<PAGE>
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
------------------------
FORM 10-Q
MARK ONE
<TABLE>
<C> <S>
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
</TABLE>
FOR THE QUARTERLY PERIOD ENDED JULY 31, 2000
<TABLE>
<C> <S>
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
</TABLE>
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
FINISAR CORPORATION
(Exact name of Registrant as specified in its charter)
<TABLE>
<S> <C> <C>
DELAWARE 000-27999 94-3038428
(State or other jurisdiction of (Commission File No.) (I.R.S. Employer
incorporation or organization) Identification No.)
1308 MOFFETT PARK DRIVE 94089
SUNNYVALE, CALIFORNIA (Zip Code)
(Address of principal executive
offices)
</TABLE>
Registrant's telephone number, including area code: 408-548-1000
------------------------
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 / /
At July 31, 2000 there were 160,112,969 shares of the registrant's common
stock, $.001 par value, issued and outstanding.
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<PAGE>
INDEX TO QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED JULY 31, 2000
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Balance Sheets (unaudited) as of April 30, 2000
and July 31, 2000......................................... 2
Condensed Statements of Operations (unaudited) for the
three months ended July 31, 1999 and July 31, 2000........ 3
Condensed Statements of Cash Flows (unaudited) for the
three months ended July 31, 1999 and July 31, 2000........ 4
Notes to Condensed Financial Statements (unaudited)....... 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations................................... 11
Item 3. Quantitative and Qualitative Disclosure About Market Risk... 27
PART II OTHER INFORMATION
Item 1. Legal Proceedings........................................... 28
Item 6. Exhibits and Reports on Form 8-K............................ 29
Signatures........................................................... 30
Index to Exhibits.................................................... 31
</TABLE>
1
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FINISAR CORPORATION
CONDENSED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
APRIL 30, JULY 31,
2000 2000
--------- -----------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $171,194 $103,022
Short-term investments.................................... 149,541 212,083
Accounts receivable-trade (net)........................... 14,348 20,215
Accounts receivable, other................................ 151 1,079
Inventories............................................... 16,494 23,594
Income tax receivable..................................... 148 148
Deferred income taxes..................................... 2,653 2,524
Prepaid expenses.......................................... 278 473
-------- --------
Total current assets........................................ 354,807 363,138
Other assets................................................ 809 733
Property, equipment and improvements, net................... 9,426 11,694
-------- --------
Total assets................................................ $365,042 $375,565
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 5,908 $ 8,397
Accrued compensation...................................... 3,001 1,934
Other accrued liabilities................................. 3,065 3,163
Income tax payable........................................ 122 2,099
-------- --------
Total current liabilities................................... 12,096 15,593
-------- --------
Long-term liabilities:
Deferred Tax Liability.................................... 392 392
Other long-term liabilities............................... 132 132
-------- --------
Total long-term liabilities................................. 524 524
-------- --------
Stockholders' equity:
Preferred stock, $0.001 par value; 5,000,000 shares
authorized; no shares issued or outstanding at April 30,
2000 and July 31, 2000.................................. -- --
Common stock:
$0.001 par value, 200,000,000 shares authorized:
159,842,784 and 160,112,969 shares issued and
outstanding at April 30, 2000 and July 31, 2000
respectively.......................................... 160 160
Additional paid-in capital................................ 384,526 385,927
Notes receivable from stockholders........................ (3,248) (2,921)
Deferred stock compensation............................... (9,404) (7,705)
Accumulated other comprehensive income (loss)............. (182) 194
Retained earnings (accumulated deficit)................... (19,430) (16,207)
-------- --------
Total stockholders' equity.................................. 352,422 359,448
-------- --------
Total liabilities and stockholders' equity.................. $365,042 $375,565
======== ========
</TABLE>
SEE ACCOMPANYING NOTES.
2
<PAGE>
FINISAR CORPORATION
CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
JULY 31,
-------------------
2000 1999
-------- --------
<S> <C> <C>
Revenues.................................................... $ 27,212 $ 13,879
Cost of revenues............................................ 16,471 6,252
-------- --------
Gross profit................................................ 10,741 7,627
-------- --------
Operating expenses:
Research and development.................................. 4,314 2,840
Sales and marketing....................................... 2,507 1,542
General and administrative................................ 1,385 759
Amortization of deferred stock compensation............... 1,699 287
-------- --------
Total operating expenses.................................... 9,905 5,428
-------- --------
Income from operations...................................... 836 2,199
Interest income (expense), net.............................. 4,445 (89)
Other non-operating income (expense) net.................... (22) (28)
-------- --------
Income before income taxes.................................. 5,259 2,082
Provision for income taxes.................................. 2,036 829
-------- --------
Net income.................................................. $ 3,223 $ 1,253
======== ========
Net income per share:
Basic..................................................... $ 0.02 $ 0.01
======== ========
Diluted................................................... $ 0.02 $ 0.01
======== ========
Shares used in computing net income per share:
Basic..................................................... 149,951 88,392
======== ========
Diluted................................................... 165,313 127,830
======== ========
</TABLE>
SEE ACCOMPANYING NOTES.
3
<PAGE>
FINISAR CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED, IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
JULY 31,
-------------------
2000 1999
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.................................................. $ 3,223 $ 1,253
Adjustments to reconcile net income to net cash from
operating activities:
Depreciation and amortization............................. 648 176
Amortization of deferred stock compensation............... 1,699 287
Loss on fixed assets disposal............................. -- --
Changes in operating assets and liabilities:
Accounts receivable....................................... (6,795) (906)
Inventories............................................... (7,100) (1,723)
Other assets.............................................. 10 (140)
Deferred income taxes..................................... -- --
Accounts payable.......................................... 2,489 1,120
Accrued compensation...................................... (1,067) (96)
Income tax payable........................................ 1,977 469
Other accrued liabilities................................. 98 473
-------- -------
Net cash provided by (used in) operating activities......... (4,818) 913
-------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment......................... (2,916) (550)
Purchase of short-term investments.......................... (62,166) --
Sale of short-term investments.............................. -- --
-------- -------
Net cash used in investing activities....................... (65,082) (550)
-------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on capital lease obligations....................... -- (16)
Proceeds from exercise of stock options, net of loans and
repurchase of unvested shares............................. 1,728 13
-------- -------
Net cash provided by (used in) financing activities......... 1,728 (3)
-------- -------
Net increase (decrease) in cash and cash equivalents........ (68,172) 360
Cash and cash equivalents at beginning of period............ 171,194 5,044
-------- -------
Cash and cash equivalents at end of period.................. $103,022 $ 5,404
======== =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest.................................... $ -- $ 188
======== =======
Cash paid for taxes....................................... $ 50 $ 360
======== =======
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING ACTIVITIES:
Issuance of common stock in exchange for notes
receivable.............................................. $ 108 $ 151
======== =======
</TABLE>
SEE ACCOMPANYING NOTES.
4
<PAGE>
FINISAR CORPORATION
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Finisar Corporation ("Finisar" or the "Company") was incorporated in the
state of California on April 17, 1987. In November 1999, Finisar reincorporated
in the state of Delaware. Finisar designs, manufactures, and markets fiber optic
subsystems and network performance test systems for high-speed data
communications.
INTERIM FINANCIAL INFORMATION AND BASIS OF PRESENTATION
The interim financial information at July 31, 2000 and for the three months
ended July 31, 2000 and 1999 is unaudited but, in the opinion of management, has
been prepared on the same basis as the annual financial statements and includes
all adjustments (consisting only of normal recurring adjustments) that Finisar
considers necessary for a fair presentation of its financial position at such
date and its operating results and cash flows for those periods. Results for the
interim period are not necessarily indicative of the results to be expected for
the entire year, or any future period.
The balance sheet at July 31, 2000 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.
FISCAL PERIODS
In fiscal 2000, the Company began to maintain its financial records on the
basis of a fiscal year ending on April 30, with fiscal quarters ending on the
Sunday closest to the end of the period (thirteen-week periods). For ease of
reference, all references to period end dates have been presented as though the
period ended on the last day of the calendar month. The first three quarters of
fiscal 2000 ended on August 1, 1999, October 31, 1999 and January 30, 2000,
respectively and the first quarter of fiscal 2001 ended on July 30, 2000.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from these estimates.
REVENUE RECOGNITION
Revenue is recognized at the time of product shipment, net of allowances for
estimated returns. Warranty expenses are also estimated and provided for at the
time of shipment.
CONCENTRATIONS OF CREDIT RISK
Financial instruments which potentially subject Finisar to concentrations of
credit risk include cash, cash equivalents, short-term investments and accounts
receivable. Finisar places its cash, cash equivalents and short-term investments
with high-credit quality financial institutions. Such investments are generally
in excess of FDIC insurance limits. Concentrations of credit risk, with respect
to accounts receivable, exist to the extent of amounts presented in the
financial statements. Accounts receivable
5
<PAGE>
FINISAR CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
from two customers represented 24.7% and 12.5% of the total balance at
April 30, 2000 and two customers represented 18.5% and 22.2% of the total
balance at July 31, 2000, respectively. Generally, Finisar does not require
collateral or other security to support customer receivables. Finisar performs
periodic credit evaluations of its customers and maintains an allowance for
potential credit losses based on historical experience and other information
available to management. Losses to date have been within management's
expectations.
CURRENT VULNERABILITIES DUE TO CERTAIN CONCENTRATIONS
Finisar sells products primarily to customers located in North America.
