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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED APRIL 26, 2003

OR

COMMISSION FILE NUMBER 000-27273

SYCAMORE NETWORKS, INC.

(Exact name of registrant as specified in its charter)

220 Mill Road Chelmsford, MA 01824

(Address of principal executive offices) (Zip code)

(978) 250-2900

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  x No  ¨.

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

The number of shares outstanding of the Registrant’s Common Stock as of May 23, 2003 was 271,916,034.

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Sycamore Networks, Inc.

Index

Part I. Financial Information

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Part I. Financial Information

Item 1. Financial Statements

Sycamore Networks, Inc.

Consolidated Balance Sheets

(in thousands, except par value)

(unaudited)

The accompanying notes are an integral part of the consolidated financial statements.

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Sycamore Networks, Inc .

Consolidated Statements of Operations

(in thousands, except per share amounts)

(unaudited)

The accompanying notes are an integral part of the consolidated financial statements.

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Sycamore Networks, Inc.

Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

The accompanying notes are an integral part of the consolidated financial statements.

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Sycamore Networks, Inc.

Notes To Consolidated Financial Statements

(unaudited)

1. Description of Business

Sycamore Networks, Inc. (the “Company”) was incorporated in Delaware on February 17, 1998. The Company develops and markets intelligent optical networking products for telecommunications service providers worldwide. The Company has developed software and advanced hardware capabilities that allow a service provider to improve the fundamental economics of their network by reducing both capital and operating costs and enabling them to offer revenue-generating services to their customers.

2. Basis of Presentation

The accompanying financial data as of April 26, 2003 and for the three and nine months ended April 26, 2003 and April 27, 2002 has been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. However, the Company believes that the disclosures are adequate to make the information presented not misleading. These consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended July 31, 2002.

In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present a fair statement of financial position as of April 26, 2003, and results of operations and cash flows for the periods ended April 26, 2003 and April 27, 2002 have been made. The results of operations and cash flows for the periods ended April 26, 2003 are not necessarily indicative of the operating results and cash flows for the full fiscal year or any future periods.

3. Stock-Based Compensation

Statement of Financial Accounting Standards (“SFAS”) No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure an Amendment of SFAS No. 123”, amends the disclosure requirements of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), to require more prominent disclosures in both annual and interim financial statements regarding the method of accounting for stock-based compensation and the effect of the method used on reported results.

The Company accounts for stock-based awards to employees and directors using the intrinsic value method of accounting in accordance with APB No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”). Under the intrinsic value method, when the exercise price of the Company’s employee stock awards equals the market price of the underlying stock on the date of grant, no compensation expense is recognized in the Company’s Consolidated Statements of Operations. The Company currently recognizes compensation expense under APB 25 relating to certain stock options and restricted stock with exercise prices below fair market value.

The Company is required under SFAS 123 to disclose pro forma information regarding the stock awards made to its employees based on specified valuation techniques that produce estimated compensation charges.

The pro forma information is as follows (in thousands, except per share data):

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The above pro forma disclosures are not necessarily representative of the effects on reported net income or loss for future periods. The fair value of the stock options at the date of grant was estimated using the Black-Scholes model.

4. Net Loss Per Share

Basic net loss per share is computed by dividing the net loss for the period by the weighted-average number of common shares outstanding during the period less unvested restricted stock. Diluted net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted-average number of common and common equivalent shares outstanding during the period, if dilutive. Common equivalent shares are composed of unvested shares of restricted common stock and the incremental common shares issuable upon the exercise of stock options and warrants outstanding.

The following table sets forth the computation of basic and diluted net loss per share (in thousands, except per share data):

Options to purchase 28.3 million and 29.7 million shares of common stock, at respective average exercise prices of $7.86 and $10.16, have not been included in the computation of diluted net loss per share for the three and nine months ended April 26, 2003 and April 27, 2002, respectively, as their effect would have been anti-dilutive. Warrants to purchase 150,000 shares of common stock at an exercise price of $11.69 have not been included in the computation of diluted net loss per share for the three and nine months ended April 26, 2003 and April 27, 2002, as their effect would have been anti-dilutive. The warrants expired during the three months ended April 26, 2003.

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5. Inventories

Inventories consisted of the following (in thousands):

6. Comprehensive Loss

The components of comprehensive loss consisted of the following (in thousands):

7. Restructuring Charges and Related Asset Impairments

In the last two years, there has been a sharp contraction in the availability of capital to the Company’s industry. As a result, capital expenditures by both emerging and incumbent service providers have been substantially reduced. These unfavorable economic conditions have negatively impacted the Company’s operating results in a progressive and increasingly severe manner. As a result, the Company restructured its business three times in order to reduce expenses and align its resources with long-term growth opportunities: the first in the third quarter of fiscal 2001 (the “fiscal 2001 restructuring”), the second in the first quarter of fiscal 2002 (the “first quarter fiscal 2002 restructuring”), and the third in the fourth quarter of fiscal 2002 (the “fourth quarter fiscal 2002 restructuring”). As a result of the combined activity under all of these restructuring programs, during fiscal 2002, the Company recorded a total net charge of $241.5 million, which was classified in the statement of operations as follows: cost of revenue - $91.7 million, operating expenses - $125.0 million, and non-operating expenses - $24.8 million.

