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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
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(Mark One)
|X| Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the Quarterly Period Ended January 31, 2003, or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the Transition Period from _________ to __________
Commission file number 0-30869
STRATOS LIGHTWAVE, INC.
(Exact name of Registrant as specified in its charter)
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Delaware 36-4360035
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
7444 West Wilson Avenue
Chicago, Illinois 60706
(708) 867-9600
(Address, including zip code, and telephone number, including
area code, of Registrant's principal executive offices)
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Not Applicable
---------------------------------------------------------------
(Former name, former address and former fiscal year, if changed
since last report)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No ___
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Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes ___ No X
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As of March 12, 2003, there were 7,339,626 shares of the Registrant's common
stock outstanding.
STRATOS LIGHTWAVE, INC.
INDEX
Page
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PART I FINANCIAL INFORMATION.............................................................................. 1
Item 1. Financial Statements............................................................................... 1
Condensed Consolidated Balance Sheets as of April 30, 2002 and January 31, 2003
(unaudited)..................................................................................... 1
Condensed Consolidated Statements of Operations (unaudited) for the three and nine months
ended January 31, 2002 and 2003................................................................. 2
Condensed Consolidated Statements of Cash Flows (unaudited) for the nine months
ended January 31, 2002 and 2003................................................................. 3
Notes to Condensed Consolidated Financial Statements (unaudited) January 31, 2003.................. 4
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operation............... 9
Item 3. Quantitative and Qualitative Disclosures About Market Risk......................................... 26
Item 4. Disclosure and Control Procedures.................................................................. 26
PART II. OTHER INFORMATION.................................................................................. 27
Item 1. Legal Proceedings.................................................................................. 27
Item 2. Changes in Securities and Use of Proceeds.......................................................... 28
Item 6. Exhibits and Reports on Form 8-K................................................................... 28
SIGNATURES..................................................................................................... 29
INDEX TO EXHIBITS.............................................................................................. 32
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PART I
FINANCIAL INFORMATION
Item 1. Financial Statements.
STRATOS LIGHTWAVE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)
APRIL 30, JANUARY
2002 31, 2003
----------- -----------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents........................................................ $ 61,020 $ 32,693
Short-term investments........................................................... 30,900 31,829
Accounts receivable, less allowance.............................................. 8,245 6,413
Inventories:
Finished products............................................................. 798 282
Work in process............................................................... 2,107 845
Materials..................................................................... 12,916 7,835
----------- -----------
15,821 8,962
Recoverable income taxes......................................................... 2,820 2,349
Prepaid expenses................................................................. 1,789 2,145
----------- -----------
Total current assets.......................................................... 120,595 84,391
Other assets:
Goodwill, less accumulated amortization....................................... 55,155 28,430
Deferred income taxes......................................................... 4,494 5,760
Other intangible assets....................................................... -- 7,158
Assets held for sale.......................................................... 4,202 3,722
Other......................................................................... 1,252 1,600
----------- -----------
65,103 46,670
Property, plant and equipment....................................................... 98,918 94,558
Less allowances for depreciation................................................. 30,020 37,233
----------- -----------
68,898 57,325
----------- -----------
Total assets.................................................................. $ 254,596 $ 188,386
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable.................................................................... $ 2,840 $ --
Accounts payable................................................................. 10,126 6,131
Other current liabilities........................................................ 5,874 4,600
Current portion of long-term debt................................................ 3,715 3,847
----------- -----------
Total current liabilities..................................................... 22,555 14,578
Long-term debt, less current portion................................................ 6,569 3,842
Deferred income taxes............................................................... 4,494 5,844
Minority interest................................................................... 498 378
Stockholders' equity:
Preferred stock.................................................................. -- --
Common stock..................................................................... 728 73
Additional paid-in capital....................................................... 283,162 284,248
Accumulated deficit.............................................................. (63,115) (120,824)
Foreign currency translation adjustment.......................................... (295) 278
Cost of shares in treasury -- (31)
----------- -----------
Total stockholders' equity.................................................... 220,480 163,744
----------- -----------
Total liabilities and stockholders' equity................................. $ 254,596 $ 188,386
=========== ===========
See notes to condensed consolidated financial statements.
-1-
STRATOS LIGHTWAVE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(in thousands, except per share amounts)
THREE MONTHS ENDED NINE MONTHS ENDED
JANUARY 31 JANUARY 31,
--------------------------- ------------------------
2002 2003 2002 2003
----------- ----------- ---------- ----------
Revenue:
Net sales............................................. $ 12,524 $ 8,109 $ 42,234 $ 29,884
License fees and royalties............................ 390 3,269 1,837 3,800
----------- ----------- ---------- ----------
Total.............................................. 12,914 11,378 44,071 33,684
Costs and expenses:
Costs of sales........................................ 11,554 11,462 45,650 38,664
Research and development.............................. 5,589 5,265 21,173 20,896
Sales and marketing................................... 1,695 1,362 5,792 5,656
General and administrative............................ 3,133 2,920 11,370 10,126
----------- ----------- ---------- ----------
Total costs and expenses........................... 21,971 21,009 83,985 75,342
----------- ----------- ---------- ----------
Loss from operations.................................. (9,057) (9,631) (39,914) (41,658)
Investment income..................................... 834 293 3,119 931
----------- ----------- ---------- ----------
Loss before income taxes.............................. (8,223) (9,338) (36,795) (40,727)
Provision (credit) for income taxes................... -- -- (2,581) --
----------- ----------- ---------- ----------
Loss before cumulative effect of a change in accounting
principle............................................ (8,223) (9,338) (34,214) (40,727)
Cumulative effect of a change in accounting principle. -- -- -- (16,982)
----------- ----------- ---------- ----------
Net loss................................................. $ (8,223) $ (9,338) $ (34,214) $ (57,709)
=========== =========== ========== ==========
Net loss per share, basic and diluted:
Before cumulative effect of a change in accounting $ (1.30) $ (1.27) $ (5.34) $ (5.57)
principle
Cumulative effect of a change in accounting principle. -- -- -- (2.33)
----------- ----------- ---------- ----------
Net loss.............................................. $ (1.30) $ (1.27) $ (5.34) $ (7.90)
=========== =========== ========== ==========
Weighted average number of common shares outstanding:
Basic.............................................. 6,409 7,339 6,409 7,309
=========== =========== ========== ==========
Diluted............................................ 6,409 7,339 6,409 7,309
=========== =========== ========== ==========
Net loss per share for the three and nine months ended January 31, 2002 has been
restated to reflect a 1 for 10 reverse stock split effected on October 21, 2002.
See notes to condensed consolidated financial statements.
-2-
STRATOS LIGHTWAVE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(in thousands)
NINE MONTHS ENDED
JANUARY 31,
----------------------------
2002 2003
----------- -----------
Operating activities:
Net loss............................................................................ $ (34,213) $ (57,709)
Adjustments to reconcile net loss to net cash used in operating activities:
Provision for depreciation and amortization................................... 9,929 13,386
Provision for impairment of goodwill and other assets -- 21,504
Provision for deferred taxes.................................................. 421 84
Provision for losses on accounts receivable................................... 152 209
Change in operating assets and liabilities.................................... 8,532 2,335
----------- -----------
Net cash used in operating activities............................................ (15,179) (20,191)
Investing activities:
Purchases of property, plant and equipment....................................... (21,447) (2,792)
Purchases of short-term investment............................................... (34,700) (24,029)
Sales of short-term investments.................................................. 22,600 23,100
Acquisitions..................................................................... (8,117) (189)
Sale of assets held for sale..................................................... -- 1,209
Other............................................................................ (77) --
----------- -----------
Net cash used in investing activities............................................ (41,741) (2,701)
Financing activities:
Loan to affiliate (3,771) --
Repayment of borrowings.......................................................... -- (5,435)
----------- -----------
Net cash used in financing activities............................................ (3,771) (5,435)
----------- -----------
Net decrease in cash and cash equivalents........................................ (60,691)) (28,327)
Cash and cash equivalents at beginning of period................................. 125,438 61,020
----------- -----------
Cash and cash equivalents at end of period....................................... $ 64,747 $ 32,693
=========== ===========
2002 2003
----------- -----------
Supplemental schedule of non cash investing and financing activities:
Proceeds of long-term debt (including current portion)
to purchase software and equipment for information technology system............. $ 9,084 --
=========== ===========
See notes to condensed consolidated financial statements.
-3-
STRATOS LIGHTWAVE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
JANUARY 31, 2003
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and Article
10 of Regulation S-X. Accordingly, they do not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the three-month and nine-month period ended
January 31, 2003 are not necessarily indicative of the results that may be
expected for the year ending April 30, 2003. This unaudited quarterly
information should be read in conjunction with the audited consolidated
financial statements and related notes for the fiscal year ended April 30, 2002
included in the Company's Annual Report on Form 10-K filed with the Securities
and Exchange Commission.
As of May 28, 2000, Methode Electronics, Inc. ("Methode") contributed and
transferred to the Company all of the capital stock and equity interests held by
Methode in subsidiaries and other entities that conducted a majority of its
optical products business, pursuant to a master separation agreement. The
capital stock and equity interests contributed and transferred to the Company
were Bandwidth Semiconductor, LLC, Methode Communications Modules, Inc. (now
Stratos Lightwave-Florida, Inc.), Stratos Lightwave, LLC, Methode's sixty
percent interest in MP Optical Communications, LLC and Stratos Limited. Prior to
its transfer of Stratos Lightwave, LLC to the Company, Methode transferred all
of the assets and liabilities of its optoelectronics and fiber optic divisions,
the properties associated with its optoelectronics research center and Methode's
corporate facilities occupied by these divisions to Stratos Lightwave, LLC.
In July 2000, the Company completed the sale of 10,062,500 shares of common
stock in its initial public offering at a price of $21 per share. The net
proceeds from the offering, after deducting the underwriting discount and the
offering expenses paid by the Company, were approximately $195.5 million.