During the quarter ended July 31, 1999, revenues from two customers represented
36% and 19.2% and during the quarter ended July 31, 2000 revenues from 4
customers represented 10.6%, 17.5%, 21.3% and 11% of net revenues.
RESEARCH AND DEVELOPMENT
Research and development expenditures are charged to operations as incurred.
CASH AND CASH EQUIVALENTS
Finisar's cash equivalents consist of money market funds and highly liquid
short-term investments with qualified financial institutions. Finisar considers
all highly liquid investments with an original maturity from the date of
purchase of three months or less to be cash equivalents.
SHORT-TERM INVESTMENTS
Short-term investments consist of interest bearing securities with
maturities greater than 90 days. The Company has adopted the provisions of
Statement of Financial Accounting Standard No. 115, "Accounting for Certain
Investments in Debt and Equity Securities" ("SFAS 115"). Under SFAS 115, the
Company has classified its short-term investments as available-for-sale.
Available-for-sale securities are stated at market value and unrealized holding
gains and losses, net of the related tax effect, are excluded from earnings and
are reported as a separate component of stockholders' equity until realized. A
decline in the market value of the security below cost that is deemed other than
temporary is charged to earnings, resulting in the establishment of a new cost
basis for the security. At July 31, 2000, the Company's marketable investment
securities consisted of highly liquid investments in both taxable and tax free
municipal obligations with various maturity dates through February 1, 2003. The
difference between market value and cost of these securities at July 31, 2000
was a gain of $202,360 or $194,276 on an after-tax basis and at April 30, 2000
was a loss of $302,608 or $182,065 on an after tax basis.
INVENTORIES
Inventories are stated at the lower of cost (determined on a first-in,
first-out basis) or market.
PROPERTY, EQUIPMENT AND IMPROVEMENTS
Property, equipment and improvements are stated at cost, net of accumulated
depreciation and amortization. Property, equipment and improvements are
depreciated on a straight-line basis over the estimated useful lives of the
assets, generally five years.
6
<PAGE>
FINISAR CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
STOCK-BASED COMPENSATION
Finisar accounts for employee stock option grants in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB Opinion No. 25") and has adopted the disclosure-only
alternative of Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation" ("SFAS 123").
NET INCOME PER SHARE
Basic and diluted net income per share are presented in accordance with SFAS
No. 128, "Earnings Per Share" ("SFAS 128"), for all periods presented. Pursuant
to Securities and Exchange Commission Staff Accounting Bulletin No. 98, common
shares and convertible preferred shares issued or granted for nominal
consideration prior to the effective date of Finisar's initial public offering
are required to be included in the calculation of basic and diluted net income
per share as if they had been outstanding for all periods presented. To date,
Finisar has not had any issuances or grants for nominal consideration.
Effective April 12, 2000, the Company's shareholders approved a
three-for-one stock split in the form of a stock dividend. Accordingly, all
share and per-share data for all prior periods presented have been restated to
reflect this event.
Basic net income per share has been computed using the weighted-average
number of shares of common stock outstanding during the period. Diluted net
income per share has been computed using the weighted-average number of shares
of common stock and dilutive potential common shares from options (under the
treasury stock method) and convertible redeemable preferred stock (on an
if-converted basis) outstanding during the period.
COMPREHENSIVE INCOME
Financial Accounting Standards Board Statement of Financial Accounting
Standard No. 130, "Reporting Comprehensive Income" ("SFAS 130"). establishes
rules for reporting and display of comprehensive income and its components.
SFAS 130 requires unrealized gains or losses on the Company's available-for-sale
securities to be included in comprehensive income. The amount of the change in
net unrealized gain on available-for-sale securities in quarter ended July 31,
2000 was $504,968 or $376,341 on an after-tax basis.
SEGMENT REPORTING
Statement of Financial Accounting Standards No. 131, "Disclosures about
Segments of an Enterprise and Related Information" ("SFAS 131") establishes
standards for the way that public business enterprises report information about
operating segments in annual financial statements and requires that those
enterprises report selected information about operating segments in interim
financial reports. SFAS 131 also establishes standards for related disclosures
about products and services, geographic areas, and major customers. The Company
has determined it operates only in one segment.
7
<PAGE>
FINISAR CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
EFFECT OF NEW ACCOUNTING STATEMENTS
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities"
("SFAS 133"). Finisar is required to adopt SFAS 133 for the year ending
April 30, 2002. SFAS 133 establishes methods of accounting for derivative
financial instruments and hedging activities. Because Finisar currently holds no
derivative financial instruments as defined by SFAS 133 and does not currently
engage in hedging activities, adoption of SFAS 133 is not expected to have a
material effect on Finisar's financial condition or results of operations.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" ("SAB
101"). SAB 101 summarizes certain of the SEC Staff's views in applying generally
accepted accounting principles to revenue recognition in financial statements.
The Company is currently evaluating the impact of SAB 101. Should the Company
determine that a change in its accounting policy is necessary, such a change
will be made effective May 1, 2000 and would result in a charge to results of
operations for the cumulative effect of the change. This amount, if recognized,
would be recorded as deferred revenue and recognized as revenue in future
periods. Prior financial statements would not be restated.
2. NET INCOME PER SHARE
The following table presents the calculation of basic and diluted net income
per share (in thousands, except per share amounts):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
JULY 31,
-------------------
2000 1999
-------- --------
<S> <C> <C>
Numerator:
Net income................................................ $ 3,223 $ 1,253
======= =======
Historical:
Denominator for basic net income per share:
Weighted-average shares outstanding--basic................ 149,951 88,392
------- -------
Effect of dilutive securities:
Employee stock options.................................... 5,293 3,720
Stock subject to repurchase............................... 10,069 8,772
Convertible redeemable preferred stock.................... -- 26,946
------- -------
Dilutive potential common shares............................ 15,362 39,438
------- -------
Denominator for diluted net income per share................ 165,313 127,830
======= =======
Basic net income per share.................................. $ 0.02 $ 0.01
======= =======
Diluted net income per share................................ $ 0.02 $ 0.01
======= =======
</TABLE>
8
<PAGE>
FINISAR CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
3. INVENTORIES
Inventories consist of the following (in thousands):
<TABLE>
<CAPTION>
APRIL 30, JULY 31,
2000 2000
--------- --------
<S> <C> <C>
Raw materials............................................. $ 8,960 $15,822
Work-in-process........................................... 6,524 6,903
Finished goods............................................ 1,010 869
------- -------
$16,494 $23,594
======= =======
</TABLE>
4. PROPERTY, EQUIPMENT AND IMPROVEMENTS
Property, equipment and improvements consist of the following (in
thousands):
<TABLE>
<CAPTION>
APRIL 30, JULY 31,
2000 2000
--------- --------
<S> <C> <C>
Computer equipment........................................ $2,603 $ 1,954
Office equipment, furniture, and fixtures................. 833 1,186
Machinery and equipment................................... 6,144 9,107
Leasehold improvements.................................... 1,470 1,719
------ -------
11,050 13,966
Accumulated depreciation and amortization................. (1,624) (2,272)
------ -------
Property and equipment, net............................... $9,426 $11,694
====== =======
</TABLE>
5. INCOME TAXES
Income taxes for the respective periods were computed using the effective
tax rate estimated to be applicable for the fiscal year, which is subject to
ongoing review and evaluation by management.
6. DEFERRED STOCK COMPENSATION
In connection with the grant of certain stock options to employees, Finisar
recorded deferred stock compensation of $2.4 million during fiscal 1999 and
$13.0 million during fiscal 2000 prior to the Company's initial public offering,
representing the difference between the deemed value of our common stock for
accounting purposes and the option exercise price of these options at the date
of grant. Deferred stock compensation is presented as a reduction of
stockholders' equity, with graded amortization recorded over the five year
vesting period. The amortization expense relates to options awarded to employees
in all operating expense categories. The following table summarizes the amount
of deferred stock compensation expense which Finisar has recorded and the
amortization it has recorded and expects to record in future periods. Amounts to
be recorded in future periods could
9
<PAGE>
FINISAR CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
6. DEFERRED STOCK COMPENSATION (CONTINUED)
decrease if options for which accrued but unvested compensation has been
recorded are forfeited (in thousands):
<TABLE>
<CAPTION>
DEFERRED
STOCK
COMPENSATION AMORTIZATION
GENERATED EXPENSE
------------ ------------
<S> <C> <C>
Fiscal year ended April 30, 1999............................ $ 2,403 $ 428
Fiscal year ended April 30, 2000............................ 12,959 5,530
First quarter ended July 31, 2000 (unaudited)............... -- 1,699
Second quarter ending October 31, 2000 (unaudited).......... -- 940
Third quarter ending January 31, 2001 (unaudited)........... -- 901
Fourth quarter ending April 30, 2001 (unaudited)............ -- 888
Fiscal year ending April 30, 2002 (unaudited)............... -- 2,659
Fiscal year ending April 30, 2003 (unaudited)............... -- 1,467
Fiscal year ending April 30, 2004 (unaudited)............... -- 715
Fiscal year ending April 30, 2005 (unaudited)............... -- 135
------- -------
Total....................................................... $15,362 $15,362
======= =======
</TABLE>
7. SUBSEQUENT EVENT
On August 16, 2000 Finisar Corporation announced it had entered into a
definitive agreement to acquire privately-held Sensors Unlimited, Inc. Sensors
Unlimited, headquartered in Princeton, New Jersey, is a leading supplier of
optical components that monitor the performance of dense wavelength division
multiplexing (DWDM) systems. Sensors Unlimited has developed photodiode array
technology based on indium gallium arsenide (InGaAs) which is emerging as a cost
effective way to optimize the use of existing bandwidth in DWDM fiber optic
networks.