During the third quarter of fiscal 2003, the Company recorded a net $2.2 million credit to operating expenses due to various changes in estimates relating to all of the Company’s restructuring activities. The changes in estimates primarily consisted of a $6.4 million reduction in the accrual for estimated legal matters associated with the restructuring activities, a $0.9 million credit relating to proceeds received from the disposal of certain equipment and a $0.8 million reduction in the costs associated with a workforce reduction, partially offset by $4.9 million of additional facility consolidation charges. In addition, the Company recorded a $1.0 million charge for the write-down of certain land. While the Company has reduced the accrual for potential legal matters based on its current estimate as adjusted for events within the current quarter, given the inherent uncertainties involved in such matters, it is reasonably possible that we may incur a loss in addition to the amount accrued. In addition, in the event that other contingencies associated with the restructuring activities occur, or the estimates associated with the restructuring activities are revised, the Company may be required to record additional charges or credits against the reserves previously recorded for the Company’s restructuring activities.

As of April 26, 2003, the Company had $24.9 million in accrued restructuring costs. Details regarding each of the restructuring programs are described below.

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Fiscal 2001 Restructuring:

The fiscal 2001 restructuring program included a workforce reduction of 131 employees, consolidation of excess facilities, and the restructuring of certain business functions to eliminate non-strategic products and overlapping feature sets. The Company recorded restructuring charges and related asset impairments of $81.9 million classified as operating expenses and an excess inventory charge of $84.0 million relating to discontinued product lines, which was classified as cost of revenue. The restructuring charges included amounts accrued for potential legal matters, administrative expenses and professional fees associated with the restructuring activities, including employment termination related claims. The fiscal 2001 restructuring program was substantially completed during the first half of fiscal 2002. In the fourth quarter of fiscal 2002, the Company recorded a net $2.1 million credit to operating expenses due to various changes in estimates. The changes in estimates consisted primarily of $4.7 million of additional facility consolidation charges due to less favorable sublease assumptions, offset by a $6.7 million reduction in the potential legal matters associated with the restructuring activities. During the third quarter of fiscal 2003, the Company recorded a net $2.3 million charge to operating expenses due to various changes in estimates. The changes in estimates consisted primarily of $3.6 million of additional facility consolidation charges due to less favorable sublease assumptions, partially offset by a $1.3 million reduction in the accrual for potential legal matters associated with the restructuring activities. As of April 26, 2003, the projected future cash payments of $15.3 million consist of facility consolidation charges that will be paid over the respective lease terms through fiscal 2007, and potential legal matters and administrative expenses associated with the restructuring activities.

The restructuring charges and related asset impairments recorded in the fiscal 2001 restructuring program, and the reserve activity since that time, are summarized as follows (in thousands):

First Quarter Fiscal 2002 Restructuring:

The first quarter fiscal 2002 restructuring program included a workforce reduction of 239 employees, consolidation of excess facilities and charges related to excess inventory and other asset impairments. As a result, the Company recorded restructuring charges and related asset impairments of $77.3 million classified as operating expenses and an excess inventory charge of $102.4 million classified as cost of revenue. In addition, the Company recorded charges totaling $22.7 million, classified as a non-operating expense, relating to impairments of investments in non-publicly traded companies that were determined to be other than temporary. The restructuring charges included $7.1 million of costs relating to the workforce reduction, $11.2 million related to the write-down of certain land, lease terminations and non-cancelable lease costs and $6.0 million for potential legal matters, administrative expenses and professional fees associated with the restructuring activities, including employment termination related claims. The restructuring charges also included $102.4 million for inventory write-downs and non-cancelable purchase commitments for inventories due to a severe decline in the forecasted demand for the Company’s products and $53.1 million for asset impairments related to the Company’s vendor financing agreements and fixed assets that were abandoned by the Company.

The first quarter fiscal 2002 restructuring program was substantially completed during the fourth quarter of fiscal 2002. During the third and fourth quarters of fiscal 2002, the Company recorded credits totaling $10.8 million to cost of revenue due to changes in estimates, the majority of which related to favorable settlements with contract

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manufacturers for non-cancelable inventory purchase commitments. In addition, during the fourth quarter of fiscal 2002, the Company recorded a net $1.7 million credit to operating expenses relating to various changes in estimates. The changes in estimates consisted of a $1.7 million reduction in potential legal matters associated with the restructuring activities and the reversal of an accrued liability of $0.8 million for workforce reductions, partially offset by $0.8 million of additional facility consolidation charges due to less favorable sublease assumptions. During the third quarter of fiscal 2003, the Company recorded a net $0.5 million credit to operating expenses due to various changes in estimates. The changes in estimates primarily consisted of a $1.3 million reduction in the accrual for potential legal matters associated with the restructuring activities, partially offset by $0.8 million of additional facility consolidation charges due to less favorable sublease assumptions. In addition, the Company recorded a $1.0 million non-cash charge for the write-down of certain land. As of April 26, 2003, the projected future cash payments of $4.1 million consist primarily of facility consolidation charges that will be paid over the respective lease terms through fiscal 2005, and potential legal matters and administrative expenses associated with the restructuring activities.

