UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

(Mark One)

Commission file number 000-27999

Finisar Corporation

Registrant’s telephone number, including area code:
408-548-1000

Common Stock, $.001 par value
(Title of Class)

     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 þ No o

     Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes þ  No o

     At March 1, 2005, there were 258,776,589 shares of the registrant’s common stock, $.001 par value, issued and outstanding.

INDEX TO QUARTERLY REPORT ON FORM 10-Q
For the Quarter Ended January 31, 2005

2

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

FINISAR CORPORATION

See accompanying notes

3

FINISAR CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

See accompanying notes.

4

FINISAR CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

See accompanying notes.

5

FINISAR CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

1. Summary of Significant Accounting Policies

Description of Business

Finisar Corporation was incorporated in the state of California on April 17, 1987. In November 1999, Finisar Corporation reincorporated in the state of Delaware. Finisar Corporation designs, manufactures, and markets optical subsystems and components and network test and monitoring systems for high-speed data communications. Optical subsystems consist primarily of transceivers sold to manufacturers of storage and networking equipment for storage area networks (SAN), local area networks (LAN) and metropolitan access networks (MAN) applications. Optical subsystems also include multiplexers, demultiplexers and optical add/drop modules used in MAN applications. Optical components consist primarily of packaged lasers and photodetectors which are incorporated in transceivers, primarily for LAN and SAN applications.

Interim Financial Information and Basis of Presentation

     The accompanying unaudited condensed consolidated financial statements as of January 31, 2005, and for the three and nine month periods ended January 31, 2005 and 2004, have been prepared in accordance with U.S generally accepted accounting principles for interim financial statements and pursuant to the rules and regulations of the Securities and Exchange Commission, and include the accounts of Finisar Corporation and its wholly-owned subsidiaries (collectively, “Finisar” or the “Company”). Intercompany accounts and transactions have been eliminated in consolidation. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with U.S generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the Company’s financial position at January 31, 2005 and its operating results and cash flows for the nine-month periods ended January 31, 2005 and 2004. These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s audited financial statements and notes for the fiscal year ended April 30, 2004.

     The balance sheet at April 30, 2004 has been derived from the audited consolidated financial statements at that date, but does not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements.

Fiscal Periods

     The Company maintains its financial records on the basis of a fiscal year ending on April 30, with fiscal quarters ending on the Sunday closest to the end of the period (thirteen-week periods). For ease of reference, all references to period end dates have been presented as though the period ended on the last day of the calendar month. The first three quarters of fiscal 2005 ended on August 1, 2004, October 31, 2004 and January 30, 2005, respectively. The first three quarters of fiscal 2004 ended on July 27, 2003, October 26, 2003 and January 25, 2004, respectively.

 Use of Estimates

     The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from these estimates.

 Revenue Recognition

     The Company’s revenue transactions consist predominately of sales of products to customers. The Company follows SEC Staff Accounting Bulletin (SAB) No. 104 Revenue Recognition. Specifically, the Company recognizes revenue when persuasive evidence of an arrangement exists, title and risk of loss have passed to the customer, generally upon shipment, the price is fixed or determinable

6

and collectability is reasonably assured. For those arrangements with multiple elements, or in related arrangements with the same customer, the Company invoices and charges for each separate element based on the list price for such element.

     At the time revenue is recognized, the Company establishes an accrual for estimated warranty expenses associated with sales, recorded as a component of cost of revenues. The Company’s customers and distributors generally do not have return rights.

However, the Company has established an allowance for estimated customer returns, based on historical experience, which is netted against revenue.

  Segment Reporting

     Statement of Financial Accounting Standards (SFAS) No. 131 Disclosures about Segments of an Enterprise and Related Information establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports. SFAS 131 also establishes standards for related disclosures about products and services, geographic areas and major customers. The Company has determined that it operates in two segments consisting of optical subsystems and components and network test and monitoring systems.

  Concentrations of Credit Risk

     Financial instruments which potentially subject Finisar to concentrations of credit risk include cash, cash equivalents, short-term and restricted investments and accounts receivable. Finisar places its cash, cash equivalents and short-term and restricted investments with high-credit quality financial institutions. Such investments are generally in excess of FDIC insurance limits. Concentrations of credit risk, with respect to accounts receivable, exist to the extent of amounts presented in the financial statements. Generally, Finisar does not require collateral or other security to support customer receivables. Finisar performs periodic credit evaluations of its customers and maintains an allowance for potential credit losses based on historical experience and other information available to management. Losses to date have been within management’s expectations. At January 31, 2005, one optical subsystems and components customer represented 21.4% of total accounts receivable. At April 30, 2004, one optical subsystems and components customer represented 12.2% of total accounts receivable.

  Current Vulnerabilities Due to Certain Concentrations

     Finisar sells products primarily to customers located in North America. During the three and nine months ended January 31, 2005, sales to one optical subsystems and components customer represented 35.8% and 30.4% of total revenues, respectively. During the three and nine months ended January 31, 2004, sales to one optical subsystems and components customer represented 26.3% and 22.1% of total revenues, respectively. No other customer represented more than 10% of sales in any of these periods.

  Foreign Currency Translation

     The functional currency of our foreign subsidiaries is the local currency. Assets and liabilities denominated in foreign currencies are translated using the exchange rate on the balance sheet dates. Revenues and expenses are translated using average exchange rates prevailing during the year. Any translation adjustments resulting from this process are shown separately as a component of accumulated other comprehensive income. Foreign currency transaction gains and losses are included in the determination of net loss.

  Research and Development

     Research and development expenditures are charged to operations as incurred.

  Advertising Costs

     Advertising costs are expensed as incurred. Advertising is used infrequently in marketing the Company’s products. Advertising costs were $135,000 and $514,000 in the three and nine months ended January 31, 2005, respectively. Advertising costs were $24,000 and $106,000 in the three and nine months ended January 31, 2004, respectively.

7

  Shipping and Handling Costs

     The Company records costs related to shipping and handling in cost of sales for all periods presented.

  Cash and Cash Equivalents

     Finisar’s cash equivalents consist of money market funds and highly liquid short-term investments with qualified financial institutions. Finisar considers all highly liquid investments with an original maturity from the date of purchase of three months or less to be cash equivalents.

  Investments

 Short-Term

     Short-term investments consist of interest bearing securities with maturities of greater than 90 days from the date of purchase and an equity security. Pursuant to SFAS No. 115 Accounting for Certain Investments in Debt and Equity Securities, the Company has classified its short-term investments as available-for-sale. Available-for-sale securities are stated at market value, which approximates fair value, and unrealized holding gains and losses, net of the related tax effect, are excluded from earnings and are reported as a separate component of accumulated other comprehensive income until realized. A decline in the market value of the security below cost, that is deemed other than temporary, is charged to earnings, resulting in the establishment of a new cost basis for the security.

  Restricted Investments

     Restricted investments consist of interest bearing securities with maturities of greater than three months from the date of purchase and investments held in escrow under the terms of the Company’s convertible subordinated notes. In accordance with SFAS 115, the Company has classified its restricted investments as held-to-maturity. Held-to-maturity securities are stated at amortized cost.

