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SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

Commission file number 0-30869

STRATOS LIGHTWAVE, INC.

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)

Not Applicable

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  o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).

         Yes  x  No  o

As of September 12, 2003, there were 7,368,261 shares of the Registrant’s common stock outstanding.

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STRATOS LIGHTWAVE, INC.

INDEX

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PART I

Item 1.     Financial Statements.

STRATOS LIGHTWAVE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands)

See notes to condensed consolidated financial statements.

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STRATOS LIGHTWAVE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(in thousands, except per share amounts)

Net loss per share for three months ended July 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.

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STRATOS LIGHTWAVE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(in thousands)

See notes to condensed consolidated financial statements.

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STRATOS LIGHTWAVE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

July 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 period ended July 31, 2003 are not necessarily indicative of the results that may be expected for the year ending April 30, 2004. 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, 2003 included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission.

     Comprehensive loss consists of net loss and foreign currency translation adjustments and totaled $28,772,000 and $7,353,000 for the first quarters of fiscal 2003 and 2004.

     Recent Accounting Pronouncements

     In June 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (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 fiscal 2003, was not accounted for under SFAS No. 146. The Company accrued a pre-tax charge of approximately $1.0 million in the first quarter of fiscal 2003 when Company management approved the current restructuring plan. If the Company had accounted for this restructuring plan under SFAS No. 146, $706,000 of the $1.0 million charge would have been recognized as incurred and not accrued at July 31, 2002.

     In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation Transaction 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 adopted these disclosure requirements beginning in fiscal 2003. See Note 9 for the disclosure required by SFAS 148.

     In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. This statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments

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embedded in other contracts. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003. The Company does not expect that the adoption of this statement will have a material effect on the Company’s financial statements.

     In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. The Company does not expect that the adoption of this statement will have a material effect on the Company’s financial statements.

     In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin (ARB) No. 51 (FIN 46), which requires variable interest entities (commonly referred to as SPEs) to be consolidated by the primary beneficiary of the entity if certain criteria are met. FIN 46 is effective immediately for all new variable interest entities created or acquired after January 31, 2003. For variable interest entities created or acquired prior to February 1, 2003, the provisions of FIN 46 became effective for the Company during its third quarter 2003. The Company has no variable interest entities.

2. Goodwill and Other Intangible Assets

     In June 2001, the FASB issued 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 their useful lives. Goodwill amortization expense in fiscal year 2003 was $848,000. The following table discloses pro forma results for net income and earnings per share as if the non-amortization of goodwill provisions of SFAS No. 142 were adopted at the beginning of fiscal year 2002.

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, in fiscal year 2002 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.

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     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.

Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets

     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 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 of 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 $17.0 million. 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 three months ended July 31, 2002. Going forward any additional impairment of goodwill will be recorded in the period the goodwill is determined to be impaired.

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3. Restructuring Charges

     The Company recorded restructuring charges of approximately $1.0 million relating to employee costs in the first quarter of fiscal 2003.

     Accruals related to the restructuring charges and their utilization are summarized as follows:

     The Company terminated 63 employees in the three months ended July 31, 2002 for the restructuring of its operations, including both production and administrative personnel.

4. 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, valuation reserves of $55.2 million were recorded through April 30, 2003, which eliminated the tax benefit attributable to the losses incurred in fiscals 2002 and 2003. We have continued to experience similar reductions in business levels during the three months ended July 31, 2003, and an additional valuation reserve of $2.7 million was recorded, which eliminated the tax benefit attributable to the net loss incurred in the first quarter of fiscal 2004.

     We have net operating loss carry forwards of approximately $121.2 million that are available to offset taxable income in the future. The net operating loss carry forwards will expire in 2022 through 2024.

5. 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 July 31, 2003, information relating to these notes and financing arrangements is as follows:

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6. Loss Per Share

The net loss per share for the three months ended July 31, 2002 is restated to reflect the reverse stock split effective October 21, 2002.

7. Sale of a Business

     Effective May 23, 2003, the Company sold the assets and business of its wholly-owned subsidiary, Bandwith Semiconductor LLC, located in Hudson, New Hampshire. The Company realized a net gain of approximately $1,200,000 which is reflected as a reduction of general and administrative expenses in the statement of operations for the three months ended July 31, 2003.

