NEW FOCUS INC - 10-K Annual Report

Back to GetFilings.com

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Year Ended December 30, 2001

Commission File Number 0-29811

NEW FOCUS, INC.

(Exact Name of Registrant as Specified in its Charter)

Incorporated in the State of Delaware

I.R.S. Employer Identification Number 33-0404910

5215 Hellyer Avenue, San Jose, California 95138-1001

Telephone: (408) 284-4700

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 ¨ No x.

On March 20, 2002, 76,137,437 shares of the Registrant’s common stock, $0.001 par value, were issued and outstanding.

NEW FOCUS, INC.

INDEX

		Page
PART I

Item 1.	Business	3
Item 2.	Properties	23
Item 3.	Legal Proceedings	23
Item 4.	Submission of Matters to a Vote of Securities Holders	25

PART II
Item 5.	Market for the Registrant’s Common Stock and Related Stockholder Matters	25
Item 6.	Selected Consolidated Financial Data	26
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	28
Item 7A.	Qualitative and Quantitative Disclosure of Market Risk	37
Item 8.	Consolidated Financial Statements and Supplementary Data	37
Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	37

PART III
Item 10.	Directors and Executive Officers of the Registrant	37
Item 11.	Executive Compensation	37
Item 12.	Security Ownership of Certain Beneficial Owners and Management	38
Item 13.	Certain Relationships and Related Transactions	38

PART IV
Item 14.	Exhibits, Financial Statement Schedules, and Reports on Form 8-K	38

SIGNATURES		70

POWER OF ATTORNEY		70

INDEX TO EXHIBITS FILED TOGETHER WITH THIS ANNUAL REPORT

Item 1. Business

In addition to historical information, this Annual Report on Form 10-K (Annual Report) contains predictions, estimates and other forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of 1934 that relate to future events or our future financial performance. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by the forward-looking statements. These risks and other factors include those listed under “Risk Factors” and elsewhere in this Annual Report. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “continue” or the negative of these terms or other comparable terminology. In addition, these forward-looking statements include, but are not limited to, statements regarding the following:

•

the anticipated market trends and uncertainties;

•

the effectiveness of our current business strategy;

•

our plans to reach profitability at quarterly revenues of $20 million;

•

our ability to grow revenues from sales of our existing product lines;

•

the revenues outlook for future periods, specifically the first quarter of 2002;

•

our plans to improve market share and increase our revenues through strategic acquisitions;

•

anticipated development and release of new products or potential reduction in our product offerings;

•

our plans to divest and sell our passive components product line;

•

our plans to divest and sell the land, building and equipment of our China operations;

•

the expected impact of restructuring plans;

•

the anticipated restructuring expenses we will incur in connection with the closing of certain of our facilities;

•

anticipated expenditures for research and development, sales and marketing and general and administrative expenses;

•

the effect of lower production volume on our gross margin performance;

•

the adequacy of the inventory-related charges recorded in 2001;

•

the maintenance of our competitive advantage; and

•

the adequacy of our capital resources to fund our operations.

These statements are only predictions and are subject to risks and uncertainties, including the following:

•

the difficulty of forecasting anticipated revenues due to weakness and uncertainties regarding overall demand within the telecommunications industry, inventory levels within the industry, sudden order reductions and cancellations by customers, lower backlog of customer orders, and potential pricing pressures that may arise from supply-demand conditions within the industry;

•

our ability to introduce and gain customer acceptance of new products on a timely basis;

•

our ability to divest the passives product line in a timely and efficient manner while fulfilling end-of-life obligations to our customers;

•

our ability to obtain adequate value from the sale of our passives product line;

•

our ability to obtain adequate value from the sale of our China manufacturing facility and equipment;

•

the difficulty of achieving anticipated cost reductions due to unforeseen expenses;

•

failure to execute on our acquisition and partnering strategies and our expansion into potential new markets may prevent achievement of profitability in a timely manner;

•

the inability to reduce expenses without jeopardizing product development schedules for products that will remain a focus of our business;

•

unforeseen development delays for new products that limit our ability to generate volume revenue;

•

the difficulty in anticipating the outcome of current litigation;

•

our ability to generate future revenues from new products commensurate with prior investments in research and development activities; and

•

the protection of our proprietary technology.

In evaluating these statements, you should specifically consider various factors, including the risks outlined under “Risk Factors.” Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements.

Overview

We develop and manufacture optical and radio-frequency (RF) components for next-generation communication networks and other photonics applications. We report revenues in two segments: telecom and photonics tools. Through March 31, 1999, substantially all of our revenues were generated from sales of photonics tools products. Our photonics tools products include instruments and tools used for measuring, moving, modulating and detecting optical signals in commercial and research applications across a wide variety of industries. Beginning in 1999, we began to derive an increasing amount of our revenues from sales of telecom products. Our telecom products include wavelength management products, high-speed opto-electronics and tunable laser modules, and are classified as actives or passives. An active component is a device that generates, encodes, amplifies or detects optical signals in optical and electronic domains. A passive component is a device that functions only in the optical domain, and is generally used to mix, filter, adjust and stabilize optical signals in advanced fiber optic networks. For the nine-month period ended December 31, 1999 and the fiscal years ended December 31, 2000 and December 30, 2001, sales of our telecom products accounted for 27.6%, 66.7% and 70.6% of overall net revenues, respectively.

Demand for our telecom products fell abruptly beginning in the latter half of the first quarter of 2001 due to the widespread business downturn in the telecommunications industry. Market conditions continued to worsen with each successive quarter of 2001. As a result of the telecommunications industry downturn, we experienced order cancellations and rescheduling of orders to later periods. Revenues from our telecom products declined in each quarter of 2001, from $32.3 million in the first quarter, to $19.0 million in the second quarter, $9.7 million in the third quarter and $4.4 million in the fourth quarter. At the same time, as a result of the broader economic downturn, demand for our photonics tools also declined, particularly impacting OEM sales to the semiconductor market. Revenues from our photonics tools products declined in each quarter of 2001, from $8.5 million in the first quarter, to $7.6 million in the second quarter, $6.1 million in the third quarter and $5.0 million in the fourth quarter. Revenues from our telecom products and photonics tool products comprised 46.3% and 53.7%, respectively, of our total net revenues in the fourth quarter of 2001. We expect that our total net revenues in the first quarter of 2002 will be within a range of $9-12 million. For more information about our net revenues and other financial results, see “Management’s Discussion and Analysis” beginning on page 28.

