UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JANUARY 26, 2002
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _____ TO _____
COMMISSION FILE NUMBER 000-27273
SYCAMORE NETWORKS, INC.
(Exact name of registrant as specified in its charter)
Delaware 04-3410558
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
150 Apollo Drive
Chelmsford, MA 01824
(Address of principal executive offices)
(Zip code)
(978) 250-2900
(Registrant's telephone number, including area code)
NONE
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No___ .
The number of shares outstanding of the Registrant's Common Stock as of February
28, 2002 was 273,680,683.
1
Sycamore Networks, Inc.
Index
- -----
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets as of January 26, 2002 and July 31, 2001 3
Consolidated Statements of Operations for the three and six months
ended January 26, 2002 and January 27, 2001 4
Consolidated Statements of Cash Flows for the six months
ended January 26, 2002 and January 27, 2001 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosure About Market Risk 29
Part II. Other Information
Item 1. Legal Proceedings 30
Item 4. Submission of Matters to a Vote of Security Holders 30
Item 6. Exhibits and Reports on Form 8-K 31
Signature 32
Exhibit Index 33
2
Part I. Financial Information
ITEM 1. FINANCIAL STATEMENTS
SYCAMORE NETWORKS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PAR VALUE)
January 26, July 31,
2002 2001
---- ----
Assets
Current assets:
Cash and cash equivalents $ 294,177 $ 492,500
Short-term investments 388,302 332,471
Accounts receivable, net of allowance for doubtful accounts
of $5,185 and $4,773 at January 26, 2002 and July 31, 2001,
respectively 33,179 41,477
Inventories, net 15,128 66,939
Prepaids and other current assets 13,419 13,739
------------ ------------
Total current assets 744,205 947,126
------------ ------------
Property and equipment, net 66,372 106,625
Long-term investments 397,979 423,578
Other assets 16,752 73,992
------------ ------------
Total assets $ 1,225,308 $ 1,551,321
============ ============
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable $ 11,054 $ 62,513
Accrued expenses 24,541 25,199
Accrued restructuring costs 56,375 61,003
Deferred revenue 6,602 6,607
Other current liabilities 5,696 8,139
------------ ------------
Total current liabilities 104,268 163,461
Stockholders' equity:
Preferred stock, $.01 par value, 5,000 shares authorized; none
issued or outstanding -- --
Common stock, $.001 par value; 2,500,000 shares authorized; 274 274
273,681 shares issued and outstanding at January 26, 2002
and July 31, 2001, respectively
Additional paid-in capital 1,736,711 1,738,505
Accumulated deficit (584,713) (301,429)
Deferred compensation (35,731) (54,110)
Treasury stock, at cost, 1,355 and 680 shares held at
January 26, 2002 and July 31, 2001, respectively (211) (126)
Accumulated other comprehensive income 4,710 4,746
------------ ------------
Total stockholders' equity 1,121,040 1,387,860
------------ ------------
Total liabilities and stockholders' equity $ 1,225,308 $ 1,551,321
============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
3
SYCAMORE NETWORKS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Three Months Ended Six Months Ended
------------------- ----------------
January 26, January 27, January 26, January 27,
2002 2001 2002 2001
---- ---- ---- ----
Revenue .............................................................. $ 21,800 $ 149,243 $ 43,043 $ 269,691
Cost of revenue (exclusive of non-cash stock compensation expense of
$437, $488, $953 and $2,131) ......................................... 19,402 79,111 142,017 143,250
--------- --------- --------- ---------
Gross profit (loss) .................................................. 2,398 70,132 (98,974) 126,441
Operating expenses:
Research and development (exclusive of non-cash stock
compensation expense of $2,339, $2,902, $5,065 and $28,291) ...... 25,985 42,314 62,500 77,993
Sales and marketing (exclusive of non-cash stock compensation
expense of $4,099, $2,503, $6,566 and $17,238) ................... 11,379 21,870 25,083 39,270
General and administrative (exclusive of non-cash stock
compensation expense of $702, $567, $1,277 and $1,553) .......... 2,614 4,557 5,804 8,619
Amortization of stock compensation ................................ 7,577 6,460 13,861 49,213
Restructuring charges and related asset impairments ............... -- -- 77,306 --
Acquisition costs ................................................. -- -- -- 4,948
--------- --------- --------- ---------
Total operating expenses ..................................... 47,555 75,201 184,554 180,043
--------- --------- --------- ---------
Loss from operations ................................................ (45,157) (5,069) (283,528) (53,602)
Losses on investments ............................................... -- -- (22,737) --
Interest and other income, net ...................................... 9,808 26,295 22,981 48,624
--------- --------- --------- ---------
Income (loss) before income taxes ................................... (35,349) 21,226 (283,284) (4,978)
Provision for income taxes .......................................... -- 7,429 -- 7,429
--------- --------- --------- ---------
Net income (loss) ................................................... $ (35,349) $ 13,797 $(283,284) $ (12,407)
========= ========= ========= =========
Basic net income (loss) per share .................................... $ (0.14) $ 0.06 $ (1.13) $ (0.05)
Diluted net income (loss) per share .................................. $ (0.14) $ 0.05 $ (1.13) $ (0.05)
Shares used in per share calculation - basic ......................... 253,150 235,299 251,082 232,979
Shares used in per share calculation - diluted ....................... 253,150 281,244 251,082 232,979
The accompanying notes are an integral part of the consolidated financial
statements.
4
SYCAMORE NETWORKS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
Six months ended
----------------
January 26, January 27,
2002 2001
---- ----
Cash flows from operating activities:
Net loss $ (283,284) $ (12,407)
Adjustments to reconcile net loss to net
cash (used in) provided by operating activities:
Depreciation and amortization 22,513 13,753
Restructuring charges and related asset impairments 136,513 --
Amortization of stock compensation 13,861 49,213
Tax benefit from employee stock plans -- 11,192
Changes in operating assets and liabilities:
Accounts receivable 8,298 (51,162)
Inventories (1,248) (26,214)
Prepaids and other current assets 320 8,807
Deferred revenue (5) (4,740)
Accounts payable (51,459) 39,544
Accrued expenses and other liabilities (3,101) 7,641
Accrued restructuring costs (4,628) --
---------- ---------
Net cash (used in) provided by operating activities (162,220) 35,627
---------- ---------
Cash flows from investing activities:
Purchases of property and equipment (10,215) (77,642)
Purchases of investments (530,627) (372,190)
Maturities of investments 500,359 344,671
Decrease (increase) in other assets 1,914 (43,078)
---------- ---------
Net cash used in investing activities (38,569) (148,239)
---------- ---------
Cash flows from financing activities:
Proceeds from issuance of common stock, net 2,712 5,571
Purchase of treasury stock (246) --
Payments received for notes receivable -- 262
Payments on notes payable -- (1,780)
---------- ---------
Net cash provided by financing activities 2,466 4,053
---------- ---------
Net decrease in cash and cash equivalents (198,323) (108,559)
Cash and cash equivalents, beginning of period 492,500 429,965
---------- ---------
Cash and cash equivalents, end of period $ 294,177 $ 321,406
========== =========
The accompanying notes are an integral part of the consolidated financial
statements.
5
SYCAMORE NETWORKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF THE BUSINESS
Sycamore Networks, Inc. (the "Company") was incorporated in Delaware on February
17, 1998. The Company is a leading provider of intelligent optical networking
products that enable telecommunications service providers to quickly and
cost-effectively transform the capacity created by their fiber optic networks
into usable bandwidth for the deployment of new high-speed data services.
The Company is subject to risks common to technology-based companies including,
but not limited to, the development of new technology, development of markets
and distribution channels, dependence on key personnel, and the ability to
obtain additional capital as needed to meet its product plans. The Company's
ultimate success is dependent upon its ability to successfully develop and
market its products.
2. BASIS OF PRESENTATION
The accompanying financial data as of January 26, 2002 and for the three and six
months ended January 26, 2002 and January 27, 2001 has been prepared by the
Company, without audit, pursuant to the rules and regulations of the Securities
and Exchange Commission ("SEC"). Certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to such
rules and regulations. However, the Company believes that the disclosures are
adequate to make the information presented not misleading. These consolidated
financial statements should be read in conjunction with the consolidated
financial statements and the notes thereto included in the Company's Annual
Report on Form 10-K for the fiscal year ended July 31, 2001.
In the opinion of management, all adjustments (which include only normal
recurring adjustments) necessary to present a fair statement of financial
position as of January 26, 2002, and results of operations and cash flows for
the three and six months ended January 26, 2002 and January 27, 2001 have been
made. The results of operations for the three and six months ended January 26,
2002 are not necessarily indicative of the operating results for the full fiscal
year or any future periods.
3. REVENUE DETAIL
Components of revenue and cost of revenue included in the consolidated statement
of operations are as follows (in thousands):
Three Months Ended Six Months Ended
------------------ ----------------
January 26, January 27, January 26, January 27,
2002 2001 2002 2001
---- ---- ---- ----
Revenue
Product $ 17,123 $ 146,414 $ 32,897 $ 264,241
Service 4,677 2,829 10,146 5,450
--------- ---------- ---------- ----------
$ 21,800 $ 149,243 $ 43,043 $ 269,691
--------- ---------- ---------- ----------
Cost of Revenue
Product $ 12,535 $ 69,548 $ 126,808 $ 127,432
Service 6,867 9,563 15,209 15,818
--------- ---------- ---------- ----------
$ 19,402 $ 79,111 $ 142,017 $ 143,250
--------- ---------- ---------- ----------
For the three and six months ended January 26, 2002, two international customers
represented the majority of the Company's revenue. For the full fiscal year
ending July 31, 2002, the Company anticipates that revenue will continue to be
highly concentrated in a relatively small number of customers, and that
international revenue will represent a relatively high percentage of total
revenue. At January 26, 2002, more than 90% of the Company's accounts receivable
balance was attributable to two international customers.
6
4. NET INCOME (LOSS) PER SHARE
Basic net income (loss) per share is computed by dividing the net income (loss)
for the period by the weighted-average number of common shares outstanding
during the period less unvested restricted stock. Diluted net income (loss) per
share is computed by dividing the net income (loss) for the period by the
weighted-average number of common and common equivalent shares outstanding
during the period, if dilutive. Common equivalent shares are composed of
unvested shares of restricted common stock and the incremental common shares
issuable upon the exercise of stock options and warrants outstanding. The
following table sets forth the computation of basic and diluted net income
(loss) per share, (in thousands, except per share data):
Three Months Ended Six Months Ended
------------------ ----------------
January 26, January 27, January 26, January 27,
2002 2001 2002 2001
---- ---- ---- ----
Numerator
Net income (loss) $ (35,349) $ 13,797 $ (283,284) $ (12,407)
========= ========= ========== ==========
Denominator
Weighted-average shares of common stock outstanding 272,370 272,876 272,549 272,662
Weighted-average shares subject to repurchase (19,220) (37,577) (21,467) (39,683)
--------- --------- ---------- ----------
Shares used in per-share calculation - basic 253,150 235,299 251,082 232,979
========= ========= ========== ==========
Weighted-average shares of common stock outstanding 253,150 272,876 251,082 232,979
Weighted-average common stock equivalents - 8,368 - -
--------- --------- ---------- ----------
Shares used in per-share calculation - diluted 253,150 281,244 251,082 232,979
========= ========= ========== ==========
Net income (loss) per share:
Basic $ (0.14) $ 0.06 $ (1.13) $ (0.05)
========= ========= ========== ==========
Diluted $ (0.14) $ 0.05 $ (1.13) $ (0.05)
========= ========= ========== ==========
Options to purchase 31.2 million and 18.6 million shares of common stock at an
average exercise price of $10.69 and $50.71 have not been included in the
computation of diluted net income (loss) per share for the three months ended
January 26, 2002 and January 27, 2001, respectively, as their effect would have
been anti-dilutive. Options to purchase 31.2 million and 33.2 million shares of
common stock at an average exercise price of $10.69 and $57.17 have not been
included in the computation of diluted net loss per share for the six months
ended January 26, 2002 and January 27, 2001, respectively, as their effect would
have been anti-dilutive. Warrants to purchase 150,000 shares of common stock at
an exercise price of $11.69 have not been included in the computation of diluted
net loss per share for the three and six months ended January 26, 2002, as their
effect would have been anti-dilutive.
