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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended JANUARY 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File number: 0-15810
SORRENTO NETWORKS CORPORATION
(Exact name of Registrant as specified in charter)
New Jersey 22-2367234
(State or other jurisdiction of incorporation or (IRS Employer Identification Number)
organization)
9990 Mesa Rim Road
San Diego, California 92121
(Address of principal executive offices) (Zip Code)
(858) 558-3960
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, Par Value $0.30 Nasdaq
Title of each class Name of exchange on which registered
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 is not contained herein, and will not be contained, to the best
of Registrant's knowledge, in a definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. _______
The Registrant's revenues for its most recent fiscal year were $40,827,000
The aggregate market value of voting stock based upon the bid and ask price held
by non-affiliates of the Registrant on April 30, 2002 was $33,244,301.
Number of shares outstanding of the Registrant's only class of common stock as
of April 30, 2002 (the latest practicable date):14,534,410.
DOCUMENTS INCORPORATED BY REFERENCE:
None.
PART I
Item 1. Business
Introduction
This Annual Report on Form 10-K may contain forward-looking statements that
involve risks and uncertainties. Such statements include, but are not limited
to, statements containing the words "believes, "anticipates," "expects,"
"estimates" and words of similar import. Our actual results could differ
materially from any forward-looking statements, which reflect, management's
opinions only as of the date of this report, as a result of such risks and
uncertainties. We undertake no obligation to revise or publicly release the
results of any revisions to these forward-looking statements. Readers should
carefully review the risk factors set forth below in "Factors That May Affect
Future Results" and in other documents the company files from time to time with
the Securities and Exchange Commission, including its quarterly reports on Form
10-Q.
We are a leading supplier of end-to-end, intelligent optical networking
solutions for metro and regional applications world-wide. Our solutions enable
communication service providers to offer broadband networking services over
optical fibers for metro and regional applications. Our technologies permit
telecommunications service providers to increase fiber capacity and fiber
bandwidth utilization, reduce network costs and network complexity over
scaleable and efficient networking platforms. Our optical networking systems
support a wide variety of protocols, mixed speeds of traffic and accommodate
changing traffic patterns directly over optical networks.
Our dense wavelength division multiplexing (DWDM) platform can be used in
both metropolitan and regional network applications. DWDM technology allows many
optical signals to be transmitted simultaneously on the same optical fiber by
using different wavelengths of light to distinguish the signals. This technology
increases optical network capacity and flexibility. Our comprehensive suite of
optical networking interfaces and optical access multiplexers allow us to also
address broadband applications in the optical access market including data
center fail-over recovery, storage area networking (SAN) and internet
connectivity applications. Our introduction of a course wavelength division
multiplexing (CWDM) product is a lower cost, entry level that can be used for
enterprise customer access that complements our DWDM product line.
We have also developed all-optical wavelength routing switch technology
that, when commercialized, will further increase the functionality of our
end-to-end all-optical networking solution. Our optical network element
management platforms permit management of end-to-end optical networks. We
currently have an installed base with over 20 communications service providers
and system integrators worldwide, including AT&T Broadband Network Solutions,
Deutsche Telekom, Belgacom, United Pan-Europe Communications, Cox
Communications, El Paso Global Networks, and INRANGE Technologies. According to
Ryan, Hankin & Kent, a telecommunications industry research group, we garnered
about 4% of the global metropolitan DWDM system market in calendar 2001 by
selling our GigaMux'r' optical transport systems and EPC'TM' access
multiplexers.
An important development in 2001 was the significant downturn in both the
general economic environment and the telecommunications industry. These adverse
market conditions affected our operations and required us to undertake a number
of initiatives, including workforce reductions and other cost reduction
measures, that have substantially reduced our fixed costs and, we believe,
enhanced our ability to respond to the new economic and industry environment.
On January 17, 2001, we changed our name to Sorrento Networks Corporation
from Osicom Technologies, Inc., in recognition of our corporate focus on the
business of our flagship optical networking subsidiary, Sorrento Networks, Inc.
Understanding Our Market
Definitions of technical terms used throughout this document can be found at the
end of this Item 1.
Rapid Growth in Bandwidth Demand
Fueled by the growth of the Internet, the volume of data traffic
transmitted across telecommunications networks now exceeds voice traffic. The
growth of data traffic is attributable to increased Internet usage, increased
access speeds
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and greater use of bandwidth intensive applications. According to Ryan, Hankin &
Kent, Internet traffic is projected to increase at a rate exceeding 40% per year
for the next five years.
Migration of Network Infrastructure
Traditional copper-based and SONET/SDH based telecommunications
infrastructures were originally designed for voice traffic. These
infrastructures do not scale effectively to provide the bandwidth needed to
support the growth in high-speed data traffic. In addition, these
infrastructures need network-wide upgrades in order to accommodate growing
traffic thus resulting in long delays for provisioning new services. DWDM and
CWDM technologies are more flexible, more efficient and more scalable networking
alternatives for meeting the growing demand for bandwidth and new broadband
services. Multi-wavelength optical (DWDM) networks for long-haul applications
were the first to be deployed, and optical solutions specifically designed to
address the challenges faced by metropolitan markets have significantly lagged
in deployment. Accordingly, metro networks are considered to be traffic
bottlenecks in the fast and efficient transmission of data. Significantly,
recent developments in technology are permitting metropolitan optical networking
vendors to address regional applications, which prior to 2000 were only
addressable by long haul networking products.
Enhanced Competition in the Service Provider Market
Worldwide deregulation in the telecommunications industry has led to an
increase in the number of service providers seeking to address the growing
demand for bandwidth. In the U.S. and internationally, traditional service
providers such as Incumbent Local Exchange Carriers (ILECs), IXCs and PTTs are
seeing new entrants in the broadband networking market seeking to capitalize on
the growing demand for bandwidth. A number of competitors to these incumbents
are building new data-centric networks to address the present bandwidth
bottlenecks in the metropolitan markets, including utilities and cable
television companies (MSOs) which are upgrading their current networks and are
leveraging existing investments in fiber optic infrastructure to deliver
high-speed data services in both the local and regional markets. This enhanced
competition in the service provider market is driving increased capital
expenditures on network infrastructure focused on delivering scalable high-speed
data services in a cost efficient manner.
Network Topography
The following describes each of the network segments within the optical
network hierarchy:
o Long-haul networks are high capacity networks that connect service
providers and carry voice and data across large geographic regions
typically spanning distances up to 4,000 kilometers. Long-haul
networks are relatively simple networks, built around the SONET/SDH
time domain multiplexing hierarchy and are primarily designed only to
satisfy carriers' long-haul network capacity requirements.
o Metropolitan core (metro-core) networks connect the central offices of
service providers in a metropolitan area and facilitate the transport
and switching of traffic within extended metropolitan areas and
between the network edge and long-haul networks. Metropolitan core
networks are typically implemented in ring configurations and reach
ring circumferences up to 300 kilometers. In order to efficiently use
the optical network, sub-rate multiplexing devices aggregate traffic
into wavelengths carrying higher speed aggregate bit rates across
telecommunications networks. Regional networks typically transport
voice and data traffic between cities across distances of 200 to 600
kilometers or more.
o Access networks connect enterprises or traffic aggregation nodes in
multiple locations throughout metropolitan areas to service providers'
central offices or connect different end-user locations to each other.
In order to efficiently use the optical network, optical access
devices aggregate traffic from end users into wavelengths for
transport across telecommunications networks. Because access networks
must support the varying demands of end users, these networks tend to
support multiple services and bit rates.
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Metropolitan area optical network opportunity
While optical technologies are being deployed in long-haul networks to
relieve capacity constraints, these solutions are not specifically designed to
address the issues inherent in metropolitan and regional optical networks. Data
is normally mapped into the voice multiplexing hierarchy for transport over the
long-haul network. Metropolitan optical networks are characterized by varying
traffic patterns and protocols, topologies and end-user requirements, making
them more complex and difficult to manage than long haul networks. As a result,
service providers have only recently begun to exploit the benefits of optical
technologies in metropolitan optical networks.
The optical networking market has seen a substantial downturn in 2001 from
2000 levels. The metro DWDM market, which was expected to increase, has also
experienced a slowdown in recent months as capital spending has declined
throughout the telecommunications industry. While Sorrento Networks believes
that the metro WDM world-wide market will grow significantly in the years to
come, such growth is not likely to occur until capital spending resumes in the
markets we serve, and we are unable to assess at present when this might take
place. According to industry analysts, including RHK (Ryan, Hankin and Kent)
and others, the metro WDM market in 2001 was about $1.2 billion worldwide and is
expected to grow to $3.6 billion by 2005.
Regional optical network opportunity
In addition to the metropolitan market, recent engineering enhancements
have permitted the use of metropolitan optical (DWDM) networking platforms in
regional optical networking applications. This development opens up the
opportunity to address a portion of the substantial long haul market. In some
regions, e.g., in Europe, regional solutions apply to the majority of the
networks installed. Industry researchers recently started looking at
reclassifying the regional market opportunity, although statistical data for
this market are not expected until next year.
Specific challenges facing metropolitan optical networks
Service providers face numerous specific challenges in addressing
metropolitan and regional optical networks:
o Scalability Limitations. Originally constructed for voice traffic, the
current (SONET/SDH) network infrastructure does not allow for the
network efficiencies necessary to address the shift to a predominantly
data-driven network. Due to its inherent lack of scalability, the
current network infrastructure may require service providers to
undertake the expensive and tedious process of replacing network
equipment or overlaying new layers of similar equipment in response to
changes or increases in bandwidth demand. Alternative approaches to
WDM are being developed by other vendors to address the scalability of
the SONET/SDH networks. These nonstandard solutions are called next
generation SONET/SDH and can minimize the wasted bandwidth of legacy
SONET/SDH. These solutions, however, are not able to accommodate the
need for large amounts of bandwidth.
o Need to Support Multiple Protocols. Metropolitan optical networks are
characterized by a wide variety of protocols. The inability to support
multiple protocols and services from a single platform further
increases the cost and complexity of the metropolitan networks.
Alternative approaches to WDM are being developed by other vendors to
address the requirement for support of multiple services. These
nonstandard solutions are called multiservice provisioning platforms.
