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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended July 31, 2004

OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                              to                             .

Commission File Number: 000-27273

SYCAMORE NETWORKS, INC.

(Exact name of registrant as specified in its charter)

220 Mill Road

Chelmsford, Massachusetts 01824

(Address of principal executive office)

(978) 250-2900

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: NONE

Securities registered pursuant to Section 12(g) of the Act:

COMMON STOCK $0.001 PAR VALUE

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K  x.

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

As of July 31, 2004 there were 273,887,455 shares outstanding of the registrant’s common stock, $0.001 par value. As of January 23, 2004 the aggregate market value of voting stock held by non-affiliates of the registrant was approximately $996,596,000.

DOCUMENTS INCORPORATED BY REFERENCE

PART III—Portions of the definitive Proxy Statement for the Annual Meeting of Stockholders to be held on December 20, 2004 are incorporated by reference into Part III (Items 10, 11, 12, 13 and 14) to this Form 10-K.

PART I

ITEM 1. BUSINESS

We incorporated under the laws of the State of Delaware on February 17, 1998 and shipped our first product in May 1999. We completed our initial public offering on October 21, 1999 and a follow-on public offering on March 14, 2000. Our principal executive offices are located at 220 Mill Road, Chelmsford, Massachusetts 01824. Our telephone number is (978) 250-2900, and our website address is www.sycamorenet.com. We provide our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports free of charge on our website as soon as reasonably practicable after we file these reports with the Securities and Exchange Commission.

Overview

Sycamore develops and markets optical networking products for telecommunications service providers worldwide. Our current and prospective customers include domestic and international large, established telecommunications service providers (sometimes referred to as incumbent service providers), Internet service providers, non-traditional telecommunications service providers, newer start-up service providers (sometimes referred to as emerging service providers), systems integrators, governments and enterprise organizations with private fiber networks (collectively referred to as “service providers”). Our optical networking product portfolio includes fully integrated edge-to-core optical switching products, network management products and design and planning tools. We believe that our products enable service providers to cost effectively and easily transition their existing fiber optic network into a network infrastructure that can provision, manage and deliver economic, high-bandwidth services to their customers.

In early 2001, the telecommunications industry began a severe decline which had a significant impact on our business. The telecommunications industry decline and the continued spending constraints in the optical networking market caused a decrease in the demand for our products which had an adverse impact on our revenue and profitability. Total revenue for fiscal 2004 was $44.5 million, an increase of 16.4% compared to fiscal 2003. Total revenue for fiscal 2003 was $38.3 million, a decrease of 41.3% compared to fiscal 2002. Our net losses for fiscal 2004 and 2003 were $44.9 million and $55.1 million, respectively, and we have incurred a cumulative net loss of $781.1 million as of July 31, 2004.

In response to these market conditions, we enacted three separate restructuring programs through the fourth quarter of fiscal 2002, which have reduced our cost structure and focused our business on optical switching products, network management products and design and planning tools. As a result of our restructuring programs we have incurred net charges totaling $402.7 million, comprised as follows: $175.1 million of net charges related to excess inventory, $202.8 million of net charges for restructuring and related asset impairments, and $24.8 million of losses on investments, as described in detail in Note 10 to our consolidated financial statements.

Despite challenging market conditions throughout fiscal 2004, we continued to maintain a significant cost structure, particularly within the research and development, sales and customer service organizations which we believe is necessary to develop, market and sell our products to current and prospective customers. As a result of these investments we were able to advance our technology and secure new business. We recognize however, that our progress in fiscal 2004 did not produce significant improvement in our operating results.

Recent industry reports continue to be very cautious regarding the optical networking environment. More specifically, Sycamore’s target market, the optical switching segment, remains a very small percentage of the total market. Competition for these limited switching opportunities is intense. We expect that market conditions will continue to have an adverse impact on our cost of revenue, gross margins and operating results.

In light of our fiscal year 2004 operating results and recent industry reports, in order to maximize shareholder value, we are focusing on a review of the strategic and financial alternatives available to Sycamore

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including but not limited to: (i) alliances with or a sale to another entity, (ii) acquisitions of, or mergers or other combinations with companies with either complementary technologies or in adjacent market segments, (iii) remaining a stand-alone entity, and (iv) recapitalization alternatives including stock buybacks and cash dividends. We have engaged Morgan Stanley to assist us in the review of our strategic and financial alternatives. During the course of this review, we intend to follow our strategy and objective as a stand-alone provider of optical networking equipment.

Industry Background

Industry Trends

The world’s telecommunications infrastructure is largely supported by fiber optic networks primarily owned and operated by service providers. Following deregulation and privatization in the global telecommunications industry, there were many new entrants into the service provider market. Emerging service providers built networks and began competing with incumbent service providers in an effort to accommodate rapid traffic growth and projected growth on the public network. At the same time, readily available capital further fueled the growth in the number of service providers. Many equipment vendors offered substantial vendor financing to service providers as an inducement to build their networks. These events created significant demand for networking equipment.

In early 2001, access to capital decreased and in response service providers began curtailing their network build-outs. Within a short time period, service providers dramatically reduced their overall capital spending. Equipment vendors also ceased providing vendor financing, which further decreased available capital. As a result, there was a slowdown in service provider equipment purchases and a sharp decline in demand for networking equipment. During this time period, several service providers failed and a number of them sought bankruptcy protection. At the same time, however, some service providers looked to new optical products to help them more efficiently optimize and expand their networks to handle the increased traffic load while also managing their spending and expenses.

In addition, following September 11, 2001, for defense and homeland security purposes, government agencies have increased investments in advanced, high-speed networking and communications technology.

Optical networking

Despite the telecommunications industry’s economic difficulties, data traffic on the public telecommunications network continues to increase with the widespread use of the Internet and the World Wide Web. Consumers and businesses increasingly use the Internet for applications such as electronic mail, electronic commerce, and other voice, video and data services. This growth is expected to increase the demand for capacity, or bandwidth, at all levels of the public network.

We believe that a service provider’s competitive advantage and differentiation comes from its ability to provide bandwidth when and where needed and to create and offer new services quickly and cost effectively. Given the economic decline in the telecommunications industry, we believe that service providers want to minimize their capital expenditures, lower their operating costs and improve the profitability of their voice and data services.

Most service providers own and operate traditional optical networks designed primarily to support voice traffic. These traditional optical networks have a number of limitations on a service provider’s ability to offer services which provide a competitive advantage due to the following factors:

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The Sycamore Solution

Sycamore’s optical switching solutions enable service providers to transition from inefficient, voice-centric networks to more efficient, data-optimized networks. We believe that our advanced hardware capabilities and software allow service providers to transform their existing network infrastructure into a more flexible network that enables them to cost effectively provision, manage, and deliver communications services to their customers. We believe that our fully integrated, edge-to-core optical switching products reduce service providers’ capital and operating costs, simplify network operations, and provide the foundation for a new generation of optical network services.

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Sycamore’s Strategy

In light of our fiscal year 2004 operating results and industry reports, in order to maximize shareholder value, we are focusing on a review of the strategic and financial alternatives available to Sycamore including but not limited to: (i) alliances with or a sale to another entity; (ii) acquisitions of, or mergers or other combinations with companies with either complementary technologies or in adjacent market segments, (iii) remaining a stand-alone entity, and (iv) recapitalization alternatives including stock buybacks and cash dividends.

Throughout this review, we continue to pursue our strategy and objective to be a leading provider of optical networking products. We remain focused on balancing strategic investment in the business with our efforts to carefully manage operating costs and preserve our cash position. We continue to invest significant amounts in research and development in order to continue to deliver innovative optical networking solutions and to reduce the manufacturing costs of our products. We are also investing in our sales and customer service infrastructure, which we believe is necessary to expand and support our customer base. While we continue to invest in these areas of the business, we also continue to focus on cost management and cash preservation. Key elements of our strategy as a stand-alone entity include the following:

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Sycamore’s Optical Networking Products

Sycamore’s optical networking product portfolio includes fully integrated edge-to-core optical switching products, network management products and design and planning tools.

Optical switching. Our family of optical switches, including the SN 16000 SC, the SN 16000 and the SN 3000, are designed to enable service providers to provision and manage network bandwidth more efficiently in the metropolitan, regional, and core segments of the optical network. The SN 16000 SC is a single chassis system that provides optimal traffic management for the metropolitan and regional segments of the network. The SN 16000 is a multi-chassis system that provides optimal traffic management at the core of the optical network. The SN 3000 provides optimal traffic management in metropolitan networks. Our optical switches combine multiple functions in a single, highly compact system and address different capacity requirements within various segments of the network. As a result, our optical switches enable service providers to lower costs, simplify network operations, optimize network capacity and transition their networks towards more flexible, efficient, and data-optimized infrastructures.

Network management. SILVX^®, our optical network management system, provides end-to-end management of services across a service provider’s optical switch network. SILVX provides comprehensive network management, planning and administration tools that communicate with existing network management systems through common standards. SILVX simplifies network configuration, service provisioning and network management by automating many labor-intensive operational processes. The combination of SILVX and our sophisticated networking software allows the SN 3000, SN 16000 SC and SN 16000 to exchange real-time information about network traffic, thereby enabling service providers to quickly provision services and more efficiently manage network capacity. In addition, SILVX allows service providers to model a broad range of optical network architectures, forecast and plan for capacity expansion, and analyze network traffic.