Recent Developments

In the fourth quarter of 2001, we announced that we were transferring more production to our offshore manufacturing facility in Shenzhen, China. However, in March 2002, we decided and announced that we will

divest operations related to the manufacture and sale of passive components. As a part of this action, we will cease operations at our 243,000 square foot manufacturing facility in Shenzhen, China after fulfillment of end-of-life orders from customers. We plan to discontinue development work on all passive products early in the second quarter of 2002 and cease operations at our China manufacturing facility by the end of the second quarter of 2002.

This product line divestiture and plant closure will reduce our worldwide work force by approximately 350 people. We expect to record a restructuring charge of $25-40 million associated with the passives product line divestiture, the China plant closure, and the related work force reductions. The restructuring charge will be recorded in either the first or second quarter of 2002, or possibly spread over both quarters, in compliance with current accounting rules. We will continue to develop and market our actives products, such as tunable lasers, data drivers and clock amplifiers, as well as test and measurement products and photonics tools.

We previously announced the planned closure of our Camarillo, California manufacturing facility by the early part of the third quarter of 2002. The work force reduction associated with this action involves approximately 160 people. Combined with the additional work force reduction associated with the divestiture of our passives product line, our headcount will drop to 390 people in the fourth quarter of 2002, down from approximately 900 employees at end of the fourth quarter of 2001 and down from the peak employment level of approximately 2,100 people in February 2001. After closure of the Camarillo and China plants, the company will occupy 213,000 square feet of facilities, down from 573,000 square feet at the start of 2001.

Net revenues from the sale of our passives products were $24.9 million, or 26.9% of total net revenues, for the year ended December 30, 2001, $35.7 million, or 44.4% of total net revenues for the year ended December 31, 2000, and $2.6 million, or 14.6% of total net revenues, for the nine months ended December 31, 1999. Recently, quarterly net revenues from passives products declined from $17.1 million, or 50.3% of total net revenues, in the fourth quarter of fiscal 2000 to $1.5 million, or 16.0% of total net revenues in the fourth quarter of fiscal 2001. At December 30, 2001, our investment in our passives product line and our China manufacturing facility totaled $43.5 million, comprised of $23.3 million for land and building and $20.2 million for equipment.

Industry Background

Telecom Products

The volume of high-speed data traffic over communications networks has increased significantly over the past few years. According to RHK, a leading market research and consulting firm, North American Internet traffic will continue its growth, increasing 85-100% annually through 2005. This growth is primarily attributable to the increasing use of the Internet among consumer and business users, easier and cheaper access to the Internet, widespread use of e-commerce as a standard mode of business, and the large and growing number of personal computers in the home and the workplace. Initially, network service providers had difficulty in meeting this growing demand in bandwidth due to significant constraints of the existing communications infrastructure, which was originally designed to carry only voice traffic. To alleviate this bottleneck and in anticipation of a growth rate in high-speed data traffic that exceeded the now lowered outlook, network service providers accelerated their capital spending and deployed next-generation optical networks to address this anticipated demand for high-speed communications.

During 1999-2000, the fiber optic components market, including actives and passives, was one of the fastest growing portions of the telecommunications sector. The growing requirements of communications networks, and the expectations for continued growth, resulted in strong demand for increasingly sophisticated systems and components. However, overly optimistic expectations for growth in bandwidth requirements resulted in unsustainable capital expenditure levels and significant over-ordering by carriers and systems providers. In 2001, demand from carriers and systems providers fell abruptly as installed capacity outstripped demand for Internet traffic, resulting in a severe downturn. RHK estimates that the market for fiber optic components for terrestrial

dense wavelength multiplexing, or DWDM, decreased from approximately $5 billion in 2000 to approximately $3 billion in 2001, and is not expected to return to approximately $5 billion until 2005.

Photonics Tools Products

We sell our photonics tools products to customers in the telecommunications, semiconductor, biotechnology and metrology industries. Our customers also include commercial, academic and government research institutions that engage in advanced research and development activities. During 1999-2000, growth in demand for photonics tools was fueled by an increased use of photonics tools in commercial markets, including use in OEM applications where we designed custom solutions for industrial environments. In 2001, however, in connection with the broader economic downturn, we experienced a decline in OEM sales of photonics tools to vertical markets, in particular the semiconductor market.

Company Strategy

Our stock price has recently traded at a discount to our cash value per share due to the significant expenses and resulting net losses associated with operating in the telecommunications market today. Due to expectations for a prolonged recovery for the telecommunications market, we intend to reduce our exposure to this market and to match telecom-related development expenses to customer needs. We will also take strategic actions that will move us toward profitability.

To reduce our exposure to the telecommunications market, we will divest our product line of passive optical components and close our China manufacturing operations. Revenues from our passives product line grew rapidly during 2000 as carriers used these components in the construction of new network capacity during this period. The current glut in long-haul network capacity, however, has dramatically lowered demand for passive components and idled passive product manufacturing capacity across the industry. The elimination of the losses associated with our passives product line and the underutilization of our China plant will contribute to our drive toward profitability.

Although we are exiting from the passives market, we plan to retain our actives product line of clock amplifiers, data drivers and tunable lasers that are integral to lighting fiber in currently installed systems. As bandwidth continues to grow, carriers will light new fiber in existing systems to carry this increased traffic, despite the glut in network capacity. This provides us with an opportunity for continued revenue from our actives product line. To help regulate our telecom-related development expenses and push market adoption of a new technology, we intend to seek strategic development partnerships that will provide funding and manufacturing capabilities for the development and launch of our second generation network tunable lasers.

We will increase investment in our core competencies, notably photonics tools and tunable lasers for test and measurement applications, which have historically operated profitably. In addition, we will pursue the application of our optics and opto-electronics expertise to markets other than telecommunications that could provide profit opportunities with a proper level of risk. We will continue to review our various lines of business and will adjust our business strategies and cost reduction plans to fit market realities.

While we believe we can grow revenue from existing product lines through internal actions, the rate of internal growth will not allow us to achieve our breakeven quarterly revenues level of $20 million in a timely manner, thus delaying our return to profitability. Therefore, we plan to pursue business combinations in our core business areas that will improve our market share position, increase our revenues and improve on our net loss position.