8. Merger

     Pursuant to a merger agreement dated as of July 2, 2003, the Company agreed to acquire Sterling Holding Company, a privately-held company based in Mesa, Arizona that designs and manufactures RF and Microwave interconnect products via its two operating units, Trompeter Electronics, Inc. and Semflex, Inc. Under the terms of the agreement, Sterling will become a wholly-owned subsidiary of the Company. Sterling shareholders will receive approximately 6.1 million shares of the Company’s common stock and 50,000 shares of the Company’s Series B preferred stock. The preferred stock has a face value of $5.0 million and a contingent value of up to an additional $6.25 million based on certain events, including the future performance of the Company’s share price. The transaction is expected to close in the Company’s third fiscal quarter of 2004 and the parties intend to take the position that the transaction will qualify as a tax-free reorganization. The transaction is subject to approval by both the Company’s and Sterling’s shareholders and other customary conditions. In connection with the transaction, the Company will expand its Board of Directors to nine members. The new board will be comprised of four members of the Company’s current Board, four members from Sterling’s Board, and an additional director chosen by Sterling.

9. Stock-Based Compensation

     In the first quarter of fiscal year 2004, the Company adopted SFAS No. 148, Accounting for Stock-Based Compensation. The Company will continue to account for stock-based compensation plans using the intrinsic value method described in Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. All stock options granted by the Company are granted at market price and thus no compensation expense is recorded in the Company’s results of operations. Under FASB No. 148, the Company is required to report quarterly pro forma net loss and loss per share as if the Company had accounted for its stock options plans under the fair value method. The following table shows the

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Company’s pro forma net loss and loss per share as if the Company had recorded the fair value of stock options as compensation expense.

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).

     Pursuant to a merger agreement dated as of July 2, 2003, the Company agreed to acquire Sterling Holding Company, a privately-held company based in Mesa, Arizona that designs and manufactures RF and Microwave interconnect products via its two operating units, Trompeter Electronics, Inc. and Semflex, Inc. Under the terms of the agreement, Sterling will become a wholly-owned subsidiary of the Company. Sterling shareholders will receive approximately 6.1 million shares of the Company’s common stock and 50,000 shares of the Company’s Series B preferred stock. The preferred stock has a face value of $5.0 million and a contingent value of up to an additional $6.25 million based on certain events, including the future performance of the Company’s share price. The transaction is expected to close in the Company’s third fiscal quarter of 2004 and the parties intend to take the position that the transaction will qualify as a tax-free reorganization. The transaction is subject to approval by both the Company’s and Sterling’s shareholders and other customary conditions. In connection with the transaction, the Company will expand its Board of Directors to nine members. The new board will be comprised of four members of the Company’s current Board, four members from Sterling’s Board, and an additional director chosen by Sterling.

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     Our net sales are derived principally 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.

     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 operating expenses 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

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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. 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 vigorously pursue such opportunities.

     Impairment of Long-Lived Assets

     We review the carrying value of our long-lived assets 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 they may be impaired. If this review indicates that 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.

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     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.

     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 is 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:

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Three Months Ended July 31, 2003 and 2002

     Net Sales. Net sales decreased to $6.6 million in the three months ended July 31, 2003 from $10.7 million in the three months ended July 31, 2002. Of this $4.1 million decrease, $2.9 million is from a decrease in net sales into the storage end market, $740,000 is from a decrease in net sales into the data networking end market and $660,000 is from a decrease in net sales into the telecom/metro end market. These decreases were offset in part by a $200,000 increase in net sales into the military/governmental end market.

     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 $4.7 million as of July 31, 2003 from $5.0 million as of April 30, 2003. 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 $506,000 in the three months ended July 31, 2003 from $207,000 in the three months ended July 31, 2002. The increase relates to the receipt of higher royalties from three licensees in the first quarter of fiscal 2004. License fees consist of both fixed schedule payments and contingent payments based on sales volumes of licensed products.

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     Cost of Sales and Gross Margins. Cost of sales decreased to $7.5 million in the three months ended July 31, 2003 from $10.7 million in the three months ended July 31, 2002. Gross profit as a percentage of net sales, or gross margin, decreased to negative (13.8)% in the three months ended July 31, 2003 from negative (.3)% in the three months ended July 31, 2002. Approximately 10.90 percentage points of the 13.50 percentage point decrease was due to the increase in charges for obsolete and slow moving inventory, 3.85 percentage points was due to employee severance pay related to the restructuring of operations and 3.10 percentage points was due to the decline in sales and the decline in the average selling price for our products. These factors were offset by 4.35 percentage points for the sale of approximately $427,000 of inventory previously considered excess and fully reserved.