The restructuring charges and related asset impairments recorded in the first quarter fiscal 2002 restructuring program, and the reserve activity since that time, are summarized as follows (in thousands):

Fourth Quarter Fiscal 2002 Restructuring:

The fourth quarter fiscal 2002 restructuring program included a workforce reduction of 225 employees, consolidation of excess facilities, and the restructuring of certain business functions to eliminate non-strategic products. This included discontinuing the development of the Company’s standalone transport products, including the SN 8000 Intelligent Optical Transport Node and the SN 10000 Intelligent Optical Transport System. As a result, the Company recorded restructuring charges and related asset impairments of $51.5 million classified as operating expenses. In addition, the Company recorded a charge of $2.1 million, classified as a non-operating expense, relating to impairments of investments in non-publicly traded companies that were determined to be other than temporary. The restructuring charges included $8.7 million of costs relating to the workforce reduction, $5.6 million for lease terminations and non-cancelable lease costs and $14.5 million relating to potential legal matters, contractual commitments, administrative expenses and professional fees related to the restructuring activities, including employment termination related claims. The restructuring charges also included $22.6 million of costs relating to asset impairments, which primarily included fixed assets that were disposed of, or abandoned, due to the rationalization of the Company’s product offerings and the consolidation of excess facilities. The fourth quarter fiscal 2002 restructuring program was substantially completed during the first half of fiscal 2003.

During the third quarter of fiscal 2003, the Company recorded a net $4.0 million credit to operating expenses due to various changes in estimates. The changes in estimates consisted of a $3.7 million reduction in the accrual for potential legal matters associated with the restructuring activities and a $0.8 million reduction in the costs associated with the workforce reduction, partially offset by $0.5 million of additional facility consolidation charges due to less favorable sublease assumptions. In addition, the Company recorded a $0.9 million credit to operating expenses relating to proceeds received from the disposal of certain equipment. As of April 26, 2003, the projected future cash payments of $5.5 million consist primarily of facility consolidation charges that will be paid over the respective lease terms through fiscal 2006 and potential legal matters and administrative expenses associated with the restructuring activities.

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The restructuring charges and related asset impairments recorded in the fourth quarter fiscal 2002 restructuring program, and the reserve activity since that time, are summarized as follows (in thousands):

8. Recent Accounting and Regulatory Pronouncements

In December 2002, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure an Amendment of SFAS No. 123”, which requires additional disclosure and provides guidance for Companies that elect to voluntarily adopt the accounting provisions of SFAS No. 123. SFAS No. 148 does not change the provisions of SFAS No. 123 that permit entities to continue to apply the intrinsic value method of Accounting Principles Board (“APB”) Opinion No.25 (“APB No. 25”), “Accounting for Stock Issued to Employees”. SFAS No. 148 is effective for fiscal years ending after December 15, 2002 and the new interim disclosure provisions are effective for the first interim period beginning after December 15, 2002. The Company intends to continue to account for its stock-based compensation in accordance with the provisions of APB No. 25 as interpreted by FASB Interpretation No. 44 (“FIN 44”), “Accounting for Certain Transactions Involving Stock Compensation, an Interpretation of APB Opinion No. 25”, and present the pro forma disclosures required by SFAS No. 123 as amended by SFAS No. 148. The requisite disclosure appears in Note 3 to the Company’s unaudited consolidated financial statements.

In January 2003, the FASB issued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities”. FIN 46 requires that if an entity has a controlling financial interest in a variable interest entity, the assets, liabilities and results of activities of the variable interest entity should be included in the consolidated financial statements of the entity. FIN 46 requires that its provisions are effective immediately for all arrangements entered into after January 31, 2003. The Company does not have any financial interest in variable interest entities created after January 31, 2003. For those arrangements entered into prior to January 31, 2003, FIN 46 provisions are required to be adopted by the Company in the first quarter of fiscal 2004. The adoption of FIN 46 is not expected to have a material impact on the Company’s financial position or results of operations.

In January 2003, the SEC issued final rules implementing Section 401(b) of the Sarbanes-Oxley Act of 2002 entitled “Conditions for Use of Non-GAAP financial measures”. The rules primarily provide guidance on disclosure of material information that includes non-GAAP financial measures. The rules applied to all disclosures as of March 28, 2003. These rules did not have a material impact on the Company’s financial position or results of operations.

