEE BENEFIT PLANS

Defined Contribution Plan

The Company has a defined contribution plan (the McDATA Retirement Savings Plan) that covers eligible employees. The Company matches 50% of an employee's
contribution up to 6% of annual eligible compensation, subject to restrictions of such plans. Such Company contributions are made in cash, and amounted to approximately $1,803,000, $1,359,000, and
$769,000 in 2002, 2001, and 2000, respectively.

Profit Sharing and Bonus Plans

The Company has various employee bonus plans. A profit sharing plan provides for the contribution of a portion of each year's profits to a profit sharing pool
that is distributed to all employees not eligible for other performance-based incentive plans. The profit sharing amount is determined annually by the Board of Directors and is paid in cash. Other
bonus plans award quarterly bonuses to the Company's executives and other members of management based on the achievement of pre-defined performance
measures and other specific performance criteria. Compensation charges related to these plans were approximately $2,991,000, $981,000, and $1,946,000 for 2002, 2001, and 2000, respectively.

NOTE 10 INCOME TAXES

Income (loss) before income taxes consisted of the following:

Year Ended December 31,2002

2001

2000Domestic

$
(16,620
)
$
(14,720
)
$
51,564Foreign


1,104


530


91$
(15,516
)
$
(13,740
)
$
51,655


F-20

---

Income
tax expense (benefit) consisted of the following:

Year Ended December 31,2002

2001

2000Current:Federal

$
3,190

$
8,894

$
26,035State


442


508


1,934Foreign


185





3,817


9,402


27,969Deferred:Federal


(8,328
)

(13,423
)

(6,511
)State


(1,018
)

(1,063
)

(567
)(9,346
)

(14,486
)

(7,078
)Total expense (benefit)

$
(5,529
)
$
(5,084
)
$
20,891


The
total income tax expense (benefit) differs from the amount computed using the federal income tax rate of 35% for the following reasons:

Year Ended December 31,2002

2001

2000Federal income tax expense (benefit) at statutory rate

$
(5,430
)
$
(4,809
)
$
18,079Research and development credit


(1,970
)




(100
)State taxes, net of federal benefit


(373
)

(346
)

2,146Foreign taxes


185





Stock-based compensation


2,958


1,803


1,926Benefit from export sales


(247
)

(305
)

(1,218
)Municipal interest income


(872
)

(1,625
)

(697
)Other


220


198


755Income tax expense (benefit)

$
(5,529
)
$
(5,084
)
$
20,891


F-21

---

Deferred
income taxes reflect the tax effect of temporary differences between the amount of assets and liabilities for financial reporting purposes and income tax purposes. The tax
effects of each type of temporary difference that give rise to significant portions of the net deferred tax assets are as follows:

December 31,2002

2001Current deferred tax assets:Inventory reserves and costs

$
10,726

$
10,249Revenue recognition


10,368


7,349Net operating loss carry forward


7,373


Warranty reserves


1,321


818Reserves related to employee benefits


1,993


1,475Stock-based compensation


1,544


1,694Other





36833,325


21,953Non-current deferred tax assets:Tax credit carry forward


3,537


Difference between book and tax depreciation


2,485


1,951Capitalized software, net of amortization


(2,930
)

3,092


1,951Total deferred tax asset, net

$
36,417

$
23,904


The
Company believes that all deferred tax assets will be realized through profitable future operations and accordingly, there is no need for a valuation allowance for any of the
deferred tax assets.

Prior
to the initial public offering on August 9, 2000, the Company was included in a consolidated Federal income tax return with EMC. The Company is no longer eligible to be
included in EMC's
consolidated tax returns and has consequently filed a separate income tax return for the tax period which began immediately following the offering and for all subsequent periods.

When
the Company was included in EMC's consolidated tax returns, the Company recorded income taxes based on the pro rata method. The pro rata method assumes the allocation of income
taxes based on EMC's consolidated tax position. The pro rata method of allocating income taxes was consistently used for all members of the consolidated group. Pursuant to a tax sharing agreement
entered into with EMC, the Company reimbursed EMC for income taxes equal to 35% of the Company's taxable income for its tax year ended August 8, 2000, which tax was reduced by the Company's
share of the research and development tax credit. Had the Company's tax provision been calculated for the period as if the Company were a separate, independent United States taxpayer, the income tax
provision would not have materially changed.