Services. We offer complete engineering, furnishing, installation and testing services as well as comprehensive customer support from multiple locations worldwide.

Customers

Our current and prospective customers include domestic and international large, established telecommunications service providers, Internet service providers, non-traditional telecommunications service providers, newer start-up service providers, systems integrators, governments and enterprise organizations with private fiber networks. We expect that substantially all of our revenue will be generated from a limited number of customers. We currently have ten product revenue customers as of July 31, 2004.

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During the year ended July 31, 2004, four customers, Sprint Government Systems Division (as a reseller to the federal government), Vodafone Group PLC, Neuf Telecom and NTT Communications, a subsidiary of Nippon Telephone and Telegraph Corporation accounted for 41%, 27%, 13% and 13% of our revenue, respectively. During the year ended July 31, 2003, three customers, Vodafone Group PLC, Neuf and NTT Communications accounted for 43%, 22% and 14% of our revenue, respectively. During the year ended July 31, 2002, two customers, Vodafone and NTT Communications, accounted for 45% and 20% of our revenue, respectively. International revenue was 59% of total revenue during the year ended July 31, 2004, compared to 91% of total revenue during the year ended July 31, 2003, and 87% of total revenue during the year ended July 31, 2002. See “Concentrations and Significant Customer Information” and “Segment Information” in Note 2 to our consolidated financial statements for additional details.

Our contracts with customers typically include the purchase of our hardware products, the right to use fees, the license of our SILVX network management system, and in some cases, maintenance and support services. These contracts include terms and arrangements that are customary and standard in our industry, such as payment, delivery and termination. We have experienced significant order cancellations and fluctuations in order backlog levels that have led us to conclude that we do not have a business history of firm backlog. None of our customers are contractually committed to purchase any minimum quantities of products from us and orders are generally cancelable prior to shipment. In addition, the federal government may terminate their contracts with any party at any time. As a result, we do not disclose our order backlog, since we believe that our order backlog at any particular date is not necessarily indicative of actual revenue for any future period.

Sales and Marketing

There are a limited number of current and prospective customers in each geographic market. Each service provider owns and operates a unique fiber optic network. The network complexity affects the integration of our optical networking products into their network. As a result, sales are made on a customer-by-customer basis and the sales cycle may extend beyond one year.

We sell our products worldwide through a direct sales force with a local presence in several locations around the world. In certain markets, we also have distribution partners, independent marketing representatives or independent sales consultants. We intend to further establish relationships with selected distribution and marketing partners to extend our reach to serve new markets.

The primary focus of our sales efforts is to develop strong relationships with resellers and incumbent service providers. Our sales and presales engineering organizations work collaboratively with both current and prospective customers to identify optical switching applications that create value in their network as well as create new services that they can offer to their customers. We also provide comprehensive post-sales customer support including network planning and deployment, technical assistance centers and logistics support. Our customer support organization leverages a network of highly qualified service partners to extend our reach and capabilities.

In support of our sales efforts, we conduct marketing programs to position and promote market awareness of Sycamore and our products. We also participate in conferences, trade shows and provide marketing information on our website. In addition, we conduct public relations activities, including interviews and demonstrations for the business and trade media, and industry analysts.

Research and Development

We believe that continued investment in research and development is necessary in order to continue to provide innovative optical networking solutions that meet our current and prospective customers’ needs. We believe that our current and prospective customers require optical networking solutions that will allow them to optimize bandwidth and capacity management while also allowing them to reduce their capital expenditures and operating costs. In order to provide such products to our customers, we believe we must make significant and

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sustained investment in research and development. Our research and development effort focuses primarily on improvements to the features and functionality of existing products and the development of new products. We believe that this investment in research and development is necessary even during periods when our revenue has declined as a result of the decreased demand for telecommunications equipment. Sycamore intends to focus its research and development efforts on optical switching and may pursue strategic alliances or acquisitions to address current and prospective customers’ needs.

Our research and development expenditures were $45.7 million, $52.4 million and $109.7 million for the years ended July 31, 2004, 2003 and 2002, respectively. All of our expenditures for research and development, as well as stock-based compensation expense relating to research and development of $2.7 million, $3.0 million and $9.9 million, for the years ended July 31, 2004, 2003 and 2002, respectively, have been expensed as incurred. As of July 31, 2004, we had approximately 222 employees involved in research and development.

Competition

There are limited optical switching opportunities since our current and prospective customers have reduced their capital expenditures. Competition for these opportunities is intense. Based on the current level of spending by telecommunications service providers, we expect that competition will continue to be very intense.

Sycamore’s competition includes larger, more established vendors of network infrastructure equipment and optical networking equipment, such as Nortel Networks, Lucent Technologies, Alcatel, Cisco, Tellabs and Ciena Corporation. Many of our established competitors have longer operating histories and greater financial, technical, sales, marketing and manufacturing resources and are able to devote greater resources to the research and development of new products. In addition, these competitors generally have more diverse product lines which allow them the flexibility to price their products more aggressively and absorb the significant cost structure associated with optical switching research and development across their entire business. Many of our competitors also have more extensive customer bases and broader customer relationships than us, including relationships with our prospective customers. In addition, to a lesser extent, we see new entrants into the optical networking market with new products that compete with our products. In order to compete effectively in this market, we must deliver products that:

In addition, we believe that our knowledge of telecommunications infrastructure requirements and experience working with service providers to develop new services for their customers are important competitive factors in our market.

Proprietary Rights and Licensing

Our success and ability to compete are dependent on our ability to develop and maintain the proprietary aspects of our technology and to operate without infringing on the proprietary rights of others. We rely on a combination of patent, trademark, trade secret and copyright law and contractual restrictions to protect the proprietary aspects of our technology. We license software to our customers pursuant to signed or shrinkwrap license agreements, which impose certain restrictions on the licensee’s ability to utilize the software. Our practice is to require employees and consultants to execute non-disclosure and proprietary rights agreements upon

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commencing employment or consulting with us. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary. We enforce our intellectual property rights vigorously against infringement or misappropriation.

We license third party software, including certain technologies that are (i) embedded into our hardware platforms and into our SILVX network management system; (ii) used internally by us as hardware design tools and (iii) used internally by us as software development tools. We also utilize publicly available technology. The majority of these licenses have perpetual terms but will generally terminate after an uncured breach of the agreement by us. We believe, based upon past experience and standard industry practice, that such licenses generally could be obtained on commercially reasonable terms in the future. Nonetheless, there can be no assurance that the necessary licenses would be available on acceptable terms, if at all.

As of July 31, 2004, we had received 25 United States patents and had pending 47 United States patent applications. We had seven pending foreign patent applications. Of the United States patents that have been issued, the earliest any will expire is February 2019. As of July 31, 2004, we had eight allowed or registered United States trademarks and 17 allowed or registered foreign trademarks. All of the registered United States trademarks have a duration of ten years from the date of application, the earliest of which will expire in February 2011.

Manufacturing

We outsource almost all of the manufacturing of our products. We utilize contract manufacturers, who provide manufacturing services, including material procurement and handling, printed circuit board assembly and mechanical board assembly. We design, specify, and monitor all of the tests that are required to meet our internal and external quality standards. We work closely with our contract manufacturers to manage costs and delivery times. Our contract manufacturing agreements generally have indefinite terms and are cancelable by either party with advance notice. We believe that outsourced manufacturing enables us to deliver products more quickly and allows us to focus on our core competencies, including research and development, sales and customer service.

We have limited internal manufacturing operations. Our internal manufacturing operations primarily consist of quality assurance for materials and components, and final testing, assembly and shipment of our products. We also use a limited number of other manufacturers to supply certain non-significant product sub-assemblies and components.

Our optical networking products utilize hundreds of individual parts, some of which are customized for our products. Component suppliers in the specialized, high technology end of the optical communications industry are generally not as plentiful or, in some cases, as reliable, as component suppliers in more mature industries. We work closely with our strategic component suppliers to pursue new component technologies that could either reduce cost or enhance the performance of our products.

We currently purchase several key components, including commercial digital signal processors, central processing units, field programmable gate arrays, switch fabric, and optical transceivers, from single or limited sources. We purchase each of these components on a purchase order basis and have no long-term contracts for these components. Although we believe that there are alternative sources for each of these components, in the event of a disruption in supply, we may not be able to develop an alternate source in a timely manner or at favorable prices.

Throughout the downturn in the telecommunications industry and the continued spending constraints in the optical networking market, the optical component industry has been downsizing manufacturing capacity while consolidating product lines from earlier acquisitions. Several suppliers have exited the market for optical components, and others have announced reductions of their product offerings. These announcements, or similar decisions by other suppliers, could result in reduced competition and higher prices for the components we purchase. In addition, the loss of a source of supply for key components could require us to incur additional costs to redesign our products that use those components.