In May 2003, the FASB issued SFAS 150, “Accounting For Certain Financial Instruments with Characteristics of Both Liabilities and Equity” which establishes standards for how an issuer of financial instruments classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances) if, at inception, the monetary value of the obligation is based solely or predominantly on a fixed monetary amount known at inception, variations in something other than the fair value of the issuer’s equity shares or variations inversely related to changes in the fair value of the issuer’s equity shares. This Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS 150 is not expected to have a material impact on the Company’s financial position or results of operations.

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9. Commitments and Contingencies

Litigation

Beginning on July 2, 2001, several purported class action complaints were filed in the United States District Court for the Southern District of New York against the Company and several of its officers and directors (the “Individual Defendants”) and the underwriters for the Company’s initial public offering on October 21, 1999. Some of the complaints also include the underwriters for the Company’s follow-on offering on March 14, 2000. The complaints were consolidated into a single action and an amended complaint was filed on April 19, 2002. The amended complaint was filed on behalf of persons who purchased the Company’s common stock between October 21, 1999 and December 6, 2000. The amended complaint alleges violations of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended, primarily based on the assertion that the Company’s lead underwriters, the Company and the other named defendants made material false and misleading statements in the Company’s Registration Statements and Prospectuses filed with the SEC in October 1999 and March 2000 because of the failure to disclose (a) the alleged solicitation and receipt of excessive and undisclosed commissions by the underwriters in connection with the allocation of shares of common stock to certain investors in the Company’s public offerings and (b) that certain of the underwriters allegedly had entered into agreements with investors whereby underwriters agreed to allocate the public offering shares in exchange for which the investors agreed to make additional purchases of stock in the aftermarket at pre-determined prices. The amended complaint alleges claims against the Company, several of the Company’s officers and directors and the underwriters under Sections 11 and 15 of the Securities Act. It also alleges claims against the Company, the individual defendants and the underwriters under Sections 10(b) and 20(a) of the Securities Exchange Act. The action against the Company is being coordinated with approximately three hundred other nearly identical actions filed against other companies. The actions seek damages in an unspecified amount. On October 9, 2002, the court dismissed the Individual Defendants from the case without prejudice based upon Stipulations of Dismissal filed by the plaintiffs and the Individual Defendants. A motion to dismiss addressing issues common to the companies and individuals who have been sued in these actions was filed on July 15, 2002. An opposition to that motion was filed on behalf of the plaintiffs and a reply brief was filed on behalf of the defendants. On February 19, 2003, the Court denied the motion to dismiss with respect to the Company. The Company believes that the claims against it are without merit and intends to defend against the complaints vigorously. The Company is not currently able to estimate the possibility of loss or range of loss, if any, relating to these claims.

On April 1, 2003, a complaint was filed against the Company in the United States Bankruptcy Court for the Southern District of New York by the creditors’ committee (the “Committee”) of 360 Networks (USA) Inc. and 360 Networks Services Inc. (the “Debtors”). The Debtors are the subject of a Chapter 11 bankruptcy proceeding. The Committee alleges that the Debtors made a preferential payment under Section 547(b) of the Bankruptcy Code to the Company during the 90-day period prior to the Debtors’ bankruptcy filings. The Debtors themselves are not the plaintiffs in this action as this claim has been brought by the creditors’ committee of the Debtors. The Company believes that the claims against it are without merit and intends to defend against the complaint vigorously. The Company is not currently able to estimate the possibility of loss or range of loss, if any, relating to these claims.

The Company is subject to legal proceedings, claims, and litigation arising in the ordinary course of business. While the outcome of these matters is currently not determinable, management does not expect that the ultimate costs to resolve these matters will have a material adverse effect on the Company’s results of operations or financial position.

Guarantees

FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”), requires that upon issuance of a guarantee, the guarantor must disclose and recognize a liability for the fair value of the obligation assumed under that guarantee. The initial recognition and measurement requirement of FIN 45 is effective for guarantees issued or modified after December 31, 2002 for those items that only require disclosure. As of April 26, 2003, the Company’s guarantees requiring disclosure consist of its accrued warranty obligations and indemnifications for intellectual property infringement claims.

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In the normal course of business, the Company also agrees to indemnify other parties, including customers, lessors and parties to other transactions with the Company, with respect to certain matters. The Company has agreed to hold the other parties harmless against losses arising from a breach of representations or covenants, or out of intellectual property infringement or other claims made against certain parties. These agreements may limit the time within which an indemnification claim can be made and the amount of the claim. It is not possible to determine the maximum potential amount under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Historically, payments made by the Company under these agreements have not had a material impact on the Company’s operating results or financial position.

Warranty liability

The Company records a warranty liability for parts and labor on its products at the time revenue is recognized. Warranty periods are generally three years from installation date. The estimate of the warranty liability is based primarily on the Company’s historical experience in product failure rates and the expected material and labor costs to provide warranty services.