Under the terms of the agreement, Sensors Unlimited will merge with a
wholly-owned subsidiary of Finisar, and Sensors Unlimited stockholders will be
entitled to receive up to approximately 20.9 million shares of Finisar Common
Stock including shares issuable upon exercise of options assumed in the merger.
The Sensors Unlimited stockholders may elect to receive cash payments in lieu of
up to 10% of the shares issuable to them. The transaction will be accounted for
as a purchase and is intended to qualify as a tax-free reorganization. The
closing price of Finisar's Common Stock on August 15, 2000 was $32.50 per share,
giving the transaction an approximate value of $700 million.
Following the merger, Sensors Unlimited will operate as a subsidiary of
Finisar at its current facility in Princeton, New Jersey. Greg Olsen, Sensors
Unlimited's founder and its President and CEO, will join Finisar as an Executive
Vice President and a member of Finisar's Board of Directors. Olsen will also
continue to serve as President and CEO of the Sensors Unlimited subsidiary.
The transaction is expected to be completed in the fourth quarter of
calendar 2000 and is subject to approval by Sensors Unlimited's stockholders,
the notification requirements of the Hart-Scott-Rodino Antitrust Improvements
Act, and other customary conditions.
For the fiscal year ended December 31, 1999, Sensors Unlimited recorded
product revenues of $8.4 million and pretax income of $3.3 million (as an S
corporation). For the twelve months ended June 30, 2000, Sensors Unlimited
recorded unaudited product revenues of $14.9 million and pretax income of $6.0
million (as an S corporation). Historically, a substantial portion of their
expenses for research and development have been offset by government research
contracts.
10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion contains forward-looking statements that involve
risks and uncertainties. Our actual results could differ substantially from
those anticipated in these forward-looking statements as a result of many
factors, including those set forth under "--Risk Factors That Could Affect Our
Future Performance." The following discussion should be read together with our
financial statements and related notes thereto included elsewhere in this
document.
OVERVIEW
We are a leading provider of fiber optic subsystems and network performance
test systems which enable high-speed data communications over local area
networks, or LANs, and storage area networks, or SANs. Additionally, we have
recently developed products for digitizing the return path of a CATV network and
for aggregating data traffic in extended networks. We are focused on providing
high-performance, reliable, value-added optical subsystems for networking and
storage equipment manufacturers that develop and market systems based on Gigabit
Ethernet and Fibre Channel protocols. Our line of optical subsystems supports a
wide range of network applications, transmission speeds, distances and mediums.
We also provide unique network performance test systems which assist networking
and storage equipment manufacturers in the design of reliable, high-speed
networking systems and the testing and monitoring of the performance of these
systems.
Finisar was founded in 1988. We funded our initial product development
efforts largely through revenues derived under research and development
contracts. After shipping our first products in 1991, we continued to finance
our operations principally through internal cash flow and periodic bank
borrowings until November 1998. At that time we raised $5.6 million of net
proceeds from the sale of equity securities and bank borrowings to fund the
continued growth and development of our business. In November 1999, we received
net proceeds of $151 million from the initial public offering of shares of our
common stock, and in April 2000 we received $191 million from an additional
public offering of shares of our common stock.
Our revenues are derived principally from sales of our optical subsystems
and network performance test systems to networking and storage systems
manufacturers. Sales to our two largest customers accounted for 55.2% of our
revenues for the quarter ended July 31, 1999 and 38.8% of our revenues for the
quarter ended July 31, 2000. Although we are attempting to expand our customer
base, we expect that significant customer concentration will continue for the
foreseeable future.
We sell our products through our direct sales force, with the support of our
manufacturers' representatives, directly to domestic customers and indirectly
through distribution channels to international customers. We recognize revenues
at the time of shipment. The evaluation and qualification cycle prior to the
initial sale for our optical subsystems may span a year or more, while the sales
cycle for our test systems is usually considerably shorter. Historically,
substantially all of our sales have been made to customers in North America. To
address expanding international markets, we have recently established
relationships with distributors in Japan, the United Kingdom, Israel, Germany,
and Korea.
The market for optical subsystems is characterized by declining average
selling prices resulting from factors such as increased competition, the
introduction of new products and a rapid growth in unit volumes as manufacturers
continue to deploy network and storage systems. We anticipate that our average
selling prices will continue to decrease in future periods, although the timing
and amount of these decreases cannot be predicted with any certainty.
Our cost of revenues consists of materials, salaries and related expenses
for manufacturing personnel, manufacturing overhead and warranty expense. We
outsource the majority of our assembly operations, and we conduct manufacturing
engineering, supply chain management, quality assurance
11
<PAGE>
and documentation control at our facility in Sunnyvale, California. Accordingly,
a significant portion of our cost of revenues consists of payments to our
contract manufacturers. There can be no assurance that we will be able to reduce
our cost of revenues to keep pace with anticipated decreases in average selling
prices.
Our gross profit margins vary among our product families, and are generally
higher on our network performance test systems than on our optical subsystems.
Our gross margins are generally lower for newly introduced products and improve
as unit volumes increase. Our overall gross margins have fluctuated from period
to period as a result of shifts in product mix, the introduction of new
products, decreases in average selling prices for older products and our ability
to reduce product costs. As a result of a significant growth in sales of optical
subsystem products over the past several quarters, including sales of new
products to a number of new customers, we have experienced a sustained product
shift toward a greater percentage of optical subsystem products resulting in a
decline in overall gross margins.
Research and development expenses consist primarily of salaries and related
expenses for design engineers and other technical personnel, the cost of
developing prototypes and fees paid to consultants. We charge all research and
development expenses to operations as incurred. We believe that continued
investment in research and development is critical to our long-term success.
Accordingly, we expect that our research and development expenses will increase
in future periods.
Sales and marketing expenses consist primarily of commissions paid to
manufacturers' representatives, salaries and related expenses for personnel
engaged in sales, marketing and field support activities and other costs
associated with the promotion of our products. We intend to pursue aggressive
selling and marketing campaigns and to expand our direct sales organization. We
therefore expect that our sales and marketing expenses will increase in future
periods.
General and administrative expenses consist primarily of salaries and
related expenses for administrative, finance and human resources personnel,
professional fees and other corporate expenses. We expect that, in support of
our continued growth and our operations as a public company, general and
administrative expenses will continue to increase for the foreseeable future.
General and administrative expenses are also likely to be affected in future
periods by significant legal fees and expenses incurred in connection with
pending patent litigation.
In connection with the grant of stock options to employees between
August 1, 1998 and October 15, 1999, we recorded deferred stock compensation of
$2.4 million in fiscal 1999 and $13.0 million in fiscal 2000, representing the
difference between the deemed value of our common stock for accounting purposes
and the option exercise price of these options at the date of grant. Deferred
stock compensation is presented as a reduction of stockholder's equity, with
accelerated amortization recorded over the vesting period which is typically
five years. We amortized $287,000 and $1.7 million of deferred compensation
during quarters ended July 31, 1999 and July 31, 2000. We expect to record
additional amortization expense relating to deferred stock compensation
approximately as follows: $2.7 million during the remainder of fiscal 2001,
$2.7 million during fiscal 2002, $1.5 million during fiscal 2003 and $850,000
thereafter. The amount of deferred stock compensation expense to be recorded in
future periods could decrease if options for which accrued but unvested
compensation has been recorded are forfeited.
12
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth certain statement of operations data as a
percentage of revenues for the periods indicated:
<TABLE>
<CAPTION>
THREE MONTHS
ENDED JULY 31,
-----------------------
1999 2000
-------- --------
<S> <C> <C>
Revenues................................................... 100.0% 100.0%
Cost of revenues........................................... 45.0 60.5
----- -----
Gross profit............................................... 55.0 39.5
----- -----
Operating expenses:
Research and development................................. 20.5 15.9
Sales and marketing...................................... 11.1 9.2
General and administrative............................... 5.5 5.1
Amortization of deferred stock compensation.............. 2.1 6.2
----- -----
Total operating expenses............................... 39.2 36.4
----- -----
Income from operations..................................... 15.8 3.1
Interest income (expense), net............................. (0.6) 16.3
Other non-operating income (expense), net.................. (0.2) (0.1)
----- -----
Income before income taxes................................. 15.0 19.3
Provision for income taxes................................. 6.0 7.5
----- -----
Net income................................................. 9.0% 11.8%
===== =====
</TABLE>
Finisar operates in one reportable segment, the design, manufacture and
marketing of fiber optic subsystems and network performance test systems for
high-speed data communications. The following is a summary of operations within
geographic areas based on the location of the entity purchasing the Company's
product (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
JULY 31,
-----------------------
1999 2000
---- --------
<S> <C> <C>
Revenues (thousands):
Optical subsystems........................................ $ 9,480 $22,038
Test Instruments.......................................... 4,399 5,174
------- -------
$13,879 $27,212
======= =======
Geographic coverage (thousands):
United States............................................. $ 8,129 $23,142
Canada.................................................... 4,877 2,877
Rest of the World......................................... 873 1,193
------- -------
$13,879 $27,212
======= =======
</TABLE>
13
<PAGE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED
JULY 31,
-----------------------
1999 2000
---- --------
<S> <C> <C>
As a percent of revenues:
Optical subsystems........................................ 68.3% 81.0%
Test Instruments.......................................... 31.7 19.0
------- -------
100.0% 100.0%
======= =======
Geographic coverage:
United States............................................. 58.6% 85.0%
Canada.................................................... 35.1 10.6
Rest of the World......................................... 6.3 4.4
------- -------
100.0% 100.0%
======= =======
</TABLE>
Revenues generated in the U.S. and Canada (collectively, North America) are
all to customers located in those geographic regions.