Under
the terms of the tax sharing agreement between the Company and EMC, the Company is obligated to indemnify EMC for any taxes arising out of the failure of the Distribution to be tax
free if that failure results from, among other things, (i) any act or omission by the Company that would cause such distribution to fail to qualify as a tax free distribution under the Internal
Revenue Code of 1986, as amended; (ii) any act or omission by the Company that is inconsistent with any representation made to the Internal Revenue Service in connection with the request for a
private letter ruling regarding the tax-free nature of the distribution; (iii) any acquisition by a third party of the Company's stock or assets; or (iv) any issuance by the
Company of stock or any change in ownership of the Company's stock. If the distribution of the Company's Class A common stock fails to qualify as a tax-free distribution, EMC would
incur tax liability as if the Company's Class A common stock that was

F-22

---

distributed by EMC had been sold by EMC for its fair market value in a taxable transaction. In the event that the Company is required to indemnify EMC because the distribution of the Company's
Class A common stock fails to qualify as a tax-free distribution, the Company's liability could exceed 35% of the value of the Company's Class A common stock distributed by
EMC as determined on the date of the distribution.

Although
the Company is no longer a member of EMC's consolidated tax group, the tax sharing agreement between the Company and EMC continues to affect the Company in two principal ways.
First, if a taxing authority effects a change to the EMC consolidated return, the Company is required to reimburse EMC for the tax of any Company-related unfavorable adjustment. Conversely, the
Company is entitled to any refund for any Company-related favorable adjustment. Second, the Company is required to remit to EMC any tax savings generated by the tax deductions, if any, related to the
issuance or sale of EMC stock upon the exercise of options held by Company employees. Included in the Company's 2001 federal tax return was a stock based compensation deduction of $25 million
related to the issuance or sale of EMC stock. Subsequent to the receipt of its IRS refund of its 2001 net operating loss carry back into 2000, the Company remitted to EMC $9.5 million pursuant
to the tax sharing agreement.

NOTE 11 RELATED PARTY TRANSACTIONS

McDATA, as EMC's majority-owned subsidiary prior to February 7, 2001, engaged in several related-party transactions with EMC and its subsidiaries. These
included benefiting from a service agreement to provide services for EMC's ESCON switch business, making direct sales of Fibre Channel products to EMC, participating in EMC's cash management system
and filing as a member of EMC's consolidated tax return (see Note 10). The terms of these arrangements, which were negotiated in the context of a parent-subsidiary relationship, may be more or
less favorable to the Company than if they had been negotiated with unaffiliated third parties.

Under
the terms of the service agreement with EMC, the Company provides management, manufacturing, research, development, sales, support and administrative services with respect to
specified customers of EMC. The amount of such service fee is subject to annual revision based on the review and concurrence of both parties. Such service fee revenue totaled $4,381,000, $9,663,000,
and $14,497,000 for 2002, 2001, and 2000, respectively. Additionally, the Company provided $2,824,000 of consulting services to EMC for 2000.

Pursuant
to a five-year OEM supply and license agreement executed in 2000, the Company sells Fibre Channel products to EMC. Such sales comprised 53%, 66% and 69% of Company
revenue in 2002, 2001, and 2000, respectively. The agreement has no minimum purchase commitments and has customary termination rights.

Until
September 2000, the Company participated in EMC's cash management program, in which it deposited excess operating funds with EMC for short-term investment when
funds in excess of operating requirements were available or borrowed funds from EMC during periods of operating cash needs. Such funds were repaid on demand and earned simple interest, calculated
monthly. Interest income includes $102,000 earned from participation in EMC's cash management program during 2000.

On
October 1, 1997, the Company entered into an unsecured term note with EMC in the amount of $1,900,000. The note required quarterly payments of interest in arrears, with
principle to be paid in 2007 or upon the consummation of a sale of all or part of the Company, including an initial public offering. On August 9, 2000, the Company consummated an initial public
offering and proceeds from the offering were used to payoff the note. Interest incurred and paid to EMC for 2000 totaled $109,000.

F-23

---

Certain directors and executive officers of the Company own EMC common stock and options to purchase EMC common stock. One of the Company's directors as of December 31, 2000 was
an employee of EMC. This director resigned from his position on the Company's Board of Directors effective upon the distribution of the McDATA Class A common stock by EMC.

NOTE 12 COMMITMENTS AND CONTINGENCIES

Operating and Capital Leases

The Company had various operating and capital leases in effect at December 31, 2002 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 December 31, 2002:

Capital Leases

Operating
Leases2003

$
1,755

$
7,8652004


1,155


3,8392005


450


2,4002006





626Total minimum lease payments


3,360

$
14,730Less portion representing interest


2163,144Less: current portion


1,604$
1,540


Operating
rent expense in 2002, 2001, and 2000 totaled approximately $8,946,000, $7,671,000, and $3,424,000, respectively.