The following table summarizes the activity related to product warranty liability during the nine months ended April 26, 2003 (in thousands):

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Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Except for the historical information contained in this report, we caution you that certain matters discussed in this report constitute forward-looking statements that involve risks and uncertainties. Forward-looking statements include statements regarding our expectations, beliefs, intentions or strategies regarding our business prospects and results of operations. You can identify these statements because they do not relate strictly to historical or current facts and contain forward-looking words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “should,” “will,” and “would” or similar words. Our actual results could differ materially from those stated or implied in forward-looking statements due to a number of factors, including, but not limited to, those risks and uncertainties we discuss under the heading “Factors That May Affect Future Operating Results” in this Form 10-Q. We cannot guarantee that any forward-looking statement will be realized. Should known or unknown risks or uncertainties materialize, or should our underlying assumptions prove inaccurate, our actual results could vary materially from our past results, or from those anticipated. You should bear this in mind as you read our report.

You should read the information in this report in conjunction with our Annual Report on Form 10-K and other reports we file from time to time with the SEC.

Overview

Sycamore Networks, Inc. was incorporated in Delaware on February 17, 1998.

Sycamore develops and markets intelligent optical networking products for telecommunications service providers worldwide. Our current and prospective customers include domestic and international large, established service providers, Internet service providers, non-traditional telecommunications service providers, enterprise organizations with private fiber networks and, to a lesser extent, newer start-up service providers. We believe that our software and advanced hardware capabilities allow a service provider to transform their existing fiber optic infrastructure into an intelligent network that enables them to provision, manage and deliver communication services to their customers. We have pursued a strategy of next generation technology by developing software to provide intelligence in the fiber optic network, along with advanced hardware capabilities. Our products enable service providers to improve the fundamental economics of their networks by reducing both capital and operating costs and enabling them to offer revenue generating services to their customers.

For many of the last several years, the market for our products was influenced by regulatory changes, in particular the Telecommunications Act of 1996, and the entry of a substantial number of new companies into the communications service business. These new companies, commonly referred to as emerging service providers, raised significant amounts of capital, much of which they invested in capital expenditures to build out their networks. In order to compete with the new emerging service providers, the large, established service providers, commonly referred to as incumbent service providers, also increased their capital expenditures above their historical levels. These trends accelerated the growth of the telecommunications equipment industry, including the demand for our products.

Over the last two years, these trends began to reverse. There has been a sharp contraction in the availability of capital to our industry. As a result, many emerging service providers were no longer able to finance the build out of their networks and subsequently have failed or have significantly reduced the scope of their business operations. In addition, many incumbent service providers also had difficulty raising additional capital and have experienced significant financial difficulties. As a result, capital expenditures by both emerging and incumbent service providers have been substantially reduced.

These developments have reduced the capital spending by telecommunications service providers. At the same time, both the United States economy and the economies in substantially all of the countries in which we market our products have slowed significantly. As a result, our existing and prospective customers have become more conservative in their capital expenditures and more uncertain about their future purchases. As a consequence, we are facing a market that is both reduced in size and more difficult to predict and plan for.

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These trends have had a number of significant effects on our business, including a decline in revenue of $309.6 million or 83% in fiscal 2002 compared to fiscal 2001 and a decline in revenue of $29.2 million or 52% for the first nine months of fiscal 2003 compared to the first nine months of fiscal 2002. In response to the deteriorating economic environment in our industry, we enacted three separate restructuring programs through the fourth quarter of fiscal 2002. As a result of our restructuring programs we have incurred charges totaling $405.2 million, comprised as follows: $175.7 million of net charges related to excess inventory, $204.7 million of net charges for restructuring and related asset impairments, and $24.8 million of losses on investments. Primarily as a result of these significant effects on our business, we have incurred a cumulative net loss to date of $726.5 million.

Our restructuring programs have reduced our cost structure compared to historical levels, however, we maintain a significant cost structure, particularly within the research and development and customer support organizations. We believe that our current cost structure is necessary in order to sell our products to incumbent service providers. Currently, we anticipate that our cost of revenue, gross margins and operating results will continue to be affected adversely by our decision to maintain our current cost structure. We anticipate that we will continue to incur low gross margins and operating losses unless our revenue increases significantly compared to current levels. At this time, we cannot predict when, or if, the market conditions and the demand for our products will improve.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements. The preparation of these financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires us to make judgments, assumptions and estimates that affect the reported amounts of assets, liabilities, revenue and expenses and disclosure of contingent liabilities. On an ongoing basis, we evaluate these estimates, including those relating to the allowance for doubtful accounts, inventory allowance, valuation of investments, warranty obligations, restructuring liabilities and asset impairments, litigation and other contingencies. Estimates are based on our historical experience and other assumptions that we consider reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. To the extent there are material differences between our estimates and the actual results, our future results of operations will be affected.