     Research and Development. Research and development expenses decreased to $2.9 million in the three months ended July 31, 2003 from $6.7 million in the three months ended July 31, 2002. This decrease of $3.8 million was due primarily to a decrease of $1.5 million in personnel costs dedicated to research and development, a decrease of $1.2 million in material and overhead costs related to major product development projects and a decrease of $1.1 million in the cost of research and development facilities.

     Sales and Marketing. Sales and marketing expenses decreased to $1.5 million in the three months ended July 31, 2003 from $2.2 million for the three months ended July 31, 2002. The $700,000 decrease was due to a $400,000 decrease in sales and marketing salaries, fringe benefits, bonuses and commissions, and a decrease of $300,000 in field sales operating costs supporting our sales.

     General and Administrative. General and administrative expenses decreased to $2.7 million in the three months ended July 31, 2003 from $3.4 million in the three months ended July 31, 2002. This $700,000 decrease was due to a reduction of $500,000 of costs for facilities and staff and a decrease of $200,000 in corporate management and legal costs.

     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 74 days at July 31, 2003 compared to 50 days at April 30, 2003.

     Investment Income, Net. Investment income, net of investment expense, decreased to $240,000 in the three months ended July 31, 2003 from $375,000 million in the three months ended July 31, 2002. Investment income consists of earnings on the short-term investment of excess cash balances and the decrease of this income in fiscal 2004 reflects the reduction of excess cash balances as well as lower interest rates throughout the market place during this period.

     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, valuation reserves of $55.2 million were recorded through April 30, 2003, which eliminated the tax benefit attributable to the losses incurred in fiscal years 2002 and 2003. We have continued to experience similar reductions in business levels during the three months ended July 31, 2003,

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and an additional valuation reserve of $2.7 million was recorded, which eliminated the tax benefit attributable to the net loss incurred in the first quarter of fiscal 2004.

     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 for the three months ended July 31, 2002. See Note 2 to the Consolidated Financial Statements located elsewhere in this filing for further discussion of this item.

Liquidity and Capital Resources

     Net cash used in operating activities totaled $2.5 million for the three months ended July 31, 2003. The use of cash in operating activities resulted primarily from a net loss offset in part by decreases in accounts receivable and inventories and increases in accounts payable and accrued expenses. Net cash used in operating activities totaled $9.7 million for the three months ended July 31, 2002. The use of cash in operating activities resulted primarily from a net loss and decrease in notes payable, accounts payable and accrued expenses offset in part by decreases in accounts receivable and inventories.

     Net cash used in investing activities was $7.6 million in the three months ended July 31, 2003. Net cash used in investing activities related primarily to the purchase of short-term investments and the purchase of equipment and facilities offset in part by the sales of short-term investments and assets held for sale. Net cash provided by investing activities was $1.9 million in the three months ended July 31, 2002. Net cash provided by investing activities related primarily to the sales of short-term investments and assets held for sale offset in part by the purchase of short-term investments and the purchases of equipment and facilities.

     Net cash used in financing activities was $3.6 million and $900,000 in the three months ended July 31, 2002 and 2003, respectively, and represents repayments on borrowings.

     As of July 31, 2003, our principal source of liquidity was approximately $61.2 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. Our only cash commitment is the repayment of long-term debt of approximately $5.7 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.

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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 39% and incurred a net loss of $7.3 million during the three months ended July 31, 2003. We experienced a decrease in net sales of 34% and incurred a net loss of $120.3 million during fiscal 2003. 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;
	•		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;

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	•		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 and components are used primarily in military, video broadcast, industrial, 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 as well as enhancements to existing products and technology in order to remain competitive. If we fail to do so, our products will no longer be competitive 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.

     The development of new, technologically advanced products 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. Further, we cannot assure you that our new products will gain market acceptance or that we will be able to respond effectively to

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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 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 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 were 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 three months ended July 31, 2003, our two largest customers and their respective contract manufacturers accounted for 9.0% of our net sales, with the Procurement Department for the German Ministry of Defense and with Manufacturing Services accounting for 4.8% and 4.2% of our net sales, respectively. For the three months ended July 31, 2002, QLogic and its contract manufacturers accounted for 11% of our net sales. We expect our dependence on sales to a small number of large customers to continue.