These solutions generally carry out protocol conversions and are much
more complex than WDM solutions.
o Market Downturn. Virtually all telecom related market segments have
suffered a decline in demand in the current economic downturn. What
was once viewed as only a long-haul decline in market demand has now
affected the regional and metropolitan networks as both enterprise and
carrier business have cut back capital spending. While we expect that
demand in the regional and metropolitan markets will be strong in
future periods, there are no assurances that capital spending will
resume within this sector in the near term.
o Several Stages of Conversion. Present solutions require several
conversions to transport data through a metropolitan network. In the
access networks, aggregation of traffic often requires protocol
conversions into a common protocol before optical transmission. In the
central office, data is often demultiplexed and
3
converted into electrical signals for regeneration, switching or
further aggregation into higher capacity links and then reconverted
into optical signals for transmission in the metro-core network.
o Inefficient Bandwidth Utilization. Within metropolitan optical
networks, service providers must cater to end-users with varying
access speeds. Current optical access solutions do not make efficient
use of scarce wavelength resources. Service providers must assign a
full wavelength to each signal, whether or not the end-user requires
the full bandwidth potential of each wavelength.
o Difficulty of Network Management. Multiple protocols and service,
coupled with the lack of standards that exist in metropolitan optical
networks, make network management functions, such as performance
monitoring and configuration, exceedingly difficult. Lack of a robust
network management platform further adds to the cost and complexity of
metropolitan optical networks.
o Need for New, Enhanced Service Offerings to Generate New Revenue
Opportunities. Broadband network service providers are searching for
next-generation solutions that will enable them to generate additional
sources of revenue by offering new or enhanced services to their
customers. Current solutions typically require the service provider to
deploy equipment that is specifically designed for a particular
service and transmission rate. Next-generation solutions must be able
to offer enhanced features, wavelength provisioning and
bandwidth-on-demand features, that end-users will increasingly request
from service providers.
Our Solution
Our solutions feature products designed to specifically address the
shortcomings of legacy SONET/SDH networks and to facilitate offering new
services throughout metropolitan and regional optical networks. We enable our
customers to meet the rapidly growing demand for bandwidth by offering
end-to-end metropolitan and regional optical networking solutions for the
aggregation, transport and management of traffic. Our current products,
including our GigaMux'r' DWDM transport system, with our EPC'TM' sub-rate
multiplexing modules, our JumpStart'TM' CWDM transport system as well network
management product line that includes GigaView, TeraManager'TM' and
TeraConfigurator'TM'. are specifically designed to meet the unique requirements
of the metropolitan and regional markets. We have also developed a prototype
all-optical wavelength routing switch, called TeraMatrix'TM', that will
complement our current products when market conditions permit us to put it into
production,
Our end-to-end metropolitan optical networking solution offers numerous
benefits, including:
Cost Effective Entry-Level Access Solution. Our Jumpstart CWDM platform
allows low cost multiplexing of up to four wavelengths carrying a mix of
protocols and signals for access applications.
Scalable Architecture. We have created a delayered or flat optical
networking solution that simultaneously transmits voice, data, and video
over optimized fiber channels. The modular architecture of our solution
enables service providers to incrementally expand capacity, as their
bandwidth needs increase. This simple, scaleable, and functional solution
solves short and long-term service provider problems, which enhances their
ability to reduce costs and offer value-added services. For example, a
service provider can begin deployment with a single channel and later
expand to multiple channels providing up to 640Gbps of transmission
capacity without interrupting existing traffic.
Protocol and Signal Transparency. Our suite of solutions transports a
mix of protocols and signals, including SONET/SDH, ATM, IP, Gigabit
Ethernet, Fibre Channel and ESCON in their native formats over numerous
wavelengths in the same fiber. This "transparency" brings in operational
simplicity in that the service provider can offer networking connectivity
without having to worry about protocol conversions. This is particularly
important in metropolitan areas where multiple protocols are utilized and
data transmission rates change often. The transparency of our solution
eliminates the unnecessary opto-electro-optical conversions as well as
several layers of equipment that would otherwise be required in the
transport and switching of traffic, thus reducing network complexity and
signal latency.
Efficient and Cost Effective Bandwidth Utilization. Our EPC'TM',
optical access sub-rate multiplexer
4
aggregates traffic, of varied rates utilizing a wavelength per direction of
transmission, from businesses and network points of presence for transport
throughout optical networks. This sub-rate aggregation allows better
utilization of wavelengths and lowers capital expenditures of telecom
service providers by reducing investments in excess network capacity. Our
GigaMux'r' optical transport product utilizes DWDM technology to provide
ring and linear optical multi-wavelength connections over new and existing
fibers and to enable traffic to travel throughout metropolitan and regional
optical networks without opto-electro-optical conversion at every node.
Manageability. The design of our end-to-end optical networking solution
will allow service providers to perform network management from a single
platform with our TeraManager'TM' product. This intelligent optical network
management software platform provides fault, configuration, performance,
and security management utilizing an easy-to-use graphical user interface
that allows "point and click" network provisioning and monitoring.
Regional optical transport. Our solution permits service providers to
expand beyond the confines of metropolitan networks using the same platform
for metropolitan and regional applications. Regional networks can now be
built using the lower cost solutions developed for the metropolitan
environment.
Sorrento Strategy
Our objective is to become a leading supplier of end-to-end, intelligent
optical networking solutions for metro and regional applications world-wide. The
key elements of our strategy are to:
Enhance and complete our end-to-end metropolitan/regional optical networking
solution
We intend to continue to enhance our existing family of metropolitan and
regional optical networking products and to introduce new products that increase
the functionality of our end-to-end optical solution. We introduced
TeraManager'TM' and TeraConfigurator'TM' in our management solution portfolio in
fiscal 2002. We also introduced JumpStart'TM', our CWDM solution, in fiscal year
2002. We have also completed the development of a prototype all-optical
wavelength routing switch, the TeraMatrix'TM', which will enable service
providers to dynamically reassign bandwidth in response to changing network
traffic patterns.
The combination of our GigaMux'r' optical transport products, with the
EPC'TM' sub-rate multiplexer, the JumpStart'TM' CWDM, and TeraManager'TM', our
carrier class network management product, creates an intelligent all-optical
transport solution. When released at a future date, our TeraMatrix'TM' switching
product will provide more efficient use of bandwidth, require less network
equipment and allow for greater scalability.
Leverage our engineering leadership
We intend to leverage our engineering expertise in the areas of optical,
mechanical, electrical and network management design to continue to provide
leading end-to-end metropolitan and regional optical networking systems and to
expand our market share. We believe we were the first company to commercially
ship a metropolitan optical networking product using DWDM technology. As of
January 31, 2002, we had a skilled team of 67 engineers that continually focus
on developing products for the metropolitan and regional optical transport
market. We believe that our technological leadership has been the key to our
success and will enable us to rapidly develop new product offerings and
end-to-end optical solutions for the metropolitan and regional markets.
Allow our customers to leverage their fiber assets by offering
revenue-generating services
The majority of our existing customers and targeted customers have a large
amount of fiber assets in the metropolitan and regional network infrastructure.
We intend to continue to develop and provide solutions that will enable our
customers to leverage their existing fiber infrastructure to deliver
revenue-generating services, while reducing their overall network costs. In
addition, we believe our existing customer base provides us with an advantage
when competing for new customers. We intend to continue to work closely with our
customers and invest in sales and marketing resources to maintain our high level
of customer service and remain responsive to our customers' changing needs.
5
Aggressively pursue expense reduction initiatives
The Company plans to aggressively pursue cost reduction initiatives to
bring its expenses in line with current and future anticipated revenues. Such
reductions may affect the size of our workforce, and may require decreasing our
operating expenses and capital spending. During fiscal 2001, we effected three
such initiatives, and anticipate the need for another cost reduction initiative
in the near future.
Maintain our sales, service and support organizations worldwide
We intend to continue to market our products worldwide. We currently have
sales, service and support teams in North America, Europe and Asia. This global
presence has helped us to position our products into the Asia-Pacific market
with shipments in the fourth quarter of fiscal year 2002. We believe that sales,
service and support efforts on a customer-by-customer basis are most effective
due to the technical evaluation and significant investments that are made by our
customers.
Products
Our family of optical networking systems is designed to provide our
customers with end-to-end solutions for the metropolitan and regional optical
networking markets. Our transport, access, switching and network management
systems include the following products, some of which are still in development.
GigaMux'r' - DWDM Optical Transport
Our GigaMux'r' optical transport product utilizes DWDM technology to
expand the capacity of new and existing fibers and enable traffic to travel
throughout metropolitan optical networks without O-E-O conversions at each
intermediate node. Our GigaMux'r' features wavelength translation,
wavelength multiplexing, optical amplification, optical add-drop
multiplexing, protection switching and performance monitoring. The scalable
and modular architecture of our GigaMux'r' product enables service
providers to easily and cost-effectively expand their existing networks as
bandwidth requirements increase. GigaMux'r' can simultaneously transport
multiple protocols bi-directionally over one or more fibers, which reduces
the cost and complexity of the network.
Our GigaMux'r' product is Network Equipment Building Standards, or
NEBS, level III certified. As of January 31, 2002, we have shipped our
GigaMux'r' product to over 20 direct carrier customers or resellers
worldwide. Our GigaMux'r' product includes the following key features:
o Scalability: the system can grow from 1 to 64 protected channels
(640 Gbps/fiber) without a major upgrade or service interruption.
o Protocol transparency: the system can aggregate and transport
SONET/SDH (OC-3/STM-1 through OC-192/STM-64 carrying voice, IP or
ATM traffic), ESCON, Fibre Channel, Fast Ethernet, Gigabit
Ethernet and video.
o Modular protection: the system's modular protection system allows
redundancy to be implemented at any point in the network.
o Add/drop channels: the system is equipped with add/drop modules
that allow specific channels to be added or dropped while all
other channels pass through. Our filter subsystem can add or drop
from single channels to larger wavelength bands.
o Reach: Up to 600 kilometers with optical amplifiers and up to 1000
km with the addition of dispersion compensation.
EPC'TM' - Sub-Rate Access Multiplexer
Electric Photonic Concentrator, or EPC'TM', is our sub-rate access
multiplexer product that aggregates a wide variety of traffic from
businesses and network points of presence for high-speed transport
throughout optical
6
networks. The traffic is aggregated and effectively shares a wavelength per
direction of transmission and can be ported directly into the DWDM stage of
our GigaMux'r'. EPC'TM' is designed to lower the cost and increase the
efficiency of bandwidth delivery within optical networks.
Our EPC'TM' products include the following key features:
o Support for asynchronous or synchronous (SONET/SDH) time division
multiplexing of data
o Provisionable bit rates and protocol and overhead transparency
JumpStart'TM' - CWDM Transport
JumpStart is our entry level solution for multiplexing up to 4
bi-directional data channels using coarse wavelength division multiplexing
technology on a single fiber. The product is very compact and can be
stacked to provide additional capacity - 4 channels per fiber.