We believe that the following critical accounting policies affect the most significant judgments, assumptions and estimates we use in preparing our consolidated financial statements. Changes in these estimates can affect materially the amount of our reported net income or loss.

When products are shipped to customers, we evaluate whether all of the fundamental criteria for revenue recognition have been met. The most significant judgments for revenue recognition typically involve whether there are any significant uncertainties regarding customer acceptance and whether collectibility can be considered reasonably assured.

Some of our transactions may involve the sales of products and services under multiple element arrangements. While each individual transaction varies according to the terms of the purchase order or sales agreement, a typical multiple element arrangement may include some or all of the following components: product shipments, installation services, maintenance and training. The total sales price is allocated based on the relative fair value of each component, which generally is the price charged for each component when sold separately. For the product portion, we recognize revenue upon shipment if there are no significant uncertainties regarding customer acceptance. If uncertainties regarding customer acceptance exist, we recognize revenue when the uncertainties are resolved. For installation services, typically we recognize revenue for services that have been performed upon acceptance in accordance with the contract. For maintenance and training services, we recognize revenue when the services are performed.

The allowance for doubtful accounts is based on our assessment of the collectibility of specific customer accounts. In the event that we become aware of a deterioration in a particular customer’s financial condition, additional provisions for doubtful accounts may be required.

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We accrue for warranty costs at the time revenue is recognized based on contractual rights and on the historical rate of claims and costs to provide warranty services. If we experience an increase in warranty claims greater than our historical experience or our costs to provide warranty services increase, we may be required to increase our warranty accrual and our gross margins could be adversely affected.

We continuously monitor our inventory balances and we record inventory allowances for any excess of the cost of the inventory over its estimated market value, based on assumptions about future demand and market conditions. While such assumptions may change significantly from period to period, we measure the net realizable value of inventories using the best information available as of the balance sheet date. To the extent that a severe decline in forecasted demand occurs, or a higher incidence of inventory obsolescence because of rapidly changing technology and customer requirements, significant charges for excess inventory are likely to occur, such as the $102.4 million charge we recorded in the first quarter of fiscal 2002.

Once we have written down inventory to its estimated net realizable value, we cannot increase its carrying value due to subsequent changes in demand forecasts. Accordingly, if inventory previously written down to its net realizable value is subsequently sold, we may realize improved gross profit margins on these transactions. During the third and fourth quarters of fiscal 2002, we recorded credits totaling $10.8 million to cost of revenue relating to inventory charges that were originally recorded in the first quarter of fiscal 2002. These credits related to favorable settlements of inventory purchase commitments with contract manufacturers, and to a lesser extent, sales of inventory that we had previously written down.

During the third quarter of fiscal 2001 and the first and fourth quarters of fiscal 2002, we recorded charges for restructuring and related asset impairments totaling $422.0 million, including inventory related charges of $186.4 million. These restructuring activities required us to make numerous assumptions and estimates, including assumptions and estimates regarding future revenue levels and product mix, the timing of and the amounts received for subleases of excess facilities, the fair values of impaired assets, the amounts of other than temporary impairments of strategic investments, and the potential legal matters, administrative expenses and professional fees associated with the restructuring activities.

We continuously monitor the judgments, assumptions and estimates relating to the restructuring activities and, if these judgments, assumptions and estimates change, we may be required to record additional charges or credits against the reserves previously recorded for these restructuring activities. For example, during the third and fourth quarters of fiscal 2002, we recorded a net credit totaling $3.8 million to operating expenses, due to various changes in estimates relating to the restructuring charges that had been recorded in the third quarter of fiscal 2001 and the first quarter of fiscal 2002. These credits included decreases in the accrual for potential legal matters associated with the restructuring activities, partially offset by increases in the accrual for projected liabilities relating to facility consolidations. During the third quarter of fiscal 2003, we recorded a net credit totaling $2.2 million to operating expenses, due to various changes in estimates relating to all of our restructuring activities. These credits included decreases in the accruals for potential legal matters associated with the restructuring activities and workforce reduction costs, partially offset by increases in the accrual for additional facility consolidation charges due to less favorable sublease assumptions. In addition, we recorded a credit totaling $0.9 million to operating expenses relating to proceeds received from the disposal of certain equipment. While we reduced the accrual for potential legal matters based on current estimates as adjusted for events within the current quarter, given the inherent uncertainties involved in such matters, it is reasonably possible that we may incur a loss in addition to the amount accrued. In addition, in the event that other contingencies associated with the restructuring activities occur, or the estimates associated with the restructuring activities are revised, we may be required to record additional charges or credits against the reserves previously recorded for the restructuring activities. As of April 26, 2003, we had $19.5 million accrued as part of our restructuring liability relating to facility consolidations, based on our best estimate of the available sublease rates and terms at the present time. In the event that we are unsuccessful in subleasing any of the restructured facilities, we could incur additional restructuring charges and cash outflows in future periods totaling $1.2 million, which represents the amount of the assumed sublease recoveries that have been incorporated into the current estimate.

