Finisar 10Q 2004 Q2 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)


x		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended October 31, 2003 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 number 000-27999

Finisar Corporation

(Exact name of Registrant as specified in its charter)


Delaware		94-3038428
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)
1308 Moffett Park Drive		94089
Sunnyvale, California		(Zip Code)
(Address of principal executive offices)

Registrant’s telephone number, including area code:
408-548-1000

Common Stock, $.001 par value
(Title of Class)

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. Yesx Noo

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yesx Noo

At December 5, 2003, there were 220,891,946 shares of the registrant’s common stock, $.001 par value, issued and outstanding.

TABLE OF CONTENTS


PART I — FINANCIAL INFORMATION
	Item 1. Financial Statements
		CONDENSED CONSOLIDATED BALANCE SHEETS
		CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
		CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
	NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3. Quantitative and Qualitative Disclosures About Market Risk.
	Item 4. Controls And Procedures.
PART II — OTHER INFORMATION
	Item 1. Legal Proceedings
	Item 2. Changes in Securities and Use of Proceeds
	Item 4. Submission of Matters to a Vote of Security Holders.
	Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
EXHIBIT INDEX
EXHIBIT 4.4
EXHIBIT 10.18
EXHIBIT 10.19
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2

INDEX TO QUARTERLY REPORT ON FORM 10-Q
For the Quarter Ended October 31, 2003


		Page

PART I FINANCIAL INFORMATION
Item 1. Financial Statements:
	Condensed Consolidated Balance Sheets as of October 31, 2003 and April 30, 2003		3
	Condensed Consolidated Statements of Operations for the three and six month periods ended October 31, 2003 and 2002		4
	Condensed Consolidated Statements of Cash Flows for the six month periods ended October 31, 2003 and 2002		5
	Notes to Condensed Consolidated Financial Statements		7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			21
Item 3. Quantitative and Qualitative Disclosure About Market Risk			39
Item 4. Controls and Procedures			39
PART II OTHER INFORMATION
Item 1. Legal Proceedings			40
Item 2. Changes in Securities and Use of Proceeds			40
Item 4. Submission of Matters to a Vote of Security Holders			41
Item 6. Exhibits and Reports on Form 8-K			41
Signatures			42

PART I — FINANCIAL INFORMATION

Item 1.Financial Statements

FINISAR CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS


				October 31, 2003			April 30, 2003

				(In thousands, except share
				and per share data)
			ASSETS
Current assets:
	Cash and cash equivalents			$	163,534		$	40,918
	Short-term investments				73,259			78,520
	Restricted investments				10,190			6,737
	Accounts receivable, trade (net)				24,317			23,390
	Accounts receivable, other				6,767			5,362
	Inventories				21,719			36,470
	Prepaid expenses				1,762			2,341
	Deferred income taxes				3,068			3,324

Total current assets					304,616			197,062
Property, plant, equipment and improvements, net					96,725			112,125
Restricted investments, long-term					10,669			3,307
Purchased intangibles, net					43,312			52,910
Goodwill, net					19,985			19,838
Minority investments					25,056			28,844
Other assets					13,392			9,520

Total assets				$	513,755		$	423,606

		LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
	Accounts payable			$	17,418		$	22,872
	Accrued compensation				5,358			4,449
	Other accrued liabilities				9,797			8,474
	Non-cancelable purchase obligations				7,549			9,380
	Income tax payable				665			536
	Current portion of other long-term liabilities				2,000			1,384

Total current liabilities					42,787			47,095
Long-term liabilities:
	Deferred income taxes				3,070			3,324
	Convertible notes, net of unamortized portion of beneficial conversion feature of $22,889 and $30,977 at October 31, 2003 and April 30, 2003, respectively				227,361			94,023
	Other long-term liabilities				2,200			4,184

Total long-term liabilities					232,631			101,531
Stockholders’ equity
	Common stock, $0.001 par value, 219,270,618 shares issued and outstanding at October 31, 2003 and 207,295,693 shares issued and outstanding at April 30, 2003				219			207
	Additional paid-in capital				1,255,368			1,219,424
	Notes receivable from stockholders				(753	)		(1,077	)
	Deferred stock compensation				(447	)		(1,045	)
	Accumulated other comprehensive income				1,118			841
	Accumulated deficit				(1,017,168	)		(943,370	)

Total stockholders’ equity					238,337			274,980

Total liabilities and stockholders’ equity				$	513,755		$	423,606

See accompanying notes.

FINISAR CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS


		Three Months Ended						Six Months Ended
		October 31,						October 31,

		2003			2002			2003			2002

		(Unaudited, in thousands,						(Unaudited, in thousands,
		except per share data)						except per share data)
Revenues		$	42,776		$	40,903		$	82,207		$	87,950
Cost of revenues			32,041			32,655			68,503			69,578
Amortization of acquired developed technology			4,656			5,441			9,312			12,836

Gross profit			6,079			2,807			4,392			5,536
Operating expenses:
	Research and development		13,695			15,994			34,610			31,510
	Sales and marketing		4,557			5,570			8,857			11,726
	General and administrative		4,356			4,333			8,309			8,183
	Amortization of deferred stock compensation		(49	)		(1,933	)		(353	)		(552	)
	Amortization of purchased intangibles		143			143			286			472
	Impairment of goodwill and intangible assets		—			—			—			485
	Restructuring costs		187			1,174			2,372			1,174
	Other acquisition costs		149			(166	)		194			31

Total operating expenses			23,038			25,115			54,275			53,029

Loss from operations			(16,959	)		(22,308	)		(49,883	)		(47,493	)
Interest income			656			1,226			1,525			2,630
Interest expense			(15,682	)		(2,809	)		(22,059	)		(5,554	)
Other expense, net			(555	)		(39,316	)		(3,135	)		(49,654	)

Loss before income taxes and cumulative effect of an accounting change			(32,540	)		(63,207	)		(73,552	)		(100,071	)
Provision for income taxes			33			30			246			91

Loss before cumulative effect of an accounting change			(32,573	)		(63,237	)		(73,798	)		(100,162	)
Cumulative effect of an accounting change to adopt SFAS 142			—			—			—			(460,580	)

Net loss		$	(32,573	)	$	(63,237	)	$	(73,798	)	$	(560,742	)

Loss per share before cumulative effect of an accounting change		$	(0.15	)	$	(0.33	)	$	(0.35	)	$	(0.52	)
Cumulative per share effect of an accounting change to adopt SFAS 142			—			—			—			(2.40	)

Loss per share — basic and diluted		$	(0.15	)	$	(0.33	)	$	(0.35	)	$	(2.92	)

Shares used in loss per share calculation — basic and diluted			215,826			194,341			211,357			191,905

See accompanying notes.

FINISAR CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


			Six Months Ended
			October 31,

			2003			2002

			(Unaudited, in thousands)
Operating Activities:
Net loss			$	(73,798	)	$	(560,742	)
Adjustments to reconcile net loss to net cash used in operating activities:
		Depreciation and amortization		18,248			10,567
		Amortization of deferred stock compensation		(353	)		(522	)
		Amortization of purchased intangibles		286			472
		Amortization of acquired developed technology		9,312			12,836
		Amortization of beneficial conversion feature		8,088			2,302
		Loss on conversion of convertible notes		10,763			—
		Pro-rata share of losses in a minority investment (equity method)		473			319
		Cumulative effect of an accounting change		—			460,580
		Amortization of premium discount on restricted securities		(115	)		(328	)
		Other than temporary decline in market value of marketable security		528			—
		Loss on disposal of subsidiary assets		—			36,839
		Loss on retirement of assets		42			—
		Impairment of minority investment		1,631			12,000
		Impairment of goodwill and intangible assets		—			485
		Loss on retirement of assets		(86	)		—
		Non-employee option expense		891			—
		Other non-cash charges		823			—

		Total non-cash adjustment in operating activities		50,531			535,550

Changes in operating assets and liabilities:
		Accounts receivable		(927	)		2,147
		Inventories		14,751			10,281
		Other assets		(991	)		4,542
		Accounts payable		(5,454	)		(16,674	)
		Accrued compensation		909			(1,853	)
		Current income taxes		2			30
		Other accrued liabilities		(1,317	)		412

		Total change in operating assets and liabilities		6,973			(1,115	)

	Net cash used in operating activities			(16,294	)		(26,307	)
Investing activities:
Purchases of property, plant, equipment and improvements				(3,551	)		(12,756	)
Sale/(purchase) of short-term investments				8,422			(255	)
Purchase of minority investments, net of loan repayments				1,684			(155	)
Acquisition of product line assets				—			(243	)
Proceeds from disposal of subsidiary assets, net of cash transferred				—			5,407

Net cash provided by (used in) investing activities				6,555			(8,002	)
Financing activities:
Payments on capital lease obligations				—			(180	)
Payment received on stockholder note receivable				279			303
Proceeds from convertible debt offering net of issuance costs				130,903			—
Repurchase of convertible notes				(1,860	)		—
Proceeds from exercise of stock options and stock purchase plan net of repurchase of unvested shares				3,033			1,542

Net cash provided by financing activities				132,355			1,665

Net change in cash and cash equivalents				122,616			(32,664	)


Cash and cash equivalents at beginning of period			40,918		75,889

Cash and cash equivalents at end of period		$	163,534	$	43,245

Supplemental disclosure of cash flow information:
	Cash paid for interest	$	2,762	$	3,281
	Cash paid for taxes	$	239	$	91
Supplemental schedule of non-cash investing and financing Activities:
	Issuance of other long term liabilities in connection with acquisition of product line	$	—	$	5,384
	Issuance of common stock in connection with acquisitions	$	—	$	485
	Issuance of common stock upon conversion of convertible Notes	$	33,513	$	6,750
	Issuance of common stock on achievement of milestones	$	147	$	1,637

See accompanying notes.

FINISAR CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Summary of Significant Accounting Policies

Description of Business

Finisar Corporation was incorporated in the state of California on April 17, 1987. In November 1999, Finisar Corporation reincorporated in the state of Delaware.

Finisar Corporation designs, manufactures, and markets fiber optic subsystems and components and network test and monitoring systems for high-speed data communications.

Interim Financial Information and Basis of Presentation

The accompanying unaudited condensed consolidated financial statements as of October 31, 2003, and for the three and six month periods ended October 31, 2003 and 2002, have been prepared in accordance with accounting principles generally accepted in the United States for interim financial statements and pursuant to the rules and regulations of the Securities and Exchange Commission, and include the accounts of Finisar Corporation and its wholly-owned subsidiaries (collectively, “Finisar” or the “Company”). Intercompany accounts and transactions have been eliminated in consolidation. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the Company’s financial position at October 31, 2003, its operating results for the three and six month periods ended October 31, 2003 and 2002 and its cash flows for the six month periods ended October 31, 2003 and 2002. These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s audited financial statements and notes for the fiscal year ended April 30, 2003.

The balance sheet at April 30, 2003 has been derived from the audited consolidated financial statements at that date, but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.

Fiscal Periods

The Company maintains its financial records on the basis of a fiscal year ending on April 30, with fiscal quarters ending on the Sunday closest to the end of the period (thirteen-week periods). For ease of reference, all references to period end dates have been presented as though the period ended on the last day of the calendar month. The first three quarters of fiscal 2003 end on July 28, 2002, October 27, 2002 and January 26, 2003, respectively, and the first three quarters of fiscal 2004 end on July 27, 2003, October 26, 2003 and January 25, 2004, respectively.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from these estimates.

Revenue Recognition

The Company follows SEC Staff Accounting Bulletin (SAB) No. 101, “Revenue Recognition in Financial Statements.” Specifically, the Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed or determinable and collectability is reasonably assured. Product revenue is generally recorded at the time of shipment when title and risk of loss pass to the customer, unless the Company has future unperformed obligations or customer acceptance is required, in which case revenue is not recorded until such obligations have been satisfied or customer

acceptance has been received.

At the time revenue is recognized, the Company establishes an accrual for estimated warranty expenses associated with sales, recorded as a component of cost of revenues. The Company also provides an allowance for estimated customer returns, which has been netted against revenues.

Segment Reporting

Statement of Financial Accounting Standards No. 131, “Disclosures about Segments of an Enterprise and Related Information” (“SFAS 131”) establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports. SFAS 131 also establishes standards for related disclosures about products and services, geographic areas, and major customers. The Company has determined that it operates in two segments consisting of optical subsystems and components, and network test and monitoring systems.

Concentrations of Credit Risk

Financial instruments which potentially subject Finisar to concentrations of credit risk include cash, cash equivalents, short-term and restricted investments and accounts receivable. Finisar places its cash, cash equivalents and short-term and restricted investments with high-credit quality financial institutions. Such investments are generally in excess of FDIC insurance limits. Concentrations of credit risk, with respect to accounts receivable, exist to the extent of amounts presented in the financial statements. In many instances, the Company sells to contract manufacturers for the ultimate end customer equipment supplier. Generally, Finisar does not require collateral or other security to support customer receivables. Finisar performs periodic credit evaluations of its customers and maintains an allowance for potential credit losses based on historical experience and other information available to management. Losses to date have been within management’s expectations. At April 30, 2003, one optical subsystems and components customer represented 10.3% of total accounts receivable. At October 31, 2003, no single customer represented greater than 10.0% of total accounts receivable.

Current Vulnerabilities Due to Certain Concentrations

Finisar sells products primarily to customers located in North America. During the six months ended October 31, 2003, revenues from one optical subsystems and components customer represented 19.8% of revenues. During the six months ended October 31, 2002, revenues from one optical subsystems and components customer accounted for 10.1% of net revenues. No other customer accounted for more than 10.0% of revenues in either period.

Foreign Currency Translation

The functional currency of our foreign subsidiaries is the local currency. Assets and liabilities denominated in foreign currencies are translated using the exchange rate on the balance sheet dates. Revenues and expenses are translated using average exchange rates prevailing during the year. Any translation adjustments resulting from this process are included as a component of accumulated other comprehensive income. Foreign currency transaction gains and losses are included in the determination of net loss.

Research and Development

Research and development expenditures are charged to operations as incurred.

Advertising Costs

Advertising costs are expensed as incurred. Advertising is used infrequently in marketing the Company’s products. Advertising costs were $82,000 and $586,000 in the six months ended October 31, 2003 and 2002, respectively.

Cash and Cash Equivalents

Finisar’s cash equivalents consist of money market funds and highly liquid short-term investments with qualified financial institutions. Finisar considers all highly liquid investments with an original maturity from the date of purchase of three months or less to be cash equivalents.

Investments

Short-Term

Short-term investments consist of interest bearing securities with maturities of greater than 90 days from the date of purchase and an equity security. Pursuant to Statement of Financial Accounting Standard No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS 115”), the Company has classified its short-term investments as available-for-sale. Available-for-sale securities are stated at market value, which approximates fair value, and unrealized holding gains and losses, net of the related tax effect, are excluded from earnings and are included in accumulated other comprehensive income until realized. A decline in the market value of the security below cost that is deemed other than temporary is charged to earnings, resulting in the establishment of a new cost basis for the security. In the quarter ended July 31, 2003, the Company recorded an other-than-temporary decline of $528,000 in the value of one equity security holding.

Restricted Investments

Restricted investments consist of interest bearing securities with maturities of greater than three months from the date of purchase and held in escrow under the terms of the Company’s convertible subordinated notes. In accordance with SFAS 115, the Company has classified its restricted investments as held-to-maturity. Held-to-maturity securities are stated at amortized cost.

Other

The Company uses the cost method of accounting for investments in companies that do not have a readily determinable fair value in which it holds an interest of less than 20% and over which it does not have the ability to exercise significant influence. For entities in which the Company holds an interest of greater than 20% or in which the Company does have the ability to exercise significant influence, the Company uses the equity method. In determining if and when a decline in the market value of these investments below their carrying value is other-than-temporary, the Company evaluates the market conditions, offering prices, trends of earnings and cash flows, price multiples, prospects for liquidity and other key measures of performance. The Company’s minority investments in private companies are generally made in exchange for preferred stock with a liquidation preference that is intended to help protect the underlying value of its investment. In the first quarter of fiscal 2004, the Company recorded an impairment charge of $1.6 million for its minority equity investments in two development stage companies. In the second quarter of fiscal 2004, there were no impairments of the Company’s minority equity investments. Included in minority investments is the Company’s loan to Quintessence Photonics Corporation. During September 2003, the Company converted $5.0 million of the remaining $5.9 million of this loan into additional equity in this company. The remainder was repaid in cash to the Company. As of October 31, 2003, the Company estimated the value of its remaining minority investments at $25.1 million.