TeraManager'TM' - Element Management System
TeraManager'TM' is our TL1-based intelligent element management
software platform that provides fault, configuration, performance and
security management for all the Sorrento networks products and for networks
built with such products. Service providers can operate our network
management platform through an easy-to-use graphical user interface, which
gives users a complete network view and enables "point and click"
provisioning and monitoring.
Our TeraManager'TM' product will includes the following features:
o Fault, configuration, security and performance management
o Carrier class performance
o Interface with higher layer operation support systems
TeraMatrix'TM' - Optical Switching
We have completed development of a fully functioning prototype of
TeraMatrix'TM', a MEMS-based, all-optical wavelength routing switch, that
enables dynamic, real-time wavelength provisioning. TeraMatrix'TM' is
designed to utilize advanced optical technology to create an all-optical
switching product requiring significantly less space in the service
provider's central office than do competing solutions.
Commercial release of TeraMatrix'TM' is on hold, given the existing
downturn in telecom spending and the uncertain market demand for an all
optical metro/regional switch.
Meret Optical Communications
Our other optical networking subsidiary, Meret Communications, Inc., doing
business as Meret Optical Communications, also markets our new CWDM product, as
well as feature-rich video transport and switching, RF transmission, and RF
synthesis products.
Customers
Our target customer base includes wholesale and retail broadband service
providers, such as inter-exchange carriers, local and foreign telephone
companies, the telecom affiliates of utility companies (utilicoms), cable
television service providers, system integrators and distributors.
Our customers generally fit the following customer profiles:
o Wholesale Network Providers - these customers provide wavelength and
broadband services to communication service providers and include
telecommunication carriers, cable companies and utilicoms.
o Managed Services Providers - these customers provide wavelength and
broadband services to enterprises and include telecommunication
carriers, cable companies, utilicoms and Internet Service Providers.
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o System Integrators - companies that specialize in providing turnkey
networking solutions for enterprise networks and applications such as
data-center connectivity and storage area networks.
o Major Enterprises - major enterprise customers are generally large
organizations with complex networking needs, usually spanning multiple
locations and difficult types of network requirements. Enterprise
customers include industrial corporations, government agencies, and
utilities.
o Small and Medium Businesses - these customers have a need for networks
as well as connection to the Internet and/or to their business
partners. However, they generally have limited resources. Therefore, we
provide product through systems integrators or Value Added Resellers.
During fiscal 2002 the majority of our sales were to relatively few
customers, and we expect this customer concentration to continue for the
foreseeable future. For fiscal 2002, we shipped our optical networking products
to a total of 17 customers worldwide. Three customers, AT&T Broadband, Cox
Communications and Deutsche Telekom each represented more than 10% of our net
sales for fiscal 2002 and two customers each accounted for more than 10% of our
net sales during fiscal 2001.
Key Relationships
We have entered into long-term agreements with some of our customers and
strategic allies, including:
AT&T Broadband Network Solutions
In February 2000, we entered into a strategic alliance agreement with AT&T
Broadband. Under the terms of this agreement, we and AT&T Broadband Network
Solutions agreed to negotiate in good faith concerning the implementation of a
number of joint sales and marketing initiatives. AT&T Broadband also agreed to
help introduce our technology to individuals at other AT&T divisions and to
provide feedback concerning our products' performance. The initial term of this
agreement expired in February 2002 and was automatically renewed for an
additional one-year term. Similar automatic renewals will occur in each
succeeding February. Either we or AT&T Broadband may terminate the agreement for
any reason upon ninety days notice. In addition, we concurrently entered into an
equipment purchase agreement. We started shipping our products to AT&T Broadband
in the second quarter of fiscal year 2001.
INRANGE Technologies
In March 2000, we entered into a strategic alliance agreement with INRANGE.
Under the terms of the agreement, INRANGE will act as an exclusive worldwide
distributor of our optical networking products for storage networks of
enterprise customers. INRANGE has agreed to offer our wave division multiplexing
(WDM) and dense wave division multiplexing, or DWDM products, including
GigaMux'r', as part of family of virtual storage networking products. In
addition, INRANGE must purchase minimum amounts of our products in order to
retain exclusive worldwide rights for offering our products in the enterprise
storage networking market. These products will facilitate the creation of
virtual storage networks by reducing the costs of sending information over long
distances. The initial term of this agreement expires in March 2005 and will be
automatically renewed for additional two-year terms. INRANGE has agreed to
purchase targeted minimum amounts of products from us. We have a right to
terminate this agreement with sixty days prior written notice to INRANGE in the
event INRANGE fails to purchase the applicable targeted minimum amounts of
products. In fiscal year 2002, INRANGE did not meet its minimum purchase
commitment under this agreement. In addition, General Signals Holding Company,
the parent company of INRANGE, purchased 550,459 of our Sorrento subsidiary's
series A convertible preferred shares in March 2000. We started shipping our
products to INRANGE in the second quarter of fiscal year 2001.
United Pan-Europe Communications
In March 2000, we entered into a strategic alliance agreement and an
equipment purchase agreement with United Pan-Europe Communications, N.V., or
UPC. Under the terms of these agreements, United Pan-Europe Communications has
agreed to make Sorrento a supplier for optical networking products in networks
deployed throughout Europe. These agreements also contemplate our working
together with United Pan-Europe Communications on joint sales and marketing
initiatives. The likelihood of any large scale deployments by UPC given its
current operating environment is questionable, and the future benefit to the
Company from this relationship is uncertain. The initial terms of these
agreements expire in March 2003 and will be automatically renewed for additional
8
one-year periods unless either we or United Pan-Europe Communications provide
notice at least 90 days prior to the expiration of the then-current term of the
intent to terminate the agreements. In addition, UnitedGlobalCom, Inc., parent
to United Pan-Europe Communications, purchased 3,027,523 of our Sorrento
subsidiary's series A convertible preferred shares in March 2000, through an
affiliated entity. We started shipping our products to UPC in the second quarter
of fiscal year 2001.
Looking Glass Networks
In August 2001, we entered into an equipment purchase agreement with Looking
Glass Networks, or LGN. Under the terms of this agreement, LGN agreed to
purchase metro DWDM optical networking equipment from Sorrento as the primary
supplier. LGN also agreed to receive early adopter access to new and emerging
Sorrento technologies, and to serve as a beta tester for new and emerging
equipment and to provide feedback concerning our products' performance. The
initial term of this agreement expires in August 2004 and will be automatically
renewed for additional one-year terms. Either LGN or Sorrento may terminate the
agreement at the end of the initial or any renewal term upon ninety days notice.
We started shipping our products to LGN in the third quarter of fiscal year
2002.
TeraBeam
In June 2000, we entered into a development, purchase and strategic
partnership agreement with TeraBeam. Under the terms of this agreement, the
customer has agreed to make commercially reasonable efforts to purchase target
quantities of our products but is not contractually committed to purchase these
target quantities. The initial term of this agreement is 48 months from the date
of the first commercial shipment of our products to the customer. At the end of
the initial term, the agreement will automatically renew for four successive one
year terms. Either we or the customer may terminate the agreement for any reason
upon 180 days prior written notice as to the initial term or 90 days prior
written notice as to any renewal term. In addition, either we or this customer
may terminate the agreement at any time subject to customary termination
provisions. Commercial shipments under this agreement have not as yet begun, and
the future benefit to the Company from this relationship is uncertain.
Sales and Marketing
Our sales effort is currently focused on North America, Europe and Asia. As
of January 31, 2002 our sales and marketing organization included 55 employees,
including account managers, sales engineers and support personnel. In North
America, Europe and Asia, we sell our products through our direct sales force as
well as through system integrators. Our international direct sales force is
located in France, Belgium, Germany, Spain, Singapore and China.
In support of our worldwide selling efforts, our marketing team targets
potential customers through in-depth market analysis. Our marketing objectives
include building market awareness and acceptance of our products as well as
expanding our customer base. Our customer acquisition strategy has focused on
targeting customers who are aggressively building network infrastructure and are
looking to leverage existing fiber assets to generate additional revenue from
broadband services. This focus has led to strategic supply agreements with
several MSOs, utilities, and to a lesser extent CLECs. We also plan to target
incumbent carriers as they expand the development of their metropolitan and
regional fiber networks. Marketing personnel coordinate our participation in
trade shows, seminars and industry events and conduct media relation's
activities with trade and general business publications. We participate in many
industry organizations responsible for developing standards that are used in
optical networks.
Customer Service and Support
Our customer service and support team provide a critical component of our
customer satisfaction initiative. This team provides support to our customers
allowing them to successfully design and implement their optical networks. All
services can be customized to meet the needs our customers. Our staff is
experienced, and has the equipment necessary to support both installation and
problem resolution. A variety of installation service packages supports the
implementation from start up to upgrades and maintenance. Specialists are
available 7 days a week, 24 hours a day. We offer a Technical Assistance Center
as well as field services support. Multiple technical support service agreements
allow our customers to define the level of support they require. Our customer
service and support team
9
provides installation, maintenance and training programs addressing the product,
installation and maintenance processes and can be delivered at the customer
location or at our training facility.
We currently provide service and support to our international customers on
a direct basis and are establishing service and support agreements throughout
the world. To date revenues from service and support agreements have not been
material. We intend to continue to develop our internal team to meet the needs
of our customers and will utilize strategic partners to allow us to provide
greater value when appropriate.
We provide a total service solution. Our hardware products are warranted
against defects for a period of 12 to 36 months dependent on purchase
agreements, including technical support and parts repair/replacement. We also
offer support contracts for a fee to our customer base, thereby allowing our
customers to select a service plan tailored to their own particular needs.
Research and Development
We have assembled a team of highly skilled engineers with extensive
experience in the fields of optical, mechanical, electrical and network
management design. We believe that our success in introducing DWDM optical
technology for use in the metropolitan and regional markets was a result of our
strength in research and development. As of January 31, 2002, 67 employees were
engaged in research and development efforts. Our research and development
efforts are focused on new product development as well as enhancing performance
and reliability of our existing products. We believe that our research and
development efforts are key in maintaining technical competitiveness, delivering
innovative products, and addressing the needs of the regional and metropolitan
market.
Our engineering, research and development expenses were $13.7 million,
$23.9 million, and $11.7 million for the years ended January 31, 2002, January
31, 2001 and January 31, 2000, respectively. The Company plans to continue to
make substantial investments in research and development for both new product
development and enhancement of existing products.