Products and Technology

We sell two primary categories of products: telecom products and photonics tools products. Our telecom products include wavelength management products, high-speed opto-electronics and tunable laser modules,

and are classified as actives or passives. An active component is a device that generates, encodes, amplifies or detects optical signals in optical and electronic domains. A passive component is a device that functions only in the optical domain, and is generally used to mix, filter, adjust and stabilize optical signals in advanced fiber optic networks. Our photonics tools products include instruments and tools used for measuring, moving, modulating and detecting optical signals in commercial and research applications across a wide variety of industries.

Telecom

Actives

Our actives products include swept-wavelength lasers, test and measurement tunable lasers, network tunable laser modules, and high-speed opto-electronics. These and other actives products are in various stages of development and production. Our high performance swept-wavelength and test and measurement tunable lasers are used for testing and measuring fiber optic components and systems in manufacturing, development and research environments. These lasers provide rapid, precise, and wide tuning or wavelength scanning for efficient testing. We are developing network tunable laser modules to replace conventional fixed wavelength lasers in telecommunications networks. These network tunable laser modules are designed for high output power and wide wavelength range to provide a high degree of flexibility in next-generation networks. Our high-speed products include modulator data drivers and clock drivers operating at OC-192, or 10 gigabits per second, and OC-48, or 2.5 gigabits per second. These products are designed to increase the data rate in optical networks.

Our actives products are based on our technologies in tunable lasers and high-speed opto-electronics. Our tunable laser capabilities include advanced laser design, development and manufacturing, advanced laser packaging for high reliability, dynamic filter technology for wide tuning, advanced thin films for extremely low optical reflections, and integrated wavelength locking technology that results in minimal error in the laser wavelength from the desired channel. These capabilities have resulted in tunable laser products with high output power and wide wavelength coverage. Our high-speed opto-electronics capabilities include analog chip design, photodetector design and advanced manufacturing, packaging and assembly. These capabilities allow us to develop products that operate at data rates of OC-192 or OC-768, 40 gigabits per second.

Passives

Our passive components are used in fiber amplifiers, including erbium-doped fiber amplifiers (“EDFAs”) and Raman amplifiers, and wavelength management products for optical add-drop and multiplexing-demultiplexing, dispersion compensation, and other optical networking applications. Our C- and L-band optical circulators are used to route signals to the desired sections of a network, such as in EDFAs or wavelength management applications. Polarization beam combiners and splitters, pump-pump combiners and pump-signal combiners are used in Raman amplifiers and EDFAs for combining the optical power from pump lasers and optical signals. Our interleavers and band splitters are used to split or combine signals in wavelength management applications. Our integrated modules combine many passive components into a single package for various applications. Our passive components feature low loss, wide wavelength performance, compact size, high optical power handling, and cost-effective design. These features result in optical networks with longer reach lengths, increased channel counts, new services, and more cost-effective systems. Our passive components are all tested to industry standards for high reliability developed by Telcordia, a company that provides certain centralized research and standard coordination for Regional Bell Operating Companies.

Our passive components were developed utilizing our technical capabilities in advanced crystal design, optics design and modeling, high power handling design and test, passive athermalization, and advanced fiber optic packaging. Our advanced crystal design technology allows us to tailor crystal materials for novel optical components with high performance and wide wavelength operation, such as for our optical circulators and polarization beam combiners. Our optics design and modeling capabilities produce components with optimized

performance and low loss. Our capabilities in high power handling design and test ensure our passive components operate under the highest optical power levels needed for new applications such as Raman amplifiers. Our passive athermalization technology is used to develop new passive components that require no electrical heating or cooling for temperature stabilization. Finally, our advanced fiber optic packaging platform is used in all of our passive components to ensure the highest reliability to Telcordia requirements.

In March 2002, we decided and announced that we will divest operations related to the manufacture and sale of passive components. As a part of this action, we will cease operations at our 243,000 square foot manufacturing facility in Shenzhen, China after fulfillment of end-of-life orders from customers. We plan to discontinue development work on all passive products early in the second quarter of 2002 and cease operations at our China manufacturing facility by the end of the second quarter of 2002.

Photonics Tools

New Focus was founded in 1990 with the goal of making “Simply Better Photonics Tools” for research and academic laboratories. Photonics tools are instruments and tools principally used for measuring, moving, modulating and detecting optical signals. In addition to research and academic laboratories, our photonics tools are now used in commercial and OEM applications, resulting in increased demand for our products.

We currently offer a wide range of photonics tools for advanced research, development and manufacturing. These products leverage our core competencies in optics for a number of applications including telecommunications, semiconductor and biotechnology research and product development. For example, our precision opto-mechanical components and picomotor products are used for semiconductor manufacturing, advanced manufacturing of fiber optic components and for research and development of high-speed network products. Our photodetectors, which are devices that convert optical signals to electrical signals faster than the products being measured, are needed to accurately characterize the optical performance of the tested device, and our high-speed photodetectors are being used to develop OC-768 products.

Our photonics tools line principally includes lasers and instruments, electro-optical components, precision opto-mechanical components and motion control devices. The tunable lasers in our photonics tools product line are used for many spectroscopic applications ranging from semiconductor inspection to biomedical diagnostics. Our electro-optical components include modulators, photodetectors and photoreceivers (photodetectors with built-in amplifiers) used for general-purpose light and fluorescence detection, light modulation, and component test and characterization. Our precision opto-mechanical components—optical mounts, fiber aligners, translation stages and actuators to name a few—provide superior stability, high resolution and precision adjustment capability for use in both manufacturing and laboratory environments. Supplementing the precision opto-mechanical component family is a motion control product line that includes motorized optical mounts, stages and picomotor drivers. When used with our precision opto-mechanical products, these tools provide high-resolution positioning and precise alignment.

Customers

We sell our telecom products to network equipment providers. We sell our photonics tools products to customers in the telecommunications, semiconductor, biotechnology and metrology industries. Our photonics tools customers also include commercial, academic and governmental research institutions that engage in advanced research and development activities. In recent years, use of these photonics tools in commercial and OEM applications has grown, especially in the semiconductor and telecommunications industries.

For the year ended December 30, 2001, Agilent Technologies and Alcatel S.A. accounted for 13.4%, and 11.3% of our net revenues, respectively. For the year ended December 31, 2000, Corvis Corporation, Agilent Technologies, and Corning Incorporated accounted for 17.6%, 14.4%, and 10.6% of our net revenues, respectively.

Sales, Marketing and Customer Support

We focus our sales and marketing efforts on a select set of key customers. We take a collaborative approach with our customers and establish relationships at all levels—engineering, procurement, and senior management. This approach allows us to rapidly respond to customer needs and to stay at the forefront of the technology required for next-generation networks.