COMPARISON OF FISCAL QUARTERS ENDED JULY 31, 1999 AND JULY 31, 2000
REVENUES. Revenues increased 96% from $13.9 million in quarter ended
July 31, 1999 to $27.2 million in quarter ended July 31, 2000. This reflects a
132% increase in sales of optical subsystems from $9.5 million in quarter ended
July 31, 1999 to $22.0 million in quarter ended July 31, 2000 and a 17.6%
increase in sales of test systems from $4.4 million in quarter ended July 31,
1999 to $5.2 million in quarter ended July 31, 2000. Sales of optical subsystems
and test systems represented 81.0% and 19.0%, respectively, of total revenues in
quarter ended July 31, 2000, and 68.3% and 31.7%, respectively, in quarter ended
July 31, 1999. Sales to our four principal customers during the quarters ended
July 31, 1999 and 2000 were as follows:
<TABLE>
<CAPTION>
QUARTER QUARTER
ENDED ENDED
JULY 31, JULY 31,
------------------- -----------------------
1999 2000 1999 2000
-------- -------- -------- --------
SALES (IN PERCENTAGE OF
MILLIONS) REVENUES
<S> <C> <C> <C> <C>
Alcatel Networks Corporation (formerly Newbridge
Networks)................................................. $5.0 $2.9 36.0% 10.6%
Brocade Communications Systems.............................. $0.0 $4.8 0.0% 17.5%
EMC......................................................... $2.7 $5.8 19.2% 21.3%
Emulex...................................................... $0.4 $3.0 3.2% 11.0%
</TABLE>
GROSS PROFIT. Gross profit increased from $7.6 million in quarter ended
July 31, 1999 to $10.7 million in quarter ended July 31, 2000. As a percentage
of revenues, gross profit decreased from 55.0% in quarter ended July 31, 1999 to
39.5% in quarter ended July 31, 2000. The lower gross margin reflects lower
average selling prices for optical subsystems as a result of increased shipment
levels and a higher percentage of total revenues from the sale of optical
subsystems (68.3% in quarter ended July 31, 1999 and 81.0% in quarter ended
July 31, 2000) which generally have lower gross margins than test systems.
RESEARCH AND DEVELOPMENT EXPENSES. Research and development expenses
increased 52% from $2.8 million in quarter ended July 31, 1999 to $4.3 million
in quarter ended July 31, 2000. This increase was primarily related to higher
compensation expense resulting from higher manpower levels and increased
expenditures for materials purchased for product development programs. Research
and development expenses as a percentage of revenues decreased from 20.5% in
quarter ended July 31, 1999 to 15.9% in quarter ended July 31, 2000.
14
<PAGE>
SALES AND MARKETING EXPENSES. Sales and marketing expenses increased 62.6%
from $1.5 million in quarter ended July 31, 1999 to $2.5 million in quarter
ended July 31, 2000. This increase was primarily due to increases in commissions
paid to manufacturers' representatives as a result of increased sales and
increases in the number of direct sales and marketing personnel. Sales and
marketing expenses as a percent of revenues decreased from 11.1% in quarter
ended July 31, 1999 to 9.2% in quarter ended July 31, 2000.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased 82.5% from $0.8 million in quarter ended July 31, 1999 to
$1.4 million in quarter ended July 31, 2000. This increase was related to higher
compensation expense resulting from higher manpower levels and increased
expenses for professional services, primarily legal and accounting services.
General and administrative expenses decreased as a percent of revenues from 5.5%
in quarter ended July 31, 1999 to 5.1% in quarter ended July 31, 2000.
INTEREST INCOME (EXPENSE), NET. Interest income, net of interest expense,
of $4,4 million in quarter ended July 31, 2000, compares to net interest expense
of $89,000 in quarter ended July 31, 1999. The increase in interest income was
the result of an increase in cash balances resulting from the Company's initial
public offering in November 1999 and an additional public offering in
April 2000. Interest expense in fiscal 1999 is related primarily to borrowings
of $11.0 million commencing in November of 1998 which were repaid from the
proceeds of the public offering in November 1999.
PROVISION FOR INCOME TAXES. The provision for income taxes increased from
$829,000 in quarter ended July 31, 1999 to $2.0 million in quarter ended
July 31, 2000 reflecting an effective tax rate of 39.8% and 38.7%, respectively.
Excluding the nondeductible charge for the amortization of deferred compensation
in both years, the effective tax rate was 35.0% in quarter ended July 31, 1999
and 29.3% in quarter ended July 31, 2000. The decrease reflects in part the
nontaxable nature of a portion of interest income earned during quarter ended
July 31, 2000. The effective tax rate differs from the statutory rate primarily
due to state taxes offset by research and development credits and projected
benefits from a foreign sales corporation. See Note 8 to our financial
statements included in our Form 10-K for the fiscal year ended April 30, 2000.
LIQUIDITY AND CAPITAL RESOURCES
From inception through November 1998, we financed our operations primarily
through internal cash flow and periodic bank borrowings. In November 1998, we
raised $5.6 million of net proceeds from the sale of preferred stock and bank
borrowings to fund the continued growth and development of our business. In
November 1999, we received net proceeds of $151 million from the initial public
offering of our common stock, and in April 2000 we received $191 million from an
additional public offering.
As of July 31, 2000, our principal sources of liquidity were $315.1 million
in cash, cash equivalents and short-term investments, and $6.5 million available
under a revolving loan facility that matures October 31, 2003. Borrowings under
the facility are collateralized by substantially all of our assets and bear
interest at our election at the time of borrowing at either the London Interbank
Offering Rate or the bank's prime rate. There were no borrowings under this
facility as of July 31, 2000.
Net cash used in operating activities totaled $4.8 million in quarter ended
July 31, 2000 while $0.9 million was provided by operating activities in quarter
ended July 31, 1999. The use of net cash in operating activities in quarter
ended July 31, 2000 was primarily a result of continuing growth in revenues and
net income which was more than offset by an increase in assets and liabilities
for working capital purposes. Cash provided by operations during quarter ended
July 31, 1999 was primarily a result of continued growth in revenues and net
income offset in part by an increase in related assets and liabilities for
working capital purposes.
15
<PAGE>
Net cash used in investing activities of $65.1 million in quarter ended
July 31, 2000 consisted primarily of short-term investments totaling
$62.2 million which generally mature greater than 90 days from the initial date
of purchase. Other investing activities during quarter ended July 31, 2000
consisted primarily of purchases of equipment and leasehold improvements
totaling $2.9 million. Net cash used in investing activities of $.6 million in
quarter ended July 31, 1999 consisted primarily of purchases of equipment.
Net cash provided by financing activities in the quarter ended July 31, 2000
reflected net proceeds to us of $1.7 million from the exercise of employee stock
options, net of loans and repurchase of unvested shares. Net cash provided by
financing activities totaled $0.0 million in quarter ended July 31, 1999.
We had no material commitments for capital expenditures at July 31, 2000. We
have total minimum lease obligations of $12.4 million from April 30, 2000
through April 30, 2007, under non-cancelable operating leases.
We believe that our existing balances of cash and cash equivalents, together
with our available credit facilities and cash flow expected to be generated from
our future operations, will be sufficient to meet our cash needs for working
capital and capital expenditures for at least the next 12 months.
RECENT ACCOUNTING PRONOUNCEMENT
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements," or
SAB 101. SAB 101 summarizes certain of the SEC Staff's views in applying
generally accepted accounting principles to revenue recognition in financial
statements. We are currently evaluating the impact of SAB 101. Should we
determine that a change in our accounting policy is necessary, such a change
will be made effective May 1, 2000 and would result in a charge to results of
operations for the cumulative effect of the change. This amount, if recognized,
would be recorded as deferred revenue and recognized as revenue in future
periods. Financial statements for prior periods would not be restated.
FACTORS THAT COULD AFFECT OUR FUTURE PERFORMANCE
OUR FUTURE PERFORMANCE IS SUBJECT TO A VARIETY OF RISKS. IF ANY OF THE
FOLLOWING RISKS ACTUALLY OCCUR, OUR BUSINESS COULD BE HARMED AND THE TRADING
PRICE OF OUR COMMON STOCK COULD DECLINE. YOU SHOULD ALSO REFER TO THE OTHER
INFORMATION CONTAINED IN THIS REPORT, INCLUDING OUR FINANCIAL STATEMENTS AND THE
RELATED NOTES.
OUR FUTURE REVENUES ARE UNPREDICTABLE, OUR OPERATING RESULTS ARE LIKELY TO
FLUCTUATE FROM QUARTER TO QUARTER, AND IF WE FAIL TO MEET THE EXPECTATIONS OF
SECURITIES ANALYSTS OR INVESTORS, OUR STOCK PRICE COULD DECLINE SIGNIFICANTLY
Our quarterly and annual operating results have fluctuated in the past and
are likely to fluctuate significantly in the future due to a variety of factors,
some of which are outside of our control. Accordingly, we believe that
period-to-period comparisons of our results of operations are not meaningful and
should not be relied upon as indications of future performance. Some of the
factors that could cause our quarterly or annual operating results to fluctuate
include market acceptance of our products and the Gigabit Ethernet and Fibre
Channel standards, product development and production, competitive pressures and
customer retention.
