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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
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(Mark One)
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended July 31, 2002
OR
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ______________ to ______________
Commission File Number: 000-27273
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SYCAMORE NETWORKS, INC.
(Exact name of registrant as specified in its charter)
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Delaware 04-3410558
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
220 Mill Road
Chelmsford, Massachusetts 01824
(Address of principal executive office)
Registrant's telephone number, including area code: (978) 250-2900
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK $0.001 PAR VALUE
(Title of class)
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Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
As of October 15, 2002 there were 271,108,606 shares outstanding of the
registrant's common stock, $0.001 par value. As of that date, the aggregate
market value of voting stock held by non-affiliates of the registrant was
approximately $425,859,000.
DOCUMENTS INCORPORATED BY REFERENCE
PART III--Portions of the definitive Proxy Statement for the Annual Meeting
of Shareholders to be held on December 19, 2002 are incorporated by reference
into Part III (Items 10, 11, 12 and 13) to this Form 10-K.
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FACTORS THAT MAY AFFECT FUTURE RESULTS
Our prospects are subject to uncertainties and risks. This Annual Report on
Form 10-K contains forward-looking statements within the meaning of the federal
securities laws that also involve substantial uncertainties and risks. Our
future results may differ materially from our historical results and actual
results could differ materially from those projected in the forward-looking
statements as a result of certain risk factors. Readers should pay particular
attention to the considerations described in the section of this report
entitled "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Factors that May Affect Future Operating Results."
Readers should also carefully review the risk factors described in the other
documents that we file from time to time with the Securities and Exchange
Commission.
PART I
ITEM 1. BUSINESS
Overview
We develop and market intelligent optical networking products that enable
telecommunications service providers to cost effectively transform the capacity
created by their fiber optic networks into usable bandwidth to deliver a broad
range of telecommunications services. Our current and prospective customer base
includes incumbent local exchange carriers (also known as Regional Bell
Operating Companies or RBOCs), Interexchange Carriers (IXCs), international
incumbent operators (also known as Postal Telephone and Telegraph operators or
PTTs), international competitive carriers, Internet Service Providers (ISPs),
emerging service providers, non-traditional telecommunications service
providers, and other large corporate and government organizations with their
own private fiber networks.
We commenced operations in February 1998 and shipped our first product in
May 1999. In September 2000, we acquired Sirocco Systems, Inc., a U.S. company
headquartered in Wallingford, Connecticut ("Sirocco"), which broadened our
switching product portfolio to include intelligent optical networking products
designed for the metropolitan or edge segment of the network. Revenue increased
from $11.3 million for the fiscal year ended July 31, 1999 to $198.1 million
for the fiscal year ended July 31, 2000 and $374.7 million for the fiscal year
ended July 31, 2001. During the latter half of fiscal 2001, a rapid and
significant decrease in capital spending by telecommunications service
providers began to impact Sycamore's business. Over the course of fiscal 2002,
capital spending by service providers continued to decline and market
conditions worsened. As a consequence, beginning in the second half of fiscal
2001 and continuing through fiscal 2002, our revenue steadily declined. Total
revenue for fiscal 2002 was $65.2 million, a decrease of 83% compared to fiscal
2001. As market conditions deteriorated, we took steps to reduce our cost
structure, decrease cash consumption and eliminate certain product lines and
feature sets by implementing restructuring programs in the third quarter of
fiscal 2001, and in the first and fourth quarters of fiscal 2002. These
restructuring programs included reductions in workforce, facilities
consolidations, the discontinuation of certain product offerings, and the write
down of excess inventory and other impaired assets, as described in detail in
Note 10 to our consolidated financial statements. During the fourth quarter of
fiscal 2002, as a component of our third restructuring program, we made a
strategic decision to exit the stand-alone optical line transport system market
and to focus Sycamore's business on optical switching. While we have taken
actions to reduce our cost structure, we anticipate that we will continue to
incur operating losses unless the overall economic environment improves and our
revenue increases significantly compared to current levels.
Although Sycamore's current and prospective customers have sharply decreased
their capital spending on optical networking systems over the past 12 to 18
months due to adverse market conditions, we continue to believe that our
industry presents long-term growth opportunities. We believe that the legacy
technologies that have been used to build the existing voice-centric public
network do not provide a scalable, cost-effective network foundation to support
the requirements of the mobile and high-speed data applications that will
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ultimately drive network growth. As data and mobile traffic on the network
grows, we believe that service providers will require new solutions to relieve
network congestion, improve service profitability and capitalize on the service
opportunities presented by new communications applications. Our intelligent
optical switching products are designed to create an intelligent optical
network infrastructure that will enable telecommunications service providers to
easily scale their networks, minimize ongoing capital and operational costs to
achieve greater service profitability and reduce the time it takes to introduce
and provision new services. Our products are designed to protect service
providers' existing investment in fiber optic and transmission equipment and
provide a migration path to a new, more data-optimized, network infrastructure.
Industry Background
Challenges Facing Telecommunications Service Providers
Over the past decade, the telecommunications industry has been reshaped by
regulatory changes, capital investment, technology innovation, and customer
demand. Data traffic across the public network has grown significantly, driven
by applications such as Internet access, electronic mail, electronic commerce
and remote network access by telecommuters. Mobile communication applications
have proliferated and wireless voice services are emerging as a competitive
alternative to traditional fixed-line telephone services for residential
applications. Over the past five years, service providers invested heavily in
the deployment of fiber optic cable to create the raw capacity needed to
transport vast amounts of network traffic. Though current market challenges are
impacting near term capital investment in network infrastructure, it is clear
that with this capacity now in place, the next step is to economically
transform that capacity into usable bandwidth that can be delivered to
customers in the form of differentiated services whenever and wherever it is
needed as mobile and data driven network traffic continues to grow.
In order to support new and competitive service offerings, the underlying
public network infrastructure continues to evolve. The existing public network
was originally designed to support traditional telephony traffic, which has
very different characteristics than data traffic. Generally, individual fixed
line voice calls consume very little bandwidth for short periods of time and
they are most often terminated within a local city environment. Overall growth
in fixed line voice traffic has been relatively slow and predictable, which has
allowed for long-term network planning and gradual network expansion. Unlike
voice traffic, data traffic has experienced rapid growth in recent years and it
has continued to grow despite the market downturn. In contrast to traditional
voice applications, data applications can consume vast amounts of bandwidth for
long periods of time and "data calls" are far less predictable than voice calls
relative to the duration of each connection and the distance that traffic is
required to travel from origin to destination. Because the growth and pattern
of data traffic is inherently unpredictable, it is difficult to plan and
anticipate network expansion requirements well in advance of customer demand.
To rise to competitive challenges and accommodate a more mobile and data
centric communications environment requires that greater levels of automation,
flexibility, and scalability be introduced into the public network
infrastructure. By creating a more agile intelligent optical network
infrastructure, telecommunications service providers will be able to improve
service profitability, accelerate the service provisioning process and create a
flexible network foundation to introduce a range of new services.
Existing Public Network Transmission Infrastructure and Limitations
Historically, to build the infrastructure of their networks,
telecommunications service providers laid fiber optic cable and installed
optical transmission equipment to "light" the fiber to create capacity.
Traditional investments in transmission equipment have been spread across dense
wave division multiplexing equipment, known as DWDM, and SONET/SDH equipment.
DWDM equipment expands the transmission capacity of a specific fiber by
dividing a single strand of fiber into multiple light-paths, or wavelengths.
SONET/SDH transmission equipment is used to transform that capacity into usable
bandwidth that can be delivered to a customer in the form of a voice or data
service.
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In a traditional public network transmission infrastructure, the ability to
manage network traffic resides in the SONET/SDH equipment. Specifically,
Add/Drop Multiplexers (ADMs) and Digital Cross Connects (DCXs) have been used
to convert traffic from electrical to optical format for transport and routing
across the optical network. The optical fiber itself is only a physical
transmission medium with no embedded intelligence. Typically deployed in a
ring-based architecture, the SONET/SDH equipment allocates half of the
bandwidth available on the ring for back-up in case of a network failure, which
limits a telecommunications service provider's ability to fully utilize all of
their optical resources. Once bandwidth on the SONET/SDH ring is fully
allocated, it is a time-consuming, complex and costly process to upgrade the
ring to support the delivery of additional bandwidth and services. To support
the bandwidth requirements, connection duration and demand characteristics of
data traffic, networks must be capable of quickly delivering and redeploying
large amounts of bandwidth cost-effectively, when and where it is needed and
for just as long as it is needed.
A traditional SONET/SDH network architecture, however, is not sufficiently
flexible to meet these requirements. Generally, the process of expanding the
capacity of a SONET/SDH network to supply more bandwidth for service delivery
is time-consuming, complex and costly, requiring trained technicians to visit
each network transit point and significant up-front capital investment by the
telecommunications service provider. In addition, once bandwidth is made
available, it cannot be easily redeployed as customer demands change.
In today's capital constrained environment, a large-scale upfront investment
in capital equipment in advance of demand is difficult to justify. Conversely,
long lead times for service delivery can negatively impact a service provider's
ability to compete for business. To retain existing accounts and attract new
customers without sacrificing profitability in a competitive market
environment, service providers need to move toward a "just-in-time" investment
and service delivery model allowing them to introduce and expand services when
and where needed in response to demand. Supporting a "just-in-time" investment
and service delivery model requires a public network architecture that
facilitates efficient resource management, scales easily and provides
sufficient flexibility to support a wide range of service and bandwidth
requirements.
The Sycamore Solution
We develop and market a family of software-based integrated intelligent
optical switching products that enable service providers to quickly and
cost-effectively create an intelligent optical network to deliver large amounts
of bandwidth in the form of voice and data services. Our products provide the
tools to enable service providers to better utilize and manage their existing
optical networks, lower the operating costs associated with managing these
networks and speed the service provisioning process, while providing a
migration path to a next generation, agile intelligent optical network.
Key benefits of our solution include the following:
Improves Network Flexibility and Scalability. Our software-based optical
switching products are designed to allow telecommunications service providers
to improve the flexibility and scalability of their networks without the long
lead times and large, upfront capital investment presently required for a
network build-out. The software-based capabilities of our products allow
service providers to effectively and efficiently identify idle bandwidth,
increase network utilization and upgrade their network infrastructure and
services. This improved flexibility and scalability enables service providers
to more easily expand their network infrastructure, support new applications
and introduce value-added services for the benefit of their customers.
Enables Rapid Service Delivery. The competitive marketplace facing service
providers and the pace of technological change require that the public network
infrastructure be adaptable to accommodate shifts in customer demand for
service. Our products are designed to shorten the time it takes for service
providers to derive and distribute bandwidth across their networks, thereby
enabling our customers to introduce network services quickly in response to
their customers' demand. We believe that this capability is particularly
important for service providers because it enables them to expand their
networks based on current, rather than forecasted, market demand for their
services.