Fair Value of Financial Instruments

The carrying amounts of certain of the Company’s financial instruments, including cash and cash equivalents, accounts receivable, accounts payable, accrued compensation and other accrued liabilities, approximate fair value because of their short maturities. Fair value for investments in public companies is determined using quoted market prices for those securities.

Inventories

Inventories are stated at the lower of cost (determined on a first-in, first-out basis) or market.

The Company permanently writes down the cost of inventory that the Company specifically identifies and considers obsolete or excessive to fulfill future sales estimates. The Company defines obsolete inventory as inventory that will no longer be used in the manufacturing process. Excess inventory is generally defined as inventory in excess of projected usage, and is determined using management’s best estimate of future demand at the time, based upon information then available to the Company. The Company uses a twelve-month demand forecast and, in addition to the demand forecast, the Company also considers: (1) parts and subassemblies that can be used in alternative finished products, (2) parts and subassemblies that are unlikely to be engineered out of the Company’s products, and (3) known design changes which would reduce the Company’s ability to use the inventory as planned.

Property, Plant, Equipment and Improvements

Property, plant, equipment and improvements are stated at cost, net of accumulated depreciation and amortization. Property, plant, equipment and improvements are depreciated on a straight-line basis over the estimated useful lives of the assets, generally three years to seven years except property which is 40 years. Land is carried at acquisition cost and not depreciated. Leased land is depreciated over the life of the lease. The cost of equipment under capital leases is recorded at the lower of the present value of the minimum lease payments or the fair value of the asset and is amortized over the shorter of the term of the related lease or the estimated useful life of

the asset.

Goodwill and Other Intangible Assets

Goodwill and other intangible assets result from acquisitions accounted for under the purchase method. Amortization of other intangibles has been provided on a straight-line basis over periods ranging from three to five years. Goodwill is not amortized.

Accounting for the Impairment of Long-lived Assets

The Company periodically evaluates whether changes have occurred to long-lived assets that would require revision of the remaining estimated useful life of the property, improvements and assigned intangible assets or render them not recoverable. If such circumstances arise, the Company uses an estimate of the undiscounted value of expected future operating cash flows to determine whether the long-lived assets are impaired. If the aggregate undiscounted cash flows are less than the carrying amount of the assets, the resulting impairment charge to be recorded is calculated based on the excess of the carrying value of the assets over the fair value of such assets, with the fair value determined based on an estimate of discounted future cash flows.

Accounting for the Impairment of Goodwill and Indefinite-Lived Intangible Assets

The Company is required to perform an annual two-step impairment test of goodwill and indefinite-lived intangible assets. Should certain events or indicators of impairments occur between annual impairment tests, the Company performs the two-step impairment test of goodwill and indefinite-lived intangible at that date. In the first step of the analysis, the Company’s assets and liabilities, including existing goodwill and other intangible assets, are assigned to its identified reporting units to determine their carrying value. For this purpose, the reporting units are determined to be the two business segments. If the carrying value of a reporting unit is in excess of its fair value, an impairment may exist and the Company must perform the second step of comparing the implied fair value of the goodwill to its carrying value to determine the impairment charge.

The fair value of the reporting units is determined using the income approach. The income approach focuses on the income-producing capability of an asset, measuring the current value of the asset by calculating the present value of its future economic benefits such as cash earnings, cost savings, tax deductions and proceeds from disposition. Value indications are developed by discounting expected cash flows to their present value at a rate of return that incorporates the risk-free rate for the use of funds, the expected rate of inflation and risks associated with the particular investment.

The Company is contingently obligated to release from escrow additional stock consideration related to the acquisition of Transwave Fiber, Inc., subject to the satisfaction of certain conditions. Should such consideration become payable, any resulting goodwill will become subject to impairment testing at the time the goodwill is recorded.

Stock-Based Compensation

Finisar accounts for employee stock option grants in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB Opinion No. 25”) and has adopted the disclosure-only alternative of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”). The Company accounts for stock issued to non-employees in accordance with provisions of SFAS 123 and Emerging Issues Task Force Issue No. 96-18, “Accounting for Equity Investments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods, or Services.”

The following table illustrates the effect on net loss and loss per share if the Company had applied the fair value recognition provisions of SFAS 123 to employee stock benefits, including shares issued under the stock option plans and under the Company’s Employee Stock Purchase Plan (collectively “options”). For purposes of pro forma disclosures, the estimated fair value of the options is assumed to be amortized to expense over the options’ vesting periods and the amortization of deferred compensation has been added back. Pro forma information follows (in thousands, except per share amounts):


	Three Months Ended						Six Months Ended
	October 31,						October 31,

	2003			2002			2003			2002

Net loss — as reported	$	(32,573	)	$	(63,237	)	$	(73,798	)	$	(560,742	)
Add: Stock based employee compensation included in net loss		(49	)		(1,933	)		(353	)		(552	)


Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(10,503	)		(40,068	)		(19,500	)		(66,765	)

Net loss — pro forma	$	(43,125	)	$	(105,238	)	$	(93,651	)	$	(628,059	)

Basic and diluted net loss per share — as Reported	$	(0.15	)	$	(0.33	)	$	(0.35	)	$	(2.92	)

Basic and diluted net loss per share — pro Forma	$	(0.20	)	$	(0.54	)	$	(0.44	)	$	(3.27	)

The fair value of the Company’s stock option grants prior to the Company’s initial public offering was estimated at the date of grant using the minimum value option valuation model. The fair value of the Company’s stock options grants subsequent to the initial public offering was valued using the Black-Scholes valuation model based on the actual stock closing price on the day previous to the date of grant. These option valuation models were developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions. Because Finisar’s stock-based awards have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock-based awards.

The fair value of these options at the date of grant was estimated using the following weighted-average assumptions for the three and six month periods ended October 31, 2003: for stock options grants we used risk-free interest rates of 2.80% and 2.69%, respectively; a volatility factor of 1.29 and 1.31, respectively; a weighted-average expected life of the option of 3.91 for both periods; and a dividend yield of 0% for both periods. For our employee stock purchase plan we used risk-free interest rates of 0.95% and 0.96%, respectively; a volatility factor of 1.29 and 1.31, respectively; a weighted-average expected life of the option of 0.50 for both periods; and a dividend yield of 0% for both periods.

The fair value of these options at the date of grant was estimated using the following weighted-average assumptions for the three and six month periods ended October 31, 2002: for stock options grants we used risk-free interest rates of 2.86% and 3.01%, respectively; a volatility factor of 1.39 and 1.41, respectively; a weighted-average expected life of the option of 4.43 and 4.14, respectively; and a dividend yield of 0% for both periods. For our employee stock purchase plan we used risk-free interest rates of 1.67% and 1.45%, respectively; a volatility factor of 1.39 and 1.09, respectively; a weighted-average expected life of the option of 0.50 and 0.75, respectively; and a dividend yield of 0% for both periods.

Net Loss Per Share

Basic and diluted net loss per share are presented in accordance with SFAS No. 128, “Earnings Per Share” (“SFAS 128”), for all periods presented. Basic net loss per share has been computed using the weighted-average number of shares of common stock outstanding during the period. Diluted net loss per share has been computed using the weighted-average number of shares of common stock and dilutive potential common shares from options and warrants (under the treasury stock method), convertible redeemable preferred stock (on an if-converted basis) and convertible notes (on an as-if-converted basis) outstanding during the period.

Comprehensive Income

Financial Accounting Standards Board Statement of Financial Accounting Standard No. 130, “Reporting Comprehensive Income” (“SFAS 130”) establishes rules for reporting and display of comprehensive income and its components. Other comprehensive income for the three and six month periods ended October 31, 2003 was a loss of $289,000 and a gain of $277,000, respectively. Other comprehensive income for the three and six month periods ended October 31, 2002 was a loss of $477,000 and a loss of $1,010,000, respectively. SFAS 130 requires unrealized gains or losses on the Company’s available-for-sale securities and foreign currency translation adjustments to be included in comprehensive income. At October 31, 2003 and April 30, 2003, accumulated other comprehensive income was approximately $1,118,000 and $841,000, respectively. The amount of the change in net unrealized gain or loss on available-for-sale securities for the three and six month periods ended October 31, 2003 was a loss of approximately $201,000 and a gain of approximately $146,000, respectively. The amount of the change in net unrealized gain or loss on available-for-sale securities for the three and six month periods ended October 31, 2002 was a loss of approximately $31,000 and a loss of approximately $854,000, respectively. Foreign currency translation adjustments for the three and six month periods ended October 31, 2003 was a loss of approximately $88,000 and a gain of approximately $131,000, respectively. Foreign currency translation adjustments for the three and six month periods ended October 31, 2002 was a loss of approximately $446,000 and a loss of approximately $156,000, respectively. Accumulative other comprehensive income of $1,118,000 at October 31, 2003 is comprised of

net unrealized gains of $437,000 on available-for-sale securities and cumulative translation adjustments of $681,000. Accumulated other comprehensive income of $841,000 at April 30, 2003 is comprised of net unrealized gains on available- for-sale securities of $291,000 and cumulative translation adjustments of $550,000.

Effect of New Accounting Standards

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51” (“FIN 46”). FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provision of FIN 46 must be applied for the first interim or annual period ending after December 15, 2003. The Company has not created or acquired any variable interest entities subsequent to January 31, 2003, and does not believe the adoption of FIN 46 will effect its operating results and financial condition. The Company is however currently evaluating the potential effect the adoption of FIN 46 may have on its operating results and financial condition with respect to potential variable interest entities created or acquired prior to January 31, 2003.

In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150 (“SFAS 150”), “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS 150 requires that certain financial instruments, which under previous guidance were accounted for as equity, must now be accounted for as liabilities. The financial instruments affected include mandatorily redeemable stock, certain financial instruments that require or may require the issuer to buy back some of its shares in exchange for cash or other assets and certain obligations that can be settled with shares of stock. SFAS 150 is effective for all financial instruments entered into or modified after May 31, 2003 and must be applied to any existing financial instruments effective July 1, 2003. The adoption of SFAS 150 did not have a material effect on the Company’s results of operations or financial condition.

Net Loss Per Share

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


		Three Months Ended						Six Months Ended
		October 31,						October 31,

		2003			2002			2003			2002
Numerator:
	Net loss before cumulative effect of an accounting change	$	(32,573	)	$	(63,237	)	$	(73,798	)	$	(100,162	)
	Cumulative effect of an accounting change to adopt SFAS 142		—			—			—			(460,580	)

	Net loss	$	(32,573	)	$	(63,237	)	$	(73,798	)	$	(560,742	)

Denominator for basic and diluted net loss per share:
	Weighted average shares outstanding - - total		216,960			200,558			212,747			198,730
	- subject to repurchase		(815	)		(2,893	)		(1,070	)		(3,294	)
	- performance stock		(319	)		(3,324	)		(320	)		(3,531	)

Denominator for basic and diluted net loss per share			215,826			194,341			211,357			191,905

	Net loss per share before cumulative effect of an accounting change	$	(0.15	)	$	(0.33	)	$	(0.35	)	$	(0.52	)
	Cumulative effect of an accounting change to adopt SFAS 142		—			—			—			(2.40	)

Net loss per share — basic and diluted		$	(0.15	)	$	(0.33	)	$	(0.35	)	$	(2.92	)

Common stock equivalents related to potentially dilutive securities excluded from computation above because they are anti-dilutive:
	Employee stock options		11,039			2,465			7,300			22,132
	Stock subject to repurchase		815			2,893			1,070			3,294
	Convertible debt, long term		24,340			22,645			23,507			22,645
	Performance stock		—			2,744			1			2,951
	Warrants		1,040			10			1,040			10

			37,234			30,757			32,918			51,032

Liabilities Related to Acquisition of Assets from New Focus

In partial consideration for the purchase of certain assets from New Focus, Inc. for a total value of $12.1 million in May 2002, the Company delivered to New Focus a non-interest bearing convertible promissory note in the principal amount of $6.75 million which was convertible into shares of the Company’s common stock. On August 9, 2002, the note was converted into 4,027,446 shares of

common stock. Additionally, in August, 2003, a $1.4 million payment was made to pay down minimum commitments to New Focus. The remaining consideration represents a minimum commitment with respect to royalty payments to be paid during the three years following the date of acquisition and totaled $4.0 million at October 31, 2003. Because such payments are not fixed in time, they were not discounted as otherwise required under Accounting Principles Board Opinion No. 21.

Inventories

Inventories consist of the following (in thousands):


	October 31, 2003		April 30, 2003

Raw materials	$	17,519	$	23,366
Work-in-process		2,281		7,808
Finished goods		1,919		5,296

	$	21,719	$	36,470

For the six months ended October 31, 2002, the Company recorded charges of $13.7 million for excess and obsolete inventory and sold inventory components that were previously written-off in prior periods with an approximate original cost of $8.6 million. As a result, cost of revenue associated with the sale of this inventory was zero.

For the six months ended October 31, 2003, the Company recorded additional charges of $16.6 million for excess and obsolete inventory and sold inventory components that were previously written-off in prior periods with an approximate original cost of $7.9 million. As a result, cost of revenue associated with the sale of this inventory was zero.

Property, Plant, Equipment and Improvements

Property, plant, equipment and improvements consist of the following (in thousands):


	October 31, 2003			April 30, 2003

Land	$	18,781		$	18,781
Buildings		21,218			21,218
Computer equipment		25,550			23,673
Office equipment, furniture and fixtures		3,087			2,930
Machinery and equipment		76,952			79,174
Leasehold improvements		6,333			8,013

		151,921			153,789
Accumulated depreciation and amortization		(55,196	)		(41,664	)

Property, plant, equipment and improvements, net	$	96,725		$	112,125

6. Income Taxes

The provision for income taxes increased from $30,000 in the quarter ended October 31, 2002 to $33,000 in the quarter ended October 31, 2003, primarily reflecting state tax requirements. The provision for income taxes increased from $91,000 in the six months ended October 31, 2002 to $246,000 in the six months ended October 31, 2003, again primarily reflecting state tax requirements.

The Company has established a valuation allowance for a portion of its gross deferred tax assets. In part, the valuation allowance at October 31, 2003 reduced net deferred tax assets by amounts related to stock option deductions that are not currently realizable. A portion of the valuation allowance will be credited to paid-in capital if and when realized. The remaining portion of the valuation allowance, if and when realized, will first reduce unamortized goodwill, then other non-current intangible assets of acquired subsidiaries and then income tax expense. There can be no assurance that deferred tax assets subject to the valuation allowance will be realized.

Realization of the deferred tax assets is dependent upon future taxable income, if any, the amount and timing of which are uncertain. Accordingly, the net deferred tax assets have been fully offset by a valuation allowance. Because the Company’s deferred tax assets equal deferred tax liabilities as of October 31, 2003, the Company does not expect to record any additional tax benefit against future operating losses.

Utilization of the Company’s net operating loss and tax credit carryforwards may be subject to a substantial annual limitation due to the ownership change limitations set forth by the Internal Revenue Code Section 382 and similar state provisions. Such an annual limitation could result in the expiration of the net operating loss and tax credit carryforwards before utilization.