5. STOCK OPTION EXCHANGE OFFER
In May 2001 the Company announced an offer to exchange outstanding employee
stock options having an exercise price of $7.25 or more per share in return for
restricted stock and new stock options to be granted by the Company (the
"Exchange Offer"). Pursuant to the Exchange Offer, in exchange for eligible
options, an option holder generally received a number of shares of restricted
stock equal to one-tenth (1/10) of the total number of shares subject to the
options tendered by the option holder and accepted for exchange, and commitment
for new options to be issued exercisable for a number of shares of common stock
equal to nine-tenths (9/10) of the total number of shares subject to the options
tendered by the option holder and accepted for exchange. In order to address
potential adverse tax consequences for employees of certain international
countries, these employees were allowed to forego the restricted stock grants
and receive all stock options.
A total of 17.6 million options were accepted for exchange under the Exchange
Offer and accordingly, were canceled in June 2001. A total of 1.7 million shares
of restricted stock were issued in June 2001 and the Company recorded deferred
compensation of $12.6 million related to these grants at that time. Due to
cancellations of restricted stock relating to employee terminations, which were
primarily due to the Company's fiscal 2002 restructuring program as described in
Note 8, the number of outstanding shares of restricted stock related to the
Exchange Offer was subsequently reduced to 1.3 million shares and the total
deferred compensation relating to the Exchange Offer was reduced to
approximately $10.1 million. The deferred compensation costs will be amortized
ratably over the vesting periods of the restricted stock, generally over a four
year period, with 25% of the shares vesting one year after the date of grant and
the remaining 75% vesting quarterly thereafter. Until the restricted stock
vests, such shares are subject to forfeiture in the event the employee leaves
the Company.
7
Upon the completion of the Exchange Offer, options to purchase approximately
15.9 million shares were expected to be granted in the second quarter of fiscal
2002, no sooner than six months and one day from June 20, 2001. However, due to
the effect of employee terminations, which were primarily due to the Company's
fiscal 2002 restructuring program as described in Note 8, the number of options
which were granted in the second quarter of fiscal 2002 related to the Exchange
Offer was approximately 12.6 million shares. The new options will generally vest
over three years, with 8.34% of the options vesting on the date of grant and the
remaining 91.66% vesting quarterly thereafter subject to forfeiture in the event
the employee leaves the Company. The new options were granted with an exercise
price of $4.89 per share, equal to the fair market value of the Company's common
stock on the date of the grant.
6. INVENTORIES, NET
Inventories, net consisted of the following (in thousands):
January 26, July 31,
2002 2001
---- ----
Raw materials $ 4,333 $25,299
Work in process 463 18,849
Finished goods 10,332 22,791
------- -------
$15,128 $66,939
======= =======
7. COMPREHENSIVE INCOME (LOSS)
The Company reports comprehensive income (loss) in accordance with Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS
No. 130). The components of comprehensive income (loss) are as follows (in
thousands):
Three Months Ended Six Months Ended
------------------ ----------------
January 26, January 27, January 26, January 27,
2002 2001 2002 2001
---- ---- ---- ----
Net income (loss) $ (35,349) $ 13,797 $ (283,284) $ (12,407)
Other comprehensive income:
Unrealized gain (loss) on investments (2,101) 1,336 (36) 503
---------- --------- ----------- -----------
Comprehensive income (loss) $ (37,450) $ 15,133 $ (283,320) $ (11,904)
========== ========= =========== ===========
8. RESTRUCTURING AND RELATED ASSET IMPAIRMENTS
Beginning in the third quarter of fiscal 2001, unfavorable economic conditions
and reduced capital spending by telecommunications service providers negatively
impacted the Company's operating results in a progressive and increasing manner.
As a result, the Company has enacted two separate business restructuring
programs, the first in the third quarter of fiscal 2001 (the "fiscal 2001
restructuring"), and the second in the first quarter of fiscal 2002 (the "fiscal
2002 restructuring"). Details regarding each of these restructuring actions are
as follows:
Fiscal 2001 Restructuring:
- --------------------------
As a result of the unfavorable conditions referred to above, the Company
implemented a restructuring program in the third quarter of fiscal 2001,
designed to reduce expenses in order to align resources with long-term growth
opportunities. The restructuring program included a workforce reduction,
consolidation of excess facilities, and the restructuring of certain business
functions to eliminate non-strategic products and overlapping feature sets. This
included the discontinuance of the SN 6000 Intelligent Optical Transport product
and the bi-directional capabilities of the SN 8000 Intelligent Optical Network
Node. As a result of the restructuring program, the Company recorded
restructuring charges and related asset impairments of $81.9 million classified
as operating expenses and an additional excess inventory charge of $84.0 million
relating to the discontinued product lines, which was classified as cost of
revenue.
8
The restructuring charges and related asset impairments recorded in the third
quarter of fiscal 2001, and the reserve activity since that time, are summarized
as follows (in thousands):
Accrual Accrual
Total Fiscal 2001 Balance at Fiscal 2002 Balance at
Restructuring Non-cash Cash July 31, Cash January 26,
Charge Charges Payments 2001 Payments 2002
------ ------- -------- ---- -------- ----
Workforce reductions $ 4,174 $ 829 $ 2,823 $ 522 $ 380 $ 142
Facility consolidations and
certain other costs 24,437 1,214 1,132 22,091 2,460 19,631
Inventory and asset write-downs 137,285 84,972 13,923 38,390 32,408 5,982
-------- ------- ------- ------- ------- -------
Total $165,896 $87,015 $17,878 $61,003 $35,248 $25,755
======== ======= ======= ======= ======= =======
The remaining cash expenditures relating to workforce reductions will be
substantially paid by the third quarter of fiscal 2002. Facility consolidation
charges will be paid over the respective lease terms through fiscal 2007. The
fiscal 2001 restructuring program was substantially completed during the first
half of fiscal 2002.
Fiscal 2002 Restructuring:
- --------------------------
As a result of a continued decline in overall economic conditions and further
reductions in capital spending by telecommunications service providers, the
Company implemented a second restructuring program in the first quarter of
fiscal 2002, designed to further reduce expenses to align resources with
long-term growth opportunities. The restructuring program included a workforce
reduction, consolidation of excess facilities, and charges related to excess
inventory and other asset impairments.
As a result of the restructuring program, the Company recorded restructuring
charges and related asset impairments of $77.3 million classified as operating
expenses and an excess inventory charge of $102.4 million classified as cost of
revenue. In addition, the Company recorded charges totaling $22.7 million
classified as a non-operating expense, relating to impairments of investments in
non-publicly traded companies that were determined to be other than temporary.
The following paragraphs provide detailed information relating to the
restructuring charges and related asset impairments which were recorded during
the first quarter of fiscal 2002.
Workforce reduction
The restructuring program resulted in the reduction of 239 regular employees
across all business functions and geographic regions. The workforce reductions
were substantially completed in the first quarter of fiscal 2002. The Company
recorded a workforce reduction charge of approximately $7.1 million relating
primarily to severance and fringe benefits. In addition the number of temporary
and contract workers employed by the Company was also reduced.
Consolidation of facilities and certain other costs
The Company recorded a charge of $17.2 million relating to the consolidation of
excess facilities and certain other costs. The total charge includes $11.2
million related to the write-down of certain land, as well as lease terminations
and non-cancelable lease costs. The Company also recorded other restructuring
costs of $6.0 million relating primarily to administrative expenses and
professional fees in connection with the restructuring activities.
Inventory and asset write-downs
The Company recorded a charge of $155.5 million relating to the write-down of
inventory to its net realizable value and the impairment of certain other
assets. The total charge includes $102.4 million of inventory write-downs and
purchase commitments for inventory which was recorded as part of cost of
revenue. This excess inventory charge was due to a severe decline in the demand
for the Company's products. The Company also recorded charges totaling $53.1
million for asset impairments, including the assets related to the Company's
vendor financing agreements and fixed assets that were abandoned by the Company.
Since revenue had been recognized under the vendor financing agreements on a
cash basis, the amount of the impairment loss was limited to the cost of the
systems shipped to the vendor financing customers, which had been recorded in
other long-term assets.
Losses on investments
The Company recorded charges totaling $22.7 million for impairments of
investments in non-publicly traded companies that were determined to be other
than temporary. The impairment charges were classified as a non-operating
expense.
9
The restructuring charges and related asset impairments recorded in the first
quarter of fiscal 2002, and the reserve activity since that time, are summarized
as follows (in thousands):
Accrual
Total Balance at
Restructuring Non-cash Cash January 26,
Charge Charges Payments 2002
------ ------- -------- ----
Workforce reduction $ 7,106 $ 173 $ 5,267 $ 1,666
Facility consolidations and certain other costs 17,181 8,522 672 7,987
Inventory and asset write-downs 155,451 105,081 29,403 20,967
Losses on investments 22,737 22,737 -- --
-------- -------- ------- -------
Total $202,475 $136,513 $35,342 $30,620
======== ======== ======= =======
The remaining cash expenditures relating to workforce reductions will be
substantially paid by the third quarter of fiscal 2002. Facility consolidation
charges will be paid over the respective lease terms through fiscal 2005. The
Company expects to substantially complete the fiscal 2002 restructuring program
by the first quarter of fiscal 2003.
9. RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible
Assets, which addresses the recognition and measurement of goodwill and other
intangible assets subsequent to their acquisition. SFAS No. 142 also addresses
the initial recognition and measurement of intangible assets acquired outside of
a business combination whether acquired individually or with a group of other
assets. SFAS No. 142 provides that intangible assets with finite useful lives be
amortized and that intangible assets with indefinite lives and goodwill will not
be amortized, but will rather be tested at least annually for impairment.
Although SFAS No. 142 is not required to be adopted by the Company until fiscal
2003, its provisions must be applied to goodwill and other intangible assets
acquired after June 30, 2001. As of January 26, 2002, the Company does not have
any goodwill or other intangible assets relating to business combinations that
were accounted for under APB Opinion No. 16. Accordingly, the adoption of SFAS
No. 142 will not have a material impact on the Company's financial position or
results of operations.
In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, which addresses the financial accounting and
reporting for the disposal of long-lived assets. SFAS No. 144 is effective for
financial statements issued for fiscal years beginning after December 15, 2001
and interim periods within those fiscal years. Accordingly, the Company will be
required to adopt SFAS No. 144 in the first quarter of fiscal 2003. The adoption
of SFAS No. 144 is not expected to have a material impact on the Company's
financial position or results of operations.