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     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 that 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 and components, 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.

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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 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 and components 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 components 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.

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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 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.

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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 subsystems and components 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 was 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 relations 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 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 significant portion of our sales are 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 37.6% of our net sales during the three months ended July 31, 2003 and approximately 39.1% of our net sales during the three months ended July 31, 2002. Our international operations are subject to a number of risks and uncertainties, including:

	•		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;

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	•		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;
	•		the incurrence of debt and contingent liabilities;
	•		potentially dilutive issuances of equity securities;
	•		large one-time write-offs; and
	•		amortization expenses related to goodwill and other 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 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,

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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 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., E20, Inc. and Picolight, 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:

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	•		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.

     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.

     Our common stock has been publicly traded only since June 27, 2000. The market price of our common stock has been subject to significant fluctuations since the date of our initial public offering. 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

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stock. These provisions apply even if the offer may be considered beneficial by some stockholders.

Risks Relating to the Merger with Sterling

We may be unable to successfully integrate the operations of Stratos and Sterling and realize the full cost savings we anticipate.

     The merger involves the integration of two companies that previously operated independently. The difficulties of combining the companies’ operations include:

	•		the necessity of coordinating geographically separated organizations, systems and facilities; and
	•		integrating personnel with diverse business backgrounds and organizational cultures.

     The process of integrating operations could cause an interruption of, or loss of momentum in, the activities of one or more of the combined company’s business and the possible loss of key personnel. The diversion of management’s attention and any delays or difficulties encountered in connection with the merger and the integration of the two companies’ operations could have an adverse effect on the business, results of operations, financial condition or prospects of the combined company after the merger.

     Among the other factors considered by the Stratos and the Sterling boards of directors in connection with their respective approvals of the merger agreement were the opportunities for operating efficiencies that could result from the merger. We cannot give any assurance that these savings will be realized within the time periods contemplated or even that they will be realized at all.

We will incur significant transaction, merger-related and restructuring costs in connection with the merger.

     Stratos expects to incur costs associated with combining the operations of the two companies, transaction fees and other costs related to the merger. The total estimate includes approximately $2.3 million for transaction costs and up to $1,000,000 in legal fees on behalf of Sterling. The estimated $2.3 million of transaction costs will be recorded as a component of the purchase price. Stratos also will incur restructuring and integration costs in connection with the merger. Stratos is in the early stages of making assessments of these costs and at this time is unable to give an estimate of these costs. Depending on the nature of the restructuring activity, certain costs may be included as a liability in the purchase price allocation or as an expense, in accordance with generally accepted accounting principles in the United States. The amount of transaction fees is expected to be incurred is a preliminary estimate and subject to change. Additional unanticipated costs may be incurred in the integration of the businesses of Stratos and Sterling. Although Stratos and Sterling expect that the elimination of duplicative costs, as well as the realization of other efficiencies related to the integration of the businesses, may offset incremental transaction, merger-related and restructuring costs over time, we cannot give any assurance that this net benefit will be achieved in the near term, or at all.

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Charges to earnings resulting from the application of the purchase method of accounting may adversely affect the market value of Stratos’ common stock following the merger.

     In accordance with generally accepted accounting principles in the United States, the merger will be accounted for using the purchase method of accounting, which will result in charges to earnings that could have an adverse impact on the market value of Stratos common stock following completion of the merger. Under the purchase method of accounting, the total estimated purchase price will be allocated to Sterling’s net tangible assets and identifiable intangible assets based on their fair values as of the date of completion of the merger. The excess of the purchase price over those fair values will be recorded as goodwill. The combined company will incur additional amortization expense based on the identifiable intangible assets acquired in connection with the merger. Additionally, to the extent the value of goodwill becomes impaired, the combined company may be required to incur material charges relating to such impairment. These amortization and potential impairment charges could have a material impact on the combined company’s results of operations.

     Stratos estimates the annual amortization expense for these identifiable intangible assets will approximate $1,331,000. Based on Sterling’s amortization expense of approximately $12,000 related to identifiable intangible assets for the year ended December 31, 2002, Stratos will incur approximately $1,343,000 of annual amortization expense after the completion of the merger. Changes in earnings per share, including as a result of this incremental expense, could adversely affect the trading price of the Stratos common stock.

     Risks Relating to the Businesses of Stratos, Sterling and the Combined Company

We may not realize expected benefits from the consolidation of certain Sterling operations into the Mesa, Arizona facility .