  Other

     The Company uses the cost method of accounting for investments in companies that do not have a readily determinable fair value in which it holds an interest of less than 20% and over which it does not have the ability to exercise significant influence. For entities in which the Company holds an interest of greater than 20% or in which the Company does have the ability to exercise significant influence, the Company uses the equity method. In determining if and when a decline in the market value of these investments below their carrying value is other-than-temporary, the Company evaluates the market conditions, offering prices, trends of earnings and cash flows, price multiples, prospects for liquidity and other key measures of performance. The Company’s policy is to recognize an impairment in the value of its minority equity investments when clear evidence of an impairment exists, such as (a) the completion of a new equity financing that may indicate a new value for the investment, (b) the failure to complete a new equity financing arrangement after seeking to raise additional funds or (c) the commencement of proceedings under which the assets of the business may be placed in receivership or liquidated to satisfy the claims of debt and equity stakeholders. The Company’s minority investments in private companies are generally made in exchange for preferred stock with a liquidation preference that is intended to help protect the underlying value of its investment.

  Fair Value of Financial Instruments

     The carrying amounts of certain of the Company’s financial instruments, including cash and cash equivalents, accounts receivable, accounts payable, accrued compensation and other accrued liabilities, approximate fair value because of their short maturities. As of January 31, 2005 and April 30, 2004, the fair value of the Company’s convertible subordinated debt was approximately $232.6 million and $230.2 million, respectively.

  Inventories

     Inventories are stated at the lower of cost (determined on a first-in, first-out basis) or market.

     The Company permanently writes down the cost of inventory that the Company specifically identifies and considers obsolete or excessive to fulfill future sales estimates. The Company defines obsolete inventory as inventory that will no longer be used in the manufacturing process. Excess inventory is generally defined as inventory in excess of projected usage, and is determined using management’s best estimate of future demand at the time, based upon information then available to the Company. The Company uses a twelve-month historical usage model to compute excess inventory and, in addition to the historical usage model, the Company also

8

considers: (1) forecast demand (2) parts and subassemblies that can be used in alternative finished products, (3) parts and subassemblies that are likely to be engineered out of the Company’s products, and (4) known design changes which would reduce the Company’s ability to use the inventory as planned.

  Property, Equipment and Improvements

     Property, equipment and improvements are stated at cost, net of accumulated depreciation and amortization. Property, plant, equipment and improvements are depreciated on a straight-line basis over the estimated useful lives of the assets, generally three years to seven years except for buildings, which are depreciated over 40 years. Land is carried at acquisition cost and not depreciated. Leased land is depreciated over the life of the lease.

  Goodwill and Other Intangible Assets

     Goodwill and other intangible assets result from acquisitions accounted for under the purchase method. Amortization of intangibles has been provided on a straight-line basis over periods ranging from one to nine years. The amortization of goodwill ceased with the adoption of SFAS No. 142 beginning in the first quarter of fiscal 2003.

  Accounting for the Impairment of Long-Lived Assets

     The Company periodically evaluates whether changes have occurred to long-lived assets that would require revision of the remaining estimated useful life of the property, improvements and assigned intangible assets or render them not recoverable. If such circumstances arise, the Company uses an estimate of the undiscounted value of expected future operating cash flows to determine whether the long-lived assets are impaired. If the aggregate undiscounted cash flows are less than the carrying amount of the assets, the resulting impairment charge to be recorded is calculated based on the excess of the carrying value of the assets over the fair value of such assets, with the fair value determined based on an estimate of discounted future cash flows.

  Stock-Based Compensation

     Finisar accounts for employee stock option grants in accordance with Accounting Principles Board (APB) Opinion No. 25 Accounting for Stock Issued to Employees and complies with the disclosure provisions of SFAS No. 123 Accounting for Stock-Based Compensation and SFAS No. 148 Accounting for Stock-based Compensation — Transition and Disclosure. The Company accounts for stock issued to non-employees in accordance with provisions of SFAS No. 123 and Emerging Issues Task Force Issue No. 96-18, Accounting for Equity Investments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services.

     The following table illustrates the effect on net loss and loss per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to employee stock benefits, including shares issued under the Company’s stock option plans and Employee Stock Purchase Plan (collectively “options”). For purposes of these pro forma disclosures, the estimated fair value of the options is assumed to be amortized to expense over the options’ vesting periods and the amortization of deferred compensation has been added back. Pro forma information follows (in thousands, except per share amounts):

9

     The fair value of the Company’s stock option grants prior to the Company’s initial public offering was estimated at the date of grant using the minimum value option valuation model. The fair value of the Company’s stock options grants subsequent to the initial public offering was determined using the Black-Scholes valuation model based on the actual stock closing price on the day previous to the date of grant. These option valuation models were developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions. Because Finisar’s stock-based awards have characteristics significantly different from those of traded options and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock-based awards.

     The fair value of these options at the date of grant was estimated using the following weighted-average assumptions for the three months ended January 31, 2005. For stock options grants the Company used a risk-free interest rate of 3.69%, a volatility factor of 1.144, a weighted-average expected life of the option of 3.84 and a dividend yield of 0%. For the employee stock purchase plan the Company used: risk-free interest rate of 2.85%, a dividend yield of 0%, a volatility factor of 0.99, and a weighted-average expected life of the option of 0.46 years.

     The fair value of these options at the date of grant was estimated using the following weighted-average assumptions for the three and nine month periods ended January 31, 2004. For stock options grants we used: risk-free interest rates of 2.14% for both periods; a volatility factor of 0.79 and 0.89, respectively; a weighted-average expected life of the option of 3.60 for both periods; and a dividend yield of 0% for both periods. For our employee stock purchase plan the Company used: risk-free interest rates of 2.14% and 1.35%, respectively; a volatility factor of 0.79 and 1.13, respectively; a weighted-average expected life of the option of 0.75 and 0.58, respectively; and a dividend yield of 0% for both periods.

  Net Loss Per Share

     Basic and diluted net loss per share is presented in accordance with SFAS No. 128 Earnings Per Share for all periods presented. Basic net loss per share has been computed using the weighted-average number of shares of common stock outstanding during the period. Diluted net loss per share has been computed using the weighted-average number of shares of common stock and dilutive potential common shares from options and warrants (under the treasury stock method), convertible redeemable preferred stock (on an if-converted basis) and convertible notes (on an as-if-converted basis) outstanding during the period.

     The following table presents the calculation of basic and diluted net loss per share (in thousands, except per share amounts):

10

     Excluded from the above listing of potentially dilutive securities are the shares of common stock to be issued upon conversion of the convertible promissory note issued during the three months ended October 31, 2004 as consideration for the purchase of assets of Data Transit Corp. Due to the uncertainty surrounding the timing of conversion, and the fact that conversion price is not fixed, the Company is unable at this time to accurately estimate the number of shares of common stock that will be issued upon conversion of the convertible promissory note.

  Comprehensive Income

     SFAS No. 130 Reporting Comprehensive Income establishes rules for reporting and display of comprehensive income and its components. SFAS No. 130 requires unrealized gains or losses on the Company’s available-for-sale securities and foreign currency translation adjustments to be included in comprehensive income.