After completion of the Company's initial public offering, Methode owned
54,029,807 shares of the Company's common stock, representing approximately
84.3% of the outstanding shares. After receiving a favorable letter ruling from
the Internal Revenue Service in March 2001, and in accordance with its
previously announced intentions, on April 28, 2001, Methode distributed all of
the shares on the Company's common stock owned by Methode to Methode's
stockholders in a distribution intended to be tax free for U.S. federal income
tax purposes.
Comprehensive loss consists of net loss and foreign currency translation
adjustments and totaled $8,340,000 and $9,329,000 for the third quarters of
fiscal 2002 and 2003, and $34,125,000 and $57,136,000 for the nine months ended
January 31, 2002 and 2003.
-4-
2. GOODWILL AND OTHER INTANGIBLE ASSETS
In June 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standard (SFAS) No. 141, Business
Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets, effective
for fiscal years beginning after December 15, 2001. Under the new rules,
goodwill and intangible assets deemed to have indefinite lives will no longer be
amortized but will be subject to annual impairment tests in accordance with the
Statements. Intangible assets with finite lives will continue to be amortized
over those useful lives. Goodwill amoritzation expense in fiscal years 2000,
2001 and 2002 was $166,000, $556,000 and $848,000, respectively. The following
table discloses pro forma results for net income and earnings per share as if
the non-amoritzation of goodwill provisions of SFAS No. 142 were adopted at the
beginning of fiscal year 2002.
THREE MONTHS ENDED NINE MONTHS ENDED
JANUARY 31, JANUARY 31,
----------- ---------- ----------- -----------
(in thousands, except per share amounts) 2002 2003 2002 2003
----------- ---------- ----------- -----------
Reported net loss........................................ $ (8,223) $ (9,338) $ (34,214) $ (57,709)
Add back: Goodwill amortization......................... 215 -- 628 --
----------- ---------- ----------- -----------
Adjusted net loss........................................ $ (8,008) $ (9,338) $ (33,586) $ (57,709)
=========== ========== =========== ===========
Reported basic and diluted loss per share................ $ (1.30) $ (1.27) $ (5.34) $ (7.90)
Add back: Goodwill amortization per share............... .03 -- .10 --
----------- ---------- ----------- -----------
Adjusted basic and diluted loss per share................ $ (1.27) $ (1.27) $ (5.24) $ (7.90)
=========== ========== =========== ===========
Financial Accounting Standards No. 141, Business Combinations
In accordance with the provisions of SFAS No. 141, $1,367,000 and
$8,566,000 of the purchase price for the Tsunami and Paracer acquisitions
respectively, previously allocated to goodwill in our preliminary purchase price
allocation has been reallocated based upon independent appraisals, to other
intangible assets which are being amortized over their estimated useful lives.
Purchased in-process research and development represents the value assigned
in a purchase business combination to research and development projects of the
acquired business that were commenced but not yet completed at the date of
acquisition, for which technological feasibility has not been established and
which have no alternative future use in research and development activities or
otherwise. In accordance with SFAS No. 2, "Accounting for Research and
Development Costs," as interpreted by FASB Interpretation No. 4, amounts
assigned to purchased in-process research and development meeting the above
criteria must be charged to expense at the date of consummation of the purchase
business combination. In connection with the Tsunami and Paracer acquisitions,
the Company recorded a $2,070,000 charge to in-process research and development
during the second quarter of fiscal 2003. The charge has been classified as
research and development in the Statement of Operations for the nine months
ended January 31, 2003.
Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets
SFAS No. 142 requires that goodwill and intangible assets deemed to have an
indefinite useful life be reviewed for impairment upon adoption of SFAS No. 142
(May 1, 2002) and annually thereafter. The Company will perform its annual
impairment review during the fourth quarter of each year, commencing in the
fourth quarter of fiscal 2003.
For the transitional goodwill impairment evaluation, SFAS No. 142 required
the Company to perform an assessment of whether there was an indication that
goodwill was impaired as of the date of adoption, or step one of the impairment
test. To implement SFAS No. 142, the Company identified
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reporting units consistent with the way the Company is managed. The Company then
determined the carrying value of each reporting unit by allocating the assets
and liabilities, including the goodwill and intangible assets, to the units as
of the date of adoption. The Company had up to six months from the date of
adoption to determine the fair value of each reporting unit and compare it to
the reporting unit's carrying value. If a reporting unit's carrying amount
exceeds its fair value, an indication exists that the reporting unit's goodwill
is impaired, and the Company would be required to perform the second step of the
transitional impairment test.
During the second quarter of fiscal 2003, the Company performed its
transitional goodwill impairment test in accordance with SFAS No. 142 which
included step one as described above for each of the reporting units. Results of
step one indicated that an impairment existed within the active optical
subsystems reporting unit since the estimated fair value of the assets of this
unit, based on expected future discounted cash flows to be generated by the
unit, was less than their carrying value. Pursuant to the second step of the
test, the Company compared the implied fair value of the unit's goodwill
(determined by allocating the unit's fair value based on expected future
discounted cash flows, to all its assets, recognized and unrecognized, and
liabilities in a manner similar to a purchase price allocation for an acquired
business) to its carrying value. The Company did not obtain independent
valuations of unrecognized intangible assets as well as fixed assets since the
unit's fair value indicated full impairment of its goodwill.
Significant negative industry and economic trends affecting the Company's
current and future operations, and therefore future cash flows, contributed to
the transitional impairment test resulting in an impairment of goodwill related
to the active optical subsystems reporting unit of approximately $16,982,000.
This one time non-cash charge is nonoperational in nature and is reflected as a
cumulative effect of a change in accounting principle in the Statement of
Operations for the nine months ended January 31, 2003. Going forward any
additional impairment of goodwill will be recorded in the period the goodwill is
determined to be impaired.
3. ACQUISITIONS
On March 28, 2002, the Company acquired all of the outstanding common stock
of Paracer, Inc. for approximately 5.5 million shares of the Company's common
stock valued at $21,832,000, and $459,000 in cash. In addition, the Company
assumed approximately $1,000,000 of debt, net of cash acquired. Paracer designs
and manufactures both serial and parallel active subsystems and is based in
Mountain View, California.
On February 4, 2002, the Company acquired all of the outstanding common
stock of Tsunami Optics, Inc. in exchange for approximately 3.2 million shares
of the Company's common stock valued at $15,879,000, and $4,750,000 in cash. In
addition, the Company assumed approximately $5,900,000 of debt, plus certain
expenses in connection with the transaction, including a loan of approximately
$3,800,000 made by the Company to Tsunami prior to the acquisition. The
$3,800,000 loan was converted to additional capital subsequent to the
acquisition. Tsunami develops and manufactures innovative optical subsystems and
is based in Mountain View, California.
On May 31, 2001, the Company purchased substantially all of the net assets
of the Optical Flexcircuits division of Advanced Interconnection Technology,
Inc., a manufacturer of fiber optic circuits located in Hauppauge, New York, for
approximately $8,117,000 in cash, including costs of acquisition.
The allocation of the purchase price to the net assets acquired was as
follows:
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Advanced
Interconnection Tsunami
Amount Allocated To: Technology Optics, Inc. Paracer, Inc.
- -------------------- --------------- ------------ -------------
Assets acquired:
Cash............................................................ $ -- $ 79,000 $ 3,144,000
Accounts receivable............................................. -- 162,000 30,000
Inventories..................................................... 559,000 827,000 --
In process research and development............................. -- 130,000 1,940,000
Developed technology............................................ -- 490,000 6,020,000
Computer software............................................... -- 87,000 66,000
Company trade name.............................................. -- 660,000 540,000
Property, plant and equipment................................... 318,000 1,286,000 1,237,000
Other........................................................... 50,000 417,000 299,000
--------------- ------------ -------------
Total assets.................................................. 927,000 4,138,000 13,276,000
Liabilities assumed:
Notes payable................................................... -- 2,118,000 3,722,000
Accounts payable................................................ -- 1,254,000 156,000
Accrued expenses................................................ 180,000 350,000 719,000
--------------- ------------ -------------
Total liabilities............................................. 180,000 3,722,000 4,597,000
--------------- ------------ -------------
Net assets acquired............................................. 747,000 416,000 8,679,000
Goodwill........................................................ 7,370,000 20,237,000 13,635,000
--------------- ------------ -------------
Purchase price.................................................. $ 8,117,000 $ 20,653,000 $ 22,314,000
=============== ============ =============
Cash paid, including transaction costs............................... 8,117,000 $ 4,774,000 482,000
Stock consideration.................................................. -- 15,879,000 21,832,000
--------------- ------------ -------------
Total purchase price................................................. $ 8,117,000 $ 20,653,000 $ 22,314,000
=============== ============ =============
The above described acquisitions were accounted for using the purchase
method of accounting. Had these acquisitions been made as of the beginning of
fiscal 2002, the impact on the Company's operating results for all periods would
not have been significant.
Because of current tax regulations, the goodwill related to the Tsunami and
Paracer acquisitions cannot be deducted for federal and state income tax
purposes.
4. RESTRUCTURING CHARGES
The Company recorded restructuring charges of approximately $31.2 million
in fiscal 2002 and approximately $3.0 million in the first nine months of fiscal
2003. These charges included excess and obsolete inventory, goodwill and fixed
asset impairment, personnel, bad debt, and legal costs related to the
restructuring of operations.
Accruals related to the restructuring charges and their utilization are
summarized as follows:
Balance
Balance 2003 Utilized through January 31,
April 30, 2002 Charges January 31, 2003 2003
--------------- -------------- ----------------- --------------
Employee costs $ 850,000 $ 2,712,000 $ 2,844,000 $ 718,000
Other costs 1,210,000 277,000 1,482,000 5,000
--------------- -------------- ----------------- --------------
Total $ 2,060,000 $ 2,989,000 $ 4,326,000 $ 723,000
=============== ============== ================= ==============
Restructuring expenses have been classified in the Statement of Operations
for the three and nine months ended January 31, 2003, as follows:
-7-
THREE MONTHS NINE MONTHS
ENDED ENDED
JANUARY 31, 2003 JANUARY 31, 2003
---------------- -----------------
Cost of sales............................................ $ 158,000 $ 889,000
Research and development................................. 291,000 1,030,000
Sales and marketing...................................... 6,000 159,000
General administrative................................... 10,000 911,000
---------------- -----------------
Total................................................. $ 465,000 $ 2,989,000
================ =================
The Company terminated 190 employees in the nine months ended January 31,
2003 for the restructuring of its operations, including both production and
administrative personnel. Severance pay in the amount of $309,000 relative to
these terminations will be paid out during fiscal 2003 and the remainder through
fiscal 2006.
