UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED APRIL 24, 2004

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM                      TO                     

COMMISSION FILE NUMBER 000-27273

SYCAMORE NETWORKS, INC.

(Exact name of registrant as specified in its charter)

Delaware	04-3410558
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

220 Mill Road

Chelmsford, Massachusetts 01824

(Address of principal executive offices)

(Zip code)

(978) 250-2900

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No ¨.

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

Yes x No ¨.

The number of shares outstanding of the Registrant’s Common Stock as of April 30, 2004 was 273,173,031.

Sycamore Networks, Inc.

Index

		Page No.
Part I.	FINANCIAL INFORMATION	3
Item 1.	Financial Statements (unaudited)	3
	Consolidated Balance Sheets as of April 24, 2004 and July 31, 2003	3
	Consolidated Statements of Operations for the three months and nine months ended April 24, 2004 and April 26, 2003	4
	Consolidated Statements of Cash Flows for the nine months ended April 24, 2004 and April 26, 2003	5
	Notes to Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
Item 3.	Quantitative and Qualitative Disclosure About Market Risk	32
Item 4.	Controls and Procedures	32
Part II.	OTHER INFORMATION	33
Item 1.	Legal Proceedings	33
Item 2.	Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities	34
Item 6.	Exhibits and Reports on Form 8-K	35
Signature		36
Exhibit Index		37

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Part I. Financial Information

Item 1. Financial Statements

Sycamore Networks, Inc.

Consolidated Balance Sheets

(in thousands, except par value)

(unaudited)

	April 24, 2004			July 31, 2003
Assets
Current assets:
Cash and cash equivalents	$	222,721		$	250,595
Short-term investments		384,812			421,784
Accounts receivable, net of allowance for doubtful accounts of $4,132 and $4,184 at April 24, 2004 and July 31, 2003, respectively		14,264			10,769
Inventories		4,017			5,117
Prepaids and other current assets		3,752			3,680
Total current assets		629,566			691,945
Property and equipment, net		10,047			14,589
Long-term investments		358,095			323,204
Other assets		2,375			2,890
Total assets	$	1,000,083		$	1,032,628
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	2,288		$	3,475
Accrued compensation		2,610			3,545
Accrued warranty		3,596			4,651
Accrued expenses		3,531			4,203
Accrued restructuring costs		14,299			19,086
Deferred revenue		6,238			2,677
Other current liabilities		3,163			2,476
Total current liabilities		35,725			40,113
Deferred revenue		672			—
Total liabilities		36,397			40,113
Stockholders’ equity:
Preferred stock, $.01 par value; 5,000 shares authorized; none issued or outstanding		—			—
Common stock, $.001 par value; 2,500,000 shares authorized; 273,163 and 272,099 shares issued at April 24, 2004 and July 31, 2003, respectively		273			272
Additional paid-in capital		1,738,265			1,733,476
Accumulated deficit		(771,941	)		(736,192	)
Deferred compensation		(2,418	)		(6,822	)
Treasury stock, at cost, 0 and 147 shares held at April 24, 2004 and July 31, 2003, respectively		—			(11	)
Accumulated other comprehensive income (loss)		(493	)		1,792
Total stockholders’ equity		963,686			992,515
Total liabilities and stockholders’ equity	$	1,000,083		$	1,032,628

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

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Sycamore Networks, Inc.

Consolidated Statements of Operations

(in thousands, except per share amounts)

(unaudited)

	Three Months Ended						Nine Months Ended
	April 24, 2004			April 26, 2003			April 24, 2004			April 26, 2003
Revenue:
Product	$	11,355		$	7,696		$	21,184		$	17,997
Service		3,363			2,905			8,850			9,367
Total revenue		14,718			10,601			30,034			27,364
Cost of revenue:
Product		7,649			6,071			13,409			16,786
Service		2,074			2,631			6,284			9,646
Stock-based compensation:
Product		77			170			233			508
Service		99			171			300			546
Total cost of revenue		9,899			9,043			20,226			27,486
Gross profit (loss)		4,819			1,558			9,808			(122	)
Operating expenses:
Research and development		11,257			12,679			34,306			40,038
Sales and marketing		4,896			4,884			13,652			14,896
General and administrative		1,642			1,852			5,092			5,261
Stock-based compensation:
Research and development		520			844			2,310			2,562
Sales and marketing		253			425			790			1,553
General and administrative		309			387			1,055			1,305
Restructuring charges and related asset impairments		—			(2,193	)		—			(2,193	)
Total operating expenses		18,877			18,878			57,205			63,422
Loss from operations		(14,058	)		(17,320	)		(47,397	)		(63,544	)
Interest and other income, net		3,485			5,426			11,648			18,171
Loss before income taxes		(10,573	)		(11,894	)		(35,749	)		(45,373	)
Provision for income taxes		—			—			—			—
Net loss	$	(10,573	)	$	(11,894	)	$	(35,749	)	$	(45,373	)
Basic and diluted net loss per share	$	(0.04	)	$	(0.04	)	$	(0.13	)	$	(0.17	)
Weighted-average shares used in computing basic and diluted net loss per share		272,652			266,638			271,642			264,640

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

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Sycamore Networks, Inc.

Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

	Nine Months Ended
	April 24, 2004			April 26, 2003
Cash flows from operating activities:
Net loss	$	(35,749	)	$	(45,373	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		8,005			17,255
Stock-based compensation		4,688			6,474
Restructuring charges and related asset impairment		—			1,000
Provision for doubtful accounts		(52	)		—
Changes in operating assets and liabilities:
Accounts receivable		(3,443	)		6,912
Inventories		1,100			6,012
Prepaids and other current assets		(72	)		(1,120	)
Deferred revenue		4,233			(990	)
Accounts payable		(1,187	)		(2,932	)
Accrued expenses and other current liabilities		(1,975	)		(5,835	)
Accrued restructuring costs		(4,787	)		(23,262	)
Net cash used in operating activities		(29,239	)		(41,859	)
Cash flows from investing activities:
Purchases of property and equipment		(3,463	)		(2,584	)
Purchases of investments		(618,901	)		(300,503	)
Maturities of investments		618,697			403,406
Decrease in other assets		515			4,429
Net cash provided by (used in) investing activities		(3,152	)		104,748
Cash flows from financing activities:
Proceeds from issuance of common stock		4,542			2,049
Purchase of treasury stock		(25	)		(152	)
Net cash provided by financing activities		4,517			1,897
Net increase (decrease) in cash and cash equivalents		(27,874	)		64,786
Cash and cash equivalents, beginning of period		250,595			172,658
Cash and cash equivalents, end of period	$	222,721		$	237,444

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

5

Sycamore Networks, Inc.

Notes To Consolidated Financial Statements

1. Description of Business

Sycamore Networks, Inc. (the “Company”) was incorporated in Delaware on February 17, 1998. The Company develops and markets optical networking products that are designed to enable telecommunications service providers to cost-effectively and easily transition their existing fiber optic network into an infrastructure that can provision, manage and deliver economic, high-bandwidth services to their customers.

2. Basis of Presentation

The accompanying financial data as of April 24, 2004 and for the three and nine months ended April 24, 2004 and April 26, 2003 has been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. However, the Company believes that the disclosures are adequate to make the information presented not misleading. These consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended July 31, 2003.

In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to present a fair statement of financial position as of April 24, 2004 and results of operations and cash flows for the periods ended April 24, 2004 and April 26, 2003 have been made. The results of operations and cash flows for the periods ended April 24, 2004 are not necessarily indicative of the operating results and cash flows for the full fiscal year or any future periods.

3. Stock-Based Compensation

The Company accounts for stock-based employee compensation arrangements in accordance with the intrinsic value provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and related interpretations and complies with the disclosure provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation,” (“SFAS 123”), as amended by SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure”.

Under the intrinsic value method, when the exercise price of the Company’s employee stock awards equals the market price of the underlying stock on the date of grant, no compensation expense is recognized in the Company’s Consolidated Statements of Operations. The Company currently recognizes compensation expense under APB 25 relating to certain stock options and restricted stock with exercise prices below fair market value on the date of grant.

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The Company is required under SFAS 123 to disclose pro forma information regarding the stock awards made to its employees based on specified valuation techniques that produce estimated compensation charges. The pro forma information is as follows (in thousands, except per share data):

	Three Months Ended						Nine Months Ended
	April 24, 2004			April 26, 2003			April 24, 2004			April 26, 2003
Net loss:
As reported	$	(10,573	)	$	(11,894	)	$	(35,749	)	$	(45,373	)
Stock-based compensation expense included in reported net loss under APB 25		1,258			1,997			4,688			6,474
Stock-based compensation expense that would have been included in reported net loss if the fair value provisions of FAS 123 had been applied to all awards		(9,732	)		(10,103	)		(28,829	)		(38,167	)
Pro forma	$	(19,047	)	$	(20,000	)	$	(59,890	)	$	(77,066	)
Basic and diluted net loss per share:
As reported	$	(0.04	)	$	(0.04	)	$	(0.13	)	$	(0.17	)
Pro forma	$	(0.07	)	$	(0.08	)	$	(0.22	)	$	(0.29	)

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

4. Net Loss Per Share

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

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

	Three Months Ended						Nine Months Ended
	April 24, 2004			April 26, 2003			April 24, 2004			April 26, 2003
Numerator:
Net loss	$	(10,573	)	$	(11,894	)	$	(35,749	)	$	(45,373	)
Denominator:
Weighted-average shares of common stock outstanding		273,103			271,518			272,598			271,489
Weighted-average shares subject to repurchase		(451	)		(4,880	)		(956	)		(6,849	)
Shares used in per-share calculation – basic and diluted		272,652			266,638			271,642			264,640
Net loss per share:
Basic and diluted	$	(0.04	)	$	(0.04	)	$	(0.13	)	$	(0.17	)

Options to purchase 28.3 million and 28.3 million shares of common stock, at respective average exercise prices of $7.45 and $7.86, have not been included in the computation of diluted net loss per share for the three and nine months ended April 24, 2004 and April 26, 2003, respectively, as their effect would have been anti-dilutive. Warrants to purchase 150,000 shares of common stock at an exercise price of $11.69 have not been included in the computation of diluted net loss per share for the three and nine months ended April 26, 2003, as their effect would have been anti-dilutive. These warrants expired unexercised during the fiscal year ended July 31, 2003.

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5. Inventories

Inventories consisted of the following (in thousands):

	April 24, 2004		July 31, 2003
Raw materials	$	106	$	861
Work in process		570		498
Finished goods		3,341		3,758
Total	$	4,017	$	5,117

6. Comprehensive Loss

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

	Three Months Ended						Nine Months Ended
	April 24, 2004			April 26, 2003			April 24, 2004			April 26, 2003
Net loss	$	(10,573	)	$	(11,894	)	$	(35,749	)	$	(45,373	)
Unrealized loss on investments		(2,230	)		(510	)		(2,286	)		(431	)
Comprehensive loss	$	(12,803	)	$	(12,404	)	$	(38,035	)	$	(45,804	)

7. Restructuring Charges and Related Asset Impairments

In fiscal 2001, the telecommunications industry began a severe decline which has impacted equipment suppliers, including the Company. In response to the telecommunications industry downturn, the Company 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 part of the Company’s fourth quarter fiscal 2002 restructuring program, the Company discontinued the development of its standalone transport products and focused its business exclusively on optical switching products. During fiscal 2002, as a result of the combined activity under all of the restructuring programs, the Company recorded a total net charge of $241.5 million, which was classified in the statement of operations as follows: cost of revenue - $91.7 million, operating expenses - $125.0 million, and non-operating expenses - $24.8 million. 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, the Company recorded a credit of $0.5 million classified as 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, the Company recorded a net $4.4 million credit to operating expenses due to various changes in estimates relating to its restructuring programs. The changes in estimates consisted primarily of an $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. While the Company has reduced the accrual for potential legal matters based on its current estimate, given the inherent uncertainties involved in such matters, it is reasonably possible that the Company 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, the Company may be required to record additional charges or credits against the reserves previously recorded for its restructuring programs.