     The components of comprehensive loss for the three and nine months ended January 31, 2005 and 2004 are as follows (in thousands):

     The components of accumulated other comprehensive income, net of taxes, were as follows (in thousands):

2. Acquisition of Assets of Data Transit Corp.

     On August 6, 2004, the Company completed the purchase of substantially all of the assets of Data Transit Corp. in exchange for a cash payment of $500,000 and the issuance of a convertible promissory note in the original principal amount of $16,270,000. Transaction costs totalled $682,000. The original principal amount of the convertible promissory note is adjustable downward by up to $3,188,375 should the acquired business fail to achieve certain business integration milestones. The principal balance of the note bears interest at 8% per annum and is due and payable, if not sooner converted, on the second anniversary of its issuance. Generally, the terms of the convertible promissory note provide for automatic conversion of the outstanding principal and interest into shares of the Company’s common stock on a biweekly basis, commencing on the later of the effectiveness of a registration statement covering the resale of the shares or one year after the closing date. The conversion price is the average closing bid price of the stock for the three days preceding the date of conversion. The amount of principal and interest to be converted on each conversion date is based on the average trading volume of the Company’s common stock over the preceding 14 days. The Company agreed to file a registration statement with the Securities and Exchange Commission to cover the resale of the shares of common stock issuable upon conversion of the convertible promissory note. In reliance on the exemption from registration set forth in Section 4(2) of the Securities Act of 1933 (the “Securities Act”), the issuance of the convertible promissory note and the shares of the Company’s common stock issuable upon conversion of the convertible promissory note were not registered under the Securities Act.

11

     The following is a summary of the initial purchase price allocation for this asset acquisition including $682,000 of transaction costs (in thousands):

     The amounts allocated to in-process research and development (“IPRD”) were determined through established valuation techniques in the high-technology industry and were expensed upon acquisition because technological feasibility had not been established and no future alternative uses existed. Research and development costs to bring the products from the acquired assets to technological feasibility are not expected to have a material impact on the Company’s future results of operations or cash flows. Goodwill represents the excess of purchase consideration over the fair value of the assets, including identifiable intangible assets, net of the fair value of liabilities assumed. Intangible assets related to the acquisition, excluding goodwill, are amortized to expense on a straight-line basis over their estimated useful lives ranging from one to nine years.

3. Loans Related to Acquisition of Assets from New Focus, Inc.

     In partial consideration for the purchase of certain assets of New Focus, Inc. for a total value of $12.1 million in May 2002, the Company delivered to New Focus a non-interest bearing convertible promissory note in the principal amount of $6.75 million. On August 9, 2002, the note was converted into 4,027,446 shares of common stock. Payments of $1.4 million in August 2003, and $2.0 million in September 2004, were made to pay down minimum commitments to New Focus under a royalty arrangement entered into in connection with the acquisition. The remaining minimum commitment with respect to royalty payments totaling $2.0 million will be paid in August 2005. Because such payments are not fixed in time, they were not discounted as otherwise required under APB Opinion No. 21.

4. Inventories

     Inventories consist of the following (in thousands):

     During the three and nine months ended January 31, 2005, the Company recorded charges of $2.2 million and $10.0 million, respectively, for excess and obsolete inventory and sold inventory that was written-off in previous periods with an approximate cost of $2.7 million and $7.5 million, respectively. As a result, cost of revenue associated with the sale of this inventory was zero.

     During the three and nine months ended January 31, 2004, the Company recorded charges of $2.2 million and $18.8 million, respectively, for excess and obsolete inventory and sold inventory that was written-off in previous periods with an approximate cost of $5.6 million and $13.5 million, respectively. As a result, cost of revenue associated with the sale of this inventory was zero.

5. Property, Plant, Equipment and Improvements

     Property, plant, equipment and improvements consist of the following (in thousands):

12

6. Impairment of Assets

     During the quarter ended January 31, 2005, the Company recorded an impairment charge of $18.8 million to write down the carrying value of one of its corporate office facilities located in Sunnyvale, California upon entering into a sale-leaseback agreement. The property was written down to its appraised value, which was based on the work of an independent appraiser in conjunction with the sale-leaseback agreement. Due to retention by the Company of an option to acquire the leased properties at fair value at the end of the fifth year of the lease, the sale-leaseback transaction will be accounted for in the Company’s fourth quarter ending April 30, 2005 as a financing transaction under which the sale will not be recorded until the option expires or is otherwise terminated.

7. Income Taxes

     The Company recorded a provision for income taxes of $0 and $57,000 for the quarter and nine months, respectively, ended January 31, 2005 compared to $43,000 and $289,000 for the quarter and nine months, respectively, ended January 31, 2004. The provision in fiscal 2005 resulted from current year state minimum tax payments and foreign income taxes netted against the return of certain state payments made in fiscal 2004 in excess of the fiscal 2004 final state tax liability. The provision for income taxes in fiscal 2004 primarily consisted of state minimum taxes.

     Realization of deferred tax assets is dependent upon future taxable income, if any, the amount and timing of which are uncertain. Accordingly, the net deferred tax assets as of January 31, 2005 have been fully offset by a valuation allowance. The Company does not expect to record any tax benefit for future operating losses that may be sustained in fiscal 2005.

     A portion of the valuation allowance at January 31, 2005 related to stock option deductions that are not currently realizable and will be credited to paid-in capital if and when realized. The remaining portion of the valuation allowance, when realized, will first reduce unamortized goodwill, then other non-current intangible assets of acquired subsidiaries and then income tax expense. There can be no assurance that deferred tax assets subject to the valuation allowance will be realized.

     Utilization of the Company’s net operating loss and tax credit carryforwards may be subject to a substantial annual limitation due to the ownership change limitations set forth by Internal Revenue Code Section 382 and similar state provisions. Such an annual limitation could result in the expiration of the net operating loss and tax credit carryforwards before utilization.

8. Deferred Stock Compensation

     In connection with the grant of certain stock options to employees, Finisar recorded deferred stock compensation prior to the Company’s initial public offering, representing the difference between the deemed value of the Company’s common stock for accounting purposes and the option exercise price of these options at the date of grant. During fiscal 2001 and fiscal 2002, the Company recorded additional deferred compensation related to the assumption of stock options associated with companies acquired during those years. Deferred stock compensation is presented as a reduction of stockholders’ equity, with graded amortization recorded over the five-year vesting period. The amortization expense relates to options awarded to employees in all operating expense categories. The following table summarizes the amount of deferred stock compensation expense which Finisar has recorded and the amortization it has recorded and expects to record in future periods in connection with grants of certain stock options to employees during fiscal 1999 and 2000 and assumptions of stock options associated with companies acquired during fiscal 2001 and 2002. Amounts to be recorded in future periods could decrease if options for which accrued but unvested compensation have been recorded are forfeited (in thousands):

13

9. Purchased Intangible Assets Including Goodwill

     During fiscal 2004, the Company recorded additional goodwill in the optical subsystems and components reporting unit in the amount of $147,000 as a result of payments made upon the achievement of certain milestones specified in the acquisition agreement under which the Company acquired Transwave Fiber, Inc. (“Transwave”), and $40.6 million in conjunction with the acquisition of the Honeywell VCSEL Optical Products business unit.

     During the first quarter of fiscal 2005, the Company recorded additional goodwill in the optical subsystems and components reporting unit in the amount of $256,000 as a result of payments made upon the achievement of certain milestones specified in the Transwave acquisition agreement. The Company also recorded an additional $7,000 in conjunction with the acquisition of the Honeywell VCSEL Optical Products business unit.

     During the second quarter of fiscal 2005, as a result of the acquisition of assets from Data Transit Corp., the Company recorded goodwill in the network test and monitoring systems reporting unit in the amount of $6.2 million as well as additional purchased technology and trade name assets in the amount of $8.5 million and $758,000, respectively. The Company also recorded an additional $32,000 of goodwill in conjunction with the acquisition of the Honeywell VCSEL Optical Products business unit.