Manufacturing and Quality
We outsource the manufacturing of our products. We design our products and
perform system integration, quality control, final testing and configuration at
our San Diego, California and Fremont, California locations. Our San Diego
facility is ISO-9002 certified and we have begun the process of becoming
ISO9000/2000. By meeting such standards, we assure our customers that we meet
internationally recognized standards for quality, customer care and sound
management practices. We believe that outsourcing our manufacturing allows us to
conserve working capital, flexibly respond to changes in market demand and more
quickly deliver products to our customers.
We currently purchase products from our contract manufacturers and other
suppliers on a purchase order basis. We generally do not enter long-term
contracts with our contract manufacturers or suppliers, and they are not
obligated to perform services for us for any specific period or at any specified
price, except as may be provided in a particular purchase order. We purchase a
limited number of key components used in the manufacturing of our products from
a limited number of suppliers and some of our components are purchased
exclusively from a single supplier on a purchase order basis.
Patent, Trademarks and Licenses
We currently hold approximately 20 patents and have several patent
applications pending. Although we attempt to protect our intellectual property
rights through patents, trademarks, and copyrights, maintaining certain
technology as trade secrets and other measures, we cannot assure that any
patent, trademark, copyright or other intellectual property rights owned by us
will not be invalidated, circumvented or challenged, that such intellectual
property rights will provide competitive advantages to us or that any of our
pending or future patent applications will be issued with the scope of the
claims sought by us, if at all. We cannot assure that others will not develop
technologies that are similar or superior to our technology, duplicate our
technology or design around the patents that we own. In addition, effective
patent, copyright and trade secret protection may be unavailable or limited in
certain foreign countries in which we do business or intend to do business in
the future. We also have licensed and
10
may in the future license technologies from other companies on a non-exclusive
basis. For example, our CWDM product incorporates technology purchased from
Entrada Networks, Inc., a former affiliate of the Company, that we then enhanced
to complete a commercially feasible product.
We believe that the future success of our business will depend on our
ability to translate the technological expertise and innovation of our personnel
into new and enhanced products. We cannot assure that the steps taken by us will
prevent misappropriation of our technology. In the future, we may take legal
action to enforce our patents and other 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. Such
litigation could result in substantial costs and diversion of resources and
could harm our business and operating results.
As is common in our industry, we have from time to time received
notification from other companies of intellectual property rights held by those
companies upon which our products may infringe. Any claim or litigation, with or
without merit, could be costly, time consuming and could result in a diversion
of management's attention, which could harm our business. If we were found to be
infringing on the intellectual property rights of any third party, we could be
subject to liabilities for such infringement, which could be material, and could
be required to seek licenses from other companies or to refrain from using,
manufacturing or selling certain products or using certain processes. Although
holders of patents and other intellectual property rights often offer licenses
to their patent or other intellectual property rights, no assurance can be given
that licenses would be offered, that the terms of any offered license would be
acceptable to us or that failure to obtain a license would not cause our
operating results to suffer.
Working Capital Practices
We have historically maintained high levels of inventories to meet output
requirements of our customers and to ensure an uninterrupted flow of inputs from
suppliers. It is not our standard policy to grant customers the right to return
merchandise that performs according to specifications. Typical payment terms
require payment within thirty days from the date of shipment, however, for one
customer we extend a 180 day payment term.
We perform ongoing credit evaluations of each customer's financial
condition and extend unsecured credit related to the sales of various products.
From time to time we receive financial instruments such as letters of credit for
payments for international customers. At January 31, 2002, accounts receivable
due from Cox Communications, Deutsche Telekom, iNOC and UPC accounted for 13.9%,
24.7%, 20.0%, and 19.8% of net receivables.
Our Backlog
At January 31, 2002 the Company had minimal backlog. Our backlog consists
of orders confirmed with a purchase order for products to be shipped within
twelve months to customers with approved credit status. We do not believe that
backlog, as of any particular date, should be used as an indication of sales for
any future period for two reasons. First, orders are increasingly being booked
and shipped in a short period of time and therefore are never calculated in the
backlog amount at the end of any particular quarter. Second, customers have and
can change delivery schedules or cancel orders without a significant penalty.
Competition
The market for optical networking equipment is extremely competitive and
subject to rapid technological change. We expect competition to intensify in the
future. Our primary competitors in the DWDM market include vendors of optical
networking and infrastructure equipment such as Nortel Networks, CIENA
Corporation, ONI Systems, Cisco Systems, Lucent Technologies, and Sycamore
Networks, as well as private companies that have been or will be focusing on our
target markets. Our primary competitors for our CWDM products include Adva,
Controlware, ONI Systems, LuxN and others. Many of our competitors have
significantly greater financial resources and are able to devote these greater
resources to the development, promotion, sales and support of their products. In
addition, many of our competitors have more extensive customer relationships
than we do, including relationships with our potential customers. We believe
each of our competitors has optical networking products in various stages of
development.
11
We believe the principal competitive factors in the optical networking
market are:
o product performance, features, functionality and reliability;
o price/performance characteristics;
o timeliness of new product introductions;
o relationships with existing customers; and
o service, support and financing.
We believe we compete favorably with our competitors with respect to most
of these factors.
The competitors for Meret's legacy products include Pesa, Artel, RGB
Spectrum, Utah Scientific, and many other companies.
Increased competition may result from further price reductions, reduced
gross margins and loss of market share, any of which could materially and
adversely affect our business, operating results and financial condition. There
can be no assurance that we will be able to compete successfully against current
and future competitors, or that competitive factors will not have a material
adverse effect on our business, operating results and financial condition.
Environmental Compliance
We are required to file environmental compliance reports with the Federal
Food and Drug Administration regarding the emissions levels of our laser-based
products, which are used in fiber optics communications. All of our products
comply with required safety level standards.
Employees
As of January 31, 2002, we had 217 employees of which 67 were in research
and development, 55 in sales and marketing, and the remainder in manufacturing
and in general and administrative functions. Of the 67 employees in research and
development 28 have masters degrees and 23 have doctorate degrees. We also
employ a number of part-time and temporary personnel from time to time in
various departments. 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. None of our employees are covered by
a collective bargaining agreement and we believe that our relations with our
employees are good.
Forward-Looking Statements - Cautionary Statement
All statements other than statements of historical fact contained in this
Form 10-K, in our future filings with the Securities and Exchange Commission, in
our press releases and in our oral statements made with the approval of an
authorized executive officer are forward-looking statements. Words such as
"propose," "anticipate," "believe," "estimate," "expect," "intend," "may,"
"should", "could," "will" and similar expressions are intended to identify such
forward-looking statements. These forward-looking statements are made pursuant
to the safe harbor provisions of the Private Securities Litigation Reform Act of
1995. Although we believe that our expectations reflected in these
forward-looking statements are based on reasonable assumptions, such statements
involve risk and uncertainties and no assurance can be given that actual results
will be consistent with these forward-looking statements. Important factors that
could cause actual results to differ materially from those forward-looking
statements include without limitation: our ability to successfully develop, sell
and market our optical networking and other products; our expectations
concerning factors affecting the markets for our products, such as demand for
increased bandwidth; the scope and duration of the economic slowdown currently
being experienced by many of our existing and prospective customers; our ability
to compete successfully with companies who are much larger than we are and who
have much greater financial resources at their disposal; our ability, or
failure, to complete strategic alliances and strategic opportunities such as
sales or spin-offs of subsidiaries or business units on terms favorable to us
for reasons either within or outside our control; our ability successfully to
finance our current and future needs for working capital; changed market
conditions, new business opportunities or other factors that might affect our
12
decisions as to the best interest of our shareholders; and other risks detailed
from time to time in our reports filed with the Securities and Exchange
Commission.
We wish to caution readers not to place undue reliance on any such
forward-looking statements, which speak only as of the date made. Such
statements are subject to certain risks and uncertainties that could cause
actual results to differ materially from historical earnings and those presently
anticipated or projected. These risks and uncertainties are described in the
following section. We specifically decline any obligation to publicly release
the result of any revisions which may be made to any forward-looking statements
to reflect anticipated or unanticipated events or circumstances occurring after
the date of such statements, or to update the reasons why actual results could
differ from those projected in the forward-looking statements.
Factors That May Affect Future Results
In connection with the safe harbor contained in the Private Securities
Reform Act of 1995 we are hereby identifying important factors that could
cause actual results to differ materially from those contained in any
forward-looking statements made by us or on our behalf. Any such statement is
qualified by reference to the following cautionary statements:
We will need additional funds to support operations in the future in order to
continue to enhance and expand our product offerings and to penetrate additional
market share in the regional and metropolitan marketplace. If we are unable to
obtain new investment, we will have to reduce or cease operations, or attempt to
sell some or all of our operations or to merge with another entity.
The further development of our products as well as the expansion of
manufacturing capabilities or the establishment of additional sales, marketing
and distribution capabilities will require the commitment of substantial funds.
Our existing working capital will not be sufficient to meet these expansion
plans. Potential sources of additional funds include public or private offerings
of debt or equity securities, bank lines of credit or extensions of existing
arrangements by us or our Sorrento subsidiary. Additional financing may not be
available on terms favorable to us, or at all. Insufficient funds may require us
to delay, scale back or eliminate certain product development programs, or
attempt to merge with another entity or otherwise reduce or cease operations. We
also expect that, as a result of the slowdown in capital spending in the telecom
industry, we will need to reduce our expenses in the near future to bring them
in line with reduced revenues in order to conserve our working capital.
Moreover, without adequate financing, potential customers who otherwise would
select our products to purchase may decide to buy from other vendors who they
perceive to have greater financial stability.
The Series A Preferred Stock issued by our Sorrento Networks, Inc. subsidiary
("SNI"), and a preliminary injunction obtained by some of the holders of that
stock, could have a material adverse effect on our ability to raise the capital
that we need.
Certain holders of SNI's Series A preferred stock obtained a preliminary
injunction in September 2001 from the Delaware Court of Chancery, which was
affirmed by the Delaware Supreme Court in January 2002. The injunction prohibits
SNI from issuing additional shares of Series A preferred stock and from
incurring debt without the consent of the holders of a majority of the
outstanding shares of Series A preferred stock. The Court of Chancery will
decide whether to make this injunction permanent at a trial that is not
currently scheduled. We cannot predict the outcome of that trial. The injunction
against SNI, our principal operating subsidiary, issuing Series A preferred
stock, makes it very difficult to fund SNI as its business operations require.