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Employees

As of July 31, 2004, we employed approximately 353 persons of which 222 were primarily engaged in research and development, 36 in sales and marketing, 27 in customer service and support, 26 in manufacturing, and 42 in general and administration. None of our employees are currently represented by a collective bargaining unit. We believe our relations with our employees are good.

Executive Officers of the Registrant

Set forth below is information concerning our current executive officers and their ages as of August 15, 2004.

Daniel E. Smith has served as our President, Chief Executive Officer and as a member of our Board of Directors since October 1998. From June 1997 to July 1998, Mr. Smith was Executive Vice President and General Manager of the Core Switching Division of Ascend Communications, Inc., a provider of wide area network switches and access data networking equipment. Mr. Smith was also a member of the board of directors of Ascend Communications, Inc. during that time. From April 1992 to June 1997, Mr. Smith served as President and Chief Executive Officer and a member of the board of directors of Cascade Communications Corp.

Frances M. Jewels has served as our Vice President of Finance and Administration, Treasurer and Secretary since June 1999 and Chief Financial Officer since July 1999. From June 1997 to June 1999, Ms. Jewels served as Vice President and General Counsel of Ascend Communications, Inc. From April 1994 to June 1997, Ms. Jewels served as Corporate Counsel of Cascade Communications Corp. Prior to April 1994, Ms. Jewels practiced law in private practice and, prior to that, practiced as a certified public accountant.

John E. Dowling has served as our Vice President of Operations since August 1998. From July 1997 to August 1998, Mr. Dowling served as Vice President of Operations of Aptis Communications, a manufacturer of carrier-class access switches for network service providers. Mr. Dowling served as Vice President of Operations of Cascade Communications Corp. from May 1994 to June 1997.

Araldo Menegon has served as our Vice President of Worldwide Sales and Support since August 2002. From April 2001 to June 2002, Mr. Menegon served as Senior Vice President of Worldwide Sales and Field Operations for Tenor Networks, a provider of networking equipment. From August 1999 to March 2001, Mr. Menegon served as Area Operations Director for Cisco Systems, Inc. From July 1997 to July 1999, Mr. Menegon served as Director of Service Provider Operations for Cisco Canada. Prior to joining Cisco in July 1996, Mr. Menegon spent 14 years with NCR and held several senior management positions, including an international assignment with NCR’s Pacific Group from January 1988 to February 1992.

Kevin J. Oye has served as our Vice President of Systems and Technology since November 2001. From October 1999 through October 2001, Mr. Oye served as our Vice President, Business Development. From March 1998 to October 1999, Mr. Oye served as Vice President, Strategy and Business Development at Lucent Technologies, Inc. and from September 1993 to March 1998, Mr. Oye served as the Director of Strategy, Business Development, and Architecture at Lucent Technologies, Inc. From June 1980 to September 1993, Mr. Oye held various positions with AT&T Bell Laboratories where he was responsible for advanced market planning as well as development and advanced technology management.

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ITEM 2. PROPERTIES

We currently lease three facilities in Chelmsford, Massachusetts, containing approximately 305,000 square feet in the aggregate. In Wallingford, Connecticut, we currently lease one facility containing a total of approximately 30,000 square feet. These facilities consist of offices and engineering laboratories used for research and development, administration, sales and customer support, ancillary light manufacturing, storage and shipping activities. We also maintain smaller offices to provide sales and customer support at various domestic and international locations. These facilities are presently adequate and suitable for our needs, and we do not expect to require additional space during fiscal 2005. We own a parcel of undeveloped land, containing approximately 106 acres, in Tyngsborough, Massachusetts. This land was acquired for the purpose of developing a campus that would serve as our corporate headquarters, if we should require additional facilities over the next several years.

ITEM 3. LEGAL PROCEEDINGS

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, which is the operative 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 Securities and Exchange Commission, (“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 amended complaint seeks damages in an unspecified amount.

The action against the Company is being coordinated with approximately three hundred other nearly identical actions filed against other companies. The action seeks 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. The Company has approved a settlement agreement and related agreements which set forth the terms of a settlement between the Company, the Individual Defendants, the plaintiff class and the vast majority of the other approximately three hundred issuer defendants and the individual defendants currently or formerly associated with those companies. Among other provisions, the settlement provides for a release of the Company and the Individual Defendants for the conduct alleged in the action to be wrongful. The Company would agree to undertake certain responsibilities, including agreeing to assign away, not assert, or release, certain potential claims the Company may have against its underwriters. It is anticipated that any potential financial obligation of the Company to plaintiffs pursuant to the terms of the settlement agreement and related agreements will be covered by existing insurance. Therefore, the Company does not expect that the settlement will involve any payment by the Company. The settlement agreement, which has not yet been executed, has been submitted to the Court for approval. Approval by the Court cannot be assured. The Company is unable to determine whether or when a settlement will occur or be finalized. In the event that a settlement is not finalized, the Company is not currently able to estimate the possibility of loss or range of loss, if any, relating to these claims. Due to the large number of nearly identical actions, the Court has

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ordered the parties to select up to twenty “test” cases. To date, along with eleven other cases, the Company’s case has been selected as one such test case. As a result, among other things, the Company will be subject to discovery obligations and expenses in the litigation, whereas non-test case issuer defendants will not be subject to such obligations.

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 360networks (USA), inc. and 360networks services inc. (the “Debtors”). The Debtors are the subject of a Chapter 11 bankruptcy proceeding but are not plaintiffs in the complaint filed by the Committee. The complaint seeks recovery of alleged preferential payments in the amount of approximately $16.1 million, plus interest. The Committee alleges that the Debtors made the preferential payments under Section 547(b) of the Bankruptcy Code to the Company during the 90-day period prior to the Debtors’ bankruptcy filings. 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.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Price Range of Common Stock

Our common stock has been traded on the Nasdaq National Market under the symbol “SCMR” since October 22, 1999. The following table sets forth, for the periods indicated, the high and low closing sale prices as reported on the Nasdaq National Market for Sycamore common stock, as adjusted for all stock splits.

As of July 31, 2004, there were approximately 1,290 stockholders of record.

Dividend Policy

We have never paid or declared any cash dividends on our common stock or other securities. Any future determination to pay cash dividends will be at the discretion of the board of directors and will be dependent upon our financial condition, results of operations, capital requirements, general business condition, results of strategic and financial review and such other factors as the board of directors may deem relevant.

Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

In the three months ended July 31, 2004, the Company purchased the following shares of common stock (in thousands, except per share data):

The Company has not publicly announced programs to repurchase shares of common stock.

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ITEM 6. SELECTED FINANCIAL DATA

The following selected financial data has been derived from our consolidated financial statements and should be read in conjunction with the consolidated financial statements and notes thereto and with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other financial data included elsewhere in this report. The historical results are not necessarily indicative of results to be expected for any future period.

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with “Selected Financial Data” and our consolidated financial statements and the related notes thereto included elsewhere in this report. Except for the historical information contained herein, we wish to caution you that certain matters discussed in this report constitute forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those stated or implied in forward-looking statements due to a number of factors, including, without limitation, those risks and uncertainties discussed under the heading “Factors That May Affect Future Results” contained in this Form 10-K and any other reports filed by us from time to time with the Securities and Exchange Commission. We disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future results or otherwise. Forward-looking statements include statements regarding our expectations, beliefs, intentions or strategies regarding the future and can be identified by forward-looking words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may, “ “should,” “will,” and “would” or similar words.

Executive Summary

Sycamore develops and markets optical networking products for telecommunications service providers worldwide. Our current and prospective customers include domestic and international large, established telecommunications service providers (sometimes referred to as incumbent service providers), Internet service providers, non-traditional telecommunications service providers, newer start-up service providers (sometimes referred to as emerging service providers), systems integrators, governments and enterprise organizations with private fiber networks (collectively referred to as “service providers”). We believe that our products enable service providers to cost effectively and easily transition their existing fiber optic network into a network infrastructure that can provision, manage and deliver economic, high-bandwidth services to their customers.

Our business has been significantly impacted by the decline in the telecommunications industry which began in 2001. As a result of this decline, service providers decreased their capital spending resulting in a reduction in demand for our products. Since fiscal 2001, our revenue decreased by $330.2 million and we enacted three separate restructuring programs in order to reduce our cost structure and focus our business on the optical switching market. We incurred net restructuring charges of $402.7 million, comprised as follows: $175.1 million of net charges related to excess inventory, $202.8 million of net charges for restructuring and related asset impairments, and $24.8 million of losses on investments, as described in detail in Note 10 to our consolidated financial statements.

Total revenue for fiscal 2004 was $44.5 million, an increase of 16.4% compared to fiscal 2003. Total revenue for fiscal 2003 was $38.3 million, a decrease of 41.3% compared to fiscal 2002. Throughout the telecommunications industry decline, our revenue has varied significantly. As part of our strategy, however, we continue to maintain a significant cost structure, particularly within the research and development, sales and customer service organizations. We believe this cost structure is necessary to develop, market and sell our products to current and prospective customers. Due to our decreased revenues, our restructuring programs and our decision to maintain a significant cost structure, we have incurred a cumulative net loss of $781.1 million at July 31, 2004. While our fiscal 2004 operating results improved modestly over fiscal 2003, we expect that current market conditions will continue to have an adverse impact on our business. We anticipate that we will continue to generate operating losses and consume cash for at least the next several quarters, if not longer.