We may experience a delay in generating or recognizing revenues for a number
of reasons. Orders at the beginning of each quarter typically do not equal
expected revenues for that quarter and are generally cancelable at any time.
Accordingly, we depend on obtaining orders during a quarter for shipment in that
quarter to achieve our revenue objectives. Failure to ship these products by the
end of a quarter may adversely affect our operating results. Furthermore, our
customer agreements typically
16
<PAGE>
provide that the customer may delay scheduled delivery dates and cancel orders
within specified time frames without significant penalty. Because we base our
operating expenses on anticipated revenue trends and a high percentage of our
expenses are fixed in the short term, any delay in generating or recognizing
forecasted revenues could significantly harm our business.
It is likely that in some future quarters our operating results may fall
below the expectations of securities analysts and investors. In this event, the
trading price of our common stock would significantly decline.
OUR SUCCESS IS DEPENDENT ON THE CONTINUED DEVELOPMENT OF THE EMERGING HIGH-SPEED
LAN, SAN, CATV NETWORK AND EXTENDED NETWORK MARKETS
Our optical subsystem and network performance test system products are used
exclusively in high-speed local area networks, or LANs, storage area networks,
or SANs, cable television, or CATV, networks and extended networks. Accordingly,
widespread adoption of high-speed LANs, SANs and extended networks and the
adoption of digital return path technology for CATV network applications is
critical to our future success. The markets for high-speed LANs, SANs, CATV
networks and extended networks have only recently begun to develop and are
rapidly evolving. Because these markets are new and evolving, it is difficult to
predict their potential size or future growth rate. Potential end-user customers
who have invested substantial resources in their existing data storage and
management systems may be reluctant or slow to adopt a new approach, like
high-speed LANs, SANs, CATV networks or extended networks. Our success in
generating revenue in these emerging markets will depend, among other things, on
the growth of these markets. There is significant uncertainty as to whether
these markets ultimately will develop or, if they do develop, that they will
develop rapidly. If the markets for high-speed LANs, SANs, CATV networks or
extended networks fail to develop or develop more slowly than expected, or if
our products do not achieve widespread market acceptance in these markets, our
business would be significantly harmed.
WE WILL FACE CHALLENGES TO OUR BUSINESS IF OUR TARGET MARKETS ADOPT ALTERNATE
STANDARDS TO FIBRE CHANNEL AND GIGABIT ETHERNET TECHNOLOGY OR IF OUR PRODUCTS
FAIL TO COMPLY WITH EVOLVING INDUSTRY STANDARDS AND GOVERNMENT REGULATIONS
We have based our product offerings principally on Fibre Channel and Gigabit
Ethernet standards and our future success is substantially dependent on the
continued market acceptance of these standards. If an alternative technology is
adopted as an industry standard within our target markets, we would have to
dedicate significant time and resources to redesign our products to meet this
new industry standard. For example, manufacturers have begun to develop
networking systems with per-port transmission speeds of 10 gigabits per second,
or Gbps, ten times faster than Gigabit Ethernet. We cannot assure you that we
will be successful in redesigning our products or developing new products to
meet this new standard or any other standard that may emerge. Our products
comprise only a part of an entire networking system, and we depend on the
companies that provide other components to support industry standards as they
evolve. The failure of these companies, many of which are significantly larger
than we are, to support these industry standards could negatively impact market
acceptance of our products. Moreover, if we introduce a product before an
industry standard has become widely accepted, we may incur significant expenses
and losses due to lack of customer demand, unusable purchased components for
these products and the diversion of our engineers from future product
development efforts. In addition, because we may develop some products prior to
the adoption of industry standards, we may develop products that do not comply
with the eventual industry standard. Our failure to develop products that comply
with industry standards would limit our ability to sell our products. Finally,
if new standards evolve, we may not be able to successfully design and
manufacture new products in a timely fashion, if at all, that meet these new
standards.
17
<PAGE>
In the United States, our products must comply with various regulations and
standards defined by the Federal Communications Commission and Underwriters
Laboratories. Internationally, products that we develop also will be required to
comply with standards established by local authorities in various countries.
Failure to comply with existing or evolving standards established by regulatory
authorities or to obtain timely domestic or foreign regulatory approvals or
certificates could significantly harm our business.
WE DEPEND ON LARGE PURCHASES FROM A FEW SIGNIFICANT CUSTOMERS, AND ANY LOSS,
CANCELLATION, REDUCTION OR DELAY IN PURCHASES BY THESE CUSTOMERS COULD HARM OUR
BUSINESS
A small number of customers have accounted for a significant portion of our
revenues. Our success will depend on our continued ability to develop and manage
relationships with significant customers. Sales to Alcatel Networks Corporation
(formerly Newbridge Networks Corporation), Brocade Communications Systems, EMC
Corporation and Emulex and represented 10.6%, 17.5%, 21.3% and 11.0%
respectively, of our revenues during quarter ended July 31, 2000 and 36.0%,
0.0%, 19.2% and 3.2%, respectively, of our revenues for quarter ended July 31,
1999. Although we are attempting to expand our customer base, we expect that
significant customer concentration will continue for the foreseeable future.
The markets in which we sell our products are dominated by a relatively
small number of systems manufacturers, thereby limiting the number of our
potential customers. Our dependence on large orders from a relatively small
number of customers makes our relationship with each customer critically
important to our business. We cannot assure you that we will be able to retain
our largest customers, that we will be able to attract additional customers or
that our customers will be successful in selling their products that incorporate
our products. We have in the past experienced delays and reductions in orders
from some of our major customers. In addition, our customers have in the past
sought price concessions from us and will continue to do so in the future.
Further, some of our customers may in the future shift their purchases of
products from us to our competitors or to joint ventures between these customers
and our competitors. The loss of one or more of our largest customers, any
reduction or delay in sales to these customers, our inability to successfully
develop relationships with additional customers or future price concessions that
we may make could significantly harm our business.
BECAUSE WE DO NOT HAVE LONG-TERM CONTRACTS WITH OUR CUSTOMERS, OUR CUSTOMERS MAY
CEASE PURCHASING OUR PRODUCTS AT ANY TIME IF WE FAIL TO MEET OUR CUSTOMERS'
NEEDS
We do not have long-term contracts with our customers. As a result, our
agreements with our customers do not provide any assurance of future sales.
Accordingly:
- our customers can stop purchasing our products at any time without
penalty;
- our customers are free to purchase products from our competitors; and
- our customers are not required to make minimum purchases.
Sales are typically made pursuant to individual purchase orders, often with
extremely short lead times. If we are unable to fulfill these orders in a timely
manner, we will lose sales and customers.
OUR MARKET IS SUBJECT TO RAPID TECHNOLOGICAL CHANGE, AND TO COMPETE EFFECTIVELY,
WE MUST CONTINUALLY INTRODUCE NEW PRODUCTS THAT ACHIEVE MARKET ACCEPTANCE
The markets for our products are characterized by rapid technological
change, frequent new product introductions, changes in customer requirements and
evolving industry standards. We expect that new technologies will emerge as
competition and the need for higher and more cost effective bandwidth increases.
Our future performance will depend on the successful development, introduction
and market acceptance of new and enhanced products that address these changes as
well as current
18
<PAGE>
and potential customer requirements. The introduction of new and enhanced
products may cause our customers to defer or cancel orders for existing
products. We have in the past experienced delays in product development and such
delays may occur in the future. Therefore, to the extent customers defer or
cancel orders in the expectation of a new product release or there is any delay
in development or introduction of our new products or enhancements of our
products, our operating results would suffer. We also may not be able to develop
the underlying core technologies necessary to create new products and
enhancements, or to license these technologies from third parties. Product
development delays may result from numerous factors, including:
- changing product specifications and customer requirements;
- difficulties in hiring and retaining necessary technical personnel;
- difficulties in reallocating engineering resources and overcoming resource
limitations;
- difficulties with contract manufacturers;
- changing market or competitive product requirements; and
- unanticipated engineering complexities.
The development of new, technologically advanced products is a complex and
uncertain process requiring high levels of innovation and highly skilled
engineering and development personnel, as well as the accurate anticipation of
technological and market trends. We cannot assure you that we will be able to
identify, develop, manufacture, market or support new or enhanced products
successfully, if at all, or on a timely basis. Further, we cannot assure you
that our new products will gain market acceptance or that we will be able to
respond effectively to product announcements by competitors, technological
changes or emerging industry standards. Any failure to respond to technological
change would significantly harm our business.
CONTINUED COMPETITION IN OUR MARKETS MAY LEAD TO A REDUCTION IN OUR PRICES,
REVENUES AND MARKET SHARE
The markets for optical subsystems and network performance test systems for
use in LANs, SANs, CATV networks and extended networks are highly competitive.
Our current competitors include a number of domestic and international
companies, many of which have substantially greater financial, technical,
marketing, distribution resources and brand name recognition than we have. We
expect that more companies, including some of our customers, will enter the
market for optical subsystems and network performance test systems. We may not
be able to compete successfully against either current or future competitors.