5. INCOME TAXES
During fiscal 2002, we determined the need for a valuation allowance
against the carrying value of deferred tax assets primarily associated with tax
loss carry forwards based on the significant reduction in business levels
experienced. As a result, a valuation reserve of $24.7 million was recorded at
April 30, 2002, which eliminated the tax benefit attributable to the losses
incurred in fiscal 2002. We have continued to experience similar reductions in
business levels during the nine months ended January 31, 2003, and an additional
valuation reserve of $10.8 million was recorded, which eliminated the tax
benefit attributable to the net loss incurred in the first nine months of fiscal
2003.
We have net operating loss carry forwards of approximately $106.2 million
that are available to offset taxable income in the future. The net operating
loss carry forwards will expire in 2022 and 2023.
6. LONG-TERM DEBT
Long-term debt consists of two notes payable for the purchase of computer
software and hardware in connection with the implementation of a new information
technology system and several equipment financing arrangements. At January 31,
2003, information relating to these notes is as follows:
Information Technology
------------------------------ Equipment
Note 1 Note 2 Financing Total
------------- ------------ ------------- ------------
Current portion................................ $ 1,792,000 $ 1,160,000 $ 895,000 $ 3,847,000
Long-term...................................... 3,155,000 594,000 93,000 3,842,000
------------- ------------ ------------- ------------
$ 4,947,000 $ 1,754,000 $ 988,000 $ 7,689,000
============= ============ ============= ============
Interest rate.................................. 5.50% 3.52% 13.72%
Payment terms.................................. Monthly Quarterly Monthly
Maturity....................................... 2006 2005 2005
7. LOSS PER SHARE
The following table sets forth the computation of basic and diluted
earnings per share:
-8-
THREE MONTHS ENDED NINE MONTHS ENDED
JANUARY 31, JANUARY 31,
------------------------------ -------------------------
2002 2003 2002 2003
------------ ------------ ---------- -----------
Numerator - net loss............................. $ (8,223) $ (9,338) $ (34,214) $ (57,709)
============ ============ ========== ===========
Denominator:
Denominator for basic and diluted loss per
share - weighted average shares.............. 6,409 7,339 6,409 7,309
============ ============ ========== ===========
Basic and diluted loss per share.............. $ (1.30) $ (1.27) $ (5.34) $ (7.90)
============ ============ ========== ===========
8. NEW ACCOUNTING PRONOUNCEMENTS
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities, effective for exit or disposal activities
initiated after December 31, 2002. The Company's current restructuring plan,
initiated in the first nine months of fiscal 2003, was not accounted for under
SFAS No. 146. The Company accrued a pre-tax charge of $3.0 million when Company
management approved the current restructuring plan. If the Company had accounted
for this restructuring plan under SFAS No. 146, $700,000 of the $3.0 million
charge would have been recognized as incurred and not accrued in the second and
third quarters of fiscal 2003.
In December 2002, the FASB issued SFAS No. 148 Accounting for Stock-Based
Compensation Transition and Disclosure. SFAS No. 148 amends SFAS No. 123,
Accounting for Stock-Based Compensation, to provide alternative methods of
transition to SFAS No. 123's fair value method of accounting for stock-based
employee compensation. SFAS No. 148 does not require companies to account for
employee stock options using the fair value method but does require additional
footnote disclosures. The Company will adopt these disclosure requirements
beginning in the fourth quarter of fiscal 2003. The adoption of SFAS No. 148
will not impact the Company's results of operations.
9. ADOPTION OF NEW ACCOUNTING POLICY
On December 15, 2002, the Company adopted the FASB Statement of
Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others. The
Interpretation requires certain guarantees to be recorded at fair value as well
as expands disclosure requirements. The adoption of this standard did not have a
material effect on the Company's financial statements or disclosures.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION.
The following discussion of our financial condition and results of operations
should be read in conjunction with the condensed consolidated financial
statements and related notes thereto included elsewhere in this Form 10-Q. The
following discussion contains forward-looking statements that involve risks and
uncertainties. Our actual results could differ substantially from those
anticipated in these forward-looking statements as a result of several factors,
including those set forth under "Factors That May Affect Our Future Results."
OVERVIEW
We develop, manufacture and sell optical subsystems for various
applications and multiple end markets. These subsystems are designed for use in
storage, data networking, metro and wide area telecom networks, military and
government applications, and other industrial markets and applications. We plan
to continue to diversify our end markets and expand our product offerings
through internal and external growth. Our optical subsystems are compatible with
the advanced transmission protocols used in these networks, including Gigabit
Ethernet, Fast Ethernet, Fibre Channel, and synchronous optical network (SONET).
As previously announced, we discontinued the manufacture of single ferrule
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connectors and certain other commodity products in the fourth quarter of fiscal
2002. Beginning in fiscal 2003, sales of optical products previously classified
as optical components will be reclassified as part of our optical subsystem
products.
On February 23, 2000, Methode Electronics, Inc. ("Methode") announced plans
to create a separate company comprised of its optical products businesses.
Accordingly, we were incorporated in Delaware in April 2000 as a wholly owned
subsidiary of Methode. In June 2000 we launched our initial public offering of
10,062,500 shares of common stock at $21.00 per share. After the completion of
our public offering, Methode owned approximately 84.3% of our outstanding common
stock. On March 23, 2001, Methode announced that its board of directors had
declared a stock dividend of all of Methode's shares in us. The dividend was
distributed on April 28, 2001 to Methode stockholders of record as of April 5,
2001. The distribution was made on the basis of 1.5113 shares of Stratos stock
for each share of Methode Class A and Class B common stock held.
Our net sales are derived primarily from the sale of optical subsystems to
original equipment manufacturers (OEMs). Our net sales have fluctuated from
period to period based on customer demand for our products, the size and timing
of customer orders, particularly from our largest customers, and based on any
canceled, delayed or rescheduled orders in the relevant period. We determine
reserves for rapid technological change on a product by product basis. While it
is likely that obsolescence due to rapid technological change will continue, the
timing and amount of this obsolescence cannot be predicted with certainty.
The average unit prices of our products generally decrease as the products
mature in response to factors such as increased competition, the introduction of
new products and increased unit volumes. We anticipate that average selling
prices will continue to decline in future periods, although the timing and
degree of the declines cannot be predicted with any certainty. We must continue
to develop and introduce on a timely basis new products that incorporate
features that can be sold at higher average selling prices.
License fees and royalties represent payments received from licensees of
our patented technology, which is also used by us in our optical subsystems.
These license agreements generally provide for up-front payments and/or future
fixed payments or ongoing royalty payments based on a percentage of sales of the
licensed products. The timing and amounts of these payments is beyond our
control. Accordingly, the amount received in any given period is expected to
vary significantly. The duration of all of these license agreements extends
until the expiration of the licensed patents. We will consider entering into
similar agreements in the future, however, we are not able to predict whether we
will enter into any additional licenses in the future and, if so, the amount of
any license fees or royalties.
Our cost of sales consists of materials, salaries and related expenses for
manufacturing personnel and manufacturing overhead. We purchase several key
components used in the manufacture of our products from a limited number of
suppliers. We have periodically experienced shortages and delivery delays for
these materials. In some circumstances, we maintain an inventory of limited
source components to decrease the risk of shortage. If we overestimate our
requirements, we may have excess inventory of these components. Substantially
all of our products are designed and manufactured in our own facilities. In the
future we may expand the volume of products manufactured by third parties.
Accordingly, a significant portion of our cost of sales is fixed over the near
term. In order to remain competitive, we must continually reduce our
manufacturing costs through design and engineering innovations and increases in
manufacturing efficiencies. There can be no assurance that we will be able to
reduce our manufacturing costs or introduce new products to offset anticipated
decreases in the average selling prices of our products.
-10-
Research and development expenses consist primarily of salaries and related
expenses for design engineers, scientists and other technical personnel,
depreciation of test and prototyping equipment, and tooling. Research and
development expenses also consist of materials and overhead costs related to
major product development projects. We charge all research and development
expenses to operations as incurred. We believe that continued investment in
research and development is critical to our long-term business success. We
intend to continue to invest in research and development programs in future
periods for the purpose of enhancing or reducing the cost of current optical
subsystems, and developing new optical subsystems.
We market and sell our products domestically and internationally through
our direct sales force, local resellers and manufacturers' representatives.
Sales and marketing expenses consist primarily of personnel costs, including
sales commissions and product marketing and promotion costs. We expect to
continue to make significant expenditures for sales and marketing services.
General and administrative expenses consist primarily of personnel costs
for our administrative and financial groups, as well as legal, accounting and
other professional fees. General and administrative expenses in fiscal 2002 also
include the amortization of goodwill resulting from the excess of the purchase
price over net assets of the acquired companies. We expect to continue to make
significant expenditures for general and administrative services.
CRITICAL ACCOUNTING POLICIES
Accounts Receivable. We sell products primarily to various original
equipment manufacturers and distributors. Sales to these customers have varying
degrees of collection risk associated with them. Judgment is required in
assessing the realization of these receivables based on aging, historical
experience and customer's financial condition.
Inventory Reserves. It is our policy to reserve 100% of the value of
inventory we specifically identify and consider obsolete or excessive to fulfill
future sales estimates. We define obsolete inventory as inventory that will no
longer be used in the manufacturing process or items that have potential quality
problems. Excess inventory is defined as inventory in excess of one year's
projected usage. Excess inventory is determined using our best estimate of
future demand at the time, based upon information then available to us. In
general, our policy is to scrap inventory determined to be obsolete shortly
after the determination is made and to keep excess inventory for a reasonable
amount of time before it is discarded. Occasionally, changed circumstances in
the marketplace present us with an opportunity to sell inventory that was
previously determined to be excessive and reserved for. If this occurs, we
intend to vigorously pursue such opportunities.