     During the third quarter of fiscal 2005, the Company recorded additional goodwill in the network test and monitoring systems reporting unit in the amount of $163,000 in conjunction with the acquisition of Data Transit Corp.

     The following table reflects the changes in the carrying amount of goodwill by reporting unit (in thousands):

     The following table reflects intangible assets subject to amortization as of January 31, 2005 and April 30, 2004 (in thousands):

14

     During the second quarter of fiscal 2005, the Company determined that the remaining intangible assets related to certain purchased passive optical technology, related to the Company’s acquisition of certain assets of New Focus, Inc., had a fair value of zero. Accordingly, an impairment charge of $3.7 million was recorded against the remaining net book value of these assets.

     Estimated remaining amortization expense for each of the next five fiscal years ending April 30, is as follows (dollars in thousands):

10. Available-For-Sale Investments

     The following is a summary of the Company’s available-for-sale investments as of January 31, 2005 and April 30, 2004 (in thousands):

     The gross realized gains (losses) for the three and nine months ended January 31, 2005 were ($13,000) and $15,000, respectively. The gross realized gains (losses)for the three and nine months ended January 31, 2004 were ($23,000) and $410,000, respectively. The gross realized gains (losses) were immaterial for each of these periods. Realized gains and losses were calculated based on the specific identification method.

15

Restricted Securities

     The Company has purchased and pledged to a collateral agent, as security for the exclusive benefit of the holders of the Company’s 2 1/2% convertible subordinated notes, U.S. government securities, which will be sufficient upon receipt of scheduled principal and interest payments thereon, to provide for the payment in full of the first eight scheduled interest payments due on each series of notes. These restricted securities are classified as held to maturity and are held on the Company’s consolidated balance sheet at amortized cost. The following table summarizes the Company’s restricted securities as of January 31, 2005 and April 30, 2004 (in thousands):

  Cost Method Investments

     Included in minority investments at January 31, 2005 and April 30, 2004 are cost method investments of $17.5 million and $16.5 million, respectively. Minority investments at April 30, 2004 represents the carrying value of the Company’s minority investments in four privately held companies accounted for under the cost method. During the quarter ended October 31, 2004, the Company made an investment of $1.0 million in a privately held company accounted for under the cost method.

  Equity Method Investments

     Included in minority investments at January 31, 2005 and April 30, 2004 are $6.5 million and $7.7 million, respectively, representing the carrying value of the Company’s minority investment in one private company, Quintessence Photonics, accounted for under the equity method. During the three and nine months ended January 31, 2005, the Company recorded expenses of $430,000 and $1,223,000, respectively, representing our share of the loss of the investee, which was classified as other income/(expense), net. During the three and nine months ended January 31, 2004, the Company recorded expenses of $454,000 and $928,000, respectively.

16

11. Segments and Geographic Information

     The Company designs, develops, manufactures and markets optical subsystems, components and test and monitoring systems for high-speed data communications. The Company views its business as having two principal operating segments, consisting of optical subsystems and components and network test and monitoring systems. Optical subsystems consist primarily of transceivers sold to manufacturers of storage and networking equipment for storage area networks (SAN), local area networks (LAN), and metropolitan access networks (MAN) applications. Optical subsystems also include multiplexers, demultiplexers and optical add/drop modules used in MAN applications. Optical components consist primarily of packaged lasers and photodetectors which are incorporated in transceivers, primarily for LAN and SAN applications. Network test and monitoring systems include products designed to test the reliability and performance of equipment for a variety of protocols including Fibre Channel, Gigabit Ethernet, 10 Gigabit Ethernet, iSCSI, SAS, and SATA. These test and monitoring systems are sold to both manufacturers and end-users of the equipment.

     The Company’s operating segments report to the President and Chief Executive Officer. Where appropriate, the Company charges specific costs to these segments where they can be identified and allocates certain manufacturing costs, research and development, sales and marketing and general and administrative costs to these operating segments, primarily on the basis of manpower levels or a percentage of sales. The Company does not allocate income taxes, non-operating income, acquisition related costs, stock compensation, interest income and interest expense to its operating segments. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. There are no intersegment sales.

     Information about reportable segment revenues and income are as follows (in thousands):

     The following is a summary of total assets by segment (in thousands):

     Short-term, restricted and minority investments are the primary components of other assets in the above table.

17

     The following is a summary of operations within geographic areas based on the location of the entity purchasing the Company’s products (in thousands):

     Revenues generated in the U.S. are all from sales to customers located in the United States.

     The following is a summary of long-lived assets within geographic areas based on the location of the assets (in thousands):

     The following is a summary of capital expenditures by reportable segment (in thousands):

12. Warranty

     The Company offers a one-year limited warranty for all of its products. The specific terms and conditions of these warranties vary depending upon the product sold. The Company estimates the costs that may be incurred under its basic limited warranty and records a liability in the amount of such costs based on revenue recognized. Factors that affect the Company’s warranty liability include the number of units sold, historical and anticipated rates of warranty claims and cost per claim. The Company periodically assesses the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary.

     Changes in the Company’s warranty liability during the following period were as follows (in thousands):

18

13. Restructuring

     As of January 31, 2005, $392,000 of committed facilities payments, net of anticipated sublease income, remains accrued and is expected to be fully utilized by fiscal 2006. This amount relates to restructuring activities in fiscal 2003 and remains in other accrued liabilities for payment in future periods as follows (in thousands):

19

14. Pending Litigation

     A securities class action lawsuit was filed on November 30, 2001 in the United States District Court for the Southern District of New York, purportedly on behalf of all persons who purchased the Company’s common stock from November 17, 1999 through December 6, 2000. The complaint named as defendants Finisar, Jerry S. Rawls, the Company’s President and Chief Executive Officer, Frank H. Levinson, the Company’s Chairman of the Board and Chief Technical Officer, Stephen K. Workman, the Company’s Senior Vice President and Chief Financial Officer, and an investment banking firm that served as an underwriter for the Company’s initial public offering in November 1999 and a secondary offering in April 2000. The complaint, as subsequently amended, alleges violations of Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20(b) of the Securities Exchange Act of 1934, on the grounds that the prospectuses incorporated in the registration statements for the offerings failed to disclose, among other things, that (i) the underwriter had solicited and received excessive and undisclosed commissions from certain investors in exchange for which the underwriter allocated to those investors material portions of the shares of the Company’s stock sold in the offerings and (ii) the underwriter had entered into agreements with customers whereby the underwriter agreed to allocate shares of the Company’s stock sold in the offerings to those customers in exchange for which the customers agreed to purchase additional shares of the Company’s stock in the aftermarket at pre-determined prices. No specific damages are claimed. Similar allegations have been made in lawsuits relating to more than 300 other initial public offerings conducted in 1999 and 2000, which were consolidated for pretrial purposes. In October 2002, all claims against the individual defendants were dismissed without prejudice. On February 19, 2003, the Court denied the Company’s motion to dismiss the complaint. In July 2004, the Company and the individual defendants accepted a settlement proposal made to all of the issuer defendants. Under the terms of the settlement, the plaintiffs will dismiss and release all claims against participating defendants in exchange for a contingent payment guaranty by the insurance companies collectively responsible for insuring the issuers in all the related cases, and the assignment or surrender to the plaintiffs of certain claims the issuer defendants may have against the underwriters. Under the guaranty, the insurers will be required to pay the amount, if any, by which $1 billion exceeds the aggregate amount ultimately collected by the plaintiffs from the underwriter defendants in all the cases. If the plaintiffs fail to recover $1 billion and payment is required under the guaranty, the Company would be responsible to pay its pro rata portion of the shortfall, up to the amount of the self-insured retention under its insurance policy, which may be up to $2 million. The timing and amount of payments that the Company could be required to make under the proposed settlement will depend on several factors, principally the timing and amount of any payment by the insurers pursuant to the $1 billion guaranty. The settlement is subject to approval of the Court, which cannot be assured. If the settlement is not approved by the Court, the Company intends to defend the lawsuit vigorously. However, the litigation is in the preliminary stage, and the Company cannot predict its outcome. The litigation process is inherently uncertain. If litigation proceeds and its outcome is adverse to the Company and if the Company is required to pay significant monetary damages, the Company’s business would be significantly harmed.