Deferred Stock Compensation

In connection with the grant of certain stock options to employees, Finisar recorded deferred stock compensation prior to the Company’s initial public offering, representing the difference between the fair value of the Company’s common stock for accounting purposes and the option exercise price of these options at the date of grant. During fiscal 2001 and 2002, the Company recorded additional deferred compensation related to the assumptions of stock options associated with companies acquired during those years. Deferred stock compensation is presented as a reduction of stockholder’s equity, with accelerated amortization recorded over the vesting period, which is typically three to five years. The amortization expense relates to options awarded to employees in all operating expense categories. The following table summarizes the amount of deferred stock compensation expense which Finisar has recorded and the amortization it has recorded and expects to record in future periods in connection with grants of certain stock options to employees during fiscal 1999 and 2000 and assumptions of stock options associated with companies acquired during fiscal 2001 and 2002. Amounts to be recorded in future periods could decrease if options for which accrued but unvested compensation has been recorded are forfeited (in thousands):


		Deferred Stock
		Compensation			Amortization
		Generated			Expense

Fiscal year ended April 30, 1999		$	2,403		$	428
Fiscal year ended April 30, 2000			12,959			5,530
Fiscal year ended April 30, 2001			21,217			13,543
Fiscal year ended April 30, 2002			1,065			11,963
Fiscal year ended April 30, 2003			(6,855	)		(1,719	)
Fiscal quarter ended July 31, 2003 (unaudited)			(674	)		(304	)
Fiscal quarter ended October 31, 2003 (unaudited)			(276	)		(49	)
Fiscal quarter ending January 31, 2004 (unaudited)			—			148
Fiscal quarter ending April 30, 2004 (unaudited)			—			135
Fiscal year ending April 30, 2005 (unaudited)			—			164

	Total	$	29,839		$	29,839

Purchased Intangible Assets Including Goodwill

The following table reflects changes in the carrying amount of goodwill by reporting unit (in thousands);


	Optical			Network Test
	Subsystems			and
	and			Monitoring			Consolidated
	Components			Systems			Total

Balance at April 30, 2002	$	406,357		$	70,223		$	476,580
Addition related to achievement of milestones		485			—			485
Addition related to acquisition of subsidiary		3,838			—			3,838
Transitional impairment loss		(406,357	)		(54,223	)		(460,580	)
Impairment loss		(485	)		—			(485	)

Adjusted balance at April 30, 2003		3,838			16,000			19,838
Addition related to achievement of milestones		147			—			147

Balance at October 31, 2003	$	3,985		$	16,000		$	19,985

Effective May 1, 2002, the Company performed the required transitional impairment testing of goodwill and recognized a transitional impairment loss of $460.6 million as a cumulative effect of an accounting change during the quarter ended July 31, 2002. Of this impairment loss, $406.4 million was related to optical subsystems and components and $54.2 million was related to network test and monitoring systems.

On May 3, 2002, the Company recorded additional goodwill in the optical subsystems and components reporting unit of $485,000 as a result of achievement of certain milestones specified in the Transwave acquisition agreement. The Company recorded an impairment loss of $485,000 in the three months ended July 31, 2002 for this additional consideration, since the Company’s transitional impairment charge, recorded in the first quarter of fiscal 2003, indicated it could not be supported. On May 3, 2003, the

Company recorded additional goodwill in the optical subsystems and components reporting unit of $147,000 as a result of achievement of additional milestones specified in the Transwave acquisition agreement.

The following table reflects intangible assets subject to amortization as of April 30, 2003 and October 31, 2003 (in thousands):


	April 30, 2003

	Gross					Net
	Carrying		Accumulated			Carrying
	Amount		Amortization			Amount

Purchased technology	$	89,525	$	(38,242	)	$	51,283
Trade name		2,867		(1,240	)		1,627

Totals	$	92,392	$	(39,482	)	$	52,910


	October 31, 2003

	Gross					Net
	Carrying		Accumulated			Carrying
	Amount		Amortization			Amount

Purchased technology	$	89,525	$	(47,554	)	$	41,971
Trade name		2,867		(1,526	)		1,341

Totals	$	92,392	$	(49,080	)	$	43,312

Estimated amortization expense for each of the next five fiscal years ending April 30, is as follows (dollars in thousands):


Year	Amount

2004	$	19,191
2005		19,190
2006		12,971
2007		1,280
2008		278

Segments and Geographic Information

The Company designs, develops, manufactures and markets optical subsystems, components and test and monitoring systems for high-speed data communications. The Company views its business as having two principal operating segments, consisting of optical subsystems and components and network test and monitoring systems. Optical subsystems consist primarily of transceivers sold to manufacturers of storage and networking equipment for storage area networks (SANs) and local area networks (LANs), and transceivers, multiplexers, demultiplexers and optical add/drop modules for use in metropolitan access networks (MAN) applications. Network test and monitoring systems include products designed to test the reliability and performance of equipment for Fibre Channel, Gigabit Ethernet, 10 Gigabit Ethernet and the iSCSI protocols. These test and monitoring systems are sold to both manufacturers and end-users of the equipment.

The Company’s operating segments report to the President and Chief Executive Officer. Where appropriate, the Company charges specific costs to these segments where they can be identified and allocates certain manufacturing costs, research and development, sales and marketing and general and administrative costs to these operating segments, primarily on the basis of manpower levels or a percentage of sales. The Company does not allocate income taxes, non-operating income, acquisition related costs, stock compensation, interest income and interest expense to its operating segments. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. There are no intersegment sales.

Information about reportable segment revenues and income are as follows (in thousands):


		Three Months Ended				Six Months Ended
		October 31,				October 31,

		2003		2002		2003		2002

Revenues:
	Optical subsystems and components	$	36,432	$	32,213	$	70,620	$	71,490
	Network test and monitoring systems		6,344		8,690		11,587		16,460

	Total revenues	$	42,776	$	40,903	$	82,207	$	87,950

Depreciation and amortization expense:
	Optical subsystems and components	$	6,557	$	6,206	$	18,118	$	10,450
	Network test and monitoring systems		24		3		130		117


Operating loss:
	Optical subsystems and components		(10,671	)		(16,860	)		(35,860	)		(30,821	)
	Network test and monitoring systems		(311	)		(789	)		(1,321	)		(2,226	)

	Operating loss before unallocated amounts		(10,982	)		(17,649	)		(37,181	)		(33,047	)
Unallocated amounts:
	Amortization of acquired developed technology		(4,656	)		(5,441	)		(9,312	)		(12,836	)
	Amortization of deferred stock compensation		49			1,933			353			552
	Amortization of other intangibles		(143	)		(143	)		(286	)		(472	)
	Impairment of goodwill and intangible assets		—			—			—			(485	)
	Non-employee option expense		(891	)		—			(891	)		—
	Restructuring costs		(187	)		(1,174	)		(2,372	)		(1,174	)
	Other acquisition costs		(149	)		166			(194	)		(31	)
	Interest income (expense), net		(15,026	)		(1,583	)		(20,534	)		(2,924	)
	Other non-operating income (expense), net		(555	)		(39,316	)		(3,135	)		(49,654	)

Loss before income tax and cumulative effect of accounting change to adopt FAS 142		$	(32,540	)	$	(63,207	)	$	(73,552	)	$	(100,071	)

The following is a summary of total assets by segment (in thousands):


	October 31,		April 30,
	2003		2003

Optical subsystems and components	$	194,809	$	240,297
Network test and monitoring systems		59,255		54,912
Other		259,691		128,397

	$	513,755	$	423,606

Cash and short-term, restricted and minority investments are the primary components of other assets in the above table.

The following is a summary of operations within geographic areas based on the location of the entity purchasing the Company’s products (in thousands):


		Three Months Ended				Six Months Ended
		October 31,				October 31,

		2003		2003		2003		2002

Revenues from sales to unaffiliated customers:
	United States	$	33,471	$	30,468	$	62,860	$	67,248
	Rest of the world		9,305		10,435		19,347		20,702

		$	42,776	$	40,903	$	82,207	$	87,950

Revenues generated in the U.S. are all from sales to customers located in the United States.

The following is a summary of long-lived assets within geographic areas based on the location of the assets (in thousands):


		October 31,		April 30,
		2003		2003

Long-lived assets United States		$	177,023	$	197,564
	Malaysia		18,330		20,378
	Rest of the world		3,117		5,295

		$	198,470	$	223,237

The following is a summary of capital expenditures by reportable segment (in thousands):


	Six Months Ended

		October 31,

	2003			2002

Optical subsystems and components		$	3,989	$	12,120
Network test and monitoring systems		$	34	$	636

10.

Option Exchange Program

On November 8, 2002, the Company announced that its board of directors had approved a voluntary stock option exchange program for eligible option holders. Under the program, eligible holders of the Company’s options who elected to participate had the opportunity to tender for cancellation outstanding options in exchange for new options to be granted on a future date at least six months and one day after the date of cancellation. Members of the Company’s board of directors were not eligible to participate in the program. The option exchange program terminated on December 17, 2002. As of that date, holders of options to purchase an aggregate of 11,816,890 shares of common stock tendered their shares for cancellation.

On June 19, 2003, new options to purchase an aggregate of 11,144,690 shares of common stock were granted at an exercise price of $1.80 per share, the closing price for the Company’s common stock on that date. Each new option preserves the vesting schedule and the vesting commencement date of the option it replaced. There were no accounting charges as a result of this stock option exchange program.

11.

Warranty

The Company offers a one-year limited warranty for all of its products. The specific terms and conditions of these warranties vary depending upon the product sold. The Company estimates the costs that may be incurred under its basic limited warranty and records a liability in the amount of such costs based on revenue recognized. Factors that affect the Company’s warranty liability include the number of units sold, historical and anticipated rates of warranty claims and cost per claim. The Company periodically assesses the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary.

Changes in the Company’s warranty liability during the following period were as follows (in thousands):


	Six Months
	Ended
	October 31, 2003

Beginning balance	$	867
Additions during the period based on product sold		435
Settlements		(40	)
Changes in liability for pre-existing warranties including expirations		(366	)

Ending balance	$	896

12.

Restructuring and Assets Impairments

During the fiscal year ended April 30, 2003, the Company initiated actions to reduce its cost structure due to sustained negative economic conditions that have impacted its operations and resulted in lower than anticipated revenues. In May and October 2002, the Company reduced its workforce in the United States. The restructuring actions in fiscal 2003 resulted in a reduction in the U.S. workforce of approximately 255 employees, or 36% of the Company’s U.S. workforce measured as of the beginning of fiscal 2003, and affected all areas of U.S. operations. During fiscal 2003, the Company sold its Sensors Unlimited subsidiary, closed its Hayward facility, and began the process of closing the facilities occupied by its Demeter subsidiary. As facilities in the United States were consolidated, related leasehold improvement and equipment were written off. As a result of these restructuring activities, a charge of $9.4 million was incurred in fiscal 2003. The restructuring charge included approximately $5.4 million for the write-off of leasehold improvements and equipment in the vacated buildings, approximately $1.8 million of severance related charges, approximately $1.5 million of excess committed facilities payments and approximately $700,000 of miscellaneous costs required to effect the closures.

During the first quarter of fiscal 2004, the Company completed the closure of its Demeter subsidiary. In addition, the Company began the process of closing its German operations and the reduction in the German workforce of approximately 10 employees in research and development in the optical subsystems and components reporting segment. As a result of these restructuring activities, a charge of $2.2 million was incurred in the first fiscal quarter. The restructuring charge included $800,000 of severance, approximately $600,000 of fees associated with the early termination of the Company’s facilities lease in Germany, approximately $450,000 for remaining payments for excess leased equipment and approximately $300,000 of miscellaneous costs incurred to effect the closures.

During the second quarter of fiscal 2004, the Company completed the closure of its German facility. The intellectual property, technical know-how and certain assets related to the German operations were consolidated with the Company’s operations in Sunnyvale, California, during the second quarter. The Company incurred an additional $187,000 of net restructuring expenses in the second quarter. This amount included an additional $273,000 of restructuring expenses related to the closure of German operations,

consisting of $373,000 for legal and exit fees associated with the closure, additional severance related payments and write-off of abandoned assets, partially offset by lower than anticipated fees associated with the termination of the German facilities lease of $100,000. The expenses related to the closure of the German facility were partially offset by an $86,000 reduction in restructuring expenses associated with the closure of the Demeter subsidiary offset by additional severance related expenses.

The facilities consolidation charge was calculated using estimates and was based upon the remaining future lease commitments for vacated facilities from the date of facility consolidation, net of estimated future sublease income. The estimated costs of vacating these leased facilities were based on market information and trend analyses, including information obtained from third party real estate sources. The Company has engaged brokers to locate tenants to sublease the Hayward facility. As of October 31, 2003, $1.1 million of committed facilities payments, net of anticipated sublease income, remains accrued and is expected to be fully utilized by fiscal 2006. In calculating the charge for facilities consolidation, certain assumptions were made with respect to the estimated time periods of vacancy and sublease rates and opportunities. Actual future circumstances could be materially different from the Company’s estimates and, accordingly, the actual total charges associated with the vacated facilities could be materially higher or lower than estimated. Adjustments to the facilities consolidation charges will be made in future periods, if necessary, based upon then current actual events and circumstances.

At October 31, 2003, $4.0 million related to restructuring activities in fiscal 2003 and first six months of fiscal 2004 remained in other accrued liabilities for payment in future periods as follows (in thousands):


	Facilities			Severance			Total

Fiscal year 2003 actions:
Total charges	$	7,548		$	1,830		$	9,378
Cash payments		(407	)		(1,718	)		(2,125	)
Non-cash charges		(3,722	)		—			(3,722	)

Balance from fiscal year 2003 actions at October 31, 2003		3,419			112			3,531
Fiscal year 2004 actions:
Total charges		1,395			977			2,372
Cash payments		(984	)		(963	)		(1,947	)
Non-cash charges		—			—			—

Balance from fiscal year 2004 actions at October 31, 2003		411			14			425
Total accrual balance at October 31, 2003	$	3,830		$	126		$	3,956

Cash payments totaling approximately $1.4 million, primarily consisting of lease payments, will be made though 2006. All other facilities consolidations expenses and the accrued severance balance of $126,000 are expected to be paid out by January 2004.

13.

Pending Litigation

surrender to the plaintiffs of certain claims the issuer defendants may have against the underwriters. Under the guaranty, the insurers will be required to pay the amount, if any, by which $1 billion exceeds the aggregate amount ultimately collected by the plaintiffs from the underwriter defendants in all the cases. If the plaintiffs fail to recover $1 billion and payment is required under the guaranty, the Company would be responsible to pay its pro rata portion of the shortfall, up to the amount of the self-insured retention under its insurance policy, which is $2 million. The timing and amount of payments that the Company could be required to make under the proposed settlement will depend on several factors, principally the timing and amount of any payment by the insurers pursuant to the $1 billion guaranty. The settlement is subject to approval of the Court, which cannot be assured. If the settlement is not approved by the Court, the Company intends to defend the lawsuit vigorously. However, the litigation is in the preliminary stage, and we cannot predict its outcome. The litigation process is inherently uncertain. If the outcome of the litigation is adverse to the Company and if the Company is required to pay significant monetary damages, the Company’s business would be significantly harmed.

14.

Conversion and Repurchase of Convertible Notes due 2008

In privately negotiated transactions concluded during the quarter ended October 31, 2003, the Company exchanged an aggregate of $17.8 million in principal amount of its convertible notes due 2008 for 7,614,402 shares of the Company’s common stock. In connection with the exchange, the Company recorded additional non-cash interest expense of approximately $8.4 million representing the fair value of the incremental shares issued to induce the exchange and non-cash interest expense of approximately $4.2 million representing the remaining unamortized discount for the beneficial conversion feature related to the convertible notes exchanged. Also, $492,000 of unamortized debt issue costs related to the convertible notes exchanged was charged to additional paid-in capital.

In another privately negotiated transaction concluded during the quarter ended October 31, 2003, the Company repurchased $2.0 million in principal amount of its convertible notes due 2008 for cash in the amount of $1.9 million. In connection with the repurchase, the Company recorded additional non-cash interest expense of approximately $458,000 representing the remaining unamortized discount for the beneficial conversion feature related to the repurchased convertible notes. Also, approximately $54,000 of unamortized debt issue costs related to the repurchased convertible notes was charged to other expense.

In aggregate, during the six months ended October 31, 2003, the Company, in privately negotiated transactions, exchanged and repurchased $24.8 million in principal amount of its convertible notes due 2008 for 9,926,339 shares of the Company’s common stock and cash in the amount of $1.9 million. In connection with the exchanges and repurchases, the Company recorded additional non-cash interest expense of approximately $10.8 million representing the fair value of the incremental shares issued to induce the exchange and non-cash interest expense of approximately $5.8 million representing the remaining unamortized discount for the beneficial conversion feature related to the convertible notes exchanged and repurchased. Also, $632,000 of unamortized debt issue costs related to the convertible notes exchanged and repurchased was charged to additional paid-in capital, and $54,000 was charged to expense.