10. LITIGATION
Beginning on July 2, 2001, several purported class action complaints were filed
in the United States District Court for the Southern District of New York
against the Company and several of its officers and directors and the
underwriters for the Company's initial public offering on October 21, 1999. Some
of the complaints also include the underwriters for the Company's follow-on
offering on March 14, 2000. The complaints were filed on behalf of persons who
purchased the Company's common stock during specified periods, all beginning on
October 21 or October 22, 1999 and ending on various dates, the latest of which
is August 10, 2001. The complaints are similar and allege violations of the
Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as
amended, primarily based on the assertion that the Company's lead underwriters,
the Company and the other named defendants made material false and misleading
statements in the Company's prospectus incorporated in its registration
statements on Form S-1 filed with the SEC in October 1999 and March 2000 because
of the failure to disclose (a) the alleged solicitation and receipt of excessive
and undisclosed commissions by the underwriters in connection with the
allocation of shares of common stock to certain investors in the Company's
public offerings and (b) that certain of the underwriters allegedly had entered
into agreements with investors whereby underwriters agreed to allocate the
public offering shares in exchange for which the investors agreed to make
additional purchases of stock in the aftermarket at pre-determined prices. The
complaints allege claims against the Company, several of the Company's officers
and directors and the underwriters under Sections 11 and 15 of the Securities
Act. The complaints also allege claims solely against the underwriter defendants
under Section 12(a)(2) of the Securities Act and some of the complaints allege
claims against the Company and the individual defendants under Section 10(b) of
the Exchange Act. The complaints against the Company have been consolidated into
a single action. Because the action against the Company is being coordinated
with over three hundred other nearly identical actions filed against other
companies, it is not yet clear when or whether a consolidated complaint will be
filed against the Company. The Company is not required to respond before a
consolidated complaint is filed. The actions seek damages in an unspecified
amount. The Company believes that the
10
claims against it are without merit and intends to defend against the complaints
vigorously. The Company is not currently able to estimate the possibility of
loss or range of loss, if any, relating to these claims.
The Company is subject to legal proceedings, claims, and litigation arising in
the ordinary course of business. While the outcome of these matters is currently
not determinable, management does not expect that the ultimate costs to resolve
these matters will have a material adverse effect on the Company's results of
operations or financial position.
11
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Except for the historical information contained herein, we wish to caution you
that certain matters discussed in this report constitute forward-looking
statements that involve risks and uncertainties. Our actual results could differ
materially from those stated or implied in forward-looking statements due to a
number of factors, including, without limitation, those risks and uncertainties
discussed under the heading "Factors That May Affect Future Operating Results"
contained in our Annual Report on Form 10-K and other reports we file from time
to time with the SEC and the risks and uncertainties discussed under the
captions "Risks Related To Our Business" and "Risks Related to the Securities
Market." Forward-looking statements include statements regarding our
expectations, beliefs, intentions or strategies regarding the future and can be
identified by forward-looking words such as "anticipate," "believe," "could,"
"estimate," "expect," "intend," "may, " "should," "will," and "would" or similar
words.
OVERVIEW
We are a leading provider of intelligent optical networking products that enable
telecommunications service providers to quickly and cost-effectively transform
the capacity created by their fiber optic networks into usable bandwidth for the
deployment of new high-speed data services. Since our inception in February
1998, our revenue has increased from $11.3 million for the fiscal year ended
July 31, 1999 to $374.7 million for the fiscal year ended July 31, 2001.
However, our revenue declined significantly beginning in the third quarter of
fiscal 2001 due to unfavorable economic conditions caused by a rapid and
significant decrease in capital spending by telecommunications service
providers. As a result, emerging service providers, which had been the early
adopters of our technology, were no longer able to continue to fund aggressive
deployments of equipment within their networks due to their inability to access
the capital markets. This trend was compounded by decisions by incumbent service
providers to slow their capital expenditures significantly. Our revenue has been
and continues to be negatively impacted by these unfavorable economic
conditions.
We currently anticipate that the cost of revenue and the resulting gross margin
will continue to be adversely affected by several factors, including reduced
demand for our products, the effects of new product introductions including
volumes and manufacturing efficiencies, component limitations, the mix of
products and services sold, competitive pricing, and possible increases in
inventory levels which could increase our exposure to excess and obsolete
inventory charges. While we have taken actions to reduce our cost structure, we
anticipate that we will continue to incur operating losses unless our revenue
increases significantly compared to current levels. During the last half of
fiscal 2001 and the first half of fiscal 2002, we incurred substantial operating
losses totaling $581.8 million, which includes restructuring and other charges
totaling $345.6 million. We expect to incur operating losses until the overall
economic environment and the demand for our products improve. At this time, we
have limited visibility into future revenue and cannot predict, when or if, the
economic environment and the demand for our products will improve.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's discussion and analysis of its financial condition and results of
operations are based upon our interim consolidated financial statements. The
preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenue and
expenses and related disclosure of contingent liabilities. We evaluate these
estimates on an ongoing basis, including those relating to bad debts,
inventories, valuation of investments, warranty obligations, restructuring
reserves, litigation and other contingencies. Estimates are based on our
historical experience and other assumptions that are considered reasonable under
the circumstances, the results of which form the basis for making judgments
about the carrying values of assets and liabilities that are not readily
apparent from other sources. Actual results may differ from these estimates. To
the extent there are material differences between our estimates and the actual
results, our future results of operations will be affected.
We believe that the following critical accounting policies affect the most
significant judgments and estimates used in the preparation of our consolidated
financial statements. When products are shipped to customers, we evaluate
whether all of the fundamental criteria for revenue recognition have been met.
The most significant judgments for revenue recognition typically involve whether
there are any significant uncertainties regarding customer acceptance and
whether collectibility can be considered reasonably assured. In addition, the
Company's transactions often consist of multiple element arrangements which must
be analyzed to determine the relative fair value of each element, the amount of
revenue to be recognized upon shipment, if any, and the period and conditions
under which deferred revenue should be recognized. After customers have been
invoiced, management evaluates the outstanding accounts receivable balances
until they are collected, to determine whether an allowance for doubtful
accounts should be recorded. In the event of a sudden deterioration in a
particular customer's financial condition, additional provisions for doubtful
accounts may be required, such as the specific provision that we recorded in the
fourth quarter of fiscal 2001. We accrue for the estimated cost of product
warranties at the time revenue is recognized, based primarily on our historical
12
experience. If actual warranty claims exceed the amounts accrued, additional
warranty charges would be required which would reduce gross margins in future
periods.
We continuously monitor our inventory balances and provisions are recorded for
any differences between the cost of the inventory and its estimated market
value, based on assumptions about future demand and market conditions. To the
extent that a severe decline in forecasted demand occurs, significant charges
for excess inventory are likely to occur, such as the $102.4 million charge we
recorded in the first quarter of fiscal 2002. Since the third quarter of fiscal
2001, we have recorded significant charges for restructuring and related asset
impairments totaling $368.4 million, which included inventory related charges of
$186.4 million. These restructuring activities required us to make numerous
assumptions and estimates, including future revenue levels and product mix, the
timing of and the amounts received for subleases of excess facilities, the fair
values of impaired assets, the amounts of other than temporary impairments of
strategic investments, and the projected administrative expenses and
professional fees associated with the restructuring activities. The estimates
and assumptions relating to the restructuring activities must be continually
monitored and evaluated, and if these estimates and assumptions change, we may
be required to record additional charges or credits against the reserves
previously recorded for these restructuring activities.
RESULTS OF OPERATIONS
REVENUE
Revenue decreased 85% or $127.4 million to $21.8 million for the three months
ended January 26, 2002 compared to $149.2 million for the same period in fiscal
2001. Revenue decreased 84% or $226.7 million to $43.0 million for the six
months ended January 26, 2002 compared to $269.7 million for the same period in
fiscal 2001. The decrease in revenue was due to the decline in the overall
economic environment, in particular the reductions in capital spending by our
target customers. For the three and six months ended January 26, 2002, product
revenue declined significantly while service revenue increased compared to the
same periods in fiscal 2001. The increase in service revenue was due to revenue
from maintenance and other services associated with product shipments that
occurred in previous periods. For the three and six months ended January 26,
2002, two international customers represented the majority of the Company's
revenue. For the full fiscal year ending July 31, 2002, the Company anticipates
that revenue will continue to be highly concentrated in a relatively small
number of customers, and that international revenue will represent a relatively
high percentage of total revenue.
Sales to emerging carriers, which had represented a large percentage of our
revenue in the first two quarters of fiscal 2001, were insignificant in the
first two quarters of fiscal 2002, and we expect this trend to continue for the
foreseeable future. While we have redirected our marketing efforts towards
incumbent carriers, these customers typically have longer sales evaluation
cycles than emerging carriers, and many incumbent carriers have also announced
significant reductions in their capital expenditure budgets. Accordingly, there
can be no certainty as to the severity or duration of the current economic
downturn and its impact on our future revenue.
COST OF REVENUE
Cost of revenue decreased 75% or $59.7 million to $19.4 million for the three
months ended January 26, 2002 compared to $79.1 million for the same period in
fiscal 2001. Cost of revenue as a percentage of revenue was 89% for the three
months ended January 26, 2002, compared to 53% of revenue for the same period in
fiscal 2001. The overall increase in cost of revenue as a percentage of revenue
reflects the overall decrease in revenue and lower utilization of certain fixed
manufacturing and customer support costs. Cost of revenue for services decreased
28% or $2.7 million to $6.9 million for the three months ended January 26, 2002
compared to $9.6 million for the same period in fiscal 2001, due primarily to
the overall decrease in revenue and the corresponding decrease in customer
support costs due to the Company's restructuring activities. In addition to the
costs associated with supporting existing customers, cost of revenue for
services includes costs to support evaluations and trials for potential
customers, such as incumbent carriers which typically have relatively long sales
evaluation cycles.
Cost of revenue decreased 1% or $1.3 million to $142.0 million for the six
months ended January 26, 2002 compared to $143.3 million for the same period in
fiscal 2001. Cost of revenue for the six months ended January 26, 2002 includes
a charge of $102.4 million relating to excess inventory due to a significant
reduction in the Company's demand forecasts in the first quarter of fiscal 2002.
Excluding the effect of this charge, cost of revenue decreased by 72% to $39.6
million and represented 92% of total revenue for the six months ended January
26, 2002, compared to 53% for the same period in fiscal 2001. Excluding the
impact of the excess inventory charge, the overall increase in cost of revenue
as a percentage of revenue reflects the overall decrease in revenue and lower
utilization of certain fixed manufacturing and customer support costs. Cost of
revenue for services decreased 4% or $0.6 million to $15.2 million for the six
months ended January 26, 2002 compared to $15.8 million for the same period in
fiscal 2001, due primarily to the overall decrease in revenue and corresponding
decrease in customer support costs.
13
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses decreased $16.3 million to $26.0 million for
the three months ended January 26, 2002 compared to $42.3 million for the same
period in fiscal 2001. Research and development expenses decreased $15.5 million
to $62.5 million for the six months ended January 26, 2002 compared to $78.0
million for the same period in fiscal 2001. The decrease in expenses for each
period was primarily due to the Company's restructuring activities, which
resulted in a consolidation of product offerings and more focused development
efforts, enabling the Company to reduce costs for project materials and
personnel related expenses.
SALES AND MARKETING EXPENSES
Sales and marketing expenses decreased $10.5 million to $11.4 million for the
three months ended January 26, 2002 compared to $21.9 million for the same
period in fiscal 2001. Sales and marketing expenses decreased $14.2 million to
$25.1 million for the six months ended January 26, 2002 compared to $39.3
million for the same period in fiscal 2001. The decrease in expenses for each
period was primarily due to reduced costs for personnel and related expenses due
to the Company's restructuring activities as well as decreased program marketing
costs.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses decreased $2.0 million to $2.6 million for
the three months ended January 26, 2002 compared to $4.6 million for the same
period in fiscal 2001. General and administrative expenses decreased $2.8
million to $5.8 million for the six months ended January 26, 2002 compared to
$8.6 million for the same period in fiscal 2001. The decrease in expenses for
each period was primarily due to reduced costs for personnel and related
expenses due to the Company's restructuring activities.