8

As of April 24, 2004, the Company had $14.3 million in accrued restructuring costs, consisting primarily of $13.8 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. The Company recorded restructuring charges and related asset impairments of $81.9 million classified as operating expenses and an excess inventory charge of $84.0 million relating to discontinued product lines, which was classified as cost of revenue. The restructuring charges included amounts accrued for potential legal matters, administrative expenses and professional fees associated with the restructuring programs, including employment termination related claims. The Company substantially completed the fiscal 2001 restructuring program during the first half of fiscal 2002. In the fourth quarter of fiscal 2002, the Company recorded a net $2.1 million credit to operating expenses due to various changes in estimates. The changes in estimates consisted primarily of $4.7 million of additional facility consolidation charges due to less favorable sublease assumptions, offset by a $6.7 million reduction in the potential legal matters associated with the restructuring programs. During the third and fourth quarters of fiscal 2003, the Company recorded a net $1.3 million charge to operating expenses due to various changes in estimates. The changes in estimates consisted of $3.6 million of additional facility consolidation charges due to less favorable sublease assumptions, partially offset by a $2.3 million reduction in potential legal matters associated with the restructuring programs. As of April 24, 2004, the projected future cash payments of $10.5 million consist 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 restructuring program, and the reserve activity since that time, are summarized as follows (in thousands):

	Original Restructuring Charge		Non-Cash Charges		Payments		Adjustments		Accrual Balance at July 31, 2003		Payments		Accrual Balance at April 24, 2004
Workforce reduction	$	4,174	$	829	$	3,203	$	142	$	—	$	—	$	—
Facility consolidations and certain other costs		24,437		1,214		9,675		658		12,890		2,356		10,534
Inventory and asset write-downs		137,285		84,972		52,313		—		—		—		—
Total	$	165,896	$	87,015	$	65,191	$	800	$	12,890	$	2,356	$	10,534

First Quarter Fiscal 2002 Restructuring:

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

9

The first quarter fiscal 2002 restructuring program was substantially completed during the fourth quarter of fiscal 2002. During the third and fourth quarters of fiscal 2002, the Company recorded credits totaling $10.8 million to cost of revenue due to changes in estimates, the majority of which related to favorable settlements with contract manufacturers for non-cancelable inventory purchase commitments. In addition, during the fourth quarter of fiscal 2002, the Company recorded a net $1.7 million credit to operating expenses relating to various changes in estimates. The changes in estimates consisted of a $1.7 million reduction in potential legal matters associated with the restructuring programs and the reversal of an accrued liability of $0.8 million for workforce reductions, partially offset by $0.9 million of additional facility consolidation charges. During the third and fourth quarters of fiscal 2003, the Company recorded a net $1.4 million credit to operating expenses due to various changes in estimates. The changes in estimates consisted of a $2.2 million reduction in potential legal matters associated with the restructuring programs, partially offset by $0.8 million of additional facility consolidation charges due to less favorable sublease assumptions. In addition, the Company recorded a $1.0 million non-cash charge 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 April 24, 2004, the projected future cash payments of $0.7 million consist primarily of facility consolidation charges that will be paid over the respective lease terms through fiscal 2005 and potential legal matters associated with the restructuring programs.

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

	Original Restructuring Charge		Non-cash Charges		Payments		Adjustments		Accrual Balance at July 31, 2003		Payments		Accrual Balance at April 24, 2004
Workforce reduction	$	7,106	$	173	$	6,106	$	827	$	—	$	—	$	—
Facility consolidations and certain other costs		17,181		8,572		4,505		2,284		1,820		1,113		707
Inventory and asset write-downs		155,451		102,540		42,107		10,804		—		—		—
Losses on investments		22,737		22,737		—		—		—		—		—
Total	$	202,475	$	134,022	$	52,718	$	13,915	$	1,820	$	1,113	$	707

Fourth Quarter Fiscal 2002 Restructuring:

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

During the third and fourth quarters of fiscal 2003, the Company 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, the Company recorded a $0.9 million credit to operating expenses relating to proceeds received from the disposal of certain equipment. As of April 24, 2004, the projected future cash payments of $3.1 million consist

10

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.

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):

	Original Restructuring Charge		Non-cash Charges		Payments		Adjustments		Accrual Balance at July 31, 2003		Payments		Accrual Balance at April 24, 2004
Workforce reduction	$	8,713	$	814	$	7,129	$	770	$	—	$	—	$	—
Facility consolidations and certain other costs		20,132		—		12,116		3,640		4,376		1,318		3,058
Asset write-downs		22,637		22,637		—		—		—		—		—
Losses on investments		2,108		2,108		—		—		—		—		—
Total	$	53,590	$	25,559	$	19,245	$	4,410	$	4,376	$	1,318	$	3,058

8. Recent Accounting Pronouncements

In November 2002, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 00-21 (“EITF 00-21”), “Revenue Arrangements with Multiple Deliverables.” EITF 00-21 provides guidance on accounting for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF 00-21 were applied to multiple element revenue arrangements entered into by the Company beginning in the first quarter of fiscal 2004. The adoption of EITF 00-21 did not have a material impact on the Company’s financial position or results of operations.

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

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

In December 2003, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 104, Revenue Recognition (“SAB 104”), which supercedes SAB 101, Revenue Recognition in Financial Statements. The primary purpose of SAB 104 is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, which was superceded as a result of the issuance of EITF 00-21, Accounting for Revenue Arrangements with Multiple Deliverables. While the wording of SAB 104 has changed to reflect the issuance of EITF 00-21, the revenue recognition principles of SAB 101 remain largely unchanged by the issuance of SAB 104. The adoption of SAB 104 did not have a material impact on the Company’s financial statements.

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9. Commitments and Contingencies

Litigation

Beginning on July 2, 2001, several purported class action complaints were filed in the United States District Court for the Southern District of New York against the Company and several of its officers and directors (the “Individual Defendants”) and the underwriters for the Company’s initial public offering on October 21, 1999. Some of the complaints also include the underwriters for the Company’s follow-on offering on March 14, 2000. The complaints were consolidated into a single action and an amended complaint was filed on April 19, 2002. The amended complaint, 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 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 actions seek damages in an unspecified amount. On October 9, 2002, the court dismissed the Individual Defendants from the case without prejudice based upon Stipulations of Dismissal filed by the plaintiffs and the Individual Defendants. The Company has approved a Memorandum of Understanding (“MOU”) and related agreements which set forth the terms of a proposed settlement between the Company and the plaintiff class. Among other provisions, the settlement contemplated by the MOU provides for a release of the Company and the Individual Defendants with respect to claims related to the conduct alleged in the action to be wrongful. Pursuant to the settlement contemplated by the MOU, the Company would agree to undertake certain responsibilities, including agreeing to assign to the plaintiffs, and not otherwise 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 MOU 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 MOU and related agreements are subject to a number of contingencies, including the negotiation of a settlement agreement and its approval by the Court. 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 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.

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

Guarantees

FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”), requires that upon issuance of a guarantee, the guarantor must disclose and recognize a liability for the fair value of the obligation assumed under that guarantee. The initial recognition and measurement requirement of FIN 45 is effective for guarantees issued or modified after December 31, 2002 only for those items that require disclosure. As of April 24, 2004, the Company’s guarantees requiring disclosure consist of its accrued warranty obligations and indemnifications for intellectual property infringement claims.

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

Warranty liability

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

The following table summarizes the activity related to product warranty liability during the nine months ended April 24, 2004 (in thousands):

Balance at July 31, 2003	$	4,651
Accruals for warranties during the period		424
Settlements		(446)
Adjustments related to preexisting warranties		(1,033)
Balance at April 24, 2004	$	3,596

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

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-Q. The information discussed in this report should be read in conjunction with our Annual Report on Form 10-K and other reports we file 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 Networks, Inc. was incorporated in Delaware on February 17, 1998.

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. We believe that our products enable service providers to cost-effectively and easily transition their existing fiber optic network into an 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 caused the failure of certain emerging service providers and significant financial difficulties for a number of incumbent service providers. Both our existing and prospective service provider customers responded by curtailing network build outs and reducing their overall capital expenditures. After several years of significantly lower capital spending, most service providers’ operating costs remain high while their revenue is growing slowly, if at all. We believe that these trends may drive industry consolidation in both the service provider and equipment supplier markets.

Our business has been significantly impacted by the decline in the telecommunications industry. Our revenue declined from a high of $374.7 million in fiscal 2001 to $38.3 million in fiscal 2003. In addition, we enacted three separate restructuring programs, which have reduced our current cost structure compared to historical levels and focused our business on optical switching products, network management software, and network design and planning tools. However, 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 third quarter net loss of $10.6 million and a cumulative net loss of $771.9 million at April 24, 2004. We expect that our continued significant cost structure will have an adverse impact on our cost of revenue, gross margins and operating results unless our revenues can be substantially increased.

As a result of this environment, Sycamore continues to face challenges as a focused optical switching vendor. These challenges include, but are not limited to the following:

• We continue to compete against a number of larger more established incumbent telecom equipment suppliers, many of whom have long-standing relationships with our current and prospective customers.

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• More established incumbent competitors generally have more diverse product lines which allow them the flexibility to price their products more aggressively and absorb the large optical switching overhead expenses across their entire business.

• In order to remain competitive, we continue to devote significant resources to research and development, sales and customer support, which may generate additional operating losses and consume cash.

To respond to these challenges, we continue to review potential options including, but not limited to, alliances with larger networking companies, acquisitions of companies with complementary technologies or of companies that participate in adjacent market segments and other such transactions. Additionally, we continue to consider appropriate actions with respect to our cash position in light of our present and anticipated business needs and the options available in which shareholders may realize value in connection with their investment in us.

We reported revenue of $14.7 million for the third quarter of fiscal 2004. This was an increase of 114.1 % from the second quarter of 2004 and a 38.8% increase from the third quarter of 2003. During the second quarter of 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 quarter of fiscal 2004, through our distribution partner, DISA purchased certain evaluation equipment and began accepting shipments of our product. The GIG-BE project had a significant impact on third quarter revenue, totaling approximately $10.3 million. At this time, DISA is finalizing its project deployment plans and as a result the size of the project, the timing of any shipments and their impact on Sycamore is uncertain. Given our historical revenue levels any significant quarterly GIG-BE shipment may have a material impact on our revenue.

Our gross margin for the quarter was 32.7%. Our gross margins fluctuate from quarter to quarter based on the mix of customers, products sold, channels of distribution, shipment volume, overhead absorption, sales discounts, increases in material or labor costs, excess inventory and obsolescence charges, loss of cost savings due to changes in component pricing, the introduction of new products or entering new markets with different pricing and cost structures. Given the competitive environment, we expect that gross margins will continue to fluctuate quarterly.

Our total cash, cash equivalents and investments were $965.6 million at April 24, 2004. Included in this amount were cash and cash equivalents of $222.7 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 alternatives discussed above.

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.

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Revenue Recognition

When products are shipped to customers, we evaluate whether all of the fundamental criteria for revenue recognition have been met. The most significant revenue recognition judgments typically involve customer acceptance and whether collection is reasonably assured.

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. For the product portion, we recognize revenue upon shipment if there are no significant uncertainties regarding customer acceptance. If uncertainties regarding customer acceptance exist, we recognize revenue when the uncertainties are resolved. For installation services, typically we recognize revenue for services that have been performed upon acceptance in accordance with the contract. For maintenance and training services, we recognize revenue when the services are performed.

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 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

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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 April 24, 2004, we had $13.8 million accrued as part of our restructuring liability relating to facility consolidations, based on our best estimate of the available sublease rates and terms at the present time. In the event that we are unsuccessful in subleasing any of the restructured facilities, we could incur additional restructuring charges and cash outflows in future periods totaling $1.2 million, which represents our current estimate of the assumed sublease recoveries.

Results of Operations

Revenue

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

	Three Months Ended								Nine Months Ended
	April 24, 2004		April 26, 2003		Variance in Dollars		Variance in Percent		April 24, 2004		April 26, 2003		Variance in Dollars			Variance in Percent
Revenue
Product	$	11,355	$	7,696	$	3,659	47.5	%	$	21,184	$	17,997	$	3,187		17.7	%
Service		3,363		2,905		458	15.8	%		8,850		9,367		(517	)	(5.5	%)
Total revenue	$	14,718	$	10,601	$	4,117	38.8	%	$	30,034	$	27,364	$	2,670		9.8	%

Product revenue increased for the three and nine months ended April 24, 2004 compared to the same periods ended April 26, 2003 primarily due to revenue generated from the GIG-BE project. Service revenue increased for the third quarter of fiscal 2004 compared to the third quarter of fiscal 2003 primarily due to revenue from the GIG-BE project. Service revenue decreased for the nine months ended April 24, 2004 compared to the nine months ended April 26, 2003 primarily due to a lower level of maintenance services partially offset by a higher level of installation services associated with product deployments.

For the third quarter of fiscal 2004, the GIG-BE product revenue accounted for the majority of revenue and domestic revenue represented 70.1% of total revenue. For the third quarter of fiscal 2003, three international customers accounted for the majority of total revenue and international revenue represented more than 97% of total revenue. For the current fiscal year ending July 31, 2004, we anticipate that revenue will continue to be highly concentrated in a relatively small number of customers. GIG-BE deployments in any given quarter may cause shifts in the percentage mix of domestic and international revenue.

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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):

	Three Months Ended						Nine Months Ended
	April 24, 2004			April 26, 2003			April 24, 2004			April 26, 2003
Gross profit (loss):
Product	$	3,630		$	1,455		$	7,542		$	703
Service		1,189			103			2,266			(825	)
Total	$	4,819		$	1,558		$	9,808		$	(122	)
Gross profit (loss):
Product		32.0	%		18.9	%		35.6	%		3.9	%
Service		35.4	%		3.5	%		25.6	%		(8.8	%)
Total		32.7	%		14.7	%		32.7	%		(0.4	%)

Product gross profit

Product gross profit increased for the three and nine months ended April 24, 2004 compared to the same periods ended April 26, 2003 primarily as a result of the following factors: (i) the sale of partially amortized evaluation equipment which had a favorable impact on gross profit, (ii) the expiration of preexisting warranty obligations and (iii) decreased manufacturing costs.

We believe that product gross profit may fluctuate in the future due to 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, loss of cost savings due to changes in component pricing, the introduction of new products or entering new markets with different pricing and cost structures and pricing pressures resulting from intense competition for limited optical switching opportunities worldwide.

Service gross profit (loss)

Service gross profit increased for the three and nine months ended April 24, 2004 compared to the same periods ended April 26, 2003 due to a reduction in fixed support costs and lower personnel-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.

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Operating Expenses

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

	Three Months Ended										Nine Months Ended
	April 24, 2004		April 26, 2003			Variance in Dollars			Variance in Percent		April 24, 2004		April 26, 2003			Variance in Dollars			Variance in Percent
Research and development	$	11,257	$	12,679		$	(1,422	)	(11.2	)%	$	34,306	$	40,038		$	(5,732	)	(14.3	)%
Sales and marketing		4,896		4,884			12		0.2	%		13,652		14,896			(1,244	)	(8.4	)%
General and administrative		1,642		1,852			(210	)	(11.3	)%		5,092		5,261			(169	)	(3.2	)%
Stock-based compensation		1,082		1,656			(574	)	(34.7	)%		4,155		5,420			(1,265	)	(23.3	)%
Restructuring charges and related impairments		—		(2,193	)		2,193		—			—		(2,193	)		2,193		—
Total operating expenses	$	18,877	$	18,878		$	(1	)	—		$	57,205	$	63,422		$	(6,217	)	(9.8	)%

Research and Development Expenses

Research and development expense decreased for the three and nine months ended April 24, 2004 compared to the same periods ended April 26, 2003. The decrease was primarily due to reduced costs for project materials, lower personnel-related expenses and reduced fixed overhead costs.

Sales and Marketing Expenses

Sales and marketing expense increased for the three months ended April 24, 2004 compared to the same period ended April 26, 2003. The increase was primarily due to higher commissions resulting from increased revenue from the GIG-BE project, and an increase in cost of demonstration equipment, partially offset by lower personnel-related expenses. The decrease in sales and marketing expense for the nine months ended April 24, 2004 compared to the same period ended April 26, 2003 was primarily due to lower personnel-related expenses.

General and Administrative Expenses

General and administrative expense decreased for the three and nine months ended April 24, 2004 compared to the same periods ended April 26, 2003. The decrease was primarily due to 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. The decrease in stock based compensation expense for the three and nine months ended April 24, 2004 compared to the same periods ended April 26, 2003 was primarily due to headcount reductions from the third quarter of fiscal 2003 through the third quarter of fiscal 2004. Stock-based compensation expense is expected to impact our reported results of operations 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 $402.4 million, comprised as follows: $175.1 million of net charges related to excess inventory, $202.5 million of net charges for restructuring and related asset impairments, and $24.8 million of losses on investments.

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The net charges of $402.4 million, include a net $2.2 million credit to operating expenses recorded in the third quarter of fiscal 2003, due to various changes in estimates relating to its restructuring programs. The changes in estimates consisted primarily of a $6.4 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.

As of April 24, 2004, we had $14.3 million in accrued restructuring costs, consisting primarily of $13.8 million of accrued liabilities for facility consolidations that will be paid over the respective lease terms through 2007.

Interest and Other income, Net

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

	Three Months Ended									Nine Months Ended
	April 24, 2004		April 26, 2003		Variance in Dollars			Variance in Percent		April 24, 2004		April 26, 2003		Variance in Dollars			Variance in Percent
Interest and other income, net	$	3,485	$	5,426	$	(1,941	)	(35.8	)%	$	11,648	$	18,171	$	(6,523	)	(35.9	)%

Interest and other income, net decreased for the three and nine months ended April 24, 2004 compared to the same periods ended April 26, 2003 due to a combination of lower interest rates and lower invested cash balances during these periods.

Provision for Income Taxes

We did not provide for income taxes for the three and nine months ended April 24, 2004, or for the same periods in 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.

Liquidity and Capital Resources

Total cash, cash equivalents and investments were $965.6 million at April 24, 2004. Included in this amount were cash and cash equivalents of $222.7 million, compared to $250.6 million at July 31, 2003. The decrease in cash and cash equivalents for the nine months ended April 24, 2004 was due to cash used in operating activities of $29.2 million and cash used in investing activities of $3.2 million, offset by cash provided by financing activities of $4.5 million.

Cash used in investing activities of $3.2 million consisted primarily of purchases of property and equipment of $3.5 million. Cash provided by financing activities of $4.5 million consisted primarily of proceeds from employee stock plan activity. Cash used in operating activities of $29.2 million consisted of the net loss for the period of $35.7 million, adjusted for net non-cash charges totaling $12.6 million and changes to working capital totaling $6.1 million. The most significant changes to working capital were a decrease in accrued restructuring costs of $4.8 million, an increase in deferred revenue of $4.2 million and an increase in accounts receivable of $3.4 million. Non-cash charges include depreciation and amortization, provision for doubtful accounts and stock-based compensation.

Our primary source of liquidity comes from our cash, cash equivalents and investments, which totaled $965.6 million at April 24, 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 April 24, 2004, $384.8 million of investments with maturities of less than one year were classified as short-term investments, and $358.1 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

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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 April 24, 2004, our accounts receivable balance was attributable to 5 customers.

As of April 24, 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. Since 1999, we have funded and 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.

Off-Balance Sheet Arrangements

At April 24, 2004, our off-balance sheet arrangements, which consist entirely of contractual commitments for operating leases and inventory purchase commitments, were as follows (in thousands):

Fiscal Year:	Operating Leases		Inventory Purchase Commitments
2004 (remainder of year)	$	2,896	$	8,115
2005		5,380		1,157
2006		7,080		—
2007		2,848		—
Total future contractual commitments	$	18,204	$	9,272

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.

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 caused the failure of certain emerging service providers and significant financial difficulties for a number of incumbent service providers. Both our existing and prospective service provider customers responded by curtailing network build outs and reducing their overall capital expenditures. After several years of significantly lower capital spending, most service providers’ operating costs remain high while their revenue is growing slowly, if at all. These trends may drive industry consolidation.

The industry decline and related reduction in service provider capital expenditures has resulted in a substantial reduction in the demand for our products and materially and adversely affected our revenue and operating results. We anticipate that our current and prospective customers will not increase their capital spending in the near future.

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As a result, we anticipate that our 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:

• our current and prospective customers will continue to have limited capital expenditures;

• we will continue to have limited ability to forecast the volume and product mix of our sales;

• we will experience increased competition as a result of reduced demand and we may experience downward pressures on pricing of our products which reduces gross margins;

• the increased competition may enable customers to demand more favorable terms and conditions of sales including extended payment terms; and

• the bankruptcies or weakened financial condition of some of our customers may require us to write off amounts due from prior sales.

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

Our strategy to pursue strategic opportunities may not be successful.

We face challenges as a focused optical switching vendor. In order to address these challenges we may, as part of our business strategy, pursue strategic alliances with larger networking companies, acquisitions of companies with complementary technologies or of companies that participate in adjacent market segments and other such transactions. Any such strategic option 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 of any strategic transaction. 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 as well as the possibility of providing a means by which shareholders may realize value in connection with their investment in our common stock.

We currently depend entirely on our line of intelligent optical networking products and our revenue depends upon their commercial success.

Our revenue depends on the commercial success of our line of intelligent optical networking products. Over the past three years, we have narrowed the scope of our product offerings, including discontinuing the development of our standalone transport products. Our research and development efforts focus exclusively on optical switching products and network management systems. We 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:

• anticipating evolving customer requirements;

• completing the development, introduction or production manufacturing of new products; or

• enhancing our existing products.

If our current and prospective customers do not adopt our intelligent 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.

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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 support large established service providers, 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. Our revenue declined from a high of $374.7 million in fiscal 2001 to $38.3 million in fiscal 2003. In addition, we enacted three separate restructuring programs, which have reduced our current cost structure compared to historical levels and focused our business on optical switching products, network management software, and network design and planning tools. However, 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 third quarter net loss of $10.6 million and a cumulative net loss of $771.9 million at April 24, 2004. We expect that our continued significant investment in research and development and sales and customer support organizations 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.

Competition in the optical networking market is intense. Competition is based upon a combination of price, functionality, network management, interoperability, installation, services, scalability, and incumbency. Large companies, such as Nortel Networks, Lucent Technologies, Alcatel and Ciena Corporation, have historically dominated this market. Many of our competitors have long operating histories and greater financial, sales, marketing and manufacturing resources. These competitors also have long standing existing relationships with our current and prospective customers. To a lesser extent, new 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:

• price discounting;

• early announcements of competing products and other marketing efforts;

• customer financing assistance;

• complete solution sales from one single source;

• marketing and advertising assistance; and

• intellectual property disputes.

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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 product lines that allow them the flexibility to price their products aggressively and absorb the optical switching overhead expenses 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.

We currently have a limited number of customers. 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 potential 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 potential 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 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 intelligent 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 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 market for sale to the federal government 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

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purchase our products in the future. Our failure to sell products to the federal government, including for use in the GIG-BE project, would adversely affect our ability to achieve our planned levels of revenue, which would affect our profitability 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:

• issue stock that would dilute our current stockholders’ holdings;

• consume cash, which would reduce the amount of cash available for other purposes;

• incur debt or assume liabilities;

• increase our ongoing operating expenses and level of fixed costs;

• record goodwill and non-amortizable intangible assets subject to impairment testing and potential periodic impairment charges;

• incur amortization expenses related to certain intangible assets;

• incur large and immediate write-offs; or

• become subject to litigation.

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

• problems combining the purchased operations, technologies or products;

• unanticipated costs or liabilities;

• diversion of management’s attention from other business issues and opportunities;

• adverse effects on existing business relationships with suppliers and customers;

• problems entering markets in which we have no or limited prior experience; and

• problems with integrating employees and potential loss of key employees.

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:

• fluctuation in demand for our products;

• the timing and size of sales of our products;

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• changes in customer requirements, including delays or order cancellations;

• the introduction of new products by us or our competitors;

• changes in the price or availability of components for our products;

• the timing of recognizing revenue and deferred revenue;

• readiness of customer sites for installation;

• changes in our pricing policies or the pricing policies of our competitors;

• satisfaction of contractual customer acceptance criteria and related revenue recognition issues;

• manufacturing and shipment delays and deferrals;

• the timing and amount of employer payroll tax to be paid on employee gains on stock options exercised;

• changes in accounting rules, such as any future requirement to record stock-based compensation expense for employee stock option grants made at fair market value; and

• general economic conditions as well as those specific to the telecommunications and related industries.

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. Accordingly, in the event that customer order activity increased, 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 the demands of our customers and damage our customer relationships.

We have limited internal manufacturing capabilities. We utilize contract manufacturers to manufacture our products in accordance with our specifications and to 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.

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The contract manufacturing industry is a highly competitive, capital-intensive business with relatively low profit margins, in which 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 favorable 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.

During the past year, component suppliers have stabilized 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 increase procurement costs. In addition, increasing consolidation in the optical component industry could result in reduced competition 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 under estimate 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.

Product performance problems could limit our current and future sales prospects.

If our products do not meet our customers’ performance requirements, our current and future prospects 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:

• loss of revenue or delay in revenue recognition or accounts receivable collection;

• loss of customers and market share;

• inability to attract new customers or achieve market acceptance;

• diversion of development and other resources;

• increased service, warranty and insurance costs; and

• legal actions by our customers.

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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 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 91% of total revenue in fiscal 2003, and 65% of total revenue in the first nine months of fiscal 2004, and our customer base is primarily international. 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:

• greater difficulty in accounts receivable collection and longer collection periods;

• difficulties and costs of staffing and managing foreign operations in compliance with local laws and customs;

• reliance on working with distribution partners for the resale of our products in certain markets and for certain types of product offerings, such as the integration of our products into third-party product offerings;

• necessity to work with third parties in certain countries to perform installation and obtain customer acceptance, and the resulting impact on revenue recognition;

• necessity to maintain staffing, or to work with third parties, to provide service and support in international locations;

• the impact of slowdowns or recessions in economies outside the United States;

• unexpected changes in regulatory requirements, including trade protection measures and import and licensing requirements;

• certification requirements;

• currency fluctuations;

• reduced protection for intellectual property rights in some countries;

• potentially adverse tax consequences; and

• political and economic instability, particularly in emerging markets.

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.

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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 particular lawsuit could have a material adverse effect 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 software, 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 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:

• stop selling, incorporating or using our products that incorporate the challenged intellectual property;

• obtain from the owner of the intellectual property right a license to sell or use the relevant technology, which license may not be available on reasonable terms, or at all;

• redesign those products that use such technology; or

• accept a return of products that use such technologies.

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

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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:

• our loss of a major customer;

• significant changes or slowdowns in the funding and spending patterns of our current and prospective customers;

• the addition or departure of key personnel;

• variations in our quarterly operating results;

• announcements by us or our competitors of significant contracts, new products or product enhancements;

• failure by us to meet product milestones;

• acquisitions, distribution partnerships, joint ventures or capital commitments;

• regulatory changes in telecommunications;

• variations between our actual results and the published expectations of securities analysts;

• changes in financial estimates by securities analysts;

• sales of our common stock or other securities in the future;

• changes in market valuations of networking and telecommunications companies; and

• fluctuations in stock market prices and volumes.

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

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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 April 24, 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.

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Item 3. Quantitative and Qualitative Disclosure 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 April 24, 2004, the fair value of the portfolio would decline by approximately $1.1million. We have the ability to hold our fixed income investments until maturity, and therefore do not expect our operating results or cash flows to be affected to any significant degree by the effect of a sudden change in market interest rates on our investment portfolio.

Exchange Rate Sensitivity

While the majority of our operations are based in the United States, our business has become increasingly global, with international revenue representing 91% of total revenue in fiscal 2003, and 65% of revenue in the first nine months of fiscal 2004. We expect that international sales may continue to represent a significant portion of our revenue. Fluctuations in foreign currencies may have an impact on our financial results, although 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.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures. Based on our management’s evaluation (with the participation of our principal executive officer and principal financial officer), as of the end of the period covered by this report, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”)) are effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

Changes in Internal Control over Financial Reporting. There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during our third fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Limitations on Effectiveness of Controls. Our management has concluded that our disclosure controls and procedures and internal controls provide reasonable assurance that the objectives of our control system are met. However, our management (including our chief executive officer and chief financial officer) does not expect that the disclosure controls and procedures or internal controls will prevent all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Due to the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, errors and instances of fraud, if any, within the company have been or will be detected.

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Part II. Other Information

Item 1. 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 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 actions seek damages in an unspecified amount. On October 9, 2002, the court dismissed the Individual Defendants from the case without prejudice based upon Stipulations of Dismissal filed by the plaintiffs and the Individual Defendants. The Company has approved a Memorandum of Understanding (“MOU”) and related agreements which set forth the terms of a proposed settlement between the Company and the plaintiff class. Among other provisions, the settlement contemplated by the MOU provides for a release of the Company and the Individual Defendants with respect to claims related to the conduct alleged in the action to be wrongful. Pursuant to the settlement contemplated by the MOU, the Company would agree to undertake certain responsibilities, including agreeing to assign to the plaintiffs, and not otherwise 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 MOU 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 MOU and related agreements are subject to a number of contingencies, including the negotiation of a settlement agreement and its approval by the Court. 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 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.

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

In the three months ended April 24, 2004, the Company purchased the following shares of common stock (in thousands, except per share data):

	Total shares purchased *	Average price paid per share
January 25, 2004 - February 21, 2004	17	$	0.09
February 22, 2004 - March 20, 2004	1		0.00
March 21, 2004 - April 24, 2004	6		0.04
Total	24	$	0.07

^* Purchased from departing employees pursuant to preexisting contractual rights.

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

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Item 6. Exhibits and Reports on Form 8-K

Exhibits:

(a) List of Exhibits

Number	Exhibit Description
3.1	Amended and Restated Certificate of Incorporation of the Company (2)
3.2	Certificate of Amendment to the Amended and Restated Certificate of Incorporation of the Company (2)
3.3	Certificate of Amendment to the Amended and Restated Certificate of Incorporation of the Company (3)
3.4	Amended and Restated By-Laws of the Company (2)
4.1	Specimen common stock certificate (1)
4.2	See Exhibits 3.1, 3.2, 3.3 and 3.4, for provisions of the Certificate of Incorporation and By-Laws of the Registrant defining the rights of holders of common stock of the Company (2)(3)
* 10.2	Exhibit I dated February 25, 2004 to the Reseller Agreement dated January 6, 2004 between Sprint and Sycamore Networks, Inc.
31.1	Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(1) Incorporated by reference to Sycamore Networks, Inc.’s Registration Statement on Form S-1 (Registration Statement No. 333-84635).

(2) Incorporated by reference to Sycamore Networks, Inc.’s Registration Statement on Form S-1 (Registration Statement No. 333-30630).

(3) Incorporated by reference to Sycamore Networks, Inc.’s Quarterly Report on Form 10-Q for the quarterly period ended January 27, 2001 filed with the Securities and Exchange Commission on March 13, 2001.

* Confidential treatment requested for certain portions of this Exhibit pursuant to Rule 24b-2 promulgated under the Securities Exchange Act, which portions are omitted and filed separately with the Securities and Exchange Commission.

(b) Reports on Form 8-K: On February 10, 2004, the Company furnished a Current Report on Form 8-K under Item 12 containing the press release relating to its second quarter fiscal 2004 results.

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Signature

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Sycamore Networks, Inc.

/s/    FRANCES M. JEWELS        

Frances M. Jewels

Chief Financial Officer

(Duly Authorized Officer and Principal

Financial and Accounting Officer)

Dated: May 13, 2004

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EXHIBIT INDEX

Number	Exhibit Description
3.1	Amended and Restated Certificate of Incorporation of the Company (2)
3.2	Certificate of Amendment to the Amended and Restated Certificate of Incorporation of the Company (2)
3.3	Certificate of Amendment to the Amended and Restated Certificate of Incorporation of the Company (3)
3.4	Amended and Restated By-Laws of the Company (2)
4.1	Specimen common stock certificate (1)
4.2	See Exhibits 3.1, 3.2, 3.3 and 3.4, for provisions of the Certificate of Incorporation and By-Laws of the Registrant defining the rights of holders of common stock of the Company (2)(3)
*10.2	Exhibit I dated February 25, 2004 to the Reseller Agreement dated January 6, 2004 between Sprint and Sycamore Networks, Inc.
31.1	Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(1) Incorporated by reference to Sycamore Networks, Inc.’s Registration Statement on Form S-1 (Registration Statement No. 333-84635).

(2) Incorporated by reference to Sycamore Networks, Inc.’s Registration Statement on Form S-1 (Registration Statement No. 333-30630).

(3) Incorporated by reference to Sycamore Networks, Inc.’s Quarterly Report on Form 10-Q for the quarterly period ended January 27, 2001 filed with the Securities and Exchange Commission on March 13, 2001.

* Confidential treatment requested for certain portions of this Exhibit pursuant to Rule 24b-2 promulgated under the Securities Exchange Act, which portions are omitted and filed separately with the Securities and Exchange Commission.

37