15. Guarantees and Indemnifications

     In November 2002, the FASB issued Interpretation No. 45 Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (“FIN 45”). FIN 45 requires that upon issuance of a guarantee, the guarantor must recognize a liability for the fair value of the obligations it assumes under that guarantee. As permitted under Delaware law and in accordance with the Company’s Bylaws, the Company indemnifies its officers and directors for certain events or occurrences, subject to certain limits, while the officer or director is or was serving at the Company’s request in such capacity. The term of the indemnification period is for the officer’s or director’s lifetime. The Company may terminate the indemnification agreements with its officers and directors upon 90 days written notice, but termination will not affect claims for indemnification relating to events occurring prior to the effective date of termination. The maximum amount of potential future indemnification is unlimited; however, the Company has a director and officer insurance policy that may enable it to recover a portion of any future amounts paid.

     The Company enters into indemnification obligations under its agreements with other companies in its ordinary course of business, including agreements with customers, business partners, and insurers. Under these provisions the Company generally indemnifies and holds harmless the indemnified party for losses suffered or incurred by the indemnified party as a result of the Company’s activities or the use of the Company’s products. These indemnification provisions generally survive termination of the underlying agreement. In some cases, the maximum potential amount of future payments the Company could be required to make under these indemnification provisions is unlimited.

     The Company believes the fair value of these indemnification agreements is minimal. Accordingly, the Company has not recorded any liabilities for these agreements as of January 31, 2005. To date, the Company has not incurred material costs to defend lawsuits or settle claims related to these indemnification agreements.

20

16. Sales of Accounts Receivable

     On October 29, 2004, the Company entered into an agreement with Silicon Valley Bank to sell certain trade receivables. In these non-recourse sales, the Company removes the sold receivables from its books and records no liability related to the sale, as the Company has assessed that the sales should be accounted for as “true sales” in accordance with SFAS No. 140 Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. During the three and nine months ended January 31, 2005, the Company sold approximately $4.7 million and $8.7 million, respectively, of its trade receivables to Silicon Valley Bank under the terms of this agreement.

17. Subsequent Events

     On February 4, 2005, the Company completed a sale-leaseback transaction on one of its corporate office facilities located in Sunnyvale, California. As a result of this transaction, the Company raised $12.0 million in cash. Due to retention by the Company of an option to acquire the leased properties at fair value at the end of the fifth year of the lease, the sale-leaseback transaction will be accounted for in the Company’s fourth quarter ending April 30, 2005 as a financing transaction under which the sale will not be recorded until the option expires or is otherwise terminated.

     On April 29, 2004, the Company entered into an agreement with Infineon Technologies AG to acquire Infineon’s fiber optics business unit. On October 11, 2004, the Company entered into an amended purchase agreement under which the terms of the acquisition were modified. On January 25, 2005, the Company and Infineon terminated the amended purchase agreement and entered into a new agreement under which the Company acquired certain assets of Infineon’s fiber optics business unit associated with the design, development and manufacture of optical transceiver and transponder products in exchange for 34 million shares of the Company’s common stock. The closing of the acquisition took place on January 31, 2005, the first day of our fourth fiscal quarter. The transaction involved the acquisition of product lines, equipment and intellectual property related to Infineon’s optical transceiver and transponder products. The Company did not acquire any employees or assume any liabilities as part of the acquisition, except for obligations under customer contracts. The 34 million shares of the Company’s common stock issued to Infineon were valued at approximately $59.5 million at the closing and represent approximately 13% of the outstanding shares of the Company’s common stock.

     The acquisition was accounted for as a purchase and, accordingly, the results of operations of the acquired assets (beginning with the closing date of the acquisition) and the estimated fair value of assets acquired will be included in the Company’s consolidated financial statements beginning in the fourth quarter of fiscal 2005 ending April 30, 2005.

     On March 2, 2005, the Company entered into an agreement to acquire InterSAN, Inc. InterSAN is a privately held company located in Scotts Valley, California. Under the terms of the agreement, InterSAN will merge with a wholly-owned subsidiary of Finisar and the holders of InterSAN’s securities will be entitled to receive shares of Finisar common stock having a value of approximately $9.5 million, subject to adjustment as provided in the Agreement. The transaction, which is expected to close in the quarter ending July 31, 2005, will be accounted for as a purchase and is intended to qualify as a tax-free reorganization. Ten percent (10%) of the shares of the Company’s common stock that would otherwise be distributed to the holders of InterSAN’s securities will be deposited into an escrow account for twelve (12) months following the closing to satisfy certain indemnification obligations of the InterSAN stockholders.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     The following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ substantially from those anticipated in these forward-looking statements as a result of many factors, including those set forth below under “Factors That Could Affect Our Future Performance.” The following discussion should be read together with our consolidated financial statements and related notes thereto included elsewhere in this report.

Overview

     We were incorporated in 1987 and funded our initial product development efforts largely through revenues derived under research and development contracts. After shipping our first products in 1991, we continued to finance our operations principally through internal cash flow and periodic bank borrowings until November 1998. At that time we raised $5.6 million of net proceeds from the sale of equity securities and bank borrowings to fund the continued growth and development of our business. In November 1999, we received net proceeds of $151.0 million from the initial public offering of shares of our common stock, and in April 2000 we received $190.6 million from an additional public offering of shares of our common stock. In October 2001, we sold $125 million aggregate

21

principal amount of 5 1/4% convertible subordinated notes due October 15, 2008, and in October 2003, we sold $150 million aggregate principal amount of 2 1/2% convertible subordinated notes due October 15, 2010.

     Since October 2000, we have acquired a number of companies and certain businesses and assets of other companies in order to broaden our product offerings and provide new sources of revenue, production capabilities and access to advanced technologies that we believe will enable us to reduce our product costs and develop innovative and more highly integrated product platforms while accelerating the timeframe required to develop such products.

     In October 2002, we sold our subsidiary, Sensors Unlimited, Inc. to a new company organized by a management group led by Dr. Greg Olsen, then an officer and director of Finisar and a former majority owner of Sensors Unlimited. The intellectual property developed after the acquisition of Sensors Unlimited was transferred to other operations within Finisar. In November 2002, we discontinued a product line at our Demeter Technologies subsidiary that was not making a significant contribution to our operating results and was no longer considered a key part of our product strategy. Certain assets of Demeter Technologies were sold in conjunction with the product line discontinuation. In April 2003, we acquired Genoa Corporation and announced the closure of Demeter Technologies and the consolidation of all active device development and wafer fabrication operations into the Genoa facility. The consolidation was completed in fiscal 2004. During the second quarter of fiscal 2004, we completed the closure of our German facility. The intellectual property, technical know-how and certain assets related to the German operations were consolidated with our operations in Sunnyvale, California, during the second quarter of fiscal 2004.