AMORTIZATION OF STOCK COMPENSATION
Amortization of stock compensation expense increased $1.1 million to $7.6
million for the three months ended January 26, 2002 compared to $6.5 million for
the same period in fiscal 2001. Amortization of stock compensation expense
decreased $35.3 million to $13.9 million for the six months ended January 26,
2002 compared to $49.2 million for the same period in fiscal 2001. Amortization
of stock compensation expense primarily resulted from the granting of stock
options and restricted shares with exercise or sale prices which were deemed to
be below fair market value as well as the granting of options to non-employees
and consultants. The significant decrease in amortization expense for the six
months ended January 26, 2002 is primarily due to $36.3 million of amortization
expense that was recorded during the first quarter of fiscal 2001, due to the
accelerated vesting of certain restricted stock and stock options in connection
with the acquisition of Sirocco Systems, Inc. ("Sirocco"). Amortization of stock
compensation is expected to impact our reported results of operations through
the fourth quarter of fiscal 2005.
RESTRUCTURING CHARGES AND RELATED ASSET IMPAIRMENTS
As a result of a continued decline in overall economic conditions and further
reductions in capital spending by telecommunications service providers, we
implemented a second restructuring program in the first quarter of fiscal 2002,
designed to further reduce expenses to align resources with long-term growth
opportunities. The restructuring program included a workforce reduction,
consolidation of excess facilities, and charges related to excess inventory and
other asset impairments.
As a result of the restructuring program, we recorded restructuring charges and
related asset impairments of $77.3 million classified as operating expenses and
an excess inventory charge of $102.4 million classified as cost of revenue. In
addition, we recorded charges totaling $22.7 million classified as a
non-operating expense, relating to impairments of investments in non-publicly
traded companies that were determined to be other than temporary. We expect
pretax savings of approximately $45 million in annual operating expenses in
connection with the restructuring program and certain cost reduction
initiatives, as compared to the levels immediately preceding the restructuring
program.
The following paragraphs provide detailed information relating to the
restructuring charges and related asset impairments which were recorded during
the first quarter of fiscal 2002.
Workforce reduction
The restructuring program resulted in the reduction of 239 regular employees
across all business functions and geographic regions. The workforce reductions
were substantially completed in the first quarter of fiscal 2002. We recorded a
workforce reduction
14
charge of approximately $7.1 million relating primarily to severance and fringe
benefits. In addition the number of temporary and contract workers employed by
us was also reduced.
Consolidation of facilities and certain other costs
We recorded a charge of $17.2 million relating to the consolidation of excess
facilities and certain other costs. The total charge includes $11.2 million
related to the write-down of certain land, as well as lease terminations and
non-cancelable lease costs. We also recorded other restructuring costs of $6.0
million relating primarily to administrative expenses and professional fees in
connection with the restructuring activities.
Inventory and asset write-downs
We recorded a charge of $155.5 million relating to the write-down of inventory
to its net realizable value and the impairment of certain other assets. The
total charge includes $102.4 million of inventory write-downs and purchase
commitments for inventory which was recorded as part of cost of revenue. This
excess inventory charge was due to a severe decline in the demand for our
products. We also recorded charges totaling $53.1 million for asset impairments,
including the assets related to our vendor financing agreements and fixed assets
that were abandoned by us. Since revenue had been recognized under the vendor
financing agreements on a cash basis, the amount of the impairment loss was
limited to the cost of the systems shipped to the vendor financing customers,
which had been recorded in other long-term assets.
Losses on investments
We recorded charges totaling $22.7 million for impairments of investments in
non-publicly traded companies that were determined to be other than temporary.
The impairment charges were classified as a non-operating expense.
The restructuring charges and related asset impairments recorded in the first
quarter of fiscal 2002, and the reserve activity since that time, are summarized
as follows (in thousands):
Accrual
Total Balance at
Restructuring Non-cash Cash January 26,
Charge Charges Payments 2002
------ ------- -------- ----
Workforce reduction $ 7,106 $ 173 $ 5,267 $ 1,666
Facility consolidations and certain other costs 17,181 8,522 672 7,987
Inventory and asset write-downs 155,451 105,081 29,403 20,967
Losses on investments 22,737 22,737 -- --
-------- -------- -------- -------
Total $202,475 $136,513 $ 35,342 $30,620
======== ======== ======== =======
The remaining cash expenditures relating to workforce reductions will be
substantially paid by the third quarter of fiscal 2002. Facility consolidation
charges will be paid over the respective lease terms through fiscal 2005. We
expect to substantially complete the fiscal 2002 restructuring program by the
first quarter of fiscal 2003.
ACQUISITION COSTS
Acquisition costs for the first quarter of fiscal 2001 were $4.9 million related
to the acquisition of Sirocco. These costs included legal and accounting
services and other professional fees associated with the transaction.
INTEREST AND OTHER INCOME, NET
Interest and other income, net decreased $16.5 million to $9.8 million for the
three months ended January 26, 2002 compared to $26.3 million for the same
period in fiscal 2001. Interest and other income decreased $25.6 million to
$23.0 million for the six months ended January 26, 2002 compared to $48.6
million for the same period in fiscal 2001. The decreases in interest and other
income were primarily attributable to lower interest rates and a lower average
cash balance during each period in fiscal 2002.
15
PROVISION FOR INCOME TAXES
We did not provide for income taxes for the first or second quarters of fiscal
2002 or the first quarter of fiscal 2001 due to the net losses sustained in each
period. During the second quarter of fiscal 2001, we recorded a tax provision of
$7.4 million because our expectation at that time was that we would generate
taxable income for the full fiscal year. During the second half of fiscal 2001,
we began to incur net losses and accordingly, the provision for taxes currently
payable that was recorded in the second quarter of fiscal 2001 was subsequently
reversed.
LIQUIDITY AND CAPITAL RESOURCES
Total cash, cash equivalents and investments were $1.08 billion at January 26,
2002. Included in this amount were cash and cash equivalents of $294.2 million,
compared to $492.5 million at July 31, 2001. The decrease in cash and cash
equivalents of $198.3 million was attributable to cash used in operating
activities of $162.2 million and cash used in investing activities of $38.6
million, offset by cash provided by financing activities of $2.5 million.
Cash used in operating activities of $162.2 million consisted of the net loss
for the period of $283.3 million, adjusted for non-cash charges totaling $172.9
million and changes in working capital totaling $51.8 million, the most
significant component of which was a decrease in accounts payable of $51.5
million. Non-cash charges included depreciation and amortization, restructuring
charges and related asset impairments, and amortization of stock compensation.
Cash used in investing activities of $38.6 million consisted primarily of net
purchases of investments of $30.3 million and purchases of property and
equipment of $10.2 million. Cash provided by financing activities of $2.5
million consisted primarily of the proceeds received from employee stock plan
activity.
During the first quarter of fiscal 2002, each of our two major vendor financing
customers experienced a significant deterioration in their financial condition.
As a result, we determined that we were unlikely to realize any significant
proceeds from these vendor financing agreements. Accordingly, we recorded an
impairment charge for the assets related to these financing agreements, which
consisted of the cost of the systems shipped to the vendor financing customers,
and had been recorded in other long-term assets.
As a result of the financial demands of major network deployments, service
providers are continuing to request financing assistance from their suppliers.
From time to time we have provided extended payment terms on trade receivables
to certain key customers to assist them with their network deployment plans. In
addition, we may provide or commit to extend additional credit or credit
support, such as vendor financing, to our customers, as we consider appropriate
in the course of our business. Our ability to provide customer financing is
limited and depends on a number of factors, including our capital structure, the
level of our available credit and our ability to factor commitments. The
extension of financing to our customers will limit the capital that we have
available for other uses.
Currently, our primary source of liquidity comes from our cash and cash
equivalents and investments, which total $1.08 billion at January 26, 2002. Our
investments are classified as available-for-sale and consist of securities that
are readily convertible to cash, including certificates of deposits, commercial
paper and government securities, with original maturities ranging from 90 days
to three years. At January 26, 2002, $388.3 million of investments with
maturities of less than one year were classified as short-term investments, and
$398.0 million of investments with maturities of greater than one year were
classified as long-term investments. At current revenue levels, we anticipate
that some portion of our existing cash and cash equivalents and investments will
continue to be consumed by operations. Our accounts receivable, while not
considered a primary source of liquidity, represents a concentration of credit
risk because the accounts receivable balance at any point in time typically
consists of a relatively small number of customer account balances. At January
26, 2002, more than 90% of our accounts receivable balance was attributable to
two international customers. As of January 26, 2002, we do not have any
outstanding debt or credit facilities, and do not anticipate entering into any
debt or credit agreements in the foreseeable future. Our fixed commitments for
cash expenditures consist primarily of payments under operating leases, and are
substantially unchanged from those which were disclosed in Note 5 to the
consolidated financial statements included in the Company's Form 10-K for the
year ended July 31, 2001.
Based on our current plans and business conditions, we believe that our existing
cash, cash equivalents and investments will be sufficient to satisfy our
anticipated cash requirements for at least the next twelve months.
16
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
RISKS RELATED TO OUR BUSINESS
WE ARE EXPOSED TO GENERAL ECONOMIC CONDITIONS AND CONDITIONS SPECIFIC TO THE
TELECOMMUNICATIONS INDUSTRY
As a result of unfavorable economic conditions and a sudden and severe
decline in the purchasing patterns of our customers, our revenue began to
decline in the third quarter of fiscal 2001, and we have incurred significant
operating losses since that time. The economic downturn and reduced capital
spending by telecommunications service providers has also resulted in longer
selling cycles with extended trial periods for new equipment purchases. While we
have implemented restructuring and cost control programs to reduce our business
expenses, our costs are largely based on the requirements that we believe are
necessary to support sales to incumbent carriers, and a high percentage of our
expenses are, and will continue to be, fixed. As a result, we currently expect
to continue to incur operating losses unless revenue increases significantly
above the current levels.
In addition to the economic downturn and the decline in capital spending by
telecommunications service providers, recent terrorist acts and related military
actions appear to have added additional uncertainty to an already weak overall
economic environment. Further acts of war or terrorism, or related effects such
as disruptions in air transportation, enhanced security measures and political
instability in certain foreign countries, may adversely affect our business,
operating results and financial condition. Our business and results of
operations have been, and will continue to be seriously harmed if current
economic conditions do not improve.
WE ARE ENTIRELY DEPENDENT ON OUR LINE OF INTELLIGENT OPTICAL NETWORKING PRODUCTS
AND OUR FUTURE REVENUE DEPENDS ON THEIR COMMERCIAL SUCCESS
Our future revenue depends on the commercial success of our line of
intelligent optical networking products. As of January 26, 2002, our SN 3000
Optical Access Switch, SN 8000 Intelligent Optical Transport Node, SN 10000
Intelligent Optical Transport System, SN 16000 Intelligent Optical Switch and
Silvx Manager Network Management System are the only products that are currently
available for sale to customers. To be successful, we believe that we must
continually enhance the capabilities of our existing products, and successfully
develop and introduce new products. We cannot assure you that we will be
successful in completing the development, introduction or production
manufacturing of new products or enhancing our existing products. Failure of our
current or planned products to operate as expected could delay or prevent their
adoption. If our target customers do not adopt, purchase and successfully deploy
our current and planned products, our results of operations could be adversely
affected.
Our line of intelligent optical networking products enables the creation of
a fundamentally different, more flexible and data-centric network architecture
than those created by traditional SONET/SDH-based network equipment that has
historically been used by incumbent carriers for optical networking. While we
believe that our mesh-based architecture offers significant competitive
advantages over traditional SONET/SDH-based equipment, we are directing our
sales efforts towards incumbent carriers, many of which have made significant
investments in SONET/SDH-based equipment. If we are unable to convince incumbent
carriers to deploy our intelligent optical networking solutions and transition
their networks toward more flexible, data-centric mesh architectures, our
business and results of operations will be seriously harmed.