As
part of the Company's move to the new office and engineering building, the Company performed a review of its real estate facility requirements and identified excess leased facility
space, which has been offered for sublease. Based upon the results of this analysis, the Company recorded a charge of $83,000 and $941,000 included in selling and marketing expense related to facility
lease losses for the years ended December 31, 2002 and 2001, respectively. In determining the anticipated lease losses, various assumptions were made, including, the time period over
which the excess space will be under contract; expected sublease terms; and expected sublease rates and anticipated recoveries from sublease income. The new office and engineering building was
completed in July 2002. Lease charges of $341,000 were recorded against the loss accrual during the year ended December 31, 2002.

Collateralized Lease

On February 9, 2001, the Company entered into an operating lease and associated agreements with Deutsche Bank AG, New York Branch ("Deutsche Bank") for the
lease of an approximately 167,000 square foot multi-story office and engineering building to be constructed on a 106 acre parcel of land located in Broomfield, Colorado. Construction of the building
commenced in the first half of 2001 and was completed in July 2002, at which time lease payments were scheduled to commence. As part of the transaction, the Company guaranteed a residual value
of the facility to Deutsche Bank of approximately 89% during the construction period and 85% thereafter of the $60 million total original cost and agreed to restrict up to $63 million of
its investment securities as collateral for specified obligations under the lease. During the first quarter of 2002, the Company elected to terminate the lease under the provisions of the agreements.
On May 9, 2002, the Company entered into a Termination Agreement with Deutsche Bank and recorded approximately $39 million in construction costs as property and

F-24

---

equipment. $41 million in restricted assets were used to pay off the lease obligation and construction costs. In addition, a loss of $1.25 million was recorded during the first quarter
of 2002 to reflect the write-off of certain lease costs that could not be capitalized.

Manufacturing and Purchase Commitments

The Company has contracted with Sanmina SCI Systems, Inc. ("SSCI") and Solectron Corporation ("Solectron") (collectively, "Contract Manufacturers") for the
manufacture of printed circuit boards and box build assembly and configuration for specific Fibre Channel directors and switches. The agreements require the Company to submit purchasing forecasts and
place orders sixty calendar days in advance of delivery. At December 31, 2002, the Company's commitment with the Contract Manufacturers for purchases over the next sixty days
totaled $54.1 million. The Contract Manufacturers had on hand materials purchased on behalf of McDATA valued at approximately $45.8 million. Finally, the Contract Manufacturers have
outstanding purchase commitments related to materials that it had also ordered on McDATA's behalf.

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. At December 31, 2002, the Company had recorded obligations of approximately $10.0 million primarily related to materials purchased by SSCI
for certain end-of-life and obsolete material used to manufacture the Company's 1 Gb products. 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.

The
Company has various other commitments for sales and purchases in the ordinary course of business. In the aggregate, such commitments do not differ significantly from current market
prices or anticipated usage requirements.

Litigation

The Company, one current officer, and two former officers have been 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, Merrill Lynch, Pierce
Fenner & Smith Incorporated, Bear, Stearns & Co., Inc., FleetBoston Robertson Stephenset al., No. 01 CIV. 6627. Three other
similar suits have been filed against the Company. The complaints are substantially identical to over 300 other complaints filed against other companies that went public over the last
several years. 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 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 ("IPOs") and (b) that certain of the underwriters had 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 relating to the Company allege claims against the Company, two of the Company's current officers, a former officer of the Company and Credit Suisse First Boston, the lead
underwriter of the Company's August 9, 2000 initial public offering, under Sections 11 and 15 of the
Securities Act of 1933, as amended. The complaints also allege claims solely against Credit Suisse First Boston and the other underwriter defendants under Section 12(a)(2) of the
Securities Act of 1933, as amended, and claims against the individual defendants under Section 10(b) of the Securities Exchange Act of 1934, as amended. We believe that the lawsuits are
without legal merit and intend to defend them vigorously.

F-25

---

In
September 2002, plaintiffs' counsel in the above-mentioned lawsuits offered to individual defendants of many of the public companies being sued 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. Nothing in the
agreement constitutes or should be construed as an admission by either party and both parties reserve their rights. This agreement was signed by Mr. John F. McDonnell, the Company's Chairman,
Mrs. Dee J. Perry, the Company's former chief financial officer, and Mr. Thomas O. McGimpsey, the Company's former Vice President and General Counsel. It is expected that plaintiffs'
executive committee will sign soon and will dismiss the claims against such individuals, without prejudice to their right to reassert those claims and subject to the agreed tolling of the statute of
limitations. This will not affect the claims against the Company or the underwriters.