     The principal strategic goal of most of our acquisitions to date related to our optical subsystems and components business has been to gain access to leading-edge technology for the manufacture of optical components in order to improve the performance and reduce the cost of our optical subsystem products. We have also sold these optical components on a stand-alone basis to other manufacturers; however, prior to our acquisition of Honeywell International Inc.’s VCSEL Optical Products business unit in March 2004, the sale of these components into this so-called “merchant market” had not been a strategic priority, and our revenues from the sale of optical subsystems and components consisted predominantly of subsystems sales. As a result of the Honeywell acquisition, we are now selling vertical cavity surface emitting lasers, or VCSELs, in the merchant market, and we intend to evaluate opportunities to increase the sale of these and other components in the merchant market. The principal strategic goal of most of our acquisitions to date related to our network test and monitoring business has been to broaden our product portfolio and to gain access to new distribution channels. The acquisition of assets and intellectual property of Data Transit, Inc., in August 2004, was the most recent example of our pursuit of this strategy. As a result of this acquisition, we expanded our product offerings for SAN test, analysis and monitoring tools to include additional products which test and monitor storage networks using the SAS and SATA protocols.

     To date, our revenues have been principally derived from sales of our optical subsystems to networking and storage systems manufacturers and sales of our network performance test systems to these manufacturers as well as end users. Optical subsystems consist primarily of transceivers sold to manufacturers of storage and networking equipment for SANs, LANs, and MAN applications. A large proportion of our sales are concentrated with a relatively small number of customers. Although we are attempting to expand our customer base, we expect that significant customer concentration will continue for the foreseeable future.

     We recognize revenue when persuasive evidence of an arrangement exists, title and risk of loss pass to the customer, which is generally upon shipment, the price is fixed or determinable and collectability is reasonably assured. For those arrangements with multiple elements, or in related arrangements with the same customer, we allocate revenue to the separate elements based upon each element’s fair value as determined by the list price for such element.

     We sell our products through our direct sales force, with the support of our manufacturers’ representatives, directly to domestic customers and indirectly through distribution channels to international customers. The evaluation and qualification cycle prior to the initial sale for our optical subsystems may span a year or more, while the sales cycle for our test and monitoring systems is usually considerably shorter.

     The market for optical subsystems and components is characterized by declining average selling prices resulting from factors such as industry over-capacity, increased competition, the introduction of new products and the growth in unit volumes as manufacturers continue to deploy network and storage systems. We anticipate that our average selling prices will continue to decrease in future periods, although the timing and amount of these decreases cannot be predicted with any certainty.

     Our cost of revenues consists of materials, salaries and related expenses for manufacturing personnel, manufacturing overhead, warranty expense, inventory adjustments for obsolete and excess inventory and the amortization of acquired developed technology associated with acquisitions that we have made. Historically, we have outsourced the majority of our assembly operations. However,

22

in fiscal 2002, we commenced manufacturing of our optical subsystem products at our subsidiary in Ipoh, Malaysia. We conduct component manufacturing, manufacturing engineering, supply chain management, quality assurance and documentation control at our facilities in Sunnyvale, California and Richardson, Texas and at our subsidiaries’ facilities in Fremont, California, Shanghai, China and Ipoh, Malaysia. With the transition of most of our production to Malaysia and the added manufacturing infrastructure associated with several acquisitions completed during the past two years, our cost structure has become more fixed, making it more difficult to reduce costs during periods when demand for our products is weak, product mix is unfavorable or selling prices are generally lower. While we undertook measures to reduce our operating costs during fiscal 2003 and 2004, there can be no assurance that we will be able to reduce our cost of revenues enough to achieve or sustain profitability during periods of weak demand or when average selling prices are low.

     Our gross profit margins vary among our product families, and are generally higher on our network test and monitoring systems than on our optical subsystems and components. Our overall gross margins have fluctuated from period to period as a result of overall revenue levels, shifts in product mix, the introduction of new products, decreases in average selling prices and our ability to reduce product costs.

     Research and development expenses consist primarily of salaries and related expenses for design engineers and other technical personnel, the cost of developing prototypes and fees paid to consultants. We charge all research and development expenses to operations as incurred. We believe that continued investment in research and development is critical to our long-term success.

     Sales and marketing expenses consist primarily of commissions paid to manufacturers’ representatives, salaries and related expenses for personnel engaged in sales, marketing and field support activities and other costs associated with the promotion of our products.

     General and administrative expenses consist primarily of salaries and related expenses for administrative, finance and human resources personnel, professional fees, and other corporate expenses.

     In connection with the grant of stock options to employees between August 1, 1998 and October 15, 1999, we recorded deferred stock compensation representing the difference between the deemed value of our common stock for accounting purposes and the exercise price of these options at the date of grant. In connection with the assumption of stock options previously granted to employees of companies we acquired, we recorded deferred compensation representing the difference between the fair market value of our common stock on the date of closing of each acquisition and the exercise price of the unvested portion of options granted by those companies which we assumed. Deferred stock compensation is presented as a reduction of stockholder’s equity, with accelerated amortization recorded over the vesting period, which is typically three to five years. The amount of deferred stock compensation expense to be recorded in future periods could decrease if options for which accrued but unvested compensation has been recorded are forfeited prior to vesting and could increase if we modify the terms of an option grant resulting in a new measurement date.

     Acquired in-process research and development represents the amount of the purchase price in a business combination allocated to research and development projects underway at the acquired company that had not reached the technologically feasible stage as of the closing of the acquisition and for which we had no alternative future use.

     A portion of the purchase price in a business combination is allocated to goodwill and intangibles. Prior to May 1, 2002, goodwill and purchased intangibles were amortized over their estimated useful lives. Subsequent to May 1, 2002, goodwill and intangible assets with indefinite lives are no longer amortized but subject to annual impairment testing.

     Restructuring costs generally include termination costs for employees associated with a formal restructuring plan and the cost of facilities or other unusable assets abandoned or sold.

     Other acquisition costs primarily consist of incentive payments for employee retention included in certain of the purchase agreements of companies we acquired and costs incurred in connection with transactions that were not completed.

     Other income and expenses generally consist of bank fees, gains or losses as a result of the periodic sale of assets and other-than-temporary decline in the value of investments.

23

Recent Acquisitions

Acquisition of Honeywell VCSEL Optical Products Business

     On March 1, 2004, we completed the acquisition of Honeywell International Inc.’s VCSEL Optical Products business unit for a purchase price and transaction expenses totaling approximately $80.9 million in cash and $1.2 million in our common stock. The acquisition was accounted for under the purchase method of accounting. The results of operations of this business unit, which we now refer to as our Advanced Optical Components Division, are included in our consolidated financial statements beginning on March 1, 2004.

Acquisition of Assets of Data Transit Corp.