The Company, however, does have the right to make such capital contributions to
SNI to fund its operations as the Board may deem necessary. Capital
contributions do not increase the Company's ownership interest in SNI, but
rather increases the basis of our ownership interest. The Board has authorized
capital contributions to be made when necessary to fund the SNI operations, but
there can be no assurance that the Board will continue to authorize such
contributions in the future should other funding methods continue to be
unavailable.
13
The redemption rights of the Series A preferred stock of our Sorrento
subsidiary, Sorrento Networks, Inc., or SNI, could have a negative impact on the
Company's business.
In April 2001, the holders of the Series A preferred stock exercised their
right to ask SNI to redeem their shares for approximately $49 million in cash.
Such request can only be paid from lawfully available funds of which SNI has
none available and would normally be generated from operating profits of the
business. SNI does not foresee any such profits in the near future. As a result,
the Company is in negotiations with the Holders of Series A Stock to allow them
to convert their Series A Stock to either the Company's common shares, preferred
shares or a combination of both. While negotiations have been under way for a
significant period of time, the Company has not reached an agreement with the
Series A Holders and there is no assurance that it will do so in the future.
Such uncertainty could impact the business negatively on both a short term and
long term basis.
We have a history of losses and expect to incur future losses.
We have incurred operating losses during the years ended January 31, 2002,
2001 and 2000 of $37.2 million, $50.4 million and $10.0 million, respectively,
and as of January 31, 2002, we had an accumulated deficit of $161.3 million. We
expect to continue to incur losses in the future. If we do not become
profitable, the value of our stock will decrease. We have large expenses in
the areas of sales and marketing, research and development, manufacturing, and
general and administrative expenses that are not covered by our current sales
volume and resulting gross margin. Currently, the majority of revenues are from
shipments of our optical networking product lines. In order for us to become
profitable, we will need to generate and sustain higher revenue while
maintaining reasonable expense levels.
Our history of losses and future losses could impact our ability to finance our
business, cause defaults under obligations to our Holders of Senior Debentures
and risk our ability to continue operating.
The Company has incurred significant losses and may incur significant
losses in the future. Such losses could cause our equity balance to fall below
necessary levels to be in compliance with our Senior Convertible Debenture
agreements and impact the Company's ability to finance its future operations. In
addition, deficient equity could violate minimum listing requirements for our
publicly traded stock on Nasdaq and could cause significant decline in
shareholder value and stock price.
Your percentage of ownership and voting power, and the price of our common stock
may decrease because we may issue a substantial number of shares of common
stock, or securities convertible or exercisable into our common stock.
We have the authority to issue up to 150 million shares of our common stock
and 2 million shares of our preferred stock without shareholder approval. We may
also issue options and warrants to purchase shares of our common stock. These
future issuances could be at values substantially below the price paid for our
common stock by current stockholders. We may conduct additional future offerings
of our common stock, preferred stock, or other securities with rights to convert
the securities into shares of our common stock, which may result in a decrease
in the value, or market price of our common stock. Further, the issuance of
preferred stock could have the effect of delaying, deferring or preventing a
change of ownership without further vote or action by the stockholders and may
adversely affect the voting and other rights of holders of common stock.
Provisions of our charter documents and New Jersey law may have anti-takeover
effects that could prevent a change in control, which could negatively affect
the market price for our stock.
Provisions of New Jersey law and our amended and restated certificate of
incorporation and bylaws could make it more difficult for a third party to
acquire us, even if doing so would be beneficial to our stockholders.
Our industry is highly competitive, and we may not have the resources required
to compete successfully.
14
The market for optical networking equipment is extremely competitive. We
expect competition to intensify in the future. Our primary sources of
competition include vendors of optical networking and infrastructure equipment
such as CIENA Corporation, Cisco Systems, Lucent Technologies, Nortel Networks,
ONI Systems, Sycamore Networks, and ADVA AG Optical Networking as well as
private companies that have been or will be focusing on our target markets. The
competitors for Meret's legacy products include Pesa, Artel, RGB Spectrum, Utah
Scientific, and many other companies. We may also face competition from a number
of other companies that have announced plans for new products to address the
same network problems that our products address. Many of our current and
potential competitors have significantly greater sales and marketing, technical,
manufacturing, financial and other resources than we do. Our competitors also
may have more extensive customer relationships than us, including relationships
with our current and potential customers. If we are unable to compete
successfully against our current and future competitors, we could experience
pricing pressures, reduced gross margins and order cancellations, any one of
which could seriously harm our business.
Our business may be seriously harmed if the market for optical networking
products in metropolitan and regional areas does not develop as we expect.
Our current and future product offerings are focused on the needs of
providers that service regional and metropolitan areas. The market for optical
networking products in regional and metropolitan areas is not yet mature, and
we cannot be certain that a feasible market for our products will develop or be
sustainable. In addition, the market has suffered a cutback in capital spending
from both enterprise and carrier customers as a result of poor economic
conditions. If this market does not develop, or develops more slowly than we
expect or continues to be impacted by the reduction in capital spending, our
business may be seriously harmed. Furthermore, the optical networking industry
is subject to rapid technological change, and newer technology or products
developed by others could render our products less competitive or obsolete. In
developing our products, we have made, and will continue to make, assumptions
about the optical networking standards that our customers and competitors may
adopt.
If the standards adopted are different from those which we have chosen to
support, market acceptance of our product would be significantly reduced and our
business will be seriously harmed.
Our future growth depends on our ability to attract new customers, and on our
customers' ability to sell additional services to their own customers.
Most of our potential customers evaluate optical networking products for
deployment in large telecommunications systems that they are installing. There
is only a relatively limited number of potential customers for our products. If
we are not selected by a potential customer, our revenues and ability to grow
our business may be seriously harmed. Similarly, our growth depends on our
customers' success in selling communications services based on our products and
complementary products from others. Our success will depend on our ability to
effectively anticipate and adapt to customer requirements and offer products and
services that meet customer demands. Any failure of our current or prospective
customers to purchase products from us for any reason, including a downturn in
their business, would seriously harm our ability to grow our business.
If we fail to establish and successfully maintain strategic alliances, long-term
contracts and relationships with distributors and system integrators, our
ability to grow and be profitable may be seriously harmed.
Strategic alliances and long-term contracts are an important part of our
effort to expand our sales opportunities and technological capabilities. To
date, we have entered into strategic alliances with AT&T Broadband, United
Pan-Europe Communications, INRANGE, Looking Glass, and Terabeam. In addition we
have a long-term contract with Cox Communications. We cannot be certain that our
existing alliances and long-term contracts will not be cancelled or that we will
be able to enter additional strategic alliances on terms that are favorable to
us. Our agreements to date with our strategic allies are non-exclusive, and we
anticipate that future agreements will also be on a non-exclusive basis. These
agreements are generally short term, have no minimum financial commitments on
either side and can be cancelled without significant financial consequence. In
addition, we cannot be certain that our existing and any future strategic
alliances will be successful. As we expand internationally, we will increasingly
depend upon distributors and system integrators. Our ability to grow and be
profitable may be seriously harmed if we fail to establish and maintain
strategic alliances, long-term contracts and relationships with distributors and
system integrators.
15
We rely on a small number of customers for most of our revenues and any loss,
cancellation, reduction or delay in sales to, or collections from, any single
customer could seriously harm our business.
Our customer base is highly concentrated. Historically, orders from a
relatively limited number of customers accounted for most of our net sales.
During the year ended January 31, 2002, five customers accounted for 61.9% of
net sales and in fiscal year 2001, five customers accounted for 44.4% of our net
sales. We expect that, for the foreseeable future, sales to a limited number of
customers will continue to account for a high percentage of our net sales. We
currently do not have any long-term purchase commitments with any of our
customers, and we are subject to the varying purchase cycles of our customers.
Our concentrated customer base significantly increases the credit risks
associated with slow payments or non-payments by our customers. The loss or
delay of orders or slow or non-payment from, any of our largest customers could
adversely impact our business.
Our backlog at any point may not be a good indicator of expected revenues.
Our backlog at the beginning of each quarter typically is not sufficient
to achieve expected sales for the quarter. To achieve our sales objective, we
are dependent upon obtaining orders during each quarter for shipment during that
quarter. Furthermore, our agreements with our customers typically provide that
they may change delivery schedules and cancel orders within specified time
frames typically 30 days or more prior to the scheduled shipment date, without
significant penalty. Our customers have in the past built, and may in the
future build significant inventory in order to facilitate more rapid deployment
of anticipated major projects or for other reasons. Decisions by such customers
to reduce their inventory levels have led and could lead to reductions in
purchases from us. These reductions, in turn, have and could cause fluctuations
in our operating results and have had and could have caused an adverse effect on
our business, financial condition and results of operations in periods in which
the inventory is reduced.
Our operating results are likely to fluctuate significantly and may fail to meet
or exceed the expectations of securities analysts or investors, causing our
stock price to decline.
Our revenues and operating results will vary significantly from quarter to
quarter and year to year due to a number of factors, many of which are outside
of our control and any of which may cause our stock price to fluctuate. Some of
the factors that may affect us include changes in market demand for our optical
networking products, the cost and availability of components used in our
products, the timing and amount of customer orders, the length and
unpredictability of the sales and deployment cycles of our products, the timing
of new product introductions and enhancements by our competitors and ourselves,
changes in our pricing or the pricing of our competitors, our ability to attain
and maintain production volumes and quality levels of our products, and general
economic conditions as well as those specific to the telecommunications and
related industries.
If we are unable to comply with regulations affecting our customers' industries,
our revenues may be seriously harmed.
Our customers are involved in industries that are subject to extensive
regulation by domestic and foreign governments. If we fail to conform our
products to these regulatory requirements, we could lose sales and our business
could be seriously harmed. Additionally, any failure of our products to comply
with relevant regulations could delay their introduction and require costly and
time-consuming engineering changes.
The time that our customers and potential customers require for testing and
qualification before purchasing our products can be long and variable, and may
require us to invest significant resources without any assurances of sales,
which may cause our results of operations to be unpredictable.
Before purchasing our products, potential customers typically undertake a
lengthy evaluation, testing and product qualification process. In addition,
potential customers often require time-consuming field trials of our products.
Our sales effort requires the effective demonstration of the benefits of our
products to, and significant training of, potential customers. In addition, even
after deciding to purchase our products, our customers may take several years to
deploy our products. The timing of deployment depends on many factors, including
the sophistication of a customer and the complexity and size of a customer's
networks. Our sales cycle, which is the period from the time a sales lead is
16
generated until the recognition of revenue, can often be longer than one year.