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Facilitates Introduction of New Services and Creation of New Revenue
Opportunities for Service Providers. Because our products are software-centric
and based on open industry standards, we are able to rapidly introduce new
features into our products, which can in turn be used by service providers to
expand the services they offer their customers. We believe that these added
features provide revenue opportunities for our customers and enable them to
differentiate their network services from those of their competitors. We have
designed a comprehensive network management solution that enables service
providers to monitor the performance of their network, isolate and manage
network faults, and otherwise manage their network on a real-time basis. With
our network management system, service providers are able to offer value-added
services such as customer network management to their customers.
Protects Existing Investments. Our products are designed to enable our
customers to increase the functionality and improve the performance of their
networks without sacrificing their infrastructure investments in SONET/SDH
equipment. Our products are designed with features that facilitate a gradual
migration from existing SONET/SDH networks to more flexible data optimized
intelligent optical networks. Service providers can introduce our products into
an existing optical network environment, when and where needed, without
replacing the current architecture. For example, over a common fiber
infrastructure, a service provider's existing SONET/SDH network could be used
to continue to support low speed voice and data services, while new higher
speed data services could be supported by our intelligent optical networking
products. Furthermore, the common software architecture, which serves as the
basis for our future products, is intended to ensure the continued
interoperability and manageability of our products as our product line evolves.
Provides Capital and Operational Cost Savings to Deliver Improved Service
Profitability. By using the latest in component technology in combination with
sophisticated software intelligence, our products are designed to minimize both
the upfront capital costs and ongoing operational costs associated with an
infrastructure build. Our products consolidate the functionality of multiple
network elements, such as ADMs, DCXs and DWDM transport equipment, which
enables significant capital savings as well as greater operational efficiencies
through a simplified network architecture and reduced power consumption, real
estate and maintenance costs. Operational costs are also positively impacted by
the strength of our software which provides the ability to automate the
provisioning and management of new services, improving time to revenue for our
customers and eliminating the requirement for labor intensive manual
installation and maintenance programs.
Provides the Ability to Deploy an Integrated Optical Networking Solution
From the Edge of the Public Network Through the Core. Our switching product
portfolio, complemented by our network management capabilities, is designed to
enable service providers to extend the scaling and service provisioning
benefits of intelligent optical networking throughout the network with an
integrated solution from the edge to the core. Our use of a common software
architecture and management system across our entire product portfolio
simplifies service creation, provisioning and management for service providers,
thereby enabling them to improve their time to market for new services.
Strategy
Our objective is to be the leading provider of intelligent optical
networking products. Key elements of our strategy include the following:
Offer End-to-End, Integrated Optical Switching Solutions to Customers. We
offer a full range of intelligent optical switching products to our customers.
Our switching products, under the umbrella of our SILVX(TM) network management
system, support an integrated deployment of intelligent optical networking
technology from the edge to the core of the network. In addition to supporting
the development of new networks, our products help service providers improve
the utilization of fiber optic capacity that has already been deployed in the
network. For example, our optical switches have been designed to facilitate the
transition to a data-optimized network environment. A data-optimized
intelligent optical network provides greater flexibility than a traditional
SONET/SDH network by providing for more direct routes between network points,
better utilization of bandwidth and
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more efficient network restoration schemes in the event of a fiber or circuit
failure. When the SN 16000 optical switch is combined with our SN 3000 optical
edge switches, telecommunications service providers can deploy an integrated
"all switched" intelligent optical network infrastructure from the core to the
edge of their network.
Advance Partnerships and Alliances with Large Telecommunications Equipment
Providers. As a company with a comprehensive portfolio of integrated,
intelligent optical switching products, partnerships and alliances with large
telecommunications equipment providers that lack such products offer the
potential to expand our access to a broader set of customers around the world.
For example, during the fourth quarter of fiscal 2002, Sycamore established a
strategic alliance with Siemens Information and Communications Networks (ICN)
for the resale of our SN 16000 optical switch by the Siemens ICN sales force,
as well as for joint product development to integrate our respective network
management systems and our SN 16000 optical switch with Siemens' optical
transmission systems.
Collaborate With Customers To Generate Demand For New Services. We work
collaboratively with our customers to help them identify and create new
services for their end-user customers. Our professional and customer services
teams provide assistance in such areas as network planning, design and
implementation to facilitate the introduction of these services. By helping our
customers to create new services, we help generate additional revenue
opportunities for our customers and enhance the value proposition of our
products.
Utilize Software-Based Product Architecture. Our products utilize a
standards-based software-centric architecture that permits greater flexibility,
enhanced interoperability and expanded network management capabilities. The
common architecture is designed to reduce the complexity of introducing new
software revisions across the network. We believe that this architecture
accelerates the release of new products and enables our customers to upgrade
with minimal network impact and operator training. All Sycamore switching
products are linked by a common network management system, SILVX NMS and rely
on a common networking software suite, Broadleaf(TM).
Incorporate Commercially Available Optical Hardware Components. We use
commercially available optical hardware components in our products when
feasible. We believe that by using these third-party components, we benefit
from the research and development of the vendors of these products, as well as
from the efficiencies of scale that these vendors generate by producing the
components in higher volumes. As a result of our use of these components, we
believe that we can more quickly bring to market a broad-based product line at
a lower cost than if we had utilized proprietary components.
Outsource Manufacturing. We outsource the manufacturing of our products to
reduce our cost structure, minimize the use of working capital for inventory
purchases, and to maintain our focus on the development of value-added software
and the integration of hard-optics components into our products.
Focus On Just-In-Time Implementation. Our product architecture strategy is
to develop products that enable service providers to expand and upgrade their
networks in response to demand on a "just-in-time" basis. Our software-based
product architecture is designed to help us achieve this goal. Our software
capabilities support a modular "plug and play" hardware architecture which is
designed to allow new and enhanced modules to be easily inserted into the
network as optical networking technology advances.
Capitalize On Extensive Industry Experience. We have significant management,
engineering and sales experience in the networking and optics industries, and
long-standing relationships with key personnel in our target customer base. We
believe that our experience and relationships are important in enabling us to
develop products to meet our customers' needs and to penetrate our target
market.
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Products and Technology
Product Architecture
Our software-based intelligent optical switching products are designed to
enable service providers to leverage their optical network infrastructure to
deliver a broad range of end-to-end services to meet the bandwidth intensive
needs of data applications.
Our products are designed to provide:
. Lower operating costs by automating manual and time-consuming service
provisioning processes and reducing the space and power requirements
associated with legacy solutions;
. Capital cost benefits through the delivery of high capacity systems in
compact form factors and the ability to select the optimal capacity for
the traffic parameters of each network site;
. A simplified and more manageable network architecture by consolidating
multiple functional elements or network devices into a single system;
. Faster service delivery capabilities by enabling automated end-to-end
provisioning of services;
. The ability to simplify network expansion and upgrade through advanced
software capabilities;
. A practical migration path from a SONET/SDH architecture to a data
optimized intelligent optical network; and
. Access to new revenue opportunities for service providers through advanced
features that support a wide range of value-added service offerings.
We believe that the acceptance and implementation of intelligent optical
networking technology by service providers is being driven by requirements to
lower network operations costs, network scaling requirements and service
demands. Our product strategy allows service providers to migrate from today's
SONET/SDH network architecture to an intelligent optical network while
preserving their investment in the existing network.
Sycamore's intelligent optical switching products incorporate the following
features:
Intelligent Optical Networking Software. Our product line shares a common
software foundation that is based on open industry standards. This software
foundation allows us to minimize product development time by leveraging our
software architecture across multiple product lines. Our software architecture
is designed to offer service providers tools to continue evolving their
networks without requiring the replacement of existing infrastructure. In
addition, the architecture is designed to allow service providers to rapidly
absorb new optical technology and functionality into the network with minimal
effort, training and incremental investment. Software-based features such as
optical signaling and routing, topology discovery and system self-inventory
allow service providers to quickly respond to customer needs.
SONET/SDH Functionality. Our products are designed to provide the optical
interfaces and management and restoration capabilities traditionally offered on
SONET/SDH equipment.
DWDM Technology. DWDM technology creates capacity by multiplying the number
of wavelengths that a single fiber can support. We integrate commercially
available DWDM optical technology into our switching products, providing a
cost-effective integrated switching and transport solution to our customers.
Network Management. Our network management products are designed to provide
end-to-end management and control of the intelligent optical network. Network
management functions include fault management, configuration management,
accounting management, performance management and security management.
SilvxManager(TM), our network management platform delivers a distributed
solution designed to provide end-to-end management of the intelligent optical
network. Our network management products are designed to manage Sycamore's
intelligent optical networking products, provide for the management of
third-party products and integrate with other operating support systems when
introduced into an existing network environment.
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Sycamore's Intelligent Optical Networking Products
SN 3000. The SN 3000 is an optical edge switch that is designed to perform
aggregation, grooming and switching functions, primarily in mid-range traffic
density environments and in the metropolitan segment of the network. The SN
3000 is a highly redundant system designed for central office applications. Due
to its space efficient design, the SN 3000 is intended to provide extremely
high port density in a compact architecture. Featuring an integrated optical
subsystem for DWDM trunking and wavelength cross-connect, the SN 3000 platforms
aggregate traffic from existing SONET/SDH rings or directly from subscribers
and support a full complement of service interfaces.
SN 16000 SC. The SN 16000 SC (Single Chassis) is a high-density, single
chassis intelligent optical grooming switch for efficient circuit routing in
regional core networks and cost-efficient aggregation of traffic in dense metro
networks. The SN 16000 SC has been designed to integrate smoothly into existing
network environments containing products from a variety of optical networking
vendors.
SN 16000. The SN 16000 is a high capacity multi-chassis intelligent optical
switch for end-to-end wavelength switching and routing at the core of the
optical network, which is necessary for the creation of a highly scalable core
network. The SN 16000 supports incremental network growth through a modular
architecture and has been designed to integrate smoothly into existing network
environments.
SILVX NMS(R). The SILVX optical network management system provides
end-to-end management of services across a service provider's optical network.
SILVX simplifies network configuration, network provisioning and network
management by automating many of today's manual and labor-intensive network
management processes via advanced software. Additionally, SILVX allows service
providers to offer network management-based services to their customers.
Customers
Our target customer base includes incumbent local exchange carriers (also
known as Regional Bell Operating Companies or RBOCs), Interexchange Carriers
(IXCs), international incumbent operators (also known as Postal Telephone and
Telegraph operators or PTTs), international competitive carriers, Internet
Service Providers (ISPs), emerging service providers, non-traditional
telecommunications service providers and other large corporate and government
organizations with their own private fiber networks.