We sell and market our telecom products primarily through our direct sales force. We sell and market our photonics tools primarily through a combination of direct sales, catalog sales and international sales representatives and resellers. We focus our direct sales efforts on optical network equipment manufacturers. Our direct sales account managers cover the market on an assigned account basis. We believe that support services are essential to the successful installation and ongoing support of our products. Our support services include customer service and technical support. Our customer service representatives assist customers with orders, warranty returns and other administrative functions. Our technical support engineers provide customers with answers to technical and product related questions as well as application support relating to the use of our products in the customer’s applications. These engineers also help to define the features that are required for our products to be successful in specific applications.

Manufacturing

We manufacture the majority of our products. We do, however, outsource on a limited basis manufacturing of selected subcomponents, primarily for our commercial photonics products. We have manufacturing operations in San Jose, California, Camarillo, California and Shenzhen, China. These plants are currently operating at low utilization rates due to decreased demand for our products. In the first half of 2001, we closed our older Santa Clara, California facility and transferred passive product development activities to our newer, larger facility in San Jose. In China, we closed our smaller production facility in Shenzhen and consolidated activities into our larger Shenzhen factory. We plan to close our larger Shenzhen, China manufacturing facility and our Camarillo, California manufacturing plant in the second and third quarters of 2002, respectively. We will rely on our San Jose, California manufacturing facilities and outsource excess manufacturing requirements as needed.

We are committed to designing and manufacturing high quality products that have been thoroughly tested for reliability and performance. Our manufacturing processes utilize stringent quality controls, including incoming material inspection, in-process testing and final test. We perform extensive in-house thermal, shock and environmental testing, including testing to industry accepted standards developed by Telcordia. Our products are designed to be fully compliant with standards for quality and interoperability with existing installation and maintenance systems. As a result of our continuing commitment to manufacturing high quality products, our operation in San Jose, California is ISO certified.

Research and Development

We have assembled a team of engineers, technicians and operators with significant experience in highly specialized manufacturing industries such as optical networking, semiconductor capital equipment, optical storage, and communications. Our product development efforts focus on our telecom products, particularly high-speed opto-electronics and innovative fiber optic products, which will enable us to offer next-generation products in volume. Due to our emphasis on telecom products in recent years, we have not historically spent significant amounts on research and development efforts for photonics tools.

Our total research and development expenses, excluding funding received from research and development contracts, totaled $50.8 million for the fiscal year ended December 30, 2001, $27.2 million for the fiscal year ended December 31, 2000 and $8.4 million for the nine-month period ended December 31, 1999.

We have made, and will continue to make, a substantial investment in research and development. At the same time, however, we plan to reduce our research and development spending to a rate of $5-6 million per

quarter by the end of 2002 in order to more closely align development expenses with recent changes in new product plans and with our revenue expectations for 2002. In addition, we plan to establish strategic development partnerships that will provide funding and help reduce telecom research and development expenses, particularly in regard to the development of network tunable lasers. We anticipate that research and development spending with respect to our photonics tools business will increase as we execute our business strategy; however, the level of research and development expenditure required for photonics tools is significantly lower than that required for telecom products.

Competition

Competition in the telecommunications market is intense. We face competition from a number of companies, including JDS Uniphase Corporation, Agere Systems, Inc. and the optical components divisions of Nortel Networks Corporation and Alcatel S.A. Some of our competitors, including JDS Uniphase Corporation, Alcatel S.A. and Nortel Networks Corporation, are also our customers. Alcatel S.A. and Nortel Networks Corporation are vertically integrated and provide both entire fiber optic systems and the components that comprise fiber optic systems. We compete with these companies with respect to the development, marketing and sale of fiber optic components. In some cases, we supply test equipment and photonics tools to competitors of our fiber optics components business.

In the photonics tools market, we face competition from a number of companies, including Coherent Inc., Melles Griot, Newport Corporation and Thorlabs, Inc.

Many of our competitors in the telecommunications market are public companies that have longer operating histories and significantly greater financial, technical, marketing and other resources than we have. As a result, these competitors are able to devote greater resources than we can to the development, promotion, sale and support of their products. In addition, some of our competitors have large market capitalizations or cash reserves and are much better positioned than we are to acquire other companies in order to gain new technologies or products that may displace our product lines. Any of these acquisitions could give our competitors a strategic advantage. Many of our potential competitors have significantly more established sales and customer support organizations than we do. In addition, many of our competitors have much greater name recognition, more extensive customer bases, better-developed distribution channels, broader product offerings and greater manufacturing capacity than we have. These companies can leverage their customer bases and broader product offerings and adopt aggressive pricing policies to gain market share. Some of our competitors may spin-out new companies in the optical component and module market, which may compete more aggressively than their former parent companies due to their greater dependence on our markets. Additional competitors may enter the market and we are likely to compete with new companies in the future. Our competitors in the photonics tools market consist of both public and private companies. Our industry is also consolidating, and we believe it will continue to consolidate in the future as companies attempt to strengthen or hold market positions. We expect to encounter potential customers that, due to existing relationships with our competitors, are committed to the products offered by these competitors.

The principal factors upon which we compete are: product features and performance; product reliability; responsive customer service and support; and price. We believe we compete favorably on each of these factors.

Intellectual Property

Our success and ability to compete depend substantially upon our technology. We pursue patent protection in the United States and abroad, and as of December 30, 2001 we have been granted 41 U.S. patents and 2 European patents. As of December 30, 2001, we have 61 U.S. utility filings, of which 5 have been allowed by the U.S. Patent and Trademark Office, 8 U.S. provisional filings and 20 overseas filings in various stages of prosecution, and we continue to file new patent applications in the United States and overseas. The expiration dates of our patents range from May 25, 2009 to August 2, 2019.

While we rely on patent, copyright, trade secret and trademark law to protect our technology, we also believe that factors such as our existing contracts with equipment manufacturers, our licensing agreements with companies and universities, the technological and creative skills of our personnel, new product developments, frequent product enhancements and reliable product maintenance are essential to establishing and maintaining a technology leadership position.

We generally enter into confidentiality or license agreements with our employees, consultants and corporate partners, and generally control access to and distribution of our proprietary information. Our confidentiality agreements generally prohibit the disclosure or use of the technology being evaluated or licensed. From time to time we license our technology to various third parties pursuant to non-exclusive license agreements that prohibit the disclosure or use of the technology except as set forth in the agreements. Despite these efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology. Policing unauthorized use of our products is difficult, and there can be no assurance that the steps taken by us will prevent misappropriation of our technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as do the laws of the United States. We cannot assure you that others will not develop technologies that are similar or superior to our technologies.