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Results of Operations

Revenue

Revenue decreased 22%, or $3.0 million, to $10.6 million for the three months ended April 26, 2003 compared to revenue of $13.6 million for the same period in fiscal 2002. Revenue decreased 52%, or $29.2 million, to $27.4 million for the nine months ended April 26, 2003 compared to revenue of $56.6 million for the same period in fiscal 2002. The decrease in revenue for the three and nine months ended April 26, 2003 was due to the continuing weak overall economic environment and adverse conditions in the telecommunications industry, in particular, the significant capital reductions by our target customers. Product revenue increased slightly to $7.7 million for the three months ended April 26, 2003 compared to product revenue of $6.9 million for the same period in fiscal 2002. For the nine months ended April 26, 2003, product revenue declined 55%, or $21.8 million, to $18.0 million compared to product revenue of $39.8 million for the same period in fiscal 2002. Service revenue declined 56% and 44%, respectively, for the three and nine months ended April 26, 2003, compared to the three and nine months ended April 27, 2002. The decrease in service revenue for the three and nine months ended April 26, 2003, was primarily due to the lower level of installation services associated with our product deployments. For the nine months ended April 26, 2003, three international customers accounted for the majority of our revenue and international revenue represented 88% of our total revenue. For the nine months ended April 27, 2002, two international customers accounted for the majority of our revenue and international revenue represented 89% of our total revenue. We anticipate that, in the near term, our revenue will continue to be highly concentrated in a relatively small number of customers and that international revenue will represent a relatively high percentage of total revenue.

Gross profit (loss)

Gross profit (loss) for product and services, including non-cash stock-based compensation expense, for the three and nine months ended April 26, 2003 and for the three and nine months ended April 27, 2002 was as follows (in thousands, except percentages):

Product gross profit (loss)

Product gross profit was 18.9% of revenue for the three months ended April 26, 2003 compared to 134.2% of revenue for the same period in fiscal 2002. Product gross profit was 3.9% of revenue for the nine months ended April 26, 2003 compared to a gross loss of (213.7%) of revenue for the same period in fiscal 2002. Product gross profit for the three and nine months ended April 26, 2003 has been adversely effected primarily from the decline in product revenue without a proportionate decline in overall manufacturing costs. For the three months ended April 27, 2002, product gross profit included a $9.0 million benefit resulting from changes in estimates relating to the excess inventory charge we recorded in the first quarter of fiscal 2002. The product gross loss for the nine months

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ended April 27, 2002 included an excess inventory net charge of $93.4 million for inventory write-downs and non-cancelable purchase commitments.

Service gross profit (loss)

Service gross profit was 3.5% of revenue for the three months ended April 26, 2003 compared to 11.9% of revenue for the same period in fiscal 2002. Service gross loss was (8.8%) of revenue for the nine months ended April 26, 2003 compared to a gross loss of (28.1%) of revenue for the same period of fiscal 2002. The lower service gross profit for the three months ended April 26, 2003 was primarily due to the decline in service revenue without a proportionate decline in overall customer support expenses. The service gross loss for the nine months ended April 26, 2003, reflects costs associated with a further realignment within the customer support organization, including employee severance costs and capital write offs.

At present, we are currently maintaining a significant cost structure within the manufacturing and customer support organizations that we believe is necessary in order to sell our products to incumbent service provider customers.

Research and Development Expenses

Research and development expenses decreased $12.8 million, or 50%, to $12.7 million for the three months ended April 26, 2003 compared to $25.5 million for the same period in fiscal 2002. Research and development expenses decreased $48.0 million, or 55%, to $40.0 million for the nine months ended April 26, 2003 compared to $88.0 million for the same period in fiscal 2002. The decrease in expenses for the three and nine months ended April 26, 2003 was primarily due to lower project materials costs and personnel-related expenses resulting from our prior restructuring activities. These prior restructuring activities resulted in a consolidation of product offerings and more focused development efforts for our optical switching platforms.

Sales and Marketing Expenses

Sales and marketing expenses decreased $4.0 million, or 45%, to $4.9 million for the three months ended April 26, 2003 compared to $8.9 million for the same period in fiscal 2002. Sales and marketing expenses decreased $19.1 million, or 56%, to $14.9 million for the nine months ended April 26, 2003 compared to $34.0 million for the same period of fiscal 2002. The decrease in expenses for the three and nine months ended April 26, 2003 was primarily due to lower personnel and related expenses resulting from our prior restructuring programs.

General and Administrative Expenses

General and administrative expenses decreased $0.3 million, or 15%, to $1.9 million for the three months ended April 26, 2003 compared to $2.2 million for the same period in fiscal 2002. General and administrative expenses decreased $2.7 million, or 34%, to $5.3 million for the nine months ended April 26, 2003 compared to $8.0 million for the same period in fiscal 2002. The decrease in expenses for the three and nine months ended April 26, 2003 was primarily due to lower personnel and related expenses resulting from our prior restructuring programs.