During the year ended July 31, 2002, shipments of products to two customers,
Vodafone Group PLC and NTT Communications, a subsidiary of Nippon Telephone and
Telegraph Corporation, accounted for 45% and 20% of our revenue, respectively.
During the years ended July 31, 2001 and 2000, shipments of products to one
customer, Williams Communications Group, Inc., accounted for 47% and 92% of our
revenue, respectively. During the year ended July 31, 2001, shipments to
another customer, 360networks inc., accounted for 11% of our revenue.
International revenue was 87% of total revenue during the year ended July 31,
2002, compared to 35% of total revenue during the year ended July 31, 2001, and
an insignificant amount for the year ended July 31, 2000. See "Segment
Information" in Note 2 to our consolidated financial statements for additional
details.
Historically, a large percentage of our revenue has been derived from
emerging service providers, including Williams Communications and 360networks.
Beginning in the third quarter of fiscal 2001, unfavorable economic conditions
caused a rapid and significant decrease in capital spending by
telecommunications service providers. As a result, emerging service providers,
which had been the early adopters of our technology, were no longer able to
continue to fund aggressive deployments of equipment within their networks due
to their inability to access the capital markets. Many of these emerging
service providers have experienced severe financial difficulties, causing them
to dramatically reduce their capital expenditures, and in many cases, file for
bankruptcy protection. As a result, we believe that sales to emerging service
providers are likely to remain at reduced levels. A key element of our strategy
is to increase our sales to incumbent service providers, which typically have
longer sales evaluation cycles than those of emerging service providers. After
adding several incumbent service providers to our customer base during the past
two years, a large percentage of our revenue is now derived from incumbent
service providers, including Vodafone and NTT Communications. However,
incumbent service
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providers have also recently slowed their capital expenditures significantly
and this trend is resulting in longer than anticipated sales evaluation cycles.
Many incumbent service providers have historically financed their capital
expenditures using significant amounts of debt. In recent months, many of these
incumbent service providers have come under increased scrutiny from credit
rating agencies and investors due to their relatively high debt levels, which
may limit their ability to make future equipment purchases, and which limits
our ability to forecast future revenue.
Sales and Marketing
We sell our products through a combination of a direct sales force and
distribution partners in certain international markets. As of July 31, 2002,
our sales and marketing organization consisted of 65 employees, located at our
headquarters in Chelmsford, Massachusetts, and various domestic and
international sales and support office locations.
Our marketing objectives include building market awareness and acceptance of
Sycamore and our products as well as generating qualified customer leads. We
participate in conferences, attend trade shows, and provide information about
our company and our products on our Web site. We also conduct public relations
activities, including interviews and demonstrations for the business and trade
media, and industry analysts.
Currently, the primary focus of our sales efforts is on developing strong
relationships with incumbent service providers through both direct and indirect
sales channels. Our sales and presales engineering organizations work
collaboratively with both existing and prospective customers to help them
identify and create new services that they can offer to their end-user
customers.
In addition, we provide comprehensive post-sales customer support including
network planning and deployment, technical assistance centers and logistics
support. Our customer support organization leverages a network of highly
qualified service partners to extend our reach and capabilities.
Research and Development
Our future success depends on our ability to increase the performance of our
products, to develop and introduce new products and product enhancements and to
effectively respond to our customers' changing needs. We believe that we can
continue to enhance our technologies to improve the scalability, performance
and reliability of our intelligent optical networking products. We also plan to
continue to enhance our network management software to enable our customers to
deliver new or enhanced services using our intelligent optical networking
products. We have made, and intend to continue to make, substantial investments
in research and development. Research and development expenses were $109.7
million, $159.6 million and $71.9 million, respectively, for the years ended
July 31, 2002, 2001, and 2000. As of July 31, 2002, we had 255 employees
involved in research and development.
Competition
The market for intelligent optical networking products is intensely
competitive, subject to rapid technological change and significantly affected
by new product introductions and other market activities of industry
participants. We expect competition to persist and intensify in the future both
domestically and internationally, in response to capital spending restrictions
by telecommunications providers and as we move into new markets and expand our
presence globally. Our primary sources of competition include vendors of
network infrastructure equipment and optical network equipment, such as Nortel
Networks, Lucent Technologies, Alcatel and Ciena Corporation, as well as other
private and public companies that have focused on our target market. Some of
our competitors have significantly greater financial resources than us and are
able to devote greater resources to the development, promotion, sale and
support of their products. We believe that being able to demonstrate strong
financial viability is becoming an increasingly important consideration to our
customers in making their purchasing decisions. In addition, many of our
competitors have more extensive customer bases and broader customer
relationships than us, including relationships with our potential customers.
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In order to compete effectively, we must deliver products that:
. Provide extremely high network reliability;
. Scale easily and efficiently with minimum disruption to the network;
. Interoperate with existing network designs and equipment vendors;
. Reduce the complexity of the network by consolidation of functional
elements into fewer physical devices;
. Provide effective network management; and
. Provide a cost-effective solution for service providers.
In addition, we believe that our knowledge of telecommunications
infrastructure requirements and experience working with service providers to
develop new services for their customers are important competitive factors in
our market.
Proprietary Rights and Licensing
Our success and ability to compete are dependent on our ability to develop
and maintain the proprietary aspects of our technology and operate without
infringing on the proprietary rights of others. We rely on a combination of
patent, trademark, trade secret and copyright law and contractual restrictions
to protect the proprietary aspects of our technology. These legal protections
afford only limited protection for our technology. We presently have numerous
patent applications pending in the United States and we cannot be certain that
patents will be granted based on these or any other applications. We seek to
protect our source code for our software, documentation and other written
materials under trade secret and copyright laws. We license our software
pursuant to signed or shrinkwrap license agreements, which impose certain
restrictions on the licensee's ability to utilize the software. Finally, we
seek to limit disclosure of our intellectual property by requiring employees,
consultants and any third party with access to our proprietary information to
execute confidentiality agreements with us and by restricting access to our
source code. Although we believe the protection afforded by our patents, patent
applications, trademarks, trade secret, copyright laws and contractual
restrictions has value, the rapidly changing technology in the networking
industry and uncertainties in the legal process makes our future success
dependent primarily on the innovative skills, technology expertise and
management abilities of our employees rather than on protection afforded by
patent, trademark, trade secret and copyright laws.
Despite our efforts to protect our proprietary rights, unauthorized parties
may attempt to copy aspects of our products or to obtain and use information
that we regard as proprietary. Policing unauthorized use of our products is
difficult and while we are unable to determine the extent to which piracy of
our software exists, software piracy can be expected to be a persistent
problem. Litigation may be necessary in the future to enforce our intellectual
property rights, to protect our trade secrets, to determine the validity and
scope of the proprietary rights of others or to defend against claims of
infringement or invalidity. However, the laws of many countries do not protect
our proprietary rights to as great an extent as do the laws of the United
States. Any such litigation could result in substantial costs and diversion of
resources and could have a material adverse effect on our business, operating
results and financial condition. There can be no assurance that our means of
protecting our proprietary rights will be adequate or that our competitors will
not independently develop similar technology. Any failure by us to meaningfully
protect our proprietary rights could have a material adverse effect on our
business, operating results and financial condition.
There can be no assurance that third parties will not claim infringement
with respect to our current or future products. Any such claims, with or
without merit, could be time-consuming to defend, result in costly litigation,
divert management's attention and resources, cause product shipment delays or
require us to enter into royalty or licensing agreements. Such royalty or
licensing agreements, if required, may not be available on terms acceptable to
us or at all. A successful claim of intellectual property infringement against
us and our failure or inability to license the infringed technology or develop
or license technology with comparable functionality could have a material
adverse effect on our business, financial condition and operating results.
10
We integrate third-party software into our products. This third-party
software may not continue to be available on commercially reasonable terms. If
we cannot maintain licenses to this third-party software, distribution of our
products could be delayed until equivalent software could be developed or
licensed and integrated into our products, which could materially adversely
affect our business, operating results and financial condition.
Manufacturing
We have limited internal manufacturing capabilities. Currently, the majority
of our products are produced under an agreement with Jabil Circuit, Inc., who
provides comprehensive manufacturing services, including assembly, test,
control and shipment to our customers, and procures materials on our behalf.
This contract has indefinite terms and is cancelable by either party with
advance notice. We believe that the outsourcing of our manufacturing enables us
to conserve the working capital that would be required to purchase inventory,
allows us to better adjust manufacturing volumes to meet changes in demand, and
enables us to deliver products more quickly.
Our optical networking products utilize hundreds of individual parts, many
of which are customized for our products. Component suppliers in the
specialized, high technology end of the optical communications industry are
generally not as plentiful or, in some cases, as reliable, as component
suppliers in more mature industries. We work closely with our strategic
component suppliers to pursue new component technologies that could either
reduce cost or enhance the performance of our products.
We currently purchase several key components, including commercial digital
signal processors, CPUs, field programmable gate arrays, switch fabric, SONET
transceivers and erbium doped fiber amplifiers, from single or limited sources.
We purchase each of these components on a purchase order basis and have no
long-term contracts for these components. Although we believe that there are
alternative sources for each of these components, in the event of a disruption
in supply, we may not be able to develop an alternate source in a timely manner
or at favorable prices. Such a failure could hurt our ability to deliver our
products to our customers and negatively affect our operating margins. In
addition, our reliance on our suppliers exposes us to potential supplier
production difficulties or quality variations. Any such disruption in supply
would seriously impact present and future sales and revenue.
Throughout the current downturn in the telecommunications industry, the
optical component industry has been downsizing manufacturing capacity while
consolidating product lines from earlier acquisitions. Recently, one of our
suppliers announced its intention to exit the market for optical components,
and several of our other suppliers have announced reductions of their product
offerings. These announcements, or similar decisions by other suppliers, could
result in reduced competition and higher prices for the components we purchase.
In addition, the loss of a source of supply for key components could require us
to incur additional costs to redesign our products that use those components.
If any of these events occurred, our results of operations could be materially
adversely affected.
Employees
As of July 31, 2002, we had a total of 445 employees of which:
. 255 were in research and development,
. 65 were in sales and marketing,
. 40 were in customer service and support,
. 29 were in manufacturing, and
. 56 were in finance and administration.
11
Our future success will depend in part on our ability to attract, retain and
motivate highly qualified technical and management personnel, for whom
competition is intense, particularly in the New England area where we are
headquartered. Our employees are not represented by any collective bargaining
unit. We believe our relations with our employees are good.
Executive Officers
Set forth below is information concerning our current executive officers and
their ages as of October 24, 2002.