In particular, as service providers limit their capital spending, competition for optical switching opportunities is intense and continues to be dominated by large, incumbent equipment suppliers. We believe that large incumbent suppliers have numerous competitive advantages that include pricing leverage, established customer relationships, broad product portfolios and large service and support teams. In addition, industry reports continue to be very cautious regarding the optical networking environment. Sycamore’s target market, the optical switching segment, remains a very small percentage of the total market.

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In light of our fiscal year 2004 operating results, recent industry reports and continuing challenges as a focused optical switching vendor, in order to maximize shareholder value, we are focusing on a review of the strategic and financial alternatives available to Sycamore including but not limited to: (i) alliances with or a sale to another entity; (ii) acquisitions of, or mergers or other combinations with companies with either complementary technologies or in adjacent market segments, (iii) remaining a stand-alone entity, and (iv) recapitalization alternatives including stock buybacks and cash dividends. We have engaged Morgan Stanley to assist us in the review of our strategic and financial alternatives. Changes, if any, implemented as a result of the strategic alternatives review could affect the basic nature of our Company. During the course of this review, we intend to follow our strategy and objective as a stand-alone provider of optical networking equipment.

Our total cash, cash equivalents and investments were $961.3 million at July 31, 2004. Included in this amount were cash and cash equivalents of $152.8 million. We intend to fund our operations, including fixed commitments under operating leases, and any required capital expenditures over the next few years using our existing cash, cash equivalents and investments. We believe that, based on our business plans and current conditions, our existing cash, cash equivalents and investments will be sufficient to satisfy our anticipated cash requirements for the next twelve months. We also believe that our current cash, cash equivalents and investments will enable us to pursue the strategic and financial alternatives discussed above.

As of July 31, 2004, Sycamore and its subsidiaries employed approximately 353 persons, which was a net reduction of 20 persons from the approximately 373 persons employed on July 31, 2003.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Our discussion and analysis of our financial condition and results of operations are based upon our 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 assets and 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.

Revenue Recognition

Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable and collectibility is reasonably assured. The most significant revenue recognition judgments typically involve customer acceptance, whether collection is reasonably assured and multiple element arrangements. In instances where customer acceptance is specified, revenue is deferred until all acceptance criteria have been met. We determine collectibility based on creditworthiness of customer, analysis and customer’s payment history. Service revenue is recognized as the services are performed or ratably over the service period. Some of our transactions involve the sale 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 and recognized when revenue recognition criteria for each element is met.

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Allowance for Doubtful Accounts

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 deterioration in a particular customer’s financial condition, a review is performed to determine if additional provisions for doubtful accounts are required.

Warranty Obligations

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 above historical experience or our costs to provide warranty services increase, we may be required to increase our warranty accrual. An increase in the warranty accrual will have an adverse impact on our gross margins.

Inventory Allowance

We continuously monitor inventory balances and 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 from period to period, we measure the net realizable value of inventories using the best information available as of the balance sheet date. If actual market conditions are less favorable than those projected, or we experience a higher incidence of inventory obsolescence because of rapidly changing technology and customer requirements, additional inventory allowances may be required, 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.

Restructuring Liabilities and Asset Impairments

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 programs required us to make numerous assumptions and estimates such as 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 programs.

We continuously monitor the judgments, assumptions and estimates relating to the restructuring programs 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 programs. For example, during the fourth quarter of fiscal 2004, we recorded a net charge of $0.3 million to operating expenses due to less favorable sublease assumptions. Additionally, during the third and fourth quarters of fiscal 2003, we recorded a net credit totaling $4.4 million to operating expenses, due to various changes in estimates relating to all of our restructuring programs. These credits included decreases in the accruals for potential legal matters associated with the restructuring programs and workforce reduction costs, partially offset by increases in the accrual for additional facility consolidation charges due to less favorable sublease assumptions. While we have reduced the accrual for potential legal matters based on our current estimate, 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 programs occur, or the estimates associated with the restructuring programs are revised, we may be required to record additional charges or credits against the reserves previously recorded for the restructuring programs. As of July 31, 2004, we had $11.5 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 $0.9 million, which represents our current estimate of the assumed sublease recoveries.

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Results of Operations

Fiscal Years ended July 31, 2004 and 2003

Revenue

The following table presents product and service revenue (in thousands, except percentages):

Total revenue increased in fiscal 2004 compared to fiscal 2003. The increase was primarily due to a 25% increase in product revenue partially offset by a 2% decrease in service revenue.

During fiscal 2004, the Defense Information Systems Agency (DISA) selected our products to serve as the optical digital cross connect platform for the Global Information Grid Bandwidth Expansion (GIG-BE) project. During the third and fourth quarters of fiscal 2004, through our distribution partner, Sprint Government Systems Division, DISA purchased certain evaluation equipment and began accepting GIG-BE product shipments.

Product revenue increased in fiscal 2004 compared to fiscal 2003. The increase was primarily due to revenue generated from the GIG-BE project. Service revenue decreased slightly in fiscal 2004 compared to fiscal 2003. The decrease was primarily due to the expiration and non-renewal of certain maintenance contracts partially offset by a higher level of installation services associated with product deployments.

For fiscal 2004, GIG-BE accounted for 41% of revenue and three other customers accounted for 27%, 13% and 13% of revenue. Three customers accounted for 43%, 22% and 14% of revenue in fiscal 2003. International revenue represented 59% of revenue in fiscal 2004, compared to 91% of revenue in fiscal 2003. We expect future revenue to continue to be highly concentrated in a relatively small number of customers and that international revenue may continue to represent a significant percentage of future revenue. GIG-BE deployments in any given quarter may cause shifts in the percentage mix of domestic and international revenue. The loss of any one of these customers or any substantial reduction in orders by any one of these customers could materially adversely affect our business, financial condition and results of operations.

Gross profit (loss)

The following table presents gross profit (loss) for product and services, including non-cash stock-based compensation expense (in thousands, except percentages):

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Product gross profit

Product gross profit increased in fiscal 2004 compared to fiscal 2003. The increase was primarily the result of the following factors: (i) decreased manufacturing costs, (ii) the expiration of preexisting warranty obligations of approximately $2.1 million and (iii) the sale of evaluation equipment of $1.2 million which had a favorable impact on gross profit due to its lower carrying value. These favorable factors were partially offset by a sales concession of approximately $0.8 million which decreased gross margins. The fiscal 2003 product gross profit included a credit of $0.5 million relating to a change in estimate relating to the excess inventory charge recorded in fiscal 2002.

In the future, we believe that product gross profit may fluctuate due to pricing pressures resulting from intense competition for limited optical switching opportunities worldwide. In addition, product gross profit may be affected by changes in the mix of products sold, channels of distribution, shipment volume, overhead absorption, sales discounts, increases in material or labor costs, excess inventory and obsolescence charges, increases in component pricing, the introduction of new products or entering new markets with different pricing and cost structures.

Service gross profit (loss)

Service gross profit increased in fiscal 2004 compared to fiscal 2003. The increase was primarily due to reduced fixed support costs and lower personnel-related expenses. The service gross loss for fiscal 2003 includes costs associated with a further realignment within the customer support organization, including employee severance and related costs.

Service gross profit may be affected in future periods by various factors such as the change in mix between technical support services and advanced services, as well as the timing of technical support service contract initiations and renewals.

Operating Expenses

The following table presents operating expenses (in thousands, except percentages):

Research and Development Expenses

Research and development expenses decreased in fiscal 2004 compared to fiscal 2003. The decrease was primarily due to reduced fixed overhead costs and lower personnel-related expenses.

We believe that continued investment in research and development is necessary in order to continue to provide innovative optical networking solutions that meet our current and prospective customers’ needs. In order to provide such products to our customers, we believe we must make significant and sustained investment in research and development. We believe that this investment in research and development is necessary even during periods when our revenue has declined as a result of the decreased demand for our optical network products.

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Sales and Marketing Expenses

Sales and marketing expenses decreased in fiscal 2004 compared to fiscal 2003. The decrease was primarily due to lower personnel-related expenses and reduced fixed overhead costs, partially offset by an increase in commissions and sales related programs.

General and Administrative Expenses

General and administrative expenses increased slightly in fiscal 2004 compared to fiscal 2003. The increase was primarily due to increased expenses relating to new regulatory requirements including certain provisions of the Sarbanes-Oxley Act, partially offset by lower personnel-related expenses.

Stock-Based Compensation Expense

Stock-based compensation expense primarily resulted from the granting of stock options and restricted shares with exercise or sale prices that were deemed to be below fair market value. Total stock-based compensation expense decreased in fiscal 2004 compared to fiscal 2003. The decrease was primarily due to lower headcount levels. We currently expect to continue to incur stock-based compensation expense through the fourth quarter of fiscal 2005.

Restructuring Charges and Related Asset Impairments

In response to the telecommunications industry downturn, we enacted three separate restructuring programs through the fourth quarter of fiscal 2002 to reduce our costs. As a result of our restructuring programs we have incurred net charges totaling $402.7 million, comprised as follows: $175.1 million of net charges related to excess inventory, $202.8 million of net charges for restructuring and related asset impairments, and $24.8 million of losses on investments.