Stock-Based Compensation Expense

Total stock-based compensation expense decreased $3.5 million, or 64%, to $2.0 million for the three months ended April 26, 2003 compared to $5.5 million for the same period in fiscal 2002. Total stock-based compensation expense decreased $12.9 million, or 67%, to $6.5 million for the nine months ended April 26, 2003 compared to $19.4 million for the same period in fiscal 2002. For the three and nine months ended April 26, 2003, $0.3 million and $1.1 million of stock-based compensation expense was classified as cost of revenue, respectively, and $1.7 million and $5.4 million was classified as operating expenses, respectively. Stock-based compensation expense primarily resulted from the granting of stock options and restricted shares with exercise or sale prices which were deemed to be below fair market value. The decrease in expenses for the three and nine months ended April 26, 2003 was primarily due to stock-based compensation expense for restricted stock and stock options relating to the acquisition of Sirocco Systems, Inc., which were fully amortized in the fourth quarter of fiscal 2002. Stock-based compensation expense also declined as a result of personnel reductions from our prior restructuring activities. We expect to continue incurring stock-based compensation expense through the fourth quarter of fiscal 2005.

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Restructuring Charges and Related Asset Impairments

In the last two years, there has been a sharp contraction in the availability of capital to our industry. As a result, capital expenditures by both emerging and incumbent service providers have been substantially reduced. These unfavorable economic conditions have negatively impacted our operating results in a progressive and increasingly severe manner. As a result, we restructured our business three times in order to reduce expenses and align our resources with long-term growth opportunities: the first in the third quarter of fiscal 2001 (the “fiscal 2001 restructuring”), the second in the first quarter of fiscal 2002 (the “first quarter fiscal 2002 restructuring”), and the third in the fourth quarter of fiscal 2002 (the “fourth quarter fiscal 2002 restructuring”). As a result of our combined activity under all of these restructuring programs, during fiscal 2002, we recorded a total net charge of $241.5 million, which was classified in the statement of operations as follows: cost of revenue – $91.7 million, operating expenses – $125.0 million, and non-operating expenses – $24.8 million.

During the third quarter of fiscal 2003, we recorded a net $2.2 million credit to operating expenses due to various changes in estimates relating to all of our restructuring activities. The changes in estimates primarily consisted of a $6.4 million reduction in the estimated legal matters associated with the restructuring activities, a $0.9 million credit relating to proceeds received from the disposal of certain equipment and a $0.8 million reduction in the costs associated with a workforce reduction, partially offset by $4.9 million of additional facility consolidation charges. In addition, we recorded a $1.0 million charge for the write-down of certain land. While we have reduced the accrual for potential legal matters based on its current estimate as adjusted for events within the current quarter, given the inherent uncertainties involved in such matters, it is reasonably possible that we may incur a loss in addition to the amount accrued. In addition, in the event that other contingencies associated with the restructuring activities occur, or the estimates associated with the restructuring activities are revised, we may be required to record additional charges or credits against the reserves previously recorded for our restructuring activities.

As of April 26, 2003, we had $24.9 million in accrued restructuring costs. Details regarding each of the restructuring programs are described below.

Fiscal 2001 Restructuring:

The fiscal 2001 restructuring program included a workforce reduction of 131 employees, consolidation of excess facilities, and the restructuring of certain business functions to eliminate non-strategic products and overlapping feature sets. We recorded restructuring charges and related asset impairments of $81.9 million classified as operating expenses and an excess inventory charge of $84.0 million relating to discontinued product lines, which was classified as cost of revenue. The restructuring charges included amounts accrued for potential legal matters, administrative expenses and professional fees associated with the restructuring activities, including employment termination related claims. We substantially completed the fiscal 2001 restructuring program during the first half of fiscal 2002. In the fourth quarter of fiscal 2002, we recorded a net $2.1 million credit to operating expenses due to various changes in estimates. The changes in estimates consisted primarily of $4.7 million of additional facility consolidation charges due to less favorable sublease assumptions, offset by a $6.7 million reduction in the potential legal matters associated with the restructuring activities. During the third quarter of fiscal 2003, we recorded a net $2.3 million charge to operating expenses due to various changes in estimates. The changes in estimates consisted primarily of $3.6 million of additional facility consolidation charges due to less favorable sublease assumptions, partially offset by a $1.3 million reduction in potential legal matters associated with the restructuring activities. As of April 26, 2003, the projected future cash payments of $15.3 million consist of facility consolidation charges that will be paid over the respective lease terms through fiscal 2007, and potential legal matters and administrative expenses associated with the restructuring activities.

The restructuring charges and related asset impairments recorded in the fiscal 2001 restructuring program, and the reserve activity since that time, are summarized as follows (in thousands):

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