The length and variability of our sales cycle is influenced by a variety of
factors beyond our control, including our customers' buildout and deployment
schedules, our customers' access to product purchase financing, our customers'
needs for functional demonstration and field trials, and the manufacturing lead
time for our products. Because our sales cycles are long and variable and may
require us to invest significant resources without any assurances of sales, our
results of operations may be unpredictable.
The GigaMux'r', EPC'TM', TeraManager'TM' and JumpStart'TM' are our only
currently available significant products, and if they are not commercially
successful, our revenue will not grow and we may not achieve profitability.
If our customers and potential customers do not adopt, purchase and
successfully deploy our GigaMux'r',EPC'TM', TeraManager and JumpStart products
in large numbers, our revenue may not grow and our business, financial condition
and results of operations will be seriously harmed. Since the market for our
products is relatively new, future demand for our products is uncertain and will
depend on the speed of adoption of optical networking, in general, and optical
equipment in metro and regional networks, in particular.
If we are not able to develop and commercialize new or enhanced products, our
operating results and competitive position will be seriously harmed.
Our growth depends on our ability to successfully fund and develop new and
enhanced products. The development of new or enhanced products is a costly,
complex and uncertain process that requires us to anticipate accurately future
technological and market trends. Our next generation of transport and network
management products, as well as our TeraMatrix'TM' line of wavelength switching
products, are currently under development. We cannot be sure whether these or
other new products will be successfully developed and introduced to the market
on a timely basis, or at all. We will need to complete each of the following
steps to successfully commercialize these and any other new products, complete
product development, qualify and establish component suppliers, validate
manufacturing methods, conduct extensive quality assurance and reliability
testing, complete software validation, and demonstrate systems interoperability.
Each of these steps presents serious risks of failure, rework or delay, any
one of which could adversely affect the rate at which we are able to introduce
and market our products. If we do not develop these products in a timely manner,
our competitive position and financial condition could be adversely affected.
In addition, as we introduce new or enhanced products, we must also manage
the transition from older products to newer products. If we fail to do so, we
may disrupt customer ordering patterns or may not be able to ensure that
adequate supplies of new products can be delivered to meet anticipated customer
demand. Any failure to effectively manage this transition may cause us to lose
current and prospective customers.
If our products do not interoperate with our customers' networks, installations
will be delayed or cancelled or our products could be returned.
Many of our customers require that we design products to interoperate with
their existing networks, each of which may have different specifications and
utilize a variety of protocols. Our customers' networks contain multiple
generations of products that have been added over time as these networks have
grown and evolved. Our products must interoperate with all of the products
within these networks as well as future products in order to meet our customers'
requirements. If we are required to modify our product design to be compatible
with our customers' systems to achieve a sale, it may result in a longer sales
cycle, increased research and development expense and reduced margins on our
products. If our products do not interoperate with those of our customers'
networks, installations could be delayed, orders for our products could be
cancelled or our products could be returned, any of which could seriously harm
our business.
Our products may have errors or defects that we find only after deployment,
which could seriously harm our relationship with our customers and our
reputation.
Our customers may discover errors or defects in our products, and our
products may not operate as expected. If we are unable to fix errors or other
problems that may be identified on a timely basis, we could experience losses of
or
17
delays in revenues and loss of market share, loss of customers, failure to
attract new customers or achieve market acceptance, diversion of engineering
resources, increased service and warranty costs, and legal actions by our
customers. Any failure of our current or planned products to operate as expected
could delay or prevent their adoption and seriously harm our relationship with
our customers and our reputation.
We depend upon contract manufacturers and any disruption in these relationships
may cause us to fail to meet the demands of our customers and damage our
customer relationships.
We use contract manufacturers to manufacture and assemble our products in
accordance with our specifications. We currently have three U.S.-based contract
manufacturers. We do not have long-term contracts with any of them, and none of
them is obligated to perform services for us for any specific period or at any
specified price, except as may be provided in a particular purchase order. We
may not be able to effectively manage our relationships with these manufacturers
and they may not meet our future requirements for timely delivery or provide us
with the quality of products that we and our customers require.
Each of our contract manufacturers also builds products for other
companies. We cannot be certain that they will always have sufficient quantities
of inventory available to fill our orders, or that they will allocate their
internal resources to fill these orders on a timely basis. Qualifying a new
contract manufacturer and commencing volume production is expensive and time
consuming and could result in a significant interruption in the supply of our
products. If we are required to change contract manufacturers, we may suffer
delays that could lead to the loss of revenue and damage our customer
relationships.
We rely on a limited number of suppliers and single suppliers for some of our
components, and our sales and operating results may be seriously harmed if our
supply of any of these components is disrupted.
We and our contract manufacturers currently purchase several key components
of our products from single and limited sources. We purchase each of these
components on a purchase order basis and have no long-term contracts for these
components. In the event of a disruption in supply or if we receive an
unexpectedly high level of purchase orders, we may not be able to develop an
alternate source in a timely manner or at favorable prices. Any of these events
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 affect our present and future sales.
We expect the average selling prices of our products to decline, which may
reduce gross margins and revenue.
Our industry has experienced significant erosion of average product selling
prices. We anticipate that the average selling prices of our products will
decline in response to competitive pressures, increased sales discounts, new
product introductions by our competitors or other factors. If we are unable to
achieve sufficient cost reductions and increases in sales volumes, the decline
in average selling prices will reduce our gross margins and revenue.
If we are unable to hire or retain highly skilled personnel, we may not be able
to operate our business successfully.
Our future success depends upon the continued services of our key
management, sales and marketing, and engineering personnel, many of whom have
significant industry experience and relationships. Many of our personnel could
be difficult to replace. We do not have "key person" life insurance policies
covering any of our personnel. The loss of the services of any of our key
personnel could delay the development and introduction of, and negatively impact
our ability to sell, our products. Competition for highly skilled personnel is
intense in our industry, and we may not be able to attract and retain qualified
personnel, which could seriously harm our business.
If we become subject to unfair hiring claims, we could incur substantial costs
in defending ourselves.
Companies in our industry whose employees accept positions with competitors
frequently claim that their competitors have engaged in unfair hiring practices.
We cannot assure you that we will not receive claims of this kind in the future
as we seek to hire qualified personnel or that those claims will not result in
material litigation. We could incur substantial costs in defending ourselves or
our employees against such claims, regardless of their merits. In
18
addition, defending ourselves from such claims could divert the attention of our
management away from our operations.
We may be unable to protect our intellectual property, which could limit our
ability to compete.
We rely on a combination of patent, copyright, trademark and trade secret
laws and restrictions on disclosure to protect our intellectual property rights.
We also enter into confidentiality or license agreements with our employees,
consultants and corporate partners, and control access to, and distribution of,
our software, documentation and other proprietary information. Despite our
efforts to protect our proprietary rights, unauthorized parties may attempt to
copy or otherwise obtain and use our products or technology. Monitoring
unauthorized use of our products is difficult, and we cannot be certain that the
steps we have taken will prevent unauthorized use of our technology,
particularly in foreign countries where the laws may not protect our proprietary
rights as fully as in the United States. If competitors gain access to our
technology, our ability to compete could be harmed.
We could become subject to litigation regarding intellectual property rights,
which could seriously harm our business and require us to incur significant
costs.
In recent years, there has been significant litigation in the United States
involving patents and other intellectual property rights. We may be a party to
litigation in the future to protect our intellectual property or as a result of
an allegation that we infringe upon others' intellectual property rights. Any
parties asserting that our products infringe upon their proprietary rights would
force us to defend ourselves and possibly our customers or manufacturers against
the alleged infringement. These claims and any resulting lawsuits, if
successful, could subject us to significant liability for damages and
invalidation of our proprietary rights. Additionally, any claims and lawsuits,
regardless of their merits, would likely be time-consuming and expensive to
resolve and would divert management time and attention.
Any claims of infringement on the intellectual property rights of others
could also force us to do one or more of the following: stop selling,
incorporating or using our products that use the challenged intellectual
property, obtain from the owner of the infringed intellectual property right a
license to sell or use the relevant technology, which may not be available to
us on reasonable terms, or at all, or redesign those products that use such
technology. If we are forced to take any of the foregoing actions, our business
may be seriously harmed. However, the Company intends to vigorously protect its
intellectual property against all material challenges.
If necessary licenses of third-party technology are not available to us or are
very expensive, our products could become obsolete.
We have been and may be required to license technology from third parties
to develop new products or product enhancements. We cannot assure you that
third-party licenses will be available to us on commercially reasonable terms,
if at all. If we are required to obtain any third-party licenses to develop new
products and product enhancements, we could be required to obtain substitute
technology, which could result in lower performance or greater cost, either of
which could seriously harm the competitiveness of our products.
We are subject to various risks associated with international sales and
operations.
Our international operations are subject to a number of risks, including
changes in foreign government regulations and telecommunications standards,
import and export license requirements, tariffs, taxes and other trade barriers,
fluctuations in currency exchange rates, difficulty in collecting accounts
receivable, the burden of complying with a wide variety of foreign laws,
treaties and technical standards, difficulty in staffing and managing foreign
operations, and political and economic instability.
The majority of our sales and expenses have been denominated in U.S.
dollars. However, in the future a larger portion of our sales and expenses may
be denominated in non-U.S. currencies. As a result, currency fluctuations
between the U.S. dollar and the currencies in which we do business could cause
foreign currency translation gains or losses that we would recognize in the
period incurred. We cannot predict the effect of exchange rate fluctuations on
our future operating results because of the number of currencies involved, the
variability of currency exposure and the potential volatility of currency
exchange rates. We do not currently engage in foreign exchange hedging
transactions to manage our foreign currency exposure.
19
If we do not effectively manage our growth, we may not be able to successfully
expand our business.
Our business has experienced wide fluctuations in sales volume from quarter
to quarter, and which place a significant strain on our management systems and
resources. Our ability to successfully offer our products and implement our
business plan in a rapidly evolving market requires an effective planning and
management process. We will need to continue to improve our financial,
managerial and manufacturing processes and reporting systems, and will need to
continue to expand, train and manage our workforce worldwide. If we fail to
effectively manage our growth and address the above requirements, our ability to
pursue business opportunities and expand our business could be harmed.
Definitions
As used in this Annual Report on Form 10-K, the following terms have the
meanings indicated:
"ATM" means Asynchronous Transfer Mode, which is a type of networking technology
based on transferring data in cells or packets of a fixed size. The small,
constant cell size allows ATM equipment to transmit video, audio, and data over
the same network, and assure that no single type of data overtakes the line.