The net charges of $402.7 million include a net $0.3 million charge to operating expenses in the fourth quarter of fiscal 2004 resulting from less favorable sublease assumptions and a net $4.4 million credit to operating expenses recorded in the third and fourth quarters of fiscal 2003, due to various changes in estimates relating to its restructuring programs. The changes in estimates consisted primarily of a $8.6 million reduction in the estimated legal matters associated with the restructuring programs, 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 and a $1.0 million charge for the write-down of certain land. In addition, the Company recorded a $0.5 million credit to cost of revenue relating to a favorable settlement with a supplier.

As of July 31, 2004, we had $12.0 million in accrued restructuring costs, consisting primarily of accrued liabilities for facility consolidations.

Interest and Other Income, Net

The following table presents interest and other income, net (in thousands, except percentages):

Interest and other income, net decreased for fiscal 2004 compared to fiscal 2003. The decrease was primarily due to a combination of lower interest rates and a lower invested cash balance during fiscal 2004.

Provision for Income Taxes

We did not provide for income taxes for fiscal 2004 or fiscal 2003 due to our cumulative taxable losses in recent years and the net losses incurred during each period. We did not record any tax benefits relating to these losses due to the uncertainty surrounding the realization of these future tax benefits.

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Fiscal Years ended July 31, 2003 and 2002

Revenue

The following table presents product and service revenue (in thousands, except percentages):

Total revenue decreased in fiscal 2003 compared to fiscal 2002. The decrease was primarily due to the decrease in demand for optical networking products worldwide.

Product and service revenue decreased in fiscal 2003 compared to fiscal 2002 primarily due to lower demand for our products resulting from the downturn in the telecommunications industry. Three customers accounted for 43%, 22% and 14% of revenue in fiscal 2003, whereas two customers accounted for 45% and 20% of revenue in fiscal 2002. International revenue represented 91% of revenue in fiscal 2003, compared to 87% of revenue in fiscal 2002.

Gross profit (loss)

The following table presents gross profit (loss) for product and services, including non-cash stock-based compensation expense (in thousands, except percentages):

Product gross profit (loss)

Product gross profit for fiscal 2003 and fiscal 2002 were adversely impacted by the decrease in product revenue without a proportionate decrease in cost of revenue. The fiscal 2003 product gross profit included a credit of $0.5 million relating to a change in estimate relating to the excess inventory charge recorded in fiscal 2002. The product gross loss for fiscal 2002 included an excess inventory net charge of $91.6 million for inventory write-downs and non-cancelable purchase commitments.

Service gross profit (loss)

Service gross loss for fiscal 2003 and fiscal 2002 were adversely impacted by the decrease in service revenue without a proportionate decrease in the costs associated with the service organization. The service gross loss for fiscal 2003 includes costs associated with a further realignment within the customer support organization, including employee severance and related costs.

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Operating Expenses

The following table presents operating expenses (in thousands, except percentages):

Research and Development Expenses

Research and development expenses decreased in fiscal 2003 compared to fiscal 2002. The decrease was primarily due to lower project material costs and lower personnel-related expenses due to our prior restructuring programs.

Sales and Marketing Expenses

Sales and marketing expenses decreased in fiscal 2003 compared to fiscal 2002. The decrease was primarily due to lower personnel-related expenses due to our prior restructuring programs.

General and Administrative Expenses

General and administrative expenses decreased in fiscal 2003 compared to fiscal 2002. The decrease was primarily due to lower personnel-related expenses due to our prior restructuring programs.

Stock-Based Compensation Expense

Stock-based compensation expense primarily resulted from the granting of stock options and restricted shares with exercise or sale prices that were deemed to be below fair market value. Stock-based compensation decreased in fiscal 2003 compared to fiscal 2002. The decrease 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 programs.

Restructuring Charges and Related Asset Impairments

In fiscal 2001 the telecommunications industry began a severe decline which has impacted equipment suppliers, including Sycamore. In response to the telecommunications industry downturn, we enacted three separate restructuring programs: 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 part of our fourth quarter fiscal 2002 restructuring program, we discontinued the development of our standalone transport products and focused our business exclusively on optical switching products. During fiscal 2002, as a result of the combined activity under all of the restructuring programs, 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 expense—$24.8 million. The originally recorded restructuring charges were subsequently reduced by credits totaling $14.6 million (cost of revenue—$10.8 million and operating expenses—$3.8 million). During fiscal 2003, due to various changes in estimates relating to the prior restructuring programs, we recorded a credit of $0.5 million classified as a cost of revenue, and a net credit of $4.4 million classified as operating expenses as described below:

During the third and fourth quarters of fiscal 2003, we recorded a net $4.4 million credit to operating expenses due to various changes in estimates relating to our restructuring programs. The changes in estimates

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consisted primarily of a $8.6 million reduction in the estimated legal matters associated with the restructuring programs, 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 and a $1.0 million charge for the write-down of certain land. In addition during fiscal 2003, we recorded a $0.5 million credit to cost of revenue relating to a favorable settlement with a supplier. We have reduced the accrual for potential legal matters based on our current estimate as adjusted for events, 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 programs occur, or the estimates associated with the restructuring programs are revised, we may be required to record additional charges or credits against the reserves previously recorded for our restructuring programs.

As of July 31, 2003, we had $19.1 million in accrued restructuring costs, consisting primarily of $18.0 million of accrued liabilities for facility consolidations. 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 programs, including employment termination related claims. We substantially completed the fiscal 2001 restructuring program during the first half of fiscal 2002.

First Quarter Fiscal 2002 Restructuring:

The first quarter of 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, we 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, we 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 programs, 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 our products and $53.1 million for asset impairments related to our vendor financing agreements and abandoned fixed assets. 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, we 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 manufacturers for non-cancelable inventory purchase commitments. In addition, during the fourth quarter of fiscal 2002, we recorded a net $3.8 million credit to operating expenses relating to various changes in estimates. The changes in estimates consisted of a $8.4 million reduction in potential legal matters associated with the restructuring programs and the reversal of an accrued liability of $0.8 million for workforce reductions, partially offset by $5.6 million of additional facility consolidation charges. During the third and fourth quarters of fiscal 2003, we recorded a net $0.1 million credit to operating expenses due to various changes in estimates. The changes in estimates consisted of a $4.5 million reduction in potential legal matters associated with the restructuring programs, partially offset by $4.4 million of additional facility consolidation charges due to less

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favorable sublease assumptions. In addition, we recorded a $1.0 million non-cash charge to operating expenses for the write-down of certain land and a $0.5 million credit to cost of revenue relating to a favorable settlement with a supplier.

As of July 31, 2003, the projected future cash payments of $14.7 million consist primarily of facility consolidation charges that will be paid over the respective lease terms through fiscal 2007 and potential legal matters associated with the restructuring programs.

The restructuring charges and related asset impairments recorded in the fiscal 2001 and first quarter fiscal 2002 restructuring programs, 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 our standalone transport products, including the SN 8000 Optical Transport Node and the SN 10000 Optical Transport System. As a result, we recorded restructuring charges and related asset impairments of $51.5 million classified as operating expenses. In addition, we 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 programs, 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 our 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 and fourth quarters of fiscal 2003, we recorded a net $4.4 million credit to operating expenses due to various changes in estimates. The changes in estimates consisted of a $4.1 million reduction in potential legal matters associated with the restructuring programs 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. In addition, we recorded a $0.9 million credit to operating expenses relating to proceeds received from the disposal of certain equipment. As of July 31, 2003, the projected future cash payments of $4.4 million consist primarily of facility consolidation charges that will be paid over the respective lease terms through fiscal 2006 and potential legal matters and contractual commitments associated with the restructuring programs.

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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):

Interest and Other Income, Net

The following table presents interest and other income, net (in thousands, except percentages):

Interest and other income decreased in fiscal 2003 compared to fiscal 2002. The decrease was primarily attributable to lower interest rates and a lower invested cash balance during fiscal 2003.

Provision for Income Taxes

We did not provide for income taxes for fiscal 2003 or fiscal 2002 due to our cumulative taxable losses in recent years and the net losses incurred during each period. We did not record any tax benefits relating to these losses due to the uncertainty surrounding the realization of our deferred tax assets.

Liquidity and Capital Resources

Total cash, cash equivalents and investments were $961.3 million at July 31, 2004. Included in this amount were cash and cash equivalents of $152.8 million, compared to $250.6 million at July 31, 2003. The decrease in cash and cash equivalents of $97.8 million was attributable to cash used in operating activities of $33.1 million and cash used in investing activities of $71.3 million, partially offset by cash provided by financing activities of $6.6 million.

Cash used in investing activities of $71.3 million consisted primarily of net purchases of investments of $68.1 million. Cash used in operating activities of $33.1 million consisted of the net loss for the period of $44.9 million, adjusted for net non-cash charges totaling $15.3 million and changes in working capital totaling $3.5 million. The most significant changes in working capital were a decrease in accrued restructuring costs of $7.1 million, a decrease in accrued expenses and other current liabilities of $5.2 million, partially offset by an increase in deferred revenue of $5.5 million and an increase in accounts payable of $2.1 million. Net non-cash charges included depreciation and amortization, provision for doubtful accounts and stock-based compensation. Cash provided by financing activities of $6.6 million consisted primarily of the proceeds received from employee stock plan activity.