Substantial litigation regarding intellectual property rights exists in each of the market segments in which we participate. We expect that the telecommunications and photonics industries may be increasingly subject to third-party infringement claims as the number of competitors grows and the functionality of products in different industry segments overlaps. In addition, we believe that many of our competitors have filed or intend to file patent applications covering aspects of their technology on which they may claim our technology infringes. We are currently defending a claim brought against us by Photonetics, Inc. and Photonetics, S.A. alleging, among other things, that we have infringed some of their intellectual property rights. We cannot make any assurances that additional third parties in the future will not claim infringement by us with respect to our products and our associated technology. The Photonetics claim and other claims of this kind in the future, with or without merit, could be time-consuming to defend, result in costly litigation, divert management’s attention and resources, result in injunctions against us, cause product shipment delays or require us to enter into royalty or licensing agreements. Royalty or licensing agreements of this kind, if required, may not be available on terms acceptable to us, if at all. A successful claim of product infringement against us and failure or inability by us to license the infringed or similar technology could harm our business.

Employees

At December 30, 2001, we had a total of 903 employees located in both the United States and China. Of the total, 588 were in manufacturing, 166 were in research and development, 49 were engaged in sales and marketing, and 100 were in administration. None of our employees are subject to a collective bargaining agreement.

Our planned closures of our Camarillo, California and Shenzhen, China manufacturing facilities in 2002 will result in workforce reductions of 160 and 350 employees, respectively. With these closures, our headcount will drop to 390 people in the fourth quarter of 2002, down from approximately 900 employees at the end of the fourth quarter of 2001 and down from the peak employment level of approximately 2,100 people in February 2001. After closure of the Camarillo and China plants, the company will occupy 213,000 square feet of facilities, down from 573,000 square feet at the start of 2001.

As of March 20, 2002, we employ approximately 875 employees.

RISK FACTORS

You should carefully consider the risks described below and all of the information contained in this annual report on Form 10-K. If any of the following risks actually occur, our business, financial condition and results of operations could be harmed, the trading price of our common stock could decline, and you may lose all or part of your investment in our common stock.

Risks Related to Our Financial Results

We have a history of losses and such net losses will likely continue if we are unable to restructure our operations through selective acquisitions and divestitures.

We incurred net losses of $495.4 million for the fiscal year ended December 30, 2001, $36.0 million for the fiscal year ended December 31, 2000, and $7.7 million for the nine months ended March 31, 1999. As of December 30, 2001, we had an accumulated deficit of $546.9 million. Due to the current economic climate and associated uncertainty within the telecommunications industry that have contributed to the sharp decline in demand for our products, we are currently unable to provide meaningful forecasts beyond the first quarter of 2002. We expect the difficult industry conditions to continue throughout 2002 and well into 2003. Consequently, our efforts to reduce our expense structure and minimize the use of our cash may not be successful. Furthermore, we need to achieve $20 million in quarterly revenues in order to return to profitability based on our announced restructuring plans. We will not achieve this level of revenues in 2002 without revenues provided by strategic acquisitions. We may be unable to complete such acquisitions for a variety of reasons. As a result of the foregoing, we may not be able to generate sufficient revenues and adequately contain costs and operating expenses necessary to achieve profitability. Even if we achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis.

We are experiencing decreased sales and increased difficulty in predicting future operating results.

We have experienced reduced order volumes of current products and slow market adoption of new products and these factors have, and will continue to have, an adverse impact on our revenues. With our limited order backlog, we are unable to predict future sales accurately or provide meaningful long-term guidance for our future financial performance. We recorded charges of $36.6 million in our fiscal year ended December 30, 2001, primarily in the first quarter, for the write-down of excess inventory and related charges due to a sharp decline in order rates. We have in the past been, and may in the future be, unable to accurately forecast our revenues, and therefore our future operating expenses. Many of our expenses are fixed in the short term, and the steps we have taken to reduce spending may not be adequate if our revenues are lower than we project. Any new product introductions will also result in increased operating expenses in advance of generating revenues, if any. Therefore, net losses in a given quarter could be greater than expected. Additional factors contributing to the difficulty in predicting future operating results include:

•

uncertainty regarding the capital spending plans of the major telecommunications carriers, upon whom our customers and, ultimately we, depend for sales;

•

our plans to develop and sell products to diversified markets other than telecom, which might not succeed;

•

bankruptcy filings by existing customers and potential customers;

•

our customers efforts to decrease inventory levels, which, in turn, reduces our sales;

•

the long sales cycle for our products;

•

minimal backlog and lower near-term sales visibility;

•

declining average selling prices; and

•

general market and economic uncertainty.

Failure to accurately forecast our revenues and future operating expenses could cause quarterly fluctuations in our net revenues and may result in volatility or a decline in our stock price.

Accounting treatment of our acquisitions has impacted our operating results.

Our operating results are adversely impacted by purchase accounting treatment, primarily due to the impact of in-process research and development charges and the amortization of and impairment charges relating to goodwill and other intangibles originating from the two acquisitions we completed in 2001. Under generally accepted accounting principles in the United States through June 30, 2001, we accounted for our acquisitions using the purchase method of accounting. Under purchase accounting, we recorded the fair market value of our common shares issued in connection with acquisitions, the fair value of the stock options assumed and the amount of direct transaction costs as the cost of acquiring these entities. That cost is allocated to the individual assets acquired and liabilities assumed, including various identifiable intangible assets such as in-process research and development, acquired technology, acquired customer base and acquired workforce, based on their respective fair values. We allocated the excess of the purchase cost over the fair value of the net identifiable assets to goodwill. We also incur other purchase accounting related costs and expenses in the period a particular transaction closes to reflect purchase accounting adjustments adversely affecting gross profit and the costs of integrating new businesses or curtailing overlapping operations. In addition, for fiscal 2001, we recorded an acquisition-related amortization expense of $54.5 million. During 2001, under applicable accounting rules, we periodically evaluated the carrying value of our goodwill and other intangible assets. As a result of these evaluations, we recorded charges totaling $289.3 million for impairment of goodwill and other intangible assets in 2001. At December 30, 2001, the remaining balance of goodwill and other intangible assets was $12.3 million. Purchase accounting treatment of future mergers and acquisitions or the write-down of goodwill and other long-lived assets could result in a reduction in net income or an increase in net loss for the period in which the transaction takes place, which could have a material and adverse effect on our results of operations.