     On August 6, 2004, we completed the purchase of substantially all of the assets of Data Transit Corp. in exchange for a cash payment of $500,000 and the issuance of a convertible promissory note in the original principal amount of $16,270,000. Transaction costs totaled $682,000. The original principal amount of the convertible promissory note is adjustable downward by up to $3,188,375 should the acquired business fail to achieve certain business integration milestones. The principal balance of the note bears interest at 8% per annum and is due and payable, if not sooner converted, on the second anniversary of its issuance. Generally, the terms of the convertible promissory note provide for automatic conversion of the outstanding principal and interest into shares of our common stock on a biweekly basis, commencing on the later of the effectiveness of a registration statement covering the resale of the shares or one year after the closing date. The conversion price is the average closing bid price of the stock for the three days preceding the date of conversion. The amount of principal and interest to be converted on each conversion date is based on the average trading volume of our common stock over the preceding 14 days. We agreed to file a registration statement with the Securities and Exchange Commission to cover the resale of the shares of common stock issuable upon conversion of the convertible promissory note. In reliance on the exemption from registration set forth in Section 4(2) of the Securities Act of 1933 (the “Securities Act”), the issuance of the convertible promissory note and the shares of our common stock issuable upon conversion of the convertible promissory note were not registered under the Securities Act.

Acquisition of Transceiver and Transponder Product Line From Infineon

     On April 29, 2004, we entered into an agreement with Infineon Technologies AG to acquire Infineon’s fiber optics business unit. On October 11, 2004, we entered into an amended purchase agreement under which the terms of the acquisition were modified. On January 25, 2005, we and Infineon terminated the amended purchase agreement and entered into a new agreement under which we acquired certain assets of Infineon’s fiber optics business unit associated with the design, development and manufacture of optical transceiver and transponder products in exchange for 34 million shares of our common stock. The closing of the acquisition took place on January 31, 2005, the first day of our fourth fiscal quarter. The transaction involved the acquisition of product lines, equipment and intellectual property related to Infineon’s optical transceiver and transponder products. We did not acquire any employees or assume any liabilities as part of the acquisition, except for obligations under customer contracts. The 34 million shares of our common stock issued to Infineon were valued at approximately $59.5 million at the closing and represent approximately 13% of the outstanding shares of our common stock.

     The acquisition was accounted for as a purchase and, accordingly, the results of operations of the acquired assets (beginning with the closing date of the acquisition) and the estimated fair value of assets acquired will be included in our consolidated financial statements beginning in the fourth quarter of fiscal 2005 ending April 30, 2005.

Critical Accounting Policies

     There have been no material changes to our critical accounting policies, which are included in our Annual Report on Form 10-K for the year ended April 30, 2004.

24

Results of Operations

     The following table sets forth certain statement of operations data as a percentage of revenues for the periods indicated:

     Revenues. Revenues increased $26.7 million, or 57.5%, to $73.1 million in the three months ended January 31, 2005 compared to $46.4 million in the three months ended January 31, 2004. Most of this increase was due to a $22.7 million, or 55.7%, increase in sales of optical subsystems and components, to $63.4 million in the three months ended January 31, 2005 compared to $40.7 million in the three months ended January 31, 2004. Approximately $5.9 million of the increase in sales of optical subsystems and components was related to sales made by our Advanced Optical Components division (“AOC”) acquired from Honeywell International, Inc. on March 2, 2004, $5.5 million was from increased sales of products for short distance LAN/SAN applications and $11.3 million was from increased sales of products for longer distance MAN and telecom applications. The increase in revenues from the sale of these products was primarily the result of increased unit sales, partially offset by a decrease in average selling prices. Sales of network test and monitoring systems increased by $4.0 million, or 70.3%, to $9.7 million in the three months ended January 31, 2005 compared to $5.7 million in the three months ended January 31, 2004. Approximately $2.0 million of this increase was related to sales of products in product lines acquired from Data Transit in August 2004. Excluding the impact of the Data Transit acquisition, total revenues for the three months ended January 31, 2005 increased by $24.7 million, or 53.2% over the comparable period of fiscal 2004.

     On a year-to-date basis, revenues increased $77.4 million, or 60.1%, to $206.0 million in the nine months ended January 31, 2005 compared to $128.6 million in the nine months ended January 31, 2004. Most of this increase was due to a $65.7 million, or 59.0%, increase in sales of optical subsystems and components, to $ 177.1 million in the nine months ended January 31, 2005 compared to $ 111.4 million in the nine months ended January 31, 2004. Approximately $23.1 million of the increase in sales of optical subsystems and components was related to sales by AOC, $13.6 million was from increased sales of products for short distance LAN/SAN applications and $40.7 million was from increased sales for longer distance applications. The increase in revenues from the sale of these products was primarily the result of increased unit sales, partially offset by a decrease in average selling prices. Sales of network test and monitoring systems increased to $28.9 million in the nine months ended January 31, 2005 compared to $17.3 million in the nine months ended January 31, 2004. Approximately $5.0 million of this increase was related to sales of products in product lines acquired from Data Transit with the remainder due to increased sales of new test and monitoring equipment used in the development of Fibre Channel SANs operating at 2 and 4 Gbps. Excluding the impact of the Data Transit acquisition, total revenues for the nine months ended January 31, 2005 increased by $72.4 million, or 56.3% over the comparable period of fiscal 2004.

25

     Gross Profit. Gross profit increased $7.7 million, or 85.8%, to $16.7 million in the three months ended January 31, 2005 compared to $9.0 million in the three months ended January 31, 2004. Gross profit as a percentage of total revenue increased to 22.8% in the three months ended January 31, 2005 compared to 19.4% in the three months ended January 31, 2004. During the three months ended January 31, 2005 and January 31, 2004, we recorded charges of $2.2 million for obsolete and excess inventory and sold inventory that was written-off in previous periods resulting in a benefit of $2.7 million in the three months ended January 31, 2005, and $5.6 million in the three months ended January 31, 2004. As a result, we recognized a net benefit of $500,000 related to excess and obsolete inventory in the three months ended January 31, 2005, compared to a net benefit of $3.4 million in the three months ended January 31, 2004. Excluding the impact of the amortization of acquired developed technology and impairments thereon and the net impact of excess and obsolete inventory, gross profit would have been $21.6 million, or 29.5% of revenue in the three months ended January 31, 2005, compared to $10.2 million, or 22.1% of revenue, in the three months ended January 31, 2004. This increase in gross profit as a percent of revenues for the three months ended January 31, 2005 was primarily due to an increase in unit sales across all of our product lines, which spread our fixed overhead costs over a higher production volume and a favorable product mix shift where we experienced a significant increase in sales of products for longer distance MAN and telecom applications that typically have higher margins than our products for shorter distance LAN/SAN applications as well as increased sales of network test and monitoring systems that have higher margins than optical subsystems and components.

     Year to date, gross profit increased $25.7 million, or 192.1%, to $39.1 million in the nine months ended January 31, 2005 compared to $13.4 million in the nine months ended January 31, 2004. Gross profit as a percentage of total revenue was 19.0% in the nine months ended January 31, 2005 compared to 10.4% in the nine months ended January 31, 2004. We recorded charges of $10.0 million for obsolete and excess inventory in the nine months ended January 31, 2005, and $18.8 million during the nine months ended January 31, 2004. We sold inventory that was written-off in previous periods resulting in a benefit of $7.5 million in the nine months ended January 31, 2005, and $13.5 million in the nine months ended January 31, 2004. As a result, we recognized a net charge of $2.5 million related to excess and obsolete inventory in the nine months ended January 31, 2005, compared to a net charge of $5.3 million in the nine months ended January 31, 2004. Excluding the impact of the amortization of acquired developed technology and impairments thereon and the net impact of excess and obsolete inventory, gross profit would have been $62.3 million, or 30.3% of revenue, for the nine months ended January 31, 2005, compared to $32.6 million, or 25.4% of revenue, for the nine months ended January 31, 2004. This increase in gross profit as a percent of revenues for the nine months ended January 31, 2005 was for the same reasons as the increase for the most recent quarter discussed above.