Current implementations of ATM support data transfer rates of 25 to 2.48 Gbps.
"Backbone" means a main segment of a network carrying large amounts of traffic.
Individual metro and interoffice rings are attached to the backbone.
"Bandwidth" means the capacity to move information down a communications
channel. Bandwidth is defined by the highest data rates that can be transmitted
by that channel and is commonly measured in bits per second (bps). For example,
Ethernet has a 10 Mbps bandwidth and OC-192 has 10 gigabits per second
bandwidth.
"Bridge" means a device that connects two or more networks of the same access
method (Ethernet to Ethernet or Token Ring to Token Ring) by making simple
forward/don't forward decisions on each data packet received from any of the
networks to which it is connected.
"Broadband" means technologies or networks that have the ability to transmit
high data rates.
"CLEC" means a Competitive Local Exchange Carrier.
"Concentrator" means the connection point, more sophisticated than a hub,
incorporating different types of cable connections, back-up power supply,
data-gathering capability for management purposes and possibly even bridge and
router features as well.
"CWDM" means Coarse Wavelength Division Multiplexing, which is a sophisticated
optoelectronics technology that uses multiple wavelengths of light spaced at
least 400 Ghz apart to increase the number of video, data or voice channels of
information that can be sent on a single optical fiber in a transmission system.
"DWDM" means Dense Wavelength Division Multiplexing, which is a sophisticated
optoelectronics technology that uses multiple wavelengths of light very
efficiently to greatly increase the number of video, data or voice channels of
information that can be sent on a single optical fiber in a transmission system.
"ESCON" - Enterprise System Connectivity - means a protocol for 200 Mbps signal
transmission speed over fiber optic cable.
"Ethernet" means a 10 Mbps speed network that runs over thick coaxial cable
(10BASE5), thin coaxial cable (10BASE2), twisted-pair (10BASE-T), and
fiber-optic cable. It is the most widely used LAN technology and the most
popular form of Ethernet is 10BASE-T. Ethernet is a network specification that
was developed at Xerox Corp's Palo Alto Research Center, and made into a network
standard by Digital, Intel, and Xerox.
"Fast Ethernet" means a 100 Mbps speed network that runs over thick coaxial,
twisted-pair, and fiber-optic cable. Fast Ethernet is 10 times faster than
Ethernet.
"FDDI" means a Fiber Distributed Data Interface and is a fiber optic network
that supports transmission speeds up to 100 Mbps.
20
"Fibre Channel" means a serial data transfer architecture standard conceived for
new mass storage devices and other peripheral devices that require very high
bandwidth connections. Bit rates for Fibre channel are either 1.06 Gbps or 2.1
Gbps.
"Gigabit Ethernet" means a 1000 Mbps speed network that runs fiber-optic cable
for wide area network connections.
"HDTV" means high definition television, which is a new type of television that
provides much better resolution than current television. HDTV is slowly being
implemented into the broadcast networks.
"Hub" means a central connection device to which many network tributaries are
connected.
"ILEC" means Incumbent Local Exchange Carrier and is a telephone company that
provides local services and does not offer long distance services. All the
regional operating companies after the break-up of AT&T became ILECs.
"ISDN" means an Integrated Services Digital Network and is an all-digital
communications network that provides a wide range of services on a switched
basis. Voice, data and video can be simultaneously transmitted on one line from
a source.
"ISO" means International Standards Organization. Founded in 1946, ISO is an
international organization composed of national standards bodies from over 75
countries. ISO has defined a number of important computer standards, the most
significant of which is perhaps is OSI (Open Systems Interconnection), a
standardized architecture for designing networks.
"ISP" means an Internet Service Provider.
"ITU" means International Telecommunications Union, which is an
intergovernmental organization through which private and public organizations
develop telecommunications. The ITU was founded in 1865 and became a United
Nations agency in 1947 and it is responsible for adopting international tax
treaties, regulations and standards governing telecommunications.
"IXC" means an inter-exchange carrier, a long distance telephone company or a
carrier that specializes in connecting central offices of local service
providers. This carrier typically does not offer services to end users. AT&T,
MCI and Sprint are IXCs. A carrier that provides the backbone of competitive
local exchange carriers can also be considered as an IXC. Therefore, an IXC can
provide service in both metropolitan and in long haul networks.
"LAN" means a Local Area Network and is a high-speed communications system
designed to link computers for the purpose of sharing files, programs and
various devices such as printers and high-speed modems within a small geographic
area such as a workgroup, department or single floor of a multi-story building.
LANs may include dedicated computers or file servers that provide a centralized
source of shared files and programs.
"MSO" means a Multiple Service Operator which is typically a cable TV operator
that offers multiple services such as video, voice and data.
"Multiplexing" means a process that combines a number of lower speed data
transmissions into one high-speed data transmission by splitting that total
available bandwidth into narrower bands (frequency division) or by allotting a
common channel to several different transmitting devices one at a time in
sequence (time division). The opposite function of separating the data channels
into their original format is called demultiplexing.
"OC-1, OC-3, OC-12, OC-48, OC-192" means the SONET bit rates of 51.85Mbps, 155
Mbps, 622 Mbps, 2.5 Gbps and 10Gbps transmission speeds for signals over fiber
optic cables. The number in the end of the term corresponds to the equivalent
multiple of OC-1 capacity (e.g., OC-192 means equivalent to 192 times OC-1)
"OEMs" means original equipment manufacturers.
"Opto-Electro-Optical" means Optical-Electrical-Optical which describes the
conversion of optical signals to electric and back to optical. Typically,
devices performing this function in the electrical domain and the signals need
to be converted back to optical for transmission over optical fibers.
"Packet" means the "envelope" in which the network software places a message
being sent from one station to another station in a network. One of the key
features of a packet is that it contains the destination address in addition to
the data.
21
"POTS" means "plain old telephone service" which refers to the standard
telephone service over copper lines that most homes use. In contrast, telephone
services based on high-speed, digital communications lines, such as ISDN and
FDDI, are not POTS. The main distinction between POTS and non-POTS services is
speed and bandwidth. POTS is generally restricted to about 52Kbps.
"Protocol" means a standard developed by international standards bodies,
individual equipment vendors, and ad hoc groups of interested parties to define
how to implement a group of services in one or more layers of the OSI model. The
Open Systems Interconnect ("OSI") reference model was developed by the ISO to
define all the services a LAN should provide. Ethernet and Token Ring, for
example, are both protocols that define different ways to provide the services
called for in the Physical and Data Link Layers of the OSI model.
"PTT" means Postal, Telephone and Telegraph, and refers to a generic telephone
company outside the United States. Typically, a PTT is state owned and can
operate both local and long distance services.
"RBOC" means a Regional Bell Operating Company.
"Router" means a network translator that reads network-addressing information
within packets to provide greater selectivity in directing traffic over multiple
network segments. It is a more complex inter-networking device.
"SDH" means Synchronous Digital Hierarchy which is transmission protocol for
high speed transmission over fiber optic cable published in 1988 by the
Consultative Committee for International Telegraph and Telephony. It a hierarchy
similar to SONET but in this case the lowest bit rate channel is STM-1 (155
Mbps).
"SONET" means a transmission protocol for high-speed transmission over fiber
optic cable, which was introduced by Bell Communications in 1984 and quickly
accepted by American National Standards Institute.
"Switch" means a device that allows the network operator to vary and select
connections between network nodes at very high speeds.
"T-1" means a dedicated phone connection supporting data rates of 1.544 Mbps. A
T-1 line actually consists of 24 individual channels, each of which supports
64Kbps and can be configured to carry voice or data traffic. T-1 lines are
sometimes referred to as DS-1 lines.
"TCP/IP" means Transmission Control Protocol/Internet Protocol, which is a suite
of protocols used for communications between two or more devices.
"TDM" means time division multiplexing which is a multiplexing process that
combines a number of lower speed data transmissions into one high-speed data
transmission by allotting a common channel to several different transmitting
devices one at a time in sequence.
"Token Ring" means a 4 Mbps or 16 Mbps speed network that uses different
technology than Ethernet to co-ordinate the transmission of data among nodes.
"WAN" means a Wide Area Network and is a communications network that connects
geographically dispersed users. Typically, a WAN consists of two or more LANs.
The largest WAN in existence is the Internet.
Item 2. Properties.
We recently moved our headquarters to the San Diego, California facility
that we own consisting of approximately 36,000 square feet used for offices,
research and development and manufacturing. We also own a 47,000 square foot
facility in San Diego, California adjacent to our headquarters that is used for
offices, manufacturing and customer support.
We occupy an additional 16,860 square feet used for office, research and
development and manufacturing activities under lease as detailed below:
Location Square Footage Facility Type Expiration Date
-------- -------------- ------------- ---------------
Santa Monica, California 6,000 Office April 30, 2003
Fremont, California 5,000 Office/Manufacturing July 31, 2003
San Diego, California 3,000 Office/R&D/Manufacturing n/a - month to month
Richardson, Texas 2,860 Office September 30, 2003
22
We have two sales office located in the United States (San Diego and
Richardson), three sales offices located in Europe (The Netherlands, Belgium and
Germany) and two sales office located in Asia (China and Singapore) totaling
approximately 14,000 square feet. All such offices are leased for varying terms.
We believe that suitable additional space will be available to us, when
needed, on commercially reasonable terms. See Note E to the Consolidated
Financial Statements contained in Part II herein for terms and amounts of
mortgages on the facility we own.
Item 3. Legal Proceedings
On September 10, 2001, holders of a portion of the outstanding Series A
Preferred Stock of our Sorrento subsidiary obtained a preliminary injunction
from the Delaware Court of Chancery prohibiting it from issuing further shares
of its Series A Preferred Stock or incurring any additional debt without the
consent of the holders of a majority of the currently outstanding shares of such
Series A Preferred Stock. On January 23, 2002, the Delaware Supreme Court
affirmed the granting of the preliminary injunction.
On October 19, 2001, an amended complaint was filed in the injunction
action, adding as named defendants, the Company, our Meret subsidiary, certain
present and former officers and directors of the Company and our subsidiaries as
well as our investment bankers. The amended complaint also added, among other
things, claims for fraud, securities fraud, breach of fiduciary duty,
conspiracy, and intentional interference with contract as well as requesting the
appointment of a receiver for our Sorrento subsidiary, all which claims are
based on alleged wrongs committed in connection with or since the Series A
placement. Our Sorrento subsidiary and the original individual defendants have
all answered this amended complaint denying all allegations of wrongdoing. The
new defendants have all moved to dismiss the amended complaint. Management
believes the allegations contained in the amended complaint are without merit.