Long-Lived Assets Impairment. We review the carrying value of our
long-lived assets, including goodwill, if the facts and circumstances, such as
significant declines in sales, earnings or cash flows or material adverse
changes in the business climate suggest that it may be impaired. If this review
indicates that goodwill or other long-lived assets will not be recoverable, as
determined based on the estimated undiscounted cash flows of the long-lived
asset, impairment is measured by comparing the carrying value of the long-lived
asset to fair value. Fair value is determined based on quoted market values,
discounted cash flows or appraisals. If an asset is considered held for sale, we
adjust the carrying value of the underlying assets to fair value, as determined
based on the estimated net realizable proceeds of the assets.
Revenue Recognition. Revenue from product sales, net of trade discounts, is
recognized when title passes, which generally occurs upon shipment. We handle
returns by replacing, repairing or issuing credit for defective products when
returned. We establish a reserve for returns based on any known and anticipated
returns.
-11-
Customer Returns. It is our policy to establish a reserve for customer
returns based on any known and anticipated returns based on past experience.
Occasionally, we will receive requests from customers to accept the return of
merchandise for which they had previously accepted delivery. Although we have no
obligation to do so, each such request is evaluated in light of the
contemplation of future business from the customer. We will continue to consider
these requests in the future, however, we are not able to predict that we will
enter into any additional agreements in the future, and, if so, the amount of
any returns.
Research and Development. All expenses relative to the development of a new
product, prior to its introduction into production, are considered research and
development expenses. In addition, the costs of the engineering effort to do
significant redesign to enhance product performance that results essentially in
a new product are also considered to be research and development expenses.
Because the true manufacturability of our products is not obvious until a period
of volume production has occurred, initial production is considered a part of
the development process. During this phase, a portion of the scrap expense and
yield loss would be considered development expense. A product is still
considered under development until it matures to the point where its production
yields (volumes) are consistent with other mature products and any engineering
effort is predominately dedicated to customer applications and/or quality
support.
RESULTS OF OPERATIONS
The following table sets forth certain statement of operations data as a
percentage of net sales for the periods indicated:
NINE MONTHS ENDED JANUARY 31,
-----------------------------
2002 2003
---------- ----------
Revenue:
Net sales.................................................................... 100.0% 100.0%
License fees and royalties................................................... 4.3 12.7
---------- ----------
Total..................................................................... 104.3 112.7
Costs and expenses:
Cost of sales................................................................ 108.1 129.4
Research and development..................................................... 50.1 69.9
Sales and marketing.......................................................... 13.7 18.9
General and administrative................................................... 26.9 33.9
---------- ----------
Total costs and expenses.................................................. 198.8 252.1
---------- ----------
Loss from operations............................................................ (94.5) (139.4)
Investment income, net.......................................................... 7.4 3.1
---------- ----------
Loss before income taxes........................................................ (87.1) (136.3)
Provision for income taxes (credit)............................................. (6.1) --
---------- ----------
Loss before cumulative effect of a change in accounting principle (81.0) (136.3)
Cumulative effect of a change in accounting principle........................ -- (56.8)
---------- ----------
Net loss........................................................................ (81.0)% (193.1)%
========== ==========
-12-
THREE AND NINE MONTHS ENDED JANUARY 31, 2003 AND 2002
Net Sales. Net sales for the third quarter of fiscal 2003 decreased to $8.1
million from $12.5 million a year ago. Net sales for the nine month period ended
January 31, 2003 decreased 29% over the same period a year ago to $29.9 million
from $42.2 million. Of the $4.4 million decrease in the third quarter, $4.2
million is from a decrease in the net sales into the storage end market, $1.2
million is from a decrease in the net sales into the data networking end market
and $200,000 is from a decrease in net sales into the telecom/metro end market.
These decreases were offset in part by a $1.0 million increase in the net sales
into the military/governmental end market and a $200,000 increase in the net
sales into other end markets.
Net sales decreased $12.3 million in the nine months ended January 31, 2003
over the comparable period last year. The decrease represents a $5.9 million
decrease in the net sales into the storage end market, a $5.0 million decrease
in the net sales into the data networking end market and a $5.4 million decrease
in the net sales into the telecom/metro end market. These decreases were offset
in part by a $2.6 million increase in the net sales into the
military/governmental end market and a $1.4 million increase in net sales into
other end markets.
The decrease in sales was primarily due to lower customer demand due to the
current economic climate and reduced capital spending for optical networking
equipment. Sales were also negatively impacted by declines in average unit
prices for our products resulting from pricing pressure and changes in product
mix. Our total sales order backlog decreased to $4.3 million as of January 31,
2003 from $8.4 million as of April 30, 2002. These decreases reflect lower
customer demand for our products, customer push-outs and cancellation of orders,
due in part to delays in the launch of new product programs by our customers.
License Fees and Royalties. License fees increased to $3.3 million in the
three months ended January 31, 2003 from $390,000 in the three months ended
January 31, 2002. The increase is attributable to a $3.0 million lump sum one
time license payment offset in part by decreases in license fees payable on
sales of optical subsystems by licensees, consistent with general economic
conditions in the optical networking market. License fees increased to $3.8
million in the nine months ended January 31, 2003 from $1.8 million in the nine
months ended January 31, 2002. The increase primarily relates to the $3.0
million lump sum payment offset in part by lump sum payments of approximately
$1.0 million in license and royalty payments in association with the settlement
of two patent infringement cases in the first nine months of fiscal 2002.
License fees consist of both fixed schedule payments and contingent payments
based on sales volumes of licensed products.
Cost of Sales and Gross Margins. Cost of sales remained constant at $11.5
million for the three months ended January 31, 2003 and 2002 and decreased to
$38.7 million for the nine months ended January 31, 2003 compared to $45.6
million for the nine months ended January 31, 2002. Gross profit as a percentage
of net sales or gross margin, decreased to negative (41.3)% in the three months
ended January 31, 2003 from 7.7% in the three months ended January 31, 2002.
Approximately 30.4 percentage points of the 49.0 percentage point decrease was
due to the decline in sales and the decline in the average selling price for
our products primarily to pricing pressure and product mix, 20.6 percentage
points was due to the write down to fair market value of assets held for sale,
and 2.0 percentage points for employee severance pay relating to the
restructuring of operations. These factors were offset 4.0 percentage points for
the reduction in charges for obsolete and slow moving inventory.
The gross margin decreased to negative (29.4)% for the nine months ended
January 31, 2003 from negative (8.1)% in the comparable year. Approximately 17.7
percentage points of the 21.3 percentage points decrease in gross margin was the
result of the decline in sales, and the decline in the
-13-
average unit price for our products due primarily to pricing pressures and
product mix, 5.6 percentage points was due to the write down to fair market
value of assets held for sale, and 3.0 percentage points for severance pay
relating to the restructuring of operations. These factors were offset 3.6
percentage points for the reduction in charges for obsolete and slow moving
inventory and the sale of approximately $413,000 of inventory previously
considered excess and fully reserved, favorably impacting gross margin by 1.4
percentage points.
Cost of sales was charged approximately $5.8 million and $9.7 million in
the nine months ended January 31, 2003 and 2002 for obsolete and excess
inventory.
Research and Development. Research and development expenses decreased to
$5.3 million in the three months ended January 31, 2003 from $5.6 million in the
three months ended January 31, 2002. The decrease of $300,000 was primarily due
to a decrease of $1.4 million in material and operating costs related to major
product development projects and a reduction of $600,000 of personnel costs
dedicated to research and development. These decreases were offset by a $700,000
increase in cost of research and development facilities, a $700,000 write down
to fair market value of assets held for sale and $300,000 for employee severance
pay related to the restructuring of operations.
Research and development expenses decreased to $20.9 million in the nine
months ended January 31, 2003 from $21.2 million in the nine months ended
January 31, 2002. The decrease of $300,000 was primarily due to a decrease of
$4.7 million in material and operating costs related to major product
development projects and a reduction of $1.3 million of personnel costs
dedicated to research and development. These decreases were offset by a $4.0
million increase in costs of research and development facilities, a $700,000
write down to fair market value of assets held for sale and $1.0 million for
employee severance pay related to the restructuring of operations.
Sales and Marketing. Sales and marketing expenses decreased to $1.4 million
in the three months ended January 31, 2003 from $1.7 million in the three months
ended January 31, 2002. This $300,000 increase was due both to a decrease of
$130,000 in sales and marketing salaries, fringe benefits. bonuses and
commissions, and $170,000 in field sales operating costs supporting our sales
volume.
Sales and marketing expenses decreased to $5.7 million in the nine months
ended January 31, 2003 from $5.8 million in the comparable period last year.
This $100,000 decrease was due to a $360,000 reduction in field sales operating
costs supporting our sales volume offset in part by an increase of $260,000 in
sales and marketing salaries, fringe benefits, bonuses and commissions.
General and Administrative. General and administrative expenses decreased
to $2.9 million in the three months ended January 31, 2003 from $3.1 million in
the three months ended January 31, 2002. The decrease was due to a decrease in
general operating expenses.
General and administrative expenses decreased to $10.1 million in the nine
months ended January 31, 2003 from $11.4 million in the comparable period last
year. The $1.3 million decrease was due to a $2.0 million decrease in general
operating expenses and a reduction of $200,000 in salaries, fringe benefits and
bonuses, offset by $900,000 for employee severance pay relating to the
restructuring of operations.
We operate in markets that are currently experiencing a severe economic
downturn that began late in the third quarter of fiscal 2001 and escalated
during the first quarter of fiscal 2002. As a result, many of our customers
began to stretch their payment terms. Days sales in accounts receivable
increased to 71 days at January 31, 2003 compared to 52 days at April 30, 2002.
During the first quarter of fiscal 2002, we identified customers that we
considered to be high risk relative to the collection of accounts
-14-
receivable. Based upon this review, we recorded an additional $2.1 million
provision for doubtful accounts in the first quarter of fiscal 2002.