Increased competition could result in significant price erosion, reduced
revenue, lower margins or loss of market share, any of which would significantly
harm our business. For optical subsystems, we compete primarily with Agilent
Technologies, Inc., Infineon Technologies, International Business Machines
Corporation, Stratos Lightwave (formerly Methode Electronics), Molex Premise
Networks and Vixel Corporation. For network performance test systems, we compete
primarily with Ancot Corporation, I-Tech Corporation and Xyratex International.
Our competitors continue to introduce improved products with lower prices, and
we will have to do the same to remain competitive. In addition, some of our
current and potential customers may attempt to integrate their operations by
producing their own optical subsystems and network performance test systems or
acquiring one of our competitors, thereby eliminating the need to purchase our
products. Furthermore, larger companies in other related industries, such as the
telecommunications industry, may develop or acquire technologies and apply their
significant resources, including their distribution channels and brand name
recognition, to capture significant market share.
19
<PAGE>
DECREASES IN AVERAGE SELLING PRICES OF OUR PRODUCTS MAY REDUCE GROSS MARGINS
The market for optical subsystems is characterized by declining average
selling prices resulting from factors such as increased competition, the
introduction of new products and increased unit volumes as manufacturers
continue to deploy network and storage systems. We have in the past experienced,
and in the future may experience, substantial period-to-period fluctuations in
operating results due to declining average selling prices. We anticipate that
average selling prices will decrease in the future in response to product
introductions by competitors or us, or by other factors, including price
pressures from significant customers. Therefore, we must continue to develop and
introduce on a timely basis new products that incorporate features that can be
sold at higher average selling prices. Failure to do so could cause our revenues
and gross margins to decline, which would significantly harm our business.
We may be unable to reduce the cost of our products sufficiently to enable
us to compete with others. Our cost reduction efforts may not allow us to keep
pace with competitive pricing pressures or lead to improved gross margins. In
order to remain competitive, we must continually reduce the cost of
manufacturing our products through design and engineering changes. We may not be
successful in redesigning our products or delivering our products to market in a
timely manner. We cannot assure you that any redesign will result in sufficient
cost reductions to allow us to reduce the price of our products to remain
competitive or improve our gross margin.
SHIFTS IN OUR PRODUCT MIX MAY RESULT IN DECLINES IN GROSS MARGINS
Our gross profit margins vary among our product families, and our gross
margins are generally higher on our network performance test systems than on our
optical subsystems. Our gross margins are generally lower for newly introduced
products and improve as unit volumes increase. Our overall gross margins have
fluctuated from period to period as a result of shifts in product mix, the
introduction of new products, decreases in average selling prices for older
products and our ability to reduce product costs. As a result of a significant
growth in sales of optical subsystem products over the past several quarters,
including sales of new products to a number of new customers, we have
experienced a sustained product shift toward a greater percentage of optical
subsystem products resulting in a decline in overall gross margins.
WE ARE SUBJECT TO A PENDING LEGAL PROCEEDING
In April 1999, Methode, a manufacturer of electronic component devices,
filed a lawsuit against us and another manufacturer alleging that our
optoelectronic products infringe four patents held by Methode. The original
complaint sought monetary damages and injunctive relief. Methode has amended its
complaint to add another manufacturer as an additional defendant, to allege
infringement of a fifth Methode patent and to allege that we breached our
obligations under a license and supply agreement with Methode by failing to
provide Methode with unspecified information regarding new technology related to
the products licensed under the agreement. The amended complaint seeks
additional compensatory damages of at least $224.3 million plus interest for the
alleged breach of this license and supply agreement. In addition, Methode has
notified us that it intends to file another amended complaint alleging
infringement of a sixth Methode patent. We believe that we have strong defenses
against Methode's lawsuit, and we have filed a counterclaim against Methode.
Portions of our counterclaim, based on principles of state law, were dismissed
in May 2000 on grounds of federal preemption; however, our basic claims of
ownership of the patents remain subject to our pending counterclaim. On June 5,
2000, Methode transferred the patents at issue in the litigation, as well as a
number of other patents, to Stratos Lightwave LLC, and on June 21, 2000, Stratos
Lightwave LLC transferred the same patents to Stratos Lightwave, Inc. Methode
has made a motion to add Stratos Lightwave, Inc. to the lawsuit as an additional
plaintiff.
20
<PAGE>
We intend to defend Methode's lawsuit and pursue our counterclaim
vigorously. However, the litigation is in the preliminary stage, and we cannot
predict its outcome with certainty. The litigation process is inherently
uncertain and we may not prevail. Patent litigation is particularly complex and
can extend for a protracted time, which can substantially increase the cost of
such litigation. In connection with the Methode litigation, we have incurred,
and expect to continue to incur, substantial legal fees and expenses. The
Methode litigation has also diverted, and is expected to continue to divert, the
efforts and attention of some of our key management and technical personnel. As
a result, our defense of this litigation, regardless of its eventual outcome,
has been, and will likely continue to be, costly and time consuming. Should the
outcome of the litigation be adverse to us, we could be required to pay
significant monetary damages to Methode and could be enjoined from selling those
of our products found to infringe Methode's patents unless and until we are able
to negotiate a license from Methode. In the event that we obtain a license from
Methode, we would likely be required to make royalty payments with respect to
sales of our products covered by the license. Any such royalty payments would
increase our cost of revenues and reduce our gross profit. If we are required to
pay significant monetary damages, are enjoined from selling any of our products
or are required to make substantial royalty payments pursuant to any such
license agreement, our business would be significantly harmed. For a more
complete discussion of this litigation matter, please refer to "Part II, Item
1.--Legal Proceedings."
OUR CUSTOMERS OFTEN EVALUATE OUR PRODUCTS FOR LONG AND VARIABLE PERIODS, WHICH
CAUSES THE TIMING OF OUR REVENUES AND RESULTS OF OPERATIONS TO BE UNPREDICTABLE
The period of time between our initial contact with a customer and the
receipt of an actual purchase order may span a year or more. During this time,
customers may perform, or require us to perform, extensive and lengthy
evaluation and testing of our products before purchasing and using them in their
equipment. Our customers do not typically share information on the duration or
magnitude of these qualification procedures. The length of these qualification
processes also may vary substantially by product and customer, and, thus, cause
our results of operations to be unpredictable. While our potential customers are
qualifying our products and before they place an order with us, we may incur
substantial sales and marketing expenses and expend significant management
effort. Even after incurring such costs we ultimately may not sell any products
to such potential customers. In addition, these qualification processes often
make it difficult to obtain new customers, as customers are reluctant to expend
the resources necessary to qualify a new supplier if they have one or more
existing qualified sources. Once our products have been qualified, our
agreements with our customers have no minimum purchase commitments. Failure of
our customers to incorporate our products into their systems would significantly
harm our business.
WE DEPEND ON CONTRACT MANUFACTURERS FOR SUBSTANTIALLY ALL OF OUR ASSEMBLY
REQUIREMENTS AND IF THESE MANUFACTURERS FAIL TO PROVIDE US WITH ADEQUATE
SUPPLIES OF HIGH-QUALITY PRODUCTS, OUR COMPETITIVE POSITION, REPUTATION AND
BUSINESS COULD BE HARMED
We currently rely on four contract manufacturers for substantially all of
our assembly requirements. We do not have long term contracts with any of these
manufacturers. We have experienced delays in product shipments from contract
manufacturers in the past, which in turn delayed product shipments to our
customers. We may in the future experience similar delays or other problems,
such as inferior quality and insufficient quantity of product, any of which
could significantly harm our business. We cannot assure you that we will be able
to effectively manage our contract manufacturers or that these manufacturers
will meet our future requirements for timely delivery of products of sufficient
quality and quantity. We intend to regularly introduce new products and product
enhancements, which will require that we rapidly achieve volume production by
coordinating our efforts with those of our suppliers and contract manufacturers.
The inability of our contract manufacturers to provide us with adequate supplies
of high-quality products or the loss of any of our contract
21
<PAGE>
manufacturers would cause a delay in our ability to fulfill orders while we
obtain a replacement manufacturer and would significantly harm our business.
If the demand for our products grows, we will need to increase our material
purchases, contract manufacturing capacity and internal test and quality
assurance functions. Any disruptions in product flow could limit our revenue,
adversely affect our competitive position and reputation and result in
additional costs or cancellation of orders under agreements with our customers.
In addition, we have recently begun outsourcing a portion of our contract
manufacturing internationally, and we intend to increase the use of
international contract manufacturers over time. Additional risks associated with
international contract manufacturing include:
- unexpected changes in regulatory requirements;
- legal uncertainties regarding liability, tariffs and other trade barriers;
- inadequate protection of intellectual property in some countries;
- greater incidence of shipping delays;
- limited oversight of manufacturing operations;
- potential political and economic instability; and
- currency fluctuations.
Any of these factors could significantly impair our ability to source our
contract manufacturing requirements internationally.
WE MAY LOSE SALES IF OUR SUPPLIERS FAIL TO MEET OUR NEEDS
We currently purchase several key components used in the manufacture of our
products from single or limited sources. We depend on these sources to meet our
needs. Moreover, we depend on the quality of the products supplied to us over
which we have limited control. We have encountered shortages and delays in
obtaining components in the past and expect to encounter shortages and delays in
the future. If we cannot supply products due to a lack of components, or are
unable to redesign products with other components in a timely manner, our
business will be significantly harmed. We have no long-term or short-term
contracts for any of our components. As a result, a supplier can discontinue
supplying components to us without penalty. If a supplier discontinued supplying
a component, our business may be harmed by the resulting product manufacturing
and delivery delays.