15.

Sale of Convertible Subordinated Notes due 2010

On October 15, 2003, the Company sold $150 million aggregate principal amount of 2 1/2 % convertible subordinated notes due October 15, 2010. Interest on the notes is 2 1/2 % per year, payable semiannually on April 15 and October 15, beginning on April 15, 2004. The notes are convertible, at the option of the holder, at any time on or prior to maturity into shares of the Company’s common stock at a conversion price of $3.705 per share, which is equal to a conversion rate of approximately 269.9055 shares per $1,000 principal amount of notes. The conversion price is subject to adjustment. The Company has purchased and pledged to a collateral agent, as security for the exclusive benefit of the holders of the notes, approximately $14.4 million of U.S. government securities, which will be sufficient upon receipt of scheduled principal and interest payments thereon, to provide for the payment in full of the first eight scheduled interest payments due on the notes.

The notes are subordinated to all of the Company’s existing and future senior indebtedness and effectively subordinated to all existing and future indebtedness and other liabilities of its subsidiaries. Because the notes are subordinated, in the event of bankruptcy, liquidation, dissolution or acceleration of payment on the senior indebtedness, holders of the notes will not receive any payment until holders of the senior indebtedness have been paid in full.

The indenture does not limit the incurrence by the Company or its subsidiaries of senior indebtedness or other indebtedness. The Company may redeem the notes, in whole or in part, at any time on or after October 15, 2007 up to, but not including, the maturity date at specified redemption prices, plus accrued and unpaid interest.

Upon a change in control, each holder of the notes may require the Company to repurchase some or all of the notes at a purchase price equal to 100% of the principal amount of the notes plus accrued and unpaid interest. Instead of paying the change of control

purchase price in cash, the Company may, at its option, pay it in shares of the Company’s common stock valued at 95% of the average of the closing sales prices of its common stock for the five trading days immediately preceding and including the third trading day prior to the date the Company is required to repurchase the notes. The Company cannot pay the change in control purchase price in common stock unless the Company satisfies the conditions described in the indenture under which the notes have been issued.

The notes have been issued in fully registered form. The notes are represented by one or more global notes, deposited with the trustee as custodian for The Depository Trust Company, or DTC, and registered in the name of Cede & Co., DTC’s nominee. Beneficial interests in the global notes will be shown on, and transfers will be effected only through, records maintained by DTC and its participants.

The Company has agreed to use its best efforts to file a shelf registration statement covering the notes and the common stock issuable upon conversion of the stock and keep such registration statement effective until two years after the latest date on which the Company issued notes in this offering (or such earlier date when the holders of the notes and the common stock issuable upon conversion of the notes are able to sell their securities immediately pursuant to Rule 144(k) under the Securities Act). If the Company does not comply with these registration obligations, the Company will be required to pay liquidated damages to the holders of the notes or the common stock issuable upon conversion. The Company will not receive any of the proceeds from the sale by any selling security holders of the notes or the underlying common stock. The notes are eligible for trading in the PORTAL market.

16.

Guaranties and Indemnifications

In November 2002, the FASB issued Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others (FIN 45). FIN 45 requires that upon issuance of a guarantee, the guarantor must recognize a liability for the fair value of the obligations it assumes under that guarantee. As permitted under Delaware law and in accordance with the Company’s Bylaws, the Company indemnifies its officers and directors for certain events or occurrences, subject to certain limits, while the officer or director is or was serving at the Company’s request in such capacity. The term of the indemnification period is for the officer’s or director’s lifetime. The Company may terminate the indemnification agreements with its officers and directors upon 90 days written notice, but termination will not affect claims for indemnification relating to events occurring prior to the effective date of termination. The maximum amount of potential future indemnification is unlimited; however, the Company has a director and officer insurance policy that limits its exposure and may enable it to recover a portion of any future amounts paid.

The Company enters into indemnification provisions under its agreements with other companies in its ordinary course of business, typically with business partners, contractors, clinical sites, insurers and customers. Under these provisions the Company generally indemnifies and holds harmless the indemnified party for losses suffered or incurred by the indemnified party as a result of the Company’s activities. These indemnification provisions generally survive termination of the underlying agreement. In some cases, the maximum potential amount of future payments the Company could be required to make under these indemnification provisions is unlimited.

The Company believes the fair value of these indemnification agreements is minimal. Accordingly, the Company has not recorded any liabilities for these agreements as of October 31, 2003. The Company has not incurred material costs to defend lawsuits or settle claims related to these indemnification agreements.


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

The following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ substantially from those anticipated in these forward-looking statements as a result of many factors, including those set forth below under “Risk Factors That Could Affect Our Future Performance.” The following discussion should be read together with our financial statements and related notes thereto included elsewhere in this document.

Overview

We are a leading provider of fiber optic subsystems and network performance test and monitoring systems which enable high-speed data communications over local area networks, or LANs, storage area networks, or SANs, and metropolitan access networks, or MANs. We are focused on the application of digital fiber optics to provide a broad line of high-performance, reliable, value-added optical subsystems for data networking and storage equipment manufacturers. Our line of optical subsystems supports a wide range of network applications, transmission speeds, distances, physical mediums and configurations. We also provide network performance test and monitoring systems to original equipment manufacturers for testing and validating equipment designs and to operators of networking and storage data centers for testing, monitoring and troubleshooting the performance of their systems. We sell our products to leading storage and networking equipment manufacturers such as Brocade, Cisco, EMC, Emulex, Extreme Networks and Hewlett-Packard Company.

We were incorporated in 1987 and funded our initial product development efforts largely through revenues derived under research and development contracts. After shipping our first products in 1991, we continued to finance our operations principally through internal cash flow and periodic bank borrowings until November 1998. At that time we raised $5.6 million of net proceeds from the sale of equity securities and bank borrowings to fund the continued growth and development of our business. In November 1999, we received net proceeds of $151.0 million from the initial public offering of shares of our common stock, and in April 2000 we received $190.6 million from an additional public offering of shares of our common stock. In October 2001, we sold $125 million aggregate principal amount of 5 1/4% convertible subordinated notes due October 15, 2008. In October 2003, we sold $150 million aggregate principal amount of 2 1/2% convertible subordinated notes due October 15, 2010.

Since October 2000, we have acquired six privately-held companies and certain assets from two other companies in order to gain access to new technologies which can be used in conjunction with our existing core competencies to develop new and innovative products. During our fiscal year ended April 30, 2001, we acquired Sensors Unlimited, Inc., Demeter Technologies, Inc., Medusa Technologies, Inc., and Shomiti Systems, Inc. During our fiscal year ended April 30, 2002, we acquired Transwave Fiber, Inc. and certain assets, including equipment and intellectual property, of AIFOtec GmbH in Germany. In May 2002, we acquired certain assets, including equipment, inventory and intellectual property related to the passive optical components business of New Focus, Inc. In April 2003, we acquired Genoa Corporation.

In October 2002, we sold certain assets and transferred certain liabilities of Sensors Unlimited to a new company organized by a management group led by Dr. Greg Olsen, then an officer and director of Finisar and former majority owner of Sensors Unlimited. The intellectual property developed after the acquisition of Sensors Unlimited was transferred to other operations within Finisar. In November 2002, we discontinued a product line at Demeter Technologies that was not making a significant contribution to our operating results and was no longer considered a key part of our product strategy. Certain assets of Demeter Technologies were sold to another party in conjunction with the product line discontinuation. In April 2003 we acquired Genoa Corporation and announced the closure of our Demeter Technologies subsidiary and the consolidation of all active device development and wafer fabrication into the Genoa facility. This consolidation was completed in July 2003. In June 2003, we announced the planned closure of our operations in Munich, Germany and transferred certain assets, intellectual property and employees to our headquarters in Sunnyvale, California during the quarter ending October 31, 2003.

The principal strategic goal of most of our acquisitions to date related to our optics business has been to gain access to leading-edge technology for the manufacture of optical components in order to improve the performance and reduce the cost of our optical subsystem products. We have also sold a limited amount of these optical components on a stand-alone basis to other manufacturers; however, to date, the sale of these components into this so-called “merchant market” has not been a strategic priority, and our revenues from the sale of optical subsystems and components has consisted predominantly of subsystems sales. We intend to evaluate opportunities to increase the sale of our components in the merchant market, although we do not expect such sales to represent a significant portion of our revenues for the foreseeable future.

To date, our revenues have been principally derived from sales of our optical subsystems and network performance test and monitoring systems to networking and storage systems manufacturers. A large proportion of our sales are concentrated with a relatively small number of customers. Although we are attempting to expand our customer base, we expect that significant customer concentration will continue for the foreseeable future.

We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed or determinable and collectability is reasonably assured.

We sell our products through our direct sales force, with the support of our manufacturers’ representatives, directly to domestic customers and indirectly through distribution channels to international customers. The evaluation and qualification cycle prior to the initial sale for our optical subsystems may span a year or more, while the sales cycle for our network test and monitoring systems is usually considerably shorter.

The market for optical subsystems and components is characterized by declining average selling prices resulting from factors such as industry over-capacity, increased competition, the introduction of new products and the growth in unit volumes as manufacturers continue to deploy network and storage systems. We anticipate that our average selling prices will continue to decrease in future periods, although the timing and amount of these decreases cannot be predicted with any certainty.

Our cost of revenues consists of materials, salaries and related expenses for manufacturing personnel, manufacturing overhead, warranty expense, inventory adjustments for obsolete and excess inventory and the amortization of acquired developed technology associated with acquisitions that we have made. Historically, we have outsourced the majority of our assembly operations. However, in fiscal 2002, we commenced manufacture of our optical subsystem products at our subsidiary in Ipoh, Malaysia. We conduct manufacturing, engineering, supply chain management, quality assurance and documentation control at our facilities in Sunnyvale and Fremont, California and at our subsidiaries’ facilities in Shanghai, China and Ipoh, Malaysia. With the transition of most of our production to Malaysia and the added manufacturing infrastructure associated with several acquisitions completed during the past three years, our cost structure has become more fixed, making it more difficult to reduce costs during periods when demand for our products is weak, product mix is unfavorable or selling prices are generally lower. While we undertook measures to reduce our operating costs during fiscal 2003 and the first half of fiscal 2004, there can be no assurance that we will be able to reduce our cost of revenues enough to achieve profitability , particularly during periods of weak demand or when average selling prices are low.

Our gross profit margins vary among our product families, and are generally higher on our network test and monitoring systems than on our optical subsystems and components. Our gross margins are generally lower for newly introduced products and improve as unit volumes increase. Our overall gross margins have fluctuated from period to period as a result of shifts in product mix, the introduction of new products, decreases in average selling prices and our ability to reduce product costs.

Research and development expenses consist primarily of salaries and related expenses for design engineers and other technical personnel, the cost of developing prototypes and fees paid to consultants. We charge all research and development expenses to operations as incurred. We believe that continued investment in research and development is critical to our long-term success.

Sales and marketing expenses consist primarily of commissions paid to manufacturers’ representatives, salaries and related expenses for personnel engaged in sales, marketing and field support activities and other costs associated with the promotion of our products.

General and administrative expenses consist primarily of salaries and related expenses for administrative, finance and human resources personnel, professional fees, and other corporate expenses.

In connection with the grant of stock options to employees between August 1, 1998 and October 15, 1999, we recorded deferred stock compensation representing the difference between the fair value of our common stock for accounting purposes and the exercise price of these options at the date of grant. In connection with the assumption of stock options previously granted to employees of companies we acquired, we recorded deferred compensation representing the difference between the fair market value of our common stock on the date of closing of each acquisition and the exercise price of options granted by those companies which we assumed. Deferred stock compensation is presented as a reduction of stockholder’s equity, with accelerated amortization recorded over the vesting period, which is typically three to five years. The amount of deferred stock compensation expense to be recorded in future periods could decrease if options for which accrued but unvested compensation has been recorded are forfeited prior to vesting and could increase if we modify the terms of an option grant resulting in a new measurement date.

Acquired in-process research and development represents the amount of the purchase price in a business combination allocated to research and development projects underway at the acquired company that had not reached the technologically feasible stage as of the closing of the acquisition and for which we had no alternative future use.

A portion of the purchase price in a business combination is allocated to goodwill and intangibles. Goodwill and intangible assets with indefinite lives are not amortized, but are subject to annual impairment testing. Other purchased intangible assets are amortized over their estimated useful lives.

Impairment charges consist of write-downs to the carrying value of intangible assets and goodwill arising from various business combinations to their implied fair value.

Restructuring costs generally include termination costs for employees associated with a formal restructuring plan and the cost of facilities or other unusable assets abandoned or sold.

Other acquisition costs primarily consist of incentive payments for employee retention included in certain of the purchase agreements of companies we acquired and costs incurred in connection with transactions that were not completed.

Other income and expenses generally consist of bank fees, gains or losses as a result of the periodic sale of assets and other-than-temporary decline in the value of investments.

Results of Operations

The following table sets forth certain statement of operations data as a percentage of revenues for the periods indicated:


		Three Months Ended						Six Months Ended
		October 31,						October 31,

		2003			2002			2003			2002

Revenues:
	Optical subsystems and components		85.2	%		78.8	%		85.9	%		81.3	%
	Network test and monitoring subsystems		14.8			21.2			14.1			18.7

Total revenues			100.0			100.0			100.0			100.0
Cost of revenues			74.9			79.8			83.4			79.1
Amortization of acquired developed technology			10.9			13.3			11.3			14.6

Gross profit			14.2			6.9			5.3			6.3
Operating expenses:
	Research and development		32.0			39.1			42.1			35.9
	Sales and marketing		10.7			13.6			10.8			13.3
	General and administrative		10.2			10.6			10.1			9.3
	Amortization of deferred stock compensation		(0.1	)		(4.7	)		(0.4	)		(0.6	)
	Amortization of purchased intangibles		0.3			0.3			0.3			0.5
	Impairment of goodwill and intangible assets		—			—			—			0.6
	Restructuring costs		0.4			2.9			2.9			1.3
	Other acquisition costs		0.3			(0.4	)		0.2			—

Total operating expenses			53.8			61.4			66.0			60.3

Loss from operations			(39.6	)		(54.5	)		(60.7	)		(54.0	)
Interest income			1.5			3.0			1.8			3.0
Interest expense			(36.6	)		(6.9	)		(26.8	)		(6.3	)
Other expense, net			(1.3	)		(96.1	)		(3.8	)		(56.5	)

Loss before income taxes and cumulative effect of an accounting change			(76.0	)		(154.5	)		(89.5	)		(113.8	)
Provision for income taxes			0.1			0.1			0.3			0.1

Loss before cumulative effect of an accounting change			(76.1	)		(154.6	)		(89.8	)		(113.9	)
Cumulative effect of an accounting change to adopt SFAS 142			—			—			—			(523.7	)

Net loss			(76.1	)%		(154.6	)%		(89.8	)%		(637.6	)%

Revenues.Revenues increased 4.6% from $40.9 million in the quarter ended October 31, 2002 to $42.8 million in the quarter ended October 31, 2003. This increase reflects a 13.1% increase in sales of optical subsystems and components, from $32.2 million in the quarter ended October 31, 2002 to $36.4 million in the quarter ended October 31, 2003, partially offset by a 27.0% decrease in sales of network test and monitoring systems, from $8.7 million in the quarter ended October 31, 2002 to $6.3 million in the quarter ended October 31, 2003. We believe that the reduction in sales of network test and monitoring systems was related primarily to a reduction in overall industry demand for such equipment.

Sales of optical subsystems and components as a percentage of revenue increased from 78.8% in the quarter ended October 31, 2002 to 85.2% in the quarter ended October 31, 2003. Sales of network test and monitoring systems as a percentage of revenue decreased from 21.2% in the quarter ended October 31, 2002 to 14.8% in the quarter ended October 31, 2003.