Investment Income, Net. Investment income, net of investment expense,
decreased to $293,000 in the three months ended January 31, 2003 from $834,000
in the three months ended January 31, 2002 and decreased to $931,000 in the nine
months ended January 31, 2003 from $3.1 million in the comparable period last
year. Investment income consists of earnings on the short-term investment of
excess cash balances and the decreases of this income in the three and nine
months ended January 31, 2003 reflect the reduction of excess cash balances as
well as lower interest rates throughout the market place during these periods.
Income Taxes. During fiscal 2002, we determined the need for a valuation
allowance against the carrying value of deferred tax assets primarily associated
with tax loss carry forwards based on the significant reduction in business
levels experienced. As a result, a valuation reserve of $24.7 million was
recorded at April 30, 2002, which eliminated the tax benefit attributable to the
losses incurred in fiscal 2002. We have continued to experience similar
reductions in business levels during the nine months ended January 31, 2003, and
an additional valuation reserve of $10.8 million was recorded, which eliminated
the tax benefit attributable to the net loss incurred in the first nine months
of fiscal 2003.
We have net operating loss carry forwards of approximately $106.2 million
that are available to offset taxable income in the future. The net operating
loss carry forwards will expire in 2022 and 2023.
Cumulative Effect of a Change in Accounting Principle. Effective May 1,
2002, the Company has adopted the provisions of SFAS No. 142, and performed a
transitional goodwill impairment test as of that date. As a result, it was
determined that the goodwill of our active optical subsystems reporting unit had
been impaired and recorded a one time noncash charge of approximately $17.0
million. This charge was recorded as of May 1, 2002 and is reflected as a
cumulative effect of a change in accounting principle in the Statement of
Operations. See Note 2 to the Condensed Consolidated Financial Statements
located elsewhere in this filing for further discussion of this item.
Because we operate in markets that are currently experiencing a severe
economic downturn, it has affected current operations as well as the market
capitalization of the Company. If the current downturn continues, the Company
may experience further impairment of goodwill when it performs its annual
impairment review in the fourth quarter of fiscal 2003.
LIQUIDITY AND CAPITAL RESOURCES
Net cash used in operating activities totaled $20.2 million for the nine
months ended January 31, 2003. The use of cash in operating activities resulted
primarily from a net loss and the decrease in accounts payable and accrued
expenses offset in part by decreases in accounts receivable and inventories. Net
cash used in operating activities totaled $15.2 million for the nine months
ended January 31, 2002. The use of cash in operating activities resulted
primarily from a net loss and the decrease in accounts payable and accrued
expenses offset in part by decreases in accounts receivable and inventories.
Net cash used in investing activities totaled $2.7 million in the nine
months ended January 31, 2003, including $2.8 million for the purchase of
equipment and facilities, a $900,000 increase in short-term investments, and
$200,000 purchase price for Tsunami Optics, Inc. and Paracer, Inc. and proceeds
from the sale of assets held for sale. Net cash used in investing activities
totaled $41.7 million in the nine months ended January 31, 2002, including $21.5
million for the purchase of equipment and facilities, a $12.1 million net
increase in short-term investments and $8.1 million for the acquisition of
Advanced Interconnection Technology, Inc.
-15-
Net cash used in financing activities was $5.4 million in the nine months
ended January 31, 2003, and represents repayments on borrowings. Cash used in
financing activities in the nine months ended January 31, 2002 represents an
advance of $3,771,000 to Tsunami Optics, Inc.
As of January 31, 2003, our principal source of liquidity was approximately
$64.5 million in cash, cash equivalents and short-term investments. Our future
capital requirements will depend on a number of factors, including our future
net sales and our ability to lower operating expenses. The continued
diversification of our end markets and expansion of our product offerings
through internal and external growth could materially change our level of cash
and cash equivalents. Our only cash commitment is the repayment of long-term
debt of approximately $7.7 million. We believe that our current cash balances
will be sufficient to meet our cash needs for working capital, capital
expenditures and repayments of long-term debt for the next 12 months.
FACTORS THAT MAY AFFECT OUR FUTURE RESULTS
RISKS RELATING TO OUR BUSINESS
We have recently incurred significant net losses, primarily due to the current
economic downturn. Unless we are able to increase our sales or further reduce
our costs, we will continue to incur net losses.
The current economic downturn has resulted in reduced capital spending for
optical networking products. As a result, many of our customers have
significantly reduced, cancelled or rescheduled orders for our products and
expressed uncertainty as to their future requirements. We experienced a decrease
in net sales of 29% and incurred a net loss of $57.7 million during the nine
months ended January 31, 2003. We experienced a decrease in net sales of 56% and
incurred a net loss of $72.2 million during fiscal 2002. We expect difficult
industry conditions to continue for at least the next 6 to 12 months and may
continue for a longer period. Any continued or further decline in demand for our
customers' products or in general economic conditions would likely result in
further reduction in demand for our products and our business, operating results
and financial condition would suffer.
Although we have implemented personnel reductions and other cost reduction
programs, many of our costs are fixed in the near term and we expect to continue
to incur significant manufacturing, research and development, sales and
marketing and administrative expenses. Consequently, we will need to generate
higher revenues while containing costs and operating expenses if we are to
return to profitability. If our efforts to increase our revenues and contain our
costs are not successful, we will continue to incur net losses.
Our net sales and operating results vary significantly from quarter to quarter,
and our stock price may fall if our quarterly performance does not meet
analysts' or investors' expectations.
Our quarterly net sales and operating results have varied significantly in
the past and are likely to vary significantly in the future, which makes it
difficult to predict our future operating results. Accordingly, we believe that
quarter-to-quarter comparisons of our net sales and operating results are not
meaningful and should not be relied upon as an indicator of our future
performance. Some of the factors which cause our net sales and operating results
to vary include:
.. the timing of customer orders, particularly from our largest customers;
.. the level of demand for our customers' products;
-16-
.. the cancellation or postponement of orders;
.. our ability to manufacture and ship our products on a timely basis;
.. changes in our product mix;
.. competitive pressures resulting in lower prices;
.. our ability to control costs and expenses;
.. the introduction of new products or technologies by us or our competitors;
.. the timing of our receipt of license fees and royalty payments relating to
our intellectual property; and
.. general economic factors.
Our net sales and operating results have been and in one or more future
quarters will likely be below the expectations of public market analysts and
investors. If this occurs, the price of our common stock would likely decline.
Our success depends on the long-term growth of communication networks and their
use of optical communication technologies. If these events do not occur, our net
sales may decline and our business would likely be significantly harmed.
Our optical subsystems are used primarily in enterprise, metropolitan area,
wide area and telecommunication networks. These markets are rapidly evolving and
it is difficult to predict their potential size or future growth rate. In
addition, there is uncertainty as to the extent to which optical communication
technologies will be used throughout these markets. Our success in generating
revenue in these markets will depend on the long-term growth of these markets
and their use of optical communication technologies. If these markets do not
grow, or if the use of optical communication technologies in these markets does
not expand, our net sales may decline and our business would likely be
significantly harmed.
We must develop new products and technology, enhance existing products and
technology and enter and develop new markets in order to remain competitive and
increase our opportunities for growth. If we fail to do so, our products will no
longer be competitive, we will limit our opportunities for growth and our net
sales will decline.
The market for our products and technology is characterized by rapid
technological change, new and improved product introductions, changes in
customer requirements and evolving industry standards. Our future success will
depend to a substantial extent on our ability to develop, introduce and support
new products and technology on a successful and timely basis. If we fail to
develop and deploy new products and technologies or enhancements of existing
products on a successful and timely basis or we experience delays in the
development, introduction or enhancement of our products and technologies, our
products will no longer be competitive and our net sales will decline. The
introduction of new and enhanced products may cause our customers to defer or
cancel orders for existing products. In addition, a slowdown in demand for
existing products ahead of a new product introduction could result in a write
down in the value of inventory on hand relating to existing products. As we
develop new products and new market opportunities, we may significantly increase
the level of component, subsystems and system technology integration in our
products. This development is expected to be generated internally and externally
through acquisitions.
-17-
The development of new, technologically advanced products for diversified
end markets is a complex and uncertain process requiring high levels of
innovation and highly skilled engineering and development personnel, as well as
the accurate anticipation of technological and market trends. We cannot assure
you that we will be able to identify, develop, manufacture, market or support
new or enhanced products successfully, if at all, or on a timely basis. This
marketing and selling process into diversified end markets may require us to
develop new sales and marketing channels, which we may not do successfully.
Further, we cannot assure you that our new products will gain market acceptance
or that we will be able to respond effectively to product announcements by
competitors, technological changes or emerging industry standards. Any failure
to respond to technological change would significantly harm our business.
Our products are incorporated into larger systems which must comply with various
domestic and international government regulations. If the performance of our
products contributes to our customers' inability to comply with these
requirements, we may lose these customers and our net sales will decline.
In the United States, our products are incorporated into larger systems
which must comply with various regulations and standards defined by the Federal
Communications Commission, other government agencies and Underwriters
Laboratories. Internationally, our products are incorporated into larger systems
which must also comply with standards established by local authorities in
various countries which may vary considerably. If the performance of our
products contributes to our customers' inability to comply with existing or
evolving standards established by regulatory authorities or to obtain timely
domestic or foreign regulatory approvals we may lose these customers and our net
sales will decline.
If our products fail to comply with evolving industry standards or compete
effectively with alternative technologies in our markets, we may be required to
make significant expenditures to redesign our products.
Our products comprise only a part of an entire networking system and must
comply with evolving industry standards in order to gain market acceptance. In
many cases, we introduce a product before an industry standard has become widely
accepted and we depend on the companies that provide other components to support
industry standards as they evolve. Because industry standards do not exist in
some cases at the time we are developing new products, we may develop products
that do not comply with the eventual industry standard. If this occurs, we would
need to redesign our products to comply with adopted industry standards. In
addition, if alternative technologies are adopted as an industry standard within
our target markets, we would have to dedicate significant time and resources to
redesign our products to meet this new industry standard. If we are required to
redesign our products, we may incur significant expenses and losses due to lack
of customer demand, unusable purchased components for these products and the
diversion of our engineers from future product development efforts. If we are
not successful in redesigning our products or developing new products to meet
new standards or any other standard that may emerge, our net sales will decline.