Name Age Position
- ---- --- --------
Daniel E. Smith 53 President, Chief Executive Officer and Director
Frances M. Jewels 37 Chief Financial Officer, Vice President, Finance and Administration,
Treasurer and Secretary
John E. Dowling 49 Vice President, Operations
Araldo Menegon 43 Vice President, Worldwide Sales and Support
Kevin J. Oye 44 Vice President, Systems and Technology
Daniel E. Smith has served as our President, Chief Executive Officer and as
a member of our Board of Directors since October 1998. From June 1997 to July
1998, Mr. Smith was Executive Vice President and General Manager of the Core
Switching Division of Ascend Communications, Inc., a provider of wide area
network switches and access data networking equipment. Mr. Smith was also a
member of the board of directors of Ascend Communications, Inc. during that
time. From April 1992 to June 1997, Mr. Smith served as President and Chief
Executive Officer and a member of the board of directors of Cascade
Communications Corp.
Frances M. Jewels has served as our Vice President of Finance and
Administration, Treasurer and Secretary since June 1999 and Chief Financial
Officer since July 1999. From June 1997 to June 1999, Ms. Jewels served as Vice
President and General Counsel of Ascend Communications, Inc. From April 1994 to
June 1997, Ms. Jewels served as Corporate Counsel of Cascade Communications
Corp. Prior to April 1994, Ms. Jewels practiced law in private practice and,
prior to that, practiced as a certified public accountant.
John E. Dowling has served as our Vice President of Operations since August
1998. From July 1997 to August 1998, Mr. Dowling served as Vice President of
Operations of Aptis Communications, a manufacturer of carrier-class access
switches for network service providers. Mr. Dowling served as Vice President of
Operations of Cascade Communications Corp. from May 1994 to June 1997.
Araldo Menegon has served as our Vice President, Worldwide Sales and Support
since August 2002. From April 2001 to June 2002, Mr. Menegon served as Senior
Vice President of Worldwide Sales and Field Operations for Tenor Networks, a
provider of networking equipment. From August 1999 to March 2001, Mr. Menegon
served as Area Operations Director for Cisco Systems, Inc. From July 1997 to
July 1999, Mr. Menegon served as Director of Service Provider Operations for
Cisco Canada. Prior to joining Cisco in July of 1996, Mr. Menegon spent 14
years with NCR and held several senior management positions, including an
international assignment with NCR's Pacific Group from January 1988 to February
1992.
Kevin J. Oye has served as our Vice President, Systems and Technology since
November 2001. From October 1999 through November 2001, Mr. Oye served as our
Vice President, Business Development. From March 1998 to October 1999, Mr. Oye
served as Vice President, Strategy and Business Development at Lucent
Technologies, Inc. and from September 1993 to March 1998, Mr. Oye served as the
Director of Strategy, Business Development, and Architecture at Lucent
Technologies, Inc. From June 1980 to September 1993, Mr. Oye held various
positions with AT&T Bell Laboratories where he was responsible for advanced
market planning as well as development and advanced technology management.
12
ITEM 2. PROPERTIES
We currently lease four facilities in Chelmsford, Massachusetts, containing
approximately 388,000 square feet in the aggregate. In Wallingford,
Connecticut, we currently lease two facilities containing a total of
approximately 43,000 square feet. These facilities consist of offices and
engineering laboratories used for administration, sales and customer support,
research and development, and ancillary light manufacturing, storage and
shipping activities. We also maintain smaller offices to provide sales and
customer support at various domestic and international locations. These
facilities are presently adequate for our needs, and we do not expect to
require additional space during fiscal 2003. We own a parcel of undeveloped
land, containing approximately 106 acres, in Tyngsborough, Massachusetts. This
land was acquired for the purpose of developing a campus that would serve as
our corporate headquarters, if we should require additional facilities over the
next several years.
ITEM 3. LEGAL PROCEEDINGS
Beginning on July 2, 2001, several purported class action complaints were
filed in the United States District Court for the Southern District of New York
against the Company and several of its officers and directors (the "Individual
Defendants") and the underwriters for the Company's initial public offering on
October 21, 1999. Some of the complaints also include the underwriters for the
Company's follow-on offering on March 14, 2000. The complaints were
consolidated into a single action and an amended complaint was filed on April
19, 2002. The amended complaint was filed on behalf of persons who purchased
the Company's common stock between October 21, 1999 and December 6, 2000. The
amended complaint alleges violations of the Securities Act of 1933, as amended,
and the Securities Exchange Act of 1934, as amended, primarily based on the
assertion that the Company's lead underwriters, the Company and the other named
defendants made material false and misleading statements in the Company's
Registration Statements and Prospectuses filed with the SEC in October 1999 and
March 2000 because of the failure to disclose (a) the alleged solicitation and
receipt of excessive and undisclosed commissions by the underwriters in
connection with the allocation of shares of common stock to certain investors
in the Company's public offerings and (b) that certain of the underwriters
allegedly had entered into agreements with investors whereby underwriters
agreed to allocate the public offering shares in exchange for which the
investors agreed to make additional purchases of stock in the aftermarket at
pre-determined prices. The amended complaint alleges claims against the
Company, several of the Company's officers and directors and the underwriters
under Sections 11 and 15 of the Securities Act. It also alleges claims against
the Company, the individual defendants and the underwriters under Sections
10(b) and 20(a) of the Securities Exchange Act. The action against the Company
is being coordinated with over three hundred other nearly identical actions
filed against other companies. The actions seek damages in an unspecified
amount. A motion to dismiss addressing issues common to the companies and
individuals who have been sued in these actions was filed on July 15, 2002. An
opposition to that motion was filed on behalf of the plaintiffs and a reply
brief was filed on behalf of the companies. The fully briefed issues are now
pending before the court and oral arguments are currently scheduled for October
29, 2002. On October 9, 2002, the court dismissed the Individual Defendants
from the case without prejudice based upon Stipulations of Dismissal filed by
the plaintiffs and the Individual Defendants. The Company believes that the
claims against it are without merit and intends to defend against the
complaints vigorously. The Company is not currently able to estimate the
possibility of loss or range of loss, if any, relating to these claims.
The Company is subject to legal proceedings, claims, and litigation arising
in the ordinary course of business. While the outcome of these matters is
currently not determinable, management does not expect that the ultimate costs
to resolve these matters will have a material adverse effect on the Company's
results of operations or financial position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
13
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Price Range of Common Stock
Our common stock has been traded on the Nasdaq National Market under the
symbol "SCMR" since October 22, 1999. The following table sets forth, for the
periods indicated, the high and low closing sale prices as reported on the
Nasdaq National Market for Sycamore common stock, as adjusted for all stock
splits.
High Low
----- -----
Fiscal year 2002:
Fourth Quarter ended July 31, 2002.... $3.86 $2.80
Third Quarter ended April 27, 2002.... 5.01 3.44
Second Quarter ended January 26, 2002. 6.44 4.31
First Quarter ended October 27, 2001.. 7.48 3.29
High Low
------- ------
Fiscal year 2001:
Fourth Quarter ended July 31, 2001.... $ 12.18 $ 5.84
Third Quarter ended April 28, 2001.... 37.75 7.25
Second Quarter ended January 27, 2001. 70.00 29.13
First Quarter ended October 28, 2000.. 167.19 64.25
As of July 31, 2002, there were approximately 1,668 stockholders of record.
Dividend Policy
We have never paid or declared any cash dividends on our common stock or
other securities and do not anticipate paying cash dividends in the foreseeable
future. Any future determination to pay cash dividends will be at the
discretion of the board of directors and will be dependent upon our financial
condition, results of operations, capital requirements, general business
condition and such other factors as the board of directors may deem relevant.
14
ITEM 6. SELECTED FINANCIAL DATA
The following selected financial data has been derived from our consolidated
financial statements and should be read in conjunction with the consolidated
financial statements and notes thereto and with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and other financial
data included elsewhere in this report. The historical results are not
necessarily indicative of results to be expected for any future period.
Period from
Inception
Year Ended July 31, (Feb. 17, 1998)
---------------------------------------- through
2002 2001 2000 1999 July 31, 1998
--------- --------- -------- -------- ---------------
(in thousands, except per share data)
Consolidated Statement of Operations Data:
Revenue........................................ $ 65,174 $ 374,746 $198,137 $ 11,330 $ --
Cost of revenue................................ 152,704 317,796 106,419 8,587 --
--------- --------- -------- -------- -------
Gross profit (loss)......................... (87,530) 56,950 91,718 2,743 --
Operating expenses:
Research and development.................... 109,654 159,607 71,903 17,979 714
Sales and marketing......................... 39,687 83,478 30,650 4,064 92
General and administrative.................. 10,166 16,820 9,824 3,056 247
Stock compensation.......................... 22,812 62,092 19,634 3,547 5
Restructuring charges and related asset
impairments............................... 124,990 81,926 -- -- --
Acquisition costs........................... -- 4,948 -- -- --
--------- --------- -------- -------- -------
Total operating expenses................ 307,309 408,871 132,011 28,646 1,058
--------- --------- -------- -------- -------
Loss from operations........................... (394,839) (351,921) (40,293) (25,903) (1,058)
Losses on investments.......................... (24,845) -- -- -- --
Interest and other income, net................. 40,027 85,299 41,706 850 108
--------- --------- -------- -------- -------
Income (loss) before income taxes.............. (379,657) (266,622) 1,413 (25,053) (950)
Income tax expense............................. -- 13,132 745 -- --
--------- --------- -------- -------- -------
Net income (loss).............................. $(379,657) $(279,754) $ 668 $(25,053) $ (950)
========= ========= ======== ======== =======
Basic net income (loss) per share.............. $ (1.49) $ (1.18) $ 0.00 $ (1.32) $ (0.17)
Diluted net income (loss) per share............ $ (1.49) $ (1.18) $ 0.00 $ (1.32) $ (0.17)
Shares used in per-share calculation--basic. 254,663 237,753 166,075 18,919 5,677
Shares used in per-share calculation--
diluted................................... 254,663 237,753 233,909 18,919 5,677
As of July 31,
-----------------------------------------------
2002 2001 2000 1999 1998
---------- ---------- ---------- ------- ------
(in thousands)
Consolidated Balance Sheet Data:
Cash, cash equivalents and investments $1,043,545 $1,248,549 $1,517,103 $47,889 $4,599
Working capital....................... 636,530 783,665 1,147,131 59,292 4,549
Total assets.......................... 1,118,575 1,551,321 1,697,915 79,038 5,522
Long term debt, less current portion.. -- -- 1,157 4,489 --
Redeemable convertible preferred stock -- -- -- 55,771 5,621
Total stockholders' equity (deficit).. $1,038,523 $1,387,860 $1,591,118 $ 6,691 $ (349)
15
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with
"Selected Financial Data" and our consolidated financial statements and the
related notes thereto included elsewhere in this report. Except for the
historical information contained herein, we caution you that certain matters
discussed in this report constitute forward-looking statements that involve
risks and uncertainties. Our actual results could differ materially from those
stated or implied in forward-looking statements due to a number of factors,
including but not limited to the rate of product purchases by current and
prospective customers; general economic conditions, including stock market
volatility and capital market conditions; conditions specific to the
telecommunications, Internet and related industries; the commercial success of
the Company's line of intelligent optical networking products; the Company's
reliance on a limited number of customers; new product introductions and
enhancements by the Company and its competitors; the length and variability of
the sales cycles for the Company's products; competition; manufacturing and
sourcing risks; variations in the Company's quarterly results; and the other
factors discussed in this Form 10-K and other reports filed by us from time to
time with the Securities and Exchange Commission. We disclaim any intention or
obligation to update or revise any forward-looking statements, whether as a
result of new information, future results or otherwise. Forward-looking
statements include statements regarding our expectations, beliefs, intentions
or strategies regarding the future and can be identified by forward-looking
words such as "anticipate," "believe," "could," "estimate," "expect," "intend,"
"may, " "should," "will," and "would" or similar words.