One optical subsystems and components customer accounted for 22.8% of total revenue in the quarter ended October 31, 2003 while two customers accounted for 11.1% and 10.9% of total revenue in the quarter ended October 31, 2002. No other customer accounted for more than 10% of total revenue in either period.

On a year-to-date basis, revenues decreased 6.5% from $88.0 million in the six months ended October 31, 2002 to $82.2 million in the six months ended October 31, 2003. This decrease reflects a 1.2% decrease in sales of optical components and subsystems from $71.5 million in the six months ended October 31, 2002, to $70.6 million in the six months ended October 31, 2003 and a 29.6% decrease in sales of network test and monitoring systems from $16.5 million in the six months ended October 31, 2002, to $11.6 million in the six months ended October 31, 2003. We believe that the reduction in sales of network test and monitoring systems was related primarily to a reduction in overall industry demand for such equipment.

Sales of optical components and subsystems as a percentage of revenue increased from 81.3% in the six months ended October 31, 2002 to 85.9% in the six months ended October 31, 2003. Sales of network test and monitoring systems as a percentage of revenue decreased from 18.7% in the six months ended October 31, 2002 to 14.1% in the six months ended October 31, 2003.

One customer accounted for 19.8% of total revenue in the six months ended October 31, 2003, and one customer accounted for 10.1% in the six months ended October 31, 2002. No other customers accounted for more than 10% of total revenue in either period.

Gross Profit.Gross profit increased from $2.8 million in the quarter ended October 31, 2002 to $6.1 million in the quarter ended October 31, 2003. As a percentage of revenues, gross profit increased from 6.9% in the quarter ended October 31, 2002, to 14.2% in the quarter ended October 31, 2003. Of the $3.3 million increase in gross profit, $1.7 million was due to a final settlement of vendor materials liability. Gross profit also benefited from a $900,000 decrease in reserves for slow-moving, obsolete and unusable inventory and a $700,000 decrease in the amortization of acquired developed technology during the quarter.

The reserve for slow-moving, obsolete and unusable inventory, primarily related to optical subsystems and components, decreased $900,000 from $2.1 million in the quarter ended October 31, 2002 to $1.2 million in the quarter ended October 31, 2003. This $1.2 million charge in the current quarter consists of a $5.1 million charge for potential slow-moving, obsolete and unusable inventory, partially offset by the use during the quarter of $3.9 million of inventory reserved in prior periods. The $2.1 million charge in the quarter ended October 31, 2002 consists of an $8.1 million charge for potential slow-moving and obsolete inventory, partially offset by the use during the quarter of $6.0 million of inventory reserved in prior periods. These charges for excess inventory were calculated based on inventory levels in excess of estimated 12-month demand for each specific product. It is possible that additional amounts of the excess inventory subject to these provisions may be used in future periods based on customer demand and product mix changes which were not anticipated at the time the estimates were made and the charges recognized.

Amortization of acquired developed technology is associated with several acquisitions completed during fiscal 2001 through 2003. The charge for acquired developed technology decreased from $5.4 million in the quarter ended October 31, 2002 to $4.7 million in the quarter ended October 31, 2003 due to earlier write-offs of acquired developed technology associated with the sale of our Sensors Unlimited subsidiary and with the sale of part of our Demeter Technologies subsidiary’s product line.

On a year-to-date basis, gross profit decreased from $5.5 million in the six months ended October 31, 2002 to $4.4 million in the six months ended October 31, 2003. As a percentage of revenues, gross profit decreased from 6.3% in the six months ended October 31, 2002 to a gross profit of 5.3% in the six months ended October 31, 2003. Gross margins were adversely effected in both periods by charges for slow-moving and obsolete inventory and charges for rework material. We recorded a charge of $5.1 million in the six months ended October 31, 2002, compared to a charge of $8.7 million in the six months ended October 31, 2003. Amortization of acquired developed technology decreased from $12.8 million in the six months ended October 31, 2002 to $9.3 million in the six months ended

October 31, 2003, primarily related to the sale of assets of Sensors Unlimited in the most recent quarter. The remaining decrease in gross profit, totaling $700,000 for the period, was related to lower average selling prices and product mix issues.

We expect gross margins to continue to improve over the balance of fiscal 2004 as a result of anticipated increases in revenue and decreases in inventory and rework charges. However, the continuing effect of competitive pricing pressures is likely to limit the magnitude of any such improvement.

Research and Development Expenses.Research and development expenses decreased $2.3 million, or 14.4%, from $16.0 million in the quarter ended October 31, 2002 to $13.7 million in the quarter ended October 31, 2003. This decrease was due primarily to reductions in salary and fringe expenses of $2.4 million related to reductions in our U.S.-based engineering personnel primarily in Sunnyvale, California, the closure of our operations at Sensors and Demeter in the U.S. and our operations in Munich, Germany. Research and development expenses decreased as a percentage of revenue to 32.0% in the quarter ended October 31, 2003 compared to 39.1% in the quarter ended October 31, 2002.

On a year-to-date basis, research and development expenses increased $3.1 million, or 10%, from $31.5 million in the six months ended October 31, 2002, to $34.6 million in the six months ended October 31, 2003. This increase reflects $6.0 million of accelerated depreciation on equipment that was abandoned as a result of the closure during the first quarter of fiscal 2004 of the facilities occupied by our Demeter Technologies subsidiary, partially offset by the reduction in salary and fringe expenses noted above.

Sales and Marketing Expenses.Sales and marketing expenses decreased $1.0 million, or 18.2%, from $5.6 million in the quarter ended October 31, 2002 to $4.6 million in the quarter ended October 31, 2003. This decrease was primarily due to a reduction of $436,000 in selling expenses reflecting lower advertising and trade show expenses as well as a $298,000 reduction of salary and fringe benefit expenses associated with lower manpower levels. As a result of these lower expense levels, sales and marketing expenses as a percentage of revenue decreased from 13.6% in the quarter ended October 31, 2002 to 10.7% in the quarter ended October 31, 2003.

On a year-to-date basis, sales and marketing expenses decreased $2.9 million, or 24.5%, from $11.7 million in the six months ended October 31, 2002 to $8.9 million in the six months ended October 31, 2003. This decrease was primarily due to a reduction of $1.0 million in selling expenses reflecting lower advertising and trade show expenses as well as a $1.1 million reduction of salary and fringe benefit expenses associated with lower manpower levels. Sales and marketing expenses as a percentage of revenue decreased from 13.3% in the six months ended October 31, 2002 to 10.8% in the six months ended October 31, 2003.

General and Administrative Expenses.General and administrative expenses increased $23,000, or 0.5%, from $4.3 million in the quarter ended October 31, 2002 to $4.4 million in the quarter ended October 31, 2003. This increase was primarily related to a non-cash expense of $756,000 related to non-employee options issued during the second quarter of fiscal 2004, partially offset by lower salary and fringe benefit expenses associated with lower headcount and lower depreciation. General and administrative expenses decreased as a percentage of revenue from 10.6% in the quarter ended October 31, 2002 to 10.2% in the quarter ended October 31, 2003.

On a year-to-date basis, general and administrative expenses increased $126,000, or 1.5%, from $8.2 million in the six months ended October 31, 2002 to $8.3 million in the six months ended October 31, 2003, primarily due to the reasons noted above. General and administrative expenses increased as a percentage of revenue from 9.3% in the six months ended October 31, 2002 to 10.1% in the six months ended October 31, 2003.

Amortization of Deferred Stock Compensation.Amortization of deferred stock compensation decreased from a benefit of $1.9 million in the quarter ended October 31, 2002 to a benefit of $49,000 in the quarter ended October 31, 2003. This decrease was related to the timing of the termination of employees with deferred compensation associated with their stock options and the effects of the graded vested method of amortization which accelerates the amortization of deferred compensation.

For the year-to-date period, amortization of deferred stock compensation decreased from a benefit of $552,000 in the six months ended October 31, 2002 to a benefit of $353,000 in the six months ended October 31, 2003 as a result of such employee terminations.

Amortization of Purchased Intangibles.Intangible assets related to trade name are associated with several acquisitions completed during fiscal 2001 through 2003. We amortized acquired purchased intangibles associated with trade name in the amount of $143,000 in the quarter ended October 31, 2003 which is consistent with the $143,000 amortized in the quarter ended October 31, 2002. For the year-to-date period, amortized acquired purchased intangibles decreased from a $472,000 in the six months ended October 31, 2002 to $286,000 in the six months ended October 31, 2003. The fiscal year 2003 period included $186,000 related to the Sensors Unlimited tradename, which was sold in the second quarter of fiscal 2003.

Impairment of Goodwill and Intangible Assets.On May 3, 2002, we recorded additional goodwill in the optical subsystems and

components reporting unit of $485,000 as a result of the achievement of certain milestones specified in the Transwave acquisition agreement. In the quarter ended July 31, 2002, we recorded an impairment loss of $485,000 related to this additional consideration. There were no similar impairments in the quarter or six month period ended October 31, 2003.

Restructuring Costs.During the quarter ended October 31, 2003, we incurred total restructuring costs of $187,000. During the quarter we completed the process of closing our facility in Munich Germany, in order to reduce future operating costs resulting in a charge of $273,000. This restructuring charge included $373,000 for legal and exit fees associated with the closure, additional severance related payments and write-off of abandoned assets, partially offset by lower than anticipated fees associated with the termination of the German facilities lease of $100,000. The expenses related to the closure of the German facility were partially offset by an $86,000 reduction in restructuring expenses associated with the closure of the Demeter subsidiary offset by additional severance related expenses.

During the quarter ended October 31, 2002, we announced a number of decisions designed to lower operating costs including (1) the sale of certain assets of Sensors Unlimited, (2) the elimination of 165 positions, or 25% of our U.S. workforce, 45 of which associated with the operations of Sensors Unlimited, (3) the implementation of a 10% reduction in salaries for most U.S.-based personnel beginning in January, 2003, and (4) a 10% reduction in commissions paid to manufacturing representatives for our network test and monitoring systems as well as optical subsystems. As a result of these decisions, we incurred total restructuring expenses during the quarter of $1.2 million.

On a year-to-date basis for fiscal year 2004, restructuring costs of $2.4 million included the second quarter expenses described above as well costs incurred in the first quarter related to the completion of consolidating our facilities and operations located at our Demeter subsidiary in El Monte, California into our facilities in Fremont, California, and additional restructuring expenses related to the closing of our facility in Munich, Germany. As a result of these restructuring activities, a charge of $2.2 million was incurred in the first fiscal quarter. This restructuring charge included $800,000 of severance, approximately $600,000 of fees associated with the early termination of our facilities lease in Germany, approximately $450,000 for remaining payments for excess leased equipment and approximately $300,000 of miscellaneous costs incurred to effect the closures.

On a year-to-date basis for fiscal year 2003, restructuring costs were $1.2 million, due to the expenses incurred in the second quarter.

Other Acquisition Costs.Other acquisition costs increased from a credit of $166,000 in the quarter ended October 31, 2002 to a charge of $149,000 in the quarter ended October 31, 2003. The credit in the prior year period was related to the reversal of a previous accrual associated with meeting milestone payments under the terms of the acquisition of Sensors Unlimited, the assets of which were sold during the quarter. The charge in the current period is primarily a result of the write off of capitalized legal fees associated with the acquisition of our German facility.

On a year-to-date basis, other acquisition costs increased from $31,000 in the six months ended October 31, 2002 to $194,000 in the six months ended October 31, 2003. This increase reflects the credit related to the prior year period and the write off of capitalized legal fees associated with the German facility in the current period as described above.

Interest Income.Interest income decreased from $1.2 million in the quarter ended October 31, 2002 to $656,000 in the quarter ended October 31, 2003. This decrease reflects lower cash, cash equivalents and short-term investments on hand during most of the quarter as well as lower interest rates. On a year-to-date basis, interest income decreased from $2.6 million in the six months ended October 31, 2002 to $1.5 million in the six months ended October 31, 2003 for the same reasons.

Interest Expense.Interest expense increased $12.9 million from $2.8 million in the quarter ended October 31, 2002 to $15.7 million in the quarter ended October 31, 2003. The increase is due to a non-cash charge of $5.7 million associated with the amortization of discount on our convertible notes and an additional $8.4 million associated with the exchange of $17.8 million in principal amount of our convertible notes for common stock in privately negotiated transactions concluded during the quarter. The prior year period included $1.2 million associated with the amortization of discount on our convertible notes.

On a year-to-date basis, interest expense increased $16.5 million from $5.6 million in the six months ended October 31, 2002 to $22.1 million in the six months ended October 31, 2003. During the current period we incurred a non-cash charge of $8.1 million associated with the amortization of discount on our convertible notes and an additional $10.8 million associated with the exchange of $22.8 million in principal amount of our convertible notes for common stock in privately negotiated transactions concluded during the six month period. Interest expense in the prior year period included $2.3 million associated with the amortization of discount on our convertible

notes.

Other Expense, net.Other expense, net of other income, decreased $38.7 million from $39.3 million in the quarter ended October 31, 2002 to $555,000 in the quarter ended October 31, 2003. In the second quarter of fiscal 2004, using the equity method, we incurred a charge of $269,000 for our pro-rata share of the loss of another company in which we hold a minority equity investment, as well as other miscellaneous charges. In the second quarter of fiscal 2003, we incurred a loss on the sale of certain assets of Sensors Unlimited totaling $36.8 million and an impairment charge of $2.0 million associated with a minority investment in a development stage company. Additionally, using the equity method, we incurred a charge of $134,000 for our pro-rata share of the loss of another company in which we hold a minority equity investment.

On a year-to-date basis, other expense, net of other income, decreased $46.6 million from $49.7 million in the six months ended October 31, 2002 to $3.1 million in the six months ended October 31, 2003. The decrease is primarily due to the reasons described above as well as an impairment charge during the first quarter of fiscal 2003 of $10.0 million for our minority equity investment in a development stage company due to that company’s inability to raise sufficient additional funding which necessitated its restructuring. During the first quarter of fiscal 2004, we recorded an impairment charge of $1.6 million for our minority equity investments in two development stage companies due primarily to recent funding efforts which suggested that the value of our investment has been impaired.

Provision for Income Taxes.The provision for income taxes remained relatively consistent increasing minimally from $30,000 in the quarter ended October 31, 2002, to $33,000 in the quarter ended October 31, 2003, primarily related to minimum state taxes.

On a year to date basis the provision for income taxes increased from $91,000 in the six months ended October 31, 2002 to $246,000 in the six months ended October 31, 2003, primarily related to minimum state taxes.

We have established a valuation allowance for a portion of the gross deferred tax assets. In part, the valuation allowance at October 31, 2003 reduced net deferred tax assets by amounts related to stock option deductions that are not currently realizable. A portion of the valuation allowance will be credited to paid-in capital when realized. The remaining valuation allowance, when realized, will first reduce unamortized goodwill, then other non-current intangible assets of acquired subsidiaries and then income tax expense. There can be no assurance that deferred tax assets subject to the valuation allowance will be realized.

Realization of the deferred tax assets is dependent upon future taxable income, if any, the amount and timing of which are uncertain. Accordingly, the net deferred tax assets have been fully offset by a valuation allowance. Because our deferred tax assets equal deferred tax liabilities as of October 31, 2003, we do not expect to record any additional tax benefit against future operating losses.

Cumulative Effect of an Accounting Changes.We adopted SFAS 142 effective May 1, 2002. Under SFAS 142, goodwill and intangible assets deemed to have indefinite lives are no longer amortized but will be subject to annual impairment tests. In adopting this new standard, we recorded a charge of $460.6 million in the quarter ended July 31, 2002.

Effect of New Accounting Standards

In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51 (“FIN 46”). FIN 46 requires certain variable interest entities to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46 is effective for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provision of FIN 46 must be applied for the first interim or annual period ending after December 15, 2003. The Company has not created or acquired any variable interest entities subsequent to January 31, 2003, and does not believe the adoption of FIN 46 will effect its operating results and financial condition. The Company is however currently evaluating the potential effect the adoption of FIN 46 may have on its operating results and financial condition with respect to potential variable interest entities created or acquired prior to January 31, 2003.