Our primary source of liquidity comes from our cash and cash equivalents and investments, which totaled $961.3 million at July 31, 2004. Our investments are classified as available-for-sale and consist of securities that are readily convertible to cash, including certificates of deposits, commercial paper and government securities, with original maturities at the date of acquisition ranging from 90 days to three years. At July 31, 2004, $482.3 million of investments with maturities of less than one year were classified as short-term investments, and $326.3

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million of investments with maturities of greater than one year were classified as long-term investments. At current revenue levels, we anticipate that some portion of our existing cash and cash equivalents and investments will continue to be consumed by operations. Our accounts receivable, while not considered a primary source of liquidity, represents a concentration of credit risk because the accounts receivable balance at any point in time typically consists of a relatively small number of customer account balances. At July 31, 2004, more than 80% of our accounts receivable balance was attributable to two customers.

As of July 31, 2004, we do not have any outstanding debt or credit facilities, and do not anticipate entering into any debt or credit agreements in the foreseeable future.

Our fixed commitments for cash expenditures consist primarily of payments under operating leases and inventory purchase commitments. We do not currently have any material commitments for capital expenditures, or any other material commitments aside from operating leases for our facilities and inventory purchase commitments. We expect to continue to fund our operations, including our fixed commitments under operating leases, and any required capital expenditures over the next few years, using our existing cash, cash equivalents and investments as our primary source of liquidity.

Based on our current plans and business conditions, we believe that our existing cash, cash equivalents and investments will be sufficient to satisfy our anticipated cash requirements for at least the next twelve months. We will continue to consider appropriate action with respect to our cash position in light of the present and anticipated business needs as well as providing a means by which our shareholders may realize value in connection with their investment.

Commitments, Contractual Obligations and Off-Balance Sheet Arrangements

At July 31, 2004, our off-balance sheet arrangements, which consist entirely of contractual commitments for operating leases and inventory purchase commitments, were as follows (in thousands):

Payments made under operating leases will be treated as rent expense for the facilities currently being utilized, or as a reduction of the restructuring liability for payments relating to excess facilities. Payments made for inventory purchase commitments will initially be capitalized as inventory, and will then be recorded as cost of revenue as the inventory is sold or otherwise disposed of.

Related Party Transactions

In July 2000, we made an investment of $2.2 million in Tejas Networks India Private Limited (“Tejas”). The Chairman of the Board of Sycamore also serves as the Chairman of the Board of Tejas. An executive officer of our Company also attends meetings of the board of directors of Tejas for the sole purpose of representing the Company’s business interests, if any. We have no obligation to provide any additional funding to Tejas. During the years ended July 31, 2004 and 2002, we did not engage in any material transactions with Tejas. During the year ended July 31, 2003, we recognized revenue of $0.2 million relating to transactions with Tejas.

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FACTORS THAT MAY AFFECT FUTURE RESULTS

OUR BUSINESS HAS BEEN, AND IS LIKELY TO CONTINUE TO BE, ADVERSELY AFFECTED BY UNFAVORABLE CONDITIONS IN THE TELECOMMUNICATIONS INDUSTRY AND THE ECONOMY IN GENERAL.

In early 2001, the telecommunications industry began a severe decline which has had a significant impact on our business. The industry decline and the continued spending constraints in the optical networking market have caused a decrease in the demand for our products which has had an adverse impact on our revenue and profitability.

We anticipate that our current and prospective customers will not increase their capital spending in the near future. As a result, we anticipate that our revenue, cost of revenue, gross profit and operating results will continue to be adversely affected by these market conditions.

We expect the trends described above to continue to affect our business in the following ways:

These factors could lead to further reduced revenues and gross margins and increased operating losses.

OUR STRATEGY TO PURSUE STRATEGIC AND FINANCIAL ALTERNATIVES MAY NOT BE SUCCESSFUL.

We face numerous challenges as a focused optical switching vendor. In order to address these challenges we may, as part of our strategic alternatives review, pursue alternatives available to us, including but not limited to: (i) alliances with or a sale to another entity, (ii) acquisitions of, or mergers or other combinations with companies with either complementary technologies or in adjacent segments and (iii) remaining a stand-alone entity. Any decision regarding strategic alternatives would be subject to inherent risk, and we cannot guarantee that we will be able to identify the appropriate opportunities, successfully negotiate economically beneficial terms, successfully integrate any acquired business, retain key employees or achieve the anticipated synergies or benefits of the strategic alternative selected. Additionally, we may issue additional shares in connection with a strategic transaction that could dilute the holdings of existing common stockholders, or we may utilize cash in such a strategic transaction. In implementing our strategy, we may enter markets in which we have little or no prior experience and there can be no assurance that we will be successful.

Further, we may consider appropriate action with respect to our cash position in light of present and anticipated business needs including but not limited to stock buybacks and cash dividends. We have engaged Morgan Stanley to assist us in the review of strategic and financial alternatives for our Company. There can be no assurances that any transaction or other corporate action will result from our review of strategic and financial alternatives. Further, there can be no assurance concerning the type, form, structure, nature, results, timing or terms and conditions of any such potential action, even if such an action does result from this review.

WE CURRENTLY DEPEND ENTIRELY ON OUR LINE OF OPTICAL NETWORKING PRODUCTS AND OUR REVENUE DEPENDS UPON THEIR COMMERCIAL SUCCESS.

Our revenue depends on the commercial success of our line of optical networking products. Our research and development efforts focus exclusively on optical switching products. In order to remain competitive, we

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believe that continued investment in research and development is necessary in order to provide innovative solutions to our current and prospective customers. We cannot assure you that we will be successful in:

If our current and prospective customers do not adopt our optical networking products and do not purchase and successfully deploy our current and future products, our business, financial condition and results of operations could be materially adversely affected.

CURRENT ECONOMIC CONDITIONS MAKES FORECASTING DIFFICULT.

Current economic and market conditions have limited our ability to forecast the volume and product mix of our sales, making it difficult to provide estimates of revenue and operating results. We continue to have limited visibility into the capital spending plans of our current and prospective customers. Fluctuations in our revenue can lead to even greater fluctuations in our operating results. Our planned expense levels depend in part on our expectations of long-term future revenue. Our planned expenses include significant investments in our research and development, sales and customer service organizations that we believe are necessary to develop, market and sell our products to current and prospective customers, even though we are unsure of the volume, duration or timing of any purchase orders. As a result, it is difficult to forecast revenue and operating results. If our revenue and operating results are below the expectations of our investors and market analysts, it could cause a decline in the price of our common stock.

OUR CURRENT STRATEGY REQUIRES US TO MAINTAIN A SIGNIFICANT COST STRUCTURE AND OUR FAILURE TO INCREASE OUR REVENUES WOULD PREVENT US FROM ACHIEVING AND MAINTAINING PROFITABILITY.

Our business has been significantly impacted by the decline in the telecommunications industry. Since 2001, our revenue decreased by $330.2 million, and we enacted three separate restructuring programs which have reduced our cost structure and focused our business on the optical switching market. In order to remain competitive, we continue to maintain a significant cost structure, particularly within the research and development, sales and customer support organizations. We believe this cost structure is necessary to develop, market and sell our products to current and prospective customers. Due to our decreased revenues, our restructuring programs and our decision to maintain a significant cost structure, we have incurred a net loss for fiscal 2004 of $44.9 million and a cumulative net loss of $781.1 million at July 31, 2004. We expect that our decision to maintain a significant cost structure will require us to generate significantly higher revenue over current levels in order to achieve and maintain profitability. As a result, we expect to continue to incur net losses. We cannot assure you that our revenue will increase or that we will generate sufficient revenue to achieve or sustain such profitability.

WE FACE INTENSE COMPETITION THAT COULD ADVERSELY AFFECT OUR SALES AND PROFITABILITY.

As service providers limit their capital spending, competition for optical switching opportunities is intense and continues to be dominated by large, incumbent equipment suppliers. Competition is based upon a combination of price, established customer relationships, broad product portfolios, large service and support teams, functionality and scalability. Large companies, such as Nortel Networks, Lucent Technologies, Alcatel, Cisco, Tellabs and Ciena Corporation, have historically dominated this market. Many of our competitors have long operating histories and greater financial, technical, sales, marketing and manufacturing resources than we do and are able to devote greater resources to the research and development of new products. These competitors also have long standing existing relationships with our current and prospective customers. To a lesser extent, new

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competitors have entered the optical networking market using the latest available technology in order to compete with our products. Our competitors may forecast market developments more accurately and could develop new technologies that compete with our products or even render our products obsolete.

The decline in the telecommunications industry beginning in early 2001 has reduced product demand for our products and resulted in even greater competitive pressures. We expect to encounter aggressive tactics such as the following:

These tactics may be effective in a highly concentrated customer base like ours. Our customers are under increasing pressure to deliver their services at the lowest possible cost. As a result, the price of an optical networking system may become an important factor in customer decisions. In certain cases, our larger competitors have more diverse product lines that allow them the flexibility to price their products more aggressively and absorb the significant cost structure associated with optical switching research and development across their entire business. If we are unable to offset any reductions in the average selling price of our products by a reduction in the cost of our products, our gross margins will be adversely affected.