Overview
We develop and market intelligent optical networking products that enable
telecommunications service providers to quickly and cost-effectively transform
the capacity created by their fiber optic networks into usable bandwidth to
deploy new services. Since our inception in February 1998, our revenue
increased from $11.3 million for the fiscal year ended July 31, 1999 to $374.7
million for the fiscal year ended July 31, 2001. Our revenue was $65.2 million
for the fiscal year ended July 31, 2002, a decrease of 83% compared to fiscal
year 2001.
Our rapid growth in revenue from fiscal year 1999 through the first half of
fiscal year 2001 reflected a strong economic environment for telecommunications
service providers, driven by strong capital markets and by changes in the
regulatory environment, in particular those brought about by the
Telecommunications Act of 1996. These factors enabled the entry of a
significant number of new companies into the telecommunications services
industry, typically referred to as emerging service providers. The entry of
emerging service providers into the market also increased the competitive
pressure on incumbent service providers that had traditionally offered
telecommunications services, causing them to increase their capital
expenditures above their historical levels during this period.
Beginning in the third quarter of fiscal 2001, our revenue declined
significantly due to unfavorable economic conditions caused by a rapid and
significant decrease in capital spending by telecommunications service
providers. Emerging service providers, which had been the early adopters of our
technology, were no longer able to continue to fund aggressive deployments of
equipment within their networks due to their inability to access the capital
markets. Since then, many emerging service providers have experienced severe
financial difficulties, and in many cases, have filed for bankruptcy
protection, or have liquidated their assets and are no longer in business. This
trend was compounded by decisions by incumbent service providers to slow their
capital expenditures significantly, in part due to reduced competitive pressure
from emerging service providers. In addition, many incumbent service providers
have found their prospects for raising additional capital through the issuance
of debt or equity securities to be greatly reduced, causing them to decrease
capital expenditures to the minimum amount required to support their existing
customer commitments. These conditions are currently impacting many of our
current and prospective customers, and make any recovery in capital spending
extremely difficult to forecast. As a result of these factors, our revenue was
$65.2 million in fiscal 2002, a decrease of 83% compared to fiscal 2001. Our
revenue has been, and continues to be, negatively impacted by these unfavorable
economic conditions.
16
We currently anticipate that the cost of revenue and the resulting gross
margin will continue to be adversely affected by several factors, including
reduced demand for our products, the effects of product volumes and
manufacturing efficiencies, component limitations, the mix of products and
services sold, increases in material and labor costs, loss of cost savings due
to changes in component pricing or charges incurred if we do not correctly
anticipate product demand, competitive pricing, and possible exposure to excess
and obsolete inventory charges. While we have taken actions to reduce our cost
structure, we anticipate that we will continue to incur operating losses unless
the overall economic environment improves and our revenue increases
significantly compared to current levels. During the last half of fiscal 2001
and the full year of fiscal 2002, we incurred substantial operating losses
totaling $693.2 million, which includes net restructuring and related asset
impairment charges totaling $382.5 million. During the fourth quarter of fiscal
2002, as a component of our third restructuring program, we made a strategic
decision to focus our business on optical switching and discontinue the
development of our stand-alone transport products. At this time, we have
limited visibility into future revenue and cannot predict when, or if, the
economic environment and the demand for our products will improve.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Management's discussion and analysis of its financial condition and results
of operations are based upon our consolidated financial statements. The
preparation of these financial statements requires us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenue and
expenses and related disclosure of contingent liabilities. We evaluate these
estimates on an ongoing basis, including those relating to bad debts,
inventories, valuation of investments, warranty obligations, restructuring
liabilities and asset impairments, litigation and other contingencies.
Estimates are based on our historical experience and other assumptions that are
considered reasonable under the circumstances, the results of which form the
basis for making judgments about the carrying values of assets and liabilities
that are not readily apparent from other sources. Actual results may differ
from these estimates. To the extent there are material differences between our
estimates and the actual results, our future results of operations will be
affected.
We believe that the following critical accounting policies represent the
most significant judgments and estimates used in the preparation of our
consolidated financial statements, because changes in such estimates can
materially affect the amount of our reported net income or loss. When products
are shipped to customers, we evaluate whether all of the fundamental criteria
for revenue recognition have been met. The most significant judgments for
revenue recognition typically involve whether there are any significant
uncertainties regarding customer acceptance and whether collectibility can be
considered reasonably assured. In addition, some of the Company's transactions
consist of multiple element arrangements which must be analyzed to determine
the relative fair value of each element, the amount of revenue to be recognized
upon shipment, if any, and the period and conditions under which deferred
revenue should be recognized. After customers have been invoiced, management
evaluates the outstanding accounts receivable balances until they are
collected, to determine whether an allowance for doubtful accounts should be
recorded. In the event of a sudden deterioration in a particular customer's
financial condition, additional provisions for doubtful accounts may be
required, such as the specific provision that we recorded in the fourth quarter
of fiscal 2001. We accrue for the estimated cost of product warranties at the
time revenue is recognized, based primarily on our historical experience. If
actual warranty claims exceed the amounts accrued, additional warranty charges
would be required which would reduce gross margins in future periods.
We continuously monitor our inventory balances and provisions are recorded
for any differences between the cost of the inventory and its estimated market
value, based on assumptions about future demand and market conditions. We
believe that the accounting estimates relating to the net realizable value of
our inventories is a critical accounting estimate because it is based primarily
on our estimate of future inventory demand and usage, which requires us to make
significant assumptions about future sales and market conditions. While such
assumptions may change significantly from period to period, the net realizable
value of inventories is measured using the best information available as of the
balance sheet date. To the extent that a severe decline in forecasted demand
occurs, significant charges for excess inventory are likely to occur, such as
the $102.4 million charge we recorded in the first quarter of fiscal 2002. Once
inventory has been written down to its estimated net realizable
17
value, its carrying value cannot be increased due to subsequent changes in
demand forecasts. Accordingly, if inventory previously written down to its net
realizable value is subsequently sold, we may realize improved gross profit
margins on these transactions. During the third and fourth quarters of fiscal
2002, we recorded credits totaling $10.8 million to cost of revenue relating to
inventory charges that were originally recorded in the first quarter of fiscal
2002. These credits related to favorable settlements of inventory purchase
commitments with contract manufacturers, and to a lesser extent, sales of
inventory that had been previously written down.
During the third quarter of fiscal 2001 and the first and fourth quarters of
fiscal 2002, we recorded charges for restructuring and related asset
impairments totaling $422.0 million, including inventory related charges of
$186.4 million. These restructuring activities required us to make numerous
assumptions and estimates, including future revenue levels and product mix, the
timing of and the amounts received for subleases of excess facilities, the fair
values of impaired assets, the amounts of other than temporary impairments of
strategic investments, and the potential legal matters, administrative expenses
and professional fees associated with the restructuring activities. The
estimates and assumptions relating to the restructuring activities are
continually monitored and evaluated, and if these estimates and assumptions
change, we may be required to record additional charges or credits against the
reserves previously recorded for these restructuring activities. For example,
during the third and fourth quarters of fiscal 2002, we recorded credits
totaling $3.8 million to operating expenses, due to various changes in
estimates relating to the restructuring charges that had been recorded in the
third quarter of fiscal 2001 and the first quarter of fiscal 2002. These
credits included decreases in the potential legal matters associated with the
restructuring activities, partially offset by increases in the projected
liabilities relating to facility consolidations. As of July 31, 2002, we had
$19.4 million accrued as part of our restructuring liability relating to
facility consolidations, based on our best estimate of the available sublease
rates and terms at the present time. In the event that we are unsuccessful in
subleasing any of the restructured facilities, we could incur additional
restructuring charges and cash outflows in future periods totaling $6.2
million, which represents the amount of the assumed sublease recoveries that
have been incorporated into the current estimate.
Results of Operations
Fiscal Years ended July 31, 2002 and 2001
Revenue
Revenue decreased 83% or $309.5 million to $65.2 million for fiscal 2002
compared to $374.7 million for fiscal 2001. Product revenue declined by 88% or
$313.0 million while service revenue increased by 19% or $3.5 million compared
to fiscal 2001. The decrease in product revenue was due to the decline in the
overall economic environment and deteriorating conditions in the
telecommunications industry, in particular the significant reductions in
capital spending by our target customers. The increase in service revenue was
due to revenue from maintenance and other services associated with product
shipments that occurred in previous periods. Two customers accounted for 45%
and 20% of our revenue in fiscal 2002, whereas two different customers
accounted for 47% and 11% of our revenue in fiscal 2001. No other customer
accounted for more than 10% of our revenue in fiscal 2002 or 2001.
International revenue represented 87% of total revenue in fiscal 2002, compared
to 35% of total revenue in fiscal 2001. We anticipate that international
revenue will continue to represent a significant portion of total revenue in
fiscal 2003.
Sales to emerging service providers, which had represented a significant
percentage of our revenue in fiscal 2001, were relatively insignificant in
fiscal 2002, and we expect this trend to continue for the foreseeable future.
While we have redirected our marketing efforts towards incumbent service
providers, these customers typically have longer sales evaluation cycles than
emerging service providers, and many incumbent service providers have also
announced significant reductions in their capital expenditure budgets.
Accordingly, there can be no certainty as to the severity or duration of the
current economic downturn and its impact on our future revenue.