Liquidity and Capital Resources

From inception through November 1998, we financed our operations primarily through internal cash flow and periodic bank borrowings. In November 1998, we raised $5.6 million of net proceeds from the sale of preferred stock and bank borrowings to fund the continued growth and development of our business. In November 1999, we received net proceeds of $151.0 million from the initial public offering of our common stock, and in April 2000 we received $190.6 million from an additional public offering. In October 2001, we sold $125 million aggregate principal amount of 5 1/4% convertible subordinated notes due October 15, 2008. Interest on the notes is 5 1/4% per year, payable semiannually on April 15 and October 15, beginning on April 15, 2002. The notes are convertible, at the option of the holder, at any time on or prior to maturity into shares of our common stock at a conversion price of $5.52 per share, which is equal to a conversion rate of approximately 181.159 shares per $1,000 principal amount of notes. The conversion price is subject to adjustment. Because the market value of the stock rose above the conversion price between the day the notes were priced and the day the proceeds were collected, we recorded a discount of $38,270,000 related to the intrinsic value of the beneficial conversion feature. This amount will be amortized to interest expense over the life of the convertible notes, or sooner upon conversion. We purchased and pledged to a collateral agent, as security for the exclusive benefit of the holders of the notes, approximately $18.9 million of U.S. government securities, which will be sufficient upon receipt of scheduled principal and interest payments thereon, to provide for the payment in full of the first six scheduled interest payments due on the notes. The notes are subordinated to all of our existing and future senior indebtedness and effectively subordinated to all existing and future indebtedness and other liabilities of our subsidiaries. In privately negotiated transactions concluded during the six months ended October 31, 2003, we exchanged and repurchased $24.8 million in principal amount of our convertible notes due 2008 for 9,926,339 shares of our common stock and cash in the amount of $1.9 million. On October 15, 2003, we sold $150 million aggregate principal amount of 2 1/2 % convertible subordinated notes due October 15, 2010. Interest on the Notes is 2 1/2 % per year, payable semiannually on April 15 and October 15, beginning on April 15, 2004. The notes are convertible, at the option of the holder, at any time on or prior to maturity into shares of our common stock at a conversion price of $3.705 per share, which is equal to a conversion rate of approximately 269.9055 shares per $1,000 principal amount of notes. The conversion price is subject to adjustment.

As of October 31, 2003, our principal sources of liquidity were $236.8 million in cash, cash equivalents and short-term investments, net of $6.4 million of short-term securities reserved for the next two interest payments due under our convertible subordinated notes due 2008 and net of $14.4 million of short-term and long-term securities reserved for the next eight payments due under our convertible subordinated notes due 2010.

Net cash used in operating activities totaled $16.3 million in the six months ended October 31, 2003, reflecting the operating loss of $73.8 million, partially offset by $50.5 million of non-cash charges and a reduction in other assets and liabilities of $7.0 million. Included in non-cash charges was $18.2 million in depreciation and amortization of which $6.0 million was related to accelerated depreciation for equipment to be abandoned in connection with the closure of our Demeter Technologies subsidiary, $9.3 million of amortization of acquired developed technology, a $1.6 million impairment charge for our minority equity investments in two development stage companies and $8.1 million for amortization of the beneficial conversion feature of our outstanding convertible notes, of which $5.8 million was related to the exchange of $24.8 million principal amount of convertible notes for common shares of stock during the quarter. Net cash used in operating activities totaled $26.3 million in the six months ended October 31, 2002, primarily reflecting a pay down of accounts payable and a loss from operations.

Net cash provided by investing activities totaled $6.6 million in the six months ended October 31, 2003, and consisted primarily of sales of short-term investments and loan repayments from a company in which we have a minority investment, offset by purchases of property and equipment net of retirements. Net cash used in investing activities totaled $8.0 million in the six month period ended October 31, 2002, and consisted primarily of the purchases of property and equipment totaling $12.8 million, offset by proceeds from the sale of Sensors Unlimited assets.

Net cash provided by financing activities totaled $132.4 million in the six months ended October 31, 2003, and consisted primarily of $130.9 million of proceeds from issuance of our subordinated convertible notes due 2010, $3.0 million of proceeds from the exercise of employee stock options, net of repurchase of unvested shares, and $279,000 of proceeds from the purchase of stock through the employee stock purchase plan, offset by the extinguishment of $1.9 million of debt due under our subordinated convertible notes due 2008. Net cash provided by financing activities totaled $1.7 million in the six month period ended October 31, 2002, and consisted primarily of proceeds from the exercise of stock options and the purchase of stock under our stock purchase plan, net of repurchase of unvested shares.

We believe that our existing balances of cash, cash equivalents and short-term investments and cash flow expected to be generated from our future operations, will be sufficient to meet our cash needs for working capital and capital expenditures for at least the next 12 months. We may, however, require additional financing to fund our operations in the future. The significant contraction in the capital markets, particularly in the technology sector, may make it difficult for us to raise additional capital if and when it is required,

especially if we experience disappointing operating results. If adequate capital is not available to us as required, or is not available on favorable terms, our business, financial condition and results of operation will be adversely affected.

Contractual Obligations and Commercial Commitments

Future minimum payments under long-term debt and operating leases are as follows as of October 31, 2003 (in thousands):


			Payments Due by Period

			Less Than		1 - 3		4 - 5		After 5
Contractual Obligations	Total		1 Year		Years		Years		Years

Long-term debt	$	250,250	$	—	$	—	$	100,250	$	150,000
Operating leases		8,862		3,220		5,290		352		—

Total contractual cash obligations	$	259,112	$	3,220	$	5,290	$	100,602	$	150,000

Long-term debt consists of $150 million in convertible notes due October 15, 2010 and $100 million in convertible notes due October 15, 2008.

Operating leases consist of base rents for facilities we occupy at various locations and photocopying equipment. Included in operating leases is $1.4 million of accrued lease cost obligations that are recorded on our balance sheet.

The following table summarizes our commercial commitments as of October 31, 2003 (in thousands):


	Amount of Commitment Expiration per Period

	Total		Less
	Amount		Than		1 - 3		4 - 5		After 5
Commercial Commitments	Committed		1 Year		Years		Years		Years

Non-cancelable purchase obligation	$	1,774	$	1,774	$	—	$	—	$	—
Standby repurchase obligations		7,549		7,549		—		—		—

Total commercial commitments	$	9,323	$	9,323	$	—	$	—	$	—

Non-cancelable purchase obligation consists of an obligation to purchase equipment from one manufacturer. Standby repurchase obligations consist of materials purchased and held by subcontractors on our behalf to fulfill the subcontractor’s purchase order obligations at their facilities. Total commercial commitments of $9.3 million has been expensed and recorded on the balance sheet as non-cancelable purchase obligations.

At October 31, 2003 and April 30, 2003, we did not have off-balance sheet arrangements or relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which are typically established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Risk Factors That Could Affect Our Future Performance

OUR FUTURE PERFORMANCE IS SUBJECT TO A VARIETY OF RISKS. IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCUR, OUR BUSINESS COULD BE HARMED AND THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE. YOU SHOULD ALSO REFER TO THE OTHER INFORMATION CONTAINED IN THIS REPORT, INCLUDING OUR CONSOLIDATED FINANCIAL STATEMENTS AND THE RELATED NOTES.

We have incurred significant net losses, our future revenues are inherently unpredictable, our operating results are likely to fluctuate from period to period, and if we fail to meet the expectations of securities analysts or investors, our stock price could decline significantly

We incurred net losses of $85.4 million, $218.7 million and $619.8 million in our fiscal years ended April 30, 2001, 2002 and 2003, respectively, and $73.8 million in the six months ended October 31, 2003. Our operating results for future periods are subject to numerous uncertainties, and we cannot assure you that we will be able to achieve and maintain profitability.

Our quarterly and annual operating results have fluctuated substantially in the past and are likely to fluctuate significantly in the future due to a variety of factors, some of which are outside of our control. Accordingly, we believe that period-to-period comparisons of our results of operations are not meaningful and should not be relied upon as indications of future performance. Some of the factors that could cause our quarterly or annual operating results to fluctuate include market acceptance of our products and the Gigabit

Ethernet and Fibre Channel standards, market demand for the products manufactured by our customers, the introduction of new products and manufacturing processes, manufacturing yields, competitive pressures and customer retention.

We may experience a delay in generating or recognizing revenues for a number of reasons. Orders at the beginning of each quarter typically represent a small percentage of expected revenues for that quarter and are generally cancelable at any time. Accordingly, we depend on obtaining orders during each quarter for shipment in that quarter to achieve our revenue objectives. Failure to ship these products by the end of a quarter may adversely affect our operating results. Furthermore, our customer agreements typically provide that the customer may delay scheduled delivery dates and cancel orders within specified time frames without significant penalty. Because we base our operating expenses on anticipated revenue trends and a high percentage of our expenses are fixed in the short term, any delay in generating or recognizing forecasted revenues could significantly harm our business. It is likely that in some future quarters our operating results will again decrease from the previous quarter or fall below the expectations of securities analysts and investors. In this event, the value of the notes and the trading price of our common stock would significantly decline.

We may have insufficient cash flow to meet our debt service obligations, including payments due on the notes

We will be required to generate cash sufficient to pay our indebtedness and other liabilities, including all amounts due on our outstanding 2 1/2% and 5 1/4% convertible subordinated notes due 2010 and 2008, respectively, and to conduct our business operations. We may not be able to cover our anticipated debt service obligations from our cash flow. This may materially hinder our ability to make payments on the notes. Our ability to meet our future debt service obligations will depend upon our future performance, which will be subject to financial, business and other factors affecting our operations, many of which are beyond our control. Accordingly, we cannot assure you that we will be able to make required principal and interest payments on the notes when due.

We may not be able to obtain additional capital in the future, and failure to do so may harm our business

We believe that our existing balances of cash, cash equivalents and short-term investments will be sufficient to meet our cash needs for working capital and capital expenditures for at least the next 12 months. We may however require additional financing to fund our operations in the future or to repay the principal of our outstanding 2 1/2% and 5 1/4% convertible subordinated notes due 2010 and 2008, respectively. The significant contraction in the capital markets, particularly in the technology sector, may make it difficult for us to raise additional capital if and when it is required, especially if we continue to experience disappointing operating results. If adequate capital is not available to us as required, or is not available on favorable terms, we could be required to significantly reduce or restructure our business operations.

Failure to accurately forecast our revenues could result in additional charges for obsolete or excess inventories or non-cancelable purchase commitments

We base many of our operating decisions, and enter into purchase commitments, on the basis of anticipated revenue trends which are highly unpredictable. Some of our purchase commitments are not cancelable, and in some cases we are required to recognize a charge representing the amount of material or capital equipment purchased or ordered which exceeds our actual requirements. In the past, we have sometimes experienced significant growth followed by a significant decrease in customer demand such as occurred between July 31, 2000 and July 31, 2001, when quarterly revenues increased from $27.2 million to a high of $64.8 million followed by a decrease to $34.2 million. Based on projected revenue trends during these periods, we acquired inventories and entered into purchase commitments in order to meet anticipated increases in demand for our products which did not materialize. As a result, we recorded significant charges for obsolete and excess inventories and non-cancelable purchase commitments which contributed to substantial operating losses in fiscal 2001 and 2002. We recorded additional charges for obsolete and excess inventories during fiscal 2003 and the first two quarters of fiscal 2004, due to unanticipated changes in demand and the mix for our products. Should revenue in future quarters again fall substantially below our expectations, or should we fail again to accurately forecast changes in demand mix, we could be required to record additional charges for obsolete or excess inventories or non-cancelable purchase commitments.

Our operating costs may need to be further reduced which could impact our future growth

We experienced a significant decline in revenues and operating results during fiscal 2002. While revenues recovered to some extent in fiscal 2003 and the first half of fiscal 2004, they have not yet reached levels required to operate on a profitable basis due primarily to higher fixed costs related to a number of acquisitions, low gross margins and continued high levels of spending for research and development in anticipation of future revenue growth. While we continue to expect future revenue growth, we have taken steps to reduce our operating costs in order to conserve our cash, and we may be required to take further action to reduce costs. These

cost reduction measures may adversely affect our ability to market our products, introduce new and improved products and increase our revenues, which could adversely affect our business and cause the value of the notes and the price of our stock to decline. In order to be successful in the future, we must reduce our operating expenses and product costs, while at the same time completing our key product development programs and penetrating new customers.

We will face challenges to our business if our target markets adopt alternate standards to Fibre Channel and Gigabit Ethernet technology or if our products fail to comply with evolving industry standards and government regulations

We have based our product offerings principally on Fibre Channel and Gigabit Ethernet standards and, to a lesser extent, the SONET standard and our future success is substantially dependent on the continued market acceptance of these standards. If an alternative technology is adopted as an industry standard within our target markets, we would have to dedicate significant time and resources to redesign our products to meet this new industry standard. Our products comprise only a part of an entire networking system, and we depend on the companies that provide other components to support industry standards as they evolve. The failure of these companies, many of which are significantly larger than we are, to support these industry standards could negatively impact market acceptance of our products. Because we may develop some products prior to the adoption of industry standards, we may develop products that do not comply with the eventual industry standard. Our failure to develop products that comply with industry standards would limit our ability to sell our products. Moreover, if we introduce a product before an industry standard has become widely accepted, we may incur significant expenses and losses due to lack of customer demand, unusable purchased components for these products and the diversion of our engineers from future product development efforts. Finally, if new standards evolve, we may not be able to successfully design and manufacture new products in a timely fashion, if at all, that meet these new standards.

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

We are dependent on widespread market acceptance of two product families, and our revenues will decline if the market does not continue to accept either of these product families

We currently derive substantially all of our revenue from sales of our optical components and subsystems and network test and monitoring systems. We expect that revenue from these products will continue to account for substantially all of our revenue for the foreseeable future. Accordingly, widespread acceptance of these products is critical to our future success. If the market does not continue to accept either our optical components and subsystems or our network test and monitoring systems, our revenues will decline significantly. Factors that may affect the market acceptance of our products include the continued growth of the markets for LANs, SANs, and MANs and, in particular, Gigabit Ethernet and Fibre Channel-based technologies, as well as the performance, price and total cost of ownership of our products and the availability, functionality and price of competing products and technologies.

Many of these factors are beyond our control. In addition, in order to achieve widespread market acceptance, we must differentiate ourselves from the competition through product offerings and brand name recognition. We cannot assure you that we will be successful in making this differentiation or achieving widespread acceptance of our products. Failure of our existing or future products to maintain and achieve widespread levels of market acceptance will significantly impair our revenue growth.

We depend on large purchases from a few significant customers, and any loss, cancellation, reduction or delay in purchases by these customers could harm our business

A small number of customers have accounted for a significant portion of our revenues. Our success will depend on our continued ability to develop and manage relationships with significant customers. Although we are attempting to expand our customer base, we expect that significant customer concentration will continue for the foreseeable future.

The markets in which we sell our products are dominated by a relatively small number of systems manufacturers, thereby limiting the number of our potential customers. Our dependence on large orders from a relatively small number of customers makes our relationship with each customer critically important to our business. We cannot assure you that we will be able to retain our largest customers, that we will be able to attract additional customers or that our customers will be successful in selling their products that incorporate our products. We have in the past experienced delays and reductions in orders from some of our major customers. In addition, our customers have in the past sought price concessions from us, and we expect that they will continue to do so in the future. Cost reduction measures that we have implemented during the past several quarters, and additional action we may take to reduce costs,

may adversely affect our ability to introduce new and improved products which may, in turn, adversely affect our relationships with some of our key customers. Further, some of our customers may in the future shift their purchases of products from us to our competitors or to joint ventures between these customers and our competitors. The loss of one or more of our largest customers, any reduction or delay in sales to these customers, our inability to successfully develop relationships with additional customers or future price concessions that we may make could significantly harm our business.

Because we do not have long-term contracts with our customers, our customers may cease purchasing our products at any time if we fail to meet our customers’ needs

Typically, we do not have long-term contracts with our customers. As a result, our agreements with our customers do not provide any assurance of future sales. Accordingly:

•

our customers can stop purchasing our products at any time without penalty;

•

our customers are free to purchase products from our competitors; and

•

our customers are not required to make minimum purchases.