WE EXPECT THAT SUBSTANTIALLY ALL OF OUR REVENUE WILL BE GENERATED FROM A LIMITED
NUMBER OF CUSTOMERS, AND OUR REVENUE IS SUBSTANTIALLY DEPENDENT UPON SALES OF
PRODUCTS TO THESE CUSTOMERS
We currently have a limited number of customers, one of whom, Williams
Communications, accounted for 47%, 92%, and 100% of our revenue during fiscal
2001, 2000 and 1999, respectively. Another customer, 360networks, accounted for
11% of our revenue in fiscal 2001. As a result of unfavorable economic and other
conditions, several of our largest customers to date, including Williams and
360networks, have slowed their capital expenditures and decreased their rate of
ordering products from us. In any given quarter, a relatively small number of
customers typically comprise a large percentage of total revenue, though the
composition of these customers may vary from quarter to quarter. For the three
and six months ended January 26, 2002, two international customers represented
the majority of the Company's revenue.
Historically, a large percentage of our sales have been made to emerging
carriers such as Williams and 360networks. Many of these emerging carriers have
experienced severe financial difficulties, causing them to dramatically reduce
their capital expenditures, and in some cases, file for bankruptcy protection.
As a result, we believe that sales to emerging carriers are likely to remain at
reduced levels. To be successful, we will need to increase our sales to
incumbent carriers, which typically have longer
17
sales evaluation cycles and have also reduced their capital spending plans. In
addition, we have relatively limited experience in selling our products to
incumbent carriers. There can be no assurance that we will be successful in
increasing our sales to incumbent carriers.
None of our customers are contractually committed to purchase any minimum
quantities of products from us. We expect that in the foreseeable future a
majority of our revenue will continue to depend on sales of our intelligent
optical networking products to a limited number of customers. The rate at which
our current and prospective customers purchase products from us will depend, in
part, on their success in selling communications services based on these
products to their own customers. Many incumbent carriers have recently announced
reductions in their capital expenditure budgets, reduced their revenue
forecasts, or announced restructurings. Any failure of current or prospective
customers to purchase products from us for any reason, including any
determination not to install our products in their networks or a downturn in
their business, would seriously harm our financial condition or results of
operations.
WE EXPECT GROSS MARGINS TO REMAIN AT REDUCED LEVELS IN THE NEAR TERM
Our gross margins declined significantly compared to historical levels
beginning in the third quarter of fiscal 2001. In the second quarter of fiscal
2002, our gross profit was 11% of revenue, as compared to 47% of revenue for the
second quarter of fiscal 2001. We currently anticipate that gross margins are
likely to continue to be adversely affected by several factors, including
reduced demand for our products, the effects of new product introductions
including volumes and manufacturing efficiencies, component limitations, the mix
of products and services sold, competitive pricing, and possible increases in
inventory levels which could increase our exposure to excess and obsolete
inventory charges, such as the charge which occurred in the first quarter of
fiscal 2002.
OUR FAILURE TO GENERATE SUFFICIENT REVENUE WOULD PREVENT US FROM ACHIEVING
PROFITABILITY
Beginning in the third quarter of fiscal 2001, our revenue has declined
considerably and we have incurred significant operating losses since that time.
As of January 26, 2002, we had an accumulated deficit of $584.7 million. We
cannot assure you that our revenue will increase or that we will generate
sufficient revenue to achieve or sustain profitability. While we have
implemented restructuring programs designed to decrease the Company's business
expenses, we will continue to have large fixed expenses and we expect to
continue to incur significant sales and marketing, product development, customer
support and service, administrative and other expenses. As a result, we will
need to generate significantly higher revenue over the current levels in order
to achieve and maintain profitability.
THE UNPREDICTABILITY OF OUR QUARTERLY RESULTS MAY ADVERSELY AFFECT THE TRADING
PRICE OF OUR COMMON STOCK
Our revenue and operating results have varied significantly from quarter to
quarter. For example, from the fourth quarter of fiscal 1999 through the second
quarter of fiscal 2001, our revenue increased each quarter sequentially compared
to the previous quarter. However, beginning in the third quarter of fiscal 2001,
our revenue declined due to a sudden and severe decline in the purchasing
patterns of our customers, and as a result, we have incurred significant
operating losses since that time. We believe that our revenue and operating
results are likely to continue to vary significantly from quarter to quarter due
to a number of factors, many of which are outside of our control and any of
which may cause our stock price to fluctuate. The primary factors that may
affect us include the following:
* fluctuation in demand for intelligent optical networking products;
* the timing and size of sales of our products;
* the length and variability of the sales cycle for our products, which we
believe is increasing in length, due to overall market conditions and our
emphasis on selling to incumbent carriers;
* the timing of recognizing revenue and deferred revenue;
* new product introductions and enhancements by our competitors and
ourselves;
* changes in our pricing policies or the pricing policies of our competitors;
18
* our ability to develop, introduce and ship new products and product
enhancements that meet customer requirements in a timely manner;
* delays or cancellations by customers;
* our ability to obtain sufficient supplies of sole or limited source
components;
* increases in the prices of the components we purchase;
* our ability to attain and maintain production volumes and quality levels
for our products;
* manufacturing lead times;
* the timing and level of prototype expenses;
* costs related to acquisitions of technology or businesses;
* general economic conditions as well as those specific to the
telecommunications, Internet and related industries.
While we have implemented restructuring and cost control programs, we plan
to continue to invest in our business, to continue to maintain a strong product
development and customer support infrastructure that will enable us to move
quickly when economic conditions improve. Our operating expenses are largely
based on the requirements that we believe are necessary to support sales to
incumbent carriers, and a high percentage of our expenses are, and will continue
to be, fixed. As a result, we currently expect to continue to incur operating
losses unless revenue increases significantly above the current levels.
Due to the foregoing factors, we believe that quarter-to-quarter
comparisons of our operating results are not a good indication of our future
performance. You should not rely on our results for one quarter as any
indication of our future performance. Occurrences of the foregoing factors are
extremely difficult to predict. In addition, our ability to forecast our future
business has been significantly impaired by the general economic downturn. As a
result, our future operating results may be below our expectations or those of
public market analysts and investors, and our net sales may continue to decline
or recover at a slower rate than anticipated by us or analysts and investors. In
either event, the price of our common stock could decrease.
OUR PRODUCTS ARE COMPLEX AND ARE DEPLOYED IN COMPLEX ENVIRONMENTS AND MAY HAVE
ERRORS OR DEFECTS THAT WE FIND ONLY AFTER FULL DEPLOYMENT, WHICH COULD SERIOUSLY
HARM OUR BUSINESS
Our intelligent optical networking products are complex and are designed to
be deployed in large and complex networks. Our customers may discover errors or
defects in the hardware or the software, or the product may not operate as
expected after it has been fully deployed. From time to time, there may be
interruptions or delays in the deployment of our products due to product
performance problems or post delivery obligations. If we are unable to fix
errors or other problems, or if our customers experience interruptions or delays
that cannot be promptly resolved, we could experience:
* loss of or delay in revenue and loss of market share;
* loss of customers;
* failure to attract new customers or achieve market acceptance;
* diversion of development resources;
* increased service and warranty costs;
* delays in collecting accounts receivable;
* legal actions by our customers; and
* increased insurance costs,
any of which could seriously harm our financial condition or results of
operations.
19
THE LONG AND VARIABLE SALES CYCLES FOR OUR PRODUCTS MAY CAUSE REVENUE AND
OPERATING RESULTS TO VARY SIGNIFICANTLY FROM QUARTER TO QUARTER
A customer's decision to purchase our intelligent optical networking
products involves a significant commitment of its resources and a lengthy
evaluation, testing and product qualification process. As a result, our sales
cycle is lengthy and recently has increased in length, as we have directed our
sales efforts towards incumbent carriers. Throughout the sales cycle, we spend
considerable time and expense educating and providing information to prospective
customers about the use and features of our products. Even after making a
decision to purchase our products, we believe that most customers will deploy
the products slowly and deliberately. Timing of deployment can vary widely and
depends on the economic environment of our customers, the skills of our
customers, the size of the network deployment and the complexity of our
customers' network environment. Customers with complex networks usually expand
their networks in large increments on a periodic basis. Accordingly, we may
receive purchase orders for significant dollar amounts on an irregular and
unpredictable basis. Because of our limited operating history and the nature of
our business, we cannot predict these sales and deployment cycles. The long
sales cycles, as well as our expectation that customers will tend to
sporadically place large orders with short lead times, may cause our revenue and
results of operations to vary significantly and unexpectedly from quarter to
quarter.
OUR LIMITED OPERATING HISTORY MAKES FORECASTING DIFFICULT
We were founded in February 1998 and began shipping our first product in
May 1999. As a result, there is limited meaningful historical financial data
upon which investors may evaluate us and our prospects. We also have limited
historical financial data upon which to base our projected revenue. Our
operating expenses are largely based on the requirements that we believe are
necessary to support sales to incumbent carriers, and a high percentage of our
expenses are and will continue to be fixed. You should consider the risks and
difficulties frequently encountered by companies like ours in a rapidly evolving
market. Our ability to sell products and the level of success, if any, we
achieve depend, among other things, on the level of demand for intelligent
optical networking products, which continues to be a rapidly evolving market. If
we do not achieve our expected revenue, our operating results will be below our
expectations and the expectations of our investors and market analysts, which
could cause the price of our common stock to decline.
WE MAY NOT BE SUCCESSFUL IF OUR CUSTOMER BASE DOES NOT GROW
Our future success will depend on our attracting additional customers. The
growth of our customer base could be adversely affected by:
* customer unwillingness to implement our optical networking architecture;
* any delays or difficulties that we may incur in completing the development,
introduction and production manufacturing of our planned products or product
enhancements;
* new product introductions by our competitors;
* any failure of our products to perform as expected; or
* any difficulty we may incur in meeting customers' delivery, installation or
performance requirements.
OUR BUSINESS IS SUBJECT TO RISKS FROM INTERNATIONAL OPERATIONS
International sales represented 35% of total revenue in fiscal 2001, and
more than 50% of total revenue in the first half of fiscal 2002, and we expect
that international sales will continue to represent a significant portion of our
revenue. Doing business internationally requires significant management
attention and financial resources to successfully develop direct and indirect
sales channels and to support customers in international markets. While
international sales currently represent a high percentage of total revenue,
these sales are concentrated within a relatively small number of customers. We
may not be able to maintain or expand international market demand for our
products.
We have relatively limited experience in marketing, distributing and
supporting our products internationally and to do so, we expect that we will
need to develop versions of our products that comply with local standards. In
addition, international operations are subject to other inherent risks,
including:
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* greater difficulty in accounts receivable collection and longer
collection periods;
* difficulties and costs of staffing and managing foreign operations in
compliance with local laws and customs;
* necessity to work with third parties in certain countries to perform
installation and obtain customer acceptance, and the resulting potential
impact on revenue recognition;
* the impact of recessions in economies outside the United States;
* unexpected changes in regulatory requirements, including trade
protection measures and import and licensing requirements;
* certification requirements;
* currency fluctuations;
* reduced protection for intellectual property rights in some countries;
* potentially adverse tax consequences; and
* political and economic instability, particularly in emerging markets.
WE RELY ON SINGLE SOURCES FOR SUPPLY OF CERTAIN COMPONENTS AND OUR BUSINESS MAY
BE SERIOUSLY HARMED IF OUR SUPPLY OF ANY OF THESE COMPONENTS OR OTHER COMPONENTS
IS DISRUPTED
We currently purchase several key components, including commercial
digital signal processors, RISC processors, field programmable gate arrays,
SONET transceivers and erbium doped fiber amplifiers, from single or limited
sources. We purchase each of these components on a purchase order basis and have
no long-term contracts for these components. Although we believe that there are
alternative sources for each of these components, in the event of a disruption
in supply, we may not be able to develop an alternate source in a timely manner
or at favorable prices. Such a failure could hurt our ability to deliver our
products to our customers and negatively affect our operating margins. In
addition, our reliance on our suppliers exposes us to potential supplier
production difficulties or quality variations. For example, component yield
limitations negatively impacted our ability to manufacture and meet customer
demand for the SN 16000 product during fiscal 2001. While these yield
limitations have since been resolved, any future disruption in supply could
seriously impact our revenue and results of operations.