     Sterling currently is engaged in a consolidation of the manufacturing operations associated with its electronic interconnect components and assemblies business, and a relocation of the manufacturing operations of its Trompeter subsidiary from Westlake Village, California to Mesa, Arizona. Although we expect this consolidation to be completed by the end of 2003 and anticipate synergies and improved operating performance to result from this consolidation, we cannot guarantee any such benefits. In addition, this consolidation may affect adversely our ability to retain key employees, which could affect adversely our operating results.

Stratos and Sterling are the subject of various legal proceedings that could have a negative impact on the business of the combined company.

     Stratos and Sterling are involved in various litigation matters that arise from time to time in the ordinary course of business. Stratos is a defendant in several lawsuits that are described in Stratos’ Annual Report on Form 10-K for the fiscal year ended April 30, 2003, Sterling is a defendant in a lawsuit filed in the United States District Court for the Eastern District of Washington by Telect, Inc., in which Telect claims that Sterling’s DSX Cross Connect Bay, Panel and Module infringe one of Telect’s parents. Sterling believes that Telect’s claim is without merit and is defending the lawsuit vigorously. If, however, Telect’s claim against Sterling is successful, and if the combined company is unable to (1) license the relevant

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technology on acceptable terms, (2) license a substitute technology or (3) redesign the applicable products to avoid infringement, our business could be harmed. For information about Stratos’ legal proceedings, see Stratos’ Annual Report on Form 10-K for the fiscal year ended April 30, 2003.

The business of Sterling is subject to the following additional risks:

•

Sterling is dependent on sales to the United States government and to the military/aerospace industry.

     Approximately 46% of Sterling’s sales for the year ended December 31, 2002 came from direct and indirect sales for U.S. government and government agency applications and sales to the military/aerospace industry, which is heavily dependent on sales to the U.S. government and government agency applications directly through contracts with the U.S. government and government agencies, and indirectly through distributors and to prime contractors or subcontractors who are building systems or subsystems for the U.S. government. Direct sales under contracts with the U.S. government and government agencies represented approximately 4% of Sterling’s sales of the year ended December 31, 2002. Despite this fact, a significant decline in U.S. government expenditures could have a material adverse effect on sales of the combined company.

•

Sterling is dependent on the communications industry.

     Approximately 29% of Sterling revenues came from sales to the communications industry for the year ended December 31, 2002. The market is dominated by several large manufacturers who regularly exert significant price pressure on their suppliers. We cannot assure you that we will be able to continue to compete successfully in our sales to the communications industry, and our failure to do so would impair our operating results.

     The market for communications equipment is changing rapidly. Our future growth will depend, in part, upon (1) our ability to develop and introduce new products for this market and (2) the growth of the communications equipment market. The growth in the market for communications equipment products and services is dependent on a number of factors, including without limitation:

	§		the amount of capital expenditures by network providers;
	§		regulatory and legal developments;
	§		changes to capital expenditure rates by network providers;
	§		the addition of new customers to the market; and
	§		end-user demand for integrated Internet, data, video, voice and other network services.

     We cannot predict the growth rate of the market for communications equipment products and services. The recent slowdown in the general economy, changes and consolidation in the service provider market and constraints on capital availability have had a material adverse effect on many of our service provider customers, causing some of these customers to go out of business and a number of other customers to substantially reduce their expansion plans and

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purchases. In addition, technological trends and new product developments in this market may adversely affect our product offerings. We also cannot predict whether any new products and services we develop will meet with market acceptance or be profitable. We may not be able to compete successfully and competitive pressures could affect, materially and adversely, our business, operating results and financial condition.

•

Sterling operates in a highly competitive environment.

     The electronic interconnect components and assemblies industries are highly competitive. Sterling competes primarily with Tyco International Ltd., Amphenol Corporation, Kings Electronics Co., Inc., ITT Cannon (a subsidiary of ITT Industries), ADC Telecommunications, Inc., Radiall, S.A., Switchcraft, Inc., Canare Electric Co., Ltd. and numerous other companies globally. Some of our competitors may have greater companies that may be planning to enter the markets in which we compete.