Sales are typically made pursuant to individual purchase orders, often with extremely short lead times. If we are unable to fulfill these orders in a timely manner, we will lose sales and customers.

Our market is subject to rapid technological change, and to compete effectively we must continually introduce new products that achieve market acceptance

The markets for our products are characterized by rapid technological change, frequent new product introductions, changes in customer requirements and evolving industry standards. We expect that new technologies will emerge as competition and the need for higher and more cost-effective bandwidth increases. Our future performance will depend on the successful development, introduction and market acceptance of new and enhanced products that address these changes as well as current and potential customer requirements. The introduction of new and enhanced products may cause our customers to defer or cancel orders for existing products. In addition, a slowdown in demand for existing products ahead of a new product introduction could result in a writedown in the value of inventory on hand related to existing products. We have in the past experienced a slowdown in demand for existing products and delays in new product development and such delays may occur in the future. To the extent customers defer or cancel orders for existing products due to a slowdown in demand or in the expectation of a new product release or if there is any delay in development or introduction of our new products or enhancements of our products, our operating results would suffer. We also may not be able to develop the underlying core technologies necessary to create new products and enhancements, or to license these technologies from third parties. Product development delays may result from numerous factors, including:

• expense reduction measures we have implemented, and others we may implement, to conserve our cash and accelerate our return to profitability;

• changing product specifications and customer requirements;

• difficulties in hiring and retaining necessary technical personnel;

• difficulties in reallocating engineering resources and overcoming resource limitations;

• changing market or competitive product requirements; and

• unanticipated engineering complexities.

The development of new, technologically advanced products is a complex and uncertain process requiring high levels of innovation and highly skilled engineering and development personnel, as well as the accurate anticipation of technological and market trends. We cannot assure you that we will be able to identify, develop, manufacture, market or support new or enhanced products successfully, if at all, or on a timely basis. Further, we cannot assure you that our new products will gain market acceptance or that we will be able to respond effectively to product announcements by competitors, technological changes or emerging industry standards. Any failure to respond to technological change would significantly harm our business.

Continued competition in our markets may lead to a reduction in our prices, revenues and market share

The markets for optical components and subsystems and network test and monitoring systems for use in LANs, SANs and MANs are highly competitive. Our current competitors include a number of domestic and international companies, many of which have substantially greater financial, technical, marketing and distribution resources and brand name recognition than we have. We expect that more companies, including some of our customers, will enter the market for optical subsystems and network test and monitoring systems. We may not be able to compete successfully against either current or future competitors. Increased competition could result in significant price erosion, reduced revenue, lower margins or loss of market share, any of which would significantly harm our business. For optical subsystems, we compete primarily with Agilent Technologies, Inc., E2O, Inc., Infineon Technologies AG, JDS Uniphase Corporation, Luminent, Inc., Molex, Premise Networks, Optical Communications Products, Inc., Picolight, Inc. and Stratos Lightwave, Inc. For network test and monitoring systems, we compete primarily with Ancot Corporation, I-Tech Corporation, Network Associates, Inc. and Xyratex International. Our competitors continue to introduce improved products with lower prices, and we will have to do the same to remain competitive. In addition, some of our current and potential customers may attempt to integrate their operations by producing their own optical components and subsystems and network test and monitoring systems or acquiring one of our competitors, thereby eliminating the need to purchase our products. Furthermore, larger companies in other related industries, such as the telecommunications industry, may develop or acquire technologies and apply their significant resources, including their distribution channels and brand name recognition, to capture significant market share.

Decreases in average selling prices of our products may reduce gross margins

The market for optical subsystems is characterized by declining average selling prices resulting from factors such as increased competition, overcapacity, the introduction of new products and increased unit volumes as manufacturers continue to deploy network and storage systems. We have in the past experienced, and in the future may experience, substantial period-to-period fluctuations in operating results due to declining average selling prices. We anticipate that average selling prices will decrease in the future in response to product introductions by competitors or us, or by other factors, including price pressures from significant customers. Therefore, we must continue to develop and introduce on a timely basis new products that incorporate features that can be sold at higher average selling prices. Failure to do so could cause our revenues and gross margins to decline, which would significantly harm our business.

We may be unable to reduce the cost of our products sufficiently to enable us to compete with others. Our cost reduction efforts may not allow us to keep pace with competitive pricing pressures and could adversely affect our margins. In order to remain competitive, we must continually reduce the cost of manufacturing our products through design and engineering changes. We may not be successful in redesigning our products or delivering our products to market in a timely manner. We cannot assure you that any redesign will result in sufficient cost reductions to allow us to reduce the price of our products to remain competitive or improve our gross margin.

Shifts in our product mix may result in declines in gross margins

Our gross profit margins vary among our product families, and are generally higher on our network test and monitoring systems than on our optical subsystems. Our gross margins are generally lower for newly introduced products and improve as unit volumes increase. Our overall gross margins have fluctuated from period to period as a result of shifts in product mix, the introduction of new products, decreases in average selling prices for older products and our ability to reduce product costs.

Past and future acquisitions could be difficult to integrate, disrupt our business, dilute stockholder value and harm our operating results

Since October 2000, we have completed the acquisition of six privately-held companies and certain assets from two other companies. We continue to review opportunities to acquire other businesses, products 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, and we from time to time make proposals and offers, and take other steps, to acquire businesses, products and technologies. Several of our past acquisitions have been material, and acquisitions that we may complete in the future may be material. In six of our eight acquisitions, we issued stock as all or a portion of the consideration, and we are obligated to release additional shares from escrow and to issue additional shares in connection with one of the acquisitions upon the occurrence of certain contingencies and the achievement of certain milestones. The issuance of stock in these and any future transactions has or would dilute stockholders’ percentage ownership.

Other risks associated with acquiring the operations of other companies include:

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problems assimilating the purchased operations, technologies or products;

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unanticipated costs associated with the acquisition;

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diversion of management’s attention from our core business;

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adverse effects on existing business relationships with suppliers and customers;

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

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potential loss of key employees of purchased organizations.

During fiscal 2003, we sold some of the assets acquired in two of our acquisitions, discontinued a product line and closed one of our acquired facilities. As a result of these activities, we incurred significant restructuring charges and charges for the write-down of assets associated with those acquisitions. We cannot assure you that we will be successful in overcoming future problems encountered in connection with our past or future acquisitions, and our inability to do so could significantly harm our business. In addition, to the extent that the economic benefits associated with any of our acquisitions diminish in the future, we may be required to record additional write downs of goodwill, intangible assets or other assets associated with such acquisitions, which would adversely affect our operating results.

Our customers often evaluate our products for long and variable periods, which causes the timing of our revenues and results of operations to be unpredictable

The period of time between our initial contact with a customer and the receipt of an actual purchase order may span a year or more. During this time, customers may perform, or require us to perform, extensive and lengthy evaluation and testing of our products before purchasing and using them in their equipment. Our customers do not typically share information on the duration or magnitude of these qualification procedures. The length of these qualification processes also may vary substantially by product and customer, and, thus, cause our results of operations to be unpredictable. While our potential customers are qualifying our products and before they place an order with us, we may incur substantial sales and marketing expenses and expend significant management effort. Even after incurring such costs we ultimately may not sell any products to such potential customers. In addition, these qualification processes often make it difficult to obtain new customers, as customers are reluctant to expend the resources necessary to qualify a new supplier if they have one or more existing qualified sources. Once our products have been qualified, the agreements that we enter into with our customers typically contain no minimum purchase commitments. Failure of our customers to incorporate our products into their systems would significantly harm our business.

We depend on facilities located outside of the United States to manufacture a substantial portion of our products, which subjects us to additional risks

In addition to our principal manufacturing facility in Malaysia, we operate a smaller facility in China and also rely on two contract manufacturers located outside of the United States. Each of these facilities and manufacturers subjects us to the following additional risks associated with international manufacturing:

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unexpected changes in regulatory requirements;

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legal uncertainties regarding liability, tariffs and other trade barriers;

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inadequate protection of intellectual property in some countries;

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greater incidence of shipping delays;

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greater difficulty in overseeing manufacturing operations;

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greater difficulty in hiring technical talent needed to oversee manufacturing operations;

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potential political and economic instability;

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currency fluctuations; and

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the outbreak of severe acute respiratory syndrome, or SARS, and other infectious diseases which could result in travel restrictions or the closure of our facilities or the facilities of our customers and suppliers.

Any of these factors could significantly impair our ability to source our contract manufacturing requirements internationally.

Our business and future operating results are subject to a wide range of uncertainties arising out of the continuing threat of terrorist attacks and military action in the Middle East

Like other U.S. companies, our business and operating results are subject to uncertainties arising out of the continuing threat of terrorist attacks on the United States and ongoing military action in the Middle East, including the potential worsening or extension of the current global economic slowdown, the economic consequences of the war in Iraq or additional terrorist activities and associated political instability, and the impact of heightened security concerns on domestic and international travel and commerce. In particular, due to these uncertainties we are subject to:

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increased risks related to the operations of our manufacturing facilities in Malaysia and China;

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greater risks of disruption in the operations of our Asian contract manufacturers and more frequent instances of shipping delays; and

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the risk that future tightening of immigration controls may adversely affect the residence status of non-U.S. engineers and other key technical employees in our U.S. facilities or our ability to hire new non-U.S. employees in such facilities.

We may lose sales if our suppliers fail to meet our needs

We currently purchase several key components used in the manufacture of our products from single or limited sources. We depend on these sources to meet our needs. Moreover, we depend on the quality of the products supplied to us over which we have limited control. We have encountered shortages and delays in obtaining components in the past and expect to encounter shortages and delays in the future. If we cannot supply products due to a lack of components, or are unable to redesign products with other components in a timely manner, our business will be significantly harmed. We generally have no long-term contracts for any of our components. As a result, a supplier can discontinue supplying components to us without penalty. If a supplier discontinued supplying a component, our business may be harmed by the resulting product manufacturing and delivery delays. We are also subject to potential delays in the development by our suppliers of key components which may affect our ability to introduce new products.

We use rolling forecasts based on anticipated product orders to determine our component requirements. Lead times for materials and components that we order vary significantly and depend on factors such as specific supplier requirements, contract terms and current market demand for particular components. If we overestimate our component requirements, we may have excess inventory, which would increase our costs. If we underestimate our component requirements, we may have inadequate inventory, which could interrupt our manufacturing and delay delivery of our products to our customers. Any of these occurrences would significantly harm our business.

We have made and may continue to make strategic investments which may not be successful and may result in the loss of all or part of our invested capital

Through fiscal 2003, we recorded minority equity investments in early-stage technology companies, totaling $43.5 million. We intend to review additional opportunities to make strategic equity investments in pre-public companies where we believe such investments will provide us with opportunities to gain access to important technologies or otherwise enhance important commercial relationships. We have little or no influence over the early-stage companies in which we have made or may make these strategic, minority equity investments. Each of these investments in pre-public companies involves a high degree of risk. We may not be successful in achieving the financial, technological or commercial advantage upon which any given investment is premised, and failure by the early-stage company to achieve its own business objectives or to raise capital needed on acceptable economic terms could result in a loss of all or part of our invested capital. During September 2003, the Company converted $5.0 million of the remaining $5.9 million of the loan to one company into additional equity in this company. The remainder was repaid in cash to the Company. In fiscal 2003, we wrote off $12.0 million in two investments which became

impaired. In the first quarter of fiscal 2004, we wrote off $1.6 million in two additional investments, and we may be required to write off all or a portion of the $25.1 million in such investments remaining on our balance sheet as of October 31, 2003 in future periods.

We are subject to pending legal proceedings

A securities class action lawsuit was filed on November 30, 2001 in the United States District Court for the Southern District of New York, purportedly on behalf of all persons who purchased our common stock from November 17, 1999 through December 6, 2000. The complaint named as defendants Finisar, Jerry S. Rawls, our President and Chief Executive Officer, Frank H. Levinson, our Chairman of the Board and Chief Technical Officer, Stephen K. Workman, our Senior Vice President and Chief Financial Officer, and an investment banking firm that served as an underwriter for our initial public offering in November 1999 and a secondary offering in April 2000. The operative amended complaint alleges violations of Section 11 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934, on the grounds that the prospectuses incorporated in the registration statements for the offerings failed to disclose, among other things, that (i) the underwriter had solicited and received excessive and undisclosed commissions from certain investors in exchange for which the underwriter allocated to those investors material portions of the shares of our stock sold in the offerings and (ii) the underwriter had entered into agreements with customers whereby the underwriter agreed to allocate shares of our stock sold in the offerings to those customers in exchange for which the customers agreed to purchase additional shares of our stock in the aftermarket at pre-determined prices. No specific damages are claimed. Similar allegations have been made in lawsuits relating to more than 300 other initial public offerings conducted in 1999 and 2000, all of which have been consolidated for pretrial purposes. In October 2002, all claims against the individual defendants were dismissed without prejudice. On February 19, 2003, our motion to dismiss was denied. We together with most of the other issuer defendants in the consolidated cases have agreed to settle. Under the terms of the settlement, the plaintiffs will dismiss and release all claims against participating defendants in exchange for a contingent payment guaranty by the insurance companies collectively responsible for insuring the issuers, and the assignment or surrender to the plaintiffs of certain claims the issuer defendants may have against the underwriters. Under the guaranty, the insurers will be required to pay the amount, if any, by which $1 billion exceeds the aggregate amount ultimately collected by the plaintiffs from the underwriter defendants in all the cases. If the plaintiffs fail to recover $1 billion and payment is required under the guaranty, We would be responsible to pay its pro rata portion of the shortfall, up to the amount of the self-insured retention under its insurance policy, which is $2 million. The timing and amount of payments that we could be required to make under the proposed settlement will depend on several factors, principally the timing and amount of any payment by the insurers pursuant to the $1 billion guaranty. The settlement is subject to approval of the Court, which cannot be assured. If the settlement is not approved by the Court, we intend to defend the lawsuit vigorously. However, the litigation is in the preliminary stage, and we cannot predict its outcome. The litigation process is inherently uncertain. If the outcome of the litigation is adverse to us and if we are required to pay significant monetary damages, our business would be significantly harmed.

Because of competition for technical personnel, we may not be able to recruit or retain necessary personnel

We believe our future success will depend in large part upon our ability to attract and retain highly skilled managerial, technical, sales and marketing, finance and manufacturing personnel. In particular, we will need to increase the number of technical staff members with experience in high-speed networking applications as we further develop our product lines. Competition for these highly skilled employees in our industry is intense. Our failure to attract and retain these qualified employees could significantly harm our business. The loss of the services of any of our qualified employees, the inability to attract or retain qualified personnel in the future or delays in hiring required personnel could hinder the development and introduction of and negatively impact our ability to sell our products. In addition, employees may leave our company and subsequently compete against us. Moreover, companies in our industry whose employees accept positions with competitors frequently claim that their competitors have engaged in unfair hiring practices. We have been subject to claims of this type and may be subject to such claims in the future as we seek to hire qualified personnel. Some of these claims may result in material litigation. We could incur substantial costs in defending ourselves against these claims, regardless of their merits.

Our products may contain defects that may cause us to incur significant costs, divert our attention from product development efforts and result in a loss of customers

Networking products frequently contain undetected software or hardware defects when first introduced or as new versions are released. Our products are complex and defects may be found from time to time. In addition, our products are often embedded in or deployed in conjunction with our customers’ products which incorporate a variety of components produced by third parties. As a result, when problems occur, it may be difficult to identify the source of the problem. These problems may cause us to incur significant damages or warranty and repair costs, divert the attention of our engineering personnel from our product development efforts and cause significant customer relation problems or loss of customers, all of which would harm our business.