Further, we believe that our industry may enter into a consolidation phase. Over the past two to three years, the market valuations of many companies in our industry have declined significantly making them more attractive acquisition candidates. Furthermore, the weakened financial position of many companies in our industry may make them more receptive to being acquired. We believe that industry consolidation may result in stronger competitors that are better able to compete for customers. Industry consolidation may have an adverse impact on our business, operating results, and financial condition.

If we are unable to compete successfully against our current and future competitors, we could experience price reductions, order cancellations and reduced gross margins, any one of which could have a material adverse effect on our business, results of operations and financial condition.

SUBSTANTIALLY ALL OF OUR REVENUE IS GENERATED FROM A LIMITED NUMBER OF CUSTOMERS, AND OUR SUCCESS DEPENDS ON INCREASING BOTH DIRECT SALES AND INDIRECT SALES THROUGH DISTRIBUTION CHANNELS TO INCUMBENT SERVICE PROVIDERS AND THE FEDERAL GOVERNMENT.

There are limited optical switching opportunities since our current and prospective customers have reduced their capital expenditures and competition for these opportunities is intense. In recent quarters our revenue has been concentrated among a limited number of customers. None of our customers are contractually committed to purchase any minimum quantities of products from us and orders are generally cancelable prior to shipment. We expect that our revenue will continue to depend on sales of our products to a limited number of customers. While expanding our customer base is a key objective, at the present time, the number of prospective customers for our products is limited. In addition, we believe that our industry may enter into a consolidation phase which would further reduce the number of prospective customers, slow purchases and delay optical switching deployment decisions.

Our direct sales efforts primarily target incumbent service providers, many of which have made significant investments in traditional optical networking infrastructures. In addition we are establishing channel relationships with distribution partners including resellers, distributors and systems integrators for the sale of our products to

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the federal government and commercial customers. We have entered into agreements with several distribution partners, some of which also sell products that compete with our products. We cannot be certain that we will be able to retain or attract distribution partners on a timely basis or at all, or that the distribution partners will devote adequate resources to selling our products. Since we have only limited experience in developing and managing such channels, the extent we will be successful is uncertain. If we are unable to develop and manage new channels of distribution to sell our products to incumbent service providers and the federal government, or if our distribution partners are unable to convince incumbent service providers or the federal government to deploy our optical networking solutions, our business, financial condition and results of operations will be materially adversely affected.

WE MAY NOT BE SUCCESSFUL IN SELLING OUR PRODUCTS THROUGH NEWLY ESTABLISHED CHANNELS TO THE FEDERAL GOVERNMENT.

We believe that in order to succeed, we must build a larger and more diverse customer base. Recently, we entered into a reseller agreement for the sale of our products to the federal government and our products were selected to serve as the optical digital cross connect platform for DISA’s GIG-BE project. Since we have only limited experience in developing and managing such channels, the extent we will be successful is uncertain. Sales to the federal government require compliance with on-going complex procurement rules and regulations with which we have little experience. We will not be able to succeed in the federal government market and sell our products to federal government contractors if we cannot comply with these rules and regulations. The federal government is not contractually committed to purchase our products for the GIG-BE project, and there can be no assurance that it will purchase our products in the future. Our failure to sell products to the federal government, including for use in the GIG-BE project, could adversely affect our ability to achieve our planned levels of revenue, which would affect our profitability and results of operations.

WE DEPEND ON A GOVERNMENT AGENCY, THROUGH OUR RESELLER, FOR A SIGNIFICANT AMOUNT OF OUR REVENUE AND THE LOSS OR DECLINE OF EXISTING OR FUTURE GOVERNMENT AGENCY FUNDING COULD ADVERSELY AFFECT OUR REVENUE AND CASH FLOWS.

For the year ended July 31, 2004, approximately 41% of our revenue was derived from a government agency through our reseller. This government agency (DISA) may be subject to budget cuts, budgetary constraints, a reduction or discontinuation of funding or changes in the political or regulatory environment that may cause the agency to terminate the projects, divert funds or delay implementation. The agency may terminate the contract at any time without cause. A significant reduction in funds available for the agency to purchase equipment would significantly reduce our revenue and cash flows. The significant reduction or delay in orders by the agency would also significantly reduce our revenue and cash flows. Additionally, government contracts are generally subject to audits and investigations by government agencies. If the results of these audits or investigations are negative, our reputation could be damaged, contracts could be terminated or significant penalties could be assessed. If a contract is terminated for any reason, our ability to fully recover certain amounts may be impaired resulting in a material adverse impact on our financial condition and results of operations.

ANY ACQUISITIONS OR STRATEGIC INVESTMENTS WE MAKE COULD DISRUPT OUR BUSINESS AND SERIOUSLY HARM OUR FINANCIAL CONDITION.

As part of our ongoing business strategy, we consider acquisitions, strategic investments and business combinations including those in complementary companies, products or technologies, or in adjacent market segments and otherwise. We may consider such acquisitions to broaden our product portfolio, gain access to a particular customer base or market, or to take immediate advantage of a strategic opportunity. In the event of an acquisition, we may:

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Our ability to achieve the benefits of any acquisition, will also involve numerous risks, including:

We cannot assure you that we will be able to successfully integrate any businesses, products, technologies or personnel that we might acquire in the future and any failure to do so could disrupt our business and seriously harm our financial condition.

THE UNPREDICTABILITY OF OUR QUARTERLY RESULTS MAY ADVERSELY AFFECT THE TRADING PRICE OF OUR COMMON STOCK.

In general, our revenue and operating results in any reporting period may fluctuate significantly due to a variety of factors including:

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We believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance. You should not rely on our results for one quarter as any indication of our future performance. The factors discussed above are extremely difficult to predict and impact our revenue and operating results. In addition, our ability to forecast our future business has been significantly impaired by the current economic and market conditions. As a result, we believe that our revenue and operating results are likely to continue to vary significantly from quarter to quarter and may cause our stock price to fluctuate.

Additionally, we believe that customers who make a decision to deploy our products will expand their networks slowly and deliberately. Potential new business opportunities for our products may be smaller than what we have experienced historically. In addition, we could receive purchase orders on an irregular and unpredictable basis. Because of the nature of our business, we cannot predict these sales and deployment cycles. The long sales cycles, as well as our expectation that customers may tend to place large orders sporadically with short lead times, may cause our revenue and results of operations to vary significantly and unexpectedly from quarter to quarter. As a result, our future operating results may be below our expectations or those of public market analysts and investors, and our revenue may decline or recover at a slower rate than anticipated by us or analysts and investors. In either event, the price of our common stock could decrease.

WE UTILIZE CONTRACT MANUFACTURERS AND ANY DISRUPTION IN THESE RELATIONSHIPS MAY CAUSE US TO FAIL TO MEET OUR CUSTOMER’S DEMANDS AND MAY DAMAGE OUR CUSTOMER RELATIONSHIPS.

We have limited internal manufacturing capabilities. We outsource the manufacturing of our products to contract manufacturers who manufacture our products in accordance with our specifications and fill orders on a timely basis. We may not be able to manage our relationships with our contract manufacturers effectively, and our contract manufacturers may not meet our future requirements for timely delivery. Our contract manufacturers also build products for other companies, and we cannot be assured that they will have sufficient quantities of inventory available to fill our customer orders or that they will allocate their internal resources to fill these orders on a timely basis. In addition, our utilization of contract manufacturers limits our ability to control the manufacturing processes of our products, which exposes us to risks including the unpredictability of manufacturing yields and a reduced ability to control the quality of finished products. Unforecasted customer demand may increase the cost to build our products due to fees charged to expedite production and other related charges.

The contract manufacturing industry is a highly competitive, capital-intensive business with relatively low profit margins, and acquisition activity is relatively common. Qualifying a new contract manufacturer and commencing volume production is expensive and time consuming, and could result in a significant interruption in the supply of our products. If we are required or choose to change contract manufacturers for any reason, our revenue, gross margins and customer relationships could be adversely affected.

WE RELY ON SINGLE OR LIMITED SOURCES FOR SUPPLY OF CERTAIN COMPONENTS AND OUR BUSINESS MAY BE SERIOUSLY HARMED IF OUR SUPPLY OF ANY OF THESE COMPONENTS IS DISRUPTED.

We purchase several key components from single or limited sources. These key components include commercial digital signal processors, central processing units, field programmable gate arrays, switch fabric, and optical transceivers. We generally purchase our key components on a purchase order basis and have no long-term contracts for these components. In the event of a disruption in supply of key components, we may not be able to develop an alternate source in a timely manner or on acceptable terms. Any such failure could impair our ability to deliver products to customers, which would adversely affect our revenue and operating results.

In addition, our reliance on key component suppliers exposes us to potential supplier production difficulties or quality variations. The loss of a source of supply for key components or a disruption in the supply chain could require us to incur additional costs to redesign our products that use those components.