We use rolling forecasts based on anticipated product orders to determine
our component requirements. Lead times for materials and components that we
order vary significantly and depend on factors such as specific supplier
requirements, contract terms and current market demand for particular
components. If we overestimate our component requirements, we may have excess
inventory, which would increase our costs. If we underestimate our component
requirements, we may have inadequate inventory, which could interrupt our
manufacturing and delay delivery of our products to our customers. Any of these
occurrences would significantly harm our business.
WE ARE DEPENDENT ON WIDESPREAD MARKET ACCEPTANCE OF TWO PRODUCT FAMILIES, AND
OUR REVENUES WILL DECLINE IF THE MARKET DOES NOT CONTINUE TO ACCEPT EITHER OF
THESE PRODUCT FAMILIES
We currently derive substantially all of our revenue from sales of our
optical subsystems and network performance test systems. We expect that revenue
from these products will continue to account for substantially all of our
revenue for the foreseeable future. Accordingly, widespread acceptance of these
products is critical to our future success. If the market does not continue to
accept either our optical subsystems or our network performance test systems,
our revenues will decline significantly.
22
<PAGE>
Factors that may affect the market acceptance of our products include the
continued growth of the markets for LANs, SANs, CATV networks and extended
versions of these networks and, in particular, Gigabit Ethernet and Fibre
Channel-based technologies as well as the performance, price and total cost of
ownership of our products and the availability, functionality and price of
competing products and technologies. Many of these factors are beyond our
control. In addition, in order to achieve widespread market acceptance, we must
differentiate ourselves from the competition through product offerings and brand
name recognition. We cannot assure you that we will be successful in making this
differentiation or achieving widespread acceptance of our products. Failure of
our existing or future products to maintain and achieve widespread levels of
market acceptance will significantly impair our revenue growth.
BECAUSE OF INTENSE COMPETITION FOR TECHNICAL PERSONNEL, WE MAY NOT BE ABLE TO
RECRUIT OR RETAIN NECESSARY PERSONNEL
We believe our future success will depend in large part upon our ability to
attract and retain highly skilled managerial, technical, sales and marketing,
finance and manufacturing personnel. In particular, we will need to increase the
number of technical staff members with experience in high-speed networking
applications as we further develop our product lines. Competition for these
highly skilled employees in our industry is intense. Our failure to attract and
retain these qualified employees could significantly harm our business. The loss
of the services of any of our qualified employees, the inability to attract or
retain qualified personnel in the future or delays in hiring required personnel
could hinder the development and introduction of and negatively impact our
ability to sell our products. In addition, employees may leave our company and
subsequently compete against us. Moreover, companies in our industry whose
employees accept positions with competitors frequently claim that their
competitors have engaged in unfair hiring practices. We have been subject to
claims of this type and may be subject to such claims in the future as we seek
to hire qualified personnel. Some of these claims may result in material
litigation. We could incur substantial costs in defending ourselves against
these claims, regardless of their merits.
CONTINUED RAPID GROWTH WILL STRAIN OUR OPERATIONS AND REQUIRE US TO INCUR COSTS
TO UPGRADE OUR INFRASTRUCTURE
We have experienced a period of rapid growth, which has placed a significant
strain on our resources. Unless we manage our growth effectively, we may make
mistakes in operating our business, such as inaccurate sales forecasting,
material planning and financial reporting, which may result in fluctuations in
our operating results and cause the price of our stock to decline. We plan to
continue to expand our operations significantly. This anticipated growth will
continue to place a significant strain on our management and operational
resources. In order to manage our growth effectively, we must implement and
improve our operational systems, procedures and controls on a timely basis. If
we cannot manage growth effectively, our business could be significantly harmed.
OUR PRODUCTS MAY CONTAIN DEFECTS THAT MAY CAUSE US TO INCUR SIGNIFICANT COSTS,
DIVERT OUR ATTENTION FROM PRODUCT DEVELOPMENT EFFORTS AND RESULT IN A LOSS OF
CUSTOMERS
Networking products frequently contain undetected software or hardware
defects when first introduced or as new versions are released. Our products are
complex and defects may be found from time to time. In addition, our products
are often embedded in or deployed in conjunction with our customers' products
which incorporate a variety of components produced by third parties. As a
result, when problems occur, it may be difficult to identify the source of the
problem. These problems may cause us to incur significant damages or warranty
and repair costs, divert the attention of our engineering personnel from our
product development efforts and cause significant customer relation problems or
loss of customers, all of which would harm our business.
23
<PAGE>
OUR FAILURE TO PROTECT OUR INTELLECTUAL PROPERTY MAY SIGNIFICANTLY HARM OUR
BUSINESS
Our success and ability to compete is dependent in part on our proprietary
technology. We rely on a combination of patent, copyright, trademark and trade
secret laws, as well as confidentiality agreements and licensing arrangements,
to establish and protect our proprietary rights. To date, we have relied
primarily on proprietary processes and know-how to protect our intellectual
property. Although we have filed for several patents, some of which have issued,
we cannot assure you that any patents will issue as a result of pending patent
applications or that our issued patents will be upheld. Any infringement of our
proprietary rights could result in significant litigation costs, and any failure
to adequately protect our proprietary rights could result in our competitors
offering similar products, potentially resulting in loss of a competitive
advantage and decreased revenues. Despite our efforts to protect our proprietary
rights, existing patent, copyright, trademark and trade secret laws afford only
limited protection. In addition, the laws of some foreign countries do not
protect our proprietary rights to the same extent as do the laws of the United
States. Attempts may be made to copy or reverse engineer aspects of our products
or to obtain and use information that we regard as proprietary. Accordingly, we
may not be able to prevent misappropriation of our technology or deter others
from developing similar technology. Furthermore, policing the unauthorized use
of our products is difficult. Litigation may be necessary in the future to
enforce our intellectual property rights or to determine the validity and scope
of the proprietary rights of others. This litigation could result in substantial
costs and diversion of resources and could significantly harm our business.
CLAIMS THAT WE INFRINGE THIRD-PARTY INTELLECTUAL PROPERTY RIGHTS COULD RESULT IN
SIGNIFICANT EXPENSES OR RESTRICTIONS ON OUR ABILITY TO SELL OUR PRODUCTS
The networking industry is characterized by the existence of a large number
of patents and frequent litigation based on allegations of patent infringement.
We are currently involved in a patent infringement lawsuit. For a more detailed
discussion of this lawsuit, please refer to "--We are subject to a pending legal
proceeding." In addition, from time to time, other parties may assert patent,
copyright, trademark and other intellectual property rights to technologies and
in various jurisdictions that are important to our business. Any claims
asserting that our products infringe or may infringe proprietary rights of third
parties, if determined adversely to us, could significantly harm our business.
Any claims, with or without merit, could be time-consuming, result in costly
litigation, divert the efforts of our technical and management personnel, cause
product shipment delays or require us to enter into royalty or licensing
agreements, any of which could significantly harm our business. Royalty or
licensing agreements, if required, may not be available on terms acceptable to
us, if at all. In addition, our agreements with our customers typically require
us to indemnify our customers from any expense or liability resulting from
claimed infringement of third party intellectual property rights. In the event a
claim against us was successful and we could not obtain a license to the
relevant technology on acceptable terms or license a substitute technology or
redesign our products to avoid infringement, our business would be significantly
harmed.
IF WE ARE UNABLE TO EXPAND OUR DIRECT SALES OPERATION AND RESELLER DISTRIBUTION
CHANNELS OR SUCCESSFULLY MANAGE OUR EXPANDED SALES ORGANIZATION, OUR ABILITY TO
INCREASE OUR REVENUES WILL BE HARMED
Historically, we have relied primarily on a limited direct sales
organization, supported by third party manufacturers' representatives, to sell
our products domestically and on indirect distribution channels to sell our
products internationally. Our distribution strategy focuses primarily on
developing and expanding our direct sales organization in North America and our
indirect distribution channels internationally. We may not be able to
successfully expand our direct sales organization and the cost of any expansion
may exceed the revenue generated. To the extent that we are successful in
expanding our direct sales organization, we cannot assure you that we will be
able to compete successfully against the significantly larger and well-funded
sales and marketing operations of many of our current or potential
24
<PAGE>
competitors. In addition, if we fail to develop relationships with significant
international resellers or domestic manufacturers' representatives, of if these
resellers or representatives are not successful in their sales or marketing
efforts, sales of our products may decrease and our business would be
significantly harmed. We have granted exclusive rights to substantially all of
our resellers to sell our product and to our representatives to market our
products in their specified territories. Our resellers and representatives may
not market our products effectively or continue to devote the resources
necessary to provide us with effective sales, marketing and technical support.
Our inability to effectively manage the expansion of our domestic sales and
support staff or maintain existing or establish new relationships with domestic
manufacturer representatives and international resellers would harm our
business.
ANY ACQUISITIONS THAT WE UNDERTAKE COULD BE DIFFICULT TO INTEGRATE, DISRUPT OUR
BUSINESS, DILUTE STOCKHOLDER VALUE AND HARM OUR OPERATING RESULTS
We expect to review opportunities to buy other businesses or technologies
that would complement our current products, expand the breadth of our markets or
enhance our technical capabilities, or that may otherwise offer growth
opportunities. We may buy businesses, products or technologies in the future. If
we make any future acquisitions, we could issue stock that would dilute existing
stockholders' percentage ownership, incur substantial debt or assume contingent
liabilities. Our experience in acquiring other business and technologies is
limited. Potential acquisitions also involve numerous risks, including:
- problems assimilating the purchased operations, technologies or products;
- unanticipated costs associated with the acquisition;
- diversion of management's attention from our core business;
- adverse effects on existing business relationships with suppliers and
customers;
- risks associated with entering markets in which we have no or limited
prior experience; and
- potential loss of key employees of purchased organizations.