We derive a significant portion of our net sales from a few large customers, and
our net sales may decline significantly if any of these customers cancels,
reduces or delays purchases of our products.
Our success will depend on our continued ability to develop and manage
relationships with significant customers. For the nine months ended January 31,
2003, our two largest customers and their respective contract manufacturers
accounted for 15% of our net sales, with Redfern Broadband and QLogic accounting
for 9% and 6% of our net sales, respectively. For the 2002 fiscal year, our two
largest customers and their respective contract manufacturers accounted for 27%
of our net sales, with McData
-18-
Corporation and ConTech Systems accounting for 22% and 5% of our net sales,
respectively. We expect our dependence on sales to a small number of large
customers to continue.
The markets in which we sell our products are dominated by a relatively
small number of systems manufacturers, thereby limiting the number of our
potential customers. As a result, our relationships with these customers are
critically important to our business. We cannot assure you that we will be able
to retain our largest customers, that we will be able to attract additional
customers or that our customers will be successful in selling their products
which incorporate our products. Our customers have in the past sought price
concessions from us and will continue to do so in the future. Also, many of our
customers have canceled, reduced or delayed purchases of our products. Further,
some of our customers may in the future shift their purchases of products from
us to our competitors or to joint ventures between these customers and our
competitors. The loss of or a significant reduction in orders from one or more
of our largest customers, our inability to successfully develop relationships
with additional customers or future price concessions that we may make could
cause our net sales to significantly decline.
Our sales cycle runs from our customers' initial design to production for
commercial sale. This cycle is long and unpredictable and may cause our net
sales to decline or increase our operating expenses.
We cannot predict the timing of our sales accurately because of the length
of our sales cycles. As a result, if sales forecasts from specific customers are
not realized, we may be unable to compensate for the sales shortfall and our net
sales may decline. The period of time between our initial contact with a
customer and the receipt of a purchase order may span up to a year or more, and
varies by product and customer. During this time, customers may perform, or
require us to perform, extensive evaluation and qualification testing of our
products. Generally, they consider a wide range of issues before committing to
purchase our products, including ability to interoperate with other subsystems,
product performance and reliability. We may incur substantial sales and
marketing expenses and expend significant management effort while our potential
customers are qualifying our products. Even after incurring these costs, we
ultimately may not sell any or only small amounts of our products to these
potential customers. Consequently, if new sales do not result from our efforts
to qualify our products, our operating expenses will increase.
Our customers may cease purchasing our products at any time and may cancel or
defer purchases on short notice, which may cause our net sales to decline or
increase our operating expenses.
We generally do not have long-term contracts with our customers. Sales are
typically made pursuant to individual purchase orders, often with extremely
short lead times, that may be canceled or deferred by customers on short notice
without significant penalty. Our customers base their orders for our products on
the forecasted sales and manufacturing schedules for their own products. Our
customers have in the past significantly accelerated, canceled or delayed orders
for our products in response to unanticipated changes in the manufacturing
schedules for their own products, and will likely do so again in the future.
During the last twelve months, our customers have cancelled a significant number
of orders. The reduction, cancellation or delay of individual customer purchase
orders has caused and could continue to cause our net sales to decline.
Moreover, these uncertainties complicate our ability to accurately plan our
manufacturing schedule and may increase our operating expenses.
If we do not decrease our manufacturing costs or increase sales of higher margin
products as the average unit price of our existing products decreases, our gross
margins will decline.
The average unit prices of our products generally decrease as the products
mature in response to increased competition, the introduction of new products
and increased unit volumes. Substantially all of
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our products are designed and manufactured in our own facilities. Accordingly, a
significant portion of our cost of sales is fixed over the near term. In order
to remain competitive, we must continually reduce our manufacturing costs
through design and engineering changes and increases in manufacturing
efficiencies. We must also continue to develop and introduce on a timely basis
new products that incorporate features that can be sold at higher average
selling prices. Our inability to reduce manufacturing costs or introduce new
products with higher average selling prices will cause our gross margins to
decline, which would significantly harm our operating results.
The market for optical subsystems is highly competitive, which may result in
lost sales or lower gross margins.
The markets for optical subsystems are highly competitive and are expected
to intensify in the future. We compete primarily with Agilent Technologies,
Inc., Finisar Corporation, Infineon Technologies Corp., JDS Uniphase
Corporation, Lucent Technologies Inc., Molex, Inc., Optical Communications
Products, Inc., Tyco International, Ltd. and a number of other smaller
companies. Many of these companies have substantially greater financial,
technical, marketing and distribution resources and brand name recognition 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, several of our competitors have large market capitalizations or
cash reserves and are much better positioned than we are to acquire other
companies in our consolidating industry in order to gain new technologies or
products. Many of our competitors have much greater name recognition, more
extensive customer bases, better-developed distribution channels and broader
product offerings. These companies can leverage their customer bases and broader
product offerings and adopt aggressive pricing policies to gain market share. In
addition, companies with diversified product offerings can better sustain an
economic downturn.
We expect that more companies, including some of our customers, will enter
the markets for our products. We may not be able to compete successfully against
either current or future competitors. Competitive pressures, combined with
weakening demand, may result in further price reductions, lower margins and loss
of market share. In addition, some of our current and potential customers are
attempting to integrate their operations by producing their own optical
subsystems or acquiring one or more of our competitors which may eliminate the
need to purchase our products. Furthermore, larger companies in other related
industries are developing and acquiring technologies and applying their
significant resources, including their distribution channels and brand name
recognition, in an effort to capture significant market share. While this trend
has not historically impacted our competitive position, it may result in future
decreases in our net sales.
We depend on suppliers for several key components. If we underestimate or
overestimate our requirements for these components, our business could be
significantly harmed.
We purchase several key components that are incorporated into our products
from a limited number of suppliers. We have experienced shortages and delays in
obtaining key components in the past and expect to experience shortages and
delays in the future. These shortages and delays have typically occurred when
demand within the industry has increased rapidly and exceeds the capacity of
suppliers of key components in the short term. Delays and shortages also often
occur in the early stages of a product's life cycle. The length of shortages and
delays in the past has varied from several days to a month. We are unable to
predict the length of any future shortages or delays.
The inability to obtain sufficient quantities of these components that meet
our quality requirements may interrupt and delay the manufacturing of our
products or result in the cancellation of orders for our products. In addition,
our suppliers could discontinue the manufacture or supply of these
-20-
components at any time. We may not be able to identify and integrate alternative
sources of supply in a timely fashion, or at all. Any transition to alternative
suppliers may result in delays in shipment and increased expenses and may limit
our ability to deliver products to our customers. Furthermore, if we are unable
to identify an alternative source of supply, we may have to redesign or modify
our products, which may cause delays in shipments, increased design and
manufacturing costs and increased prices for our products.
We make forecasts for our component requirements based on anticipated
product orders. Although we enter into long-term agreements for the purchase of
key components from time to time, our purchases of key components are generally
made on a purchase order basis. We may also maintain an inventory of limited
source components to limit the potential impact of a component shortage. We may
not accurately predict the demand for our products and the lead-time required to
obtain key components. If we overestimate our requirements, we may have excess
inventory, which may become obsolete and would increase our costs. If we
underestimate our requirements, we may have inadequate inventory, which could
interrupt our manufacturing and delay delivery of our products to our customers.
Either of these occurrences would significantly harm our business.
Our success depends on our ability to hire and retain qualified technical
personnel, and if we are unable to do so, our product development efforts and
customer relations will suffer.
Our products require sophisticated manufacturing, research and development,
marketing and sales, and technical support. Our success depends on our ability
to attract, train and retain qualified technical personnel in each of these
areas. Competition for personnel in all of these areas is intense and we may not
be able to hire or retain sufficient personnel to achieve our goals or support
the anticipated growth in our business. The market for the highly-trained
personnel we require is very competitive, due to the limited number of people
available with the necessary technical skills and understanding of our products
and technology. If we fail to hire and retain qualified personnel, our product
development efforts and customer relations will suffer.
Our products may contain defects which may cause us to incur significant costs,
divert our attention from product development efforts and result in a loss of
customers.
Our products are complex and may contain defects, particularly when first
introduced or as new versions are released. Our customers integrate our optical
subsystems into systems and products that they develop themselves or acquire
from other vendors. As a result, when problems occur in equipment or a system
into which our products have been incorporated, it may be difficult to identify
the source of the problem. We may be subject to liability claims for damages
related to product defects or experience manufacturing delays as a result of
these defects in the future, any or all of which could be substantial. The
length of any future manufacturing delays in connection with a product defect
will depend on the nature of the defect and whether we or one of our component
suppliers were the source of the defect. Moreover, the occurrence of defects,
whether caused by our products or technology or the products of another vendor,
may result in significant customer relation problems and injury to our
reputation and may impair the market acceptance of our products and technology.
We are subject to environmental laws and other legal requirements that have the
potential to subject us to substantial liability and increase our costs of doing
business.
Our properties and business operations are subject to a wide variety of
federal, state, and local environmental, health and safety laws and other legal
requirements, including those relating to the storage, use, discharge and
disposal of toxic, volatile or otherwise hazardous substances used in our
manufacturing processes. We cannot assure you that these legal requirements will
not impose on us the
-21-
need for additional capital expenditures or other requirements. If we fail to
obtain required permits or otherwise fail to operate within these or future
legal requirements, we may be required to pay substantial penalties, suspend our
operations or make costly changes to our manufacturing processes or facilities.
Although we believe that we are in compliance and have complied with all
applicable legal requirements, we may also be required to incur additional costs
to comply with current or future legal requirements.
Economic, political and regulatory risks associated with international
operations may limit our sales and increase our costs of doing business abroad.
A portion of our sales is generated from customers located outside the
United States, principally in Europe. We also operate manufacturing facilities
in China and the United Kingdom. Sales to customers located outside of the
United States were approximately 44.8% of our net sales during the nine months
ended January 31, 2003 and approximately 29.1% of our net sales in fiscal 2002.