Cost of Revenue
Total cost of revenue decreased $165.1 million to $152.7 million for fiscal
2002 compared to $317.8 million for fiscal 2001. Total cost of revenue was 234%
of revenue for fiscal 2002, compared to 85% of revenue for fiscal 2001. Cost of
revenue for fiscal 2002 included a net charge of $91.6 million relating to
excess inventory
18
due to a significant reduction in the Company's sales forecasts in the first
quarter of fiscal 2002. The original charge of $102.4 million, recorded in the
first quarter of fiscal 2002, was reduced by credits totaling $10.8 million due
to changes in estimates, the majority of which related to favorable settlements
with contract manufacturers. Cost of revenue for fiscal 2001 included an
inventory write-down of $84.0 million associated with the consolidation and
elimination of certain product lines. Cost of revenue for fiscal 2002 included
$1.8 million of stock compensation expense, compared to $3.1 million for fiscal
2001. Excluding the effect of the inventory write-downs and stock compensation
charges, total cost of revenue as a percentage of revenue was 91% for fiscal
2002, compared to 62% for fiscal 2001. Excluding the impact of these charges,
the increase in total cost of revenue as a percentage of revenue reflects the
overall decrease in revenue and lower utilization of certain fixed
manufacturing and customer support costs.
Cost of revenue for services decreased $12.6 million to $24.5 million for
fiscal 2002 compared to $37.1 million for fiscal 2001, due primarily to the
overall decrease in revenue levels and the decrease in customer support costs
due to the Company's restructuring activities. In addition to the costs
associated with supporting existing customers, cost of revenue for services
includes costs to support evaluations and trials for potential customers, such
as incumbent service providers which typically have relatively long sales
evaluation cycles.
Research and Development Expenses
Research and development expenses decreased $49.9 million to $109.7 million
for fiscal 2002 compared to $159.6 million for fiscal 2001. The decrease was
primarily due to reduced costs for project related materials and a decrease in
personnel related expenses due to the Company's restructuring activities, which
resulted in a consolidation of product offerings and more focused development
efforts.
Sales and Marketing Expenses
Sales and marketing expenses decreased $43.8 million to $39.7 million for
fiscal 2002 compared to $83.5 million for fiscal 2001. The decrease was
primarily due to reduced costs for personnel and related expenses due to the
Company's restructuring activities as well as decreased program marketing costs.
General and Administrative Expenses
General and administrative expenses decreased $6.6 million to $10.2 million
for fiscal 2002 compared to $16.8 million for fiscal 2001. The decrease was
primarily due to reduced costs for personnel and related expenses due to the
Company's restructuring activities.
Stock Compensation Expense
Total stock compensation expense decreased $40.6 million to $24.6 million
for fiscal 2002 compared to $65.2 million for fiscal 2001. For fiscal 2002,
$1.8 million of stock compensation expense was classified as cost of revenue
and $22.8 million was classified as operating expenses. Stock compensation
expense primarily resulted from the granting of stock options and restricted
shares with exercise or sale prices which were deemed to be below fair market
value. The significant decrease was primarily due to $36.3 million of expense
recorded during the first quarter of fiscal 2001, upon the accelerated vesting
of certain restricted stock and stock options in connection with our
acquisition of Sirocco Systems, Inc. ("Sirocco"). The remaining decrease was
primarily due to headcount reductions associated with the Company's
restructuring activities, offset partially by the amortization of restricted
stock issued pursuant to the Company's Stock Option Exchange Offer in the
fourth quarter of fiscal 2001. Stock compensation expense is expected to impact
our reported results of operations through the fourth quarter of fiscal 2005.
Restructuring Charges and Related Asset Impairments
Beginning in the third quarter of fiscal 2001, unfavorable economic
conditions and reduced capital spending by telecommunications service providers
negatively impacted our operating results in a progressive and
19
increasingly severe manner. As a result, we have enacted three separate
business restructuring programs, the first in the third quarter of fiscal 2001
(the "fiscal 2001 restructuring"), the second in the first quarter of fiscal
2002 (the "first quarter fiscal 2002 restructuring"), and the third in the
fourth quarter of fiscal 2002 (the "fourth quarter fiscal 2002 restructuring").
As a result of the combined activity under all of the restructuring actions,
during the year ended July 31, 2002, we recorded a total net charge of $241.5
million, which was classified in the statement of operations as follows: cost
of revenue--$91.7 million, operating expenses--$125.0 million, and
non-operating expense--$24.8 million. The originally recorded restructuring
charges were subsequently reduced by credits totaling $14.6 million (cost of
revenue--$10.8 million and operating expenses--$3.8 million). Details regarding
each of the restructuring actions are as follows:
Fiscal 2001 Restructuring:
As a result of the unfavorable conditions referred to above, we implemented
a restructuring program in the third quarter of fiscal 2001, designed to reduce
expenses in order to align resources with long-term growth opportunities. The
restructuring program included a workforce reduction of 131 employees,
consolidation of excess facilities, and the restructuring of certain business
functions to eliminate non-strategic products and overlapping feature sets.
This included the discontinuance of the SN 6000 Intelligent Optical Transport
product and the bi-directional capabilities of the SN 8000 Intelligent Optical
Network Node. As a result of the restructuring program, we recorded
restructuring charges and related asset impairments of $81.9 million classified
as operating expenses and an excess inventory charge of $84.0 million relating
to the discontinued product lines, which was classified as cost of revenue.
The restructuring charges and related asset impairments recorded in the
third quarter of fiscal 2001, and the reserve activity since that time, are
summarized as follows (in thousands):
Accrual Accrual
Total Fiscal 2001 Balance at Fiscal 2002 Balance at
Restructuring Non-cash Cash July 31, Cash July 31,
Charge Charges Payments 2001 Payments Adjustments 2002
------------- -------- ----------- ---------- ----------- ----------- ----------
Workforce reduction...... $ 4,174 $ 829 $ 2,823 $ 522 $ 380 $ 142 $ --
Facility consolidations
and certain other costs 24,437 1,214 1,132 22,091 4,287 1,994 15,810
Inventory and asset
write-downs............ 137,285 84,972 13,923 38,390 38,390 -- --
-------- ------- ------- ------- ------- ------ -------
Total.................... $165,896 $87,015 $17,878 $61,003 $43,057 $2,136 $15,810
======== ======= ======= ======= ======= ====== =======
The fiscal 2001 restructuring program was substantially completed during the
first half of fiscal 2002. During the fourth quarter of fiscal 2002, we
recorded a net $2.1 million credit to operating expenses due to changes in
estimates. The changes in estimates consisted primarily of $4.7 million of
additional facility consolidation charges due to less favorable sublease
assumptions, offset by a $6.7 million reduction in the potential legal matters
associated with the restructuring activities. The remaining cash payments
consist of facility consolidation charges that will be paid over the respective
lease terms through fiscal 2007 and potential legal matters and administrative
expenses associated with the restructuring activities.
First Quarter Fiscal 2002 Restructuring:
As a result of a continued decline in overall economic conditions and
further reductions in capital spending by telecommunications service providers,
we implemented a second restructuring program in the first quarter of fiscal
2002, designed to further reduce expenses to align resources with long-term
growth opportunities. The restructuring program included a workforce reduction,
consolidation of excess facilities, and charges related to excess inventory and
other asset impairments.
20
As a result of the restructuring program, we recorded restructuring charges
and related asset impairments of $77.3 million classified as operating expenses
and an excess inventory charge of $102.4 million classified as cost of revenue.
In addition, we recorded charges totaling $22.7 million classified as a
non-operating expense, relating to impairments of investments in non-publicly
traded companies that were determined to be other than temporary. The following
paragraphs provide detailed information relating to the restructuring charges
and related asset impairments which were recorded during the first quarter of
fiscal 2002.
Workforce reduction
The restructuring program resulted in the reduction of 239 regular employees
across all business functions and geographic regions. The workforce reductions
were substantially completed in the first quarter of fiscal 2002. We recorded a
workforce reduction charge of approximately $7.1 million relating primarily to
severance payments and fringe benefits. In addition we also reduced the number
of temporary and contract workers employed by us.
Consolidation of facilities and certain other costs
We recorded a charge of $17.2 million relating to the consolidation of
excess facilities and certain other costs. The total charge includes $11.2
million related to the write-down of certain land, as well as lease
terminations and non-cancelable lease costs relating to abandoned facilities.
We also recorded other restructuring costs of $6.0 million relating primarily
to potential legal matters, administrative expenses and professional fees in
connection with the restructuring activities.
Inventory and asset write-downs
We recorded a charge of $155.5 million relating to the write-down of
inventory to its net realizable value and the impairment of certain other
assets. The total charge includes $102.4 million of inventory write-downs and
non-cancelable purchase commitments for inventory which was recorded as part of
cost of revenue. This excess inventory charge was due to a severe decline in
the forecasted demand for our products. We also recorded charges totaling $53.1
million for asset impairments, including the assets related to our vendor
financing agreements and fixed assets that were abandoned by us. Since revenue
had been recognized under the vendor financing agreements on a cash basis, the
amount of the impairment loss was limited to the cost of the systems shipped to
the vendor financing customers, which had been classified in other long-term
assets.
Losses on investments
We recorded charges totaling $22.7 million for impairments of investments in
non-publicly traded companies that were determined to be other than temporary.
The impairment charges were classified as a non-operating expense.
The restructuring charges and related asset impairments recorded in the
first quarter of fiscal 2002, and the reserve activity since that time, are
summarized as follows (in thousands):
Accrual
Original Balance at
Restructuring Non-cash Cash July 31,
Charge Charges Payments Adjustments 2002
------------- -------- -------- ----------- ----------
Workforce reduction........ $ 7,106 $ 173 $ 6,106 $ 827 $ --
Facility consolidations and
certain other costs...... 17,181 8,572 1,684 835 6,090
Inventory and asset write-
downs.................... 155,451 102,540 41,358 10,804 749
Losses on investments...... 22,737 22,737 -- -- --
-------- -------- ------- ------- ------
Total...................... $202,475 $134,022 $49,148 $12,466 $6,839
======== ======== ======= ======= ======
21
The first quarter fiscal 2002 restructuring program was substantially
completed during the fourth quarter of fiscal 2002. During the third and fourth
quarters of fiscal 2002, we recorded credits totaling $10.8 million to cost of
revenue due to changes in estimates, the majority of which related to favorable
settlements with contract manufacturers for non-cancelable inventory purchase
commitments. In addition, during the fourth quarter of fiscal 2002, we recorded
a credit to operating expenses of $1.7 million relating to various changes in
estimates. The changes in estimates consisted of $0.9 million of additional
facility consolidation charges, offset by a $1.7 million reduction in the
potential legal matters associated with the restructuring activities and the
reversal of an accrued liability of $0.8 million for workforce reductions. The
remaining cash payments consist primarily of facility consolidation charges
that will be paid over the respective lease terms through fiscal 2005 and
potential legal matters and administrative expenses associated with the
restructuring activities.