During the past year, the optical component industry has been
downsizing manufacturing capacity while consolidating product lines from earlier
acquisitions. This business environment could impact product deliveries and
result in the consolidation of product offerings. Because optical components are
integrated into our products, the business environment for optical component
manufacturers could negatively impact our revenue and results of operations.
WE DEPEND UPON CONTRACT MANUFACTURERS AND ANY DISRUPTION IN THESE RELATIONSHIPS
MAY CAUSE US TO FAIL TO MEET THE DEMANDS OF OUR CUSTOMERS AND DAMAGE OUR
CUSTOMER RELATIONSHIPS
We have limited internal manufacturing capabilities. We rely on
contract manufacturers to manufacture our products in accordance with our
specifications and to fill orders on a timely basis. Currently, the majority of
our products are produced under an agreement with Jabil Circuit, Inc., which
provides comprehensive manufacturing services, including assembly, test, control
and shipment to our customers, and procures material on our behalf. During the
normal course of business, we may provide demand forecasts to our contract
manufacturers up to six months prior to scheduled delivery of products to our
customers. If we overestimate our requirements, the contract manufacturers may
assess cancellation penalties or we may have excess inventory which could
negatively impact our gross margins. If we underestimate our requirements, the
contract manufacturers may have inadequate inventory, which could interrupt
manufacturing of our products and result in delays in shipment to our customers
and revenue recognition. During the first quarter of fiscal 2002, we recorded an
excess inventory charge of $102.4 million due to a severe decline in our
forecasted revenue. A portion of this charge was related to inventory purchase
commitments.
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We may not be able to effectively manage our relationship with our
contract manufacturers, and such contract manufacturers may not meet our future
requirements for timely delivery. Our contract manufacturers also build products
for other companies, and we cannot assure you that they will always have
sufficient quantities of inventory available to fill orders placed by our
customers or that they will allocate their internal resources to fill these
orders on a timely basis. In addition, our reliance on contract manufacturers
limits our ability to control the manufacturing processes of our products, which
exposes us to risks including the unpredictability of manufacturing yields and a
reduced ability to control the quality of finished products.
The contract manufacturing industry is highly competitive, and in
recent months, several major acquisitions within the industry have been
consummated or announced. While to date there has been no significant impact on
our contract manufacturers, future acquisitions could potentially have an
adverse effect on our working relationship with our contract manufacturers. For
example, in the event of a major acquisition involving one of our contract
manufacturers, difficulties could be encountered in the merger integration
process that could negatively impact our working relationship. Qualifying a new
contract manufacturer and commencing volume production is expensive and time
consuming and could result in a significant interruption in the supply of our
products. If we are required or choose to change contract manufacturers, we may
lose revenue and damage our customer relationships.
IF WE DO NOT RESPOND RAPIDLY TO TECHNOLOGICAL CHANGES, OUR PRODUCTS COULD BECOME
OBSOLETE
The market for intelligent optical networking products continues to
evolve, and has been characterized by rapid technological change, frequent new
product introductions and changes in customer requirements. We may be unable to
respond quickly or effectively to these developments. We may experience design,
manufacturing, marketing and other difficulties that could delay or prevent our
development, introduction or marketing of new products and enhancements. The
introduction of new products by competitors, market acceptance of products based
on new or alternative technologies or the emergence of new industry standards
could render our existing or future products obsolete.
In developing our products, we have made, and will continue to make,
assumptions about the standards that may be adopted by our customers and
competitors. If the standards adopted are different from those which we have
chosen to support, market acceptance of our products may be significantly
reduced or delayed and our business will be seriously harmed. The introduction
of products incorporating new technologies and the emergence of new industry
standards could render our existing products obsolete.
In addition, in order to introduce products incorporating new
technologies and new industry standards, we must be able to gain access to the
latest technologies of our customers, our suppliers and other network vendors.
Any failure to gain access to the latest technologies could impair the
competitiveness of our products.
CUSTOMER REQUIREMENTS ARE LIKELY TO EVOLVE, AND WE WILL NOT RETAIN CUSTOMERS OR
ATTRACT NEW CUSTOMERS IF WE DO NOT ANTICIPATE AND MEET SPECIFIC CUSTOMER
REQUIREMENTS
Our current and prospective customers may require product features and
capabilities that our current products do not have. To achieve market acceptance
for our products, we must effectively and timely anticipate and adapt to
customer requirements and offer products and services that meet customer
demands. Our failure to develop products or offer services that satisfy customer
requirements would seriously harm our ability to increase demand for our
products.
We intend to continue to invest in product and technology development.
The development of new or enhanced products is a complex and uncertain process
that requires the accurate anticipation of technological and market trends. We
may experience design, manufacturing, marketing and other difficulties that
could delay or prevent the development, introduction, volume production or
marketing of new products and enhancements. The introduction of new or enhanced
products also requires that we manage the transition from older products in
order to minimize disruption in customer ordering patterns and ensure that
adequate supplies of new products can be delivered to meet anticipated customer
demand. Our inability to effectively manage this transition would cause us to
lose current and prospective customers.
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OUR MARKET IS HIGHLY COMPETITIVE, AND OUR FAILURE TO COMPETE SUCCESSFULLY COULD
ADVERSELY AFFECT OUR MARKET POSITION
Competition in the public network infrastructure market is intense.
This market has historically been dominated by large companies, such as Nortel
Networks, Lucent Technologies, Alcatel and Ciena Corporation. In addition, a
number of smaller companies have either announced plans for new products or
introduced new products to address the same network problems which our products
address. Many of our current and potential competitors have significantly
greater selling and marketing, technical, manufacturing, financial and other
resources, including vendor-sponsored financing programs. Moreover, our
competitors may foresee the course of market developments more accurately and
could develop new technologies that compete with our products or even render our
products obsolete. Due to the rapidly evolving markets in which we compete,
additional competitors with significant market presence and financial resources
may enter those markets, thereby further intensifying competition.
In order to compete effectively, we must deliver products that:
* provide extremely high network reliability;
* scale easily and efficiently with minimum disruption to the network;
* interoperate with existing network designs and equipment vendors;
* reduce the complexity of the network by decreasing the need for
overlapping equipment;
* provide effective network management; and
* provide a cost-effective solution for service providers.
In addition, we believe that knowledge of the infrastructure
requirements applicable to service providers, experience in working with service
providers to develop new services for their customers and an ability to provide
vendor-sponsored financing, are important competitive factors in our market. We
have a limited ability to provide vendor-sponsored financing and this may
influence the purchasing decisions of prospective customers, who may decide to
purchase products from one of our competitors who are able to provide more
extensive financing programs. Furthermore, as we are increasingly directing our
sales efforts towards incumbent carriers which typically have longer sales
evaluation cycles, we believe that being able to demonstrate strong financial
viability is becoming an increasingly important consideration to our customers
in making their purchasing decisions.
If we are unable to compete successfully against our current and
future competitors, we could experience price reductions, order cancellations
and reduced gross margins, any one of which could materially and adversely
affect our business, results of operations and financial condition.
THE INDUSTRY IN WHICH WE COMPETE IS SUBJECT TO CONSOLIDATION
We believe that the industry in which we compete may enter into a
consolidation phase. Recently, one of our larger competitors, Ciena Corporation,
announced an agreement to acquire another company in our industry, ONI Systems.
Over the past year, the market valuations of the majority of companies in our
industry have declined significantly, and many companies have experienced
reduced revenue due to decreased customer demand in general, a smaller customer
base due to the financial difficulties impacting emerging carriers, financial
exposures due to customer financing commitments, and other factors. We expect
that the weakened financial position of many companies in our industry may cause
acquisition activity to increase. We believe that industry consolidation may
result in stronger competitors that are better able to compete as sole-source
vendors for customers. This could lead to more variability in operating results
as we compete to be a single vendor solution and could have a material adverse
effect on our business, operating results, and financial condition.
SALES TO EMERGING SERVICE PROVIDERS MAY INCREASE THE UNPREDICTABILITY OF OUR
RESULTS
As a result of economic and other conditions, emerging service
providers, which had been the early adopters of our technology, are no longer
able to continue to fund aggressive deployments. Accordingly, we currently
expect that sales to emerging service providers will remain at reduced levels
for the foreseeable future. However, in the event that economic and capital
market conditions were to improve, and emerging service providers elected to
increase their level of capital expenditures, the unpredictability of our
results may increase. The timing and volume of purchases by emerging service
providers tends to be unpredictable due to factors which include their need to
build a customer base and capacity while working within their budgetary
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constraints. Our ability to recognize revenue from emerging service providers
will depend on the relative financial strength of the particular customer. We
may be required to write off or decrease the value of our accounts receivable
from a customer whose financial condition materially deteriorates. For example,
during the fourth quarter of fiscal 2001, we recorded a specific provision for
doubtful accounts of $4.4 million, due to the filing for bankruptcy protection
by our customer, 360networks. In the event that sales to emerging service
providers increase in the future, changes in their financial condition or
decreases in their purchasing volumes could have a material adverse effect on
our results of operations.
THE INTELLIGENT OPTICAL NETWORKING MARKET IS EVOLVING AND OUR BUSINESS WILL
SUFFER IF IT DOES NOT DEVELOP AS WE EXPECT
The market for intelligent optical networking products continues to
evolve. In recent periods, there has been a sharp decline in capital spending by
our current and prospective customers. We cannot assure you that a viable market
for our products will develop or be sustainable. If this market does not
develop, develops more slowly than we expect or is not sustained, our business,
results of operations and financial condition would be seriously harmed.
IF OUR PRODUCTS DO NOT INTEROPERATE WITH OUR CUSTOMERS' NETWORKS, INSTALLATIONS
WILL BE DELAYED OR CANCELLED AND WE COULD HAVE SUBSTANTIAL PRODUCT RETURNS,
WHICH COULD SERIOUSLY HARM OUR BUSINESS
Many of our customers utilize multiple protocol standards, and each of
our customers may have different specification requirements to interface with
their existing networks. Our customers' networks contain multiple generations of
products that have been added over time as these networks have grown and
evolved. Specifically, incumbent carriers typically have less evolutionary
networks that contain more generations of products. Our products must
interoperate with all of the products within our customers' networks as well as
future products in order to meet our customers' requirements. The requirement
that we modify product design in order to achieve a sale may result in a longer
sales cycle, increased research and development expense and reduced margins on
our products. If our products do not interoperate with those of our customers'
networks, installations could be delayed, orders for our products could be
cancelled or our products could be returned. This would also seriously harm our
reputation, all of which could seriously harm our business and prospects.
UNDETECTED SOFTWARE OR HARDWARE ERRORS AND PROBLEMS ARISING FROM USE OF OUR
PRODUCTS IN CONJUNCTION WITH OTHER VENDORS' PRODUCTS COULD RESULT IN DELAYS OR
LOSS OF MARKET ACCEPTANCE OF OUR PRODUCTS
Networking products frequently contain undetected software or hardware
errors when first introduced or as new versions are released. We expect that
errors will be found from time to time in new or enhanced products after we
begin commercial shipments. In addition, service providers typically use our
products in conjunction with products from other vendors. 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 warranty, support and repair costs,
divert the attention of our engineering personnel from our product development
efforts and cause significant customer relations problems. The occurrence of
these problems could result in the delay or loss of market acceptance of our
products and would likely have a material adverse effect on our business,
results of operations and financial condition. Defects, integration issues or
other performance problems in our products could result in financial or other
damages to our customers or could damage market acceptance for our products. Our
customers could also seek damages for losses from us. A product liability claim
brought against us, even if unsuccessful, would likely be time consuming and
costly.