     Amortization of Acquired Developed Technology. Amortization of acquired developed technology is associated with several acquisitions completed during fiscal years 2001 through October 2004. Amortization of acquired developed technology increased $720,000, or 15.5%, to $5.4 million in the three months ended January 31, 2005 compared to $4.7 million in the three months ended January 31, 2004 and increased $6.7 million, or 48.1%, to $20.7 million in the nine months ended January 31, 2005 compared to $14.0 million in the nine months ended January 31, 2004. The increase for the three months ended January 31, 2005 was due to the addition of $910,000 of amortization of acquired developed technology related to our acquisition of the Honeywell VCSEL Optical Products business unit in March 2004, and $520,000 of amortization of acquired developed technology related to our purchase of assets of Data Transit in August 2004. The increase was partially offset by the removal of $710,000 of amortization of acquired developed technology related to certain passive optical technology associated with our acquisition of assets of New Focus, Inc. in May 2002, for which we recorded an impairment charge in October 2004. The increase for the nine months ended January 31, 2005 was primarily due to an impairment charge of $3.7 million recorded in October 2004 to write-off the remaining net book value of certain passive optical technology associated with our acquisition of assets of New Focus, Inc. in May 2002. Our acquisitions of the Honeywell VCSEL Optical Products business unit in March 2004 and our purchase of assets of Data Transit in August 2004, contributed $2.7 million and $1.0 million, respectively, to the increases as well.

     Research and Development Expenses. Research and development expenses increased $1.7 million, or 13.1%, to $14.5 million in the three months ended January 31, 2005 compared to $12.8 million in the three months ended January 31, 2004. The increase was primarily due to the addition of $1.1 million of expenses associated with the operations of the Honeywell VCSEL Optical Products business acquired in March 2004, and additional spending to develop higher speed optical subsystems and components. Research and development expenses increased $194,000, or 0.4%, to $47.7 million in the nine months ended January 31, 2005 compared to $47.5 million in the nine months ended January 31, 2004. Research and development expenses decreased as a percentage of revenue to 19.9% in the three months ended January 31, 2005 compared to 27.7% in the three months ended January 31, 2004 and decreased as a percentage of revenue to 23.1% in the nine months ended January 31, 2005 compared to 36.9% in the nine months ended January 31, 2004 due to increased revenue as a result of increased unit sales.

     Sales and Marketing Expenses. Sales and marketing expenses increased $2.3 million, or 46.4%, to $7.2 million in the three months ended January 31, 2005 compared to $4.9 million in the three months ended January 31, 2004. Sales and marketing expenses increased $8.1 million, or 59.1%, to $21.9 million in the nine months ended January 31, 2005 compared to $13.8 million in the nine months ended January 31, 2004. The increases were primarily due to increases in salaries and commissions related to our increased revenues. Sales and marketing expenses as a percentage of revenue was 9.8% in the three months ended January 31, 2005 compared to 10.6% in the three months ended January 31, 2004. Sales and marketing expense as a percentage of revenue was 10.6% in the nine months ended January 31, 2005 compared to 10.7% in the nine months ended January 31, 2004.

     General and Administrative Expenses. General and administrative expenses increased $1.0 million, or 21.2%, to $5.5 million in the three months ended January 31, 2005 compared to $4.5 million in the three months ended January 31, 2004. General and administrative expenses increased $2.4 million, or 18.1%, to $15.2 million in the nine months ended January 31, 2005 compared to $12.8 million in the nine months ended January 31, 2004. This increase was primarily related to additional expenses associated with the acquisition of the Honeywell VCSEL Optical Products business in March 2004 and an increase in legal expenses associated with

26

efforts to license our intellectual property. General and administrative expenses decreased as a percent of revenues to 7.5% in the three months ended January 31, 2005 compared to 9.7% in the three months ended January 31, 2004 and decreased as a percent of revenues to 7.4% in the nine months ended January 31, 2005 compared to 10.0% in the nine months ended January 31, 2004 due to increased revenue as a result of increased unit sales.

     Amortization of Deferred Stock Compensation. Amortization of deferred stock compensation decreased $94,000 to $21,000 in the three months ended January 31, 2005 compared to $115,000 in the three months ended January 31, 2004. Amortization of deferred stock compensation increased $380,000 to $142,000 in the nine months ended January 31, 2005 compared to a benefit of $238,000 in the nine months ended January 31, 2004. This increase was related to the termination of employees in the nine months ended January 31, 2004, with deferred compensation associated with their stock options and the effects of the graded vested method of amortization which accelerates the amortization of deferred compensation.

     Restructuring Costs. During the quarter ended January 31, 2004, we incurred a benefit from the reversal of certain restructuring accruals of $1.2 million, due to lower than anticipated fees from the termination of a contractual obligation related to the closure of our Demeter subsidiary. For the nine months ended January 31, 2004, restructuring costs of $1.2 million included $2.4 million incurred in the first half of fiscal 2004 related to the completion of consolidating our facilities and operations located at our Demeter subsidiary in El Monte, California into our facilities in Fremont, California, and additional restructuring expenses related to the closing of our facility in Munich, Germany, offset by the third quarter benefit described above.

     Impairment of Assets. During the quarter ended January 31, 2005, we recorded an impairment charge of $18.8 million to write down the carrying value of one of our corporate office facilities located in Sunnyvale, California upon entering into a sale-leaseback agreement. The property was written down to its appraised value, which was based on the work of an independent appraiser in conjunction with the sale-leaseback agreement. Due to retention by us of an option to acquire the leased properties at fair value at the end of the fifth year of the lease, the sale-leaseback transaction will be accounted for in our fourth quarter ending April 30, 2005 as a financing transaction under which the sale will not be recorded until the option expires or is otherwise terminated.

     Interest Income. Interest income decreased $243,000, or 30.2%, to $561,000 in the three months ended January 31, 2005 compared to $804,000 in the three months ended January 31, 2004. Interest income decreased $616,000, or 26.5%, to $1.7 million in the nine months ended January 31, 2005 compared to $2.3 million in the nine months ended January 31, 2004. The decreases in interest income reflect reductions in cash, cash equivalents and short-term investments.

     Interest Expense. Interest expense increased $533,000, or 16.0%, to $3.8 million in the three months ended January 31, 2005 compared to $3.3 million in the three months ended January 31, 2004. This increase was primarily due to the addition of interest expense related to the convertible promissory note issued in August 2004 in connection with our acquisition of certain assets of Data Transit Corp. Interest expense decreased $14.6 million, or 57.5%, to $10.8 million in the nine months ended January 31, 2005 compared to $25.4 million in the nine months ended January 31, 2004. Included in interest expense in the nine months ended January 31, 2004 was a non-cash charge of $10.8 million associated with the exchange of $22.8 million in principal amount of our convertible notes for common stock in privately negotiated transactions concluded during this six-month period. Also, amortization of the discount on our convertible notes decreased $6.0 million, to $3.2 million in the nine months ended January 31, 2005, compared to $9.2 million in the nine months ended January 31, 2004, due to the reduction in balance of our convertible notes. These decreases in interest expense for the nine months ended January 31, 2005 were partially offset by interest on the convertible promissory note issued in August 2004 in connection with the Data Transit Corp. acquisition.