Our failure to protect our intellectual property may significantly harm our business

Our success and ability to compete is dependent in part on our proprietary technology. We rely on a combination of patent, copyright, trademark and trade secret laws, as well as confidentiality agreements to establish and protect our proprietary rights. We license certain of our proprietary technology, including our digital diagnostics technology, to customers who include current and potential competitors, and we rely largely on provisions of our licensing agreements to protect our intellectual property rights in this technology. Although a number of patents have been issued and we have filed applications for additional patents, we cannot assure you that any patents will issue as a result of pending patent applications or that our issued patents will be upheld. Any infringement of our proprietary rights could result in significant litigation costs, and any failure to adequately protect our proprietary rights could result in our competitors offering similar products, potentially resulting in loss of a competitive advantage and decreased revenues. Despite our efforts to protect our proprietary rights, existing patent, copyright, trademark and trade secret laws afford only limited protection. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as do the laws of the United States. Attempts may be made to copy or reverse engineer aspects of our products or to obtain and use information that we regard as proprietary. Accordingly, we may not be able to prevent misappropriation of our technology or deter others from developing similar technology. Furthermore, policing the unauthorized use of our products is difficult. Litigation may be necessary in the future to enforce our intellectual property rights or to determine the validity and scope of the proprietary rights of others. This litigation could result in substantial costs and diversion of resources and could significantly harm our business.

Claims that we infringe third-party intellectual property rights could result in significant expenses or restrictions on our ability to sell our products

The networking industry is characterized by the existence of a large number of patents and frequent litigation based on allegations of patent infringement. We have been involved in the past in patent infringement lawsuits. From time to time, other parties may assert patent, copyright, trademark and other intellectual property rights to technologies and in various jurisdictions that are important to our business. Any claims asserting that our products infringe or may infringe proprietary rights of third parties, if determined adversely to us, could significantly harm our business. Any claims, with or without merit, could be time-consuming, result in costly litigation, divert the efforts of our technical and management personnel, cause product shipment delays or require us to enter into royalty or licensing agreements, any of which could significantly harm our business. Royalty or licensing agreements, if required, may not be available on terms acceptable to us, if at all. In addition, our agreements with our customers typically require us to indemnify our customers from any expense or liability resulting from claimed infringement of third party intellectual property rights. In the event a claim against us was successful and we could not obtain a license to the relevant technology on acceptable terms or license a substitute technology or redesign our products to avoid infringement, our business would be significantly harmed.

Our executive officers and directors and entities affiliated with them own a large percentage of our voting stock, which could have the effect of delaying or preventing a change in our control

As of September 30, 2003, our executive officers, directors and entities affiliated with them beneficially owned approximately 52.1 million shares or approximately 23.7% of the outstanding shares of our common stock. These stockholders, acting together, may be able to effectively control matters requiring approval by stockholders, including the election or removal of directors and the approval of mergers or other business combination transactions. This concentration of ownership could have the effect of delaying or preventing a change in our control or otherwise discouraging a potential acquirer from attempting to obtain control of us, which in turn could have an adverse effect on the market price of our common stock or prevent our stockholders from realizing a premium over the market price for their shares of common stock.

Delaware law, our charter documents and our stockholder rights plan contain provisions that could discourage or prevent a potential takeover, even if such a transaction would be beneficial to our stockholders

Some provisions of our certificate of incorporation and bylaws, as well as provisions of Delaware law, may discourage, delay or prevent a merger or acquisition that a stockholder may consider favorable. These provisions include:

•

authorizing the board of directors to issue additional preferred stock;

•

prohibiting cumulative voting in the election of directors;

•

limiting the persons who may call special meetings of stockholders;

•

prohibiting stockholder actions by written consent;

•

creating a classified board of directors pursuant to which our directors are elected for staggered three-year terms;

•

permitting the board of directors to increase the size of the board and to fill vacancies;

•

requiring a super-majority vote of our stockholders to amend our bylaws and certain provisions of our certificate of incorporation; and

•

establishing advance notice requirements for nominations for election to the board of directors or for proposing matters that can be acted on by stockholders at stockholder meetings.

We are subject to the provisions of Section 203 of the Delaware General Corporation Law which limit the right of a corporation to engage in a business combination with a holder of 15% or more of the corporation’s outstanding voting securities, or certain affiliated persons.

In addition, in September 2002, our board of directors adopted a stockholder rights plan under which our stockholders received one share purchase right for each share of our common stock held by them. Subject to certain exceptions, the rights become exercisable when a person or group (other than certain exempt persons) acquires, or announces its intention to commence a tender or exchange offer upon completion of which such person or group would acquire, 20% or more of our common stock without prior board approval. Should such an event occur, then, unless the rights are redeemed or have expired, Finisar stockholders, other than the acquiror, will be entitled to purchase shares of our common stock at a 50% discount from its then-Current Market Price (as defined) or, in the case of certain business combinations, purchase the common stock of the acquiror at a 50% discount.

Although we believe that these charter and bylaw provisions, provisions of Delaware law and our stockholder rights plan provide an opportunity for the board to assure that our stockholders realize full value for their investment, they could have the effect of delaying or preventing a change of control, even under circumstances that some stockholders may consider beneficial.

Our business and future operating results may be adversely affected by events outside of our control

Our business and operating results are vulnerable to events outside of our control, such as earthquakes, fire, power loss, telecommunications failures and uncertainties arising out of terrorist attacks in the U.S. and overseas. Currently, our corporate headquarters and a portion of our manufacturing operations are located in California. California in particular has been vulnerable to natural disasters, such as earthquakes, fires and floods, and other risks which at times have disrupted the local economy and posed physical risks to our property. Because of our overseas manufacturing locations, we are also dependent on communications links with these facilities and would be significantly harmed if these links were interrupted for any significant length of time. We presently do not have adequate redundant, multiple site capacity if any of these events were to occur nor can we be certain that the insurance we maintain against these events would be adequate, in which case our business would suffer.

Our stock price has been and may continue to be volatile

The trading price of our common stock has been and may continue to be subject to large fluctuations and, therefore, the trading price of the notes may fluctuate significantly, which may result in losses to holders of the notes. Our stock price and the value of the notes may increase or decrease in response to a number of events and factors, including:

•

trends in our industry and the markets in which we operate;

•

changes in the market price of the products we sell;

•

changes in financial estimates and recommendations by securities analysts;

•

acquisitions and financings;

•

quarterly variations in operating results;

•

the operating and stock price performance of other companies that investors in our common stock may deem comparable; and

•

purchases or sales of blocks of our common stock.

Part of this volatility is attributable to the current state of the stock market, in which wide price swings are common. This volatility may adversely affect the prices of our common stock and the notes regardless of our operating performance.


Item 3.	*Quantitative and Qualitative Disclosures About Market Risk.*

Our exposure to market risk for changes in interest rates relates primarily to our investment portfolio. The primary objective of our investment activities is to preserve principal while maximizing yields without significantly increasing risk. We place our investments with high credit issuers in short-term securities with maturities ranging from overnight up to 36 months or have characteristics of such short-term investments. The average maturity of the portfolio will not exceed 18 months. The portfolio includes only marketable securities with active secondary or resale markets to ensure portfolio liquidity. We have no investments denominated in foreign country currencies and therefore our investments are not subject to foreign exchange risk.

We invest in equity instruments of privately held companies for business and strategic purposes. These investments are included in other long-term assets and are accounted for under the cost method when ownership is less than 20%. For these non-quoted investments, our policy is to regularly review the assumptions underlying the operating performance and cash flow forecasts in assessing the carrying values. We identify and record impairment losses when events and circumstances indicate that such assets might be impaired. If certain of these investments in privately-held companies became marketable equity securities upon the company’s completion of an initial public offering in the future or acquisition by another company, then they would be subject to significant fluctuations in fair market value due to the volatility of the stock market. We also invest in equity securities of a publicly traded company. Such investments in publicly traded equity securities are subject to market price volatility. Equity security price fluctuations of plus or minus 10% would have had a $208,000 impact on the value of these securities as of October 31, 2003. There has been no material change in our interest rate exposure since April 30, 2003.


Item 4.	*Controls And Procedures.*

Under the supervision and with the participation of our management, including our President and Chief Executive Officer and our Senior Vice President, Finance and Chief Financial Officer, we evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended). Based on this evaluation, our President and Chief Executive Officer and Senior Vice President, Finance and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this quarterly report.

PART II — OTHER INFORMATION


Item 1.	*Legal Proceedings*

A securities class action lawsuit was filed on November 30, 2001 in the United States District Court for the Southern District of New York, purportedly on behalf of all persons who purchased our common stock from November 17, 1999 through December 6, 2000. The complaint named as defendants Finisar, Jerry S. Rawls, our President and Chief Executive Officer, Frank H. Levinson, our Chairman of the Board and Chief Technical Officer, Stephen K. Workman, our Senior Vice President and Chief Financial Officer, and an investment banking firm that served as an underwriter for our initial public offering in November 1999 and a secondary offering in April 2000. The operative amended complaint alleges violations of Section 11 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934, on the grounds that the prospectuses incorporated in the registration statements for the offerings failed to disclose, among other things, that (i) the underwriter had solicited and received excessive and undisclosed commissions from certain investors in exchange for which the underwriter allocated to those investors material portions of the shares of our stock sold in the offerings and (ii) the underwriter had entered into agreements with customers whereby the underwriter agreed to allocate shares of our stock sold in the offerings to those customers in exchange for which the customers agreed to purchase additional shares of our stock in the aftermarket at pre-determined prices. No specific damages are claimed. Similar allegations have been made in lawsuits relating to more than 300 other initial public offerings conducted in 1999 and 2000, all of which have been consolidated for pretrial purposes. In October 2002, all claims against the individual defendants were dismissed without prejudice. On February 19, 2003, our motion to dismiss was denied. We together with most of the other issuer defendants in the consolidated cases have agreed to settle. Under the terms of the settlement, the plaintiffs will dismiss and release all claims against participating defendants in exchange for a contingent payment guaranty by the insurance companies collectively responsible for insuring the issuers, and the assignment or surrender to the plaintiffs of certain claims the issuer defendants may have against the underwriters. Under the guaranty, the insurers will be required to pay the amount, if any, by which $1 billion exceeds the aggregate amount ultimately collected by the plaintiffs from the underwriter defendants in all the cases. If the plaintiffs fail to recover $1 billion and payment is required under the guaranty, we would be responsible to pay its pro rata portion of the shortfall, up to the amount of the self-insured retention under its insurance policy, which is $2 million. The timing and amount of payments that we could be required to make under the proposed settlement will depend on several factors, principally the timing and amount of any payment by the insurers pursuant to the $1 billion guaranty. The settlement is subject to approval of the Court, which cannot be assured. If the settlement is not approved by the Court, we intend to defend the lawsuit vigorously. However, the litigation is in the preliminary stage, and we cannot predict its outcome. The litigation process is inherently uncertain. If the outcome of the litigation is adverse to us and if we are required to pay significant monetary damages, our business would be significantly harmed.


Item 2.	*Changes in Securities and Use of Proceeds*

During the period July through October 2003, we exchanged and repurchased $24.8 million in principal amount of our convertible notes due 2008, in privately negotiated transactions, for 9,926,339 shares of the our common stock and cash in the amount of $1.9 million. The issuance of the shares of our common stock in these transactions was not registered under the Securities Act of 1933, as amended (the “Act”), in reliance on Section 3(a)(9) of the Act which exempts from the provisions of the Act an exchange of securities by an issuer with its existing security holders exclusively where no commission or other remuneration is paid or given for soliciting such exchange.

On October 15, 2003, we completed an offering of $150 million in aggregate principal amount of our 2 1/2% convertible subordinated notes due 2010. The initial purchasers of the notes were Merrill Lynch, Pierce, Fenner & Smith Incorporated, CIBC World Markets Corp., A.G. Edwards & Sons, Inc., Needham & Company, Inc., RBC Dain Raucher Inc., Soundview Technology Corporation, and Thomas Weisel Partners, LLC. From the aggregate offering price of $150 million we received approximately $145.3 million in net proceeds after deducting the aggregate initial purchasers’ discount and other fees of approximately $4.7 million. Subject to market conditions and our ability to complete privately negotiated transactions with individual holders, we intend to use a portion of the net proceeds to repurchase a portion of our outstanding 5 1/4% convertible subordinated notes due 2008. We intend to use the remaining net proceeds from the offering for general corporate purposes, including working capital. We may also use a portion of the net proceeds to acquire complementary business, products or technologies, although we currently have no commitments or agreements for any such acquisitions. The notes are convertible, at the option of the holder, at any time on or prior to maturity into shares of the our common stock at a conversion price of $3.705 per share, which is equal to a conversion rate of approximately 269.9055 shares per $1,000 principal amount of notes. The notes may be redeemed for cash, at our option, at any time on or after October 15, 2007 in whole or in part at a redemption price equal to 100% of the principal amount of notes being redeemed, plus accrued and unpaid interest, if any, on such notes to, but excluding, the redemption date, if the closing price of our common stock has exceeded 150% of

the conversion price then in effect for at least 20 trading days within a period of 30 consecutive trading days ending on the trading day immediately preceding the date of mailing notice to holders of such optional redemption.

Interest is payable on the notes on April 15 and October 15 each year, beginning April 15, 2004. We have purchased and pledged to a collateral agent under a pledge agreement, as security for the exclusive benefit of the holders of the notes, pproximately $14.4 million of U.S. government securities to provide for the payment in full of the first eight scheduled interest payments due on the notes.

The offer and sale of the notes was exempt from the registration requirements of the Securities Act of 1933, as amended, pursuant to Rule 144A promulgated thereunder. We have agreed to file a registration statement for the resale of the notes and the shares of common stock issuable upon conversion of the notes within 90 days after the closing of the offering.


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

At the annual meeting of our shareholders held on October 1, 2003, the following matters were considered and voted upon:

The following nominees were elected as Class I directors to serve on our Board of Directors for a three-year term expiring at the 2006 annual meeting of stockholders and until their successors are duly elected and qualified. The number of shares voted and withheld for such nominees were as follows:


Name	For		Withheld

Roger C. Ferguson		187,786,407		2,504,954
Larry D. Mitchell		189,509,082		782,279

A proposal to approve certain provisions of the 1999 Stock Option Plan in order to preserve the ability to deduct in full certain plan-related compensation under Section 162(m) of the Internal Revenue Code was approved and ratified by a vote of 187,229,471 shares for, 2,746,915 shares against, and 314,975 shares abstaining.

The appointment of Ernst & Young LLP as our independent auditors for the fiscal year ending April 20, 2004 was approved and ratified by a vote of 190,031,294 shares for, 148,090 shares against, and 111,977 shares abstaining.


Item 6.	*Exhibits and Reports on Form 8-K*

Exhibits:


4.4		Indenture between the Company and U.S. Bank Trust National Association, a national banking association, dated October 15, 2003
10.18		Collateral Pledge and Security Agreement among the Company, U.S. Bank Trust National Association and U.S. Bank National Association, dated October 15, 2003
10.19		Registration Rights Agreement between the Company and the Initial Purchasers of the Company’s 2 1/2% Convertible Subordinated Notes due 2010, dated October 15, 2003
31.1		Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1		Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2		Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the


		Sarbanes-Oxley Act of 2002

Reports onForm 8-K:

We filed or furnished the following reports on Form 8-K during the quarter ended October 31, 2003:

(1)

Press Release dated September 3, 2003 regarding financial information for Finisar for the quarter ended July 31, 2003.

(2)

Press Release dated October 7, 2003, regarding the proposed offering of $100 million of convertible subordinated notes due 2010 in a private placement to qualified institutional investors.

(3)

Press Release dated October 9, 2003 regarding the pricing of $130 million of convertible subordinated notes due 2010 in a private placement to qualified institutional investors.

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.


		FINISAR CORPORATION

		By:		/s/ JERRY S. RAWLS
		Jerry S. Rawls
		Chief Executive Officer

		By:		/s/ STEPHEN K. WORKMAN
		Stephen K. Workman
		Senior Vice President, Finance and Chief Financial Officer

Dated: December 10, 2003

EXHIBIT INDEX


Exhibit
Number		Description

4.4		Indenture between the Company and U.S. Bank Trust National Association, a national banking association, dated October 15, 2003
10.18		Collateral Pledge and Security Agreement among the Company, U.S. Bank Trust National Association and U.S. Bank National Association, dated October 15, 2003
10.19		Registration Rights Agreement between the Company and the Initial Purchasers of the Company’s 2 1/2% Convertible Subordinated Notes due 2010, dated October 15, 2003
31.1		Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1		Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2		Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	H.S. sophomore Avg

Finisar (FNSR) 10-Q2004 Q2 Quarterly report

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