Our international operations are subject to a number of risks and uncertainties,
including: o difficulties in managing operations in different locations;
.. changes in foreign currency rates;
.. longer accounts receivable collection cycles;
.. difficulties associated with enforcing agreements through foreign legal
systems;
.. seasonal reductions in business activities in some parts of the world, such
as during the summer months in Europe;
.. trade protection measures and import and export licensing requirements;
.. changes in a specific country's or region's political or economic
conditions;
.. potentially adverse tax consequences;
.. the potential difficulty in enforcing intellectual property rights in some
foreign countries; and
.. acts of terrorism directed against the United States or U.S. affiliated
targets.
These factors could adversely impact our international sales or increase
our costs of doing business abroad or impair our ability to expand into
international markets, and therefore could significantly harm our business.
We intend to pursue additional acquisitions. If we are unable to successfully
integrate any businesses or technologies that we acquire in the future or are
unable to realize the intended benefits of any future acquisitions, our business
will be harmed.
As part of our strategy, we intend to pursue opportunities to buy other
businesses or technologies that would complement our current products, expand
our markets or enhance our technical capabilities, or that may otherwise offer
growth opportunities. Our experience in acquiring other businesses and
technologies is limited. Acquisitions could result in a number of financial
consequences, including:
.. use of significant amounts of cash;
-22-
.. the incurrence of debt and contingent liabilities;
.. potentially dilutive issuances of equity securities;
.. large one-time write-offs; and
.. amortization expenses related to intangible assets.
Acquisitions also involve numerous operational risks, including:
.. difficulties in integrating operations, products, technologies and
personnel;
.. unanticipated costs or write-offs associated with the acquisition;
.. diversion of management's attention from other business concerns;
.. diversion of capital and other resources from our existing businesses; and
.. potential loss of key employees of purchased organizations.
If we are unable to successfully integrate these businesses or any other
businesses or technologies that we may acquire in the future or are unable to
realize the intended benefits of any future acquisitions, our business will be
harmed.
Our recent acquisitions have not generated significant sales and require
significant amounts of capital. If these businesses do not become profitable,
our operating results could be seriously harmed.
In February 2002, we acquired all of the capital stock of Tsunami Optics,
Inc. In March 2002, we acquired all of the capital stock of Paracer, Inc. The
integration of these businesses into our company is not complete. These
businesses are expected to focus on the development and introduction of new
products and have not generated significant revenues to date. In addition, these
businesses have or will require significant amounts of capital to support their
product development activities, and we expect to continue to invest substantial
amounts of capital in these businesses for the foreseeable future. If these
businesses do not become profitable, our operating results could be seriously
harmed.
Our inability to protect our intellectual property rights would significantly
impair their value and our competitive position.
We rely on a combination of patent, copyright, trademark and trade secret
laws, as well as confidentiality agreements and licensing arrangements, to
establish and protect our proprietary rights. Although we have numerous issued
patents and pending patent applications, we cannot assure you that any patents
will issue as a result of our pending patent applications or, if issued, that
any patent claim allowed will be sufficiently broad to protect our technology.
In addition, we cannot assure you that any existing or future patents will not
be challenged, invalidated or circumvented, or that any right granted thereunder
would provide us with meaningful protection of our technology. Despite our
efforts to protect our proprietary rights, unauthorized parties may attempt to
copy or otherwise obtain and use our products or technology. We may be unable to
detect the unauthorized use of our intellectual property or to take appropriate
steps to enforce our intellectual property rights. Policing unauthorized use of
our products and technology is difficult. In addition, the laws of some foreign
countries do not protect our proprietary rights to the same extent as do the
laws of the United States. Further, enforcing our intellectual property
-23-
rights could result in the expenditure of significant financial and managerial
resources and the success of these efforts cannot be predicted with certainty.
Litigation has been necessary and may continue to be necessary in the future to
enforce our intellectual property rights. This litigation could be costly and
its outcome cannot be predicted with certainty. Our inability to adequately
protect against unauthorized use of our intellectual property would
significantly impair its value and our competitive position.
We are currently involved in pending patent litigation which, if decided against
us, could impair our ability to prevent others from using our technology, result
in the loss of future royalty income and require us to pay significant monetary
damages.
We are plaintiffs in several lawsuits relating to our intellectual property
rights. The defendants in these lawsuits include Infineon Technologies Corp.,
Picolight, Inc. and E20, Inc. In these actions, Stratos alleges that
optoelectronic products sold by the defendants infringe upon certain Stratos
patents. The defendants in these lawsuits have filed various affirmative
defenses.
These lawsuits are in the preliminary stage, and we cannot predict their
outcome with certainty. If one or more of these patents were found to be invalid
or unenforceable, we would lose the ability to prevent others from using the
technologies covered by the invalidated patents. This could result in
significant decreases in our sales and gross margins for our products that use
these technologies. In addition, we would lose the future royalty payments from
our current licensees of these patents. We could also be required to pay
significant monetary damages to one or more of the defendants or be required to
reimburse them for their legal fees. Accordingly, if one or more of these
patents were found to be invalid or unenforceable, our business would be
significantly harmed.
Claims that we infringe third-party intellectual property rights could result in
significant monetary damages and expenses or restrictions on our ability to sell
our products.
In recent years, there has been significant litigation in the United States
involving patents and other intellectual property rights. From time to time,
third parties may assert patent, copyright and other intellectual property
rights to technologies used in our business. In addition, our rights to use our
name or other trademarks are subject to challenge by others. Any claims, with or
without merit, could be time-consuming, result in costly litigation, and divert
the efforts of our technical and management personnel. If we are unsuccessful in
defending ourselves against these types of claims, we could be subject to
significant monetary damages and may be required to do one or more of the
following:
.. stop using the challenged trademarks or selling our products that use or
incorporate the relevant technology;
.. attempt to obtain a license to sell or use the challenged intellectual
property, which license may not be available on reasonable terms or at all;
or
.. redesign those products that use the relevant technology.
In the event a claim against us was successful and we could not obtain a
license to the relevant technology on acceptable terms or license a substitute
technology or redesign our products to avoid infringement, our business would be
significantly harmed.
-24-
We are currently defending several class action lawsuits which could subject us
to significant money damages, cause us to incur significant costs or otherwise
harm our business.
We and certain of our executive officers are defendants in certain
purported class action lawsuits filed in the United States District Court,
Southern District of New York. Although we believe these lawsuits are without
merit, an adverse result in these lawsuits could subject us to significant money
damages. This litigation may also require us to incur significant costs in
defense of these lawsuits, could require significant involvement of our senior
management and may divert management's attention from our business and
operations, any of which could have a material adverse affect on our business,
results of operation or financial condition.
Risks Relating to the Securities Markets and Ownership of Our Common Stock
The market prices for securities of technology related companies have been
volatile in recent years and our stock price could fluctuate significantly.
The market price of our common stock has been subject to significant
fluctuations since the date of our initial public offering in June 2000. These
fluctuations could continue. Factors that could affect our stock price include:
.. economic and stock market conditions generally and specifically as they may
impact participants in the communication industry;
.. earnings and other announcements by, and changes in market evaluations of,
participants in the optical communication industry;
.. changes in financial estimates and recommendations by securities analysts
following our stock;
.. announcements or implementation by us or our competitors of technical
innovations or new products; and
.. strategic moves by us or our competitors, such as acquisitions.
In addition, the securities of many companies have experienced extreme
price and volume fluctuations in recent years, often unrelated to the companies'
operating performance. Specifically, market prices for securities of technology
related companies have frequently reached elevated levels, often following their
initial public offerings. These levels may not be sustainable and may not bear
any relationship to these companies' operating performances.
Provisions in our charter documents and Delaware law may delay or prevent an
acquisition of our company, which could decrease the value of your shares.
Our restated certificate of incorporation and bylaws and Delaware law
contain provisions that could make it more difficult for a third party to
acquire us without the consent of our board of directors. These provisions
include a classified board of directors and limitations on actions by our
stockholders by written consent. In addition, our board of directors has the
right to issue preferred stock without stockholder approval, which could be used
to dilute the stock ownership of a potential hostile acquiror. Delaware law also
imposes some restrictions on mergers and business combinations between us and
any holder of 15% or more of our outstanding common stock. These provisions
apply even if the offer may be considered beneficial by some stockholders.
-25-
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is subject to certain market risks, including foreign currency
and interest rates. Although certain of our subsidiaries enter into transactions
in currencies other than their functional currency, foreign currency exposures
arising from these transactions are not material to us. The primary foreign
currency exposure arises from the translation of our net equity investment in
our foreign subsidiaries to U.S. dollars. We generally view as long-term our
investments in foreign subsidiaries with functional currencies other than the
U.S. dollar. The primary currencies to which we are exposed are the pound
sterling and Chinese renminbi.
The Company does not have exposure to interest rate risk related to its
debt obligations because the interest rates are fixed. The Company's market risk
is the potential loss of income from the reduction in interest rates from the
renewal of short-term investments. The Company has experienced such reductions
in these rates during fiscal year 2002 and the first nine months of fiscal 2003.
ITEM 4. DISCLOSURE AND CONTROL PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures. Our management,
including our Chief Executive Officer and Chief Financial Officer, within 90
days prior to the filing date of this quarterly report have conducted an
evaluation of the effectiveness of disclosure controls and procedures pursuant
to Rule 13a-14 promulgated under the Securities Exchange Act of 1934. Based on
that evaluation, our Chief Executive Officer and Chief Financial Officer
concluded that the disclosure controls and procedures were adequate and designed
to ensure that all material information required to be filed in this quarterly
report has been made known to them in a timely fashion.
(b) Changes in Internal Controls. There have been no significant changes in
internal controls, or in factors that could significantly affect internal
controls, subsequent to the date our Chief Executive Officer and Chief Financial
Officer completed their evaluation, including any corrective actions with regard
to significant deficiencies and material weaknesses.
-26-
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
From time to time, we become involved in various lawsuits and legal
proceedings that arise in the normal course of business. Litigation is subject
to inherent uncertainties and an adverse result in a lawsuit may harm our
business, financial condition or results of operation. Our management believes
that the resolution of these lawsuits and legal proceedings will not have a
significant effect on our business, financial condition or results of operation.