On
February 14, 2002, the Company filed a patent infringement lawsuit against Brocade Communications Systems, Inc. ("Brocade") in the United States District Court for the
District of Colorado (Case No. 02-K-0303) alleging that Brocade's Frame Filtering feature in their switch products infringed our U.S. Patent No. 6,233,235
"Method and apparatus for measuring traffic within a switch." On March 5, 2002, the Company filed for a preliminary injunction against Brocade to
immediately stop infringing the patent after they announced another product containing their Frame Filtering feature.

On
April 8, 2002, Brocade filed an answer to the motion for preliminary injunction generally alleging that Brocade has not infringed and is not infringing the patent. Brocade
alleged various counterclaims in its answer including a claim that the patent is invalid and unenforceable, and that the Company misappropriated trade secret information from them under prior
agreements and that a 1999 OEM agreement contained a covenant not to sue. The United States District Court for the District of Colorado on December 6, 2002, denied our motion for a preliminary
injunction. The Company filed documents on December 23, 2002 with the American Arbitration Association to initiate an arbitration proceeding to resolve contract and patent issues relating to
the 1999 OEM agreement with Brocade. On January 24, 2003, Brocade, in response to the initiation of the arbitration proceeding, filed an answer and counterclaim with the American Arbitration
Association that objected to the inclusion of the patent infringement claims in the arbitration. In addition, Brocade claims the patent is invalid and unenforceable and claims the Company
misappropriated trade secret information from Brocade. The Company strongly believes that Brocade's counterclaims are factually incorrect and without any merit. The Company intends to vigorously
pursue the patent infringement claims against Brocade.

Indemnifications and Guarantees

During its normal course of business, the Company has made certain indemnities, commitments and guarantees under which it may be required to make payments in
relation to certain transactions. These indemnities include intellectual property indemnities to the Company's customers in connection with the sales of its products, indemnities for liabilities
associated with the infringement of other parties' technology based upon the Company's software products, indemnities to various lessors in connection with facility leases for certain claims arising
from such facility or lease, and indemnities to directors and officers of the Company to the maximum extent permitted under the laws of the State of Delaware. The Company has also indemnified it's
former parent, EMC for any income taxes arising out of the Distribution in the event it does not qualify for tax free treatment. The duration of these indemnities, commitments and guarantees varies,
and in certain cases, is indefinite. 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. As such, the Company is unable to estimate with any reasonableness its potential exposure under these items. The Company has not recorded any liability for these
indemnities, commitments and guarantees in the accompanying consolidated balance sheets. The Company does, however, accrue for losses for any known contingent liability, including those that may arise
from indemnification provisions, when future payment is both

F-26

---

reasonably determinable and probable. Finally, the Company carries specific and general liability insurance policies, which the Company believes would provide, in most circumstances, some, if not
total recourse to any claims arising from these indemnifications.

From
time to time, the Company is subject to claims arising in the ordinary course of business. In the opinion of management, no such matter, individually or in the aggregate, exists
which is expected to have a material effect on the Company's consolidated results of operations, financial position or cash flows.

NOTE 13 SEGMENT INFORMATION

The Company has one reporting segment relating to the design, development, manufacture and sales of open 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 131, "Disclosures about Segments of an Enterprise and
Related Information," allocate resources and assess the performance of the Company based on revenue and overall profitability.

For
the years ended December 31, 2002, 2001, and 2000, the Company had two customers each who contributed greater than 10% of the Company's total revenues as follows:

Year Ended December 312002

2001

2000EMC

54
%
69
%
76
%IBM

25
%
17
%
14
%


The
level of sales to any single customer may vary and the loss of any one of these customers, or a decrease in the level of sales to any one of these customers, could have a material
impact on the Company's financial condition or results of operations.

The
Company's operations are conducted in the United States with sales offices throughout the European Community and Asia Pacific and a research and development facility in Canada, none
of which are individually significant to the Company's overall operations. The Company has not incurred any foreign currency translation adjustments as all of its sales are settled in U.S. dollars.

Certain
information related to the Company's operations by geographic area is presented below. The Company's revenues are attributed to the geographic areas according to the location of
the customers. Long lived assets include property and equipment and other non-current assets.

Net Sales

Long-Lived
Assets2002United States

$
207,015

$
131,094Foreign countries


121,264


1,339Total

$
328,279

$
132,4332001United States

$
263,416

$
65,110Foreign countries


80,990


1,245Total

$
344,406

$
66,3552000United States

$
171,888

$
27,347Foreign countries


76,798


1,353Total

$
248,686

$
28,700


F-27

---

Included
in the United States long-lived assets balances at December 31, 2002, 2001, and 2000 are intangible assets totaling $19,615,000, $21,715,000, and $0,
respectively. Included in the foreign countries long-lived assets balances as of December 31, 2002, 2001, and 2000 are intangible assets totaling $53,000, $125,000, and $542,000,
respectively.