OUR FAILURE TO ESTABLISH AND MAINTAIN KEY CUSTOMER RELATIONSHIPS MAY RESULT IN
DELAYS IN INTRODUCING NEW PRODUCTS OR CAUSE CUSTOMERS TO FOREGO PURCHASING OUR
PRODUCTS
Our future success will also depend upon our ability to develop and
manage key customer relationships in order to introduce a variety of new
products and product enhancements that address the increasingly sophisticated
needs of our customers. Our failure to establish and maintain these customer
relationships may adversely affect our ability to develop new products and
product enhancements. In addition, we may experience delays in releasing new
products and product enhancements in the future. Material delays in introducing
new products and enhancements or our inability to introduce competitive new
products may cause customers to forego purchases of our products and purchase
those of our competitors, which could seriously harm our business.
The majority of our product sales to date have been to emerging
carriers rather than incumbent carriers. We believe that it is important for us
to increase our sales to incumbent carriers, including incumbent local exchange
carriers such as the Regional Bell Operating Companies ("RBOCs"). Incumbent
carriers typically have longer sales evaluation cycles than emerging carriers,
24
and we have limited experience in selling our products to incumbent carriers. In
addition, we are currently investing in product certification standards such as
the OSMINE standard, which will be necessary for us to increase our sales to the
RBOCs. While we have made a commitment to invest resources in obtaining these
certification standards, there is no assurance that such efforts will enable us
to increase our sales to incumbent carriers. Any failure to establish or
maintain strong customer relationships would likely have a material adverse
effect on our business and results of operations.
OUR FAILURE TO CONTINUALLY IMPROVE OUR INTERNAL CONTROLS AND SYSTEMS, AND RETAIN
NEEDED PERSONNEL COULD ADVERSELY AFFECT OUR RESULTS OF OPERATIONS
Since inception, the scope of our operations has increased and we have
grown our headcount substantially. However, over the past twelve months our
headcount levels have been reduced significantly, due primarily to our
restructuring activities. At January 26, 2002, we had a total of 694 employees,
which represents a reduction of approximately 35% from headcount levels
immediately prior to the restructuring actions. Our initial growth, followed by
more recent headcount reductions, has placed a significant strain on our
management systems and resources. Our ability to successfully offer our products
and services and implement our business plan in a rapidly evolving market
requires an effective planning and management process. We expect that we will
need to continue to improve our financial, managerial and manufacturing controls
and reporting systems, and will need to effectively manage our headcount levels
worldwide. We may not be able to implement adequate control systems in an
efficient and timely manner. In spite of recent economic conditions, competition
for highly skilled personnel is intense, especially in the New England area
where we are headquartered. Any failure to attract, assimilate or retain
qualified personnel to fulfill our current or future needs could adversely
affect our results of operations.
WE DEPEND ON OUR KEY PERSONNEL TO MANAGE OUR BUSINESS EFFECTIVELY IN A RAPIDLY
CHANGING MARKET, AND IF WE ARE UNABLE TO RETAIN OUR KEY EMPLOYEES, OUR ABILITY
TO COMPETE COULD BE HARMED
We depend on the continued services of our executive officers and
other key engineering, sales, marketing and support personnel, who have critical
industry experience and relationships that we rely on to implement our business
plan. None of our officers or key employees is bound by an employment agreement
for any specific term. We do not have "key person" life insurance policies
covering any of our employees. All of our key employees have been granted stock
options which are intended to represent an integral component of their
compensation package. These stock options may not provide the intended incentive
to our employees if our stock price declines or experiences significant
volatility. The loss of the services of any of our key employees, the inability
to attract and retain qualified personnel in the future, or delays in hiring
qualified personnel could delay the development and introduction of, and
negatively impact our ability to sell, our products.
IF WE BECOME SUBJECT TO UNFAIR HIRING, WRONGFUL TERMINATION OR OTHER EMPLOYMENT
RELATED CLAIMS, WE COULD INCUR SUBSTANTIAL COSTS IN DEFENDING OURSELVES
Companies in our industry, whose employees accept positions with
competitors, frequently claim that their competitors have engaged in unfair
hiring practices. We cannot assure you that we will not receive claims of this
kind or other claims relating to our employees, or that those claims will not
result in material litigation. During the third quarter of fiscal 2001 and the
first quarter of fiscal 2002, we terminated approximately 371 employees in
response to changing business conditions, and as a result, we may face claims
relating to their compensation and/or wrongful termination based on
discrimination. We could incur substantial costs in defending ourselves or our
employees against such claims, regardless of their merits. In addition,
defending ourselves or our employees against such claims could divert the
attention of our management away from our operations.
OUR ABILITY TO COMPETE COULD BE JEOPARDIZED IF WE ARE UNABLE TO PROTECT OUR
INTELLECTUAL PROPERTY RIGHTS FROM THIRD-PARTY CHALLENGES
We rely on a combination of patent, copyright, trademark and trade
secret laws and restrictions on disclosure to protect our intellectual property
rights. We also enter into confidentiality or license agreements with our
employees, consultants and corporate partners and control access to and
distribution of our software, documentation and other proprietary information.
Despite our efforts to protect our proprietary rights, unauthorized parties may
attempt to copy or otherwise obtain and use our products or technology.
25
Monitoring unauthorized use of our products is difficult and we cannot be
certain that the steps we have taken will prevent unauthorized use of our
technology, particularly in foreign countries where the laws may not protect our
proprietary rights as fully as in the United States. If competitors are able to
use our technology, our ability to compete effectively could be harmed.
IF NECESSARY LICENSES OF THIRD-PARTY TECHNOLOGY ARE NOT AVAILABLE TO US OR ARE
VERY EXPENSIVE, THE COMPETITIVENESS OF OUR PRODUCTS COULD BE IMPAIRED
From time to time we may be required to license technology from third
parties to develop new products or product enhancements. We cannot assure you
that third-party licenses will be available to us on commercially reasonable
terms, if at all. The inability to obtain any third-party license required to
develop new products and product enhancements could require us to obtain
substitute technology of lower quality or performance standards or at greater
cost, either of which could seriously harm the competitiveness of our products.
WE COULD BECOME SUBJECT TO CLAIMS REGARDING INTELLECTUAL PROPERTY RIGHTS, WHICH
COULD SERIOUSLY HARM OUR BUSINESS AND REQUIRE US TO INCUR SIGNIFICANT COSTS
In recent years, there has been significant litigation in the United
States involving patents and other intellectual property rights. Our industry in
particular is characterized by the existence of a large number of patents and
frequent claims and related litigation regarding patents and other intellectual
property rights. In the course of our business, we may receive claims of
infringement or otherwise become aware of potentially relevant patents or other
intellectual property rights held by other parties. We evaluate the validity and
applicability of these intellectual property rights, and determine in each case
whether we must negotiate licenses or cross-licenses to incorporate or use the
proprietary technologies in our products.
Any parties asserting that our products infringe upon their proprietary
rights would force us to defend ourselves and possibly our customers,
manufacturers or suppliers against the alleged infringement. Regardless of their
merit, these claims could result in costly litigation and subject us to the risk
of significant liability for damages. These claims, again regardless of their
merit, would likely be time consuming and expensive to resolve, would divert
management time and attention and would put the Company at risk to:
* stop selling, incorporating or using our products that use the
challenged intellectual property;
* obtain from the owner of the intellectual property right a license to
sell or use the relevant technology, which license may not be available
on reasonable terms, or at all;
* redesign those products that use such technology; or
* accept a return of products that use such technologies.
If we are forced to take any of the foregoing actions, our business may
be seriously harmed.
ANY ACQUISITIONS OR STRATEGIC INVESTMENTS WE MAKE COULD DISRUPT OUR BUSINESS AND
SERIOUSLY HARM OUR FINANCIAL CONDITION
As part of our ongoing business development strategy, we consider
acquisitions and strategic investments in complementary companies, products or
technologies. We completed the acquisition of Sirocco Systems, Inc. in September
2000, and may consider making other acquisitions from time to time. In the event
of an acquisition, we could:
* issue stock that would dilute our current stockholders' percentage
ownership;
* consume cash, which would reduce the amount of cash available for
other purposes;
* incur debt;
* assume liabilities;
* increase our ongoing operating expenses and level of fixed costs;
26
* record goodwill and non-amortizable intangible assets that will be
subject to impairment testing and potential periodic impairment charges;
* incur amortization expenses related to certain intangible assets;
* incur large and immediate write-offs; or
* become subject to litigation;
Our ability to achieve the benefits of any acquisition, will also
involve numerous risks, including:
* problems combining the purchased operations, technologies or products;
* unanticipated costs;
* diversion of management's attention from other business issues and
opportunities;
* adverse effects on existing business relationships with suppliers and
customers;
* risks associated with entering markets in which we have no or limited
prior experience; and
* problems with integrating employees and potential loss of key
employees.
We cannot assure you that we will be able to successfully integrate
any businesses, products, technologies or personnel that we might acquire in the
future and any failure to do so could disrupt our business and seriously harm
our financial condition.
As of January 26, 2002, we have made strategic investments in
privately held companies totaling approximately $26.0 million, and we may decide
to make additional investments in the future. During the first quarter of fiscal
2002, we recorded impairment losses of $22.7 million relating to these
investments. These types of investments are inherently risky as the market for
the technologies or products they have under development are typically in the
early stages and may never materialize. We could lose our entire investment in
certain or all of these companies.
Our strategic investments in privately held companies include an
investment of $2.2 million in Tejas Networks India Private Limited ("Tejas"),
which was made during the fiscal year ended July 31, 2001. The Chairman of the
Board of Sycamore also serves as the Chairman of the Board of Tejas. We have no
obligation to provide any additional funding to Tejas, and have not engaged in
any material transactions with Tejas since the date of our original investment.
ANY EXTENSION OF CREDIT TO OUR CUSTOMERS MAY SUBJECT US TO CREDIT RISKS AND
LIMIT THE CAPITAL THAT WE HAVE AVAILABLE FOR OTHER USES
We are experiencing increased demands for customer financing and we
expect these demands to continue. We believe it is a competitive factor in
obtaining business. From time to time we have provided extended payment terms on
trade receivables to certain key customers to assist them with their network
deployment plans. In addition, we may provide or commit to extend additional
credit or credit support, such as vendor financing, to our customers as we
consider appropriate in the course of our business. Such financing activities
subject us to the credit risk of customers whom we finance. In addition, our
ability to recognize revenue from financed sales will depend upon the relative
financial condition of the specific customer, among other factors. Although we
have programs in place to monitor the risk associated with vendor financing, we
cannot assure you that such programs will be effective in reducing our risk of
an impaired ability to pay on the part of a customer whom we have financed. We
could experience losses due to customers failing to meet their financial
obligations which could harm our business and materially adversely affect our
operating results and financial condition, such as the losses that we incurred
during the first quarter of fiscal 2002.
During the first quarter of fiscal 2002, we experienced losses
relating to our two existing vendor financing customers, as each of them
experienced a significant deterioration in their financial condition. As a
result, we determined that we were unlikely to realize any significant proceeds
from these vendor financing agreements. Accordingly, we recorded an impairment
charge for the assets related to these financing agreements, which consisted of
the cost of the systems shipped to the vendor financing customers, and had been
recorded in other long-term assets.