On December 14, 2001, plaintiffs filed motions to sequester the common
stock of our Sorrento subsidiary owned by Meret and the Sorrento Series A
preferred stock that we own, as an alternative method of obtaining jurisdiction
over us and Meret in the Delaware litigation. Management also believes that
these motions are without merit.
Currently, hearings on all pending motions have been taken off calendar
at the request of all parties, pending the resolution of ongoing settlement
discussions between the Company and the plaintiffs. While the Company is
encouraged at the progress of these negotiations, there can be no assurance
that a settlement will be reached.
During June 2000, we entered into various agreements with Par Chadha, our
former CEO and Chairman, which, among other matters, provides for payments of
$250,000 per year for three years of consulting services and loans by us for
the exercise of previously granted options to acquire 1,178,500 options at
prices varying from $7.03 to $49.25 per share. As the members of our Board of
Directors at the time of his resignation ceased to represent more than 50%
of the Board in October 2000, all payments for consulting services were
accelerated and no future consulting services are required. During October
2000, Mr. Chadha exercised 71,112 options, applying the $500,000 accelerated
payment to the exercise. In addition, he exercised 507,388 options for which
we are contractually obligated to loan the $5,034,000 due on the exercise.
During September 2001, Mr. Chadha notified us that he does not have any
obligations under the agreements. We have notified him that we do not agree
with his interpretation of his repayment obligations under the terms of the
agreements.
During December 2001, we entered into an agreement whereby the 507,388
option exercise was rescinded. Mr. Chadha returned the 507,388 shares to us for
cancellation and we cancelled the receivable due from him and restored the
original option agreements. This rescission agreement did not resolve any
underlying dispute as to the option loan repayment obligations. We anticipate
this dispute will be resolved through binding arbitration. Should
23
Mr. Chadha prevail in the arbitration, the Company may be required to issue him
1,178,500 shares of the Company's stock for no consideration.
In April 2002, our former Chairman and CEO, Dr. Xin Cheng, filed a
claim in arbitration seeking, among other things, payment of $500,000 and
acceleration of the vesting of options pursuant to alleged contractual
obligations of our Sorrento subsidiary. The Company is disputing these claims.
From time to time, we are involved in various other legal proceedings
and claims incidental to the conduct of our business. Although it is impossible
to predict the outcome of any outstanding legal proceedings, we believe that
such legal proceedings and claims, individually and in the aggregate, are not
likely to have a material effect on our financial position, results of
operations, or cash flows.
Item 4. Submission of Matters to a Vote of Security Holders
Our Annual Meeting of Stockholders was held on February 21, 2002. During
the Annual Meeting, the stockholders elected our nominees to the Company's Board
of Directors to serve for the term of one year or until their successors have
been elected and qualified with each nominee receiving no less than of the total
votes cast for the election of directors.
In addition, the stockholders approved the following proposals:
Votes Broker
Votes For Against Abstentions Non-Votes
--------- ------- ----------- ---------
Ratification of the appointment of
BDO Seidman, LLP as auditors 11,111,316 629,573 10,731 n/a
24
PART II
Item 5. Market for Company's Common Equity and Related Stockholder Matters.
Our common stock traded on the Nasdaq Small Cap Market under the symbol FIBR
since 1994. On December 16, 1998, we commenced trading on the Nasdaq National
Market System under the same symbol.
The following table sets forth the high and low closing bid prices for our
common stock in the over-the-counter market from February 1, 2000 to January 31,
2002, based upon information obtained from Nasdaq. Quotations represent
inter-dealer prices; they do not include retail markups, markdowns, or
commissions; and, they may not represent actual transactions.
Fiscal 2000-2001 High Low
---------------- ---- ---
Quarter from February 1, 2000 to April 30, 2000 $144.88 $29.19
Quarter from May 1, 2000 to July 31, 2000 $86.00 $32.44
Quarter from August 1, 2000 to October 31, 2000 $74.50 $14.88
Quarter from November 1, 2000 to January 31, 2001 $40.88 $10.38
Fiscal 2001-2002
----------------
Quarter from February 1, 2001 to April 30, 2001 $25.50 $3.91
Quarter from May 1, 2001 to July 31, 2001 $16.19 $5.53
Quarter from August 1, 2001 to October 31, 2001 $8.02 $1.67
Quarter from November 1, 2001 to January 31, 2002 $5.06 $3.21
On April 30, 2002, the average of the high and low bid quotation for our common
stock was $2.15 per share. There is no assurance that a market in our common
stock will continue.
As of April 30, 2002 (the latest practicable date) there were 795 shareholders
of record, including brokerage firms and nominees, of our common stock.
We have never paid any cash dividends on our common stock. The present policy of
the Board of Directors is to retain all available funds to finance the planned
level of operations. In light of the anticipated cash needs of our business, it
is not anticipated that any cash dividends will be paid to the holders of our
common or preferred stock in the foreseeable future.
Item 6. Selected Financial Data
The following table sets forth selected consolidated financial data with respect
to our five most recent fiscal years ended January 31. The selected consolidated
statement of operations data set forth below for each of our three most recent
fiscal years, and the selected consolidated balance sheet data set forth at
January 31, 2002 and 2001, are derived from our consolidated financial
statements which have been audited by BDO Seidman, LLP, independent certified
public accountants, as indicated in their report which is included elsewhere in
this annual report. The selected consolidated statement of operations data set
forth below for each of the two fiscal years ended January 31, 1999 and 1998,
and the consolidated balance sheet data set forth below at January 31, 2000,
1999 and 1998 are derived from our audited consolidated financial statements not
included in this annual report. The selected consolidated financial data should
be read in conjunction with our consolidated financial statements, and the notes
thereto including Note A which discusses our significant acquisitions,
dispositions and discontinued operations, included elsewhere in this annual
report, and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" in Item 7.
25
Fiscal Year Ended January 31,
-----------------------------
2002 2001 2000 1999 1998
---- ---- ---- ---- ----
Statement of Operations Data:
Net sales $ 40,827 $ 44,641 $ 68,372 $ 58,362 $ 65,811
Net income (loss) from
continuing operations $(43,136) $(41,905) $ 2,410 $(11,069) $(16,377)
Net income (loss) per share
from continuing operations:
Basic $ (3.10) $ (3.71) $ 0.17 $ (1.69) $ (3.32)
Diluted $ (4.36) $ (3.71) $ 0.15 $ (1.69) $ (3.32)
Balance Sheet Data:
Cash and cash equivalents $ 14,243 $ 9,965 $ 13,511 $ 3,480 $ 1,422
Working capital 5,839 71,993 189,486 11,399 8,986
Total assets 90,339 113,123 223,265 66,796 69,589
Total debt (including short-term debt) 72,122 24,770 20,727 27,938 26,872
Stockholders' equity 18,217 39,733 202,538 38,858 42,717
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Certain statements contained in this Annual Report on Form 10-K, including,
without limitation, statements containing the words "believes", "anticipates",
"estimates", "expects", and words of similar import constitute "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. Readers are referred to the "Other Risk Factors" section of this Annual
Report on Form 10-K, as well as the "Financial Risk Management" and "Future
Growth Subject to Risks" sections contained herein, which identify important
risk factors that could cause actual results to differ from those contained in
the forward-looking statements.
The results of operations reflect our activities and our wholly-owned
subsidiaries; this consolidated group is referred to individually and
collectively as "We" and "Our".
Entrada Networks
On August 31, 2000, we completed a merger of our Entrada subsidiary with Sync
Research, Inc. a Nasdaq listed company. After the merger, our purchase of Sync
shares prior to the merger and our purchase of shares for cash from Entrada, we
owned 48.9% of the merged entity which changed its name to Entrada Networks.
Pursuant to our plans adopted prior to the merger, we distributed to our
shareholders' one-fourth shares of an Entrada share for each of our outstanding
shares and reserved a similar number for each unexercised option and warrant to
acquire our common stock outstanding on the record date. After the distribution
and reserve for options and warrants we own approximately 9.2% of Entrada common
shares outstanding as of January 31, 2002, and account for this remaining
interest as an "available for sale security" which is marked to market at the
end of each period. Additional information regarding Entrada is available from
its various filings with the Securities and Exchange Commission which are
available online at www.freeedgar.com and www.sec.gov or from the Securities and
Exchange Commission.
NETsilicon or NSI
The results of NSI were included in our consolidated results only through
September 15, 1999. Additional information regarding NSI is available from its
various filings with the Securities and Exchange Commission which
26
are available online at www.freeedgar.com and www.sec.gov or from the Securities
and Exchange Commission. See "Results of Operations: Comparison of the Years
Ended January 31, 2000 and January 31, 1999."
Results of Operations: Comparison of the Years Ended January 31, 2002 and
January 31, 2001.
Net sales. Our consolidated net sales decreased $3.8 million or 8.5% to
$40.8 million for fiscal 2002 when compared to net sales of $44.6 million for
fiscal 2001. Net sales for our Sorrento Networks Inc., the Company's primary
operating subsidiary, increased $9.6 million or 36% to $36.0 million for fiscal
2002 as compared to net sales of $26.4 million in fiscal 2001. Net sales for
Meret Optical segment decreased $1.5 million or 23.8% in fiscal 2002 to $4.8
million as compared to net sales of $6.3 million in fiscal year 2001. Entrada
Networks, an operating subsidiary which the Company spun-off in August 2000,
had a revenues of $11.9 million in fiscal 2001 whereas no revenues were
reported for Entrada Networks in fiscal year 2002.
Gross profit. Cost of sales consists principally of the costs of
components, subcontract assembly from outside manufacturers, and in-house system
integration, quality control, final testing and configuration costs. Gross
margin percent on a consolidated basis decreased to 22.8% for fiscal 2002 from
29.5% in fiscal 2001. Consolidated gross profit was $9.3 million, a decrease of
29.2% for fiscal 2002 from $13.2 million for fiscal 2001. Gross margin percent
and gross profit were impacted negatively by increases in inventory reserves and
sales that were made at lower gross profit than the prior year. Gross profit for
our Sorrento subsidiary decreased to $7.7 million in fiscal 2002, as compared to
$9.1 million in fiscal 2001, a decrease of 16.2%. An increase in inventory
reserves accounts for $3.7 million of the decrease in gross profit. The gross
profit of our Meret Optical segment decreased by $941,000 from the prior fiscal
year and was primarily the result of the revenue