The Company and certain of its directors and executive officers have been
named as defendants in purported class action lawsuits filed in the United
States District Court, Southern District of New York. The first of these
lawsuits, filed on July 25, 2001, is captioned Kucera v. Stratos Lightwave, Inc.
et. al., No. 01 CV 6821. Three other similar lawsuits have also been filed
against the Company and certain of its directors and executive officers. The
complaints also name as defendants the underwriters for the Company's initial
public offering. The complaints are substantially identical to numerous other
complaints filed against other companies that went public over the last several
years. The complaints generally allege, among other things, that the
registration statement and prospectus from the Company's June 26, 2000 initial
public offering failed to disclose certain alleged actions by the underwriters
for the offering. The complaints charge the Company and two or three of its
directors and executive officers with violations of Sections 11 and 15 of the
Securities Act of 1933, as amended, and/or Sections 10(b) and Section 20(a) of
the Securities Exchange Act of 1934, as amended. The complaints also allege
claims solely against the underwriting defendants under Section 12(a)(2) of the
Securities Act of 1933, as amended. We believe that these lawsuits are without
merit and intend to defend them vigorously.
In June 2002, Catherine Lego, as representative of the former stockholders
of Tsunami Optics, Inc. filed a lawsuit against the Company in the Superior
Court of California, City and County of Santa Clara, relating to the Company's
acquisition of Tsunami Optics, Inc. in February 2002. In August 2002, the
lawsuit was removed to the United States District Court for the Northern
District of California. The complaint alleges, among other things, that the
Company breached the acquisition agreement by failing and refusing to allow
Tsunami to operate as a separate subsidiary in the ordinary course and by firing
the Tsunami executives necessary to operate the business in the ordinary course,
making it impossible for Tsunami to achieve the potential earn-out payment of up
to $18 million provided for in the acquisition agreement. The complaint also
alleges failure of consideration in connection with the acquisition agreement,
and breach of covenants of good faith and fair dealing. Plaintiff is seeking a
declaratory judgment that the Company has materially breached the agreement and
$18 million in damages or, in the alternative, rescission of the acquisition
agreement. The Company has filed various affirmative defenses to this lawsuit.
In addition, the Company has filed a cross complaint against James P. Campbell
and Catherine Lego, individually. In its cross-complaint, the Company seeks
declaratory judgment that it has the right to make changes in Tsunami's business
under the agreement for the Tsunami acquisition. The cross-complaint also
includes claims against Lego and Campbell for fraud and breach of contract for
misrepresentations made by them to the Company in connection with the Tsunami
acquisition and a claim for breach of fiduciary duty against Campbell. The
cross-complaint seeks compensatory and punitive damages. We believe that this
lawsuit is without merit and intend to defend these claims vigorously.
In August 2002, James Campbell filed a separate lawsuit against the Company
in the Superior court of California, County of Santa Clara, alleging breach of
contract, fraud, violation of the implied covenant of good faith and fair
dealing, age discrimination and wrongful termination in violation of public
policy. Campbell seeks unspecified damages, punitive damages and attorneys'
fees. We believe that this lawsuit is without merit and intend to vigorously
defend against these claims.
-27-
We are plaintiffs in several lawsuits relating to our intellectual property
rights. The defendants in these lawsuits include Infineon Technologies Corp. in
the U.S. District Court for the Northern District of California and E2O, Inc.
and Picolight, Inc. in the District Court for the District of Delaware. In these
actions, Stratos alleges that optoelectronic products sold by the defendants
infringe upon up to nine of our patents. We are seeking monetary damages and
injunctive relief. The defendants in these lawsuits have filed various
affirmative defenses and contend that the patents are invalid, unenforceable
and/or not infringed by the products sold by the defendants and, if successful,
are seeking attorneys' fees and costs in connection with the lawsuits. In
addition, Picolight has filed counterclaims alleging that products sold by us
infringe Picolight patents. We intend to pursue these lawsuits and defend
against these counterclaims vigorously.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
Stratos Lightwave's registration statement on Form S-1 filed under the
Securities Act of 1933, Commission File No. 333-34864, was declared effective by
the Commission on June 26, 2000. A total of 10,062,500 shares of our common
stock were registered pursuant to this registration statement. The managing
underwriters for the offering were Lehman Brothers, CIBC World Markets, U.S.
Bancorp Piper Jaffray, Robert W. Baird & Co., Tucker Anthony Cleary Gull, and
Fidelity Capital Markets, a division of National Financial Services Corporation.
The offering commenced on June 26, 2000 and has been completed. All
10,062,500 registered shares, including 1,312,500 shares sold upon exercise of
the underwriters' over allotment option, were sold by Stratos Lightwave at an
initial public offering price of $21.00 per share. The aggregate underwriting
discount paid in connection with the offering was $14,791,875.
The net proceeds from the offering, after deducting the underwriting
discount and the estimated offering expenses to be paid by Stratos Lightwave,
were approximately $195 million. Uses of proceeds to date include $109.9 million
for general corporate purposes and the purchase of equipment and facilities,
payments of $17.1 million in connection with various acquisitions, repayment of
$2.7 million of advances from a Methode subsidiary, and $333,000 for repayment
of a note assumed in connection with the acquisition of our Stratos Ltd.
subsidiary. The remainder of the proceeds will be used for acquisitions and
general corporate purposes, including working capital, capital expenditures, and
research and development. Pending these uses, the remaining net proceeds have
been invested in short-term interest bearing, investment grade marketable
securities.
Other than the repayment of advances from a Methode subsidiary described
above and the payment of the additional purchase price described above in
connection with our Stratos Lightwave-Florida acquisition which was paid to two
of our officers (and the payment of salaries and expense reimbursements to
employees in the ordinary course of business), none of the net proceeds of the
offering have been paid, directly or indirectly, to any Stratos Lightwave
director or officer or any of their associates, to any persons owning 10% or
more of our common stock, or to any Stratos Lightwave affiliate.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits. Please see the Exhibit Index following the signature page.
(b) Reports on Form 8-K. A current report on Form 8-K was filed on November
11, 2002 to report that the Company had regained compliance with Nasdaq
continuing listing requirements. No other reports on Form 8-K were filed by the
Registrant in the three months ended January 31, 2003.
-28-
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Dated: March 17, 2003 Stratos Lightwave, Inc.
By: /s/ James W. McGinley
--------------------------------------------
James W. McGinley
President and Chief Executive Officer
By: /s/ David A. Slack
--------------------------------------------
David A. Slack
Chief Financial Officer
(Principal Financial and Accounting Officer)
-29-
CERTIFICATION
I, James W. McGinley, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Stratos Lightwave,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Dated: March 17, 2003 /s/ James W. McGinley
-------------------------------------
James W. McGinley
President and Chief Executive Officer
-30-
CERTIFICATION
I, David A. Slack, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Stratos Lightwave,
Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated subsidiaries,
is made known to us by others within those entities, particularly during the
period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of
the disclosure controls and procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee of
registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls
which could adversely affect the registrant's ability to record, process,
summarize and report financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Dated: March 17, 2003 /s/ David A. Slack
-----------------------
David A. Slack
Chief Financial Officer
-31-
EXHIBIT INDEX
Exhibit
Number Description of Document
- ------ -----------------------
3.1 Certificate of Incorporation of Registrant (1)
3.2 Restated Certificate of Incorporation of Registrant (1)
3.3 Certificate of Amendment to Restated Certificate of Incorporation (8)
3.4 Bylaws of the Registrant (1)
3.5 Certificate of Designation of Series A Junior Participating Preferred
Stock, included as Exhibit A to Exhibit 4.2
4.1 Specimen certificate representing the common stock (1)
4.2 Rights Agreement, dated as of March 23, 2001, between Stratos
Lightwave, Inc. and Mellon Investor Services LLC (2)
10.1 Master Separation Agreement between Methode Electronics, Inc. and
Registrant (1)
10.2 Initial Public Offering and Distribution Agreement between Methode
Electronics, Inc. and Registrant (3)
10.3 Tax Sharing and Indemnification Agreement between Methode
Electronics, Inc. and Registrant (3)
10.4 Master Transitional Services Agreement between Methode Electronics,
Inc. and Registrant (1)
10.5 General Assignment and Assumption Agreement between Methode
Electronics, Inc. and Stratos Lightwave, LLC (1)
10.6 Form of Indemnity Agreement between Registrant and Registrant's
directors and officers (1)
10.7 Stratos Lightwave, Inc. 2000 Stock Plan, as amended and restated (4)
10.8 Agreement and Plan of Reorganization, dated January 22, 2002, by and
among the Registrant, Tundra Acquisition Corp. and Tsunami Optics,
Inc. (5)
10.9 Stratos Lightwave, Inc. 2002 Stock Plan for Acquired Companies (6)
10.10 Agreement and Plan of Reorganization, dated March 22, 2002, by and
among the Registrant, Polar Acquisition Corp. and Paracer, Inc. (7)
10.11 Management Retention Agreement between the Registrant and James
McGinley (8)
10.12 Management Retention Agreement between the Registrant and David A.
Slack (8)
10.13 Management Retention Agreement between the Registrant and Robert
Scharf (8)
10.14 Management Retention Agreement between the Registrant and Richard
Durrant (8)
10.15 Stratos Lightwave, Inc. Severance Plan (8)
99.1 Certification of Periodic Financial Report Pursuant to 18 U.S.C.
Section 1350 *
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(1) Incorporated by reference to the Registrant's Registration Statement on
Form S-1 effective June 26, 2000.
(2) Incorporated by reference to the Registrant's Form 8-K dated March 22,
2001.
(3) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
for the quarter ended July 31, 2000.
(4) Incorporated by reference to the Registrant's Annual Report on Form 10-K
for the year ended April 30, 2001.
(5) Incorporated by reference to the Registrant's Form 8-K dated February 15,
2002.
(6) Incorporated by reference to the Registrant's Registration Statement on
Form S-8 dated January 31, 2002.
(7) Incorporated by reference to the Registrant's Form 8-K dated April 12,
2002.
(8) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q
for the quarter ended October 31, 2002.
* Filed herewith
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