As a result of our planned divestiture of our passive components product line and the closing of our China manufacturing facility in 2002, we will have $43.5 million of idle or excess assets for which we may not be able to recover adequate value.

In March 2002, we announced that we are divesting operations related to the manufacture and sale of passive components to the telecommunications market, and closing our 243,000 square foot manufacturing facility in Shenzhen, China. We anticipate that this closure will occur by the end of the second quarter of 2002. At December 30, 2001, our investment in our passives product line and our China manufacturing facility totaled $43.5 million, comprised of $23.3 million for land and building and $20.2 million for equipment. We estimate that the restructuring charge for the related workforce reduction, write-down of capital assets, and facility closure costs will total approximately $25-40 million. The restructuring charge contains estimates for facilities and equipment salvage values. We may not be able to sell these assets for their estimated values or at all, and could be forced to liquidate the assets at a fraction of our original investment. If we fail to accurately estimate the facilities and equipment salvage values, we could incur additional restructuring charges, which would adversely impact our results of operations.

The long sales cycles for our telecom products may cause operating results to vary from quarter to quarter, which could continue to cause volatility in our stock price.

The length and variability of the sales and implementation cycles for our telecom products may cause our operating results to vary from quarter to quarter. We do not recognize revenue until a product has been delivered to a customer, all significant vendor obligations have been performed and collection is considered probable. Customers often view the purchase of our telecom products as a significant and strategic decision. As a result, customers typically expend significant effort in evaluating, testing and qualifying our telecom products and our manufacturing process. This customer evaluation and qualification process frequently results in a lengthy initial sales cycle of up to one year or more. In addition, some of our customers require that our telecom products be

subjected to Telcordia qualification testing, which can take up to nine months or more. While our customers are evaluating our telecom products and before they place an order with us, we may incur substantial costs and expenses to customize our telecom products to the customer’s needs. We may also expend significant management efforts, increase manufacturing capacity and order long lead-time components or materials prior to receiving an order. Even after this evaluation process, a potential customer may not purchase our telecom products, or may return purchased products due to defects after the revenue for the sale has been recognized. Because of the difficulties of the telecommunications market in which we compete, our customers are slower to adopt new technologies that require expensive modification of currently installed systems or the possible installation of new systems, thus increasing the length of these sales and development cycles. The long sales cycles have caused and may continue to cause, our revenues and operating results to vary significantly and unexpectedly from quarter to quarter, which could continue to cause volatility in our stock price.

We depend on a few key customers and the loss of these customers or a significant reduction in sales to these customers could significantly reduce our revenues.

Our customer base is highly concentrated. Historically, orders from a relatively limited number of customers accounted for a substantial portion of our net sales. In the fiscal year ended December 30, 2001, Agilent Technologies and Alcatel S.A accounted for 13.4% and 11.3% of our net revenues, respectively. In the fiscal year ended December 31, 2000, Corvis Corporation, Agilent Technologies, and Corning Incorporated accounted for 17.6%, 14.4% and 10.6% of our net revenues, respectively. In the nine-month period ended December 31, 1999, none of our customers accounted for more than 10% of our net revenues. We anticipate that our operating results will continue to depend on sales to a relatively small number of customers. During 2001, our customers significantly reduced their order volumes, and we have a minimal amount of order backlog. If we lose of any of our key customers or if these customers continue to reduce order volumes, we may not be able to replace the loss of orders with orders from new customers, which would materially adversely affect our revenues.

We have incurred, and may in the future continue to incur, inventory-related charges, the amounts of which are difficult to predict accurately.

Our sales are generally made pursuant to purchase orders that are subject to cancellation, modification or rescheduling without significant penalties. None of our current customers have any minimum purchase obligations, and they may stop placing orders with us at any time, regardless of any forecast they may have previously provided. As a result of the business downturn, we have incurred charges to align our inventory with actual customer requirements over the near term. Despite our limited ability to forecast customer demand, due to the long lead time required for some of the raw materials used to manufacture our products, we have to order certain raw materials months in advance of when we expect to need them. If we over-estimate demand, we will incur additional inventory write-downs. As discussed above, our ability to forecast our customers’ needs for our products in the current economic environment is very limited. We have incurred, and may in the future incur, significant inventory-related charges. In 2001, we incurred charges related to excess inventory write-downs and related order cancellation fees of $36.6 million. We may incur significant similar charges in future periods. Moreover, because of our current difficulty in forecasting sales, we may in the future revise our previous forecasts. While we believe, based on current information, that the inventory-related charges recorded in 2001 are appropriate, subsequent changes to our forecast may indicate that these charges were insufficient or even excessive.

Risks Related to Our Business

Our current net revenues do not support the complexity of our business infrastructure. Our results of operations will continue to be adversely affected if we are unable to successfully restructure our operations.

Our two business segments are comprised of telecom and photonics tools. We have distinct product lines within these segments that require significant development resources, and we manufacture our products in multiple production facilities. The complexity of our multiple product lines necessitates a business infrastructure requiring substantially higher revenue levels than we are currently achieving. As a result of the slowdown in the economy and excess customer inventories, our order rates have declined, and we have a minimal amount of order backlog. We are currently reviewing the products we sell to customers, the locations in which we operate and the manner in which we go to market with our core product offerings. As a result, we have decided to exit the business of selling passives components to the telecommunications market. Ultimately, we may decide to eliminate additional product offerings through termination, sale or other disposition or to sustain certain products at a minimum level where customer commitments prevent us from eliminating the offering altogether. In June 2001, we initiated our restructuring plan, pursuant to which we consolidated our older Santa Clara, California facility and our smaller Shenzhen, China production facility into our larger, existing facilities in San Jose and Shenzhen, respectively. We plan to close our large offshore plant in Shenzhen and our Camarillo, California manufacturing facility in the second and third quarters of 2002, respectively. We will concentrate our manufacturing activities in San Jose, California and use offshore subcontract manufacturers as needed. At December 30, 2001, we had reduced our workforce from a peak of approximately 2,100 in February 2001 to approximately 900 at the end of December 2001. We plan to reduce the workforce by approximately 510 people by the end of 2002 as a result of these plant closures and our exit from the passives business. Any decision to further eliminate or limit our offering of a product could involve the expenditure of capital, the realization of losses, a reduction in workforce, additional facility consolidations and/or the elimination of revenues along with the associated costs, any of which could harm our financial condition and operating results.