Fourth Quarter Fiscal 2002 Restructuring:
As a result of continued weakness in overall economic conditions and capital
spending by telecommunications service providers, we implemented a third
restructuring program in the fourth quarter of fiscal 2002, designed to further
reduce expenses to align resources with long-term growth opportunities. The
restructuring program included a workforce reduction, consolidation of excess
facilities, and the restructuring of certain business functions to eliminate
non-strategic products. This included discontinuing the development of our
standalone transport products, including the SN 8000 Intelligent Optical
Transport Node and the SN 10000 Intelligent Optical Transport System.
As a result of the restructuring program, we recorded restructuring charges
and related asset impairments of $51.5 million classified as operating
expenses. In addition, we recorded a charge of $2.1 million classified as a
non-operating expense, relating to impairments of investments in non-publicly
traded companies that were determined to be other than temporary. As a result
of the combined impact of the first quarter and fourth quarter fiscal 2002
restructuring programs, we expect pretax savings of approximately $95 million
in annual operating expenses, as compared to the levels immediately preceding
the restructuring programs. The following paragraphs provide detailed
information relating to the restructuring charges and related asset impairments
which were recorded during the fourth quarter of fiscal 2002.
Workforce reduction
The restructuring program resulted in the reduction of 225 regular employees
across all business functions and geographic regions. The workforce reductions
were substantially completed in the fourth quarter of fiscal 2002. We recorded
a workforce reduction charge of approximately $8.7 million relating primarily
to severance payments and fringe benefits. In addition we also reduced the
number of temporary and contract workers employed by us.
Consolidation of facilities and certain other costs
We recorded a charge of $20.1 million relating to the consolidation of
excess facilities and certain other costs, including $5.6 million for lease
terminations and non-cancelable lease costs relating to abandoned facilities.
We also recorded other restructuring costs of $14.5 million relating to
potential legal matters, contractual commitments, administrative expenses and
professional fees related to the restructuring activities.
Asset write-downs
We recorded charges totaling $22.6 million for asset impairments, which
related primarily to fixed assets that were disposed of or that we abandoned,
due to the rationalization of our product offerings and the consolidation of
excess facilities.
22
Losses on investments
We recorded a charge of $2.1 million for impairments of investments in
non-publicly traded companies that were determined to be other than temporary.
The impairment charge was classified as a non-operating expense.
The restructuring charges and related asset impairments recorded in the
fourth quarter of fiscal 2002, and the reserve activity since that time, are
summarized as follows (in thousands):
Accrual
Total Balance at
Restructuring Non-cash Cash July 31,
Charge Charges Payments 2002
------------- -------- -------- ----------
Workforce reduction............................ $ 8,713 $ 814 $2,059 $ 5,840
Facility consolidations and certain other costs 20,132 -- 454 19,678
Asset write-downs.............................. 22,637 22,637 -- --
Losses on investments.......................... 2,108 2,108 -- --
------- ------- ------ -------
Total.......................................... $53,590 $25,559 $2,513 $25,518
======= ======= ====== =======
The remaining cash expenditures relating to workforce reductions will be
substantially paid by the first quarter of fiscal 2003. Facility consolidation
charges will be paid over the respective lease terms through fiscal 2006.
Acquisition Costs
Acquisition costs for the first quarter of fiscal 2001 were $4.9 million
related to the acquisition of Sirocco. These costs included legal and
accounting services and other professional fees associated with the transaction.
Interest and Other Income, Net
Interest and other income, net decreased $45.3 million to $40.0 million for
fiscal 2002 compared to $85.3 million for fiscal 2001. The decrease in interest
and other income was primarily attributable to lower interest rates and a lower
average cash balance during fiscal 2002.
Provision for Income Taxes
We did not provide for income taxes for fiscal 2002 due to the significant
net loss incurred during the year and the significant uncertainty as to the
realization of our deferred tax assets. In fiscal 2001, we recorded a provision
for income taxes of $13.1 million. The provision for income taxes for fiscal
2001 consisted primarily of a valuation allowance and state and foreign taxes,
offset by a federal loss carryback benefit. The Company recorded a full
valuation allowance in fiscal 2001 to offset net deferred tax assets as the
Company believes it is more likely than not that net deferred tax assets will
not be realized.
Fiscal Years ended July 31, 2001 and 2000
Revenue
Revenue increased $176.6 million to $374.7 million for fiscal 2001 compared
to $198.1 million for fiscal 2000. The overall increase in revenue was
primarily due to increased sales of our SN 8000 product and the broadening of
our product offerings to include the SN 3000, SN 10000 and SN 16000. One
customer accounted for 47% and 92% of our revenue for fiscal 2001 and 2000,
respectively, and another customer accounted for 11% of our revenue in fiscal
2001. No other customer accounted for more than 10% of our revenue in fiscal
2001 and 2000. Revenue increased significantly in the first two quarters of
fiscal 2001 compared to the same period in fiscal 2000, but beginning in the
third quarter of fiscal 2001, declined significantly compared to the first two
quarters of fiscal 2001, primarily due to a reduction in capital spending by
our customers, and to a lesser extent,
23
component issues related to our SN 16000 product. International revenue was 35%
of total revenue in fiscal 2001, compared to an insignificant amount in fiscal
2000.
Cost of Revenue
Cost of revenue increased $211.4 million to $317.8 million for fiscal 2001
compared to $106.4 million for fiscal 2000. Cost of revenue for fiscal 2001
included $3.1 million of stock compensation expense, compared to $1.4 million
for fiscal 2000. Excluding stock compensation expense, cost of revenue
represented 84% of total revenue in fiscal 2001, as compared to 53% of total
revenue for fiscal 2000. The increase in cost of revenue was primarily related
to the increase in revenue, the impact of an $84.0 million inventory write-down
associated with the consolidation and elimination of certain product offerings,
headcount increases in our manufacturing overhead and customer service
organizations, additional warranty expenses and other period costs. During the
first two quarters of fiscal 2001, cost of revenue excluding stock compensation
expense remained constant as a percentage of revenue at 53% compared to the
same period in fiscal 2000. Because of the sharp decrease in revenue which
occurred during the last two quarters of fiscal 2001, cost of revenue exceeded
total revenue for the last half of fiscal year 2001.
Research and Development Expenses
Research and development expenses increased $87.7 million to $159.6 million
for fiscal 2001 compared to $71.9 million for fiscal 2000. The increase was
attributable to costs associated with increased personnel and related expenses,
increased depreciation expense due to increased investments in lab and testing
equipment, and increases in engineering costs and prototype expenses for the
design and development of new products, as well as enhancements to existing
products.
Sales and Marketing Expenses
Sales and marketing expenses increased $52.8 million to $83.5 million for
fiscal 2001 compared to $30.7 million for fiscal 2000. The increase was
attributable to increased personnel and related expenses, higher sales-based
commissions, the expansion of sales offices and higher marketing program costs,
including trade shows and new product launch activities. In addition, during
fiscal 2001 we recorded a provision for doubtful accounts of $5.5 million, of
which $4.4 million related to a specific accounts receivable balance for a
customer that filed for bankruptcy protection during the fourth quarter of
fiscal 2001. There was no provision for doubtful accounts in fiscal 2000.
General and Administrative Expenses
General and administrative expenses increased $7.0 million to $16.8 million
for fiscal 2001 compared to $9.8 million for fiscal 2000. The increase in
expenses reflects the hiring of additional general and administrative personnel
and expenses necessary to support increased levels of business activities.
Stock Compensation Expense
Total stock compensation expense was $65.2 million for fiscal 2001, an
increase of $44.1 million from $21.1 million for fiscal 2000. For fiscal 2001,
$3.1 million of stock compensation expense was classified as cost of revenue
and $62.1 million was classified as operating expenses. Amounts for fiscal 2001
and 2000 include $22,000 and $6.2 million of compensation expense associated
with the grant of options to purchase common stock to non-employees,
respectively. In addition, the amount for fiscal 2001 includes $36.3 million of
expense attributable to the acceleration of options and restricted stock
relating to the acquisition of Sirocco. Stock compensation expense primarily
resulted from the granting of stock options and restricted shares with exercise
or sale prices which were deemed to be below fair market value. Stock
compensation expense relating to these grants is expected to affect our results
of operations through the fourth quarter of fiscal 2005.
24
In March 2001, we issued a two-year warrant to purchase 150,000 shares of
common stock at $11.69 per share, exercisable immediately, in exchange for
general and administrative services. We valued the warrant using the
Black-Scholes model with the following assumptions: 6.5% risk free interest
rate, 90% expected volatility, and a two year expected life, and recorded a
charge for stock compensation of $0.9 million in the third quarter of fiscal
2001.
As described in Note 7 to the consolidated financial statements, in May 2001
we announced an offer to exchange outstanding employee stock options having an
exercise price of $7.25 or more per share in return for restricted stock and
new stock options to be granted by the Company (the "Exchange Offer"). Pursuant
to the Exchange Offer, in exchange for eligible options, an option holder
generally received a number of shares of restricted stock equal to one-tenth
( 1/10) of the total number of shares subject to the options tendered by the
option holder and accepted for exchange, and commitment for new options to be
issued exercisable for a number of shares of common stock equal to nine-tenths
( 9/10) of the total number of shares subject to the options tendered by the
option holder and accepted for exchange. In order to address potential adverse
tax consequences for employees of certain international countries, these
employees were allowed to forego the restricted stock grants and receive all
stock options.
A total of 17.6 million options were accepted for exchange under the
Exchange Offer and accordingly, were canceled in June 2001. A total of 1.7
million shares of restricted stock were issued in June 2001 and we recorded
deferred compensation of $12.6 million related to these grants. The deferred
compensation costs will be amortized ratably over the vesting periods of the
restricted stock, generally over a four year period, with 25% of the shares
vesting one year after the date of grant and the remaining 75% vesting
quarterly thereafter. Until the restricted stock vests, such shares are subject
to forfeiture in the event the employee leaves the Company.
Upon the completion of the Exchange Offer, options to purchase approximately
15.9 million shares were originally expected to be granted in the second
quarter of fiscal 2002, no sooner than six months and one day from June 20,
2001. However, due to the effect of employee terminations, which were primarily
due to our fiscal 2002 restructuring programs as described in Note 10 to the
consolidated financial statements, the number of options which were granted in
the second quarter of fiscal 2002 related to the Exchange Offer was
approximately 12.6 million shares. The new options will generally vest over
three years, with 8.34% of the options vesting on the date of grant and the
remaining 91.66% vesting quarterly thereafter subject to forfeiture in the
event the employee leaves the Company. The new options were granted with an
exercise price of $4.89 per share, equal to the fair market value of our common
stock on the date of grant.