NOTE 14 SUBSEQUENT EVENTS

Change in Fiscal Year

On January 15, 2003, the Board of Directors approved a change to the fiscal year end of the Company from December 31 to January 31 of each
year, commencing with the fiscal year beginning February 1, 2003.

Issuance of Convertible Debt

On February 7, 2003, the Company sold $172.5 million of 2.25% convertible subordinated notes (the "Notes") due February 15, 2010, raising net
proceeds of approximately $167.1 million. The Notes are convertible into our Class A common stock at conversion rate of 93.3986 shares per $1,000 principal amount of notes (aggregate of
approximately 16.1 million shares). Upon a conversion, the Company may choose to deliver, in lieu of shares of Class A common stock, cash or a combination of cash and Class A
common stock. The Company intends to file a registration statement with respect to the Notes and the common stock issuable upon conversion of the Notes. Concurrently with the issuance of the
Notes, the Company entered into a share option transactions using approximately $20.5 million of net proceeds. Under the terms of the share option transactions, the Company has the option to
purchase outstanding shares equivalent to the number of shares that may be issued if all Notes are converted into shares, thereby mitigating dilution to shareholders. These share option transactions
are intended to give the Company the option to mitigate dilution as a result of the Notes being converted to common shares up to the $10.71 price per common share and significantly mitigate dilution
if the share price exceeds $15.08 at that time.

NOTE 15 SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

The following summarizes selected financial information for each of the two years in the period ended December 31, 2002:

|                                    |  | Q1 |         | Q2 |   | Q3     |   | Q4 |         | Total |  
|----------------------------------- |  | -- | ------- | -- | - | ------ | - | -- | ------- | ----- | -
|2002                                |  |    |         |    |   |        |   |    |         |       |  
|Total revenue                       |  | $  | 64,543  |    | $ | 77,254 |   | $  | 80,941  |       | $
|Gross profit(1)                     |  |    | 13,890  |    |   | 35,091 |   |    | 42,580  |       |  
|Net income (loss)(1)(2)             |  |    | (17,071 | )  |   | (3,858 | ) |    | 2,343   |       |  
|Basic net income (loss) per share   |  |    | (0.15   | )  |   | (0.03  | ) |    | 0.02    |       |  
|Diluted net income (loss) per share |  |    | (0.15   | )  |   | (0.03  | ) |    | 0.02    |       |  
|2001                                |  |    |         |    |   |        |   |    |         |       |  
|Total revenue                       |  | $  | 83,035  |    | $ | 81,289 |   | $  | 86,600  |       | $
|Gross profit(3)                     |  |    | 37,464  |    |   | 34,095 |   |    | 22,813  |       |  
|Net income (loss)(3)(4)             |  |    | 7,542   |    |   | 3,371  |   |    | (13,582 | )     |  
|Basic net income (loss) per share   |  |    | 0.07    |    |   | 0.03   |   |    | (0.12   | )     |  
|Diluted net income (loss) per share |  |    | 0.06    |    |   | 0.03   |   |    | (0.12   | )     |  

---

F-28

---



F-29

---



MCDATA CORPORATION

SCHEDULE IIVALUATION AND QUALIFYING ACCOUNTS  (IN THOUSANDS)

|                                |  | Balance at
Beginning
of Period |        | Charged to
Costs and
Expenses |   | Deductions |  | Balance at
End of
Period
|------------------------------- |  | ------------------------------ | ------ | ----------------------------- | - | ---------- |  | ------------------------
|Year ended December 31, 2000    |  |                                |        |                               |   |            |  |                         
|Allowance for doubtful accounts |  | $                              | 95     |                               | $ | 248        |  | $                       
|Inventory reserves              |  |                                | 2,064  |                               |   | 2,541      |  |                         
|Year ended December 31, 2001    |  |                                |        |                               |   |            |  |                         
|Allowance for doubtful accounts |  | $                              | 284    |                               | $ | 707        |  | $                       
|Inventory reserves              |  |                                | 4,315  |                               |   | 29,919     |  |                         
|Year ended December 31, 2002    |  |                                |        |                               |   |            |  |                         
|Allowance for doubtful accounts |  | $                              | 783    |                               | $ | 525        |  | $                       
|Inventory reserves              |  |                                | 18,965 |                               |   | 11,332     |  |                         

---

S-1

---