If the telecommunications market does not recover for an extended period of time, our ability to generate revenues from sales of our telecom products will be severely affected.

We derived over 70% and 46% of our revenues from our telecom products in fiscal year 2001 and the three-month period ending December 30, 2001, respectively. In 2001, the telecommunications market experienced, and continues to experience, a substantial market downturn. Even if we are successful with our strategy to diversify, we will still be dependent upon the telecommunications market, although to a lesser degree. Our success will still depend partly on the continued growth of the Internet as a widely-used medium for commerce and communications, the continuing increase in the amount of data, or bandwidth, transmitted over communications networks and the growth and upgrading of optical networks to meet the increased demand for bandwidth. If the bandwidth requirements do not expand and upgrading of optical networks does not continue, the telecommunications market will not grow as we anticipate and sales of our telecom products will remain stagnant and could decline further, adversely affecting our total net revenues. During 1999-2000, carriers and systems providers’ expectations for growth in bandwidth requirements were overly optimistic and resulted in significant over-ordering. This over-ordering has created significant excess inventories within the telecommunications industry. The excess inventory has reduced visibility for component and equipment suppliers as to the real demand for product within the industry. If we cannot accurately forecast the demand for our telecom products, our product development efforts may not be timed to our customers’ requirements and availability of our existing products may not be matched to our customers’ needs, either of which would adversely impact our results of operations.

Our future success depends on our ability to develop and successfully introduce new and enhanced products that meet the needs of our customers in a timely manner.

Our future success depends in part on our ability to anticipate our customers’ needs and develop products that address those needs. We have reduced, and expect to further reduce, our research and development spending as part of our restructuring measures, which may harm our ability to develop new and enhanced products. Even if we develop new products, customers may not purchase the new or enhanced product because, among other things, the product may be too expensive, defective in design, manufacture or performance, uncompetitive, or may have been superceded by another product or technology. If we fail to effectively transfer production processes, or introduce and sell new products or enhanced products, our revenues will be adversely affected and our results of operations will be harmed.

We will face technical, operational and strategic challenges that may prevent us from successfully integrating businesses we have acquired or may acquire in the future.

Our growth strategy in the past has included, and continues to include, acquisitions of other companies, technologies or product lines to complement our internally developed products.

In the event of any future acquisitions, we could:

•

use cash resources that would reduce our financial reserves;

•

issue stock that would dilute our current stockholders’ percentage ownership;

•

incur debt;

•

assume liabilities;

•

further increase operational and administrative complexity of our business; or

•

incur expenses related to in-process research and development, amortization of goodwill and other intangible assets.

Any future acquisitions we may make also involve numerous other risks, including:

•

problems related to the integration and management of acquired technology, operations and personnel;

•

problems completing product development programs of the acquired company and consolidating research and development efforts;

•

unanticipated costs or liabilities;

•

diversion of management’s attention from our core business;

•

adverse effects on existing business relationships with suppliers and customers;

•

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

•

potential loss of key employees, particularly those of the acquired organizations.

The integration of businesses that we have acquired into our business has been and will continue to be a complex, time consuming and expensive process. We must operate as a combined organization utilizing common information and communication systems, operating procedures, financial controls and human resources practices to be successful. We have recorded significant impairment charges with respect to our acquisitions of JCA and Globe Y (see Note 12 of the Notes to Consolidated Financial Statements). We cannot guarantee that in the long-term these acquisitions or any future acquisitions will result in sufficient revenues or earnings to justify our investment in, or expenses related to, these acquisitions or that any synergies will develop. If we are not successful in integrating acquired businesses or if expected earnings or synergies do not materialize, we could be forced to attempt to resell or cease operations of acquired businesses. In either event, we would likely incur

significant expenses as well as non-cash charges to write-off acquired assets, which could seriously harm our financial condition and operating results.

Competition may increase, which could reduce our sales and gross margins, or cause us to lose market share.

Competition in the telecommunications and photonics tools markets in which we compete is intense. We face competition from other large companies, including JDS Uniphase Corporation, Agere Systems, Inc., Nortel Networks Corporation and Alcatel S.A., many of which have longer operating histories and significantly greater financial, technical, marketing and other resources than we have. As a result, these competitors are able to devote greater resources than we can to the development, promotion, sale and support of their products. In addition, the market capitalization and cash reserves of several of our competitors are much larger than ours, and, as a result, these competitors are much better positioned than we are to acquire other companies in order to gain new technologies or products that may displace our product lines. Some of our competitors may spin-out new companies in the optical component and module market, which may compete more aggressively than their former parent companies due to their greater dependence on our markets. Additional competitors may enter the market, and we are likely to compete with new companies in the future. Our competitors in the photonics tools market consist of both public and private companies. We face competition from other public companies, including Coherent, Inc. and Newport Corporation, some of which have longer operating histories and significantly greater financial, technical, marketing and other resources than we have. Our industry is also consolidating, and we believe it will continue to consolidate in the future as companies attempt to strengthen or hold market positions. We anticipate that consolidation will accelerate as a result of the current industry downturn. We believe that industry consolidation may result in stronger competitors that are better able to compete as sole-source vendors for customers. As a result of the foregoing factors, we expect that competitive pressures may result in further price reductions, reduced margins and loss of market share.

Our telecom products are deployed in large and complex systems and may contain defects that are not detected until after our products have been installed, and if our products fail to perform our business will be harmed.

Our business depends on our producing excellent products of consistently high quality. Some of our telecom products are designed to be deployed in large and complex optical networks. Because of the nature of these products, they can only be fully tested for reliability when deployed in networks for long periods of time. For various reasons including, among others, the occurrence of performance problems unforeseeable in testing, our products may fail to perform as expected. Furthermore, our customers may discover defects in our products only after they have been fully deployed and operated under peak stress conditions. Failures could result from faulty design or problems in manufacturing. In either case, we could incur significant costs to repair and/or replace defective products under warranty, particularly when such failures occur in installed systems. We have experienced some field failures with our telecommunications products in the past, which resulted in increased product returns, requiring increased warranty costs and adversely affecting our net revenues, and we remain exposed to similar failures in the future. In addition, our products are combined with products from other vendors. As a result, should problems occur, it may be difficult to identify the source of the problem. If we are unable to fix defects or other problems, we could experience, among other things:

•

loss of existing customers and failure to attract new customers;

•

costly product redesigns or expenditure of additional capital equipment required to correct a defect;

•

damage to our brand reputation;

•

diversion of development and engineering resources; and

•

legal actions by our customers.