27
RISKS RELATED TO THE SECURITIES MARKET
OUR STOCK PRICE MAY CONTINUE TO BE VOLATILE
Historically, the market for technology stocks has been extremely
volatile. Our common stock has experienced, and may continue to experience,
substantial price volatility. The following factors could cause the market price
of our common stock to fluctuate significantly:
* our loss of a major customer;
* significant changes or slowdowns in the funding and spending patterns
of our current and prospective customers;
* the addition or departure of key personnel;
* variations in our quarterly operating results;
* announcements by us or our competitors of significant contracts, new
products or product enhancements;
* failure by us to meet product milestones;
* acquisitions, distribution partnerships, joint ventures or capital
commitments;
* variations between our actual results and the published expectations of
analysts;
* changes in financial estimates by securities analysts;
* sales of our common stock or other securities in the future;
* changes in market valuations of networking and telecommunications
companies; and
* fluctuations in stock market prices and volumes.
In addition, the stock market in general, and the Nasdaq National
Market and technology companies in particular, have experienced extreme price
and volume fluctuations that have often been unrelated or disproportionate to
the operating performance of such companies. These broad market and industry
factors may materially adversely affect the market price of our common stock,
regardless of our actual operating performance. In the past, following periods
of volatility in the market price of a company's securities, securities
class-action litigation has often been instituted against such companies.
Beginning on July 2, 2001, several purported securities class action
complaints were filed against the Company, several of its officers and directors
and the Company's lead underwriters in connection with the Company's initial
public offering and follow-on offering. The Company believes that the claims
against it are without merit and intends to defend against the complaints
vigorously. However, defending the Company and its officers against these
complaints may result in substantial costs and a diversion of management's
attention and resources. See Part II, Item 1 - Legal Proceedings for additional
details regarding these cases.
THERE MAY BE SALES OF A SUBSTANTIAL AMOUNT OF OUR COMMON STOCK THAT COULD CAUSE
OUR STOCK PRICE TO FALL, OR INCREASE THE VOLATILITY OF OUR STOCK PRICE
As of January 26, 2002, options to purchase a total of 31.2 million
shares of our common stock were outstanding. Included in this amount were
options to purchase approximately 12.6 million shares that were issued during
the second quarter of fiscal 2002, in accordance with the terms of an option
exchange program in which most of our employees were eligible to participate.
While these options are subject to vesting schedules, a number of the shares
underlying these options are freely tradable. Sales of a substantial number of
shares of our common stock could cause our stock price to fall or increase the
volatility of our stock price. In addition, sales of shares by our stockholders
could impair our ability to raise capital through the sale of additional stock.
28
INSIDERS OWN A SUBSTANTIAL NUMBER OF SYCAMORE SHARES AND COULD LIMIT YOUR
ABILITY TO INFLUENCE THE OUTCOME OF KEY TRANSACTIONS, INCLUDING CHANGES OF
CONTROL
As of January 26, 2002, the executive officers, directors and entities
affiliated with them, in the aggregate, beneficially owned approximately 41.5%
of our outstanding common stock. These stockholders, if acting together, would
be able to significantly influence matters requiring approval by our
stockholders, including the election of directors and the approval of mergers or
other business combination transactions.
PROVISIONS OF OUR CHARTER DOCUMENTS AND DELAWARE LAW MAY HAVE ANTI-TAKEOVER
EFFECTS THAT COULD PREVENT A CHANGE OF CONTROL
Provisions of our amended and restated certificate of incorporation,
by-laws, and Delaware law could make it more difficult for a third party to
acquire us, even if doing so would be beneficial to our stockholders.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The following discussion about our market risk involves forward-looking
statements. Actual results could differ materially from those projected in the
forward-looking statements. We are exposed to market risk related to changes in
interest rates and foreign currency exchange rates. We do not use derivative
financial instruments for speculative or trading purposes.
Interest Rate Sensitivity
We maintain a portfolio of cash equivalents and short-term and
long-term investments in a variety of securities including: commercial paper,
certificates of deposit, money market funds and government and non-government
debt securities. These available-for-sale securities are subject to interest
rate risk and may fall in value if market interest rates increase. If market
interest rates increase immediately and uniformly by 10 percent from levels at
January 26, 2002, the fair value of the portfolio would decline by approximately
$1.6 million. We have the ability to hold our fixed income investments until
maturity, and therefore do not expect our operating results or cash flows to be
affected to any significant degree by the effect of a sudden change in market
interest rates on our securities portfolio.
Exchange Rate Sensitivity
We operate primarily in the United States, and the majority of our
sales to date have been made in US dollars. However, our business has become
increasingly global, with international revenue representing 35% of total
revenue in fiscal 2001, and more than 50% of total revenue in the first half of
fiscal 2002. We anticipate that international sales will continue to represent a
significant portion of total revenue. As a result, we expect that sales in
non-dollar currencies and our exposure to foreign currency exchange rate
fluctuations are likely to increase. To date, international sales that create
exposure to foreign currency exchange rate fluctuations have been made primarily
in British Pounds and Japanese Yen. We are prepared to hedge against
fluctuations in foreign currencies if the exposure is material, although we have
not engaged in hedging activities to date.
29
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Beginning on July 2, 2001, several purported class action complaints were filed
in the United States District Court for the Southern District of New York
against the Company and several of its officers and directors and the
underwriters for the Company's initial public offering on October 21, 1999. Some
of the complaints also include the underwriters for the Company's follow-on
offering on March 14, 2000. The complaints were filed on behalf of persons who
purchased the Company's common stock during specified periods, all beginning on
October 21 or October 22, 1999 and ending on various dates, the latest of which
is August 10, 2001. The complaints are similar and allege violations of the
Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as
amended, primarily based on the assertion that the Company's lead underwriters,
the Company and the other named defendants made material false and misleading
statements in the Company's prospectus incorporated in its registration
statements on Form S-1 filed with the SEC in October 1999 and March 2000 because
of the failure to disclose (a) the alleged solicitation and receipt of excessive
and undisclosed commissions by the underwriters in connection with the
allocation of shares of common stock to certain investors in the Company's
public offerings and (b) that certain of the underwriters allegedly had entered
into agreements with investors whereby underwriters agreed to allocate the
public offering shares in exchange for which the investors agreed to make
additional purchases of stock in the aftermarket at pre-determined prices. The
complaints allege claims against the Company, several of the Company's officers
and directors and the underwriters under Sections 11 and 15 of the Securities
Act. The complaints also allege claims solely against the underwriter defendants
under Section 12(a)(2) of the Securities Act and some of the complaints allege
claims against the Company and the individual defendants under Section 10(b) of
the Exchange Act. The complaints against the Company have been consolidated into
a single action. Because the action against the Company is being coordinated
with over three hundred other nearly identical actions filed against other
companies, it is not yet clear when or whether a consolidated complaint will be
filed against the Company. The Company is not required to respond before a
consolidated complaint is filed. The actions seek damages in an unspecified
amount. The Company believes that the claims against it are without merit and
intends to defend against the complaints vigorously. The Company is not
currently able to estimate the possibility of loss or range of loss, if any,
relating to these claims.
The Company is subject to legal proceedings, claims, and litigation arising in
the ordinary course of business. While the outcome of these matters is currently
not determinable, management does not expect that the ultimate costs to resolve
these matters will have a material adverse effect on the Company's results of
operations or financial position.
Item 4. Submission of Matters to a Vote of Security Holders
At the Company's annual meeting held on December 13, 2001, the stockholders of
the Company elected the following nominees, each to serve for a three-year term
as a Class II Director and until his successor is elected and appointed:
Nominee For Withheld
------- --- --------
Gururaj Deshpande 226,138,641 876,137
Paul J. Ferri 226,071,367 943,411
Timothy A. Barrows, John W. Gerdelman and Daniel E. Smith also continued as
directors of the Company after the annual meeting.
At the same annual meeting, the stockholders of the Company ratified the
appointment of PricewaterhouseCoopers LLP as the Company's independent auditors
for the fiscal year ending July 31, 2002 by the following vote:
For Against Abstain
--- ------- -------
226,434,953 498,087 81,738
30
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits:
(a) List of Exhibits
Number Exhibit Description
------ -------------------
3.1 Amended and Restated Certificate of Incorporation of the Company
(2)
3.2 Certificate of Amendment to the Amended and Restated Certificate
of Incorporation of the Company (2)
3.3 Certificate of Amendment to the Amended and Restated Certificate
of Incorporation of the Company (3)
3.4 Amended and Restated By-Laws of the Company (2)
4.1 Specimen common stock certificate (1)
4.2 See Exhibits 3.1, 3.2, 3.3 and 3.4, for provisions of the
Certificate of Incorporation and By-Laws of the Registrant
defining the rights of holders of common stock of the Company
(2)(3)
4.3 Second Amended and Restated Investor Rights Agreement dated
February 26, 1999, as amended by Amendment No. 1 dated as of
July 23, 1999 (1)
4.4 Amendment No. 2 dated as of August 5, 1999 to the Second Amended
and Restated Investor Rights Agreement dated February 26, 1999
(2)
4.5 Amendment No. 3 dated as of September 20, 1999 to the Second
Amended and Restated Investor Rights Agreement dated February
26, 1999 (2)
4.6 Amendment No. 4 dated as of February 11, 2000 to the Second
Amended and Restated Investor Rights Agreement dated February
26, 1999 (2)
10.1 Separation agreement between the Company and Ryker Young
(1) Incorporated by reference to Sycamore Networks Inc.'s Registration
Statement on Form S-1 (Registration Statement No. 333-84635).
(2) Incorporated by reference to Sycamore Networks Inc.'s Registration
Statement on Form S-1 (Registration Statement No. 333-30630).
(3) Incorporated by reference to Sycamore Networks Inc.'s Quarterly Report
on Form 10-Q for the quarterly period ended January 27, 2001 filed with
the Commission on March 13, 2001.
(b) Reports on Form 8-K: None
31
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Sycamore Networks, Inc.
/s/ Frances M. Jewels
- ---------------------
Frances M. Jewels
Chief Financial Officer
(Duly Authorized Officer and Principal Financial and Accounting Officer)
Dated: March 4, 2002
32
EXHIBIT INDEX
Number Exhibit Description
------ -------------------
3.1 Amended and Restated Certificate of Incorporation of the
Company (2)
3.2 Certificate of Amendment to the Amended and Restated
Certificate of Incorporation of the Company (2)
3.3 Certificate of Amendment to the Amended and Restated
Certificate of Incorporation of the Company (3)
3.4 Amended and Restated By-Laws of the Company (2)
4.1 Specimen common stock certificate (1)
4.2 See Exhibits 3.1, 3.2, 3.3 and 3.4, for provisions of the
Certificate of Incorporation and By-Laws of the Registrant
defining the rights of holders of common stock of the Company
(2)(3)
4.3 Second Amended and Restated Investor Rights Agreement dated
February 26, 1999, as amended by Amendment No. 1 dated as of
July 23, 1999 (1)
4.4 Amendment No. 2 dated as of August 5, 1999 to the Second
Amended and Restated Investor Rights Agreement dated February
26, 1999 (2)
4.5 Amendment No. 3 dated as of September 20, 1999 to the Second
Amended and Restated Investor Rights Agreement dated February
26, 1999 (2)
4.6 Amendment No. 4 dated as of February 11, 2000 to the Second
Amended and Restated Investor Rights Agreement dated February
26, 1999 (2)
10.1 Separation agreement between the Company and Ryker Young
(1) Incorporated by reference to Sycamore Networks Inc.'s Registration
Statement on Form S-1 (Registration Statement No. 333-84635).
(2) Incorporated by reference to Sycamore Networks Inc.'s Registration
Statement on Form S-1 (Registration Statement No. 333-30630).
(3) Incorporated by reference to Sycamore Networks Inc.'s Quarterly Report
on Form 10-Q for the quarterly period ended January 27, 2001 filed with
the Commission on March 13, 2001.
33