     Sterling manufactures its electronic interconnect components, subsystems and assemblies at its manufacturing facilities in Mesa, Arizona and Westlake Village, California. Sterling’s manufacturing costs are higher than the manufacturing costs of some of its competitors, particularly those located in foreign countries that benefit from lower-priced labor and government subsidies. If current or potential future customers of the combined business decide to purchase products from these lower-cost competitors, we could suffer a significant decline in our sales, which could have a material adverse effect on our business, operating results and financial condition.

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 2003 and the first quarter of 2004.

Item 4.     Controls and Procedures

     As of the end of the period covered by this quarterly report on Form 10-Q, the Company performed an evaluation under the supervision and with the participation of the Company’s management, including its President and Chief Executive Officer (“CEO”) and Executive Vice President, Finance and Chief Financial Officer (“CFO”), of its “disclosure controls and procedures” (as defined in Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)).

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The Company’s disclosure controls and procedures are designed to ensure that the information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s applicable rules and forms. As a result of this evaluation, the Company’s CEO and CFO have concluded that, as of the date of such evaluation, the Company’s disclosure controls and procedures were effective for their intended purposes.

          There have been no changes in the Company’s internal control over financial reporting during the fiscal quarter covered by this quarterly report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

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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 the Company’s 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.

     The Company recently agreed to a Memorandum of Understanding, which reflects a settlement of these class actions as between the purported class action plaintiffs, the Company and the defendant officers and directors, and the Company’s liability insurer. Under the terms of the Memorandum of Understanding, the Company’s liability insurers will pay certain sums to the plaintiffs, with the amount dependent upon the plaintiffs’ recovery from the underwriters in the IPO class actions as a whole. The plaintiffs will dismiss with prejudice their claims against the Company and its officers and directors, and the Company will assign to the plaintiffs certain claims that it may have against the underwriters.

     In June 2002, Catherine Lego, as representative of the former stockholders of Tsunami Optics, Inc. (“Tsunami”) 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 in February 2002. Stratos has removed the lawsuit to the federal 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 $18 million earn-out payment provided for in the acquisition agreement. The complaint also alleges fraud and violations of federal securities laws in connection with the acquisition of Tsunami. Plaintiffs

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are seeking $18 million in damages or, in the alternative, rescission of the acquisition agreement. The Company has filed a counterclaim which alleges, among other things, claims for fraud, breach of contract and violations of federal securities laws against Lego and several other shareholders and officers of Tsunami in connection with the acquisition of Tsunami. The counterclaim seeks compensatory and punitive damages. The Company believes that the plaintiffs’ claims in this lawsuit are without merit and intends to vigorously defend against these claims.

     In August 2002, James Campbell filed a lawsuit against the Company and Tsunami alleging breach of an alleged employment 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 attorney’s fees. The Company believes that this lawsuit is without merit and intends to vigorously defend against these claims.

     In a separate action filed in the Circuit Court of Cook County, Illinois, the Company filed suit against James P. Campbell and Catherine Lego, individually. In its complaint, the Company seeks declaratory judgment that the Company has the right to make changes in Tsunami’s business under the agreement for the Tsunami acquisition. The 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 complaint seeks compensatory and punitive damages.

     We are plaintiffs in several lawsuits relating to our intellectual property rights. The defendants in these lawsuits include Infineon Technologies Corp. (Northern District of California), E2O, Inc. (District of Delaware and Northern District of Illinois), and Picolight, Inc. (District of Delaware and Northern District of Illinois). In these actions, Stratos alleges that optoelectronic products sold by the defendants infringe numerous Stratos 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. 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. As adjusted for the 1 for 10 reverse stock split in October, 2002, a total of 1,006,250 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.

     These shares were sold by Stratos Lightwave at an initial public offering price of $210.00 per share. The aggregate underwriting discount paid in connection with the offering was $14,791,875.

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     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 $115.1 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 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 owing 10 percent or more of our common stock, or to any Stratos Lightwave affiliate.

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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 July 1, 2003 to report results for the fourth quarter and fiscal year ended April 30, 2003. A current report on Form 8-K was filed on July 3, 2003 to report the execution of the Agreement and Plan of Merger with Sterling Holding Company. No other reports on Form 8-K were filed by the Registrant in the three months ended July 31, 2003.

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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.

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EXHIBIT INDEX

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(7)		Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended October 31, 2002.
(8)		Incorporated by reference to the Registrant’s Form 8-K dated July 2 , 2003.
(9)		Incorporated by reference to the Registrant’s Annual Report on Form 10-K for the fiscal year ended April 30, 2003.
*		Filed herewith

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