The occurrence of any one or more of the foregoing factors could cause our net revenues to decline.

We may in the future, and we have in the past, become involved in costly and time-consuming litigation that may substantially increase our costs and harm our business.

We may from time to time become involved in various lawsuits and legal proceedings. For example, the Company has been a defendant in various putative securities class actions filed in the United States District Court for the Northern District of California, which actions were recently dismissed by the court with leave to amend. Litigation is subject to inherent uncertainties, and an adverse result in these or other matters that may arise from time to time could have a material adverse effect on the business, results of operations or financial condition of the Company. Any litigation to which we are subject could require significant involvement of our senior management and may divert management’s attention from our business and operations. For more information about current legal proceedings, see “Part II—Other Information, Item 1—Legal Proceedings.”

We depend on key personnel to manage our business effectively. If we are unable to retain key personnel, or if our senior management and key personnel are unable to work together effectively, our business and operations may be harmed.

Our future success depends upon the continued services of our executive officers and other key engineering, sales, marketing, manufacturing and support personnel. Our officers and key employees are not bound by employment agreements that require them to work for us for any specific term.

In October 2001, we announced the appointment of R. Clark Harris, the Chairman of our board of directors, as our new President and Chief Executive Officer following the resignation of Kenneth Westrick from his position as President and Chief Executive Officer. Our management team has not worked together for a significant length of time and may not be able to work together effectively to successfully implement our business strategies. If the management team is unable to accomplish our business objectives, our ability to stabilize and then grow our business could be severely impaired.

We have reduced our work force from approximately 2,100 in the first quarter of 2001 to approximately 900 employees at the end of fiscal 2001. We have instituted restructuring plans that include further reductions in our worldwide workforce. Under these plans, we expect to further reduce our worldwide workforce by approximately 510 people by the end of 2002. Our ability to continue to retain highly skilled personnel in light of these reductions in force and other factors will be a critical factor in determining whether we will be successful. Despite the economic downturn, competition for highly skilled personnel continues to be intense. We may not be successful in retaining qualified personnel to fulfill our current or future needs, which could adversely impact our ability to develop and sell our products.

We face risks associated with our international sales that could harm our financial condition and results of operations.

For the fiscal year ended December 30, 2001, 35.7% of our net revenues were from international sales, for the fiscal year ended December 31, 2000, 30.7% of our net revenues were from international sales. We expect that sales to customers outside North America will continue to account for a significant portion of net sales. We continue to expand our operations outside of the United States and to enter additional international markets, both of which will require significant management attention and financial resources.

Since a significant portion of our foreign sales are denominated in U.S. dollars, our products may also become less price competitive in countries in which local currencies decline in value relative to the U.S. dollar. Lower sales levels that typically occur during the summer months in Europe and some other overseas markets may also materially and adversely affect our business.

Our international operations are subject to risks including the following:

•

greater difficulty in accounts receivable collection and longer collection periods;

•

our ability to comply with the customs, import/export and other trade compliance regulations of the countries in which we do business, together with any unexpected changes in such regulations;

•

difficulties and costs of staffing and managing foreign operations;

•

sudden and unexpected reductions in demand in particular countries in response to exchange rate fluctuations;

•

reduced protection for intellectual property rights in some countries;

•

potentially adverse tax consequences; and

•

political, legal and economic instability in foreign markets, particularly in those markets in which we maintain manufacturing facilities.

While we expect our international revenues and expenses to be denominated predominantly in U.S. dollars, a portion of our international revenues and expenses may be denominated in foreign currencies in the future. Accordingly, we could experience the risks of fluctuating currencies and may choose to engage in currency hedging activities to reduce these risks.

Risks Related to Manufacturing Our Products

If we fail to balance our manufacturing capacity with the demand for our products, our business will be adversely affected.

We face a challenge in accurately balancing our manufacturing capacity with the demand for our products. Throughout 2000 we aggressively expanded our manufacturing capacity in both the U.S. and China, through the expansion of facilities and the hiring of employees. As a result of the lower order volumes by our customers in 2001, we have slowed the rate of production in our U.S. and China factories. We believe that the difficult conditions in the telecommunications industry will extend well into 2003, and this poor outlook has lead us to the decision to close manufacturing facilities.

Currently we operate manufacturing facilities in San Jose, California, Camarillo, California, and Shenzhen, China. In the first half of 2001, we closed our older Santa Clara facility and transferred passives components development activities to our newer, larger facility in San Jose. In China, we closed our smaller production facility in Shenzhen and consolidated activities into our larger Shenzhen factory. We intend to close our larger Shenzhen facility and our Camarillo, California facility in the second and third quarters of 2002, respectively. We will concentrate manufacturing activities in San Jose and outsource manufacturing requirements as needed. Our efforts to close underutilized manufacturing facilities may involve significant cash expenditures and cause potential disruption, which would adversely impact our results of operations.

Delays, disruptions or quality control problems in manufacturing could result in delays in shipments of products to customers and adversely affect our business.

We may experience delays, disruptions or quality control problems in our manufacturing operations or the manufacturing operations of our subcontractors, and, as a result, product shipments to our customers could be delayed beyond the shipment schedules requested by our customers, which would negatively impact our revenues, competitive position and reputation. We have, in the past, experienced a disruption in the manufacture of some of our products due to changes in our manufacturing processes, which resulted in reduced manufacturing yields and delays in the shipment of our products. If we experience similar disruptions in the future, it may result in lower yields or delays of our product shipments, which could adversely affect our revenues, gross margins and results of operations. In addition, we may experience manufacturing delays and reduced manufacturing yields upon introducing new products to our manufacturing lines. Due to the planned closures of our Camarillo, California and Shenzhen, China facilities, we will be transferring certain production activities to offshore

subcontractors, which will require precise coordination between our operations and those of the subcontractors. Without this coordination we may experience manufacturing delays and reduced manufacturing yields. We have in the past experienced lower-than-targeted product yields, which have resulted in delays of customer shipments, lost revenues and impaired gross margins. We may experience shipment delays in the future, which could adversely affect our operating results.

If our customers do not qualify our manufacturing lines or the manufacturing lines of our subcontractors for volume shipments, our operating results could suffer.

Generally, customers do not purchase our products, other than