Acquisition Costs
In connection with the acquisition of Sirocco in the first quarter of fiscal
2001, we incurred $4.9 million of acquisition costs for legal, accounting and
professional services. An aggregate of approximately 28.6 million shares of our
common stock were either exchanged for all outstanding shares of Sirocco or
reserved for issuance under outstanding Sirocco stock options assumed by us in
the transaction.
Restructuring Charges and Related Asset Impairments
As a result of unfavorable economic conditions and reduced capital spending
by telecommunications service providers, we implemented a restructuring program
in the third quarter of fiscal 2001, designed to reduce expenses in order to
align resources with long-term growth opportunities. The restructuring program
included a workforce reduction, consolidation of excess facilities, and the
restructuring of certain business functions to eliminate non-strategic products
and overlapping feature sets. This included the discontinuance of the SN 6000
Intelligent Optical Transport product and the bi-directional capabilities of
the SN 8000 Intelligent Optical Network Node.
As a result of the restructuring program, we recorded restructuring charges
and related asset impairments of $81.9 million classified as operating expenses
and an additional excess inventory charge of $84.0 million classified as cost
of revenue.
25
The following paragraphs provide detailed information relating to the
restructuring charges and related asset impairments which were recorded during
the third quarter of fiscal 2001.
Workforce reduction
The restructuring program resulted in the reduction of approximately 131
regular employees across all business functions, and geographic regions. The
workforce reductions were substantially completed in the third quarter of
fiscal 2001. We recorded a workforce reduction charge of approximately $4.2
million relating primarily to severance payments and fringe benefits. In
addition we also reduced the number of temporary and contract workers employed
by us.
Consolidation of facilities and certain other costs
We recorded a restructuring charge of $24.4 million relating to
consolidation of excess facilities and certain other costs. The consolidation
of excess facilities relates to business activities that have been exited or
restructured. We recorded a restructuring charge of $12.2 million primarily
related to lease terminations and non-cancelable lease costs. We also recorded
other restructuring costs of $12.2 million relating primarily to administrative
expenses and professional fees in connection with the restructuring activities.
Inventory and asset write downs
We recorded a restructuring charge of $137.3 million relating to the
write-down of inventory to its net realizable value and the write down of
certain assets which became impaired as a result of the decision to eliminate
non-strategic products and overlapping feature sets. The restructuring charge
includes $84.0 million of inventory write-downs which are recorded as part of
cost of revenue. The restructuring charge also includes $53.3 million of
impaired assets which largely relate to the rationalization of our future
product offerings and contract settlements associated with the discontinuance
of certain product offerings.
A summary of the restructuring charges and related asset impairments is
outlined as follows (in thousands):
Accrual
Total Balance at
Restructuring Non-cash Cash July 31,
Charge Charges Payments 2001
------------- -------- -------- ----------
Workforce reduction............................ $ 4,174 $ 829 $ 2,823 $ 522
Facility consolidations and certain other costs 24,437 1,214 1,132 22,091
Inventory and asset write-downs................ 137,285 84,972 13,923 38,390
-------- ------- ------- -------
Ending balance at July 31, 2001................ $165,896 $87,015 $17,878 $61,003
======== ======= ======= =======
The restructuring program was substantially completed during the first half
of fiscal 2002. Facility consolidation charges will be paid over the respective
lease terms through fiscal 2007.
Interest and Other Income, Net
Interest and other income, net increased $43.6 million to $85.3 million for
fiscal 2001 compared to $41.7 million for fiscal 2000. The increase in interest
income was primarily attributable to higher balances of cash and investments,
resulting from the proceeds of our two public offerings in fiscal year 2000
being available to earn interest for the entire year in fiscal 2001.
Provision for Income Taxes
We recorded a tax provision of $13.1 million and $0.7 million for fiscal
years 2001 and 2000 respectively. The provision for income taxes for fiscal
2001 consists primarily of a valuation allowance and state and foreign
26
taxes, offset by a federal loss carryback benefit. The Company recorded a full
valuation allowance in fiscal 2001 to offset net deferred tax assets as the
Company believes it is more likely than not that net deferred tax assets will
not be realized. The provision for fiscal 2000 was higher than the expected
federal statutory rate of 35% primarily due to non-deductible stock
compensation offset by the utilization of net operating carryforwards and tax
credits.
Liquidity and Capital Resources
Total cash, cash equivalents and investments were $1.04 billion at July 31,
2002. Included in this amount were cash and cash equivalents of $172.7 million,
compared to $492.5 million at July 31, 2001. The decrease in cash and cash
equivalents of $319.8 million was attributable to cash used in operating
activities of $202.5 million and cash used in investing activities of $122.1
million, offset by cash provided by financing activities of $4.8 million.
Cash used in operating activities of $202.5 million consisted of the net
loss for the period of $379.7 million, adjusted for non-cash charges totaling
$226.0 million and changes in working capital totaling $48.8 million, the most
significant components of which were a decrease in accounts payable of $56.4
million, offset by a decrease in accounts receivable of $23.4 million. Non-cash
charges included depreciation and amortization, restructuring charges and
related asset impairments, and stock compensation. Cash used in investing
activities of $122.1 million consisted primarily of net purchases of
investments of $115.0 million and purchases of property and equipment of $15.9
million. Cash provided by financing activities of $4.8 million consisted
primarily of the proceeds received from employee stock plan activity.
During the first quarter of fiscal 2002, each of our two major vendor
financing customers experienced a significant deterioration in their financial
condition. As a result, we determined that we were unlikely to realize any
significant proceeds from these vendor financing agreements. Accordingly, we
recorded an impairment charge for the assets related to these financing
agreements, which consisted of the cost of the systems shipped to the vendor
financing customers, and had been classified in other long-term assets.
As a result of the financial demands of major network deployments, service
providers are continuing to request financing assistance from their suppliers.
From time to time we have provided extended payment terms on trade receivables
to certain key customers to assist them with their network deployment plans. In
addition, we may provide or commit to extend additional credit or credit
support, such as vendor financing, to our customers, as we consider appropriate
in the course of our business. Our ability to provide customer financing is
limited and depends on a number of factors, including our capital structure,
the level of our available credit and our ability to factor commitments. The
extension of financing to our customers will limit the capital that we have
available for other uses.
Currently, our primary source of liquidity comes from our cash and cash
equivalents and investments, which totaled $1.04 billion at July 31, 2002. Our
investments are classified as available-for-sale and consist of securities that
are readily convertible to cash, including certificates of deposits, commercial
paper and government securities, with original maturities ranging from 90 days
to three years. At July 31, 2002, $509.4 million of investments with maturities
of less than one year were classified as short-term investments, and $361.5
million of investments with maturities of greater than one year were classified
as long-term investments. At current revenue levels, we anticipate that some
portion of our existing cash and cash equivalents and investments will continue
to be consumed by operations. Our accounts receivable, while not considered a
primary source of liquidity, represents a concentration of credit risk because
the accounts receivable balance at any point in time typically consists of a
relatively small number of customer account balances. At July 31, 2002, more
than 90% of our accounts receivable balance was attributable to three
international customers. As of July 31, 2002, we do not have any outstanding
debt or credit facilities, and do not anticipate entering into any debt or
credit agreements in the foreseeable future. Our fixed commitments for cash
expenditures consist primarily of payments under operating leases totaling
$29.5 million, as described in Note 5 to the consolidated financial statements.
27
Based on our current plans and business conditions, we believe that our
existing cash, cash equivalents and investments will be sufficient to satisfy
our anticipated cash requirements for at least the next twelve months.
Related Party Transactions
Our strategic investments in privately held companies include an investment
of $2.2 million in Tejas Networks India Private Limited ("Tejas"), which was
made during the fiscal year ended July 31, 2001. The Chairman of the Board of
Sycamore also serves as the Chairman of the Board of Tejas. We have no
obligation to provide any additional funding to Tejas, and have not engaged in
any material transactions with Tejas since the date of our original investment.
Recent Accounting Pronouncements
In June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible
Assets, which addresses the recognition and measurement of goodwill and other
intangible assets subsequent to their acquisition. SFAS No. 142 also addresses
the initial recognition and measurement of intangible assets acquired outside
of a business combination whether acquired individually or with a group of
other assets. SFAS No. 142 provides that intangible assets with finite useful
lives be amortized and that intangible assets with indefinite lives and
goodwill will not be amortized, but will rather be tested at least annually for
impairment. Although SFAS No. 142 is not required to be adopted by the Company
until fiscal 2003, its provisions must be applied to goodwill and other
intangible assets acquired after June 30, 2001. The Company does not have any
goodwill or other intangible assets relating to business combinations or any
intangible assets acquired outside of a business combination. Accordingly, the
adoption of SFAS No. 142 did not have a material impact on the Company's
financial position or results of operations.
In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment
or Disposal of Long-Lived Assets, which addresses the financial accounting and
reporting for the disposal of long-lived assets. SFAS No. 144 is effective for
financial statements issued for fiscal years beginning after December 15, 2001
and interim periods within those fiscal years. Accordingly, the Company will be
required to adopt SFAS No. 144 in the first quarter of fiscal 2003. The
adoption of SFAS No. 144 is not expected to have a material impact on the
Company's financial position or results of operations.
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities, which addresses the accounting for disposal
and exit activities, and supercedes EITF 94-3. SFAS No. 146 is required to be
adopted for disposal activities initiated after December 31, 2002. Under SFAS
No. 146, certain types of restructuring charges will be recorded as they are
incurred over time, rather than being accrued at the time of management's
commitment to an exit plan as specified by EITF 94-3. The adoption of SFAS No.
146 is not expected to have a material impact on the Company's financial
position or results of operations.
FACTORS THAT MAY AFFECT FUTURE OPERATING RESULTS
RISKS RELATED TO OUR BUSINESS
OUR BUSINESS HAS BEEN ADVERSELY AFFECTED BY UNFAVORABLE ECONOMIC AND MARKET
CONDITIONS
As a result of unfavorable economic conditions and a sudden and severe
decline in the purchasing patterns of our customers, our revenue began to
decline in the third quarter of fiscal 2001, and we have incurred significant
operating losses since that time. The economic downturn and reduced capital
spending by telecommunications service providers has also resulted in longer
selling cycles with extended trial periods for new equipment purchases. While
we have implemented restructuring and cost control programs to reduce our
business expenses, our costs are largely based on the requirements that we
believe are necessary to support sales to incumbent service providers, and a
high percentage of our exp