We cannot assure you that we would be successful in overcoming problems
encountered in connection with such acquisitions, and our inability to do so
could significantly harm our business.
OUR EXECUTIVE OFFICERS AND DIRECTORS AND ENTITIES AFFILIATED WITH THEM OWN A
LARGE PERCENTAGE OF OUR VOTING STOCK, WHICH WILL ALLOW THEM TO CONTROL ALL
MATTERS REQUIRING STOCKHOLDER APPROVAL
Our executive officers, directors and 5% or greater stockholders
beneficially own approximately 73.3 million shares or 46% of the outstanding
shares of our common stock. These stockholders, acting together, would be able
to effectively control all matters requiring approval by stockholders, including
the election or removal of directors and the approval of mergers or other
business combination transactions. This concentration of ownership could have
the effect of delaying or preventing a change in our control or otherwise
discouraging a potential acquirer from attempting to obtain control of us, which
in turn could have an adverse effect on the market price of our common stock or
prevent our stockholders from realizing a premium over the market price for
their shares of common stock.
IF WE ARE UNABLE TO EXPAND OUR INTERNATIONAL OPERATIONS OR MANAGE THEM
EFFECTIVELY, OUR BUSINESS WOULD BE SIGNIFICANTLY HARMED
Historically, substantially all of our sales have been made to customers in
North America. To address expanding international markets, we have recently
established relationships with distributors in
25
<PAGE>
Japan, the United Kingdom, Israel, Germany and Korea. The growth of our
distribution channels outside of North America will be subject to a number of
risks and uncertainties, including:
- the difficulties and costs of obtaining regulatory approvals for our
products;
- unexpected changes in regulatory requirements;
- legal uncertainties regarding liability, tariffs and other trade barriers;
- inadequate protection of intellectual property in some countries;
- increased difficulty in collecting delinquent or unpaid accounts;
- potentially adverse tax consequences;
- adoption of different local standards; and
- potential political and economic instability.
Any of these factors could significantly harm our existing international
operations and business or significantly impair our ability to expand into
international markets.
Our international sales currently are U.S. dollar-denominated. As a result,
an increase in the value of the U.S. dollar relative to foreign currencies could
make our products less competitive in international markets. In the future, we
may elect to invoice some of our international customers in local currency.
Doing so will subject us to fluctuations in exchange rates between the U.S.
dollar and the particular local currency.
DELAWARE LAW AND OUR CHARTER DOCUMENTS CONTAIN PROVISIONS THAT COULD DISCOURAGE
OR PREVENT A POTENTIAL TAKEOVER, EVEN IF SUCH A TRANSACTION WOULD BE BENEFICIAL
TO OUR STOCKHOLDERS
Some provisions of our Certificate of Incorporation and Bylaws, as well as
provisions of Delaware law, may discourage, delay or prevent a merger or
acquisition that a stockholder may consider favorable. These provisions include:
- authorizing the board to issue additional preferred stock;
- prohibiting cumulative voting in the election of directors;
- limiting the persons who may call special meetings of stockholders;
- prohibiting stockholder actions by written consent;
- creating a classified Board of Directors pursuant to which our directors
are elected for staggered three-year terms; and
- establishing advance notice requirements for nominations for election to
the board of directors or for proposing matters that can be acted on by
stockholders at stockholder meetings.
OUR HEADQUARTERS AND MOST OF OUR CONTRACT MANUFACTURERS ARE LOCATED IN NORTHERN
CALIFORNIA WHERE NATURAL DISASTERS MAY OCCUR
Currently, our corporate headquarters and most of our contract manufacturers
are located in Northern California. Northern California historically has been
vulnerable to natural disasters and other risks, such as earthquakes, fires and
floods, which at times have disrupted the local economy and posed physical risks
to our and our manufacturers' property. We presently do not have redundant,
multiple site capacity in the event of a natural disaster. In the event of such
disaster, our business would suffer.
26
<PAGE>
OUR STOCK PRICE IS VOLATILE AND YOU MAY BE UNABLE TO RESELL YOUR SHARES AT OR
ABOVE YOUR PURCHASE PRICE
The trading price of our common stock has fluctuated substantially since our
initial public offering in November 1999. The stock market in general, and the
Nasdaq National Market and stocks of technology companies in particular, have
experienced extreme price and volume fluctuations. This volatility is often
unrelated or disproportionate to the operating performance of these companies.
Broad market and industry factors may 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 initiated against these
companies. This litigation, if initiated, could result in substantial costs and
a diversion of management's attention and resources, which would significantly
harm our business.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk for changes in interest rates relates primarily
to our investment portfolio. We place our investments with high credit issuers
in short-term securities with maturities ranging from overnight up to
36 months. The average maturity of the portfolio will not exceed 18 months. The
portfolio includes only marketable securities with active secondary or resale
markets to ensure portfolio liquidity. We have no investments denominated in
foreign country currencies and therefore our investments are not subject to
foreign exchange risk.
27
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In April 1999, Methode, a manufacturer of electronic component devices,
filed a lawsuit against us and another manufacturer, Hewlett-Packard Co., in the
United States District Court for the Northern District of Illinois alleging that
our optoelectronic products infringe four patents held by Methode. The original
complaint sought monetary damages and injunctive relief. Methode has amended its
complaint to add another manufacturer as an additional defendant, to allege
infringement of a fifth Methode patent and to allege that we breached our
obligations under a license and supply agreement with Methode by failing to
provide Methode with unspecified information regarding new technology related to
the products licensed under the agreement. The amended complaint seeks
compensatory damages of at least $224.3 million plus interest for the alleged
breach of contract. In addition, Methode has notified us that it intends to file
another amended complaint alleging infringement of a sixth Methode patent. On
June 5, 2000, Methode transferred the patents at issue in the litigation, as
well as a number of other patents, to an affiliated company, Stratos Lightwave
LLC, and on June 21, 2000, Stratos Lightwave LLC transferred the same patents to
Stratos Lightwave, Inc. Methode has made a motion to add Stratos
Lightwave, Inc. to the lawsuit as an additional plaintiff.
Based on consultation with counsel, it is our position that the Methode
patents are invalid, unenforceable and/or not infringed by our products. The
United States Patent and Trademark Office has determined that all of the claims
asserted by Methode in one of the patents are invalid, although this
determination is not final and is subject to further administrative review. We
also believe, based on consultation with counsel, that the breach of contract
claim included in the amended complaint is without merit and that, in any event,
the amended complaint grossly overstates the amount of damages that Methode
could possibly have suffered as a result of any such breach. We believe that we
have strong defenses against Methode's lawsuit. In addition, we have filed a
counterclaim against Methode asserting, among other things, that one of our
founders, Frank H. Levinson, is the primary inventor of the technology that is
the subject of all five patents, that Methode improperly obtained the patents
based on our disclosure of the technology to Methode and that we are the
rightful owner or co-owner of the patents. Portions of our counterclaim, based
on principles of state law, were dismissed in May 2000 on grounds of federal
preemption; however, our basic claims of ownership of the patents remain subject
to our pending counterclaim.
We intend to defend Methode's lawsuit and pursue our counterclaim
vigorously. However, the litigation is in the preliminary stage, and its outcome
cannot be predicted with certainty. The litigation process is inherently
uncertain. Patent litigation is particularly complex and can extend for a
protracted time, which can substantially increase the cost of such litigation.
In connection with the Methode litigation, we have incurred, and expect to
continue to incur, substantial legal fees and expenses. The Methode litigation
has also diverted, and is expected to continue to divert, the efforts and
attention of some of our key management and technical personnel. As a result,
our defense of this litigation, regardless of its eventual outcome, has been,
and will likely continue to be, costly and time consuming. Should the outcome of
the litigation be adverse to us, we could be required to pay significant
monetary damages to Methode and could be enjoined from selling those products
found to infringe Methode's patents unless and until we are able to negotiate a
license from Methode. In the event we obtain a license from Methode, we would
likely be required to make royalty payments with respect to sales of products
covered by the license. Any such payments would increase our cost of revenues
and reduce our gross profit. If we are required to pay significant monetary
damages, are enjoined from selling any of our products or are required to make
substantial royalty payments pursuant to any such license agreement, our
business would be significantly harmed.
28
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Exhibits.
Reference is hereby made to the Exhibit Index commencing on page 31.
b. Reports on Form 8-K
None.
29
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
<TABLE>
<S> <C> <C>
DATE: September 13, 2000 FINISAR CORPORATION
By: /s/ JERRY S. RAWLS
-----------------------------------------
Jerry S. Rawls
PRESIDENT AND CHIEF EXECUTIVE OFFICER
By: /s/ STEPHEN K. WORKMAN
-----------------------------------------
Stephen K. Workman,
VICE PRESIDENT, FINANCE AND
CHIEF FINANCIAL OFFICER
</TABLE>
30
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF DOCUMENT
--------------------- -----------------------
<C> <S>
27.1 Financial Data Schedule
</TABLE>
31