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During the past year, component suppliers have planned their production capacity to better match demand. If the demand for certain components increases beyond the component suppliers planned production capacity, there may be component shortages which may increase procurement costs. In addition, consolidation in the optical component industry could result in reduced competition for supply of key components and higher component prices. If any of these events occurred, our revenue and operating results could be adversely affected.

OUR INABILITY TO ANTICIPATE INVENTORY REQUIREMENTS MAY RESULT IN INVENTORY CHARGES OR DELAYS IN PRODUCT SHIPMENTS.

During the normal course of business, we may provide demand forecasts to our contract manufacturers for up to six months prior to scheduled delivery of products to our customers. If we overestimate our product requirements, the contract manufacturers may assess cancellation penalties or we may have excess inventory which could negatively impact our gross margins. If we underestimate our product requirements, the contract manufacturers may have inadequate inventory that could interrupt manufacturing of our products and result in delays in shipment to our customers. We also could incur additional charges to manufacture our products to meet our customer deployment schedules. If we over or underestimate our product requirements, our revenue and gross profit may be impacted.

PRODUCT PERFORMANCE PROBLEMS COULD LIMIT OUR SALES TO CURRENT AND PROSPECTIVE CUSTOMERS.

If our products do not meet our customers’ performance requirements, our relationships with current and prospective customers may be adversely affected. The design, development and deployment of our products often involve problems with software, components, manufacturing processes and interoperability with other network elements. If we are unable to identify and fix errors or other problems, or if our customers experience interruptions or delays that cannot be promptly resolved, we could experience:

These factors may adversely impact our revenue, operating results and financial condition. In addition, our products are often critical to the performance of our customers’ network. Generally, we seek to limit liability in our customer agreements. If we are not successful in limiting our liability, or these contractual limitations are not enforceable or if we are exposed to product liability claims that are not covered by insurance, a successful claim could harm our business.

OUR BUSINESS IS SUBJECT TO RISKS FROM INTERNATIONAL OPERATIONS.

International sales represented 59% of total revenue in fiscal 2004, and 91% of total revenue in fiscal 2003, and we have a substantial international customer base. We are subject to foreign exchange translation risk to the extent that our revenue is denominated in currencies other than the U.S. dollar. Doing business internationally requires significant management attention and financial resources to successfully develop direct and indirect sales channels and to support customers in international markets. We may not be able to maintain or expand international market demand for our products.

In addition, international operations are subject to other inherent risks, including:

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These factors may adversely impact our revenue, operating results and financial condition.

WE DEPEND ON OUR KEY PERSONNEL TO MANAGE OUR BUSINESS EFFECTIVELY IN A RAPIDLY CHANGING MARKET, AND IF WE ARE UNABLE TO RETAIN OUR KEY EMPLOYEES, OUR ABILITY TO COMPETE COULD BE HARMED.

We depend on the continued services of our executive officers and other key engineering, sales, marketing and support personnel, who have critical industry experience and relationships that we rely on to implement our business strategy. None of our officers or key employees is bound by an employment agreement for any specific term. We do not have “key person” life insurance policies covering any of our employees.

All of our key employees have been granted stock-based awards that are intended to represent an integral component of their compensation package. These stock-based awards may not provide the intended incentive to our employees if our stock price declines or experiences significant volatility. The loss of the services of any of our key employees, the inability to attract and retain qualified personnel in the future, or delays in hiring qualified personnel could delay the development and introduction of, and negatively impact our ability to sell, our products.

WE FACE CERTAIN LITIGATION RISKS.

We are the defendant in a securities lawsuit and a party to other litigation and claims in the normal course of our business. Litigation is by its nature uncertain and there can be no assurance that the ultimate resolution of such claims will not exceed the amounts accrued for such claims, if any. Litigation can be expensive, lengthy, and disruptive to normal business operations. An unfavorable resolution of a legal matter could have a material adverse affect on our business, operating results, or financial condition. For additional information regarding certain lawsuits in which we are involved, see Part II, Item 1—“Legal Proceedings”.

OUR ABILITY TO COMPETE COULD BE JEOPARDIZED IF WE ARE UNABLE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS OR INFRINGE ON INTELLECTUAL PROPERTY RIGHTS OF OTHERS.

We rely on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect our intellectual property rights. We also enter into confidentiality or license agreements with our employees, consultants and corporate partners and control access to and distribution of our products, documentation and other proprietary information. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy or otherwise obtain and use our products or technology. Monitoring unauthorized use of our products is difficult and we cannot be certain that the steps we have taken will prevent unauthorized use of our technology, particularly in foreign countries where the laws may not protect our

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proprietary rights as fully as in the United States. If competitors are able to use our technology, our ability to compete effectively could be harmed. Litigation may be necessary to enforce our intellectual property rights. Any such litigation could result in substantial costs and diversion of resources and could have a material adverse affect on our business, operating results and financial condition.

Our industry is characterized by the existence of a large number of patents and frequent claims and related litigation regarding patents and other intellectual property rights. In the course of our business, we may receive claims of infringement or otherwise become aware of potentially relevant patents or other intellectual property rights held by other parties. We evaluate the validity and applicability of these intellectual property rights, and determine in each case whether we must negotiate licenses or cross-licenses to incorporate or use the proprietary technologies in our products.

Any parties asserting that our products infringe upon their proprietary rights would force us to defend ourselves, and possibly our customers, manufacturers or suppliers against the alleged infringement. Regardless of their merit, these claims could result in costly litigation and subject us to the risk of significant liability for damages. Such claims would likely be time consuming and expensive to resolve, would divert management time and attention and would put us at risk to:

If we are forced to take any of the foregoing actions, our business may be seriously harmed.

In addition, we license public domain software and proprietary technology from third parties for use in our existing products, as well as new product development and enhancements. We cannot be assured that such licenses will be available to us on commercially reasonable terms in the future, if at all. The inability to maintain or obtain any such license required for our current or future products and enhancements could require us to substitute technology of lower quality or performance standards or at greater cost, either of which could adversely impact the competitiveness of our products.

ANY EXTENSION OF CREDIT TO OUR CUSTOMERS MAY SUBJECT US TO CREDIT RISKS AND LIMIT THE CAPITAL THAT WE HAVE AVAILABLE FOR OTHER USES.

From time to time we have received requests for financing assistance from existing and prospective customers. In the near term, we expect these requests to continue. We believe the ability to offer financing assistance can be a competitive factor in obtaining business. In the past, we have provided extended payment terms on trade receivables to certain key customers to assist them with their network deployment plans. Such financing activities subject us to the credit risk of customers whom we finance. In addition, our ability to recognize revenue from financed sales will depend upon the relative financial condition of the specific customer, among other factors. We could experience losses due to customers failing to meet their financial obligations that could harm our business and materially adversely affect our operating results and financial condition.

OUR STOCK PRICE MAY CONTINUE TO BE VOLATILE.

Historically, the market for technology stocks has been extremely volatile. Our common stock has experienced, and may continue to experience, substantial price volatility. The occurrence of any one or more of the factors noted above could cause the market price of our common stock to fluctuate significantly. In addition, the following factors could cause the market price of our common stock to fluctuate significantly:

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In addition, the stock market in general, and the Nasdaq National Market and technology companies in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of such companies. These broad market and industry factors may materially adversely affect the market price of our common stock, regardless of our actual operating performance. In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been instituted against such companies.

YOUR ABILITY TO INFLUENCE KEY TRANSACTIONS, INCLUDING CHANGES OF CONTROL, MAY BE LIMITED BY SIGNIFICANT INSIDER OWNERSHIP, PROVISIONS OF OUR CHARTER DOCUMENTS AND PROVISIONS OF DELAWARE LAW.

As of July 31, 2004, our officers, directors and entities affiliated with them, in the aggregate, beneficially owned approximately 36% of our outstanding common stock. These stockholders, if acting together, would be able to significantly influence matters requiring approval by our stockholders, including the election of directors and the approval of mergers or other business combination transactions. In addition, provisions of our amended and restated certificate of incorporation, by-laws, and Delaware law could make it more difficult for a third party to acquire us, even if doing so would be beneficial to certain stockholders.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Sensitivity

The primary objective of our current investment activities is to preserve investment principal while maximizing income without significantly increasing risk. We maintain a portfolio of cash equivalents and short-term and long-term investments in a variety of securities including commercial paper, certificates of deposit, money market funds and government debt securities. These available-for-sale investments are subject to interest rate risk and may fall in value if market interest rates increase. If market interest rates increased immediately and uniformly by 10 percent from levels at July 31, 2004, the fair value of the portfolio would decline by approximately $1.5 million. Depending on the outcome of our review of strategic and financial alternatives, we may not hold our investments to maturity and as a result, may realize a gain or loss.

Exchange Rate Sensitivity

While the majority of our operations are based in the United States, our business includes sales globally, with international revenue representing 59% of total revenue in fiscal 2004. To the extent that international sales represent a significant portion of our revenue, fluctuations in foreign currencies may have an impact on our financial results. To date the impact has not been material. We are prepared to hedge against fluctuations in foreign currencies if the exposure is material, although we have not engaged in hedging activities to date.

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ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS