10-Q

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 JANUARY 28, 2006

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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  x        Accelerated filer                     Non accelerated filer             

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

The number of shares outstanding of the Registrant’s Common Stock as of February 9, 2006 was 278,262,603.

Sycamore Networks, Inc.

Index		Page No.
Part I.	FINANCIAL INFORMATION	3
Item 1.	Financial Statements (unaudited)	3
	Consolidated Balance Sheets as of January 28, 2006 and July 31, 2005	3
	Consolidated Statements of Operations for the three and six months ended January 28, 2006 and January 29, 2005	4
	Consolidated Statements of Cash Flows for the six months ended January 28, 2006 and January 29, 2005	5
	Notes to Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	17
Item 3.	Quantitative and Qualitative Disclosure About Market Risk	37
Item 4.	Controls and Procedures	37
Part II.	OTHER INFORMATION	38
Item 1.	Legal Proceedings	38
Item 4.	Submission of Matters to a Vote of Security Holders	39
Item 6.	Exhibits	40
Signature		41

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Part I. Financial Information

Item 1. Financial Statements

Sycamore Networks, Inc.

Consolidated Balance Sheets

(in thousands, except par value)

(unaudited)

	January 28, 2006			July 31, 2005
Assets
Current assets:
Cash and cash equivalents	$	691,236		$	508,281
Short-term investments		232,666			446,258
Accounts receivable, net of allowance for doubtful accounts of $4,132 at January 28, 2006 and July 31, 2005		10,490			8,384
Inventories		4,100			5,445
Prepaids and other current assets		4,329			3,812
Total current assets		942,821			972,180
Property and equipment, net		9,103			8,437
Long-term investments		41,877			496
Other assets		885			950
Total assets	$	994,686		$	982,063
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	1,804		$	2,144
Accrued compensation		1,438			3,640
Accrued warranty		1,398			1,654
Accrued expenses		2,022			4,209
Accrued restructuring costs		6,925			8,455
Reserve for contingencies		10,032			10,282
Deferred revenue		3,816			8,700
Other current liabilities		1,803			1,850
Total current liabilities		29,238			40,934
Long term deferred revenue		2,350			1,584
Total liabilities		31,588			42,518
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; 278,229 and 276,046 shares issued at January 28, 2006 and July 31, 2005, respectively		278			276
Additional paid-in capital		1,790,352			1,780,243
Accumulated deficit		(826,673	)		(838,533	)
Deferred compensation		—			(35	)
Accumulated other comprehensive loss		(859	)		(2,406	)
Total stockholders’ equity		963,098			939,545
Total liabilities and stockholders’ equity	$	994,686		$	982,063

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						Six Months Ended
	January 28, 2006			January 29, 2005			January 28, 2006			January 29, 2005
Revenue:
Product	$	15,128		$	11,225		$	37,161		$	22,164
Service		5,707			3,667			10,972			6,943
Total revenue		20,835			14,892			48,133			29,107
Cost of revenue:
Product		8,242			6,565			18,819			13,188
Service		2,155			1,837			4,519			3,754
Stock-based compensation:
Product		40			37			83			102
Service		292			41			572			100
Total cost of revenue		10,729			8,480			23,993			17,144
Gross profit		10,106			6,412			24,140			11,963
Operating expenses:
Research and development		7,377			11,217			15,090			22,889
Sales and marketing		2,401			3,011			5,038			6,155
General and administrative		2,122			1,932			5,020			4,180
Stock-based compensation:
Research and development		511			229			1,136			516
Sales and marketing		251			32			493			81
General and administrative		303			45			579			257
Litigation settlement		750			—			750			—
Total operating expenses		13,715			16,466			28,106			34,078
Loss from operations		(3,609	)		(10,054	)		(3,966	)		(22,115	)
Interest and other income, net		8,726			4,672			16,156			8,870
Income (loss) before income taxes		5,117			(5,382	)		12,190			(13,245	)
Income tax expense		111			—			330			—
Net income (loss)	$	5,006		$	(5,382	)	$	11,860		$	(13,245	)
Net income (loss) per share:
Basic	$	0.02		$	(0.02	)	$	0.04		$	(0.05	)
Diluted	$	0.02		$	(0.02	)	$	0.04		$	(0.05	)
Weighted average shares outstanding:
Basic		277,435			274,963			276,854			274,497
Diluted		281,036			274,963			280,084			274,497

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

4

Sycamore Networks, Inc.

Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

	Six Months Ended
	January 28, 2006			January 29, 2005
Cash flows from operating activities:
Net income (loss)	$	11,860		$	(13,245	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization		1,739			2,522
Stock-based compensation		2,863			1,056
Loss on disposal of property and equipment		178			—
Adjustments to provision for excess and obsolete inventory		(436	)		—
Changes in operating assets and liabilities:
Accounts receivable		(2,106	)		531
Inventories		1,781			146
Prepaids and other current assets		(985	)		(1,075	)
Deferred revenue		(4,118	)		(3,004	)
Accounts payable		(340	)		(462	)
Accrued expenses and other current liabilities		(4,942	)		858
Accrued restructuring costs		(1,530	)		(1,729	)
Net cash provided by (used in) operating activities		3,964			(14,402	)
Cash flows from investing activities:
Purchases of property and equipment		(2,583	)		(1,515	)
Purchases of investments		(443,317	)		(102,779	)
Maturities of investments		617,075			442,415
Decrease in other assets		65			79
Net cash provided by investing activities		171,240			338,200
Cash flows from financing activities:
Proceeds from issuance of common stock		7,751			3,944
Net cash provided by financing activities		7,751			3,944
Net increase in cash and cash equivalents		182,955			327,742
Cash and cash equivalents, beginning of period		508,281			45,430
Cash and cash equivalents, end of period	$	691,236		$	373,172

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 is a leading provider of intelligent optical switching products that form the reliable foundation for some of the world’s most respected and innovative communications networks. Sycamore’s fully integrated edge-to-core optical switching solutions enable network operators to efficiently and cost-effectively provision and manage optical network capacity to support a wide range of voice, video and data services.

2. Basis of Presentation

The accompanying financial data as of January 28, 2006 and for the three and six months ended January 28, 2006 and January 29, 2005 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, 2005 filed with the SEC.

In the opinion of management, all adjustments necessary to present a fair statement of financial position as of January 28, 2006 and results of operations and cash flows for the periods ended January 28, 2006 and January 29, 2005 have been made. The results of operations and cash flows for the period ended January 28, 2006 are not necessarily indicative of the operating results and cash flows for the full fiscal year or any future periods.

3. Stock-Based Compensation

Effective August 1, 2005, the Company adopted the provisions of Statement of Financial Accounting Standards No. 123R, (“SFAS 123R”) “Share-Based Payment,” which establishes accounting for equity instruments exchanged for employee services. Under the provisions of SFAS No. 123R, share-based compensation cost is measured at the grant date, based on the calculated fair value of the award, and is recognized as an expense over the employee’s requisite service period (generally the vesting period of the equity grant). Prior to August 1, 2005, the Company accounted for share-based compensation to employees in accordance with Accounting Principles Board Opinion No. 25, (“APB 25”) “Accounting for Stock Issued to Employees,” and related interpretations. The Company also followed the disclosure requirements of SFAS No. 123, “Accounting for Stock-Based Compensation”, as amended by SFAS 148, “Accounting for Stock-Based Compensation - Transition and Disclosure”. The Company elected to adopt the modified prospective transition method as provided by SFAS No. 123R and, accordingly, financial statement amounts for the prior periods presented in this Form 10-Q have not been restated to reflect the fair value method of expensing share-based compensation.

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The following table presents share-based compensation expense included in the Company’s consolidated statements of operations:

	Three Months Ended			Six Months Ended
	January 28, 2006
Cost of product revenue	$	40		$	83
Cost of service revenue		292			572
Research and development		511			1,136
Sales and marketing		251			493
General and administrative		303			579
Share-based compensation expense before tax		1,397			2,863
Income tax benefit		(30	)		(75	)
Net compensation expense	$	1,367		$	2,788

The Company estimates the fair value of stock options using the Black-Scholes valuation model. Key input assumptions used to estimate the fair value of stock options include the exercise price of the award, the expected option term, the expected volatility of the Company’s stock over the option’s expected term, the risk-free interest rate over the option’s expected term, and the Company’s expected annual dividend yield. The Company believes that the valuation technique and the approach utilized to develop the underlying assumptions are appropriate in calculating the fair values of the Company’s stock options granted in the three and six months ended January 28, 2006. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by persons who receive equity awards.

The fair value of each option grant was estimated on the grant date using the Black-Scholes option-pricing model with the following assumptions:

	Three Months Ended	Six Months Ended
	January 28, 2006
Expected option term (1)	6.5 years	6.5 years
Expected volatility factor (2)	62%	62%
Risk-free interest rate (3)	4.4%	4.4%
Expected annual dividend yield	0%	0%

(1) The option term was determined using the simplified method for estimating expected option life, which qualify as “plain-vanilla” options.

(2) The stock volatility for each grant is measured using the weighted average of historical daily price changes of the Company’s common stock over the most recent period equal to the expected option life of the grant, adjusted for activity which is not expected to occur in the future.

(3) The risk-free interest rate for periods equal to the expected term of the share option is based on the U.S. Treasury yield curve in effect at the time of grant.

The Company did not recognize compensation expense for employee share-based awards for the three and six months ended January 29, 2005, when the exercise price of the Company’s employee stock awards equaled the market price of the underlying stock on the date of grant. The Company did recognize 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.

The Company had previously adopted the 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” through disclosure only. The following table illustrates the effects on net income and earnings per share for the three and six months ended January 29, 2005 as if the Company had applied the fair value recognition provisions of SFAS 123 to share-based employee awards.

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	Three Months Ended			Six Months Ended
	January 29, 2005
Net loss as reported:	$	(5,382	)	$	(13,245	)
Stock-based compensation expense included in reported net loss under APB 25		384			1,056
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		(17,806	)		(46,559	)
Pro forma net loss	$	(22,804	)	$	(58,748	)
Basic and diluted net loss per share:
As reported	$	(0.02	)	$	(0.05	)
Pro forma	$	(0.08	)	$	(0.21	)

The fair value of each option grant was estimated on the grant date using the Black-Scholes option pricing model with the following assumptions:

	Three Months Ended	Six Months Ended
	January 29, 2005
Expected option term	5 years	5 years
Expected volatility factor	88.7%	90.2%
Risk-free interest rate	3.7%	3.4%
Expected annual dividend yield	0%	0%

Stock Incentive Plans

The Company currently has three primary stock incentive plans: the 1998 Stock Incentive Plan (the “1998 Plan”), the 1999 Stock Incentive Plan (the “1999 Plan”) and the Sirocco 1998 Stock Option Plan (the “Sirocco 1998 Plan”). A total of 145,554,894 shares of common stock have been reserved for issuance under these plans. The 1999 Plan is the only one of the three primary plans under which new awards are currently being issued. The total amount of shares that may be issued under the 1999 Plan is the remaining shares to be issued under the 1998 Plan, plus 25,000,000 shares, plus an annual increase equal to the lesser of (i) 18,000,000 shares, (ii) 5% of the outstanding shares on August 1 of each year, or (iii) a lesser number as determined by the Board. The plans provide for the grant of incentive stock options, nonstatutory stock options, restricted stock awards and other stock-based awards to officers, employees, directors, consultants and advisors of the Company. No participant may receive any award, or combination of awards, for more than 1,500,000 shares in any calendar year. Options may be granted at an exercise price less than, equal to or greater than the fair market value on the date of grant. The Board determines the term of each option, the option exercise price, and the vesting terms. Stock options generally expire ten years from the date of grant and vest over three to five years.

All employees who have been granted options by the Company under the 1998 and 1999 Plans are eligible to elect immediate exercise of all such options. However, shares obtained by employees who elect to exercise prior to the original option vesting schedule are subject to the Company’s right of repurchase, at the option exercise price, in the event of termination. The Company’s repurchase rights lapse at the same rate as the shares would have become vested under the original vesting schedule. As of January 28, 2006, there were no shares related to immediate option exercises subject to repurchase by the Company through fiscal 2006.

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Stock option activity under all of the Company’s stock plans since July 31, 2004 is summarized as follows:

	Number of Shares			Weighted Average Exercise Price
Outstanding at July 31, 2004		30,846,472		$	6.95
Options granted		1,626,500			3.77
Options exercised		(1,595,084	)		2.65
Options canceled		(4,192,193	)		7.15
Outstanding at July 31, 2005		26,685,695		$	6.98
Options granted		453,250			4.13
Options exercised		(2,182,414	)		3.34
Options canceled		(2,596,906	)		10.28
Outstanding at January 28, 2006		22,359,625		$	6.89
Options exercisable at end of period		22,359,625		$	6.89
Weighted average fair value of options granted	$	2.60

The following table summarizes information about stock options outstanding at January 28, 2006:

	Options Outstanding				Vested Options
Range of Exercise Prices	Number of Shares Outstanding	Weighted Average Remaining Contract Life	Weighted Average Exercise Price		Number Exercisable	Weighted Average Exercise Price
$ 0.11 - $ 3.33	3,576,232	5.3	$	2.43	2,943,107	$	2.36
$ 3.34 - $ 3.77	7,906,363	7.2	$	3.56	6,042,813	$	3.51
$ 3.79 - $ 4.81	2,639,383	7.4	$	4.09	1,420,643	$	4.19
$ 4.89 - $ 4.89	4,570,774	5.9	$	4.89	4,570,774	$	4.89
$ 4.91 - $154.00	3,666,873	4.6	$	22.95	3,617,573	$	23.17
$ 0.11 - $154.00	22,359,625	6.2	$	6.89	18,594,910	$	7.54

The aggregate intrinsic value of outstanding options as of January 28, 2006 was $21.3 million, of which $16.7 million were vested. The intrinsic value of options exercised during the three and six months ended January 28, 2006 were $1.5 million and $1.8 million, respectively.

The following table summarizes the status of the Company’s nonvested shares since July 31, 2005:

	Number of Shares		Weighted Average Fair Value
Nonvested at July 31, 2005	5,056,157		$	2.58
Granted	453,250			2.60
Vested	(1,481,922	)		3.03
Forfeited	(262,770	)		2.31
Nonvested at January 28, 2006	3,764,715		$	2.42

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As of January 28, 2006, there was $6.3 million of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Company’s stock plans. That cost is expected to be recognized over a weighted-average period of 1.1 years.

4. Net Income (Loss) Per Share

Basic net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted-average number of common shares outstanding during the period less unvested restricted stock. Diluted net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted-average number of common and common equivalent shares outstanding during the period, if dilutive. The dilutive effect of outstanding options and restricted stock is reflected in diluted earnings per share by application of the treasury stock method, which includes consideration of stock-based compensation required under SFAS 123R.

The following table sets forth the computation of basic and diluted net income (loss) per share

(in thousands, except per share data):

	Three Months Ended					Six Months Ended
	January 28, 2006		January 29, 2005			January 28, 2006		January 29, 2005
Numerator:
Net income (loss)	$	5,006	$	(5,382	)	$	11,860	$	(13,245	)
Denominator: Weighted-average shares of common stock outstanding		277,435		275,037			276,854		274,593
Weighted-average shares subject to repurchase		—		(74	)		—		(96	)
Shares used in per-share calculation – basic		277,435		274,963			276,854		274,497
Weighted-average shares of common stock outstanding		277,435		274,963			276,854		274,497
Weighted common stock equivalents		3,601		—			3,230		—
Shares used in per-share calculation – diluted		281,036		274,963			280,084		274,497
Net income (loss) per share:
Basic	$	0.02	$	(0.02	)	$	0.04	$	(0.05	)
Diluted	$	0.02	$	(0.02	)	$	0.04	$	(0.05	)

Options to purchase 10.8 million and 13.3 million shares of common stock were not included in the calculation of diluted net income per share for the three and six months ended January 28, 2006 because the sum of the option exercise proceeds, including the unrecognized compensation and unrecognized future tax benefit, exceeded the average stock price and therefore would be antidilutive.

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5. Cash Equivalents and Investments

Cash equivalents are short-term, highly liquid investments with original maturity dates of three months or less at the date of acquisition. Cash equivalents are carried at cost plus accrued interest, which approximates fair market value. The Company’s investments are classified as available-for-sale and are recorded at fair value with any unrealized gain or loss recorded as an element of stockholders’ equity. The fair value of investments is determined based on quoted market prices at the reporting date for those instruments. As of January 28, 2006 and July 31, 2005, investments consisted of (in thousands):

January 28, 2006:	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Market Value
Government securities	$	268,059	$	1	$	(837	)	$	267,223
Commercial paper		7,318		2		—			7,320
Total	$	275,377	$	3	$	(837	)	$	274,543
July 31, 2005:	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Market Value
Government securities	$	428,339	$	—	$	(2,374	)	$	425,965
Commercial paper		20,821		—		(32	)		20,789
Total	$	449,160	$	—	$	(2,406	)	$	446,754

6. Inventories

Inventories consisted of the following (in thousands):

	January 28, 2006		July 31, 2005
Raw materials	$	752	$	889
Work in process		1,243		1,221
Finished goods		2,105		3,335
Total	$	4,100	$	5,445

7. Comprehensive Income (Loss)

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

	Three Months Ended					Six Months Ended
	January 28, 2006		January 29, 2005			January 28, 2006		January 29, 2005
Net income (loss)	$	5,006	$	(5,382	)	$	11,860	$	(13,245	)
Unrealized gain (loss) on investments, net of taxes of $19 and $39 for the three and six months ended January 28, 2006		870		(1,269	)		1,508		(459	)
Comprehensive income (loss)	$	5,876	$	(6,651	)	$	13,368	$	(13,704	)

8. Restructuring Charges and Related Asset Impairments

In fiscal 2001, the telecommunications industry began a severe decline which had a significant impact on our business. In response to the telecommunications industry downturn and to reposition the Company to changing market requirements, the Company enacted four 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”), the third in the fourth quarter of fiscal 2002 (the “fourth quarter fiscal 2002 restructuring”), and the fourth in the third quarter of fiscal 2005 (the “third quarter fiscal 2005 restructuring”). 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

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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. During the fourth quarter of fiscal 2004, the Company recorded a net charge of $0.3 million to operating expense resulting from changes in estimates relating to its restructuring programs. During fiscal 2005, due to changes in estimates relating to its restructuring programs, the Company recorded a net charge of $0.4 million to operating expense. 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.

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.

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. The first quarter fiscal 2002 restructuring program was substantially completed during the fourth quarter of fiscal 2002.

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.

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Third Quarter Fiscal 2005 Restructuring:

During the third quarter of fiscal 2005, the Company enacted a fourth restructuring plan and reduced its workforce by approximately 20 employees due to a rationalization of certain R&D initiatives. The Company recorded a restructuring charge of $0.7 million that was comprised of expenses related to the workforce reduction and contract termination costs. As a result of the third quarter fiscal 2005 restructuring, the Company wrote down $0.2 million of certain development assets to their fair value based on the expected discounted cash flows they would generate over their remaining economic life. Due to the short remaining economic life and current market conditions for such assets, the fair value of these assets was estimated to be zero. The third quarter fiscal 2005 restructuring program was substantially completed during the first quarter of fiscal 2006.

As of January 28, 2006, the future restructuring cash payments for the fiscal 2001, the first quarter fiscal 2002, the fourth quarter fiscal 2002 and the third quarter fiscal 2005 restructuring programs of $6.9 million consist primarily of facility consolidation charges that will be paid over the respective lease terms through fiscal 2007 and potential legal matters.

The restructuring charges and related asset impairments recorded in the fiscal 2001, the first quarter fiscal 2002, the fourth quarter fiscal 2002 and the third quarter fiscal 2005 restructuring programs, 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, 2005		Payments		Accrual Balance at January 28, 2006
Workforce reduction	$	20,438	$	1,816	$	16,850	$	1,739	$	33	$	8	$	25
Facility consolidations and certain other costs		62,028		9,795		37,842		5,969		8,422		1,522		6,900
Inventory and asset write-downs		315,373		210,149		94,420		10,804		—		—		—
Losses on investments		24,845		24,845		—		—		—		—		—
Total	$	422,684	$	246,605	$	149,112	$	18,512	$	8,455	$	1,530	$	6,925

9. Recent Accounting Pronouncements

In June 2005, the FASB issued FSP No. FAS 143-1, Accounting for Electronic Equipment Waste Obligations (“FSP143-1”). FSP 143-1 provides guidance in accounting for obligations associated with Directive 2002/96/EC (the “Directive”) on Waste Electrical and Electronic Equipment adopted by the European Union. FSP 143-1 is required to be applied to the later of the first reporting period ending after June 6, 2005 or the date of the Directive’s adoption into law by the applicable EU member countries in which we have significant operations. The Directive distinguished between “new” and “historical” waste. New waste relates to products put on the market after August 13, 2005. FSP 143-1 directs commercial users to apply the provisions of FASB Statement No. 143, Accounting for Asset Retirement Obligations, and the related FASB interpretation No. 47, Accounting for Conditional Asset Retirement Obligations, for the measurement and recognition of the liability and asset retirement obligation associated with the historical waste management requirements of the Directive. Additionally, FSP 143-1 provides guidance for the accounting by producers for financial obligations of historical waste held by private households.

We adopted FAS 143-1 in the first quarter of fiscal 2006 and concluded that no significant liability had been incurred as of January 2, 2006. We are continuing to analyze the impact of the Directive and FSP 143-1, on our financial position and results of operations as additional EU member countries adopt the Directive.

Separate from the requirements of FSP 143-1, we believe that the internal cost of compliance with the Directive, and the liability associated with new waste obligations, which according to the Directive is to be borne solely by the producers of the new equipment, was not significant for the quarter and six months ended January 28, 2006, but could be significant in the future.

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10. 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 claims against the Company, several of the Individual Defendants and the underwriters for violations under Sections 11 and 15 of the Securities Act of 1933, as amended (the “Securities Act”), primarily based on the assertion that the Company’s lead underwriters, the Company and several of the Individual Defendants made material false and misleading statements in the Company’s Registration Statements and Prospectuses filed with the Securities and Exchange Commission, or 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. 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 of 1934, as amended (the “Exchange Act”), primarily based on the assertion that the Company’s lead underwriters, the Company and the Individual Defendants defrauded investors by participating in a fraudulent scheme and by making materially false and misleading statements and omissions of material fact during the period in question. 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. 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 sixteen 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 broader discovery obligations and expenses in the litigation than non-test case issuer defendants.

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. This dismissal disposed of the Section 15 and Section 20(a) claims without prejudice, because these claims were asserted only against the Individual Defendants. On October 13, 2004, the court denied the certification of a class in the action against the Company with respect to the Section 11 claims alleging that the defendants made material false and misleading statements in the Company’s Registration Statement and Prospectuses. The certification was denied because no class representative purchased shares between the date of the IPO and January 19, 2000 (the date unregistered shares entered the market), and thereafter suffered a loss on the sale of those shares. The court certified a class in the action against the Company with respect to the Section 10(b) claims alleging that the Company and the Individual Defendants defrauded investors by participating in a fraudulent scheme and by making materially false and misleading statements and omissions of material fact during the period in question.

The Company, the Individual Defendants, the plaintiff class and the vast majority of the other approximately three hundred issuer defendants and the individual defendants currently or formerly associated with those companies approved a settlement and related agreements (the “Settlement Agreement”) which set forth the terms of a settlement between these parties. Among other provisions, the Settlement Agreement provides for a release of the Company and the Individual Defendants for the conduct alleged in the action to be wrongful and for the Company to undertake certain responsibilities, including agreeing to assign away, not assert, or release, certain potential claims the Company may have against its underwriters. In addition, no payments will be required by the issuer defendants under the Settlement Agreement to the extent plaintiffs recover at least $1 billion from the underwriter defendants,

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who are not parties to the Settlement Agreement and have filed a memorandum of law in opposition to the approval of the Settlement Agreement. To the extent that plaintiffs recover less than $1 billion from the underwriter defendants, the approximately three-hundred issuer defendants are required to make up the difference. It is anticipated that any potential financial obligation of the Company to plaintiffs pursuant to the terms of the Settlement Agreement will be covered by existing insurance. The Company currently is not aware of any material limitations on the expected recovery of any potential financial obligation to the plaintiffs from the Company’s insurance carriers. The Company’s insurance carriers are solvent, and the Company is not aware of any uncertainties as to the legal sufficiency of an insurance claim with respect to any recovery by the plaintiffs. Therefore, we do not expect that the Settlement Agreement will involve any payment by the Company. If material limitations on the expected recovery of any potential financial obligation to the plaintiffs from the Company’s insurance carriers should arise, the Company’s maximum financial obligation to plaintiffs pursuant to the Settlement Agreement would be less than $3.4 million. On February 15, 2005, the Court granted preliminary approval of the settlement agreement, subject to certain modifications consistent with its opinion. Those modifications have been made. There is no assurance that the court will grant final approval to the settlement. If the Settlement Agreement is not approved and the Company is found liable, we are unable to estimate or predict the potential damages that might be awarded, whether such damages would be greater than the Company’s insurance coverage, and whether such damages would have a material impact on our results of operations or financial condition in any future period.

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 mostly without merit and has been defending against the complaint vigorously. The parties are currently engaged in ongoing discovery activities.

In January 2006, we entered into an Agreement of Settlement and Release to resolve a 2003 lawsuit that had been filed by a former component supplier against a company that we acquired. Under the terms of the agreement, the Company paid the supplier $1.0 million and the parties filed a stipulation of dismissal with prejudice in the underlying lawsuit. In the second quarter of fiscal 2006 we recorded $0.8 million as an operating expense with the remaining being charged to our existing reserve for contingencies.

The Company is subject to legal proceedings, claims, and litigation arising in the ordinary course of business. On a quarterly basis, the Company reviews its commitments and contingencies to reflect the effect of ongoing negotiations, settlements, rulings, advice of counsel, and other information and events pertaining to a particular case. We are also subject to potential tax liabilities associated with ongoing tax audits by various tax authorities. As a result, the Company has accrued $10.0 million as of January 28, 2006, associated with contingencies related to claims, litigation and other disputes and tax matters. While we believe the amounts accrued are adequate, any subsequent change in our estimates will be recorded at such time the change is probable and estimable.

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. As of January 28, 2006, the Company’s guarantees requiring disclosure consist of its accrued warranty obligations, indemnifications for intellectual property infringement claims and indemnifications for officers and directors.

In the normal course of business, the Company may 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

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indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. Historically, payments made by the Company under these agreements have not had a material impact on the Company’s operating results or financial position. Accordingly, the Company has not recorded a liability for these agreements as the Company believes the fair value is not material.

The Company has agreed to indemnify its officers and directors for certain events or occurrences arising as a result of the officer or director serving in such capacity. These agreements may limit the time within which an indemnification claim can be made. It is not possible to determine the maximum potential amount that may be paid under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular claim. The Company has incurred expenses under these agreements of $0.4 million and $0.2 million for the three month periods ended October 29, 2005 and January 28, 2006 respectively, on behalf of eligible persons for legal fees incurred by them in connection with the independent investigation conducted by the Audit Committee of the Board of Directors, the resulting restatement of previously issued financial statements and the subsequent review by the SEC of information and documentation related thereto. Due to the unique facts and circumstances involved in each particular situation, the Company has not recorded a liability for these agreements. The Company maintains insurance policies whereby certain payments made under the indemnification agreements may be recoverable subject to the terms and conditions provided in such policies.

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 date of shipment. 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 (in thousands):

	Three Months Ended						Six Months Ended
	January 28, 2006			January 29, 2005			January 28, 2006			January 29, 2005
Beginning balance	$	1,482		$	1,978		$	1,654		$	2,017
Accruals for warranties during the period		303			224			711			443
Settlements		(101	)		(278	)		(110	)		(523	)
Adjustments related to preexisting warranties		(286	)		162			(857	)		149
Ending balance	$	1,398		$	2,086		$	1,398		$	2,086

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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 SEC. We disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future results or otherwise. Forward-looking statements include statements regarding our expectations, beliefs, intentions or strategies regarding the future and can be identified by forward-looking words such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “should,” “will,” and “would” or similar words.

Executive Summary

Sycamore develops and markets optical networking products for telecommunications service providers worldwide. Sycamore also offers services such as installation, maintenance, technical assistance, and customer training. Our current and prospective customers include domestic and international wireline and wireless network service providers and government entities with private fiber networks (collectively referred to as “service providers”). Our optical networking product portfolio includes fully integrated edge-to-core optical switching products, network management products and design and planning tools. We believe that our products enable network operators to efficiently and cost-effectively provision and manage optical network capacity to support a wide range of voice, video and data services.

Our business has been significantly impacted by the decline in the telecommunications industry which began in 2001 and continued for several years. As a result of this decline, service providers decreased their capital spending, resulting in a reduction in demand for our products. In response to these adverse market conditions and to reposition the Company to changing market requirements, we enacted four separate restructuring programs to reduce our cost structure and focus our business on the optical switching market. As part of our strategy, however, we continue to maintain a significant cost structure, relative to our revenue, particularly within the research and development organization. We believe that these investments have enabled us to advance our technology and secure new business.

Revenue for the second quarter of fiscal 2006 increased 40% to $20.8 million year over year and revenue for the six months ended January 28, 2006 increased 65% to $48.1 million year over year. Net income was $5.0 million and $11.9 million for the three and six months ended January 28, 2006 compared to net losses of $5.4 million and $13.2 million for the same periods ended January 29, 2005 and we have incurred a cumulative net loss of $826.7 million as of January 28, 2006. Although revenue and net income have improved, our customer base is highly concentrated and as a result, our revenue and results of operations may vary significantly from quarter to quarter.

Although we face challenges as a vendor focused exclusively on optical switching, we have made progress in improving our operating performance and securing new business in a difficult market environment. As we remain focused on improvements in the performance of our stand-alone optical switching business, our management and Board will continue to consider other strategic options that may serve to maximize shareholder value. These options include, but are not limited to (i) acquisitions of, or mergers or other combinations with, companies with either complementary technologies or in adjacent market segments, (ii) alliances with or a sale to another entity, and (iii) recapitalization alternatives, including stock buybacks, cash distributions or cash dividends.

Our total cash, cash equivalents and investments were $965.8 million at January 28, 2006. Included in this amount were cash and cash equivalents of $691.2 million. We intend to fund our operations, including fixed commitments under operating leases, and any required capital expenditures using our existing cash, cash equivalents and investments. We believe that, based on our business plans and current conditions, our existing cash, cash equivalents and investments will be sufficient to satisfy our anticipated cash requirements for the next twelve months. We also believe that our current cash, cash equivalents and investments will enable us to pursue the strategic and financial alternatives discussed above.

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Critical Accounting Policies and Estimates

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

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

Revenue Recognition

Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable and collectibility is reasonably assured. The most significant revenue recognition judgments typically involve customer acceptance, whether collection is reasonably assured and multiple element arrangements. In instances where customer acceptance is specified, revenue is deferred until all acceptance criteria have been met. We determine collectibility based on the creditworthiness of customer and customer’s payment history. Service revenue is recognized as the services are performed or ratably over the service period. Some of our transactions involve the sale of products and services under multiple element arrangements. While each individual transaction varies according to the terms of the purchase order or sales agreement, a typical multiple element arrangement may include some or all of the following components: product shipments, installation services, maintenance and training. The total sales price is allocated based on the relative fair value of each component, which generally is the price charged for each component when sold separately and recognized when revenue recognition criteria for each element is met.

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. 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.

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Restructuring Liabilities and Asset Impairments

We enacted several restructuring programs during the last four years in response to the decline in the telecommunications industry which began in 2001 and continued for several years. 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. As of January 28, 2006, we had $6.9 million in accrued restructuring costs, consisting primarily of facility consolidation charges that will be paid over the respective lease terms through 2007.

Reserve for Contingencies

We are subject to various claims, litigation and other disputes, as well as potential liabilities associated with various tax matters. Periodically, we review the status of each significant matter and assess our potential financial exposure. If the potential loss from any claim or legal proceeding is considered probable and the amount can be estimated, we accrue a liability for the estimated loss. Because of uncertainties related to these matters, accruals, if any, are based only on the most current and dependable information available at any given time. As additional information becomes available, we may reassess the potential liability from pending claims and litigation and the probability of claims being successfully asserted against us. As a result, we may revise our estimates related to these pending claims, litigation and other disputes and potential liabilities associated with various tax matters. Such revisions in the estimates of the potential liabilities could have a material impact on our consolidated results of operations, financial position and cash flows in the future. For further detail, see note 10 to our consolidated financial statements.

Stock-Based Compensation Expense

As of August 1, 2005, we account for employee stock-based compensation costs in accordance with Statement of Financial Accounting Standards No. 123R, “Share-Based Payment” (“SFAS 123R”). We utilize the Black-Scholes option pricing model to estimate the fair value of employee stock based compensation at the date of grant, which requires the input of highly subjective assumptions, including expected volatility and expected life. Further, as required under SFAS 123R, we now estimate forfeitures for options granted, which are not expected to vest. Changes in these inputs and assumptions can materially affect the measure of estimated fair value of our share-based compensation.

Segment Information

The Company has determined that it conducts its operations in one business segment.

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Results of Operations

Revenue

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

	Three Months Ended								Six Months Ended
	January 28, 2006		January 29, 2005		Variance in Dollars		Variance in Percent		January 28, 2006		January 29, 2005		Variance in Dollars		Variance in Percent
Revenue
Product	$	15,128	$	11,225	$	3,903	34.8	%	$	37,161	$	22,164	$	14,997	67.7	%
Service		5,707		3,667		2,040	55.6	%		10,972		6,943		4,029	58.0	%
Total revenue	$	20,835	$	14,892	$	5,943	39.9	%	$	48,133	$	29,107	$	19,026	65.4	%

Total revenue increased for the three and six months ended January 28, 2006 compared to the same periods ended January 29, 2005. Product revenue consists primarily of sales of our optical networking products including the SN16000 and SN3000 optical switches. Product revenue increased for the three months ended January 28, 2006 compared to the same period ended January 29, 2005, primarily due to existing customers increasing the capacity of their networks. Product revenue increased for the six months ended January 28, 2006 compared to the same period ended January 29, 2005, primarily due to a significant shipment in the first quarter of fiscal 2006 that constituted the initial phase of a deployment and existing customers increasing the capacity of their networks. Service revenue consists primarily of fees for services relating to the maintenance of our products, installation services and training. Service revenue increased for the three and six months ended January 28, 2006 compared to the same periods ended January 29, 2005. The increases for both periods were primarily due to a higher level of installation services associated with customer deployments and to a lesser degree a higher base of maintenance.

For the second quarter of fiscal 2006, we had four customers who contributed 10% or more of our total revenue. International revenue represented 67% of our total revenue for the second quarter of fiscal 2006. We expect future revenue will continue to be highly concentrated in a relatively small number of customers and that international revenue will continue to represent a significant percentage of future revenue. Customer deployments in any given quarter may cause shifts in the percentage mix of domestic and international revenue. The loss of any one of these customers or any substantial reduction in orders by any one of these customers could materially and adversely affect our business, financial condition and results of operations.

Gross profit

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

	Three Months Ended						Six Months Ended
	January 28, 2006			January 29, 2005			January 28, 2006			January 29, 2005
Gross profit:
Product	$	6,846		$	4,623		$	18,259		$	8,874
Service		3,260			1,789			5,881			3,089
Total	$	10,106		$	6,412		$	24,140		$	11,963
Gross profit:
Product		45.3	%		41.2	%		49.1	%		40.0	%
Service		57.1	%		48.8	%		53.6	%		44.5	%
Total		48.5	%		43.1	%		50.2	%		41.1	%

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Product gross profit

Cost of product revenue consists primarily of amounts paid to third-party contract manufacturers for purchased materials and services and other fixed manufacturing costs. Product gross profit increased for the three and six months ended January 28, 2006 compared to the same periods ended January 29, 2005. The increase was primarily the result of a favorable product and customer mix and higher revenue. In the future, we believe that product gross profit may fluctuate due to pricing pressures resulting from intense competition for limited optical switching opportunities worldwide. In addition, product gross profit may be affected by changes in the mix of products sold, channels of distribution, shipment volume, overhead absorption, sales discounts, increases in labor costs, excess inventory and obsolescence charges, increases in component pricing or other material costs, the introduction of new products or the entry into new markets with different pricing and cost structures.

Service gross profit

Cost of service revenue consists primarily of costs of providing services under customer service contracts which include salaries and related expenses and other fixed costs. Service gross profit increased for the three and six months ended January 28, 2006 compared to the same period ended January 29, 2005. The increase was primarily due to increased installation services and maintenance revenues. As most of our service cost of revenue is fixed, increases or decreases in revenue will have a significant impact on service gross profit. Service gross profit may be affected in future periods by various factors including, but not limited to, the change in mix between technical support services and advanced services, as well as the timing of technical support service contract initiations and renewals.

Operating Expenses

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

	Three Months Ended									Six Months Ended
	January 28, 2006		January 29, 2005		Variance in Dollars			Variance in Percent		January 28, 2006		January 29, 2005		Variance in Dollars			Variance in Percent
Research and development	$	7,377	$	11,217	$	(3,840	)	(34	)%	$	15,090	$	22,889	$	(7,799	)	(34	)%
Sales and marketing		2,401		3,011		(610	)	(20	)%		5,038		6,155		(1,117	)	(18	)%
General and administrative		2,122		1,932		190		10	%		5,020		4,180		840		20	%
Stock-based compensation:
Research and development		511		229		282		123	%		1,136		516		620		120	%
Sales and marketing		251		32		219		684	%		493		81		412		509	%
General and administrative		303		45		258		573	%		579		257		322		125	%
Litigation settlement		750		—		750		100	%		750		—		750		100	%
Total operating expenses	$	13,715	$	16,466	$	(2,751	)	(17	)%	$	28,106	$	34,078	$	(5,972	)	(18	)%

Research and Development Expenses

Research and development expenses consist primarily of salaries and related expenses and prototype costs relating to design, development, testing and enhancements of our products. Research and development expenses decreased for the three and six months ended January 28, 2006 compared to the same periods ended January 29, 2005. The decreases for both periods were primarily due to lower personnel-related expenses and lower project materials costs. We continue to focus our R&D investments on features and functionality targeted at existing and prospective customer requirements.

Sales and Marketing Expenses

Sales and marketing expenses consist primarily of salaries, commissions and related expenses, customer evaluation inventory and other sales and marketing support expenses. Sales and marketing expenses decreased for the three and

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six months ended January 28, 2006 compared to the same periods ended January 29, 2005. The decreases for both periods were primarily due to lower personnel-related expenses and lower fixed expenses. Within our existing spend levels, we continue to reallocate sales and marketing resources to those geographic regions where we see the most attractive opportunities.

General and Administrative Expenses

General and administrative expenses consist primarily of salaries and related expenses for executive, finance and administrative personnel, professional fees and other general corporate purposes. General and administrative expenses increased for the three and six months ended January 28, 2006 compared to the same period ended January 29, 2005. The increases for both periods were primarily due to increased professional and advisory fee expenses, including amounts for legal fees advanced to persons eligible to receive payments pursuant to the Company’s policies and practices of providing indemnification to officers and directors against certain liabilities occurring in connection with serving in such capacity.

Stock-Based Compensation Expense

Total stock-based compensation increased for the three and six months ended January 28, 2006 compared to the same period ended January 29, 2005. The increase was primarily due to the requirement to record stock-based compensation under SFAS 123R beginning August 1, 2005. Stock-based compensation expense for the three and six months ended January 29, 2005 was recorded in accordance with Accounting Principles Board Opinion (“APB”) No. 25.

Litigation Settlement

In January 2006, we entered into an Agreement of Settlement and Release to resolve a 2003 lawsuit that had been filed by a component supplier to a company that we acquired. Under the terms of the agreement, the Company paid the supplier $1.0 million and the parties filed a stipulation of dismissal with prejudice in the underlying lawsuit. In the second quarter of fiscal 2006 we recorded $0.8 million as an operating expense with the remaining being charged to our existing reserve for contingencies.

Interest and Other Income, Net

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

	Three Months Ended								Six Months Ended
	January 28, 2006		January 29, 2005		Variance in Dollars		Variance In Percent		January 28, 2006		January 29, 2005		Variance in Dollars		Variance In Percent
Interest and other income, net	$	8,726	$	4,672	$	4,054	87	%	$	16,156	$	8,870	$	7,286	82	%

Interest and other income, net increased for the three and six months ended January 28, 2006 compared to the same periods ended January 29, 2005. The increase was primarily due to higher interest rates.

Income Tax Expense

During the three and six months ended January 28, 2006, the U.S. taxable income was offset by U.S. net operating loss carryforwards. The provision for income taxes for the three and six months ended January 28, 2006 consists of U.S. Alternative Minimum Taxes, state minimum taxes and foreign income taxes in profitable jurisdictions. The Company did not record a deferred tax benefit from the net operating loss incurred in the three and six months ended January 29, 2005.

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As a result of incurring substantial net operating losses from 2001 through 2005, the Company determined that it is more likely than not that its deferred tax assets may not be realized. Therefore, in accordance with the requirements of FASB 109, the Company maintains a full valuation allowance. If the Company generates sustained future taxable income against which these tax attributes may be applied, some or a portion of all of the valuation allowance would be reversed. If the valuation allowance were reversed, a portion would be recorded as an increase to paid in capital and the remainder would be recorded as a reduction in income tax expense.

Liquidity and Capital Resources

Total cash, cash equivalents and investments were $965.8 million at January 28, 2006. Included in this amount were cash and cash equivalents of $691.2 million, compared to $508.3 million at July 31, 2005. The increase in cash and cash equivalents for the six months ended January 28, 2006 was attributable to cash provided by investing activities of $171.2 million, cash provided by financing activities of $7.8 million and cash provided by operating activities of $4.0 million.

Net cash provided by investing activities was $171.2 million for the six months ended January 28, 2006 and consisted of net maturities of investments partially offset by purchases of property and equipment.

Net cash generated by operating activities was $4.0 million for the six months ended January 28, 2006. Net income for the six months ended January 28, 2006 was $11.9 million and included significant non-cash charges including depreciation and amortization of $1.7 million and stock-based compensation of $2.9 million. Accounts receivable increased to $10.5 million at January 28, 2006 from $8.4 million at July 31, 2005. Days sales outstanding as of January 28, 2006 and July 31, 2005 was 46 days and 41 days, respectively. Our accounts receivable and days sales outstanding are impacted primarily by the timing of shipments, collections performance and timing of support contract renewals. Inventory levels decreased to $4.1 million at January 28, 2006 from $5.4 million at July 31, 2005. We continue to manage our inventory levels and the decrease was primarily due to the timing of receipts. Deferred revenue decreased to $6.2 million at January 28, 2006 from $10.3 million at July 31, 2005. The decrease is primarily due to a seasonally low quarter for maintenance contract renewals and the ongoing amortization of deferred maintenance revenue. Accrued expenses and other current liabilities decreased to $16.7 million at January 28, 2006 from $21.6 million at July 31, 2005. The decrease is primarily due to decreases in accrued compensation and accrued expenses.

Net cash provided by financing activities was $7.8 million for the six months ended January 28, 2006 and consisted of proceeds from employee stock plan activity.

Our primary source of liquidity comes from our cash, cash equivalents and investments, which totaled $965.8 million at January 28, 2006. 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. At January 28, 2006, $232.7 million of investments with maturities of less than one year were classified as short-term investments. Based on our current expectations, we anticipate that some portion of our existing cash and cash equivalents and investments may continue to be consumed by operations. Our accounts receivable, while not considered a primary source of liquidity, represents a concentration of credit risk because the accounts receivable balance at any point in time typically consists of a relatively small number of customer account balances. At January 28, 2006, more than 85% of our accounts receivable balance was attributable to four of our customers. As of January 28, 2006, we do not have any outstanding debt or credit facilities, and do not anticipate entering into any debt or credit agreements in the foreseeable future. Our fixed commitments for cash expenditures consist primarily of payments under operating leases and inventory purchase commitments. We do not currently have any material commitments for capital expenditures, or any other material commitments aside from operating leases for our facilities and inventory purchase commitments. We currently intend to fund our operations, including our fixed commitments under operating leases, and any required capital expenditures using our existing cash, cash equivalents and investments.

As of January 28, 2006, the future restructuring cash payments of $6.9 million consist primarily of facility consolidation charges that will be paid over the respective lease terms through fiscal 2007 and potential legal matters.

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

Commitments, Contractual Obligations and Off-Balance Sheet Arrangements

At January 28, 2006, our off-balance sheet arrangements, which consist entirely of contractual commitments for operating leases and inventory purchase commitments, were as follows (in thousands):

	Total		Less than 1 Year		1-3 Years		3-5 Years
Operating leases	$	8,158	$	6,786	$	1,372	$	—
Inventory purchase commitments		6,786		6,786		—		—
Total	$	14,944	$	13,572	$	1,372	$	—

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 has had a significant impact on our business. The industry decline and the resulting spending constraints in the optical networking market, which continued for several years, caused a decrease in the demand for our products which has had an adverse impact on our revenue and profitability.

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

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

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

• consolidation of our customers may cause delays, disruptions or reductions in their optical switching capital spending plans as well as increase their relative purchasing power in any negotiation;

• 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 limited demand and we may experience downward pressure on the pricing of our products which reduces gross margins and constrains revenue growth;

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

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

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

Consolidation in the industry may lead to increased competition and harm our business.

The telecommunications industry has experienced consolidation and we expect this trend to continue. Consolidation among our customers may cause delays or reductions in their capital expenditure plans and may cause increased competitive pricing pressures as the number of available customers declines and their relative purchasing power increases in relation to suppliers. Consolidation may also result in a combined entity choosing to standardize on a certain vendors’ optical networking platform. Any of these factors could adversely affect our business.

Our strategy to pursue strategic and financial alternatives may not be successful.

We face numerous challenges as a vendor focused exclusively on the optical switching market segment of the overall optical networking market. As we remain focused on improvements in the performance of our stand-alone optical switching business, our management and Board will continue to consider other strategic options that may serve to maximize shareholder value. These options include, but are not limited to (i) acquisitions of, or mergers or other combinations with, companies with either complementary technologies or in adjacent market segments, and (ii) alliances with or a sale to another entity. Any decision regarding strategic alternatives would be subject to inherent risk, and we cannot guarantee that we will be able to identify appropriate opportunities, successfully negotiate economically beneficial terms, successfully integrate any acquired business, retain key employees or achieve the anticipated synergies or benefits of any strategic alternative which may be selected. Additionally, in connection with a strategic transaction, we may issue additional shares that could dilute the holdings of existing common stockholders, or we may utilize cash. In implementing a strategy, we may enter markets in which we have little or no prior experience and there can be no assurance that we will be successful.

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

Whether or not we pursue any specific strategic alternative, the value of your shares may decrease.

The Company continues to consider various strategic options, including, but not limited to: (i) acquisitions of, or mergers or other combinations with, companies with either complementary technologies or in adjacent market segments, (ii) alliances with or a sale to another entity, and (iii) recapitalization alternatives, including stock buybacks, cash distributions or cash dividends. We cannot predict whether, or when, such review may result in the Company entering into any transaction or transactions with respect to any specific strategic option, and we cannot assure you that we would be able to consummate any transaction or transactions or that any transaction or transactions would provide you with a positive return on your investment. Accordingly, notwithstanding such review or any outcome thereof, and whether or not we pursue any specific strategic option, the value of your shares may decrease.

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

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

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

Current economic and market conditions make 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 future revenue. Our planned expenses include significant investments, particularly within the research and development organization, which we believe is necessary to continue to provide innovative optical networking solutions to meet our current and prospective customers’ needs. 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.

In early 2001, the telecommunications industry began a severe decline which had a significant impact on our business. This decline and the resulting spending constraints in the optical networking market, which continued for several years, caused a decrease in the demand for our products which had an adverse impact on our revenue and profitability. In response to these adverse market conditions and to reposition the Company to changing market requirements, we enacted four separate restructuring programs through the third quarter of fiscal 2005, which reduced our cost structure and focused our business on our optical switching product portfolio. As a result of these restructuring programs we incurred net charges totaling $403.6 million, comprised as follows: $175.4 million of net charges related to excess inventory, $203.4 million of net charges for restructuring and related asset impairments, and $24.8 million of losses on investments. In order to remain competitive, we continue to maintain a significant cost structure relative to our revenue, particularly within the research and development organization which we believe is necessary to continue to provide innovative optical networking solutions to meet our current and prospective customers’ needs. Due to our decreased revenues, our restructuring programs and our decision to maintain a significant cost structure, we have incurred a cumulative net loss of $826.7 million at January 28, 2006. We expect that our decision to maintain a significant cost structure will require us to generate revenue above current levels in order to achieve and maintain profitability and as a result we may 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.

Service providers continue to limit their capital spending. Competition for limited optical switching opportunities is intense and continues to be dominated by large, incumbent equipment suppliers. Competition is based upon a combination of price, established customer relationships, broad product portfolios, large service and support teams, functionality and scalability. Large companies, such as Alcatel, Ciena, Cisco, Lucent, Nortel and Tellabs have historically dominated this market. Many of our competitors have longer operating histories and greater financial, technical, sales, marketing and manufacturing resources than we do and are able to devote greater resources to the research and development of new products. These competitors also have long standing existing relationships with our current and prospective customers. New competitors, such as Huawei and ZTE, 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. Moreover, these competitors have more diverse product lines which allow them the flexibility to price their products more aggressively.

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The decline in the telecommunications industry beginning in early 2001 has reduced demand for our products and resulted in intensified 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.

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

If we are unable to compete successfully against our current and future competitors, we could experience revenue 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 a limited number of service providers.

There are limited optical switching opportunities. Competition for these opportunities is intense. Our revenue is concentrated among a limited number of customers. None of our customers are contractually committed to purchase any minimum quantities of products from us and orders are generally cancelable prior to shipment. We expect that our revenue will continue to depend on sales of our products to a limited number of customers. While expanding our customer base is a key objective, at the present time, the number of prospective customer opportunities for our products is limited. In addition, we believe that the telecommunications industry will continue in a consolidation phase which may further reduce the number of prospective customers, slow purchases and delay optical switching deployment decisions.

Our direct sales efforts primarily target service providers, many of which have already made significant investments in traditional optical networking infrastructures. In addition, we are utilizing established channel relationships with distribution partners including resellers, distributors and systems integrators for the sale of our products to service providers including the federal government. We have entered into agreements with several distribution partners, some of whom 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 to which we will be successful is uncertain. If we are unable to develop and manage new channels of distribution to sell our products to service providers, or if our distribution partners are unable to convince service providers to deploy our optical networking solutions, our business, financial condition and results of operations will be materially adversely affected.

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We may not continue to be successful in selling our products through established channels to the federal government.

We have a reseller agreement for the sale of our products to the federal government and our products were selected to serve as the Optical Digital Cross Connect platform for DISA’s GIG-BE project. Sales to the federal government require compliance with ongoing complex procurement rules and regulations with which we have limited experience. We will not be able to succeed in the federal government market and sell our products to federal government contractors if we cannot comply with these rules and regulations. The federal government is not contractually committed to purchase our products for the GIG-BE project, and there can be no assurance that it will purchase our products in the future. Our failure to sell products to the federal government, including for use in the GIG-BE project, could adversely affect our ability to achieve our planned levels of revenue, which would affect our profitability and results of operations.

We depend on a government agency, through our reseller, for a significant amount of our revenue and the loss or decline of existing or future government agency funding could adversely affect our revenue and cash flows.

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

Certain larger customers may have substantial negotiating leverage, which may require that we agree to terms and conditions that may have an adverse effect on our business.

Large telecommunications providers, key resellers and the federal government, who make up a large part of our target market, have substantial purchasing power and potential leverage in negotiating contractual arrangements with us. These customers and prospects may require us to develop additional features and require penalties for failure to deliver such features. As we seek to increase sales into our target markets, we may be required to agree to such terms and conditions, which may affect the timing of revenue recognition and amount of deferred revenues and may have other unfavorable effects on our business and financial condition.

Any acquisitions or strategic investments we make could disrupt our business and seriously harm our financial condition.

As part of our 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 capital expenditures;

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

• incur amortization expenses related to certain intangible assets;

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• 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;

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

• additional regulatory compliance issues.

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, but not limited to:

• fluctuation in demand for our products;

• the timing and amount of sales of our products;

• 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 revenue recognition 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;

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

• changes in accounting rules, such as the 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, optical networking and related industries.

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We believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance. You should not rely on our results for one quarter as any indication of our future performance. The factors discussed above are extremely difficult to predict and impact our revenue and operating results. In addition, our ability to forecast our future business has been significantly impaired by the ongoing difficult 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.

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

We utilize contract manufacturers and any disruption in these relationships may cause us to fail to meet our customers’ demands and may damage our customer relationships.

We have limited internal manufacturing capabilities. We outsource the manufacturing of our products to contract manufacturers who manufacture our products in accordance with our specifications and fill orders on a timely basis. We may not be able to manage our relationships with our contract manufacturers effectively, and our contract manufacturers may not meet our future requirements for timely delivery. Our contract manufacturers also build products for other companies, and we cannot be assured that they will have sufficient quantities of inventory available to fill our customer orders or that they will allocate their internal resources or capacity to fill our orders on a timely basis. Unforecasted customer demand may increase the cost to build our products due to fees charged to expedite production and other related charges.

The contract manufacturing industry is a highly competitive, capital-intensive business with relatively low profit margins, and 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 and our contract manufacturers 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 and our contract manufacturers 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 including, but not limited to, production disruptions, low yield or discontinuance of manufacture, we may not be able to develop an alternate source in a timely manner or on acceptable terms. Any such failure could impair our ability to deliver products to customers, which would adversely affect our revenue and operating results.

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

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

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

Product performance problems could limit our sales.

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

• 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.

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

Environmental costs could harm our operating results.

We may be subject to various state, federal and international laws and regulations governing the environment, including those restricting the presence of certain substances in electronic products and making producers of those products financially responsible for the collection, treatment, recycling and disposal of certain products. Such laws and regulations have been passed in several jurisdictions in which we operate, including various European Union member countries. For example, the European Union has enacted the Restriction of the Use of Certain Hazardous Substances in Electrical and Electronic Equipment Directive 2002/95/EC (“RoHS”). RoHS prohibits the use of certain substances, including lead, in certain products, including hard disk drives, put on the market after July 1, 2006. Similar legislation may be enacted in other locations where we sell our products. The European Union has also enacted the Waste Electrical and Electronic Equipment Directive 2002/96/EC, which makes producers responsible for financing the collection, treatment, recovery and disposal of specified equipment placed in the relevant market after August 13, 2005. We will need to ensure that we comply with such laws and regulations as they are enacted, and that our component suppliers also comply on a timely basis with such laws and regulations. If

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alternative components are not readily available or commercially feasible we may be forced to discontinue selling certain products. If we are not in compliance with such legislation, our customers may refuse to purchase our products, which would have a materially adverse effect on our business, financial condition and results of operations.

We could incur substantial costs in connection with our compliance with such environmental laws and regulations, and we could also be subject to governmental fines and liability to our customers if we were found to be in violation of these laws. If we have to make significant capital expenditures to comply with environmental laws, or if we are subject to significant expenses in connection with a violation of these laws, our financial condition or operating results could suffer.

Our business is subject to risks from international operations.

International sales represented 67% of total revenue for the second quarter of fiscal 2006 and we have a substantial international customer base. We are subject to foreign exchange translation risk to the extent that our revenue is denominated in currencies other than the U.S. dollar. Doing business internationally requires significant management attention and financial resources to successfully develop direct and indirect sales channels and to support customers in international markets. We may not be able to maintain or expand international market demand for our products.

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

• 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 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 may impact the timing of 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;

• obtaining export licensing authority on a timely basis and maintaining ongoing compliance with export and reexport regulations;

• 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.

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If we lose key personnel or are unable to hire additional qualified personnel, our business may 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, many of whom would be difficult to replace. None of our officers or key employees is bound by an employment agreement for any specific term. We do not have “key person” life insurance policies covering any of our employees.

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

We face certain litigation risks.

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

The findings of the independent investigation and the resulting restatements of previously issued financial statements may result in shareholder litigation and formal inquiries or other actions by government agencies.

The independent investigation conducted under the direction of the Audit Committee of our Board of Directors has been completed and the necessary adjustments have been made in our restatements. It is possible that the restatements could result in the occurrence of certain events, including shareholder litigation or formal inquiries or other actions by government agencies. Such litigation or inquiries could result in considerable legal expenses, could require the utilization of significant time and resources and could adversely affect our business and the results of operations and financial condition, including the price of our common stock. The Securities and Exchange Commission has requested that the Company voluntarily provide certain information, including documentation gathered or created during the independent investigation, and the Company has agreed to provide such information and documentation. There can be no assurances as to what, if any, further action may be taken with respect to this matter by the Securities and Exchange Commission or other government agencies or what effect such actions may have on the Company.

We have made a voluntary self-disclosure to the Department of Commerce regarding certain products we have exported without the proper export authority. There can be no assurances as to what sanctions, if any, may be imposed by the Department of Commerce with respect to this matter.

If we do not maintain our compliance with the requirements of the Nasdaq National Market, our common stock may be delisted from the Nasdaq National Market and transferred to the National Quotation Service Bureau, or “Pink Sheets”, which may, among other things, reduce the price of our common stock and the levels of liquidity available to our stockholders.

On June 7, 2005 the Company announced an independent investigation being conducted under the direction of the Audit Committee of its Board of Directors. The investigation findings related to certain stock options granted during the calendar years 1999 to 2001 that were erroneously accounted for under GAAP. On June 10, 2005, we filed a Form 12b-25 stating that we would not be able to file our Form 10-Q on a timely basis for the quarter ended April 30, 2005. On June 16, 2005, we received notice from Nasdaq stating that we were not in compliance with Nasdaq’s Marketplace Rule 4310(c)(14), and thus our securities were subject to delisting because we had not yet filed our Report on Form 10-Q for the quarter ended April 30, 2005. We appealed this determination, and requested a hearing with a Nasdaq Listings Qualifications Panel (“Panel”). On August 12, 2005, the Company was notified that the Panel had granted the Company’s request for continued listing of the Company’s securities on The Nasdaq National

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Market subject to the Company filing its Form 10-Q for the period ended April 30, 2005 with the Securities and Exchange Commission on or before September 23, 2005. On September 19, 2005 we filed our Report of Form 10-Q for the period ended April 30, 2005. On September 21, 2005, the Nasdaq notified us that we were in compliance with all Nasdaq’s Marketplace Rules.

If we do not maintain compliance with all requirements for continued listing on Nasdaq, then our securities may be delisted from Nasdaq. If our securities are delisted from Nasdaq, they would subsequently trade on the Pink Sheets. The trading of our common stock on the Pink Sheets may reduce the price of the Company’s common stock and the levels of liquidity available to its stockholders. In addition, the trading of the Company’s common stock on the Pink Sheets will materially adversely affect its access to the capital markets, and the limited liquidity and potentially reduced price of its common stock could materially adversely affect its ability to raise capital through alternative financing sources on terms acceptable to the Company or at all. Stocks that trade on the Pink Sheets are no longer eligible for margin loans, and a company trading on the Pink Sheets cannot avail itself of federal preemption of state securities or “blue sky” laws, which adds substantial compliance costs to securities issuances, including pursuant to employee option plans, stock purchase plans and private or public offerings of securities. If the Company is delisted in the future from the Nasdaq National Market and transferred to the Pink Sheets, there may also be other negative implications, including the potential loss of confidence by suppliers, customers and employees and the loss of institutional investor interest in our company.

If we are not current in our SEC filings, we will face several adverse consequences.

If the Company is unable to remain current in its SEC filings, investors in its securities will not have information regarding the Company’s business and financial condition with which to make decisions regarding investment in its securities. In addition, if we are unable to remain current in our filings, the Company will not be able to have a registration statement under the Securities Act of 1933, covering a public offering of securities, declared effective by the SEC, and will not be able to make offerings pursuant to existing registration statements pursuant to certain “private placement” rules of the SEC under Regulation D to any purchasers not qualifying as “accredited investors.” As a result of our inability to timely file our Quarterly Report on Form 10-Q for the quarter ended April 30, 2005, the Company also will not be eligible to use a “short form” registration statement on Form S-3 for a period of 12 months from the time we became current in our filings. These restrictions could adversely affect our financial condition or our ability to pursue specific strategic alternatives.

Recently enacted and proposed changes in securities laws and regulations will increase our costs.

The Sarbanes-Oxley Act, which became law in July 2002, and rules subsequently implemented by the SEC and the Nasdaq National Market have imposed various new requirements on public companies, including requiring changes in corporate governance practices. Our management and other personnel will need to continue to devote a substantial amount of time to these compliance initiatives. Moreover, these rules and regulations have increased our annual legal and financial compliance costs, have made some activities more time-consuming and costly, and could expose us to additional liability. In addition, these rules and regulations may make retention and recruitment of qualified persons to serve on our board of directors or executive management more difficult.

Our ability to compete and pursue strategic alternatives could be jeopardized if we are unable to protect our intellectual property rights or infringe on intellectual property rights of others.

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

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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 require 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 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.

Adverse outcomes resulting from examination of our tax returns could adversely affect our results.

We are subject to the continuous examination of our tax returns by the Internal Revenue Service and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provisions. There can be no assurances that the outcomes from these continuous examinations will not have an adverse effect on our operating results and financial condition.

Our net income and earnings per share have been significantly reduced as a result of the requirement that we record compensation expense for shares issued under our stock plans.

In the past, we have used stock options as a key component of our employee compensation packages. We believe that stock options provide an incentive to our employees to maximize long-term shareholder value and can encourage valued employees to remain with the Company. Beginning in fiscal 2006, Statement of Financial Accounting Standards No. 123(R) (“SFAS No. 123(R)”), “Share-Based Payment,” requires us to account for share-based compensation granted under our stock plans using a fair value-based model on the grant date and to record such grants as stock-based compensation expense. As a result, our net income and our earnings per share have been and will continue to be significantly reduced and may reflect a loss in future periods. We currently calculate share-based compensation expense using the Black-Scholes option-pricing model. A fair value-based model, such as the Black-Scholes option-pricing model, requires the input of highly subjective assumptions and does not necessarily provide a reliable measure of the fair value of our stock options. Assumptions used under the Black-Scholes option-pricing model that are highly subjective include the expected stock price volatility and expected life of an option.

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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:

• 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;

• fluctuations in stock market prices and volumes and;

• announcements or implementation of a stock buyback or cash distribution.

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

Significant insider ownership, provisions of our charter documents and provisions of Delaware law may limit shareholders’ ability to influence key transactions, including changes of control.

As of January 28, 2006, 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 January 28, 2006, the fair value of the portfolio would decline by approximately $0.7 million. 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 63% of total revenue in fiscal 2005, and 78% of revenue in the first six months of fiscal 2006. 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. Our management (with the participation of our Chief Executive Officer and Chief Financial Officer) evaluated the effectiveness of 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”)), as of January 28, 2006. Disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported on a timely basis and that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. 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, because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, have been or will be detected. These inherent limitations include the fact that there are resource constraints, and that the benefits of controls must be considered relative to their costs. Based on this evaluation, our principal executive officer and principal financial officer concluded that these disclosure controls and procedures are effective and designed to ensure that the information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the requisite time periods.

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 the quarter ended January 28, 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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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 claims against the Company, several of the Individual Defendants and the underwriters for violations under Sections 11 and 15 of the Securities Act of 1933, as amended (the “Securities Act”), primarily based on the assertion that the Company’s lead underwriters, the Company and several of the Individual Defendants made material false and misleading statements in the Company’s Registration Statements and Prospectuses filed with the Securities and Exchange Commission, or 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. 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 of 1934, as amended (the “Exchange Act”), primarily based on the assertion that the Company’s lead underwriters, the Company and the Individual Defendants defrauded investors by participating in a fraudulent scheme and by making materially false and misleading statements and omissions of material fact during the period in question. 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. 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 sixteen 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 broader discovery obligations and expenses in the litigation than non-test case issuer defendants.

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. This dismissal disposed of the Section 15 and Section 20(a) claims without prejudice, because these claims were asserted only against the Individual Defendants. On October 13, 2004, the court denied the certification of a class in the action against the Company with respect to the Section 11 claims alleging that the defendants made material false and misleading statements in the Company’s Registration Statement and Prospectuses. The certification was denied because no class representative purchased shares between the date of the IPO and January 19, 2000 (the date unregistered shares entered the market), and thereafter suffered a loss on the sale of those shares. The court certified a class in the action against the Company with respect to the Section 10(b) claims alleging that the Company and the Individual Defendants defrauded investors by participating in a fraudulent scheme and by making materially false and misleading statements and omissions of material fact during the period in question.

The Company, the Individual Defendants, the plaintiff class and the vast majority of the other approximately three hundred issuer defendants and the individual defendants currently or formerly associated with those companies approved a settlement and related agreements (the “Settlement Agreement”) which set forth the terms of a settlement between these parties. Among other provisions, the Settlement Agreement provides for a release of the Company and the Individual Defendants for the conduct alleged in the action to be wrongful and for the Company to undertake certain responsibilities, including agreeing to assign away, not assert, or release, certain potential claims the Company may have against its underwriters. In addition, no payments will be required by the issuer defendants under the Settlement Agreement to the extent plaintiffs recover at least $1 billion from the underwriter defendants, who are not parties to the Settlement Agreement and have filed a memorandum of law in opposition to the approval of the Settlement Agreement. To the extent that plaintiffs recover less than $1 billion from the underwriter defendants, the approximately three-hundred issuer defendants are required to make up the difference. It is

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anticipated that any potential financial obligation of the Company to plaintiffs pursuant to the terms of the Settlement Agreement will be covered by existing insurance. The Company currently is not aware of any material limitations on the expected recovery of any potential financial obligation to the plaintiffs from the Company’s insurance carriers. The Company’s insurance carriers are solvent, and the Company is not aware of any uncertainties as to the legal sufficiency of an insurance claim with respect to any recovery by the plaintiffs. Therefore, we do not expect that the Settlement Agreement will involve any payment by the Company. If material limitations on the expected recovery of any potential financial obligation to the plaintiffs from the Company’s insurance carriers should arise, the Company’s maximum financial obligation to plaintiffs pursuant to the Settlement Agreement would be less than $3.4 million. On February 15, 2005, the Court granted preliminary approval of the settlement agreement, subject to certain modifications consistent with its opinion. Those modifications have been made. There is no assurance that the court will grant final approval to the settlement. If the Settlement Agreement is not approved and the Company is found liable, we are unable to estimate or predict the potential damages that might be awarded, whether such damages would be greater than the Company’s insurance coverage, and whether such damages would have a material impact on our results of operations or financial condition in any future period.

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 mostly without merit and has been defending against the complaint vigorously. The parties are currently engaged in ongoing discovery activities.

In January 2006, we entered into an Agreement of Settlement and Release to resolve a 2003 lawsuit that had been filed by a former component supplier against a company that we acquired. Under the terms of the agreement, the Company paid the supplier $1.0 million and the parties filed a stipulation of dismissal with prejudice in the underlying lawsuit. In the second quarter of fiscal 2006 we recorded $0.8 million as an operating expense with the remaining being charged to our existing reserve for contingencies.

The Company is subject to legal proceedings, claims, and litigation arising in the ordinary course of business. On a quarterly basis, the Company reviews its commitments and contingencies to reflect the effect of ongoing negotiations, settlements, rulings, advice of counsel, and other information and events pertaining to a particular case. We are also subject to potential tax liabilities associated with ongoing tax audits by various tax authorities. As a result, the Company has accrued $10.0 million as of January 28, 2006, associated with contingencies related to claims, litigation and other disputes and tax matters. While we believe the amounts accrued are adequate, any subsequent change in our estimates will be recorded at such time the change is probable and estimable.

Item 4. Submission of Matters to a Vote of Security Holders

At the Company’s Annual Meeting held on December 19, 2005, the stockholders of the Company elected the following nominees, each to serve for a three-year term as a Class III Director and until their respective predecessors are elected and qualified:

Nominees	For	Withheld
Daniel E. Smith	256,273,498	753,536
Paul W. Chisholm	256,303,669	723,365

Gururaj Deshpande, Timothy A. Barrows, Paul J. Ferri and John W. Gerdelman also continued as directors of the Company after the Annual Meeting.

At the same Annual Meeting, the stockholders of the Company ratified the appointment of PricewaterhouseCoopers LLP as the Company’s independent registered public accounting firm for the fiscal year ending July 31, 2006 by the following vote:

For	Against	Abstention
256,458,711	511,304	57,019

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Item 6. Exhibits

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)
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.

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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/ Richard J. Gaynor

Richard J. Gaynor

Chief Financial Officer,

Vice President, Finance and Administration,

Secretary and Treasurer

(Duly Authorized Officer and Principal

Financial and Accounting Officer)

Dated: February 21, 2006

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EX-31.1

EXHIBIT 31.1 – CERTIFICATION OF CHIEF EXECUTIVE OFFICER

I, Daniel E. Smith, certify that:

1) I have reviewed this quarterly report on Form 10-Q of Sycamore Networks, Inc.;

2) Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3) Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report.

4) The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5) The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: February 21, 2006

/s/ DANIEL E. SMITH

Daniel E. Smith

President and Chief Executive Officer

EX-31.2

EXHIBIT 31.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER

I, Richard J. Gaynor, certify that:

1) I have reviewed this quarterly report on Form 10-Q of Sycamore Networks, Inc.;

2) Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3) Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report.

4) The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5) The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: February 21, 2006

/S/ RICHARD J. GAYNOR

Richard J. Gaynor

Chief Financial Officer,

Vice President, Finance and Administration,

Secretary and Treasurer

EX-32.1

EXHIBIT 32.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Sycamore Networks, Inc. (the “Company”) on Form 10-Q for the period ending January 28, 2006 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Daniel E. Smith, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:

(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company, as of, and for the periods presented in the Report.

/s/ Daniel E. Smith

Daniel E. Smith

President and Chief Executive Officer

February 21, 2006

EX-32.2

EXHIBIT 32.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Sycamore Networks, Inc. (the “Company”) on Form 10-Q for the period ending January 28, 2006 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Richard J. Gaynor, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:

(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company, as of, and for the periods presented in the Report.

/s/ Richard J. Gaynor

Richard J. Gaynor

Chief Financial Officer, Vice President,

Finance and Administration, Secretary and Treasurer

February 21, 2006